By Chan Kung and Wei Hongxu*
As the COVID-19 pandemic continues to spread, the Federal Reserve is widely expected to keep interest rates on hold at its monetary policy meeting and continue its ultra-loose monetary policy to rescue the U.S. economy from a deep recession. Internationale Nederlanden Group (ING) believes the Federal Reserve will maintain its accommodative stance at this stage, given the impact of the outbreak revulsion on the real economy and the fact that long-term Treasury yields remain low. Although this continuous massive easing has played a role in stabilizing the U.S. financial market and the real economy, it is now increasingly causing a variety of concerns and doubts. There is widespread concern among institutions and academics that the unrestrained easing of sovereign money has led to a trend towards currency liberalization and whether it will lead to unpredictable outcomes, leaving economists and central banks confused in both theory and practice.
A recent article in the Economist expressed concern about current currency liberalization. Ultra-loose monetary policy is making the world’s money and capital increasingly worthless, and unlimited government debt may pose huge risks to the world. In fact, ANBOUND has previously analyzed and predicted that the zero/negative interest rate phenomenon of this currency liberalization will lead to a new global geopolitical pattern. Now Goldman Sachs has taken a similar view, warning that the dollar could lose its status as the world’s reserve currency, raising concerns about inflation in the United States. With the relief of the liquidity crisis in March, the long-term effects of the Fed’s ultra-loose monetary policy will begin to emerge. The dollar is heading for depreciation, and the long-term effects of currency liberalization will become more and more obvious.
As it stands, the COVID-19 outbreak has not only caused unprecedented shocks to the global economy and financial markets, but also brought new challenges and confusion to conventional monetary and fiscal policies. It forced central banks to push the global monetary easing policies that had been in place since the 2008 financial crisis to the extreme, overturning various monetary theories and understanding of the economy and inflation from Keynes to Friedman, and pushing the economic theory and practice into new uncharted territory. As the Economist has pointed out, the COVID-19 outbreak has led to historically alarming levels of government intervention in economic activity and financial markets, as well as unexpected risks. It can be said that the price of the currency liberalization may be the disappearance of the free markets, and that global financial markets and economic activity are inevitably subject to the increasing government intervention.
This new era of “currency liberalization” has several new features in the eyes of the Economist: One is that unlimited money supply has led to unprecedented levels of government debt, and that government debt in credit money seems to be growing without limit. According to the IMF, government debt in the developed countries will reach 17% of GDP by 2020 to cover the USD 42 trillion deficit caused by fiscal stimulus packages implemented by countries. On the basis of the global economic stimulus packages in March, all major economies are currently preparing a new round of stimulus. The European Union has launched a new stimulus package to further increase the EU’s common debt. The United States is also mulling trillions of dollars of new stimulus to save the U.S. economy that may sink into a recession as a result of the pandemic. Without exception, the consequences of these fiscal policies will increase the debt of governments.
Another feature of the era of “currency liberalization” is “deficit monetization”, whereby central banks’ monetary easing “pays for” fiscal deficits. Countries such as the United States, the United Kingdom, and Japan have already “printed” more than USD 37 trillion of money this year, most of which are used to purchase government bonds. The result has been a low level of real interest rates around the world. The third feature of the new era is the intervention of sovereign governments in the markets. The Economist went so far as to say that governments and central banks are acting as the country’s “chief investment officers”, with both the Federal Reserve and the Bank of Japan continuing to buy assets in financial markets, including corporate bonds and ETFs, and even lending directly to companies and individuals. Corporate financial assets backed by the Federal Reserve and the U.S. Treasury already account for 11% of the market, according to one estimate. The most worrying feature is that ultra-loose monetary policy has left the world facing a long-term monetary environment of zero/negative interest rates. Low inflation takes the pressure off central banks to achieve “currency liberalization” and gives them no incentive to raise short-term interest rates to sustain and stimulate growth. This brought the cost of debt close to zero and currency unfettered.
In this era of currency liberalization, fiscal deficits and “quantitative easing” are likely to be the long-term “standard” combination of macro policy. This has a disruptive impact on financial institutions and financial markets. Zero interest rates have compressed the profits of banks’ lending business, while excess money supply has created an “asset shortage”, pushing up asset prices. Central banks are no longer the lenders of last resort, but have become the “market makers” that influence the markets.
Of course, the government’s policy options of expanding fiscal expenditure can promote infrastructure construction, increase investment in science and technology research and development, and improve the security of education, medical care, and people’s livelihood through low-cost debt, which is beneficial to economic development. However, in the context of “currency liberalization”, the government’s unlimited intervention in the economy may bring a series of negative consequences. In particular, it has made markets inelastic and distorted, leaving the economy facing a long period of low growth. If inflation picks up and interest rates rise, it will become a debt problem, triggering a crisis in financial markets and the real economy. As ANBOUND has pointed out, the long-term risk of currency liberalization is that it masks market risks with a bigger bubble, eventually leading to a catastrophic crisis. The price of currency liberalization, therefore, is a gradual loss of free markets. In the long run, as long the pandemic persists, the effect of the ultra-loose monetary policy, which mainly focuses on short-term emergency response is diminishing, policymakers of all countries need to strike a balance between the two.
Final analysis conclusion:
Ultra-loose monetary policy is making currency issuance unconstrained and “liberalized”, but the price will be a loss of free-market mechanism. If this distortion were to break, it would have disastrous consequences.
Founder of Anbound Think Tank in 1993, Chan Kung is now ANBOUND Chief Researcher. Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing.