Picto Diary 25, 26 March 2020 - Dennis Lockhart
Above: Dennis Lockhart (file image) speaks to LSDM. 25 March 2020.
DENNIS LOCKHART. FORMER HEAD ATLANTA FED.
A new debate is emerging: how long can we follow disease suppression strategies before the economy is damaged beyond the point of being able to supply basic services? What do you prioritize? Where is the sweet spot between public health and economic health? An Easter economic restart doesn't seem realistic to many, but its a valid debate to consider: When is the point where the cure is worse than the disease?
Above: Dennis Lockhart (file image) speaks to La Societe Deux Magots (LSDM), a Park City, UT ROMEO group, 25 March 2020. Dennis P. Lockhart became the fourteenth president and chief executive officer of the Federal Reserve Bank of Atlanta on March 1, 2007. He retired on February 28, 2018. Dennis has been a frequent speaker at LSDM.
Note: Note taker is fallible. Mistakes are his. Dennis Lockhart is welcome to make corrections/clarifications to these remarks.
Introduction:
US economic future depends on the course taken by the epidemic.
We are now in a fog of uncertainty... about, the epidemic and the economy.
Economy today: Economic suppression; physical distancing; stay at home; suppressed demand. Little doubt we will have a recession by end of first quarter and likely outright contraction second quarter.
2nd Quarter forecasts vary: JPM; 14% contraction. Goldman Sachs: 24% contraction Oxford Economics: 12% contraction.
Hoped for recovery starting third/fourth quarter. But what type of recovery? A "V" (fast rebound), a "U" (more gradual turnaround), or an "L' (bottom out and very slow recovery)? The recovery from the 2008 financial crises was an "L."
Best case recovery is a "V". Assumes a lot of pent up demand... but, in a majority service economy, I'm not sure the kind of demand a "V" recovery requires is there.
Worst case recovery... and "L," or even a depression... lasting beyond two quarters. Treasury Secretary Mnuchin has indicated that unemployment could go as high as 20%, or great depression level numbers.
We just don't know. So much depends on path of the epidemic.
The US response to the coronavirus pandemic takes two forms. Monetary Policy and Fiscal Policy. I'll address each one:
Monetary Policy
The Federal Reserve Bank (Fed) is acting on three fronts: 1. Weakened economy. 2. Financial market viability. 3. Risk of global meltdown a la 2008 financial crisis.
So far, actions taken by the Fed on all three of the above have far exceeded actions taken responding to the 2008 financial crisis. The Fed has pulled out all the stops:
1. Policy rate lowered 150 bp on 03 March; a further 100 bp on 15 March.
2. Fed has enacted its statutory emergency powers.
3. Quantitative easing implemented. Immediate purchase of $500 billion in Treasuries and $200 billion in mortgage backed securities (MBS). Caps are off to buy more, if necessary.
4. Commercial Paper Support Fund established.... to protect on runs against money market funds.
5. Support fund for short term municipal obligations implemented.
6. Primary dealers support fund implemented.... protection for repo markets.
7. Asset based securities fund implemented... directed towards assets that are packaged and securitized, such as student loans, consumer loans and small business loans.
8. Terms at discount window eased. Banks with short term liquidity problems are encouraged to use the discount window.
9. Swap lines set up with the central banks of thirteen other countries.
10. Increase $300 billion to support exchange traded funds. Back stop for F/X markets and support for large employers eg. airlines, Beoing… strategic industries.
11. "Main Street" business lending support; to be implemented via Treasury department and IRS.
Only the Central Bank has the power to create dollars out of nothing. The Fed has unleashed almost all of the tools at its disposal. Could the Fed do more? There could be more support for the banks... but, so far, the banks appear to be in reasonably good shape. At some point, the Fed will start to issue forward guidance, that is, more precision on how long its actions are expected to take effect.
Fiscal Policy
A $2 trillion package to bolster economy is expected to pass congress later this morning. Package will include assistance for small business, hospitals, state and local government etc. Unemployment insurance draws will be increased by $600. Unemployment draws will be allowed for an extra four months beyond statute.
My take
Monetary actions and fiscal actions can ease the stress, but, can't "fix" the problem.
This is a public health problem.
We are buying time... for testing improvements; assessment of viable therapeutics; vaccine, hopefully for next year; other public health strategy fine tuning.
Monetary and fiscal strategies/actions have been put in place to soften the blow.
A new debate is emerging: how long can we follow disease suppression strategies before the economy is damaged beyond the point of being able to supply basic services? What do you prioritize? Where is the sweet spot between public health and economic health? An Easter economic restart doesn't seem realistic to many, but its a valid debate to consider: When is the point where the cure is worse than the disease?
My best guess:
Severe recession for two, or even three quarters. Over the next couple of months there will be more refinement in the public health strategy. Economic re-engagement likely to be determined by internal geography and, selectively, by industry. This will be done in context with balancing public health concerns in targeted geographies/industries.
Q and A
LSDM: What's going to happen to the value of the dollar? Won't giving $1200 to each citizen create a dollar oversupply that will suppress the value of the dollar?
DL: The dollar has risen dramatically over the last few weeks. The US remains, by far, the most attractive investment opportunity in the world. We don't know the outcome of strong monetary strategies set in motion. Bernard Bernanke, in an early 2000's speech in Japan, introduced the term "helicopter money." In a financial crises (or read global pandemic crisis) you could just "fly over" a country and drop money from a helicopter... so the speech went. We already have big indebtedness in the country. When I joined the Fed in 2007, the Fed balance sheet was $800 billion. When I left the Fed in 2017, the Fed balance sheet was $4.5 trillion. Some say that with current actions, the Fed balance sheet could rise to as high as $10 trillion. The long term consequences of all this are unknown. It is normal to be anxious. But, we have to put out the fire before we start worrying about the aftermath.
LSDM: How are relations with China from a monetary point of view?
DL: China holds a good deal of our debt. It is in their interest that the US economy stabilizes as soon as possible. The last thing the Chinese want to do is roil the financial markets. So, the Chinese are behaving themselves during this period. In recent years, the Chinese have been working to internationalize their own currency... but, that, all along was a twenty to thirty year project. We don't know what will happen to that project in the wake of coronavirus. The People's Bank of China PBC) is not something to worry about now.
LSDM: The Fed has put backstops behind money market funds. What's to prevent them from, arbitrarily, pulling those guarantees back. leaving money market investors vulnerable?
DL: The Fed will withdraw the guarantees when they see the risk on money market funds "normalize." I think the risk of arbitrary, precipitate withdrawal of the guarantee is very low.
LSDM: Are we going to zero to negative rates?
DL: We will not see "official" negative rates in the United States. There are technical reasons for this... some of them accounting related. One problem is that the banks make up a smaller percentage of the US financial system than in other countries. Its possible, that in an inverted yield curve environment where the policy rate is at, or near "0%," that thirty year rates could go negative. But, I think that is unlikely.
LSDM: How can you trust the PBC? I am not an apologist for the Chinese. It is outrageous for the Chinese to blame the US military for the Wuhan originated coronavirus.
DL: The statement blaming the US military was unfortunate and unacceptable, I agree. But, there is hyperbole in the US as well as China. I can say that at the ministry level and a layer or two below that, there are highly competent, responsible people who are not crazy. I have some comfort in trusting PBC competence and reliability.
LSDM: Dennis, you have given an excellent summary of where we are. In fact, its the best summary I have heard to date. Congratulations and well done. My question. There are financial regulations in place now that weren't there before the 2008/09 financial crisis. The Volker rules... bank liquidity rules etc. Will action be taken to relax some of these rules to give more flexibility to policy makers given current unusual circumstances?
DL: There has been quite a bit of discussion on that. Some of the strictures put in place following the 2008/09 financial crisis haven't worked so well. We're likely to see shortly steps taken to reassess regulations that might constrain implementation of fiscal and monetary actions taken to date.
LSDM: There is so much debt! What happens when Congress just decides to turn the debt into grants?
DL: Loan programs will, in some cases, turn into grants if certain conditions are met. That then becomes an addition to the national debt. No question there is a problem here. We already have a $1 trillion deficit and $23 trillion in total indebtedness (at or near 100% of GDP) We are worsening our financial situation dramatically. No one knows the extent, if any, of the reckoning down the road. As I said before, you have to deal with the here and now, then worry about the longer term when the blaze subsides.
LSDM: What advice to you have for those of us who are old geezers?
DL: Die as quickly as you can (said in jest)! Look. Consider yourself lucky. This won't be our problem soon enough. It will be a lifelong problem for our children and grandchildren.
Thank-you
La Societe Deux Magots thanks Dennis Lockhart for a fascinating, timely update on the actions taken by the US Government and the Federal Reserve Bank to deal with the coronavirus pandemic.
La Societe Deux Magots (LSDM) is a non-partisan ROMEO (retired old men eating out) group which meets daily, at 7:00 AM at Wasatch Bagel in Park City, UT. LSDM members are the rightful intellectual heirs of a group of authors and artists (Hemingway, Joyce, Sartre, Picasso, Camus, de Beauvoir) who met daily at Cafe Deux Magots, in Paris, France in the 1930's.
Above: Iron Canyon. Park City, UT. 26 March 2020.
Springtime in the Rockies.