Economics / Special Report

Vol. 5, NO. 1 / April 2020

Enter the Coronavirus

Henri Lepage

Letters to the Editors

In response to “Enter the Coronavirus

A  recessionary downturn was underway well before the advent of the coronavirus, its trajectory fixed at the beginning of 2018 by the inner operating logic and methods of the new global Eurodollar system. There seemed to have been a pause in the recession in the autumn of 2019. By January 2020, economic indicators showed that the world economy had resumed its recessionary descent. The only unknown was its intensity. For all that, it was likely that the world economy was approaching an inflection point—which did not rule out an American recession and severe difficulties in the emerging economies.

On February 20, 2020, some yet unknown financial incident tipped the economy into a crash, one similar to the crash triggered by the events of August 2007. At that time, it took more than a year for the crash to produce its full effects. Enter the coronavirus, whose disastrous economic consequences became obvious after February 20. To what extent did the pandemic accelerate the crash? We will never know. What is quite exceptional is the telescoping of the two events: on the one hand, the pandemic, and on the other, a recession generated at the level of the global wholesale money market by a growing scarcity of collateral assets.

What is quite astonishing, and almost incomprehensible, is the almost total ineffectiveness of the monetary measures taken by the Fed to avoid a repetition of the great crash of 2007–2008. The Fed has intervened massively. The figures involved are gigantic. The Fed has done just what mainstream economists told it to do. In less than a fortnight, it put in place the full panoply of intervention measures that it had taken months to mobilize during the last major financial crisis. Measure after measure showed disappointing results. Monetary liquidity remained scarce. Two weeks ago, it had virtually disappeared. Markets were paralyzed. The Fed’s auctions have not protected the repo market from suffocation. By reviving its network of swaps between major central banks, the Fed has apparently shown its determination to assume its role as the bank of last resort. This is an important event. With the Fed’s announcement that all the money taps will be open, the real economy should find itself drowning in liquidity. This is clearly not the case. It’s as if the money is stuck somewhere.

But where?

The central banks have not yet grasped the nature of money in the new banking and monetary world inherited from globalization. If a currency does not spread in the real economy, it is no longer truly a currency.

In the past, the central bank needed only to carry out a few open market operations and thus increase the supply of money by expanding its balance sheet. This was generally enough to set in motion a multiplier mechanism that spread this money throughout the economy. Things are not like that anymore. The world has acquired a two-tier banking system. It is the wholesale interbank market that comprises the second tier. Transcending borders, it also acts as a transmission channel for the monetary policies of central banks. The global wholesale market operates according to rules unlike those of the old first-tier banking system. That system was characterized by the guarantee that state currencies would have fiat money status. In the global wholesale money market there is no such guarantee. Everything is ordered by the principle that all credit operations must be accompanied by a concomitant deposit of collateral: a pledge of a financial value whose term to maturity at least matches the debt at issue. This means that the distribution of central bank money, which passes through the accounts of a small number of dealer banks, can only take place if the banking and nonbanking institutions that are their clients are able to accompany their requests with a corresponding supply of collateral assets, public or private.

This is where the taps of Eurodollar global money creation lie; and they are controlled by the system’s primary dealers, who determine the list of securities that may be collateralized. The longer the list, the greater the supply of collateral. The greater the supply of collateral, the easier the credit. The converse is true, as well. The shorter the list, the smaller the supply of collateral. The smaller the supply of collateral, the tighter the credit and global money supply. Since February 20, collateral has been very scarce indeed. This situation developed over the past two years as a consequence of increasing risk aversion by global banking markets. It was recently aggravated by the rebirth of quantitative easing, which policy culminated in the seizure of the best of collateral securities by the central bank—the other little-known side effect of the Fed’s interventions.

What is today missing from the Fed’s anti-crash package is collateral. This crucial issue of collateral scarcity has not been dealt with at all. Nobody takes it into account. Central banks remain focused on long anachronistic monetary models with a concept of base money which, in our new world of globalized banking, has become totally inoperative. In this new banking environment, what makes money economically active is the extent to which it is matched to collateral availability—so much so that the system’s real money now lies in its collateral. Neglecting its role leads monetary authorities, in times of falling asset prices, to aggravate the global shortage of liquidity, even as they attempt to flood the market. This is, in fact, where the blockage is located.

At last count, the Fed’s interventions would have saved half a dozen large US hedge funds that were, until recently, blamed for the September 2019 events in the repo market. These are circumstances that will reinforce the criticisms from those who believe that the central bank’s actions consist mainly of helping the rich. On the other hand, voices are being raised to explain that $2 trillion or $4 trillion is not yet enough to be economically efficient. In reality, the real problem is not just a question of amounts, however huge they may be, but of piping. In today’s globalized economic world, it takes two pipes to get money flowing.

The Fed has forgotten one, and central bankers do not seem to be aware of it either. The global economy is now acquiring the distinctive character of a highly nonlinear system subjected to severe random shocks. One has apparently been endogenous and occurred on February 20. The other in the form of a global pandemic is exogenous and is occurring still.

There is every risk that this peculiar combination of defect and disease will lead to a very deep depression.

Events are now in the saddle.


Henri Lepage is a French economist.

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