COVID19: A Wartime Economy Emerges

As this week closes, policymakers continue to accelerate their pivot towards a wartime economy to combat the COVID19 pandemic. Every day, we have analyzed for our daily report subscribers the technical moves being made by policymakers. Our patented platform has been tracking policy responses to the coronavirus globally since February. But this week represented a paradigm shift for the policy response function. The scale and scope of support being provided to the economy and financial markets globally is stunning. 

The full extent of liquidity assistance being provided to the global economy far exceeds the headline grabbing initiatives associated with asset purchases, interest rate cuts, and fiscal stimulus. To appreciate how much support the official sector has provided to the economy globally so far, the analytical lens must widen to include extraordinary regulatory capital and regulatory compliance relaxations triggered this week. More will likely arise as the health crisis intensifies.

Shifting to a wartime economy implies at least a medium-term shift in the center of gravity for demand from the private sector to the public sector. It also implies that central banks may continue to contribute technical lifelines to the economy for quite some time. But first, let's look at the main lifelines provided to the economy so far.

 The Big Picture – Main Lifelines So Far

To grasp the full extent of the support structures hastily finalized over the last ten days, consider the aggregate impact of all these policies implemented at some or all G7 economies. Where appropriate, the descriptions also indicate if additional room exists for easing from this week's baseline moves.

Get comfortable; the list is long.

• Targeted fiscal stimulus (focus: health care; hospitality; transportation; unemployment benefits): hundreds of billions globally. Additional support may be provided based on the scale and severity of the crisis. If the wartime economy expands, some of that stimulus may flow through military budgets in some countries.
• Unrestricted fiscal stimulus: cash distributions have already been implemented in the Netherlands. The United States is rounding the corner to provide an unprecedented $500bn program on a means-tested basis to each citizen. Not every country has this capacity, of course. Nor can this mechanism become permanent particularly given the widespread tax holidays that have been implemented in the United States and elsewhere.
• Government Procurement/Comandeering: Procurement and requisitioning authorities are being expanded and/or fast-tracked to permit governments to acquire or mandate that manufacturers shift production from consumer goods to life saving materials. the most significant of these moves occurred earlier this week when the President of the United States triggered the Defense Production Act in order to accelerate domestic production of respirators and personal protective equipment.
• Interest rate reductions: implemented globally, sometimes coordinated. Most countries have not yet hit zero, however. Interest rates are not the best tool to deploy in this context, as discussed HERE a few weeks ago.
• Government loan guarantees and grants to businesses large and small. However, this implies that traditional credit risk analysis and traditional sovereign risk analysis will have to adjust or be ignored since the government is guaranteeing private sector credit risk. The issue will become particularly relevant if the EuroArea begins to issue common bonds which are now a live option given Chancellor Merkel's new support for those instruments.
• Central Bank Asset Purchases: including Corporate Commercial Paper purchases (usually with maturities under one year) and Corporate Bond Purchases (maturities over one year).
• Directed Lending: central bank liquidity conditioned on pass-through to specific types of companies (usually SMEs).
• Discount Window lending expansions. Data released yesterday by the Federal Reserve indicates that the rate of increase for discount window lending in the United Stated doubled in the last week.
• Money Market Mutual Fund Purchases
• Direct repo market operations
• Reserve Currency Liquidity: Dollar swap facilities now exist not only among the leading global reserve currencies (United States, United Kingdom, ECB, Japan, Canada, Switzerland) and as of today are settled DAILY . In addition, as of yesterday, swap lines were expanded to include a widening range of systemically significant countries (Australia, New Zealand, South Korea, Sweden, Norway, Finland, Singapore, Mexico, and Brazil). China is notably absent from this list.
• Liquidity for Securities Dealers: direct credits from the central bank to primary government bond dealers, collateralized by investment grade securities (including commercial paper, municipal bonds, and some equity securities) and with an interest rate equivalent to discount window lending for commercial banks.
• Bank Regulatory Capital: Reductions in the CounterCyclical Buffer (CCyB) are within the planned Basel III structure and are wholly within national discretion. Other technical shifts are potentially more problematic to the notion of a common minimum standard. For example, in the United States, banks are permitted to apply the most favorable rules possible for the treatment of discount window lending under the Liquidity Coverage Ratio and the new definition of "eligible retained earnings" expands the amount of permissible distributions without triggering regulatory reporting or operating restrictions for firms that entered the crisis with a large capital cushion. At the end of February, the European Systemic Risk Board publicly warned banks and their auditors that using fair market values "can affect financial stability and have a macroprudential impact." While this is not a new view in Europe, that perspective takes on new relevance in the current environment. Significant easing from here is possible across a broad range of capital ratios. But significant regulatory capital easing will raise existential questions concerning the role and future of minimum international capital standards.
• Massive relaxation or waiving of securities regulatory requirements including, but not limited to: voice recordings, audit trail requirements, regulatory reporting.
• Short selling bans: implemented in a few European countries and formally authorized swiftly (after the fact) by the European Securities Markets Authority.

Additional policies were implemented by individual nations globally to support their individual economies, but these are the main items so far. Proposals are flying thick and fast. Notably, one EuroArea head of state this week endorsed nationalization as a strategy to ensure companies are insulated from bankruptcy.

In other words, the scale and scope of official sector support to the economy is under-estimated in most commentary. Focusing exclusively on fiscal stimulus, monetary policy, and emergency liquidity facilities misses the feedback loop associated with regulatory capital and regulatory compliance relaxations.

Powered by our patented platform, we analyze daily policy developments globally for our customers and colleagues. To find out how we can help you and your company navigate these challenging coronavirus days, please reach out to us HERE. To subscribe to our daily COVID19 Report, please reach out to us HERE.