By Mike Dolan
LONDON (Reuters) – The public’s financial caution around lockdowns continues to give governments and central banks both the reason and room for open-ended support of their economies through another looming wave of this year’s devastating pandemic.
With a second surge of the COVID-19 virus in full swing in Europe at least and no effective vaccine on the table yet, questions about how governments can afford the blinding costs of economic support through the Northern winter are resurfacing.
The unprecedented numbers being clocked up worldwide are daunting. Estimating a global tally for this year’s fiscal rescues so far, the International Monetary Fund last week pinned it at $11.7 trillion, or almost 12% of world output.
And that was before the latest resurgence of the virus and renewed clampdowns on mass gatherings, socialising and travel.
The IMF reckons developed economy governments are likely to have exploded annual budget gaps by about 11% of gross domestic product (GDP) by the end of the year, lifting debt-to-GDP ratios by almost a fifth to 125%.
This year’s deficit in the United States is set to jump more than 12 percentage points to almost 19% and the euro zone budget shortfall is due to balloon 9 points to more than 10% – or almost a trillion euros ($1.2 trillion).
The commensurate surge in central bank bond buying is clearly the main reason financial markets haven’t run scared and benchmark 10-year borrowing rates remain near record lows of less than 1% stateside and below zero in much of the euro zone.
And on that, the IMF estimates the European Central Bank (ECB) has bought as much as 71% of all euro government debt sold since February while the U.S. Federal Reserve has snapped up 57% of all Treasury debt issued since then.
The question for the public at large, however, is how long can governments keep this up and what’s the payback?
Part of the answer lies in a circular flow involving the mass build-up of precautionary household savings during pandemic lockdowns and beyond, and whether, or how quickly, they get run down and spent.
Unlike the money supply implosion that accompanied the banking crash and credit crunch 12 years ago, the opposite happened this year as governments pre-empted their own shutdowns with a flood of income support, lending and credit guarantees while firms rushed to borrow and build cash buffers.
Yet without households running down those savings fully, its unlikely the money supply surge from government and central bank largesse will spur any significant inflation – in itself the only significant reason central banks would rethink underwriting the government bond boom and keeping debt costs affordable.
“If more fiscal stimulus is needed, the ECB will buy it,” said UniCredit chief economist Erik Nielsen. “So long as this debt is parked on the central bank’s balance sheet, it’ll be de facto cost-free for governments and taxpayers.”
Money printing is only inflationary if people and companies spend it, Nielsen wrote, and there’s really no realistic prospect of the private savings glut becoming inflationary even if spent in a very short period.
“It’s an output gap story. The huge expansion in private savings in recent months illustrates this, so the fiscal expansion is basically no more than an exercise in propping up demand as the private sector retrenches.”
SAVING THE WORLD
U.S. household savings quintupled from January to more than $6.3 trillion in April, with the savings rate as a share of income quadrupling to a record of more than 33% as most people continued getting paid, or received additional benefits, but had little to spend it on during lockdowns.
The savings rate has more than halved since to 14% – or $2.4 trillion – in August. But it remains more than twice as high as in January.
While Europe only publishes savings data on a quarterly basis, it paints a similar picture. Eurostat shows the euro zone savings rate more than doubled to a record of almost 25% by the middle of the year.
That’s why TS Lombard economist Shweta Singh describes the money growth surge back to World War Two peaks in the United States as a “false positive” and no precursor to inflation.
What’s more, if the virus dissipates, consumer spending re-emerges and those precautionary savings are run down quickly, it will most likely be an environment where deficits and debt sales shrink too and central bank balance sheets flatten out.
Myriad questions and longer-term conundrums persist.
Can debts rise endlessly if inflation never emerges? What happens to sovereign credit ratings in that scenario? What happens if, or when, inflation does re-emerge?
Investors at Columbia Threadneedle, for example, think caution is still warranted over the “political will” in the euro zone to manage the rising debt stock of countries such as Italy and Spain which have debt-to-GDP ratios above 100% but no domestic central bank.
Pan-European borrowing helps, they say, but it may have political limits too.
Yet on the issue of “exit policies” and inflation in a recovery, UniCredit’s Nielsen is adamant: “If I were a central banker, I would be much happier navigating those future challenges than those that they have been facing these past few years.”
(The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own)
(by Mike Dolan, Twitter: @reutersMikeD; Editing by David Clarke)
