The ongoing and incredibly politicised COVID-19 saga has thrown monetary policy into the spotlight once again. Unlike the previous financial crisis that the world experienced in 2008, the one we face today was not caused by financial practice, or rather malpractice. The remedy for the 2008 financial crisis was stimulus packages, new policy and industry reform. Unfortunately, world leaders are trying to tackle a health crisis with the same game-plan.
Temporary relief in the form of stimulus is undoubtedly essential to prevent people, businesses and corporations from slipping into hopeless situations that will be tough to escape from. Who wants to make it to the other side of months or even years of social distancing and missing opportunities only to realise that they still can’t enjoy the luxuries they missed out on because shops, bars, restaurants, hotels, airlines, wedding planners, concert venues have all gone out of business.
The apparent downside of propping up companies with injections of cash fresh off the figurative printing press is that it rapidly increases the money supply and inevitably trickles down into the economy, leading to inflation. In the short term, stimulus packages are a viable solution; they can even become a valuable solution depending on how they are rolled out.
Some countries mail cheques out to individuals, some offer furlough schemes and others go for even more nurturing approaches. For example, the Monetary Authority of Singapore is offering incentives to financial services companies who enrol their employees on training courses by subsidising the cost of a course by 95% and reimbursing SG$ 15 per hour of the employee’s salary while they take the course. The company saves on the wage, the worker gains experience, and the government is constructively stimulating the economy.
The approach to stimulus packages in other countries hasn’t been as nurturing as in Singapore. In the US, for example, the Federal Reserve went for an aggressive quantitative easing push, rapidly buying risky assets and underperforming bonds from the market and injecting more liquidity into banks.
On the week commencing the 11th of March 2020, the Federal Reserve balance sheet stood at $4.31 trillion. On the 15th of March, the Fed announced a massive QE program along with a target of 0% to 0.25% on short term interest rates. As of week commencing 6th of October 2020, the Fed’s balance sheet stands at $7.06 trillion. This method has been echoed by Central Banks around the world, but as per usual, it’s the US that has the most influence for reasons obvious to anyone familiar with investing.
The dramatic stimulus package announced in March seemed to have been the primary factor that triggered a reversal in the global equities market, albeit with a slightly delayed reaction. Ever since, the markets have gone from hating low-interest rates that indicate a weak economy, to loving multi-trillion dollar stimulus packages which do also hint at a vulnerable economy. Take a glance at the below S&P 500 daily chart where important stimulus-related announcements have been flagged.
The correlations do hint that the market likes stimulus. The problem is, a stimulus is not a sign of health and the notion that it triggers a positive reaction is a toxic situation.
The risks of a fiat-based monetary system are not difficult to grasp. There are no boundaries to how much currency can be created; that’s how Zimbabwe was able to print $100 trillion dollar banknotes.
If left unchecked, a government can borrow, or instead request the central bank to create too much currency. As more cash is added to the money supply, this causes inflation. We’ve seen inflation and even hyperinflation happen many times over. Almost every case of inflation occurs for the same reason, poor economic prospects plus rapid and excessive creation of new currency.
Many people are concerned by the policies they are witnessing being rolled out month after month. Will the stock markets slump every time policymakers hint that stimulus packages will be ceased or reduced in size. Will falling stock markets twist the arm of policymakers to revise their position and push yet more free money for businesses and individuals because it’s what they have come to expect?
There are countless critics of fiat-based monetary systems and many arguments against the system that are valid. We depend on economists and politicians to develop a sound fiscal policy to ensure the integrity of an incredibly elastic system. The dilemma is, what if we cannot trust the institutions tasked with ensuring the confidence of the monetary system we live by.
A gold standard does sound like an idyllic system. Sadly, it’s far too complex to operate in a globalised marketplace with eight billion people. However, that doesn’t mean that a fiat monetary system is the only solution either.
They say more money, more problems and in the case of fiscal policy that’s often true. Creating money and offering bailouts, loans, and benefits is an easy way to escape from a painful problem. Unfortunately, the issue we face with COVID-19 is not merely a financial one. Until the virus has subsided one way or another, life will not return to normal.
Economists argue that the actions they have taken so far are unlikely to trigger an inflationary response, especially while consumer demand is low. The counter-argument is obviously the demand is low; consumers who are not economically active are clinging onto every cent they have, and those who are feeling flush have nowhere to splash their cash. This leads to the concern that once the economy recovers from the COVID-19 pandemic and consumer demand increases, all the cash that has been parked in gold, bank deposits and under mattresses will flood the marketplace. Inflation would be amplified if, during the lockdown period, supply subsides.
Needless to say, a stimulus is undeniably required, but the question is, how much and for how long; that will be the factor that determines how this plays out.