How central banks will wage war on the Covid crisis
The crucial role of central banks in the analysis of Alessandro Fugnoli, chief strategist of the Kairos funds
The idea of the second wave of Covid stems from the experience of the flu pandemics of 1918-19 (50 to 100 million deaths, depending on estimates), 1957-58 (two million deaths) and 1968-69 (one million deaths). In the three cases, the virus showed up in the winter, seemed to recede in the summer and reappeared in force in the following winter, in an even more dire form in 1919 and slightly attenuated in the other two cases.
Three pandemics are a significant precedent, but they are not enough to make a rule. To stay in the field of coronaviruses, Sars lasted three years and MERS hit in 2012, 2015 and 2018. And the same flu of 1968-69, more than a new cycle, was actually a return of that of ten years ago. As you can see, each pandemic is a story in itself.
As for Covid, in the media of these days the concept of the second wave already underway is being widely used with reference to countries, such as France, which again register the same number of cases as in March-April. If mortality is lower, it is said, it is due to improved treatments and earlier diagnoses. All this is true, fortunately, but the comparison with the first wave is improper, because the number of cases was then largely underestimated. While only a small part of the symptomatic alone was tested, today a large number of asymptomatic ones are also tested.
In practice, if next winter Covid were to really present itself with the same virulence as in the first months of 2020, the number of cases surveyed would be much higher this time, so much so that it is difficult for governments not to restore those generalized lockdowns that they have firmly promised to to avoid. In particular, Biden, should he enter the White House on January 30, would find it difficult not to at least partially close the economy after harshly criticizing Trump for closing it too little.
Then there is another worrying aspect, from the point of view of economies and markets. Although we started talking about the second wave in the spring next winter, none of the macro forecasts in circulation (from which the estimates on profits and therefore on the stock exchanges of 2021 derive) take this into account. All estimates, in fact, assume a gradual and regular recovery, quarter after quarter. This is understandable. Since no one can predict how the virus will change and how the pandemic will evolve, no hypothesis has been loaded into the models. The same did the markets, which in fact navigate on sight without pricing the risks for a winter that still appears far away.
The explanation for this attitude is also offered by the waiting for vaccines, which have been seen for months as the final solution to the problem, the moment in which we can turn the page and end this sad experience forever. However, the reality will be much more nuanced. Vaccine approval criteria are not particularly strict. It is enough that they create immunity for some time in at least half of the vaccinated. If these are, say, 50 percent of the population, it means that only 25 percent will be truly protected. A big step forward, certainly, but not such as to allow the generalized reopening of the economies. There is also the hypothesis, to conclude with the bad news, that the virus mutates and renders vaccines ineffective. It has not happened so far, but we are not sure for the future.
It is therefore legitimate to ask whether, in the worst scenario of a genuine second wave, there are still policy tools to support economies and markets with the same effectiveness as we have seen so far. Fortunately, the answer is largely positive, but there are some important caveats.
Let's start with monetary policy. In the toolbox we find, in increasing order of effectiveness, the continuation of the Quantitative easing underway in Europe and America, the expansion of Qe and the introduction of deep negative rates. The continuation of the Qe underway, of impressive proportions, is not questioned by anyone and denies the idea that central banks, after the great measures of the past months, are no longer doing anything.
The expansion of the Qe, for its part, is always possible. There is no theoretical limit to the expansion of the size of central banks' balance sheets and in any case, even if there were, the ECB and even more so the Fed are far from the levels that the Bank of Japan and the Swiss National Bank have gone to. , so far without particular negative consequences. In recent years, the idea was widespread that filling a central bank with securities carries the risk that their eventual fall in price will eat up the bank's capital and send it to negative equity. Today nobody thinks that anymore because we know that in a fiat money regime the central bank can recreate its capital from scratch with a simple accounting entry.
The expansion of QE would then be particularly effective, seen by the markets, if at some point it were to involve regular purchases of shares by the Fed and the ECB. Here too we have the precedent of Japan and Switzerland. The BoJ has been buying Japanese stocks for years, while the Swiss National Bank has been printing francs to buy American stocks, in particular technology, on which it has accumulated large capital gains. In America and Europe, however, such operations would lend themselves, in the current climate, to the accusation of subsidizing the rich. The accusation could theoretically be circumvented if the Fed and the ECB bought, as Switzerland does, foreign equities. In this case, the declared objective would not be support for stock exchanges but the weakening of the national currency. There would be many other ways to improve the image of support for stock exchanges (creation of sovereign wealth funds, mixed private and public funds, generalized purchases of real assets of all kinds) but the bar to overcome, especially in the event of a democratic victory in November, it would be very high.
Less problematic politically would be the drop in rates to one, two, three points below zero. The difficulty here would be to properly dose the timing of a measure of this type. Presenting it as short-lived would risk making it ineffective, maintaining it for a long time would produce increasing side effects.
Even simpler, in the new climate, would be to act on the fiscal level, spending another 10-20 points of GDP financed by central banks. It seems a lot, given the already existing debt load, but the American package that Mnuchin and Pelosi are discussing at the moment (and which will in any case be approved by February) alone is worth 10 points of GDP and is considered a simple stopgap waiting for the big measures that will be launched in autumn 2021 by a possible Biden administration.
As you can see, the ammunition available in the case of the second wave are powerful and numerous. They will not avoid waves of bankruptcies in the most exposed sectors and subsequent repercussions on bank accounts, but they will support the core of economies and markets.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/come-le-banche-centrali-faranno-guerra-alla-crisi-da-covid/ on Sun, 04 Oct 2020 04:51:58 +0000.