Category: General

Kuppy via adventures in capitalism

April 9

Last week,we got news that Carnival (CCL – USA) became the first of many large corporations to aggressively dilute shareholders after a decade of reckless financial engineering.

Before discussing this malfeasance of capital structure management, let’s rewind three decades. Excluding brief periods of exuberance at the end of the 1920s and 1960s most public companies historically were staid organizations—they grew a few percent a year and paid out some of their profits in dividends. Boards of directors were mainly recruited from large shareholders who were more focused on sustainability than quarterly numbers or pushing the share price. Sure, there were outliers, there were guys doing crazy things, but a large portion of corporate America was focused on building long-term wealth for the large shareholders (often the families who controlled these businesses).

Then came Mike Milken and his cohort of extortioners and restructuring artists. Don’t get me wrong, by the 1980s, many US corporations had grown fat and a bit lazy—a good shake-up was needed, but the following generation of financial engineers took things too far. I’m all about improving returns on assets (ROA)—my gripe is that the focus then shifted to returns on equity (ROE). Here’s a simple exercise, take a mediocre business, add ten turns of leverage and then marvel at how amazing the returns to equity are. For the past generation, every corporate executive has undertaken a similar exercise and congratulated themselves on the results. For the holdouts who refused to lever up, there was a wolf-pack of hedge funds ready to pounce and educate them on why returning too much capital to shareholders was necessary. Is it any wonder that corporate balance sheets are such a mess today? Like a wounded gazelle, if your leverage ratios were low, you were pounced upon and told to lever up.

Visual Representation of the CCL Cap Structure…

Coming out of the GFC, Boards of Directors tasked every CFO with a simple mission; figure out how much excess liquidity they’ll need if there’s another GFC that is 50% worse. What does 50% worse mean? Who cares—CFOs built models and created numbers that were agreed upon. The models mostly looked at how deeply earnings could decline. Not a single model looked at what would happen if revenue stopped. As a result, there was no rainy-day fund. There was no excess capital beyond a revolver that lasts only a few weeks at best. What should have been excess cash reserves were squandered long ago on buybacks at all-time high multiples.

As we come out of this COVID-19 crisis, I suspect that Directors will demand larger liquidity buffers. How much of a buffer? What if you need six months of op-ex in cash on the balance sheet? What if Directors demand Japan style balance sheets? What happens when you take leverage down at most corporations? You end up with middling ROEs and reduced valuations (like in Japan). I suspect that ROEs across corporate America are going to converge towards a new and much lower level. Think of the lesson from Carnival; if you spent a decade buying back stock and then dilute down 80%, have you created any value for anyone? I think a lot of corporations are about to have some real soul searching after they undertake similar exercises. If you’re a shareholder in an industry with terrible asset-level returns (think of your typical property REIT or pipeline MLP for instance), made palatable by high leverage, you may want to stop and think a bit about how the economics will look when leverage drops precipitously. You may be surprised at just how dramatically the ROE also declines. Conversely, industries that have been plagued by oversupply may now have a moment with reduced competition as companies focus on balance sheet repair instead of growth at any cost.

As the balance sheets of the world are reshaped, there will be winners and losers. You’d be foolish if you aren’t thinking about how capital structure evolution will impact your portfolio. I guarantee you, as you are reading this, Boards of Directors are re-reading their D&O policies and then thinking deeply about the balance sheet…

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April 09, 2020

You can put aside your fancy chart patterns, and your in-depth fundamental analyses.  The Fed is now in charge of everything, and the Fed is buying.  As the late Martin Zweig advised, “Don’t fight the Fed.”

After 10 years of having stimulative interest rate policy, the Fed started having restrictive short term rates.  We say that based on a comparison between the Fed Funds target rate and the 2-year T-Note yield, shown in the chart above.  The 2-year T-Note yield is the best guide for where the Fed should set its interest rate target.  In fact, we ought to outsource interest rate policy to the 2-yeare T-Note yield, saving on meeting costs for the FOMC.

In March 2019, the 2-year dropped below the Fed Funds target rate.  So even though there was no real action by the Fed then, the Fed still shifted to a tightening rate policy.  The FOMC finally woke up and started cutting rates as of the July 31, 2019 meeting, but they were behind the power curve since the 2-year yield kept on falling.

The FOMC finally took care of that problem of being behind with its emergency rate cut to zero, at an unannounced weekend meeting held on Saturday, March 14.  And Chairman Powell stated in an April 9 CNBC interview that the Fed would keep rates there until they are confident that the economy has recovered.

Getting the Fed Funds target rate back down below the 2-year T-Note yield puts the Fed back into stimulative mode.  Here is a chart showing the spread between those two, and compared to the NYSE A-D Line.  The A-D Line tends to do much better when there is a positive spread, meaning that the 2-year yield is above the Fed Funds target.

Having fired all of its guns on interest rate policy, the Fed is turning to other avenues to help stimulate the economy.  It has resumed “quantitative easing”, or QE, meaning purchases of Treasury debt and mortgage backed securities (MBS).  They are doing these purchases at a greater rate than ever before.  And on April 9, the Fed announced a new $2.3 trillion package of purchases of all sorts of things, including municipal bonds, corporate bond ETFs, and even junk bonds.  The junk bonds they will purchase are said to only be from companies downgraded to junk ratings after March 22.

Why that date?  It could have something to do with the fact that Ford Motor Company (NYSE:F) was downgraded on March 24.

The Fed has apparently learned its lesson from the 2008 financial crisis, when it was slow to act, and its first actions were bad.

In mid-2008, the Fed actually reduced its holdings of Treasury debt, which harmed banking system liquidity.  They reportedly invested the proceeds into other sorts of programs, but that was not helpful.  The market finally made an important and lasting bottom in March 2009, when the Fed commenced purchasing Treasuries again in what came to be known as QE1.  That month was also when accounting rules were changed, such that banks did not have to continue the “mark to market” downgrades of its bond assets. 

QE1 worked great for lifting the stock market, until it was stopped in early 2010, and the May 2010 Flash Crash was the result of that sudden stop in the flow of liquidity. 

So the Fed started up again with QE2 beginning in August 2010, and QE2 worked great for lifting the stock market, until it was stopped in June 2011.  A 19% stock market decline ensued in July 2011. 

The Fed got smarter when it did QE3, keeping it going longer, and then “tapering” when it started stopping that program.  There was no sudden illiquidity event like the 2010 Flash Crash, but the market still had some liquidity problems in late 2015 and early 2016.  And when the Fed started actively reducing its holdings in late 2017, we got the wild and illiquid price swings of 2018.

The Fed got back to doing QE again starting in Oct. 2019, and now thanks to Covid-19 it has sped up those purchases.  As with QE1, 2, and 3, it is working to lift stock prices.  It should continue working to lift stock prices for however long the Fed keeps doing it.  And then once the Fed tries to stop this latest round of QE, we should expect that we will experience illiquidity problems once again.  How the Fed will ultimately extricate itself from this intervention is an interesting question, but not a relevant one right now for investors.  For now, it is an open bar at the party, and the Fed is buying.

https://www.mcoscillator.com/learning_center/weekly_chart/dont_tug_on_supermans_cape/

Blain’s Morning Porridge – April 8th 2020

“The greatest idiot is a man who thinks strong stock markets are an indication of economic health.“

That was a curious day in markets… The good news ran out of steam and the rally faded… Reality rears its head again? Was it just a bull phase in a bear market, or something more significant? Does the market realise just how deep the crisis has bit into the real economy?

I’ve been trying to think through what the increasing dis-connect between the financial reality of the looming deep and dark global recession – which is upon us – versus Euphoric Markets, means in terms of opportunities and likely outcomes. The perception gap is wide enough to drive a container ship thru. 

Personally, I remain massively uncomfortable with current stock and bond prices, but can I afford to remain flat/short as Central Bank monetary policy will underpin and support prices? Some analysts are predicting record stock levels later this year. Banks are all saying buy corporate credit. It’s all on the back of market distortions created by policy.

After 35 years working in finance – when it comes to the real world, it sometimes feels like: FINANCIAL MARKETS HAVE BECOME TOTALLY IRRELEVENT.  

Yet that would be a mistake. Financial assets – listed bonds and stocks – are cocooned in a bubble, but global commerce desperately requires liquidity and cash to survive. It’s happening – behind the illusion created by public markets. 

What is actually happening out there in the real world? 

According to a note I read this morning 80% of the global workforce has seen their workplaces closed or partly closed as a result of the crisis. A tiny portion of workers will be covered by government payroll schemes or other insurance, and they face long delays in receiving money. Over a billion workers have been affected. Many will be forced to take on crippling debt to get through the crisis. This will prove the biggest, most devasting, demand shock in history. 

That is reality. 

There is not a single corporate on the planet preparing itself for a global boom. All around the globe corporates are engaged in a mad-cash scramble. Smart Chief Financial Officers know long cash is going to be critical as the globe slides into depression in Q2 and a recession that will last far longer than Wall Street and the City perceive. 

There are some fascinating trades being done – and they tell us lot about real condition, business, commerce and the developing crisis. I am working on secured asset deals with decent spreads, and full capital equity/debt financings in decent double digits. Email for details. Carnival’s secured 11.5% Senior bond last week was just one example of what is bubbling under in transport, consumer debt, property and receivables.

This morning we’ve seen details of AirBNB raising $1 bln from Silver Lake and Sixth Street in a debt/equity deal that slashes their last valuation of $31 bln to $18 bln. The two hedge funds will be getting a 11-12% Coupon. The company will raise further debt to cover the obvious short-falls in income the Virus lockdown has triggered. I’m told it’s looking to raise more debt.

After cutting 95% of its routes, Lufthansa is ditching 40 aircraft (including its’ A-380 superjumbos which I doubt will ever fly again), axing its low-cost carrier and warning about years of disruption. It’s talking to brokers about monetising part of its fleet by raising senior debt on unencumbered aircraft. Its eyeing up its $5 bln in bank lines for drawdown. Its CFO has resigned on health grounds. 

The crisis for airlines will get worse as credit card companies hold back on paying immediately on any ticket sales because of their declining credit, and fuel suppliers demand upfront payments. I’m seeing Airlines around the globe engaged in a similar scramble. Easy Jet got £600 mm from the UK Treasury y’day, and took bids on financing part of its fleet. Name an airline and I can probably tell you what they are looking to sell, steal or suborn in order to raise cash. 

Global Travel and Tourism accounts for about 10% of Global GDP, and its clearly the first hit sector. Tui got a massive bailout from Germany last month. Its back at the front door asking for more already. 

If it’s bad in Travel, go factor what a sudden 30% unemployment shock does to demand for clothes, tech, cars, and property. Listen to the anecdotal evidence around you. Workers not yet furloughed having their salaries cut because of tumbling demand. Managers beginning to panic about whether government support, subsidy and payroll schemes will kick in before they go bankrupt. 

And then widen your focus outside the developed world, and wonder how critically this is going to impact across Emerging Markets and the Developing World. 

There may be a few bright spots – although Zoom is getting it in the neck about security.. There are jobs in supermarkets and healthcare. 

However, all that glitters is not gold: former US FDA executives say the only reason Cholorquine treatments have been getting attention is not due to any scientific evidence,but purely down to Trump advocacy of the drugs. (Some might wonder if manufacturers of the drugs might feature in the President’s personal undisclosed portfolio – that definitely, absolutely, and categorically does not exist. (US Readers – Sarcasm Alert.))

Economic mayhem is the reality. Not the fact global markets briefly made it into a 20% recovery bull market yesterday. 

This is going to be a long, hard, slog of a recovery. 

Yoorp

I suppose I better say something about the big European meeting y’day If that was test of European Integration, then it was a F- Fail. Some kind of hash-up will be announced involving blah blah and some more blah with a bit of really, yeah-but, well, if and maybe. Not our problem – except it probably is. 

Five Things to Read This Morning

WSJ – The Art of Coronavirus Modeling

WSJ – Deal Spreads You Can Drive A Truck Through

FT – Tracking coronavirus: big data and the challenge to privacy

BBerg – CEOs Ditching Dividends Should Consider Their Pay, Investors Say

ZH – Here Comes The Second Wave: Wuhan Lockdown Ends And Tens of Thousands Are About to Flee The City.

If you are as bored of lockdown as I, then please use the comments function on the Porridge, send me an email or give me a call! 

Out of time, and back to the day job..

Bill Blain 

Shard Capital

This crisis is about too many to fail, as opposed to too big to fail.

Well its been 20 years since I entered the exciting world of investments and nothing prepared me for what I saw in the month of March 2020. This current disruption has already eclipsed the 2008 chaos in some markets, as we suddenly find ourselves in a period in which some markets can move up and down more in one day than they did in an entire year. A bull and bear market can happen inside of a week. This cycle is even worse than past cycles because the current era of low and negative yields has seen a ‘reach for yield’ that forces market players further and further out on the risk curve and into super-illiquid financial assets such as private equity and high-risk corporate credit.

March was the most volatile period on record.

“The virus outbreak has set three major macro impulses in motion: a global demand shock, a global supply shock and an oil war that has forced prices to multi-year lows. This final development will result in an enormous destruction of capital and, soon, structural unemployment.” Saxo Bank

The Federal Reserve’s balance sheet has swelled by a historic $1.5 trillion since repo markets first blew out in September 2019, the fastest expansion in history. During the same period, the national debt has increased by ‘just’ $900 billion. In other words, the Fed has indirectly monetized every single penny that the Federal government has borrowed since September, and then some.

In spite of the efforts by Fed, the market is on a brink of spinning out of control as credit, which is everything in today’s market, has dried up — such that US mortgage yields are rising even though 30-year US treasury yields have collapsed. In other words, the market is tightening terms on credit even as the Fed tries to ease by cutting rates. With the central bank policy tool- box empty, I think we are on the verge of full Modern Monetary Theory (MMT), when politicians take the reins from obsolete central banks and expand spending, without constraint, from debt issuance (true money printing!). The UK budget announced by chancellor Rishi Sunak,was an early indication of this and was drawn up even before the coronavirus impacts began to crystallize. And the concept of the government filling the gap left behind on demand is now even accepted in Germany, which issued its own form of Mr. Draghi’s 2012 ‘whatever it takes’ speech in vowing infinite support to German businesses large and small through a government agency. Think of the Marshall Plan after WWII, where the US issued infinite credit to war-torn Europe in order to create demand and help to rebuild the destroyed continent. In economics, this is Say’s law: the idea that supply creates its own demand. And that will be the solution here because failure via debt deflation and a credit implosion is not an option. Governments will create money far beyond any on- or off-balance sheet constraint. 

The first steps washed over the currency market with the usual patterns of risk-off behavior and squaring of crowded speculative positions. EM currencies have collapsed, the smaller G10 currencies are universally under pressure. Interestingly, the US dollar came under initial pressure against the Japanese Yen and Euro on the initial deleveraging, but later mounted a broader and more vicious rise akin to what we saw in the worst phase of the 2008-09 crash. This USD rise came even as the Fed, just as then, chopped rates to zero and launched all manner of QE and liquidity facilities.

Putting out deflationary fires = inflation?

We are convinced that the policy medicine of MMT will eventually be employed on sufficient scale to avoid deflationary outcomes. If so, and if inflation stages a sharp recovery and even begins to run hot, the key metric that many are likely to focus on for relative currency strength is the real interest rate — how much the CPI exceeds the policy rate at various points on the sovereign bond curve. Those countries overheating the printing press and running ugly, negative real rates will eventually find their currencies weakening rather than benefitting from the initial push of fiscal stimulus (I would see most emerging economies currency including India in this list).

“Never allow a good crisis to go waste”

Saudis decided to take revenge on US shale when US economy was already under pressure from dealing with Covid 19 situation and they promptly opened the spigot of oil production in the world which was already in excess of 15 MBD of supply. This led to OIL prices briefly crashing below $20 per Barrel, lowest since 2002. Demand has collapsed due to Covid 19 and supply has gone up leading to a massive contango of $15 by March end ( 12 months forward crude price is trading $13-15 over spot as market expects that demand will start picking up in next few months as the current crisis dissipates) . This has led to a hilarious massively profitable investment opportunity where every VLCC is now being hired at 10 times the normal price to store the crude.

Outlook

Vulnerabilities throughout global supply chains, ‘just in time’ manufacturing models and the pursuit of cost minimization above all else have been exposed by the virus outbreak. The crisis of confidence among has been perpetuated by political fragmentation, populism and pro-nationalist sentiment. This means the tailwind for the ongoing de-globalization shift has only grown — and with it, nationalism, protectionism and localization.

If low inflation has been perpetuated by globalization and a 30-year spate of deregulation, the opposite should be true down the line. But only once the global economy emerges from the deflationary demand shock the virus crisis and oil price war brings. The assumptions that have underpinned asset prices for many decades are shifting, which favors increased portfolio diversification to counter trend assets to achieve superior risk-adjusted returns. For example, by building long-term allocations to real assets that benefit from eventual higher growth and inflation — such as commodities and precious metals.

The extraordinary fiscal stimulus and a de-globalization tailwind is on the verge of overwhelming the markets and the only thing which can stop that is the rise in Dollar index. Any sustained rise in Dollar index beyond 103 on DXY will be massive deflationary and might result in equity markets breaking the low set in the month of March. We are in a battle for the dollar. It will decide whether the loss of income from rolling global lockdowns will metastasise into a debilitating credit crunch & a global depression, or instead, that we see the start of a global reflationary boom in H2 2020, and then the beginnings of an inflationary era.

The stakes couldn’t be higher. I am betting on the latter. 

Ritesh Jain

Harris Kupperman via Adventures in capitalism

April 5, 2020

Roughly a month ago on the afternoon of Sunday, March 8^th, Fed Chairman Powell had an emergency staff meeting.

Powell: I want the nuttiest money printing plan ever. What action plans do we have that are prepared and ready to initiate?

Admin: Well, we have this one named “GFC 2.0”

Powell: Sounds tame and sedate. Won’t impress anyone.

Admin: What about this one named “Whatever It Takes”

Powell: Lemme look… Meh… I want more shock and awe. This needs at least two more zeros.

Admin: Well, we have this other one named “Project Zimbabwe” but it’s so ridiculous that the Fed would forever lose all credibility…

Powell: hmmm… I like the sound of “Project Zimbabwe.” Just makes you want to turn dollars into toasters and washing machines to preserve wealth. This one will force guys so far out on the risk curve that they’ll think crypto-coins are value investments.

Admin: Yeah, it’s absolutely Wuhan-bat-shit nutty. We’d be criminally insane to unleash this on a population that isn’t prepared for hyperinflation…

Powell: Perfect!! Let’s have a press conference.

A few hours later…

Powell: Mr. President, I finally took rates to zero and launched QE infinity. Can you stop trolling me on twitter already? I can’t take any more of my wife cracking jokes about your tweets.

Trump: Be a man. You got it easy. Wait until you see what I do to Biden. He puts the “Dem in Dementia” haha…

Powell: Please, no more nasty tweets. Even my kids laugh at me.

Trump: Fine, but you’re thinking too small with “Project Zimbabwe.” Figure out how to print more aggressively. Look at what Mnuchin is doing with all his bailout programs. He’s gonna blow $10 trillion by early summer, then try to double that by election time. You better crank up that printing press of yours. I’ll stop tweeting if you keep monetizing the “Mnuchin Money.”

Look, everyone knows the bull thesis for gold, so I won’t wade into the weeds here. It was never a question of if, but of when. I’d say that if not now, then when? With every government and Central Bank in full-on Weimar-mode, gold’s potential upside will surprise people, especially as mines shut down from COVID-19 and limit supply. The best part is that  margin calls and liquidations have capped the gold price, giving investors one last chance to get in before the run. As people catch their breath and realize what’s happening with simultaneous monetary and fiscal stimulus, gold will be going higher. Never has a trade been this well telegraphed by this many government officials in my lifetime. Do you have enough gold to survive “Project Zimbabwe”…???

Disclosure: Funds that I control are long gold. I personally own gold.

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With the coronavirus pandemic slamming the economy into a severe recession, it’s natural to try to see the light at the end of the tunnel – and imagine the shape of the recovery. Yet, that revival will depend critically on the nature and intensity of this recession.

A recession’s severity is measured by its depth, diffusion and duration, or what we call the 3Ds. In terms of depth, this recession looks extreme, and will likely be the deepest in living memory. It’s also exceptionally widespread in terms of industries affected, so in terms of diffusion, as well, it’s a severe recession.

Regarding duration, though, this recession still could end up on the short side. In fact, there’s reason to believe it’ll be much shorter than the 2007-09 Great Recession, which dragged on for 18 months.

Here’s why we believe that this recession will be extremely deep, very broad, but relatively brief. By mid-year, we’ll have seen a huge plunge in economic activity forced by medically mandated shutdowns and widespread job losses cascading through the economy.

But if those shutdowns start ebbing by summertime, the economy will then begin reviving, albeit slowly and partially. As a result, the level of economic activity – in terms of output, employment, income and sales – will necessarily rise above the lows seen during the worst of the closures. By definition, when such economic activity starts to increase on a sustained basis – even slowly from a low base – the recession will have ended. So it’s plausible that this recession could last about a half-year, rather than the one and a half years we endured during the Great Recession.

Let’s be clear. When this recession ends, the jobless rate will still be very high, and it certainly won’t feel like a recovery. Millions of formerly employed people will still be without jobs and incomes, so sales would still be pretty weak, meaning there wouldn’t be enough demand for production to really ramp up.

A recession is really a specific sort of vicious cycle, in which falling output triggers job losses, declining incomes, and sliding sales, which, in turn, feeds back into further declines in output. It’s when this vicious cycle ends, and switches to a virtuous cycle of self-feeding increases in output, employment, income and sales, that a recession is officially over. We believe that the end of the compulsory closures can jump-start this virtuous cycle in relatively short order.

That isn’t to say that this eventual upturn is already in sight. Some might assume that this is a normal – though deep – economic valley, with steep mountains going up on the other side. However, this isn’t a recession where we can simply look across that valley, because we’re trying to look through the fog of pandemic.

We will start to see that recovery in due course, and it could be relatively soon. But this revival may be very different from the historical norm.

Some answers will come from ECRI’s publicly available Weekly Leading Index (WLI), already available through March. But right now, the WLI is in free fall.

With the WLI plunging for nine weeks – since the week ending January 24th – a recessionary window of vulnerability was violently thrown open. So, given the shock of the pandemic, there’s no question that a recession is underway.

The nine-week drop in the WLI is more pronounced than anything we’ve ever seen at this stage of a recession. It’s literally off the charts. It’s more pervasive than average, and about as persistent as it’s been at this stage of past WLI downturns.

For perspective, it’s helpful to look at a chart of WLI growth going back half a century. It looks like WLI growth has just fallen off a cliff, not having been this low since the immediate aftermath of the Lehman Brothers collapse.


 
Historically, the vigor of a recovery – at least in its first year – has been proportional to the depth of the preceding recession. But this time around, a sustained “V” shaped recovery is improbable.

Sure, it might start with a little bit of a “V” as existing businesses get employees back to work. But so many small and medium size firms are going out of business that it might actually require rebuilding rather than restarting business relationships to really get things going. In any case, people may not be so eager to get out there to restaurants and entertainment venues and mingle – not until they feel safe. That could take a while, and will hamper the services side of the economy.

In order to feel safe after such a deeply traumatic experience, people have to feel confident about their safety. They’ll venture out only when health officials can credibly assure them that the pandemic has been contained, and that a vaccine or, at least, a therapeutic drug – whether a prophylactic or a treatment – is available. Indeed, while we all appreciate the urgency of reopening the economy, saving lives is a precondition for saving livelihoods.

After we restart the economy’s engines, it will pull out of its nosedive. But without all engines firing, it won’t be a steep climb back up.

The key takeaway from our cyclical research is that this could very well be a slow, halting recovery from a severe economic contraction, but it shouldn’t take as long to arrive as the end of the Great Recession. Meanwhile, we’ll keep our eyes peeled for its advent with the aid of high-frequency leading indicators, like the Weekly Leading Index.

https://www.businesscycle.com/ecri-news-events/news-details/business-cycle-economic-cycle-research-ecri-recession-recovery-lakshman-achuthan-anirvan-banerji-a-nasty-short-bitter-recession

Is this turning out as badly as you thought it would?

First, the economic data seem worse than I had expected. The economic drawdown is going to be bigger than I originally thought, and we are currently estimating an economic contraction of well over 10 percent this year.  Second, the Federal Reserve’s (Fed) response has been really good. They’ve managed to stem the liquidity crisis in the market pretty quickly with programs that intervene directly to stabilize markets. Third, the response out of Congress and the White House has been disappointing. The programs that have been put in place likely will not be anywhere near sufficient and, in some cases, they are somewhat misguided. Extending and increasing unemployment benefits is very good but sending out $1,200 checks to lower- and middle-class families is not going to have the kind of impact that we need to keep the economy going.

Probably the most surprising thing to me at this point is how well the markets are holding up. Given the economic data, and given the fact that large portions of the capital markets are still virtually closed for business, I would have expected stock prices to be lower at this point.

How are you allocating capital as the pandemic progresses?

Coming in to this period we were very conservative. We were concerned about valuations being too high and thought that interest rates could sink lower. We believe that this has left the portfolios we manage for clients in a terrific position to take advantage of opportunities that are being uncovered. At this point, we are opportunistically trying to move from some of our more conservative investments to securities that, in our view, look attractive. We are looking at investment-grade corporate bonds and municipal bonds, and select securities in structured credit and high-yield, where prices have dropped and spreads have widened significantly, look interesting. As this situation continues to play out, we will slowly increase our risk tolerance and watch for more buying opportunities.

As I have said before, we are in the value ZIP Code, and bonds are historically cheap, so it would be foolish to remain underweight. It’s time to start nibbling, not gorging on these values. At the very least it is probably best to get to neutral versus the benchmark, which is the position to which we have moved.

How cheap are corporate bonds and asset-backed securities right now? Looking at the historical spread relationships to U.S. Treasurys for domestic debt markets, virtually every sector is at or near extreme wides. But we still expect spreads could spike wider from here, and these kinds of spikes in the past have not always been short-lived. This is why we are still cautious.

Current Sector Valuations Are More Attractive, But the Selloff Is Not Over

Fixed Income Spread Percentiles (% of Time Spent at or Below Current Spreads Historically)

Source: Guggenheim Investments, Credit Suisse, BAML, Bloomberg Barclays. Data as of 4.2.2020. Index Legend: Credit Suisse Leveraged Loan Index, Credit Suisse High-Yield Corporate Bond Index, Bloomberg Barclays Investment-Grade Corporate Bond Index, Bloomberg Barclays US Aggregate Index (Agency Bond subset), Historical CLO spreads provided by Bank of America Merrill Lynch Research, current CLO spreads based on JP Morgan CLOIE Index, Non-agency CMBS spreads provided by JP Morgan Research.

What aren’t you buying?

It is difficult to try to buy what has really been hammered. Some of the hospitality stocks and airline stocks, for example, could be a death trap—some of them may never come back. One place to look for opportunity is in companies that will perform in what I expect to be a resurgence in the United States in manufacturing.

But one thing I would caution is that if earnings continue to fall as I expect them to, S&P earnings could get as low as $100 this year. Given the traditional market multiple of about 15 times earnings, that would put the S&P at about 1,500, still about a thousand points lower than we are today. Certainly, we are down from the recent peak of 3,386, so we’ve made a big move, but we still have a pretty good move to make. Investors should probably focus their activity on bonds at this point.

We need to see the other shoe drop. When the markets start to see some of the data on unemployment rising and economic growth and corporate earnings contracting, there will be another level of panic in the market. The most likely indicators that will coincide with a buy signal would be a sharp rise in the unemployment rate and a continued fall in the ISM Manufacturing Index.

read more

https://www.guggenheiminvestments.com/perspectives/global-cio-outlook/note-to-clients-where-we-are-nibbling-at-value?utm_source=pardot&utm_medium=email&utm_campaign=nibbling%20at%20value&utm_content=global%20cio%20outlook

by Bob Rodriguez, 3/24/20

The following letter was sent by Bob Rodriguez to his friends and colleagues yesterday, as well as to Bob Huebscher. Bob Rodriguez has graciously allowed us to publish it.

Robert L. Rodriguez was the former portfolio manager of the small/mid-cap absolute-value strategy (including FPA Capital Fund, Inc.) and the absolute-fixed-income strategy (including FPA New Income, Inc.) and a former managing partner at FPA, a Los Angeles-based asset manager. He retired at the end of 2016, following more than 33 years of service.

He won many awards during his tenure. He was the only fund manager in the United States to win the Morningstar Manager of the Year award for both an equity and a fixed income fund and is tied with one other portfolio manager as having won the most awards. In 1994 Bob won for both FPA Capital and FPA New Income, and in 2001 and 2008 for FPA New Income.

The opinions expressed reflect Mr. Rodriguez’ personal views only and not those of FPA.

Dear friends and colleagues,

Though the virus pandemic has been tumultuous, challenging and with little precedence, from a capital market perspective, this market collapse was quite predictable. Capital market excesses became pervasive in ways that were also unprecedented. Zombie companies, corporate operating strategies that elevated financial risk to extreme levels and consumers who also became highly leveraged were the accepted actions of the day. Prudence was an extremely rare virtue. Many times I expressed the opinion that I thought the various equity markets were at least 40-60% over valued. Recent events would tend to confirm my assessment.

Back in 2009, in my Morningstar speech, and then after I returned from my 2010 sabbatical, I argued that, if we did not get our economic house in order, we would experience a crisis of equal or greater magnitude than the 2008-2009 period and that this would take place after 2017. With the passage of the 2017 omnibus bill and the 2017 tax cut, along with a continuation of unsound and insane monetary policies, this speculative excess period was able to be extended. We knew there would be a pin that would prick this unbelievably speculative bubble but we just didn’t know what it would be. Now we do.

Our economic and financial market systems were not prepared with appropriate “rainy day reserves” to withstand an exogenous shock. Balance sheets were stretched in all economic sectors. The shock to the US economy by the bombing of Pearl Harbor and the beginning of WW2 was more traumatic and of greater magnitude than what we are experiencing now and it would also last longer. However, after 12 years of Depression, the financial system was cleansed of speculative excesses that allowed for a financial re-leveraging of the economy to fight the war. After the carnage was over, the economy was able to grow out of an extreme leverage position. In contrast to then, this is not the case today, given that the economy is already extremely leveraged prior to the onset of the crisis. My worst fears have materialized.

Since 2013, I have been preparing for an economy of monumental excess, where debt and deficits do not appear to matter, along with Fed and other central bank monetary policies that totally distort the fundamental elements of the Capital Asset Pricing Model. With the events of the past three weeks, the perversion and conversion to a dystopian capital market and economic system is virtually complete.

As for me, with the yesterday’s Fed announcement of unlimited QE and its “will buy or support almost anything,” along with the pending passage of a $2-2.5 trillion stimulus package, this is the end of the capital markets as we have known them. We have now entered unlimited QE and MMT where there is no escape. It is the Roach Motel all over again. In Chairman Bernanke‘s 2010 Washington Post op-ed, he argued that QE would lead to a virtuous economic cycle; therefore, the Fed would eventually be able to exit from its QE operations. I argued that once initiated, a reversal would be impossible. It would be like the Roach Motel, “You can check in, but you cannot check out.”

With the initiation of the Fed’s complete takeover and control of the US financial economy, there is now absolutely no accurate pricing discovery in the capital markets and we have entered a period of total manipulation. In light of this, the only markets I have an interest in are those where the heavy hand of government is not involved or only minimally involved. This leads me to rare commodities and collectibles. The public equity and debt markets are now nothing more than greater fool markets that are led by the greatest fools of all, the Fed and the Congress. US capital markets, RIP!

Despite my having avoided 100% of the market carnage and also being profitable, I have to shed a tear for the passing of a capital market that has benefitted the real and financial economy so well for decades. In 2008, when I wrote, “Crossing the Rubicon,” I argued we had crossed over into a new economic order and system. Little did I know that within twelve short years this transformation would be virtually complete. We have entered into a far more dangerous environment where normal rules of analytics will likely not apply. When everything is essentially socialized as to risk, a return vs risk evaluation is essentially meaningless since the risk side of the equation has been truncated. Over a period of time which I cannot estimate yet, I will continue my preparation for a far different economic and financial environment. Capital deployment strategies will likely have to change from what has been the norm in the post WW2 environment. We are in a New World Order.

I hope I am wrong in my assessment, but I doubt it.

Good luck,

Bob

https://www.advisorperspectives.com/articles/2020/03/24/preliminary-thoughts-the-new-world-order?bt_ee=zaYI9QKI6HMXlkPptWZYsNxPIg3YvZyWBl%2BUje%2FLSVvMTKP1A0xBPzdPhF46PCfS&bt_ts=1585994477044

The past week witnessed 6.6 million new U.S. unemployment claims, pushing the two-week surge to a sickening almost 10 million. The U.S. economy is sliding into the steepest of downturns, with awful consequences for society, economic structure and financial stability. But this week’s CBB will focus more on the global economy.

April 2 – Bloomberg (Emily Barrett): “Foreign official holdings of Treasuries stashed at the Federal Reserve fell $109 billion in March, the largest monthly drop on record, as international governments and central banks struggled with the economic fallout from the new coronavirus. The decline showed up in the Fed’s weekly custody data, with the latest figure released Thursday showing a $24 billion drop in the week to April 1. The sales amid the past month’s pandemic-fueled turmoil are a further signal of the global rush to raise U.S. dollars…”

The Greenspan Fed in the early nineties collapsed short-term rates to (at that time) an unprecedented 3.0%. With the banking system severely impaired following late-eighties excess – and exploding fiscal deficits exacerbated by saving & loans and bank bailouts – Greenspan orchestrated a covert banking system bailout. The capacity of banks to borrow cheap (3.0%) and lend dear (7-8%) provided a powerful mechanism for replenishing depleted capital.

Aggressive reflationary policy measures come with consequences. Federal Reserve policies were a godsend to the fledging leveraged speculating community. The “government carry trade” (borrow at 3% to lever in higher-yielding Treasury and Agency securities) was tantamount to free money. With speculative leverage boosting liquidity and securities prices – along with hedge fund assets – speculative excess soon gravitated to corporate Credit, derivatives and, importantly, the emerging markets.

The Fed’s 25 bps rate increase in February 1994 pierced the speculative Bubble. Mexico, having been on the receiving end of large speculative flows, was in deep crisis by the end of the year. The peso, which had essentially been pegged to the U.S. dollar, collapsed in December. The “Tequila Crisis” saw contagion effects ripple throughout Latin America and other developing markets.

I thought at the time the destabilizing flow of speculative Bubble “Wall Street Finance” to EM had run its course. But the Clinton administration partnered with the IMF for a $50 billion Mexican bailout. Emboldened, the hedge fund industry bounced back strongly from the 1994 bond and derivatives market dislocation. The inflationary boom in securitizations, GSE Credit, and market-based finance more generally didn’t miss a beat. Rather quickly, powerful speculative flows (and underlying leverage) to the emerging markets resumed – with the booming Southeast Asian “Tiger Economies” a prime target.

Pegged currencies (“fixed currency regimes”) were an integral facet of 1990s boom and bust dynamics. Why not borrow cheap in these exciting new Wall Street funding markets to lever in higher-yielding EM debt instruments with currencies pegged to the U.S. dollar. At the same time, the booming U.S. derivatives industry was cranking out term sheets, making EM speculation easier than ever before. If you weren’t playing the melt-up in late-1996, you were a nobody.

By early-1997, booms were overheating. The Thai baht suffered huge speculative outflows in the spring and was forced to devalue by the summer. A devastating regional collapse had begun – Indonesia, Malaysia, Philippines, South Korea and beyond. The pegged currencies regime suffered a spectacular domino collapse. It was a catastrophic crisis – utter financial, economic and social meltdown. I most recall the deplorable ethnic strife that erupted in Indonesia (specifically, attacks on ethnic Chinese businesses). Currency collapse in South Korea provoked its citizens to donate $2 billion of its gold to be melted down and used to service the nation’s international debt obligations.

EM contagion made it to the ruble and Russia’s bond market in 1998, with the spectacular Russia/LTCM collapse pushing a severely impaired global financial to the edge. The dangers of New Age speculative finance were conspicuous. So was the extent global policymakers were willing to go to backstop this financial apparatus. The Fed orchestrated another bailout in 1998 – providing powerful stimulus to U.S. Bubble Dynamics that had attained critical momentum. It was off to the races (Nasdaq almost doubling in 1999).

Speculative finance is just too enticing to resist. After the dreadful 1990s experience, I expected EM economies to adopt measures to insulate their systems from “hot money” flows. What unfolded was something altogether different – and fundamental to the current unfolding collapse of the global Bubble.

Following the nineties’ episode, EM economies came to believe (or were convinced) that holding large stockpiles of dollar reserves was key to currency and system stability. And stockpile they did. After beginning 2003 at $2.3 TN, total International Reserve Assets held globally surpassed $12 TN by 2014. Over this period, Chinese reserves jumped from $300 million to $4.0 TN. South Korean reserves rose four-fold to $400 billion. Brazil $36 billion to $390 billion; Mexico $40 billion to $200 billion; Russia $42 billion to about $500 billion; Indonesia $30 billion to $130 billion; Taiwan $15 billion to $480 billion; Thailand $12 billion to $45 billion; and Turkey $20 billion to $110 billion.

I’ve long had issues with this global structure. For one, unrelenting demand for dollar reserves accommodated persistent U.S. trade and Current Account Deficits – with attendant domestic and international imbalances. There was no market mechanism to discipline U.S. over-borrowing and spending. Dollar liquidity flowed to EM, where companies would exchange dollars for local currency from their local central bank – with these dollars immediately recycled into U.S. Treasury, agency and other debt securities. The lack of market discipline was also fundamental to U.S. deindustrialization, with our fateful shift into consumption and “services” (why produce, among other things, ventilators, face masks and other “PPE” when they can be cheaply acquired from China).

The flooding of dollars globally ensured mounting excess and deepening complacency. Levered finance flowed freely into EM, spurring protracted booms and New Paradigm thinking by EM policymakers. For China and EM more generally, 2008 was but a hiccup. Reflationary finance flooded the world, pushing fledgling Bubbles to unprecedented extremes. In the U.S., the recycling of “Bubble dollars” back into Treasurys was instrumental in bolstering the view that any amount of debt issuance could be financed at low yields (“deficits don’t matter”).

This dysfunctional global Financial Structure ensured a protracted period of self-reinforcing Credit and speculative excess coupled with deep structural impairment. The massive accumulation of non-productive debt and speculative leverage was always an accident in the making. A momentous consequence of the unfolding crisis is a likely breakdown of this global financial arrangement.

Federal Reserve Assets expanded another $557 billion this week, with a five-week gain of $1.653 TN. The Fed has been aggressively buying Treasury and Agency securities, along with announcing a program to purchase U.S. corporate bonds (and bond ETFs). The Fed is employing a long list of lending facilities – backstopping the banking system, primary dealers, commercial paper, municipal debt, corporate Credit and, soon, even “main street.”

The Federal Reserve has also expanded international swap arrangements, where it exchanges dollars for foreign currencies with its global central bank partners. This week the Fed announced a new program that allows central banks to borrow against Treasury holdings held in custody at the New York Fed.

There is no doubt that unprecedented policy measures come with unintended consequences. There have already been complaints that Fed purchases have worsened instability and market distortions throughout the MBS marketplace. I fear more momentous market dynamics globally.

In all the late-nineties global market chaos, U.S. securities provided a bastion of stability. The Fed and Treasury Department’s capacity to employ system-stabilizing measures was unmatched. The Fed’s ability to stabilize U.S. securities markets provided a momentous competitive advantage over other regions and nations. The resulting U.S. market and economic resiliency were fundamental to late-nineties “king dollar” strength – that came at the expense of deflating EM Bubbles.

The dollar index gained 2.2% this week to 100.576, just below recent multi-year highs. I fear “king dollar” dynamics are exacerbating an unfolding EM crisis poised to dwarf the nineties. Of the more than $16 TN foreign currency-denominated debt globally, $11.9 TN is denominated in U.S. dollars (BIS, June 2019). Estimates vary, with EM dollar-denominated debt as high as $5.8 TN (Barron’s).

One unintended consequence of massive U.S. fiscal and monetary stimulus has been an escalation of flight out of EM currencies. Especially over recent years, the combination of rampant dollar liquidity and sizable troves of EM international reserves underpinned massive “hot money” flows into EM financial systems and economies. And with the dollar The International Currency of Leveraged Speculation, EM economies responded to the intense demand for their higher-yielding securities with unprecedented debt issuance – way too much dollar-denominated.

This week from the Wall Street Journal (Avantika Chilkoti and Caitlin Ostroff): “Emerging markets borrowed $122.6 billion through sovereign dollar-denominated bonds last year, according to the latest Dealogic estimates, up from $63.3 billion in 2009. Nearly $24 billion of sovereign emerging market dollar-denominated bonds are set to mature this year.” From the Financial Times: “The overall debt burden of so-called ‘frontier’ markets — the smaller, lesser-developed countries — reached a record $3.2tn last year, equal to 114% of their annual economic output.” And from Bloomberg: “Households around the world now have $12 trillion more debt than they did during the run-up to the 2008 financial crisis.”

It is difficult to envisage this terrible pandemic attacking a global financial system and economy at more fragile states. A heavily indebted world is heading into the worst crisis since World War II. I fear the emerging markets are at the epicenter, with dollar-denominated debt the Achilles heel.

The South African rand sank 7.4% this week. Currencies were down 6.7% in Mexico, 5.8% in Hungary, 4.7% in Brazil, 4.5% in the Czech Republic, 4.1% in Turkey, 4.0% in Poland, and 3.5% in Chile. In the changed environment, scores of companies, financial institutions and countries will struggle mightily to service large debt loads. For many, dollar-denominated liabilities will prove unmanageable.

No nation has accumulated more dollar-denominated debt than China. With its trove of international reserves, large trade surpluses with the U.S., and a quasi-pegged currency, Chinese companies and financial institutions have enjoyed unlimited access to cheap dollar funding markets. Notably, China’s now fragile banks and homebuilders have accumulated enormous dollar-denominated liabilities. This debt mismatch heightens systemic vulnerability to disorderly renminbi devaluation. How large is the levered China “carry trade”?

From the “Periphery to Core” analytical framework, China remains the “Core” of this problematic global currency mismatch. Crisis Dynamics have engulfed the “Periphery,” with key EM economies now succumbing to a “contagion” of illiquidity and market dislocation. Expanded Federal Reserve swap facilities worked to arrest global collapse. I expect effects to prove fleeting.

That China appeared to gain the upper hand on the virus has provided hope. Beijing’s aggressive efforts both to bolster its markets and restart its economy support the constructive view of China pulling EM economies and markets back from the brink. But with pandemic conditions rapidly deteriorating around the world, it may prove more a case of EM pushing a wavering China toward the precipice.

Over this incredible boom cycle, China became banker to the world. As financier to “frontier” economies, the Chinese banking system evolved into the King of Sovereign Subprime. Funding “belt and road” and other initiatives, China formulated a massive “captive finance” operation for nations previously starved of finance and investment. It now faces the prospect of a dramatic drop in capital goods export orders and thousands of customers lacking wherewithal to pay their bills.

As an analogy, automobile manufactures repeatedly succumb to the urge to “go subprime.” Lending to buyers previously unable to obtain financing is a sure way of boosting revenues. And so long as the general economy holds up, manufactures report booming profits both on auto sales and from “captive finance” businesses lending at above-market rates.

Unfortunately, things invariably turn really sour when the bust arrives. Not only do auto sales tank and used car prices sink (vast buildup in used-car inventories). The finance business turns into an unmitigated disaster. The perils of subprime surface as soon as growth slows. Before long, massive losses wipe out all previously reported “profits,” as bad loan charge-offs and servicing costs spiral.

Years of Federal Reserve market interventions and the perception global central bankers have everything under control are coming home to roost. The same can said for the belief that the great Beijing meritocracy can handle any crisis. The deeply-embedded view that Chinese officials could adeptly and, when necessary, forcefully manage their economy, financial system and currency created precarious fragilities that are in the process of being exposed.

China’s economy is today acutely vulnerable to collapsing demand, both domestically and internationally. Its $40 TN plus banking system goliath (add “shadow” lending) is a spectacular accident in the making. In the past, I’ve made the point that China’s huge international reserve position appears relatively less impressive with each passing year (of booming Credit and financial system expansion). With China’s reserves at $4.0 TN and Total Banking System Assets at $26.9 TN, reserves were about 15% of bank assets in mid-2014. Today, with reserves down to $3.1 TN and Bank Assets up to $41.7 TN, this ratio has been cut in half to 7.4%. There is also the issue of the liquidity, availability and transparency of these reserve holdings.

“The West will never allow Russia to collapse.” “Washington will never tolerate a housing bust.” “Central banks have everything under control.” I greatly fret ramifications for the day markets question Beijing’s capacity to stabilize China’s currency and Credit system. Perhaps they have the coronavirus situation contained. Yet it’s foolhardy to disregard the reality that Chinese officials have lost control of their economic and financial systems. Sure, massive liquidity injections and “national team” support have bolstered securities market prices (Shanghai Composite down only 9.4% y-t-d). Yet I believe this only ensures more destabilizing adjustments in the near future. Beijing is losing its bet that the coronavirus is a short-term financial and economic phenomenon.

I’m comfortable with the analysis that the Chinese economy suffers from epic maladjustment. Running trade deficits with many EM economies, there is no doubt that weakness in Chinese demand will hit many economies hard. And the EM and global downturn will be one more blow to the already disabled Chinese export machine. With my view of no near-term return to normalcy, spiraling bad debt problems are a certainty. The Chinese banking system hangs in the balance.

From Henry Kissinger’s Friday evening Wall Street Journal op-ed: “Nations cohere and flourish on the belief that their institutions can foresee calamity, arrest its impact and restore stability. When the Covid-19 pandemic is over, many countries’ institutions will be perceived as having failed. Whether this judgment is objectively fair is irrelevant. The reality is the world will never be the same after the coronavirus. To argue now about the past only makes it harder to do what has to be done.”

That the coronavirus crisis is a catalyst for piercing history’s greatest Bubble greatly broadens the scope of institutional failure. “The Coronavirus Pandemic Will Forever Alter the World Order,” is the title of Mr. Kissinger’s insightful piece. “While the assault on human health will—hopefully—be temporary, the political and economic upheaval it has unleashed could last for generations.”

Confidence in government will be shattered for years to come. Here in the U.S., we run up national debt past $21 TN – and fail to accumulate a reasonable stockpile of ventilators, masks and PPG. No preparation for a pandemic? After the downfall, it will take generations to restore faith in central banks. If trust in Wall Street has been thin, just wait. And right now Washington is hell-bent on destroying trust in government finances. We continue to witness behavior ensuring a systemic crisis of confidence in the financial markets and policymaking.

It’s a different world now. The chasm that developed between inflated expectations and deflating economic prospects gapped wider than ever. Prospects for a ravaging EM meltdown keep me awake at night. The existing financial structure, dominated by unsound debt, leveraged speculation, derivatives and free-flowing finance – I don’t see how it works going forward.

When EM citizens come to appreciate their boom experience has left them with unmanageable debt loads – and see their nation’s reserve holdings depleted in fruitless currency support operations – there’s going to be hell to pay. The house of cards is being exposed – and a crisis of confidence is at this point unavoidable. A domino collapse of currencies, Credit and banking systems, and economies has become a frighteningly high probability outcome.

In such a scenario, how would a crisis of confidence in Chinese finance be held at bay? Will Beijing turn more insular as it confronts calamitous domestic issues? Or would a more aggressive global stance be considered advantageous in the face of mounting domestic insecurity and dissent? The upside of Bubbles, buoyed by an optimistic view of an expanding “pie,” is conducive to cooperation, assimilation and integration. The downside unleashes a demoralizing slide into antipathy, disintegration and confrontation.

Kissinger: “We went on from the Battle of the Bulge into a world of growing prosperity and enhanced human dignity. Now, we live an epochal period. The historic challenge for leaders is to manage the crisis while building the future. Failure could set the world on fire.”

http://creditbubblebulletin.blogspot.com/2020/04/weekly-commentary-king-of-sovereign.html

He talks about the priorities, pain points, and fiscal needs of what he calls a “warlike economy”.

Rathin Roy, director, National Institute of Public Finance and Policy, was one of the members of a committee chaired by NK Singh that reviewed the FRBM Act. The report of the committee formed the basis to the amendment of the Act two years ago. In an interview to P Vaidyanathan Iyer, he talks about the priorities, pain points, and fiscal needs of what he calls a “warlike economy”. Edited excerpts:

As a member of the FRBM review committee, based on which the Act was amended, do you think the situation today, given the coronavirus health pandemic, and the subsequent lockdown, warrants a substantial easing?

A. I do not think that in the present situation an analytical framework that talks about “easing” and “tightening” is relevant. As I have said before, we are now repurposing from a ‘business as usual’ economy to a ‘warlike’ economy. In these circumstances money, indeed finance, needs to be directed to the purposes of a) fighting the pandemic and b) dealing with the consequences of fighting the pandemic. Therefore, we first need to clearly identify what needs to be done and what it will cost. We then address the problem of how (not how much) finance will be mobilised.

What are the main pain points, which need immediate relief?

A. Well, the first priority is to make sure that we have the medical equipment and personnel to execute the measures that are needed to identify, diagnose, and treat those seeking medical attention. As the number of cases grow, it is clear that we need a massive transitory increase in healthcare financing. Of course, we need more beds, quarantining facilities etc., but remember that going forward, the binding constraint will be our healthcare workers. Each healthcare worker who falls sick, breaks down, or is unable to perform his/her job, retards our effort. You do not want a situation where, to use a war analogy, you have aircraft that are idle because there are no pilots or ground crew. So, we need to ensure that finance is not a constraint in increasing our spending on securing the health and lives of these personnel who must be now given priority, and for them to be convinced that their families are provided for, wherever they may be. So, I estimate we will need to then increase the CTC spending on these personnel by 350 – 400 percent.

The second priority is to maintain supply chains such that people are able to get essential commodities and, going forward, other things that they need to live a normal life. We need to spend money on integrating unutilized supply chains and making sure that these deliver from farm and factory to home. This is going to be expensive if social distancing is to be maintained.

Third, we need to make sure that all migrant workers are secure in decent surroundings and have access to counseling, communication facilities, and government services on a priority basis. This will be expensive because our migrant workers lived in crammed and insanitary conditions in the first place and therefore the infrastructure to do these things will have to be created or repurposed.

The government announced a relief package, which was less than 1 per cent of GDP. What is your assessment of the fiscal relief requirement?

Again, “fiscal relief” is not an appropriate framework. In a warlike economy, government needs to do two things. One, protect national wealth and two, alleviate loss of national income as far as possible. This would encompass wage support, compensatory payments to those operating their own businesses and services (which is a significant chunk of the Indian workforce), and the temporary publicly financed coverage of costs associated with maintaining working and fixed capital including, but not limited to, interest relief. This is obviously going to cost far more than 1 per cent of GDP, so I am assuming that a much larger publicly financed support package is in the offing. I hope that offing is not further delayed. It has already been forthcoming for quite some time now.

What are the avenues for fund raising?

It is important to understand that financing will have to be provided at an elevated scale and therefore “fundraising” through relief funds etc. will not do the job at the macro level. There are several calibrated steps that are possible.

First, the government of India has considerable unspent balances which should be mobilized. This will take time; therefore, government should immediately use its WMA window with the RBI to mobilize these finances and extinguish such as the unsent balances are mobilized. The RBI has indeed enhanced WMA limits but it is desirable that fiscal prudence be secured by linking the extinguishing of WMAs to specific resource mobilization by government.

States are the frontline fighters of this epidemic. RBI should open a Rs 1 lakh crore zero interest WMA window for the states. The window should be for 11 months and its rollover can be reviewed in month nine. States could access this window according to some criteria. This simplest would be to use per capita population and then develop criteria according to need going forward. Sub-committee of the interstate council or GST council should be set up to monitor this process.

Second, the government of India could design a specific purpose bond to raise debt resources. The current debt mobilization system should be ring-fenced from this Covid specific debt instrument. There are several examples of such instruments being developed in a warlike situation. My preference would be for a consol – a bond that pays interest during its lifetime but has no date of expiry. It can be traded. Government should commit to announcing whether and in what proportion consol will be amortized in every budget speech commencing, say, in 2022. The consol should be denominated in rupees though foreign investors should be free to buy them.

The third measure would be the nuclear one- to increase money supply and use the incremental money supply to fund the government’s fiscal deficit. This should not be undertaken except as a final line of defense as it will have eventual inflationary repercussions. However, should the situation warrant, there is no reason not to use this instrument at scale.

Thus, I do not think availability of finance is an immediate constraint in this warlike situation. The key danger is that the resources mobilized will not be spent on the purposes intended. If money is put into people’s hands and there are no goods to buy with this money then, if the situation persists, hyperinflation will become a problem. Similarly, if money used to protect the net worth of companies by providing income and interest support but companies cut their purchases, then there will be profiteering. So, it is important to first have a clear picture from the recipients of how much, in what calendar, and to what purpose finances will be deployed before releasing finances at scale. The focus at this time should be on preparing a comprehensive spending battle plan which has not yet been forthcoming.

It is important to recognize that the states need to be funded well. It is distressing to see state governments cutting public sector salaries; this will only further shrink aggregate demand and resources must immediately be deployed to prevent this. In addition to the WMA window I spoke of earlier, a one lakh crore untied grant window should be opened for states and managed along the lines I have outlined for the WMA window.

The FRBM review report said public debt should be the most important criteria, and provided flexibility on reaching fiscal deficit targets. Given the elevated levels today, would an easing jeopardise macroeconomic stability? Should you be very concerned about rating agencies’ reaction to the breaching of deficit targets, and a rise in public debt?

I remember discussing extreme situations during the deliberation of the FRBM committee, and there was a general understating that in warlike situations, the FRBM act would need to be suspended. However, government should keep a real-time track of what is happening to key fiscal parameters, including debt and deficit ratios, and when a pathway to the crisis abating is visible, a task force should work out how to return to business as usual.

But that can wait for a later day; today it is important to focus on making sure that finance is not a binding constraint and that it is spent for the purposes intended to achieve the outcomes desired. In a warlike economy, the latter is the focus of fiscal prudence.

I do not think we need to worry about rating agencies because of the ‘business as usual’ rules, they will be cutting all government ratings to junk. We have to wait for them to come up with metrics appropriate to the current economic global crisis and respond when these are available.

https://indianexpress.com/article/business/rathin-roy-govt-needs-to-protect-national-wealth-and-alleviate-loss-of-national-income-as-far-as-possible-6342732/