The last two days have seen the biggest rally in stock markets since the financial crisis, on the back of the US Congress reaching consensus on the largest rescue and stimulus package in history.
It includes helicopter money to the tune of $1,200 in direct payments to each taxpayer earning less than $75,000 per year, $500 for children and a supplement to state unemployment worth $600 for every unemployed person.
The package was passed in the Senate 96-0 and is expected to be waived through the House of Representatives later today. At the same time, the German Bundestag approved a package worth more than €1.1 trillion. The EU has relaxed stringent deficit rules on countries for the time being.
German Minister of Finance Olaf Scholz also flagged the possibility of deploying the European Investment Bank. European leaders are discussing the ability to raise the European Central Bank’s (ECB) member countries credit line. The ECB shook off its the parameters €750 billion bond purchasing program, giving it virtually unlimited firepower. They might use the European Stability Mechanism and OMC as tools to implement the program.
We should take the equity rally with a grain of salt. The coronavirus disease (COVID-19) continues to ravage the world and all major economies are in lockdown. As the world economy is all but certain to head toward recession, if not depression, most sectors will be adversely affected.
Mid-morning on Monday all major indices as well as the S&P futures were down by a few percentage points. The Tadawul bucked the trend being up slightly above 1 percent. With economic activity so sharply down, it is no wonder though that petrochemical stocks are down. For instance, SABIC lost more than 28 percent in value for the year to date.
Why it happened:
The various rescue packages are able to give temporary relief as they insert hitherto unprecedented liquidity into the system.
Former US Federal Reserve Gov. Ben Bernanke made a good point when he compared COVID-19 to a natural disaster such as an earthquake rather than to the financial crisis of 2007/2008 or the Great Depression, which were financial-sector liquidity and asset-devaluation shocks respectively.
One could argue that the current situation is worse than the average natural disaster, because they tend to be geographically limited, one-time events, which enables non-affected areas to come to the rescue of the affected geographies. COVID-19 is a global phenomenon with no visibility to its duration.
That is why it is important to deploy the “big bazookas” efficiently to achieve maximum impact. Scholz told Bloomberg that the various packages needed to be timely, targeted and temporary. The temporary aspect is difficult to determine, because the duration of the crisis is unknown.
This brings us to the question of liquidity: Countries such as Germany and Switzerland, which have stuck to a tight budgetary regime, are relatively well placed because they balanced their budgets and adhered to strict debt limits. In Germany, the principle of balancing the budget or the so called “black 0” was even enshrined in the constitution. This means that those countries have bigger firepower to address the crisis now.
The same holds true for companies. For instance, the US rescue package does not give grants but loans to small- to medium-sized enterprises (SMEs), which constitutes temporary relief. However, it will increase their debt burden, which is more feasible to service in a low interest-rate environment and increasingly more difficult if interest rates gain. With loans there is always the issue of repaying the principle, which may not be easy depending on the sector and the shape of the recovery.
This is the classic liquidity and solvency dilemma. While it is important to inject liquidity to keep companies and households solvent, we need to minimize the danger of additional debt leading to future insolvency and bankruptcies.
A good example are the various downgrades of listed companies: For instance, Standard and Poor’s downgraded the debt of Ford – an icon of US industry – to junk. Creditworthiness will become an even greater issue for SME companies, who are by the way the biggest employers in most countries.
Where we go from here:
It will be important that the various stimulus packages are disbursed in an efficient and timely manner.
Germany and other EU countries may be in the best position, because their welfare states have the institutional capacity and mechanisms in place to disburse both loans and grants to companies, and welfare and/or helicopter money to households.
It will be a lot more difficult in laissez-faire economies such as the US: The question being how fast the helicopter money can be disbursed to the Uber driver or the nurse in California or Wisconsin?
The rescue packages are targeting individual workers. What will matter though, is how fast they can get back to work and how many will lose their jobs. The US jobless number, released at 8:30 a.m. Eastern Standard Time, surged to 3.3 million, with more than 3 million filing for unemployment last week alone, which constitutes the largest jump in history.
We shall look at employment tomorrow.
In the meantime, stay safe and stay healthy, yours sincerely, Cornelia.
— Cornelia Meyer is a Ph.D.-level economist with 30 years of experience in investment banking and industry. She is chairman and CEO of business consultancy Meyer Resources. Twitter: @MeyerResources