Central banks riding to the rescue of crashing debt markets must think twice
- Aside from the moral hazards of such a massive bailout, the risk is that a wall of central bank money meeting slumping growth and output can cause the greater damage of hyperinflation
Financial markets are, to quote one seasoned and expert observer, “in full-blown panic mode” while the United States Federal Reserve and other central banks are poised to go into full-blown lender-of-last-resort mode. All this is being blamed on the coronavirus pandemic but in truth it is (yet) another financial market crisis.
It will not be allowed to happen (for now, at least) because the Fed will be forced to step in and reliquefy it, “thus aggravating the moral hazard it has been running for some time”, as Hung Tran, a former senior official at the Institute of International Finance, put it to the Post.
As Tran, now a non-resident fellow at the Atlantic Council in Washington, said, there has been a “noticeable deterioration of liquidity amidst rising volatility in the US Treasury market, [which is] the risk-free benchmark for the pricing the world’s fixed income market”.
Or as Harvard fellow Paul Sheard, S&P’s former chief global economist, said: “US Treasuries are the world’s ‘safe asset’ and are used as collateral in all kinds of financial transactions.” Market liquidity is not a fixed quantity but depends entirely on buyer and seller sentiment.
It is nice to think of central banks as benevolent institutions with infinite resources ready to ride to the rescue whenever a financial crisis threatens, and ready to regard the financial excesses that provoke the need for rescue with a kind of avuncular indulgence.
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Setting aside the merits or otherwise of such arguments, central banks in the world’s leading economies face the prospect of having to monetise huge volumes of not only government debt, but also corporate, and maybe even household, debt too.
But they are not. First, the Trump trade wars and now the coronavirus crisis are threatening to bring on a global recession, which in turn threatens massive debt defaults and financial institution failures unless central banks underwrite them by embarking on massive reliquefying and support programmes.
They will almost certainly do so and it might be supposed that, as with modern monetary theory and fiscal manoeuvring, such an unprecedented bailout can be accomplished with minimal shock to the system and relatively little pain to consumers and investors.
We can only hope that the coronavirus crisis subsides rapidly, allowing human activity and economic output to return to something like normal before long. That would allow the system to stabilise somewhat, if only at lower output levels.
But the mood of panic in financial markets, matching public panic over the threat of catching the coronavirus, does not augur well. Maybe the mere promise of central bank support may calm nerves – but let us hope that such support does not need to be forthcoming.
Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs