The weekend just passed was one which saw one of the economic dams of our time creak and then look like it had broken. This was due to the announcements coming out of Germany which as regular readers will be aware has a debt brake and had been planning for a fiscal surplus.
Under Germany’s so-called debt brake rule, Berlin is allowed to take on new debt of no more than 0.35% of economic output, unless the country is hit by a natural disaster or other emergencies. ( Reuters)
Actually the economic slow down in 2019 caused by the trade war was pulling it back towards fiscal balance and what it taking place right now would have caused a deficit anyway. But now it seems that the emergency clause above is being activated.
Germany is readying an emergency budget worth more than 150 billion euros ($160 billion) to shore up jobs and businesses at risk from the economic impact of the coronavirus outbreak, the finance minister said on Saturday.
Government sources told Reuters hundreds of billions in additional backing for the private sector would be raised, as Finance Minister Olaf Scholz said a ceiling on new government debt enshrined in the country’s constitution would be suspended due to the exceptional circumstances.
Putting that into context it is around 5% of Germany’s GDP in 2019 and I am stating the numbers like that because we have little idea of current GDP other than the fact there will be a sizeable drop. It then emerged that there was more to the package.
According to senior officials and a draft law seen by Reuters, the package will include a supplementary government budget of 156 billion euros, 100 billion euros for an economic stability fund that can take direct equity stakes in companies, and 100 billion euros in credit to public-sector development bank KfW for loans to struggling businesses.
On top of that, the stability fund will offer 400 billion euros in loan guarantees to secure corporate debt at risk of defaulting, taking the volume of the overall package to more than 750 billion euros.
As you can see we end up with intervention on a grand scale with the total being over 22% of last year’s economic output or GDP. This will lead to quite a change in the national debt dynamics which looked on their way to qualifying under the Stability and Growth Pact or Maastricht rules. This is because it was 61.2% of GDP at the end of the third quarter of last year which now looks a case of so near and so far.
Bond Market
There were times when such an audacious fiscal move would have the bond market creaking and yields rising. In fact the ten-year yield has dropped slightly this morning to -0.37%. Indeed even the thirty-year yield is at -0.01% so Germany is either being paid to borrow or is paying effectively nothing.
This is being driven by the purchases of the ECB or European Central Bank and as the Bundesbank seems not to have updated its pages then by my maths we will be seeing around 30 billion Euros per month of German purchases. Also let me remind you that the risk is not quite what you might think.
This implies that 20% of the asset purchases under the PSPP will continue to be subject to a regime of risk sharing, while 80% of the purchases will be excluded from risk sharing. ( Bundesbank)
The situation gets more complex as we note Isabel Schnabel of the ECB Governing Council put this out on social media over the weekend.
The capital key remains the benchmark for sovereign bond purchases, but flexibility is needed in order to tackle the situation appropriately.
That will be particularly welcomed by Italy as other ECB policy makers try to undo the damage created by the “bond spreads” comment of President Lagarde. Although you may note that most of the risk will be with the Bank of Italy.
Also as a German she did a bit of cheer leading for her home country.
The success of our measures hinges on what happens in fiscal policy. This is a European issue which needs a European solution. No country can be indifferent to what happens in another European country – not only because of solidarity, but also for economic reasons.
Some might think she has quite a cheek on the indifference point as that is exactly how countries like Greece described Germany. Still I also think the ECB has plenty of tools but maybe not from the same perspective.
The ECB is in the comfortable position of having a large set of tools, none of which has been used to its full extent
QE
It was only last Thursday that I was pointing out that I expected QE to go even more viral and last night it arrived at what is in geographical terms one of the more isolated countries.
The Monetary Policy Committee (MPC) has decided to implement a Large Scale Asset Purchase programme (LSAP) of New Zealand government bonds……..The Committee has decided to implement a LSAP programme of New Zealand government bonds. The programme will purchase up to $30 billion of New Zealand government bonds, across a range of maturities, in the secondary market over the next 12 months. The programme aims to provide further support to the economy, build confidence, and keep interest rates on government bonds low.
You can almost hear the cries of “The Precious! The Precious!”
Heightened risk aversion has caused a rise in interest rates on long-term New Zealand government bonds and the cost of bank funding.
Which follows on from this last week.
“To support credit availability, the Bank has decided to delay the start date of increased capital requirements for banks by 12 months – to 1 July 2021. Should conditions warrant it next year, the Reserve Bank will consider whether further delays are necessary.”
This reminds me of one of my themes from back in the day that bank capital requirement changes were delayed almost hoping for something to turn up. Albeit of course they had no idea a pandemic would occur.
Let us move on noting for reference purposes that the ten-year All Black yield is 1.46%.
The US
There are some extraordinary numbers on the way here according to CNBC.
Administration statements over the past few days point to something of the order of $2 trillion in economic juice. By contrast, then-President Barack Obama ushered an $831 billion package through during the financial crisis.
Indeed they just keep coming.
That type of fiscal burden comes as the government already has chalked up $624.5 billion in red ink through just the first five months of the fiscal year, which started in October. That spending pace extrapolated through the full fiscal year would lead to a $1.5 trillion deficit, and that’s aside from any of the spending to combat the corona virus.
At the moment we know something is coming but not the exact size as debate is ongoing in Congress but we can set some benchmarks.
A $2 trillion deficit, which seems conservative given the current scenario, would push deficit to GDP to 9.4%. A $3 trillion shortfall, which seems like not much of a stretch, would take the level to 14%.
Comment
The headline today for those unaware was from Viv Nicholson back in the day after her husband had won the pools. But we see something of a torrent of fiscal action on its way oiled by an extraordinary amount of sovereign bond buying by central banks. For example the Bank of England will buy an extra £5.1 billion today in addition to its ongoing replacement of its holdings of a matured bond.
On the other side of the coin is the scale of the economic contraction ahead. Below are the numbers for the German IFO which we can compare with the fiscal response above albeit that I suggest we treat them as a broad brush.
“If the economy comes to a standstill for two months, costs can range from 255 to 495 billion euros, depending on the scenario. Economic output then shrinks by 7.2 to 11.2 percentage points a year, ”says Fuest. In the best scenario, it is assumed that economic output will drop to 59.6 percent for two months, recover to 79.8 percent in the third month and finally reach 100 percent again in the fourth month. “With three months of partial closure, the costs already reach 354 to 729 billion euros, which is a 10.0 to 20.6 percentage point loss in growth,” says Fuest.
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