People and markets experience policy risk in a linear manner. Markets have a term for this: "headline risk." But strategy professionals know that smart response functions occur only with the benefit of some distance from developments. Perspective requires being able to see official sector activity using a 360-degree viewpoint. This is why our platform provides daily aggregate momentum measurements using a 24-hour cycle time.
The point is that often the most strategically significant development may not be the item that captured screaming headlines.
The rapidly evolving Coronavirus/COVID-19 situation in the last 24 hour illustrates the point perfectly. Arguably the most important monetary policy move occurred in Hong Kong, not at the G7 or the Federal Reserve. The Hong Kong Monetary Authority's action (see below) raises important questions about the ability of monetary policy to address non-financial crisis situations as well as real questions about how the ongoing dramas among sovereign currencies, stablecoins, and cryptocurrencies will evolve.
The Last 24 Hours -- Well Known Monetary Policy Moves
This time yesterday, Group of Seven (G7) finance ministers and central bank governors met in an emergency format. The meting itself occurred within 24 hours of a dramatic and dire set of economic projections regarding COVID19 fallout released by the OECD. Nonetheless, the G7 declined to take coordinated action.
It is fair to assess this move as a "saving the bullets" decision. While infection and transmission rates are acute in China and growing globally, economic slowdown data does not yet suggest the global economy is in the same kind of downward spiral that sparked the most recent coordinated rate cut (the October 2008 financial crisis).
Following the emergency meeting and the decision to avoid taking action, the Federal Reserve then unilaterally implemented an emergency rate cut.
The Last 24 Hours -- Other Monetary Policy Moves
The Federal Reserve move was not the end of the story. Consider the reaction taken by the Hong Kong Monetary Authority (HKMA) yesterday in response to the Federal Reserve move:
Economic policy wonks won't be surprised. Any country whose currency is pegged to the USD or pegged to a basket in which the USD is a major component, effectively commits to creating a mirror monetary policy in order to remain in line with the USD within FX markets. Moreover, experience with financial crises in the last decade creates concrete experience for central bankers seeking to operate monetary policy at or near the Zero Lower Bound (ZLB). After Lehman Brothers, extremely ow or zero interests rates no longer are taboo.
Why it Matters -- Monetary Policy
A vibrant and valid debate exists in the economic policy community regarding whether monetary policy can address effectively economic dislocations from an epidemic (or a pandemic). Monetary policy traditionally has been used as a mechanism to adjust economic demand for the purpose of delivering steady, reliable growth rates.
Following the financial crisis of 2008-10, extremely low and/or zero interest rates have been credited by many as delivering financial and economic stabilization and supporting economic activity amid historically low consumption and demand levels. Economists will spend a generation debating the relative impact of interest rate policy compared to other stabilization tools used by central banks, notably open market operations (direct purchases of domestic currency in the capital markets), asset purchases (direct purchases of stocks and bonds), central bank swap lines (which mostly guaranteed the supply of reserve currencies globally), and various bank resolution actions.
The question is whether any one or all of the tools noted in the previous paragraph can serve the same stabilizing function in situations where shifts in economic demand are triggered by exogenous factors.
In other words, fighting a financial crisis with financial tools makes sense. But if demand is elevated due to hoarding or supply constraints (as with disease testing kits, respirator masks, and pharmaceuticals) or if demand decreases due to voluntary or mandatory isolation (e.g., decreased discretionary travel, shopping, and restaurant dining), do the financial incentives associated with monetary easing have the same stabilizing impact? We are about to find out.
More subtle monetary policy questions exist as well. Dramatic decreases in consumption during one quarter of the year will certainly dent short-term economic growth. The human cost in China has been significant and dreadful. It will certainly serve as a drag on the global growth rates for the rest of the year. But it is far from clear that the rest of the world will experience the same transmission and mortality rates as China. Among other things, the rest of the world has the benefit of being hyper-aware of the contagion risk....which means most people will take at least some precautions to protect themselves from infection. Earlier detection can also dent transmission rates while improving the opportunity for better recovery rates.
If warm weather in the Northern Hemisphere generates a rebound in economic activity, then monetary policy will need to respond in order to stave off inflation. We could be in for a wild ride regarding monetary policy during 2020 if the best possible outcomes occur. Conversely, if the worst case scenarios occur (pandemic-level infection and mortality rates, mandatory quarantines and curfews, medicine and food shortages, and other consequences worthy of dystopian novels), then it is difficult to see how monetary policy can address effectively the downward pressure on the global economy.
Fiscal policy instead seems to be a more effective mechanism for addressing challenges and concerns regarding the COVID-19 situation. Fiscal policy can precisely target and quickly deploy resources to areas of vulnerability.
For example, today's rapid bipartisan and bicameral Congressional agreement to release $8.3 billion in federal funding for vaccine research, improved testing, and pharmaceutical delivery to infected people stands in stark contrast to the partisan bickering and legislative chaos during the autumn of 2008 financial crisis. Rapid bipartisan action can also generate ancillary benefits by calming a jittery populace with concrete activities designed to address the root cause of the problem (lack of defenses against infection).
Why It Matters -- Stablecoins and Cryptocurrency
The ripple effect regarding USD monetary policy in 2020 is no longer limited to sovereign-issued currencies. A growing number of cryptocurrency issuers in the last year have gravitated towards "stablecoin" constructs that peg all or some of the value of their tokens to the USD. The most famous of these in the banking sector would be last year's JPMorganCoin.
It is very likely that COVID19 may one day be remembered as much for its impact on the private token universe as for its impact on human lives.
As this analysis illustrates, significant public policy issues arise when private issuers generate payment tokens pegged to a sovereign currency. Private issuance is not a new phenomenon. Issuance in this sense is easy. Maintaining confidence in the currency, particularly through a peg or a basket, is much harder
Monetary policy only become more interesting from here. There are more questions and answers:
--Will stablecoins pegged to the USD deliver more advantageous transaction opportunities because they indirectly benefit from the Federal Reserve's rate cut?
--Will any transaction data be available to analysts and economists in order to determine whether economic behavior in the crypto space is responding (or not) to the Fed's rate cut?
--Will issuers and miners of the largest cryptocurrencies feel pressure to adjust available supply in order to compete with or mirror the Federal Reserve?
--Will central banks experimenting with retail deployments of their own digital currencies seek to accelerate pilot programs in order to minimize the circulation of bank notes that some believe can transmit disease? This is not a hypothetical scenario. The Guardian reported last month that the Bank of China is sealing for fourteen days used banknotes in order to contain transmission.
--In periods of great uncertainty, capital and foreign exchange markets traditionally experience a "flight to safety" usually to reserve currencies in general and the USD in particular. Successful currency baskets are difficult to maintain at scale and usually require significant transparency as well as predictability regarding operations. Are the stablecoin and cryptocurrency issuers up to the challenge? Will COVID19-related economic dislocations generate increased demand for these tokens relative to sovereign currencies?
--As we have been noting for the last year (particularly in this October 2018 post), financial policymakers already have raised significant concerns regarding the role that stablecoins and cryptocurrencies can and should play in an economy.
It's Not Over
The policy process is just getting warmed up. Increased scientific and medical coordination and information sharing (now in play at the G7 level, according to President Macron today) could easily provide a mechanism to sidestep preexisting transatlantic trade tensions. Starting next month, we will also enter into a series of monthly major global meetings, providing plenty of opportunity for headline risk and realignments as policymakers coalesce against a shared enemy: COVID-19.
The coronavirus may have disrupted global supply chains during 1Q2020, but policymakers and businesses will not declare defeat that quickly. People adapt to new circumstances. We don't have to live in a dystopian novel. Congressional and G7 leaders are giving every indication this week of an alternative narrative.
So pull up a chair; grab a seat on our platform. Our 9+ levels of analytical automation and quantification will help you spot global inflection points as they emerge every day. It's going to be a very interesting year.
Last week, the BCMstrategy, Inc. platform began tracking the global economic and financial regulation policy shifts associated with the Coronavirus Outbreak. We have also launched a #coronavirus channel on our open Slack workspace where we will share insights and daily platform data regarding global policy initiatives on this topic. For more information on how the BCMstrategy Inc. policy monitoring platform can accelerate your ability to identify strategically significant developments please contact us. If you would like to join our free and open Slack channels, we will be glad to send you an invitation if you reach out to us.