A Money View of the Pandemic
March 26, 2020
If your cash inflows disappear but your cash outflows remain, what do you do? Dash for cash. Sell what you can for what you can, max out your contractual credit lines, and hold the proceeds in spendable form. The idea is to buy time by finding a way to continue to meet your cash outflow obligations while you scurry to find a new source of cash inflow.
Usually when you sell a Treasury bond, there is a dealer who takes the other side of the trade, and usually that dealer finds it easy to fund the purchase by using the bond itself as collateral for borrowing, say from his clearing bank. But when everyone else is also selling, and when the dealer’s bank is using its balance sheet to meet contractual credit lines, then there may be no one to take the other side, or only at a fire sale price. Market liquidity disappears.
On March 15, the Fed stepped in as dealer of last resort in response to exactly this kind of problem. Today you can sell your Treasury bond, no problem, thanks to the willingness of the Fed to expand its balance sheet on both sides. And if you are a central bank with a swap line, you can borrow dollars simply by putting your own currency up as collateral, and then use the dollars to meet dollar funding needs in your own jurisdiction.
And that was just the beginning. In subsequent days, additional measures were added to provide liquidity support to commercial paper and corporate bond markets, now with Treasury backstop for the credit risk involved. Here the rollout is slower because the asset class is more disparate, but the underlying strategy is apparently the same, to accommodate the dash for cash, not just inside the United States but also outside in the global dollar funding system.
That’s a big deal, but familiar from 2009. What’s different is the speed with which the Fed has acted, an important learning from 2009 no doubt.
It’s a big deal, but it is also the easy part; now comes the hard part.
The hard part involves repricing of assets everywhere, and reallocation of existing productive resources. That’s hard enough, but made more difficult in an environment where price discovery is hampered by the inability of dealers to supply market liquidity even for the safest assets. And for all the other assets, the problem is even harder because of the lack of obvious deep pockets willing to buy or sell when price moves significantly away from value, for the simple reason that no one knows what value is. Even if they had the balance sheet, dealers can’t be expected to make an inside spread when there is no outside spread to support them.
The underlying challenge is that the future toward which we were building before the coronavirus is not the future toward which we will be building after the coronavirus (BC and AC respectively). Businesses and business models that were great BC may not be so great AC, and businesses and business models that did not even exist BC may be great AC. Same goes for jobs. We’ve turned off the economy temporarily, in order to fight the public health fight, but turning the economy back on will not be so simple because it will not be simply a return to status quo ante, but rather a process of reconstruction analogous to the aftermath of war.
That’s the frame we need for thinking about the Treasury’s $2 trillion spend, going forward. The trick will be to preserve productive assets, while also facilitating the necessary reallocation. By replacing missing cash inflows, Treasury enables continued cash outflows, and thus prevents default that would spread the liquidity crunch to those on the receiving end. It’s a kind of economic distancing, analogous to the social distancing which is at present our main weapon against the virus.
But in the longer run what is important is reconstruction, which means finding new sources of cash inflow, and in many cases that means reallocation of productive resources. Crony capitalism is the biggest danger we face, bailing out BC businesses rather than building AC businesses, simply because that is where the pressure and political clout is. The strength of future economic recovery will depend on how effective is the economic reconstruction today.
After WWII, starting April 1948 the Marshall Plan played a critical role in restarting the economies of Europe. The legislation approving the Plan took months to prepare, as each European country had to come up with their own plan and then all the plans made consistent and trimmed to the likely size of Congressional appetite. And once the money was approved, an entire apparatus had to be built to distribute and manage. That was the OEEC, which morphed in 1961 into the OECD. It worked.
The Fed’s actions of March 15 and subsequent days have bought us some time, and now the Treasury a bit more. The challenge will be for each and every one of us, individually and collectively, inside the United States and outside in the global dollar system more generally, to use that time to put in place the foundations of an AC economy.