At a time when conflicting voices are raised as to when full recovery will arrive, we are pleased to present below a summary of three articles and one podcast with unique insights that may have an impact on our lives and portfolios in the medium term.

The threat of long economic Covid looms

Martin Wolf, Financial Times 

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The global economy is likely to experience not just a deep recession, but years of debility in what the author of the article calls “long economy Covid”. The economic costs have been greatest for the young, unskilled, and minorities across the world and the International Monetary Fund warns that close to 90 million people could fall below the $1.90 a day income threshold of extreme poverty. Despite the terrible consequences from the pandemic thus far, things could have been much worse. Central banks and governments have deployed extraordinary levels of support, far surpassing the levels offered after the global financial crisis. So far, fiscal support has amounted to close to 12% of GDP, or $11.7 trillion. On the other hand, all of this spending will raise public deficits and debt greatly. The global ratio of government debt to GDP is expected to reach 83-100 percent of GDP between 2019 and 2022, and in high-income countries it will be even higher, from 105 to 126 percent. Governments will have to spend to get the globe out of this economic crisis, but in due time, they will have to shift their focus to sustainable growth. 

How China Threatens American Democracy 

Robert C. O’Brien, Foreign Affairs 

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For decades, US foreign policy believed that it was only a matter of time until China would become more liberal both economically and politically. The author calls this “a miscalculation that stands as the greatest failure of US foreign policy since the 1930s”. The Chinese Communist Party (CCP) is a self-proclaimed Marxist-Leninst organization which aims to spread propaganda, restrict speech, and exploit personal data in order to dominate political thought and achieve “ideological security”. The CCP has done a multitude of things to meet their goals including, but not limited to, censoring all types of foreign media, reinterpreting religious texts, and locking up Muslim Uighurs and other minorities in “reeducation camps”. The CCP’s efforts are by no means limited to China; it is also influencing information Americans receive regarding China, using its leverage to control American speech, and collecting Americans’ data. On a global scale, China is coercing compliance through trade and international organizations. 

The US government has designated the US operations of nine Chinese state-controlled media outlets as “foreign missions”, sanctioned companies like Huawei who answer to CCP’s intelligence, and imposed restrictions on companies and individuals who have been complicit in the detention of Uighurs and other minorities, among many other policy actions. Such actions mark the beginning of the process of correcting decades of US foreign policy towards China. 

Benoît Cœuré on Central Bank Digital Currencies and the Future of Monetary Policy

Benoît Cœuré, hosted by Tracy Alloway and Joe Weisenthal; Bloomberg “Odd Lots” Podcast

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In this episode of Odd Lots, hosts Tracy Alloway and Joe Weisenthal interview Benoît Cœuré, former member of the Executive Board of the European Central Bank. The conversation focuses on the role of central bank digital currencies (CBDC’s), their implementation, and their potential effects on the world economic system. Cœuré emphasizes that there is no one-size-fits-all policy; the decisions surrounding CBDC’s are primarily political, as different societies have different comfort levels on the balance of privacy and convenience. In most cases, CBDC’s would serve as a replacement for physical cash, a direct liability of the central bank, like the currency and notes of today’s cash system. Digital currencies would still be distributed to commercial banks, maintaining their role as creditors. Similarly, the private sector would continue developing the underlying technologies (such as payment systems and digital money protocols). On the other hand, implementing a CBDC system in which the anonymity of physical cash is difficult, if not impossible. Such concerns would need to be considered by politicians in partnership with central banks to ensure the construction of a system that meets its constituents’ needs. Overall, the goal of CBDC’s is to further the goal of central banks – to provide economic stability by providing a unit of underlying value and regulating its exchange.

Key Elements of the Fed’s New Monetary Policy Strategy, and Challenges to the Fed’s New Monetary Policy Strategy

Kevin L. Kliesen and Kathryn O. Bokun, St. Louis Fed

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(Please note that this article is split into two parts)

In 2018, the Fed announced that it was going to conduct a review of its monetary policy framework, the results of which were summarized in August with Fed Chair Jerome Powell’s announcement of modified maximum employment definitions and a new strategy of average inflation targeting. Prior to this point, the Fed’s stated goals were to prevent inflation from deviating from its 2% target to either the upside or the downside, while keeping employment as close to its maximum level as possible. While the new strategy will maintain these goals, the Fed has expanded its understanding of its toolkit to effectively meet its goals. One primary aspect of this new understanding is the inability of the Fed to lower the federal funds rate due to its proximity to zero. To make up for this deficiency, the FOMC has expressed a willingness to use its “full range of tools,” including balance sheet policy, forward guidance language, and possibly negative interest rates or yield curve control (though the FOMC has ruled out these latter two measures for now). Under the new framework, the definition of maximum employment has been revised to be a “broad-based and inclusive goal,” an opaque description of what is admittedly a measure with a wide variety of definitions. That said, the tangible effects of this shift in thinking are reflected in several significant ways: employment is now listed before price stability in the Fed’s list of goals, and policy decisions will be made to limit “shortfalls” from the maximum employment level rather than “deviations.” These changes indicate that the FOMC is now less willing to implement preemptive tightening policies against future inflation acceleration, provided threats to price stability and the financial system remain muted.

The third aspect of the Fed’s new monetary policy is the approach to achieving the 2% average long-term inflation rate. Under the new framework, a period of inflation below 2% would necessitate policymaking to keep inflation above 2% for a period of time to keep the long-term average at 2%. While the prior policy made no effort to correct sub-2% inflation, thereby resulting in price levels below the target level in periods of lower inflation, the new policy introduces a methodology to return to the 2% inflation trajectory, while also introducing the possibility of overshoot. While the policy would then allow for a contractionary policy to return to the mean, should such policy occur in a recessionary environment the consequences could be severe. Meanwhile, there remain concerns as to the efficacy of the FOMC’s existing toolkit in reaching and sustaining its inflation goals; the Bank of Japan’s recent track record indicates that this may be a difficult task with the current measures. The next few years will see whether balance sheet policies and forward guidance are sufficient for meeting the challenges of inflation and employment.