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IMF: “Keep the fiscal taps running”

October 2020

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In the latest Fiscal Monitor published earlier this month, the IMF encourages advanced economies to keep their fiscal taps running even beyond the initial phases of the crisis. Fiscal policy has so far been focused on building a ‘bridge’ over the initial collapse in economic activity to limit long term scarring in the form of permanent job losses and large-scale bankruptcies. This has cost governments around the world over $11.7 trillion or 12% of global GDP. Yet even as cash transfers, wage subsidies, furlough schemes and the like come to a tapered end, the IMF has emphasized the need for greater public investment in the ‘post pandemic’ phase of the recovery. Projects that are green, health related and/or digital will be the immediate beneficiaries of this increased investment.

This is a remarkable volte-face from the same economists who preached austerity in the aftermath of the GFC and the Eurozone Debt Crisis. What has changed in the decade or so since? Certainly, the failures of austerity are now well documented and therefore likely to not be repeated. More importantly, central bank financing of government spending is no longer an idea touted by the modern monetary theory (MMT) fringe. Rather, it has been welcomed into the domain of mainstream policymakers. Of the total US government debt issued since February 2020, the Federal Reserve has bought 57%. In the same period, the BOJ has bought 75%, the ECB 71% and the BOE 50% of their respective national government debts. With central banks financing most of the debt build up this year, borrowing costs have remained suppressed. Therefore, rather than crowding out, the IMF argues that fiscal stimulus will ‘crowd in’ even more private investment: ‘public investment can boost private investors’ confidence in the recovery and induce them to invest too, in part because it signals the government’s commitment to sustainable growth.’ Will advanced economies and their aging populations be able to spend and then grow their way out of a debt hole? We remain skeptical.

Some of the effects of prematurely withdrawing stimulus have played out in the US. With congress in deadlock and no further stimulus since July 31st, US personal income has fallen by 2.7% in August and permanent job losses have increased by 39% in Q3, still above the peak rate during the GFC. In this sense, an election win for either candidate will likely be positive in the immediate term as the deadlock is broken and much needed fiscal stimulus is renewed. The consensus view has been that a ‘Blue Wave’ scenario in which Biden wins the election and Democrats control both Houses would result in a c.$2 trillion package. Yet, like most things this year uncertainty is at an all time high. With millions voting through mail-in ballots for the first time, the risks of a delayed or contested election are very real.

U.S. lawmakers taking on Big Tech

Behind the constant debate on stimulus talks, elsewhere in Washington lawmakers have taken noteworthy steps in the fight against Big Tech. A 16-month long bipartisan investigation of the anti-competitive practices of Amazon, Apple, Google and Facebook concluded this month. The findings are numerous and provide evidence of abuse of power across the various business groups of the four giants. This was followed by a DOJ lawsuit against Google, specifically for ‘unlawfully maintaining monopolies in the markets for general search services.’ Whilst lawmakers agree on the anti-competitive practices among Big Tech firms, there remains uncertainty as to the best way to curb these practices. A more nuanced approach will likely be needed, as opposed to the simple breaking up of monopolies as done with Standard Oil over a century ago. Part of the EU’s Digital Services Act, expected to be released at the end of the year, proposes that these firms share their data with the marketplace. Such regulation would likely lower the barriers to entry for smaller tech firms, who don’t have access to the large swaths of data that give Big Tech firms a competitive advantage. Whilst we agree that regulation against Big Tech is both inevitable and necessary, it may take years before governments formulate and then enforce the appropriate legislation.

COVID surges causing slowdowns, selloffs

Turning to Europe, a slowdown is underway as the daily infections rates surge past the peaks seen in the first phase of the pandemic. Countries across the continent have attempted to impose restrictions that are less stringent than the full-scale lockdowns in the first phase of the pandemic. Nevertheless, the hit to economic activity will be severe. In its latest World Economic Outlook, the IMF claimed that voluntary social distancing contributed more than half the reduction in mobility among advanced economies. In other words, the lifting of lockdown measures created only a partial boost to economic activity. People remained hesitant to resume mobility in the fear of contracting the virus. This is further evidence that economic activity will likely not return to pre-pandemic levels until a vaccine is widespread and the perceived health risks are mitigated.
Both the Euro Area service sector PMI (46.2) and flash consumer confidence indicator (-15.5pt) hit 5-month lows. Industrial production, which saw a strong rebound in the months after reopening has grown only 0.7% for the month of August, compared to 5% in July and 9.5% in June. Most worryingly for the ECB, core inflation came in below consensus at 0.2% for the month of September. The latest data out of the UK was equally dull. Monthly GDP in August grew at 2.1%, less than half consensus estimates of 4.6%.
In the face of an increase in coronavirus cases and the reality of a return to lockdown restrictions for many, global stocks indiscriminately sold off. Europe’s approach to combatting the virus had appeared to be working better than in the US though European stocks are at a five-month low, lagging US stock performance.
Whilst the cause of the selloff is clear, additional uncertainty is provided by the US election and uncertainty around the process of confirming the winner has heightened market concerns. Optimism lingers on the hopes of a “Blue Wave” which would clear the way for significant fiscal expansion. Hopes are that this would lead into a reflation trade where we see the return of growth and inflation. At the time of writing, polls are suggesting a narrowing in the polls so a “Blue Wave” is no guarantee. Whatever the outcome on the 3rd November, the virus will still exist and remain the dominant risk to economic growth to the US and Western Europe. Valuations do not reflect this risk, nor do they reflect the burdensome debt loads that governments have taken on through support packages in response to the coronavirus.


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