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Thursday’s ECB meeting hinted at more monetary stimulus in light of a growing rate of COVID infections and increasing restrictions as well as lockdowns across Europe. Whatever monetary stimulus there will be, and there almost surely will be some, one should not forget that the global fiscal response to COVID already amount $11.7trn, or almost 12% of GDP, according to the IMF’s latest Fiscal Monitor.
We believe that the massive monetary and fiscal measures taken during the COVID pandemic thus far were necessary – a “necessary evil” to prevent an economic collapse; however, we are also convinced that they will lead to severe problems down the road.
First, we’ve long reached the point at which “standard” monetary policy stops working. Standard monetary policy is implemented through changes in base interest rates: Down to stimulate or speed up the economy, and up to do the opposite. But since the rates of the major central bank are all close to zero, the “down” is no longer available, maybe with the exception of a few basis points in the US. It’s like pushing on a string.
Second, the quantitative easing measures (a form of “advanced” monetary policy now that the standard toolbox is exhausted) have caused, and continue to cause, strong asset price inflation as central banks purchase government bonds, corporate bonds, and even equities. This leads to a direct increase in the wealth of people who are in a position to own these assets in the first place, leading to a widening wealth gap across societies. It also causes real estate prices to increase. It causes assets of all sorts to become so expensive that the average person can no longer afford them. While the rich become richer, the average person is left behind, and the poor become poorer. Retirees no longer receive any interest on their pensions, and everyone is forced to go out on the risk curve. All of this creates tension and long-term instability.
Third, a form of modern monetary policy, based on MMT, seeks to send funds and support directly to the people who need it most. Think universal basic income, helicopter money and relief checks, tax breaks, bailout of the pension funds, etc. Such measures may soon become inevitable because the trauma of the COVID crisis continues to be severe and its impact cannot easily be shaken off. Large firms are likely to continue to automate and streamline, and machines are forecast to take over greater parts of the value chain. Some businesses (bars, cinemas, smaller shops) may never reopen again, and millions of jobs are likely to remain lost. Against such backdrop, which is deflationary, the implementation of additional modern monetary policies may again feel like a “necessary evil” – but what comes thereafter? What happens when all that money gets deployed?
Possible outcomes are high inflation and thus fiat currency debasement, downgrades of sovereign credit ratings, an increase in the cost of borrowing and rising interest rates generally, more trade wars and capital wars, and more geopolitical tensions – followed by the “great reset?” We don’t know, and the Twoquants make no predictions about any of the aforementioned aspects; however, as mentioned before, in our opinion this is not the time to put a lot of risk on or go “all in” on stocks. We think a cautious stance is warranted and needed, especially since we’ll probably run into yet another deflationary phase before inflation kicks in. And this is precisely how we run the 2Q Portfolio at this point in time. Long bonds, long gold, long Bitcoin, long USD.
November 3 is approaching fast (only a few days to go). The final Trump-Biden debate is now over, and it was a more civilized affair than the first, helped by a format change that meant microphones were partially muted to avoid interruptions. Joe Biden remains in the lead, around 9 points ahead on national polls, leaving a big gap for Donald Trump to make up in the next couple of days. The Economist continues to forecasted a 91% chance of a Biden-win. As Donald Trump would say: “Let’s see what happens.”
Stay safe and #happytrading.