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Tuesday, 9 June 2020

Hope for the best, plan for the worst

The title of today’s blog is a quote taken from various Jack Reacher novels, written by Lee Child. This quote seems to contain a universal truth, or perhaps it's just common sense. For example, the first part of this quote is applicable to the UK in its Brexit negotiations. The second part of the quote fits the approach taken by the EU.

In 2020, we are facing a joint asset bubble and a recession. Either, this asset bubble will burst and the recession will take over, OR the asset bubble will continue and "neutralize" the recession. The only reason that both can take place simultaneously is the ginormous amount of money supply by Central Banks (eg, ECB, Fed) to avert a coronavirus related recession.

On 15 August 2018, I wrote my blog: The 2020 recession: who will be hit? My 2018 blog argued that Central Banks and/or governments would be hit in 2020, rather than consumers, companies and commercial banks as the latter had already learned from previous crises.

Countries and their central banks have two basic options when facing deficits or bankruptcy: (1) order the Central Bank to print extra money, and/or (2) ask for external help (eg, IMF).

The 1st option is also known as the Modern Monetary Theory (MMT), which claims that government budget deficits are not a problem. The Central Bank can just keep printing new money to finance such deficits. In times of very low or negative interest, the risks of budget deficits indeed appear minimal. That changes dramatically when - and not if - interest levels will rise again.

Allegedly, the 2nd option is being considered by "more than 100 nations [that] have asked the IMF for help" (eg, Oman). That source claims a crisis of unfolding sovereign defaults. I'm a little skeptic as that number would represent more than 50% of the global total of 195 countries.

However, only some countries are in a position to apply the MMT, like USA. Other countries will have to obey market rules that the public debt/GDP ratio remains below 100%, in order to be able to borrow on (government budget) sustainable interest levels. Reuters BreakingViews expects that "150% is the new 100% for public debt/GDP".

The balance sheets of the ECB and Fed have been exploding following (i) quantitative easing (2008-2019) and (ii) monetary support to avert bankruptcies and unemployment following the coronavirus pandemic (2020 - onwards). How much air can you pump into a balloon, a tyre or an economy before it explodes? We should hope for the best and plan for the worst.

Also see my related blogs: The drivers of an asset bubble and a recession (2018), Deficits, losses and (government) debt (2018), The 2020 recession: who will be hit? (2018) and The inflation conundrum (2019).

Hope For The Best, Expect The Worst (1970) from The Twelve Chairs

Note: all markings (bolditalicunderlining) by LO unless stated otherwise.

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