March 26, 2020<\/p>\n
If your cash inflows disappear but your cash outflows remain, what do you do?\u00a0 Dash for cash.\u00a0 Sell what you can for what you can, max out your contractual credit lines, and hold the proceeds in spendable form.\u00a0\u00a0 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.<\/p>\n
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.\u00a0 But when everyone else is also selling, and when the dealer\u2019s 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.\u00a0 Market liquidity disappears.<\/p>\n
On March 15, the Fed stepped in as dealer of last resort in response to exactly this kind of problem.\u00a0 Today you can sell your Treasury bond, no problem, thanks to the willingness of the Fed to expand its balance sheet on both sides.\u00a0 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.<\/p>\n
And that was just the beginning.\u00a0 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.\u00a0 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.<\/p>\n
That\u2019s a big deal, but familiar from 2009.\u00a0 What\u2019s different is the speed with which the Fed has acted, an important learning from 2009 no doubt.<\/p>\n
It\u2019s a big deal, but it is also the easy part; now comes the hard part.<\/p>\n
The hard part involves repricing of assets everywhere, and reallocation of existing productive resources.\u00a0 That\u2019s 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.\u00a0 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.\u00a0 Even if they had the balance sheet, dealers can\u2019t be expected to make an inside spread when there is no outside spread to support them.<\/p>\n
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).\u00a0<\/strong> 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.\u00a0 Same goes for jobs.\u00a0 We\u2019ve 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.<\/p>\n That\u2019s the frame we need for thinking about the Treasury\u2019s $2 trillion spend, going forward.\u00a0 The trick will be to preserve productive assets, while also facilitating the necessary reallocation.\u00a0\u00a0 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.\u00a0 It\u2019s a kind of economic distancing, analogous to the social distancing which is at present our main weapon against the virus.<\/p>\n 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.\u00a0 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.\u00a0 The strength of future economic recovery will depend on how effective is the economic reconstruction today.<\/p>\n After WWII, starting April 1948 the Marshall Plan played a critical role in restarting the economies of Europe.\u00a0 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.\u00a0 And once the money was approved, an entire apparatus had to be built to distribute and manage.\u00a0 That was the OEEC, which morphed in 1961 into the OECD.\u00a0 It worked.<\/p>\n The Fed\u2019s actions of March 15 and subsequent days have bought us some time, and now the Treasury a bit more.\u00a0 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.<\/p>\n","protected":false},"excerpt":{"rendered":" March 26, 2020 If your cash inflows disappear but your cash outflows remain, what do you do?\u00a0 Dash for cash.\u00a0 Sell what you can for what you can, max out your contractual credit lines, and hold the proceeds in spendable form.\u00a0\u00a0 The idea is to buy time by finding a way to continue to meet […]<\/p>\n","protected":false},"author":15789,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[4,32,28,11],"_links":{"self":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/595"}],"collection":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/users\/15789"}],"replies":[{"embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/comments?post=595"}],"version-history":[{"count":2,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/595\/revisions"}],"predecessor-version":[{"id":603,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/595\/revisions\/603"}],"wp:attachment":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/media?parent=595"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/categories?post=595"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/tags?post=595"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}