After deploying almost $9 trillion, crisis fighters face new dilemmas
Central bankers used to bail out financial institutions. During the pandemic, they’ve given money to a motley cast of unlikely beneficiaries. Will it ever end?
When Tottenham Hotspur striker Son Heung-Min put the ball in the back of the net early in the second half against Crystal Palace in April of last year, he etched his name into history as the first player to score at his soccer club's glistening new 62,000-seat north London home. Less than a year after his team's triumphant 2-0 win that day, the £1 billion ($1.3 billion) stadium sat eerily empty as a coronavirus lockdown brought sports, and much of normal life, to a halt across the U.K.
Then came another milestone. In June, Spurs became the first club in the English Premier League to qualify for Bank of England support. It tapped a £175 million commercial-paper facility to help cushion the estimated loss of more than £200 million in revenue from canceled matches and other events between then and June 2021.
If BOE support for Spurs sounds improbable, it shouldn't. The central bank was hardly the only one to mount extraordinary rescue operations in response to the pandemic. In less exceptional circumstances, that money would be used to bail out banks or other lenders to stave off financial contagion. With Covid-19 hammering economies, that changed this year.
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For the first time in its history, the U.S. Federal Reserve bought a wide variety of corporate debt issued by blue-chip borrowers such as Apple Inc., as well as junk bonds from riskier companies. The Bank of Japan, the petri dish for central banking after more than two decades of extraordinary stimulus, launched a $940 billion package of loan support for businesses.
Those moves are just a few examples of how central banks are digging deeper and deeper into their monetary toolboxes to cushion the Covid-19-induced shock to the global economy. The pandemic cast aside the notion that the banks were already at full stretch. Instead, it's accelerated the transformation of monetary mandarins focused on inflation into guardians combating inequality, climate change, and more—leaving less and less scope for a return to a simpler existence.
It's a policy spiral that began after the 2008 financial crisis and has shoved central banks more profoundly into politically treacherous territory. "The more tasks you give to central banks, the more they're dealing with trade-offs associated with political choices," says Stephen King, senior economic adviser at HSBC Holdings Plc. "In the old days, monetary policy was very much a story about price stability. One tool: interest rates. One objective: price stability. Easy!"
As the virus spread, central banks from Washington to Wellington flooded financial markets with liquidity. They backstopped companies. They helped to finance massive government stimulus. The blitz included 164 interest-rate cuts in 147 days, according to a tally by Bank of America Corp.; altogether, the banks pumped in $8.5 trillion in monetary support and governments an additional $11.4 trillion in fiscal stimulus—almost $20 trillion in total.
What made the rescue all the more remarkable was this: Before the pandemic struck, a pressing concern at gatherings such as those in Davos, Switzerland, and Jackson Hole, Wyo., was that central banks were in no shape to fight a crisis given that interest rates were already so low. Not everyone was convinced pouring more cheap liquidity into financial markets would work again, given that a decade of easy money hadn't been enough to ward off the threat of secular stagnation.
But within weeks of the central banks' interventions this year, global markets began to recover, and by August stocks worldwide had reached record highs, powered in large part by the ultra-easy money. "The global track record and responses to the current pandemic show that central banks have very extensive capabilities to shape financial conditions," says Philip Lane, an executive board member of the European Central Bank who, as ECB chief economist, crafts policies including its €1.4 trillion ($1.65 trillion) pandemic bond-buying program.
What's less clear is whether the real economy will get the same kind of boost. That's why Lane's boss, ECB President Christine Lagarde, warned European governments that failure to pump in fiscal stimulus risked an economic calamity.
Similarly, Fed Chairman Jerome Powell has spoken of the limits to the U.S. central bank's abilities, stressing that it can lend money but not spend it. Prior to the pandemic, Powell was justly proud of the job the bank had done in managing the economy. By pushing the unemployment rate to a half-century low of 3.5%, the Fed was allowing the benefits of the record-long U.S. economic expansion to reach many Americans who've historically been left behind. Black and Latino unemployment fell to the lowest levels on record. Americans with disabilities or prison records—long shut out of the labor market—were finding jobs.
"The world turned upside down"
Then "the world turned upside down," as Amanda Cage, a workforce development expert, told Powell at a Fed Listens public outreach event in May. Unemployment was spiking to levels not seen since the Great Depression. Low-paid minority and women workers were being particularly hard hit—a development Powell called "heartbreaking."
Cage, president and chief executive officer of the National Fund for Workforce Solutions, based in Washington, says she fears many of the millions of jobs lost in the hospitality and health-care sectors during the crisis won't be coming back—jobs disproportionately held by workers of color. She also says she sees another "tsunami" of job losses coming at state and local governments, a sector where, again, Black workers are overrepresented. "The crisis has shone a light on the disparities that were there before but most people were blind to," Cage says.
Patrick "Duke" Dujakovich, a former firefighter and now president of the Greater Kansas City AFL-CIO, also participated in the May Fed Listens event. A member of the board of the Federal Reserve Bank of Kansas City, he praises the central bank for its response to the Covid-19 crisis. But he has a message from workers. "We talk about price stability and stability in all the financial markets, but we never talk about employment stability," he says. "Maybe that should be one of the focuses."
Economists Jared Bernstein, an adviser to Joe Biden, and Janelle Jones, managing director for policy and research at Groundwork Collective, have called on the Fed to target the Black unemployment rate when it makes policy decisions to narrow the unemployment gap with Whites. In February, the peak of the last expansion cycle, the Black jobless rate was more than 2.5 percentage points higher than that of White Americans. Brookings Institution fellow Aaron Klein says the reaction to the pandemic has been off-kilter. "The Covid disease plagues American families, particularly communities of color," he says. "Our response has been to save markets, particularly high-end, wealthy investors."
At a Princeton webinar in late May, Powell vehemently denied that the Fed's policies are widening the income gap between rich and poor; he said they're aimed at restoring the stellar job markets that existed pre-Covid-19. To do more for the real economy, Powell and his fellow policymakers came up with the Main Street Lending Program earlier this year. It guarantees payment on 95% of the value of loans made by banks to eligible small and midsize businesses. The Treasury used money appropriated by Congress to provide $75 billion to the Fed to cover potential losses resulting from defaults on the $600 billion program.
For all its ambition, the Main Street program has been slow to get off the ground partly because of the Treasury's reluctance to make it too generous. It had attracted just eight borrowers as of July 27, according to a report released by the central bank. The largest recipient identified was a casino in Mount Pocono, Pa., that got $50 million, the maximum amount allowed under the program's priority loan facility.
In another apparent effort to combat charges that its policies favor the rich, the Fed in late August unveiled a long-run monetary policy strategy aimed at achieving a goal of maximum employment that's "broad-based and inclusive." It also adopted a more relaxed posture toward inflation, saying it would welcome temporary, moderate price gains above its average 2% target. The result of the subtle yet significant changes in the Fed's operating framework: Interest rates are likely to stay lower for longer.
The ECB has had more success than the Fed in promoting bank lending to businesses. It's using a program it launched six years ago when it was grappling with a euro zone that's far more reliant on such financing than the U.S. Instead of pushing down short-term market rates and hoping they would flow through to loans, it gave ultracheap long-term funding to banks. The condition was that they use it to provide credit to companies and households, excluding mortgages. That program now stands at about €1.5 trillion, equivalent to over a tenth of the region's economy.
"We have seen a much more fundamental shift in the way that central bankers understand their mission and their role"
Annelise Riles, a professor of law and anthropology at Northwestern University, has observed that central bankers, especially in the past year, seem more aware of the need to explain their actions and respond to concerns among the general public. That's partly because of the latest crisis, she says, but also because of heightened public interest, including through channels such as social media.
She's spent more than 20 years studying central banks, having been drawn to the subject by the role monetary policy played in calming the Asian financial crisis of the late 1990s. "We have seen a much more fundamental shift in the way that central bankers understand their mission and their role. We have seen new ways of thinking and talking and new values coming in," says Riles, author of Financial Citizenship: Experts, Publics & the Politics of Central Banking.
As part of its first strategic review since 2003, the ECB, for example, planned events similar to this year's Fed Listens, but the pandemic forced Lagarde to delay the exercise. She's said she wants to make the central bank think more about popular issues such as climate change.
Nowhere is the dependence on central banks more visible than in financial markets. The biggest central banks, excluding the People's Bank of China, now own assets worth almost one-quarter of the world's stock market capitalization—about four times the pre-2008 level.
Those holdings are only going to grow, according to an analysis by JPMorgan Chase & Co. in August, which estimated that since February the central banks of the U.S., U.K., euro zone, and Japan expanded their balance sheets by almost $5.7 trillion. According to JPMorgan, further asset purchases and credit-easing policies should increase these banks' balance sheets from $21.5 trillion, or 57% of their gross domestic product, to almost $27 trillion, 67% of GDP, by the end of 2021.
"I never would have thought … our morning meeting would spend the first 15 minutes of every day talking about what central banks are doing"
Stephen Diggle knows firsthand how paradigm shifts in central banking upend markets and business models. He spent almost a decade running what eventually became one of the biggest hedge funds in Asia, Artradis Fund Management, making $2.7 billion on volatility bets during the financial crisis as markets swooned. By 2010 that strategy was dead: Major central banks had slashed interest rates, adopted quantitative easing, and flooded markets with liquidity, squeezing out volatility in the process.
So Diggle liquidated Artradis, and in 2011 set up a family office, Vulpes Investment Management Pte, to manage his own wealth and work with other family offices. For a generation, rich people such as Diggle could invest in U.S. Treasuries and other bonds to generate steady and safe returns, then juice the portfolio with riskier assets such as equities or property. But since the financial crisis, bonds have offered meager income as central banks anchored yields, forcing funds like Diggle's toward new corners of the investment landscape.
Vulpes, for instance, invested in New Zealand's biggest avocado farm, where a successful crop can cover costs and return a dividend for investors, yielding income that bonds these days just can't replicate. "A lot of the things we have been looking at have been trying to solve this bond problem," says Diggle, an Oxford University graduate who worked at Lehman Brothers before co-founding Artradis. "So, for example, we're farmers now."
Diggle's agrarian turn is just another example of how the continued Japanification of economies and financial markets—a world of low growth and low inflation and, by extension, low rates and low volatility—is affecting investors. "I never would have thought, when I first set up my hedge fund in 2002, that our morning meeting would spend the first 15 minutes of every day talking about what central banks are doing," he says. "That used to be something that these nerds in the corner of the repo markets spent all their time thinking about."
The snowballing power of the central banks is a source of great frustration for investors like Diggle. "At some level the markets don't make sense anymore," he says. "You are playing poker against the man who can make his own chips. It's a very bad idea."
Economics textbooks tell us the cheap money gushing out of central banks should eventually get people spending again and businesses hiring, pushing up prices and wages and forcing interest rates higher. That would then allow central banks to slow their intervention, halt their stimulus, and maybe even unwind it once the recovery is strong enough. But recent economic history tells a different story.
After more than two decades of purchasing public debt, the Bank of Japan now has a balance sheet larger than the country's economy, and yet inflation is back around zero. The Fed and ECB haven't gone that far yet. This suggests that if their economies follow a Japanese trajectory, it could be many years—even decades—before they'd have to impose limits on their QE programs.
But does anybody expect the power of central banks to return to pre-2008 days? The demands on them are growing and evolving in ways that keep challenging them to do more, not less: Solve the financial crisis, address climate change, avert the pandemic-driven economic collapse, restore inflation, combat income and racial inequalities.
As central banks perform roles that once resided with governments, their independence from politicians comes into question. Coordination during times of crisis is vital, but the worry in the case of those central banks that have historically set monetary policy at arm's length from government is that it will be tough to wrestle back that independence when (and if) the tide of crises subsides.
A hopeful scenario is that if the impact of the pandemic fades and economies start to grow again, there may be a way for monetary authorities to unwind at least some measures. Central bankers generally insist they could do that—the ECB's Lane says the challenges "should not be overstated"—but it could be a long and bumpy process if politicians continue leaning on the banks to dig deeper.
In the process, says Teresa Kong, a portfolio manager at Matthews Asia in San Francisco, the world may be getting hooked. Central bank support, she says, is "like a drug: The more you take, the higher your tolerance and the deeper your addiction. It's going to take a lot to get us out of this." —With Alaa Shahine and Paul Gordon
Disclaimer: This article first appeared on bloomberg.com, and is published by special syndication arrangement
Curran is chief Asia economics correspondent, based in Hong Kong. Miller covers the U.S. economy and Federal Reserve in Washington
