The Coronavirus and the federal government’s response to it have set off free-floating anxiety, which in turn has affected economic and financial market optimism and pricing — sometimes with a downward tilt, and sometimes with an upward lift.
Witness to that was the immediate 30% one-week decline of the S&P index when the virus threat was first realized and social distancing served as a constant reminder of the risk. And then just two weeks later, we experienced the largest S&P weekly gain since 1938 with the newfound realization that the virus was not an automatic death sentence.
Sentiment has rocked and rolled, with economic observers now wondering whether to prepare for a depression or runaway inflation. Both are being expressed with almost equal concern.
Well, you can’t have it both ways, as depressions are deflationary — but it’s far more likely that neither will be the outcome and we will go back to the semi-normal of moderate growth, low unemployment and moderate inflation of the last decade. But let’s cut through the free-floating anxiety.
What has occurred economically still leaves a lot to digest. We’ve seen a near-total shutdown of the economy — both the supply and demand sides — followed by government fiscal policy and central bank expansion on super steroids, which themselves have set off both hopes and fears. It’s rare to find greater consternation with inconsistent projections in all directions at once. The result is almost complete and total uncertainty.
First, sending workers home has eliminated both production and paychecks, so both sides of the economy (supply and demand) are reduced. However, sales via home delivery have ramped up, with Amazon hiring 100,000 new workers in about a month. With production largely shut down, more than order fulfillment, producers are likely running short of inventory.
A reduction in inventory on producers’ shelves implies that that there will be strong incentives to re-start production when allowed. It also means that the outcome of a recession — or perhaps a depression — is far less likely, as excess inventories are not a stumbling block to get back to work as in past recessions. Indeed, it’s quite the opposite.
To fill the paycheck void, the government created an income support program like no other before. What has occurred to fill the payroll void is an unprecedented one-two move: the government borrowed $2.3 trillion from the central bank (through the Fed’s purchase of Treasury bonds in that amount) and created a new stabilization tool called the Payroll Protection Program (PPP). A portion of the cash proceeds of the bonds received by the government from the Fed will, in turn, be loaned to workers and companies via their own banks, as administrators. And while these cash advances to private parties are technically loans, the government has indicated in advance that the loans will be forgiven (wink, wink) and “covered” by Uncle Sam.
This manner of government and central bank involvement that puts money in the hands of private parties without recourse is unprecedented. And they have gone back for a second round of the same. The presumption is the money will find its way to the demand side of goods markets.
This means that this combination of monetary and fiscal policy has produced what has been euphuistically called “helicopter money.” That is, money raining down from heaven to be spent by the lucky parties that managed to get their non-recourse loan approved. Hence, helicopter money has moved from being a joke to being actual policy.
If spent by private parties which is the intention, it elevates demand in goods markets. This will partially offset the vacuum in income and spending created by the go-home order.
But the amounts of the PPP so far are in the billions of dollars whereas the government borrowed in the trillions. So, all in all, while it raises the specter of inflation from money financed income and spending the amounts are relatively small (if you can envision billions being small). But it does raise the specter of this being the new norm of how a government will handle a soft economy.
However, this modern helicopter money drop has raised concerns, that the monetary base has taken off and spending in goods markets will follow, generating high levels of inflation.
The concern derives from the quantity theory of money as a concept that has merited a chapter in virtually every economics textbook written over the last 50 years. A lot of folks have read those chapters, and they’re unnerved by the inflation prospects that the theory suggests.
Source: The Spellman Report
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