Can Money Grows On Trees?

Many years ago during my undergrad in economics I debated among friends and classmates about the benefits of governments printing money to ease short-term economic crises. They disagreed strongly and said such Keynesian policies would be ruinous! They reminded me how hyperinflation in the 1920’s crippled the German economy as its central bank printed money to refinance its debts from World War 1.

​True, after the war the Deutsche Mark collapsed as investors lost confidence in the German economy. Germany had suspended the gold standard and began printing new Deutsche Marks to fund the war. When the economy contracted the global demand for these Deutsche Marks fell as investors bought less German goods. In addition to large reparations, a vicious cycle ensued as the government continued printing money to cover on-going deficits

Similar circumstances befell Argentina in 2001 and again in 2018. It has now defaulted on its external debt ten times since independence in 1816. Argentina has also entered into 21 IMF programmes since joining the fund in 1956. It’s current inflation troubles stem from low growth and monetary financing of budget deficits.

In contrast, the demand for goods and services in the major economic powers such as The United States and Europe result in their currencies remaining strong relative to the weaker economies. With 70% of all trading around the world carried out in US dollars the demand for dollars is extremely high. The Euro is the second largest currency making up 15% of all trades. This might explain why printing money in the larger economies has had less effect on inflation in recent years, particularly during a downturn.

In the years that followed the global financial crisis in 2008, the USA, UK, and the EU embarked on large monetary expansion policies in an effort to stimulate their economies. Central banks, concerned about low inflation, reduced interest rates, printed money and bought large scale corporate and government debt. From 2008-2010 the US Federal Reserve’s quantitative easing programme was worth approximately $1.2 trillion.

It turned out however that - aside from asset prices - consumer prices remained low. Quantitative easing served only to calm the stock market and ensure orderly financial conditions. World interest rates remained low and the exchange rates between the major currencies remained largely stable. 

The current QE programmes in the US and Europe dwarf those during the financial crisis. Many commentators now believe that the central banks did not act aggressively enough at the time, causing a deeper downturn than was necessary.

As a result, in April of this year, the US Federal Reserve announced a 2 trillion dollar stimulus plan for the US economy, the largest financial package in its history. A week later a second similar package was announced meaning that, at the time of writing, over 4 trillion dollars will be generated by the US central bank in response to Covid-19. The majority of these funds will be used to buy treasury bonds and mortgage-backed securities in the private sector.

In April 2020, the UK also announced a £300 billion package, estimated to be approximately half of what will eventually be used to tackle Covid-19. The Bank of England’s policy has been to bypass the bond market and directly fund the government itself. In response, the British chancellor, Rishi Sunak recently said ‘This is not a time for ideology and orthodoxy, this is a time to be bold – a time for courage.’ 

As Adair Turner, former chairman of Britain’s Financial Services Authority, recently explained:

“That possibility terrifies those who believe that monetary finance must eventually lead to hyperinflation. But such fears are absurd. [Milton] Friedman famously said that in a deflationary depression, we should scatter dollar bills from a helicopter for people to pick up and spend.”

In the Eurozone, the ECB has committed €1.3 billion towards a QE programme of its own. In addition to this, a €750 Rescue Fund will be borrowed on financial markets on behalf of the 27 member states to draw down from. However, policymakers continue to quarrel over how the Fund should be paid for. The main disagreements surround the idea of grants, of which €500 billion are being proposed.

Grants are not a favoured option of “The Frugal Four”, The Netherlands, Austria, Denmark and Sweden however, who argue that the fund should be borrowed and paid for in full.

It’s therefore yet to be seen what conditions will be attached to this fund and countries such as Italy and Spain, the most seriously affected by the coronavirus, are understandably reluctant to add to their existing national debt from the financial crisis little over a decade ago. The implications for social cohesion in the EU is therefore a matter of concern and on-going debate, often bitter. Notwithstanding the human tragedy, further debt particularly in these southern EU countries could prove to be societies breaking point.

Regarding debt-to-GDP ratios, Ireland is in a very similar situation to Spain and Italy. Branded a so called “PIIG” during the financial crisis, Ireland’s national debt before the Covid crisis stood at approx 70% of GDP. In more simple terms Ireland is approximately €250 billion in the red. Now add another estimated €30 billion needed to tackle Covid-19 and the debt it faces as a small Eurozone country with no monetary control becomes quite enormous.

Yet the Irish government and The National Treasury (NTMA) seem happy to continue borrowing from international markets outside of any EU deal. This could prove costly if more favourable conditions from the agreements emerge. With so much extra debt to be paid off, combined with so much potential ill-will between neighbours, the collapse of the Euro could become a very serious possibility should strict conditions be attached to new loans. In this context perhaps grants or some form of debt-forgiveness would be the less politically toxic option to consider.

If debt forgiveness is agreed then one suggestion might be to restructure loan repayments over such a period of the time that they become practically inconsequential. Economies recover and no one loses face. After all in 2015 Britain made its final repayment on its debt from World War 1, over 100 years later. Why should Italy, Spain, France or the developing world not expect similar terms?

Outside of the West the picture facing the third world countries is even more challenging. Should the virus wreak havoc as is predicted, the crisis could, according to the WHO, claim as many lives from starvation as from the Coronavirus itself. With little or no social benefits in densely populated third world countries such as Somalia, Guatemala or parts of India people who cannot work cannot feed themselves.

The central banks of the wealthier economies could have a role to play in this however. The Fed, The ECB, The Bank of Japan and The Bank of England could offer the poorer nations a once-off ‘humanitarian gift’ by crediting the accounts of the poorer central banks. Based on past QE data, inflation is unlikely to be affected.

In fact, in the emerging markets this is precisely what The Fed has been doing in recent weeks. Faced with dollar shortages in Mexico and Brazil the Fed has been directly transferring funds to those central banks. This has had the effect of driving down bond yields in Latin America while also providing security for investors with dollar denominated debt.

During the height of the liquidity crisis in March/April of this year, the Fed provided over $440 billion worth of credit swap lines to 10 central banks around the world. As reported in The Financial Times on June 16th, Eric Baurmeister, head of emerging markets fixed income at Morgan Stanley, said “these global liquidity operations don’t stay within borders - they spill over into the developing world.”

Debt investment in emerging markets has consequently soared in countries such as The Philippines, Indonesia, South Africa and Turkey as central banks in these regions carry out QE programmes of their own. Uday Patnaik, head of emerging market debt at LGIM, explains that recent QE programmes represent the largest opportunity to increase EM (emerging market) exposure in 30 years. “If you want to do it, it’s now”.

Given the demand for liquidity in the emerging markets, the IMF and World Bank have recently stressed that they may not be adequately resourced to cover all requests. Perhaps it is no coincidence then that since April, according to The Institute of International Finance, EM countries have managed to raise $83 billion in debt on financial markets. Government and corporate bonds in these regions, guaranteed by foreign and domestic central banks, provide security for investors and ultimately life lines to struggling economies. Strong investment usually means stable currencies and therefore less inflation. 

Of course few would argue that pumping seemingly limitless amounts of liquidity into the financial system can continue indefinitely. Many economists argue that the central bank's actions have only served to create asset bubbles by artificially inflating equity valuations in the stock market. The equality gap between the rich and door thus widens. 

Maybe these are the short-term trade-offs worth living with however, especially when faced with a humanitarian crisis like a plague or famine.

​If that proves to be the case, the old adage “Money doesn’t grow on trees”  may open up fresh and compelling debates.

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