Tanvi Ratna
In a season of headlines and dramatic measures, the Federal Reserve on March 23 made its most dramatic announcement yet -- QE Infinity. However, the underlying vulnerabilities for the dollar are deep, and despite unprecedented measures, the dollar might face a deep crisis. This is a matter of concern to all watchers of the global economy, and to central banks in India and abroad.
It is important to understand that the current economic crisis in America is not merely a coronavirus-fuelled crisis. There are two crises at play. The first is a coronavirus health pandemic which has created global demand-supply shocks and other effects. The second underlying crisis is a full-blown debt crisis, which has been a long time coming. As early as 2019, experts were betting on a downturn – due to corporate debt – well before coronavirus even raised its head.
The chief economist of Moody’s Analytics already predicted a corporate debt-laden recession in 2020 as early as January 2019! In September 2019, the head of the world’s biggest hedge fund, Ray Dalio spoke of the debt bubble being comparable to the 1930s depression and by November 2019 he had bet $1.5 billion on a stock market collapse in the US by exactly March 2020.
Everybody is in debt
At the level of citizens, American household debt crossed a whopping $14 trillion as of February 2020. Credit card debt rose abnormally by $46 billion. More importantly, delinquent loans have risen substantially, especially amongst young consumers in their 20s and 30s. A survey conducted by the Fed in 2016 revealed that 47 percent American households would find it difficult to scrape together even an extra $400 in a crisis.
Debt levels of the US government are at a league far out of pre-2008 crisis levels. While US national debt stood at about $7 trillion in 2007 pre-crisis, it had ballooned to $23.5 trillion by March 2020. The debt ceiling has been retired by Congress until after the 2020 elections. The current clamour for fiscal packages amidst the coronavirus is expected to push national debt to beyond $25 trillion.
It is America’s corporate debt that has had observers most worried and it stands at $10 trillion. Many observers critique the vulnerability of the system and the failure of overleveraged corporates to learn lessons from the 2008 crisis. In a time of record stock market highs, corporates used a lot of their profits to buy back shares rather than focus on productive investment. For example, Boeing spent 74 percent of its free cash flow on share buybacks and has been one of the first to apply for a bailout with a $60 billion ask. The top 5 airlines in the country spent $45 billion in share buybacks and are the first in line for bailouts.
There is no guarantee that these bailouts will go in the right direction for the economy either. We are now in a situation where politicians via bailouts are deciding the allocation of capital, not a market process. Some argue that the first line of companies for bailouts should be pharmaceuticals, hospitals and others who would stop the spread of coronavirus in the country. However, there is no mention of these companies in the proposal by President Trump. Airlines, hotels (perhaps including Mar-a-Lago) which could revive on the back of stemming coronavirus, appear to have been given first priority.
A recent analysis phrased these concerns succinctly: “Why do we continue to aid and abet a small class of insiders using their overleveraged companies to extort bailouts from society?”
Who is going to pay for the new dollars being created?
The latest US GDP contraction estimates stand at -1 percent to -24 percent. This raises the question of how the government will finance its recovery if there is neither rising tax income nor other effects of growth to pay back the spending. American citizens and corporations are indebted, as is the government. Where raised taxes would be used to finance the bailout, President Trump has been cutting taxes aggressively ahead of the 2020 elections. His tax cuts of 2017 were estimated to add $1 trillion to the national deficit. He has now pushed for payroll taxes to be cut. These financed unemployment benefits and cuts come at a time when a record 2 million Americans have filed for unemployment benefits.
All of this stimulus hinges on two factors – that the Federal Reserve can prop up the dollar and that there is unlimited global demand for US dollars from the world’s central banks given the reserve currency status. Both premises are under threat in this crisis.
It’s not 2008
Apart from cutting interest rates to zero, the Federal Reserve has just announced the beginning of unlimited asset purchases. The Fed is venturing for the first time into purchasing corporate bonds, apart from the purchase of commercial paper, T-bills and other assets. While this created a few hours of relief in the stock markets it is also dangerous as risks are now transferring to the government balance sheet from the rest of the economy. With a sharp economic downturn, the Fed could be left holding on to bad assets. This is also pushing the Fed into the risk of permanent debt monetisation, with debt being converted into credit or cash. The inflation created by this will be tremendous, and it could put the US economy through the experience of Zimbabwe, Venezuela, the Weimar republic and others who have tried to print their way out of a deficit.
Such as disaster can be averted if the demand for the dollar stays high globally based on its reserve currency status. And this is where the situation is very different from 2008. While the 2008 crisis started in the US financial markets, the coronavirus pandemic has simultaneously put every global economy under strain. Most countries have imposed nationwide shutdowns and all domestic and international supply chains are impacted. In addition, almost all governments are creating stimulus packages. At the moment there is a clamour for dollars in the market, and many economists believe this will only strengthen. However, this demand should not be misunderstood – it is a short-term global rush to cater to dollar-denominated debt. This would continue for some time but might not continue too long.
We are seeing the first impacts of the dollar reserve currency hitting the currency markets, with the dollar strengthening considerably and other currencies taking hits. The rupee breaching Rs 76 to a dollar made headlines nationally. The Australian dollar saw a flash crash to record lows. The dollar is only expected to appreciate more in the short term as the scarcity is acute. With every country facing a contraction and financing stimulus, how much precious national wealth would be put towards currency stabilisation? With a backdrop of sanctions and trade wars, we have already seen countries switch out of dollar-based pricing for some commodities. India, for example, bought oil from Iran in rupees, bypassing the dollar. China-Russia and China-Japan settle some of their trade directly, bypassing the dollar.
If inflation rises in most economies and the dollar continues to strengthen, at some point countries would be incentivised to find other denominations for trade. What the future standard might look like is anybody’s guess. But if the dollar cannot provide stability for global trade, the dollar standard will be challenged in this environment.
Tanvi Ratna worked in the US Congress in the aftermath of the 2008-9 crisis. She is the Founder and CEO of Policy 4.0, a think tank and policy advisory body specialising in fintech, blockchain and cryptocurrency issues.
