The Covid-19 outbreak led most governments to embark on an unprecedented stimulus train, both in scope and size. The US injected an estimated equivalent of 20% of GDP, EU around 15% so far. This accounts to 3 to 4x the amount printed during the financial crisis of 2008. As a reference point, in Q4 2008, the FED was buying USD 120bn of Treasuries under its QE program - in March 2020 it was buying USD 70bn per day (!).
On the fiscal side, the Modern Monetary Theory ("MMT") pandora box (which we discussed at length in this
blog( you can start here for instance, http://factualmacro.blogspot.com/2012/) has been opened. Conceptually, the objective of MMT is to guide governement to maximise the spending capacity of the private sector focusing on sectoral balance sheet and using government spending as a vector. The main beneficiaries of MMT are mainly
the less privileged part of the population (economic
agents with higher propensity to spend but also an increasing part of the
voting population). MMT is therefore a powerful tool for politicians. It answers positively to the raise in inequalities and the consequent global surge in populism. Covid crisis has essentialy made deficit spending fashionable...But this also means that
it will be very hard for politicians to remove such fiscal impulse. We are entering the uncharted water of unlimited USD supply – or at
least very deep budget deficits and its impact on the USD value vs real assets will probably be quite negative in the mid to long term (I will discuss this in the next article).
In China, however, the response to Covid-19 has been surprisingly different. China was the largest contributor to the huge increase in the global monetary base in 2008. In 2020 its response to the crisis has been tame in comparison to the say the least.
US and China M2
increase (YoY). US stands at a approx 6x structural GDP growth rate (!) China only 1.5x...
US deficit is ballooning to level equivalent to approx. 3x China 's (that targets 3.5%)
China Sovereign yield curve did not move compared to the US one
As a result, China CNY bonds offer now the highest real yield in the world
I believe that these are quite important structural developments which should not be overlooked by global investors.
China long term objective has always been to open its capital account and make the Chinese Yuan an international currency. But for this it needs a stable Yuan and foreign capital inflows.
Few recent events made the need even more pressing. a. Hong Kong has been experiencing
significant social and political troubles. b. Trump has been threatening to stop HK banks
access to USD c. US senators tightening conditions for chinese listing in the US d. South east Asia tensions (China has been targeting Taiwan to take over its strategic position in semiconductor production and therefore insure its supremacy in the global race for AI) are growing.
I believe that there is a high probability that China relative small stimulus response is well planed and strategic: I believe China is quietly planning to de-peg the HKD, re-peg to the CNY while at the same time opening the capital account.
US NIIP is at around 45% of GDP; the highest ever and according to economic history, corresponding to stretched levels. Soaring US deficit, rock bottom US bond yields should decrease investor' appetite for US safe assets going forward. Particularly if there is a very large liquid safe asset market alternative, yielding positive real yield, not correlated to G7 safe assets and backed by a fast growing economy that should become the world largest economy in a short amount of time...
It seems that China has been leveraging Covid-19 crisis to design the optimal environment for the CNY to become the new global reserve currency.
A world that needs fewer dollars while the USD printing press is accelerating is a very, very different world.
This will have a profound impact on
global portfolios asset allocation, global flows and on the global political balance of
power.
