Intraday Market Thoughts

Breaking the Ultimate Taboo

by Adam Button
Apr 28, 2020 14:48

Global indices resume their advances while USD extends selloff as optimism broadens from positive news on the Coronavorus cases front. Although the number of confirmed cases worlwide passed 3 million, new cases in Italy hit the lowest in seven weeks, while the number of deaths in the UK dropped to its lowest since March. Bank Indonesia will become the first of a wave of central banks to buy debt directly from the government in what is a case of breaking the ultimate taboo of central banking. A new Premium trade was posted.

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Breaking the Ultimate Taboo - Balance Sheets Apr 28 2020 (Chart 1)

Direct debt monetization is the oldest trick in the monetary playbook but it's suddenly back in vogue as government spending explodes. Bank Indonesia will become the first of a wave of central banks to buy debt directly from the government. The Australian dollar was the top performer on Monday while the Swiss franc lagged.

For centuries governments have tried to engineer tricks to spend more while paying less. Some have even worked. China was able to finance an export boom buy buying US Treasuries to keep the yuan low. The US directly monetized debt in WWII but engineered an escape because of the dollar's newfound reserve status and the economic boom of the 1950s.

Japan has never admitted to monetary financing but it's hardly plausible that government debt will ever fall to manageable levels, or that the BOJ's balance sheet will significantly decline. So far it's arguably worked.

The examples of it failing in economic history are countless.

Now that we find ourselves in the midst of a long-term disinflationary period and with a global human catastrophe, central banks are going to push the envelope. Tuesday's planned purchases in Indonesia break all the rules of modern central banking.

This is the culmination of a 10-year period of QE that started with central banks saying it was a temporary measure to suppress long-term yields. They said assets would be allowed to run off. Those illusions have faded and central banks have purchased an ever-increasing pool of assets. The ultimate taboo is buying debt directly from the government. At least by selling it to the public at auction and then to the central bank in the secondary market, there's some illusion of free-market policies. Now with this – and in so many other instances – that myth is shattered.

This is a crisis in the making; it will end disastrously. But a look at history shows that the illusion of money is powerful and the charade can go on for many years. In particular, if everyone is doing it, then all currencies tend to fall together.

The playbook now isn't so much betting on a bad outcome; it's betting on government deficits never seen before outside of wartime. It's betting that fiscal conservatism is dead and that any spending project is in play. That's a powerful force; at least for awhile.


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