Macro Outlook Relies on more than Liquidity Infusions
The macro recovery is not just about large doses of economic liquidity, but getting it moving around the economy at a fast-enough rate.
The response of governments to the Covid-19 pandemic was not to create war time economies. Whatever the same governments may have said to describe the impact. The effect of policy was to demobilise and create what the Federal Reserve Chief, amongst many, called ‘unprecedented’ when referring to the depth of the economic contraction.
Actual growth figures do not convey the extent of contractions. For this, levels are much better. Levels will be far more of a focus as economies (hopefully) begin to recover. In recovery, economies grow, but to fully recover, they need to reach the pre-downturn level. It is during the pandemic economic recovery that governments will be more entitled to describe policy as attuned to a war time economy. Policy in a war time economy is to maximise production.
Reacting to the pandemic, central banks and governments alike are throwing the policy kitchen sink at economies in order to prevent large scale job losses. This to support as robust a recovery as possible. By any measure, the global monetary base is soaring and is highly unlikely to fall for a significant period of time. Concurrently, though, velocity of circulation is falling. This matters a great deal as the lower velocity is, the less bang for the central bank buck. Crudely, velocity is a proxy for how much an economy will create per unit (dollar, yen, yuan, euro etc) that is sent out by central banks. In other words, each unit increase in the monetary base will create less economic growth as velocity declines. Falling velocity is a long-term trend that accelerated during the Great Financial Crisis and has never recovered to pre-2008 levels. In the US, M2 (a measure of money supply) velocity has fallen from 2 to under 1.4.
Ultimately, economic recovery will rely on final demand. For many economies, this means consumer spending directly and indirectly. Germany for instance makes and exports the capital goods that China uses to produce a lot of stuff consumed globally. Globalisation in action. The lockdowns and furloughing schemes introduced to save jobs combine to create a large chunk of involuntary savings accumulation. Turning that into actual spending (final demand) rather than precautionary saving will be the hope. This in turn depends on how long lockdowns last. The longer they last, the greater the chances of higher unemployment now and in the future which will dampen confidence and induce more precautionary saving. The higher precautionary saving, the lower the velocity of circulation and the slower the recovery.