Will Monetary Policy be Crushed by the Weight of the Corona Crisis? (w/ Raoul Pal & Dan Morehead)
RAOUL PAL: Yeah, but I've been looking at China because if China started this first, then we should be able to understand what lies ahead for us, it's worked pretty well to use them as a roadmap. Now, obviously they lied about that the numbers and et cetera. That's irrelevant for now. What's interesting is they've forced people back to work. We've seen factories start up again, we've seen pollution go back up. Problem is one, who do you think they'll sell those goods to? You're creating I think a default cycle not only in China but around the world. I think there's a solvency crisis that we have no parallel for that is coming. Additionally, if I look at simple stuff, like really fascinating, TomTom produces traffic data for any city in the world. You look at the traffic data for Beijing, it's almost at normal during the weekdays as people get to work, weekends down 80%. People aren't going anywhere. I just spoke to somebody who was in Beijing, and they're talking about restaurants. Yeah, restaurants are open, the problem is there's only 10 tables and you're only allowed three people in a table and there has to be social distancing. In a restaurant business, which is low margin business, you basically, you're compounding negative returns. It's that destruction of cash flow that really worries me in this that we end up with a default cycle. As you rightly said, the governments have started to try and inject money to repair balance sheets, i.e. at household level. The problem is they're not offsetting people's wages so you're basically just giving them subsistence living. That doesn't drive consumption, it's not stimulus. It's just trying to paper over some of the cracks. DAN MOREHEAD: I agree. I think it's unfortunately true that in past recessions, fiscal or monetary stimulus always could cure the problem. I really think they have very, very little efficacy here, unfortunately, because even if you replace the lost income, nobody wants to go to a restaurant, or nobody wants to go to a movie theater. I do think China and other countries like Korea and Taiwan are really good case studies of how to combat the virus. I think it's very important to note that China basically walled off 60 million citizens in Wuhan on January 23rd when they had only 17 deaths, and most other countries have taken less drastic measures way later in the cycle and so I think we'll end up with a larger economic hit and China is going to endure. RAOUL PAL: What's your view of the US situation? Because that's the one that seems quite concerning and I think it's the one which will drive potentially monetary policy and a whole bunch of other stuff, fiscal stimulus. What's your view of the US situation and how that's going to evolve? DAN MOREHEAD: I would say I don't have any deeper insights than the experts on it. I'm not the guy to say it, but from an economic standpoint, it seems like this is going to be a really big hit. The call now from Goldman Sachs is the 34% annual rate fall in GDP. That's just the number you and I've obviously never seen, will leave GDP 6.2% lower than it was. Honestly, I think that's highly likely, if not more. Again, if you go back to just the, if we all just didn't work for two weeks, and then we all went right back to work doing 100% of what we used to, that's a 4% hit to trend GDP. If trend was 2%, that's minus two. I think we have to keep in mind that the US is not even really into the worst part of this problem and so it's going to be many, many months until it's worked out. RAOUL PAL: What is the role you think that the government and central banks are going to play in this on a global level? What are they going to do? Because that's the next phase, is looking forwards and is trying to understand what they do, and whether they can address any of this and how excessive monetary and fiscal policy becomes. DAN MOREHEAD: Well, yeah, they certainly can be helpful, and I'm encouraged that they have been engaged very quickly. This is a totally different thing we're fighting. We're fighting an invisible virus rather than a lack of income or lack of credit. The coordination that we're used to where the Finance Minister and the central bank governor of all the countries who are used to working together and used to using monetary and fiscal policy tools, to combat these things that are very well studied, very well known what to do with a lack of income or a lack of credit. That's not the issue here. The issue is a medical one, a science one and so we are at war. I think it's a good analog. In physical wars, you have the general give the press briefings and talk about the issues in the war. In this, it should be the scientists that are telling us what the issues are and what are tradeoffs are, scientists and economists because it obviously is a tradeoff with the economy, but those groups are not really used to coordinating. In the United States, good example of three or four different health organizations that each have some remit here and coordinating between them is difficult. They're not used to coordinating with the Fed and with the Treasury and so it's very unprecedented policy challenge. Unfortunately, I think the fiscal and monetary stimulus are going to have less impact than people would hope. In the last crisis, the US was able to cut 437 basis points. Here, we only had 150 basis points of ammo left. Then globally, the world was able to cut 298 basis points in the 2008-2009 recession. Here, we're only going to get 55 basis points on average of global rate cuts. We're seeing one fifth of the monetary stimulus we had in the last recession. This is much bigger recession, so if we wanted monetary policy to be effective, we would want much more of it. Unfortunately, the one policy lever, monetary policy is really tapped out. Then the fiscal policy, we've seen a 10% of GDP stimulus signed days before a new stimulus plan has been talked about. These are just numbers that are literally off the charts. I think it's almost certain that the United States is going to exit this crisis with more debt than after the battle against the Great Depression and World War II. That's just an amazing place to be. We entered it with a very large structural fiscal deficit, the US was spending 31% more than it was taking in even with record employment, record stock prices, record real estate prices. Essentially, just creating a ton of money, increases the quantity of money. That's the whole objective of quantitative easing, is to increase the quantity of paper money. It's already having its intended effects, a very clear policy goal was to raise the level of stock prices relative to where they would have been otherwise. That is obviously working, but it's like hydrostatic pressure is going to raise the level of all assets that are not quantitatively usable. It's going to raise the level of real estate. It's going to raise the level of gold and cryptocurrencies and dozens of other things. RAOUL PAL: Using your macro viewpoints, if you weren't in the crypto world, what would you be doing now? How do you see this evolving in market terms? DAN MOREHEAD: That's a great question. Since I hung up my global macro cleats seven years ago, I really don't want to get over my skis here. The only thing I would say is relative to what everyone else is talking about, I think it's going to be a much bigger and longer recession than other people are talking about. All things being equal, I think it's probably negative for equities. Then I think in the end, you're going to see a divergence. There's always this knee jerk reaction in a crisis. Things like the dollar and treasuries always go up, flight to safety, potentially repatriation of assets. Developed countries selling emerging market assets to bring them back to their country. They trade weighted dollars up about 5%, I think. I would have to say, I think in the long run, all of the essentially the easing of the quantity of money in countries like the United States relative to some of the other countries on Earth, is probably negative for the dollar. Again, I haven't looked at the global macro markets very closely for a long time. That's just a hunch, not something I put some money on. RAOUL PAL: I'm more fearful because if we go through a solvency event, the largest financial position on earth is the $13 trillion short position held by foreign corporations in US dollars. I worry that as global cash flow goes negative, the chance of servicing that debt becomes almost zero. You have to go through a default cycle in generally emerging markets. That makes me fear that we get a much stronger dollar. My view for a long time has been this cycle breaks not from the weak dollar but from the strong dollar and eventually forces the other central banks who have been talking about this already, that the dollar standard is not something that is manageable any longer. It's broken. Triffin's dilemma is at play and as a reserve currency, there's not enough dollars abroad to deal with this. That's what I'm fearing, and I pick up a lot from the central banks, Mark Carney was the first one to make it clear that he'd love to move the Bank of England away from this dollar standard. The first step is towards a digital currency world.