Jim Bianco on Policy Responses to the Coronavirus: Details, Implications, and Concerns Moving Forward

The post-virus economy faces possibility of higher inflation, threats to Fed independence, and increased pressure on the European Union.

Jim Bianco, of Bianco Research joins Macro Musings to discuss the latest on the economic impact from the coronavirus. David and Jim discuss the details and implications of the $2 Trillion Relief bill, the possibility of higher inflation, renewed threats to Fed independence, and implications for the Eurozone.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Jim, welcome back to the show.

Jim Bianco: Thanks for having me.

Beckworth: Well, I wish it were under better circumstances, but I think you're a great person to have on to continue our conversation about the implications of this virus. We've been doing a number of shows. We've actually increased the frequency to twice a week. We'll keep this up for a bit anyhow, try to make timely commentary in what's going on. And you always have a great market commentary. You've got your fingertip on the pulse of the market and what people are saying. So it's great to have your perspective on the show as well.

Beckworth: Today is March 25th, Wednesday, and this show will be played on the following Monday, the 30th so a lot could change between now and then. But still, there's a lot of big developments that have happened to date. And today even, the Senate was debating a big bill, $2 trillion bill and it looks like it got held up by Senator Sanders and a few other republican senators having issues with it.

Beckworth: But it's a big, big bill from Congress and the White House. And we'll talk about that later in the show as well as what the Federal Reserve has been up to. But before we get to all of that, I just want to hear how are you doing, Jim? How are you adapting to life with the virus?

Bianco: Well, I'm adapting fine. I'm at home working like everybody else. But I also have within my house four kids. Now, two of them are already out of college. One is in college, so they're not ... And an eighth grader. I have two dogs. I have two cats, and I have my wife working at home. So my house is stuffed to the gills right now with people. And they're all daughters and it's all drama all the time.

Beckworth: Great. So you got the drama outside and inside that you got to wrestle with on a daily basis. But you're in Chicago. Is that right?

Bianco: Yes, I am.

Beckworth: So how was-

Bianco: We're in locked down.

Beckworth: You're in locked down, okay. So what's the feel of Chicago right now?

Bianco: It feels like it's Sunday morning at seven o'clock everywhere you go. A little while ago, I went out for lunch, there's hardly any traffic. Half the stores are closed. The ones that are open, I went to a Subway, I was the only person in there. And I'd been the only person there for 20 minutes, is what they told me.

Bianco: There's a lot of people walking around riding bikes, social distancing, but other than that it's pretty empty right now. Not a whole lot is going on.

State of the US Economy

Beckworth: That's a great way to describe it. It's like a Sunday for many parts of America right now, lazy Sunday. Well, let's move on and begin our conversation today by talking about the state of the economy. We'll get to the policy developments later again, what Congress and the White House had been up to as well as the Federal Reserve. I want to talk to you, Jim, about the state of the economy and how bad is it going to get. So I believe coming up shortly, is it tomorrow, we get jobless claims? Is that right?

Bianco: Yeah.

Beckworth: Yes, so it's this Wednesday, and then tomorrow, Thursday, we get jobless claims and I'm hearing some pretty staggering numbers. We're going to go from around 200,000 to 3 million, is that right?

Bianco: Yeah. Wall Street estimates are anywhere between 1 and 4 million and around 1.5 to 2 is the estimate. But there are some that are as high as 4. And you put this number in the perspective. Two weeks ago, we were at around 211,000, 204,000 and that was one of the lowest numbers in 50 years. And the highest number recorded was around 660,000. That was in late 2008, early 2009.

Bianco: So we're going to go to 3 million, 2 million. I mean, these are numbers that are hard to fathom at this point. And the antidotes all say it too that a lot of people are saying that they can't even file for claims because they have to go to a claims office and they're overrun and then they try to go to the website, and the website crashes because it's got so many people that are trying to file for claim. So there could be ... Excuse me, whatever this number is, it could be a bigger number even next week too.

Beckworth: That's interesting. We've been talking on the show about the need for infrastructure or capacity to handle the large government stimulus programs that are coming online to cash distributions, for example. But unemployment insurance, that too takes capacity. It takes infrastructure and what you're saying is we don't have it right now to handle three million people.

Bianco: Yeah, there was an interesting story that I read this morning in one of the states and I forgot which one. But he laid off all of the workers in his restaurant and I guess, he needed to go on one of the sites and kind of note that they've been laid off so they could be eligible for insurance. It took him two hours to do what should have taken five minutes.

Bianco: And then when he was done, he got an error message and said, "Please try again next week."

Beckworth: Frustrating.

Bianco: Yeah, it has been. And that's only going to get more complicated as all of these bailout bills like the small business relief package comes in and the stimulus package comes with potential loans and guarantees and stuff like that for a company. Yeah, that's great that they're going to get the money but the process of getting that money is going to be very difficult.

Beckworth: Right, because many of the employees who had process that themselves maybe at home or sick. And then on top of that, you got to get more of them and now is not an easy time to ramp up your staffing needs when you're on locked down. So this could be a huge logistical nightmare for the US government.

Bianco: Absolutely.

Beckworth: Yeah, so that's jobless claims. So we're going to see a pretty dramatic increase in jobless claims, so people file in for unemployment insurance or benefits something very, very staggering which is not surprising given the sudden stop, the break, the off switch we've applied to the US economy.

Beckworth: Also pretty dramatic are some of the estimates for the unemployment rates. So what are the numbers you're seeing?

Bianco: Anywhere between, eventually, when this is settled out in the second quarter, the high peak has Bullard of 30%. And I've seen a lot of 20s as well too. I got a chart I'm looking at that shows the unemployment rate going back to 1869. That is the DLS data plus a bunch of academic studies that have tried to estimate it all the way back to the Civil War.

Bianco: The highest number was just under 22% in 1934. So that is at risk of following for a new record here in the second quarter if these estimates are to be believed. Let's face facts, when you get in a situation like that, all people are doing is guessing. I doubt that anybody could put together some kind of a mathematical model to try and estimate this stuff when you get into this kind of environment.

Beckworth: Yeah, it is a pretty scary number, 20%, 30% unemployment but we don't know for sure what it will be really large number of people filing for unemployment benefits. GDP also very high and you mentioned Jim Bullard too. He had a 50% contraction in Q2. I've seen 24%. Where do you think that will come out?

Bianco: Yeah, I'll throw in that Morgan Stanley said 30% and Capital Economics is out today at 40%. Now, remember that these are annualized second quarter numbers. So it's not that the whole economy is going to be halved. It's just that the annualized rate for one quarter could be down that much.

Bianco: Depending on where we go with this, I'll give you another statistic too. So I've got a yearly chart here of real GDP back to 1790. Again, the compilation of a bunch of academic studies, they have tried to reverse engineer it and the worst quarter or the worst year, remember this is a 1231 year, is down 1289, 1933. And then down 1106, 1946. They're wind down into war.

Bianco: If these estimates are right, we're going to be talking about those kind of numbers as well too. This is like almost surreal that, could you imagine 60 days ago that you would talking about the idea that we're going to set the all-time record with unemployment rate and the all-time record for GDP in the next quarter and stuff. This is just surreal that we're talking about these in these terms.

Beckworth: It is. And when the Jim Bullard numbers came out, I tweeted, this is either absurd or terrifying and I put that out there and someone actually retweet it and actually spun it in a positive light. They said, "This is actually great news. We want to shut down the economy. We want there to be a contraction in economic activity so that we can break the curve or flatten the curve." How do you respond to that comment?

Bianco: Good question. I think that there is the need to flatten the curve, and I think that that's an important thing that we need to do because what I'm worried about with the economy is like we're going to have a V bottom. We're going to have a terrible second quarter, maybe it bleeds into the third quarter, maybe not and then we're going to bounce back. But it doesn't end there.

Bianco: I also don't think we go all the way back. We're going to come up short because attitudes are going to change, deglobalization may take hold, a more conservative attitude. Steven Major of HSBC thinks the handshake will go away because that's culturally what this will do to us and stuff.

Bianco: So I think that all of that could definitely lead to more of an L. So after we V, we don't go all way back so you got somewhat of an L. How much of an L are we going to have? You tell me how bad the healthcare system is overrun in the next several weeks. Is it overrun bad? Do we look like Italy or do we look more like South Korea?

Bianco: If we look more like South Korea, I think then that it won't be as bad as everybody thinks and we'll go most of the way back. But if we look more like Italy or worst, Spain, which might be worse than Italy right now, I think we're going to come back well short and we're going to have awhile before we can eventually gain whatever we thought was potential pre-crisis or pre-virus as you'd call it.

Beckworth: Yeah, and the reason for this is because we can't commit to doing what is necessary, to lower the curve, right?

Bianco: Right. If we can't commit to doing it, then this drags on and on and on, and the healthcare system gets overrun and it spreads. One of the things that I found concerning was yesterday. Anthony Fauci came out and the President came out and said, "A lot of people are leaving New York City and they're going all over the place."

Bianco: And they said, "Well, if you are leaving New York City, you should self-quarantine yourself for 14 days." And the first thing I could think of, probably you too, is no one is going to ... Not enough people are going to do that. I just got out of New York. The restaurants are open here in take your pick, Miami or Scottsdale or wherever they're going or some ... They're going to go out and they're going to socially interact with people.

Bianco:  I feel fine. There's no problem with that. And so this could turn out that New York could wind up being the United States's Wuhan in a worst case scenario that everybody is leaving and they're going to spread it all over the place to the rest of the country.

Beckworth: Well, that's a pleasant thought, but maybe the right one. And interestingly, there's been a number of articles about this issue, how soon can we relax the lockdown or should we make it tighter?

Beckworth: As you know, President Trump came out the other day suggesting he didn't want to have a cure that was worse than the disease and he was talking about maybe loosening things up and all the public health officials were like, "No, no, no, don't go there." But there are some trade-offs ultimately and The Wall Street Journal had a couple of pieces on this today, had one article titled, "When will it be safe to loosen coronavirus lockdowns?"

Beckworth: And Jason Furman, he had an interesting thread I want to read really quickly on Twitter along these lines. And this is what he says, I want to read some tweets that he made today. He says, "A quick expansion on our statement," talking about a statement, a letter he wrote, "right now the best way to save the economy is to save lives. So the cost per life saved is effectively negative. A no-regrets policy we should definitely undertake but only right now. We can't keep the economy close until a vaccine or even an effective therapeutic or antibody test. We all need a gradual phase reopening when one, the virus is more under control; and two, we have testing in place."

Beckworth: "Extreme social distancing is buying us time for this. At some point, there will be a trade-off between economic performance and lives. We will have to ask tough questions about how to balance them." So he's saying, "Look, right now maybe we can keep this locked down going in place but at some point, we're going to have to make some tough decisions."

Beckworth: And Michael Strain had a column along these lines in Bloomberg that was really interesting and he was responding to President Trump's suggestion that we dial them back sooner rather later. And he said, "Look, President Trump is wrong." I'm going to start reading what he says here. "Trump is deluding himself if he thinks that he can step behind a podium and reopen the economy. First, there is the practical problem that the economic shutdowns have been ordered by governors and mayors."

Beckworth: So he goes on to say, "Look, this is a decision that's going to be made more at the local and state level." And then he goes on to say, "Even if they do try to reopen it, there's a lot of decisions that have been made that will make it very difficult. You can't just restart economic activity where you left off prior to everything locking down."

Beckworth: So he gave an example of his own life, Michael Strain, and he works at a think tank and he said, "Two weeks ago, my spring calendar was filled with conferences and speaking engagements. Those have all been canceled along with them the airline tickets and hotel reservations I'd made. Even if Trump calls off the shutdown, once these 15 days to slow the spread campaign expires, those tickets and reservations will not be re-booked and those conferences will not be resumed as planned. Trump can't just restart economic activity in these sectors with the wave of his hand."

Beckworth: So no matter where we come down on this decision, at some point we have to make some trade-offs, it's going to be potentially challenging to get the economy up and running again.

Bianco: I agree. And I also think he's also got to keep in mind two other things. A lot of these lockdowns are being driven by governors as well too. They're going to have some say in when this happens. And then finally, there's going to be attitude. Just because you announce the lockdown is over doesn't mean we go back to business as usual.

Bianco: In China, when they attempted to restart around mid to late-February, Apple reopened a bunch of its stores at the behest of the Chinese government only to find out the public wasn't ready. No one went to the store. Yeah, you can open it up but no one wants to go crowded in Apple store and absenteeism was very high.

Bianco: A lot of people are looking around going, "Everybody is still sick. I don't want to be hanging around with a lot of people," which begs the question that I've asked, when the restart comes and the restaurants reopen, how long until that popular restaurant is packed again? Is it a week or is it a year? Or is it somewhere in between?

Bianco: And I think a lot of that is to be determined. Finally, I'd say there's an interesting paper. It's been making the rounds in the internet and social media. And it talks about what's called the hammer and the dance. And the hammer is a real harsh lockdown to basically bring the curve down fast to get the virus growth rate down. Then you reopen and that's called the dance.

Bianco: Now, we have to learn how to live with it. And we have to learn how to social distance. We have to learn how to culturally be aware enough to say, "I don't feel good. I think I should say home. And no, that's not me being a slacker." And we don't want people to toughen up and come to work and cough on everybody. What we need to have, extensive testing.

Bianco: So if somebody thinks that they're sick, better be taking two weeks off of work, go ahead and stick Q-tip down my throat and then tell me if I can continue to go back to work, or if not, we now need to have contract tracing who I've been in touch with for the last 10 years. We do that, that dance, then we could open the economy and slow the virus through the system so we don't overwhelm the healthcare system until we eventually find out a vaccine.

Bianco: The problem with that is a lot of people think, "Is the American public really ready for that? I mean, are we really going to do all that stuff or are we just going to say we're going to do it and get bored after four days and then just go back to all of that, that will just create another reinfection."

Bianco: But that's kind of I think what we have to do. Yeah, I think we could open sooner if we could do it the right way and if we can all agree to do certain things. But I'm just not so sure like I was mentioning to you a minute ago. How many people do you think that are leaving New York by the tens of thousands every day are really going to self-quarantine themselves for 14 days once they've left New York? Or they're going to do it for a day and a half and they're going to get tired of it and they're going to go out to dinner at a restaurant.

Bianco: If they do that, we'll never get past this. But if we do that dance, I think we can get the economy opened a lot sooner and we could start living with this thing instead of just doing these draconian measures to keep the healthcare system from being overrun.

Beckworth: Jim, I don't think that is the American dance. I don't think people coming from New York are going to have the patience or just the ability for most people to quarantine themselves and not engage publicly. This doesn't seem consistent with the American psyche.

Bianco: I agree. I completely agree, and that's why this has the potential if we start looking more like Italy of dragging on and on, if we did all that, and what I'm trying to describe I think is what South Korea does, what Singapore does, if we all do that, then we could do both. We can have a pandemic going through the economy and still go to work at the same time.

Bianco: But if we don't do that, then we either got to pick one of two things. We'll let the healthcare system get overrun or we stop working. So hopefully, we could kind of come to that agreement, because I still ... My feeling or my sense is a lot of people recognize that this is not as important because they've been told it's important, not because they actually believe it.

Bianco: I still think there's a fair number of people, probably not a majority anymore, but even two weeks ago was a majority that think we're just completely overreacting to this. It's just the flu. We don't do this over the flu. Why are we going off the deep end on it? And I think Trump had the right answer to that, is that, "Well, isn't everybody on the planet doing that?" I mean, now India is in lockdown. That's 1.3 billion people?"

Bianco: So it isn't we're doing anything different than anybody else. China did it. They started with it. And so, is the whole planet has been duped by this thing? Or maybe it is more serious and we just have to lackadaisical in attitude about it?

Beckworth: You're absolutely right. And I worry about India. It seems they have a huge undertaking to lock down 1.3 billion people, poor people who depend on their daily earnings just to survive and I just can't see how that's going to go down very well.

Bianco: I completely agree. It's not going down very well pretty much anywhere that it is being tried.

$2 Trillion Relief Bill: Details and Implications

Beckworth: Fair point, right. Alright, Jim, let's move on to the big news of the day and that is the big, big bill coming out of the Senate. The White House has signed on. The house still has to approve it and it looks like it's getting hung up in the Senate. A few senators are still uncertain about a few parts but kind of the big contour to the bill are as follows:

Beckworth: First, most Americans under a certain income level will receive $1,200 in checks and there'll be some other details like if you have children, you'll get more money. If you're a couple, you'll get more. Also-

Bianco: By the way, Dave, I refer to that as 1.2 yangs is what they're going to get.

Beckworth: Okay. Very nice, very nice. So that's the first thing. So cash transfers directed at the households. Secondly will be $367 billion in loans for small businesses, $500 billion for industries and expand it on employment insurance, $130 billion for hospitals, $150 billion for states and cities, and that's kind of the rough outline of this.

Beckworth: It's going to sum up to about $2 trillion, a fairly large amount. I mean if you think back to 2008, we never touched a trillion. We came close, I think $800 billion was the stimulus package back then. So this is fairly large comparatively speaking. Of course, this shutdown, this economic contraction is also going to be fairly large as well.

Beckworth: But this is a pretty big bill. It's working its way through the Senate right now as we talk. Thousands of pages I've heard, any thoughts on it?

Bianco: My biggest concern with the bill is going to be inflation. Look, we're on the downside of the V on the economy, but when we get to the upside, all the stimulus in the pipeline and as the economy restarts, do we get some big bursts of stimulus that produces some level of inflation? I'm not talking about the Weimar Republic here or anything, but at least the pulse of inflation.

My biggest concern with the bill is going to be inflation.

Bianco: Remember then that was, in my mind, was the biggest story at least in 2009 and 2010 when it comes to the economy. Did all that stimulus would have produce inflation? And a lot of us, me included thought it would and it didn't. But this is so much larger now. And we're not done. With this $2 trillion plus to $4 trillion from the Fed that more could be in the offing before it's all said and done.

Bianco: I saw some Congressmen say, "Yeah, we've got three more stimulus bill we're thinking about. So let's get this one done so we can start the next one that we could eventually on the upside see some real inflation for the first time in a couple of decades."

Beckworth: Yeah, so that is a possibility and that thought has crossed my mind. I mean, we might actually finally get the inflation that's been missing from the economy for some time. But let me play devil's advocate and take the other side while we may not see even with this big of an increase in government expenditure.

Beckworth: First on the Fed’s $4 trillion. That really is more or less going to be lending that they'll recoup. It's not going to be an outright transfer. Now, some of that will be, I mean some subsidized loaning, there'll be some implicit transfers in there but it's not like we're going to add $4 trillion to the economy. It's going to be buying up $4 trillion of assets or lending $4 trillion with a loan, some combination of the two.

Beckworth: So I'm looking at $2 trillion. If I take the $2 trillion and I add them to the existing government spending programs, you're getting something close to 30% of GDP. Now, during World War II, it crossed 40%. So we're getting closer to World War II conditions which would say, "Hey, maybe this might create some inflation." And that may be the case.

Beckworth: So I can't say it won't. But the other thing that gives me pause and I think allows me to play the devil's advocate here is just this demand for our debt. As you know, we talked about this last time, there seems to be this sensational appetite for our government debt around the world.

Beckworth: Now, I guess what you could throw back at me is something we're going to talk about more in detail later, but the Germans now seem eager to create more of their own bonds. So it might be case where we'll see a huge increase in debt not only in the US but in Europe. And we might get past that threshold but where we have satiated safe asset demand, and therefore, we would see higher inflation.

Bianco: I think that that's a real possibility. The way that I'd like to say it is I started in the fixed-income business and investment business on Wall Street, 1987. I literally started the week before the crash. So I've been on the business for almost 33 years. For 33 years, I've heard people say to varying degrees that we're going to see a crowding out. That at some point, we're going to issue so many bonds, we're going to see higher interest rates.

Bianco: And for 33 years, I always said that's not a thing. If you look at the statistics, there's no correlation between the size of the debt in interest rates or anything like that. But I do think that if there's ever a time that that becomes an issue, it's about to happen. The amount of debt we're going to get and the amount of stimulus we're going to get could change the trajectory. And I'm going to jump ahead a little bit here on this.

Beckworth: Sure.

Bianco: The Fed announced QE infinity and I know we'll talk about that in a few minutes. They are buying $600 billion of bonds a week and promised to be open-ended. At that rate, they will own two-thirds of the Treasury market in a year. The 10-year Treasury has collectively done nothing on that announcement. It should be down at 0 right now on its yield.

Bianco: With that size of buying and net commitment of buying, it's hard to understand that commitment of buying even if you work in the bond market. Yet, I think that the reason it's trending higher is the fear of massive issuance, massive stimulus leading to inflation is overwhelming what should be the single most bullish story in the history of the bond market. An unlimited buyer of over 600 a week forever cannot get the rally going again in bond anymore?

Bianco: I don't want to talk about risk parity trades. I don't want to talk about what position these traders did or didn't do or anything. That stuff is small rounding errors compared to this. And yet, they're not moving. And I think the reason they're not moving is there's a lot of sellers out there in that market.

Bianco: If the Fed is buying $75 billion of Treasury every day and $50 billion of mortgages every day and coming soon will be a bunch of corporate bond buying and these yields are not just absolutely imploding on themselves, there's a lot of sellers of that and I think the motivation is huge supply finally maybe crowding out and a real risk of inflation due to the stimulus.

Beckworth: Sure, but the 10-year Treasury yield is what? Just under 1% right now?

Bianco: Yes, it's 87 basically.

Beckworth: So I get your point. It hasn't fallen but I would also ask why hasn't it shut up? I mean, the Fed is doing all of these you just mentioned. In fact, we're talking earlier, we think this could lead potentially a Fed balance sheet of $10 trillion, maybe 40% of GDP, up from around 21% right now. I mean the Fed is doing all of these and yet the 10-year Treasury is still less than 1%. I mean doesn't that say something to?

Bianco: I think that speaks volumes. I think that that speaks volumes as to what's happening in the marketplace right now. It isn't, if we could argue for a minute, the 10-year Treasury is not rising like we did in '09 and '10. In '09 and '10, when the Fed was doing QE1 and then in 2011 QE2, the interest rates would rise when they would announce QE. The correct thing now that we have history with this was they were just about to announce with the stimulus package, the bond market responded to the stimulus of potential higher inflation or potential faster growth or higher nominal growth by having rates go up.

Bianco: It's not responding to the future of higher nominal growth because we know nominal growth is going to collapse here in Italy next and yeah, they'll be a rebound on the other side. But I don't think the market can look that far ahead. Or we'll just see the biggest collapse in nominal growth in history but ignore that because right after that, it's going to be better. I don't think the market can see that far ahead. So, I do think that there is something that is really not right.

Bianco: Now, part of it also might be that the bond market is still somewhat dysfunctional, that there's not enough proper bids and offers in the market. The trading in the market has been disjointed. It hasn't been what you would consider normal. The volumes are down. So, maybe part of it is along those lines too. A lot of relationships that traders and portfolio managers look at are not working right now where they're scratching their head going, "This is not the way it's supposed to be." And that's largely because of the dysfunctionality in the market.

Bianco: So, maybe that's got part of it too. But I find it surprising that we were able to get the 30 basis points in the 10-year two weeks ago. And then the Fed announces unlimited and it can't go down anymore after that.

Beckworth: Yeah. I mean that is a bit of a puzzle, but again, I would like to see the 10-year go up, to have this convince me that it's really going to be really inflationary or much of a pack. Another way of saying this is that the Fed's balance sheet is going to go ... If it grows to $10 trillion, we'll about the size of the ECB's, European Central Bank's balance sheet which is also about around 40%. And they've had a challenge with that big of a balance sheet generating inflation over there. So, maybe it's not unreasonable that we're not going to generate a big surge here. But your answer is, if I understand you correctly, that maybe markets just haven't properly priced it in yet, is that fair?

Bianco: Yeah, I think that that's fair. By the way, the BOJ, the Bank of Japan's balance sheet is well over 100% of their GDP as well too. So, we've seen a lot of stimulus from Central Banks that have come in into the game that haven't produced the inflation or the growth that they want. But I think that what's happening now is, keep in mind, we are the reserved currency and we are the market that is ... We're the most important market. I'm sorry for everybody who is in Europe and Japan, but we are and we all know that.

Bianco: And let me give you one quick example. So, there's been this insatiable demand for dollars. Now, you've got the insatiable demand for dollars because it's the safe haven currency. Everybody doesn't know what's going in the world. They see nothing but problems, and their conclusion is I have to basically hide in dollars, so much so that the Fed has opened their swap lines to a lot of central banks to try meet that dollar need to prevent the dollar strength from just going and going and going.

Bianco: So insatiable is that in those swap lines are coming up that are so much that the Bank of Japan has announced a bunch of repurchase agreements and more programs of QE in order to buy back their bond, and no one is taking them up on it because they would rather swap those into dollars to take them up on the dollar swap line and get dollars.

Bianco: So, the Bank of Japan is almost at the point where they're holding a QE and no one is calling them and saying, "I want to sell you my bonds anymore." They would rather convert them to dollars and they would rather call the ECB and say, "Here's some yen, please give me dollars." That's the transaction that they would rather do. This is how unusual ... I guess what I'm trying to say is relationships are so unusual in this market, but I do think that even aside from that, we are the reserved currency. Our central bank going to 40% is a lot more meaningful than the ECB or the BOJ going to 40%.

Bianco: And again, I'm not looking for hyperinflation or return of 1980. I'm just saying, "Hey, there's the flat line. It's got a pulse. There's a blip right there." There’s this claim it showed something because that was what has been missing since the '09 era is especially if you look at core inflation, we really haven't shown much in terms of inflation.

Bianco: We've been more along the lines of the old joke of, "How do you know an economist who has a sense of humor? They use a decimal point." But that's really been the case with inflation, is that we keep talking about the difference between 1.6 and 1.8 core inflation. Come on, we know that's a rounding error but it doesn't move. So, that's the best we've got right now, is to basically talk about rounding errors.

Beckworth: Yeah, and I think a fair critique is that this is not just the Fed going to 40% of GDP potentially. It's the Fed going to 40% of GDP plus the Federal Government having its expenditures also reach 30% or so of GDP. So, both fiscal policy is going to take on a lot of activity and then so will the Fed’s, so combined together, it is very unusual.

Beckworth: And this leads me to a comment that you made, you worry about this. You've mentioned to me that you see this as a return to kind of a World War II arrangements where Treasury and the Fed were closely coordinated. And so the Fed is going to lose independence. President Trump can brow-beat the Fed into doing what he wants it to do given the crisis. And I think that's a fair concern.

Potential New Threats to Fed Independence

Beckworth: Let me ask the question I want to ask this way. If we compare this effort against the virus like a war, we're fighting a war, public health war. And it's a big war. It's a tough war as we've talked about a lot of uncertainties surrounding it, isn't it fair to look back at other wars where Treasury and monetary policy have combined, so World War II, Civil War, World War I? Isn't that kind of normal, I guess, to see this happen and almost by default. When we get desperate, this kind of façade where we separate monetary policy from fiscal policy even though they are intricately linked because of debt markets and other kinds of deeper stories…

Beckworth: Are we just kind of pulling that veil back and saying, "Okay, this is the reality. The reality is when push comes to shove, it's really one consolidated government balance sheet."

Bianco: To your first question, yeah, I mean this is a war and I like to say that we should give everybody a wide latitude when you're in the middle of it. It's easy to armchair quarterbacking after the fact. And I've also kind of postulated like the first part we were talking about. Is the cure of an economic shutdown worse than the disease? How about the cure of reducing ... The cure of trying to get liquidity back into bond market, is that cure worse than the disease itself of illiquidity in the bond market?

Bianco: Let me back this up and let me explain what I mean here. The Fed is not allowed to buy securities that don't have an implicit guarantee by the government. So, they can't buy corporate bonds, they can't buy equities, they can't buy ETFs, and they can buy treasuries, agencies, MBS that is mortgage-backed securities that have a Fannie or Freddie guarantee. They can buy debt issued by Fannie and Freddie, agency debt. We could discuss whether or not they can buy municipals, that's kind of on the gray line.

Bianco: But corporates are out of bounds, the ETF is out of bounds. But wait a minute, they just announced that they're going to do corporate bond buyer program and an ETF bond, but how are they pulling this off? The simple answer is the owner of that is going to be the Treasury. It's not going to be the Fed. They created a special purpose vehicle and then they use a lot of high-finance talk where they said the Treasury will put $10 billion into it and they'll be at the first loss position.

Bianco: Well, let's cut through the chase. What is a first loss position? I own my company, I'm in the first loss position whenever my company losses money. The owner takes the first loss. The owner is the Treasury. So, what we got is we got the Treasury is buying corporate bonds. Their agent that's providing the financing is the Fed and they just engaged yesterday with BlackRock to actually do the transaction with TIMCO in 2008.

Bianco: That is merging the Fed and the Treasury together. The Treasury had a say in these programs, of ETF buying and corporate bond buying because they're the owner and their agent or the financier, the banker is the Fed. So, let me say this differently, Donald Trump has a say in this. I read where they said, "Okay, we're going to do this ETF buying and we're going to do this corporate bond program." And they're kind of hoping that they're going to end it by September 30th by which before the election. Donald Trump is going to tell you, "You're buying this market because I'm the guy that's going to get reelected on a higher stock market. And you're going to stop five weeks before the election? You have-

Beckworth: That's a good point.

Bianco: ...You're going to keep ... And by the way, it's my program, the Treasury program. And so, Jay, I'll tell you when you're going to stop and if I get reelected, the answer might be never. Or at least until we get back to the old highs in the S&P so I could go back to tweeting again what a great president I am and then continue to go even beyond that as well too.

Bianco: If you wind up doing that, what you're doing is I think you're partially nationalizing these markets. If you're forcing the Treasury as an owner and its financier the Fed into buying these markets, you will crowd out the private sector. You will take away the function of the private sector.

Bianco: Look at what's happened to the JGB market in Japan, going back to that example again. Its volume is down in the private sector, 90% plus over the last several years since they've been doing QQE which is qualitative and quantitative easing. It's what they've done. There's no reason to be a private sector bond trader anymore. The BOJ, they set the price. The price never moved. They got yield control on top of that as well.

Bianco: That's another word saying, "We're going to set the price at zero and then do our best to make sure that it never moves." Well, if I'm a bond trader, why do I want to trade this thing? It never moves anymore, so they're all leaving. We run that risk with our market's longer term that we're going to chase everybody up.

Bianco: There are days in the Japanese government bond market that benchmark issues don't trade at all, once all day. And that's because you've chased the private sector out. If we're going to be in this process of having the Treasury running the show and Trump is looking and saying, "You guys keep buying because the stock market is not that high enough yet and don't stop."

Bianco: And let's throw this on Biden too. Biden is getting a lot of money from Wall Street, and Wall Street is going to love this too. "Oh, wow, we could issue bonds, and the Treasury through the Fed buys these stuff so we make profits? So here, Joe, here's a bunch of campaign contributions. We want you to keep doing this as well too." I'm not saying that will happen but it's a possibility. In 2009, now you could say, "Wait in a minute, we did this in 2009." Yes, that was new. We didn't understand it, and everybody deferred to Bernanke. He had the ultimate authority on when to stop this program.

Bianco: But now that we understand them and now that we expect them, and now that we've got a different mindset in The White House, that I think that this problem of Fed independence is going to become a big problem. You've created, you being the Fed and the Treasury, have created this program that Trump gets to decide when they stop. And he's going to decide they don't stop and that can be a real problem moving forward. Hence, my question, I get you're trying to fix the disease of no liquidity in the bond market by going around the Federal Reserve Act and finding this way to buy into ETF.

Now that we've got a different mindset in The White House, that I think that this problem of Fed independence is going to become a big problem.

Bianco: By the way, they're only buying ETF that are backed by investment grade bond, so they're not buying SPDRs and the S&P 500 ETF or anything. And you're buying corporate bond. I get that you're trying to fix that liquidity problem, but what I'm trying to explain is, is the cure worse than the disease that you could be bringing on, the loss of independence, the loss of freely traded capital markets with a government hand that's constantly in those markets as well too?

Beckworth: I think those are great points, and they're the best points against my reply to you earlier that, we know we'll have high inflation. I think the best answer is political economy considerations may be why we get inflation after this is over which you just described. And maybe not that the numbers themselves are so big or by themselves so alarming, but it's the interconnections that we've made. The linkage between Treasury and the Fed's operations and the President with an election coming on. Yeah, you could definitely paint a pretty bleak picture there.

Beckworth: So I think that to me is the most convincing reason why we might have higher inflation, just a purely political economy business cycle story here or political business cycle story. And I agree also about what do we do afterwards. So, I mentioned earlier another comeback was, well, what's the big deal? We always do this during war time. And I think that's fair. I think this kind of close working between the Fed and the Treasury is a big deal. I mentioned Civil War. Civil War, there was no central bank. It was just all the Treasury doing it but the same idea.

Beckworth: But I think that two points you bring out are really good ones. Number one, when you get the Federal Reserve and the Treasury involved at this scale, you can create such a big footprint that you do create market sclerosis. You do see a pulling back of kind of true market-driven liquidity which I think is a big deal because there's price discovery. There's a role for markets to play and disciplining participants and counterparties. And if you take that all away, then you create all kinds of new risks and new problems.

Beckworth: So, I do think it's important to keep markets healthy and that means at some point, pulling back, dialing back the government's footprint in financial markets. And what we've seen, this would be my second concern, is that it's hard to do that after 2008. The Fed's balance sheet grew really large. They tried to do that. Part of the challenge was all these new regulations, increased bank's demand for reserve so I can't blame the Fed on that. But it just goes to show you never know what's going to happen down the road. Sometimes, it is easier to play it safe than to take the risk.

Beckworth: So, I do see your points here. We should worry about the health of the markets. We should worry about the ability of the government to control itself, to dial back its interactions in the market. And if history is a guide, I'm using now previous wars as a guide. We could also look at the Treasury Accord 1951. That wasn't an easy experience to go through. It took some thick skin. It took the Federal Reserve having to stand up to the President at that time. And we may have to go through something like that again to get back to a point where we have an independent Federal Reserve.

Bianco: I completely agree. I mean that is going to be the problem. Now, what would alleviate those concerns, if no less than Trump himself came out and said, "This is to alleviate an immediate liquidity problem in markets. And we're going to do the bare minimum that we need to do to fix that and then get out, and then get out." But if he's going to start looking at this as his little personal dial that he could dial up and down the stock market as he needs to or think of it in those terms, then we're into a big slippery slope.

Bianco: He's got a history here of demanding negative interest rate, demanding that the Fed get more aggressive, praising them when they cut rates to zero. So, he's a big, aggressive kind of monetary policy guy to begin with. And now you've given him personally an aggressive monetary policy tool to work with. So, we'll see how this one plays it out. I hope it doesn't become like QE was. In 2008, we used to call QE an unconventional policy.

Bianco: The implication there was it would go for a little while and then go away. Did it ever really go away? We tried to taper for a while there a couple of times in '09 and then from 2015 to a couple of months ago, but it never really went away. And I'm afraid that this is going to be another one of these things that Reagan used to talk about a government program is the closest thing to eternal life. This is a Treasury program so this is a government program as well too. That's what I'm really afraid of, is that it will just continue to go forever and ever.

Beckworth: Right. And no matter who's president, it's hard not to want to pull those levers, turn those dials if your election is nearing. You want to do everything you can to get reelected. And if these tools in front of you whether you're a person with great self-control or little self-control ... Lord Acton has this saying, "Power corrupts, an absolute power corrupts absolutely." So, I think any of us in that position would be tempted to do what we can to keep the economy running and to do well going into the election.

Renewed Case for Rules-Based Monetary Policy

Beckworth: This also speaks to me why we need rules. And I'm a big advocate of monetary policy rules, but I'd say in general rules for the government as well. And in this case, I would like to step back and just get in my soap box here, Jim, for a minute. I think everything that the Fed is doing and that Congress is doing should be framed around a nominal income target or nominal GDP level target. And to be clear, that target doesn't solve the problems of increased scarcity, supply disruptions. A nominal income target would provide some guard rails for what the government collectively is doing. And let me be specific, and I mentioned this in the last episode but just to repeat myself. I think the Treasury and the Fed should come out and say, "Look, everything we're doing is to maintain the country's income at about $22 trillion, $23 trillion that where we thought it would be going into this crisis so that households and businesses can meet their preexisting financial obligations, and that's all we're trying to do. And once we do that, we dial back. We don't do anything more. We need to put this rule upon ourselves so that we're not tempted going into the election to tinker with it."

Beckworth: I think it's useful to have an overarching framework as well as a rule that kind of constrains what they can do. And that has to be self-imposed and maybe they can't do that. But that's why I think a rule is useful here.

Bianco: I completely agree. More than ever now, you need a rule because when you get into a situation like this, the natural re-inclination, I mean talking about the pandemic and the big plunge that we're expecting in economic activity is to lose all your discipline, is to lose your discipline and to go wherever you want to go. It seems like that's what they're arguing about with the stimulus bill, is they have agreed that they want to spend $2 trillion. And now they're basically agreeing where they want to put discipline or where they don't want to put discipline, and they both have different views on that.

More than ever now, you need a rule because when you get into a situation like this, the natural re-inclination, I mean talking about the pandemic and the big plunge that we're expecting in economic activity is to lose all your discipline.

Bianco: And it's going to be something that it's going to have to get worked out over time. I don't know what the right answer is. I mean, but I agree with you that we absolutely need robust guard rails that would work even in an environment like this. NGDP, what actually might be a better rule to use now than it was-

Beckworth: Absolutely.

Bianco: ...before. Before, it was easy. It was easy to say, "Oh, no, there's more sophisticated rules when we were in the advance." But now that you get into a situation like this, something like NGDP, it seems to work now and it worked then too. But all the sophisticated stuff doesn't work here in this kind of environment.

Beckworth: Yes, absolutely. We all need rules to help govern our behavior. We all suffer from time inconsistency problems and the government is no different in that regard. And again, in the fog of war and in the middle of battle, it's hard to know what's the right call.

Beckworth: I mean many of these people, they mean well and I don't mean to impugn their motives. But I think your concern and my concern is even the good intentions can lead us astray when you start really bring in together the capacity both fiscal policy and monetary policy.

Bianco: Yeah. And you know to be clear about the fog of war, I am not suggesting that what they did was wrong. I understand why they instituted these programs in conjunction with the Treasury and sort of merged the Fed in the Treasury more than we've seen in a while, at least since 2008 if not further back than that.

Bianco: I'm just saying that you've opened up a can of worms, so tell me about the worms and tell me about what you're worried about how you plan on getting out, how you plan on dealing with the conflicts of interest at the Treasury via the President, via the Treasury might want to program to go one way. The Fed might want the program to go another way. How do you square that situation as well too.

Bianco: So, this is not stand on my soapbox and say, "Whoa, you shouldn't have done that." Oh, I understand why you did it and I'm not saying it's wrong that you did it but we got to address some of these issues as we look further ahead.

Beckworth: Absolutely. And to be clear, I made a proposal in the fog of war myself, the Mercatus Center has a policy brief series out where I actually called for giving the Federal Reserve more power. I called for giving them helicopter drop ability, a constrained form of it when you get to the zero lower bound or the effective lower bound, and many people push back against that because I thought that was giving the Fed too much power, too much ability.

Beckworth: So I mean a listener who follows me closely might think I'm being inconsistent here, but I completely understand that critique applies to my proposal as well as what's being done now.

Beckworth: Jim, we have a few minutes left. And I want to quickly touch on what the virus means for Europe. We haven't had a lot of discussion. I had Robin Brooks on, we talked a little bit about the world and touched a little bit on Europe. But you have made some interesting comments about what the Germans are now willing to do. In fact, we touched on it earlier.

Beckworth: But walk us through it. What are the big developments over there in Germany as they pertain to the Eurozone?

Implications of the Coronavirus for the Eurozone

Bianco: So, the virus is much worse in Europe, especially in Spain and especially in Italy. We all focused on Italy, but Spain might be worse right now. And there is a big need in Europe right now to do some kind of a bailout for pretty much the country of Italy because they're on a full shutdown, even industrial production is shut down at least to the end of next week. So they are as close to zero economic growth as a developed country will ever get unless somebody else just repeats what they've done in the next couple of weeks.

Bianco: So the Germans, I like to call them the sound money adults in the room at the ECB, have always been worried about being too profligate with their money. And they've turned around and yesterday, they made an announcement that they're willing to help bail out Italy. They're willing to write German taxpayer checks to help bail out Italy. And then the question has come up, how do we do that and there's this big push for what's called Coronabonds so that they want to issue basically a new version of a Eurobond under the auspice that we're going to float these Eurobonds for Coronabonds.

Bianco: And the Germans are, I think, rightly so uncomfortable with Coronabond because as a Eurobond, it will get the credit rating of Germany. So, you're going to allow Greece and Spain and Italy and Portugal and the rest of those countries to basically borrow a German term. And the Coronabond, yeah, you could limit it to, well, just what you need to do to bail out your economy from the impact of the virus but, boy, that's beauty in the eye of the beholder. The next thing you know is that we got to do every public works project that we'd ever wished for under the auspice of, it's part of the corona bailout and we're going to issue money at German rates in order to do it.

Bianco: So, the Germans have faced with two ... They're faced with a bad choice, and their bad choice is, do we allow Eurobonds to open because that would ... We talked about discipline. It's not going to go that there would be a lack of discipline among the southern European countries that have lesser credit because now you're giving a better credit and more access to borrow money.

Bianco: So, they've opened themselves up to the idea of open market transactions or OMT where you and I would know it as QE bond buying. The Germans have ferociously pushed back against this, was not interested in it in 2012 all through … whatever it takes moment as well too. That's why the ECB came up with TLTROs, their lending program because they couldn't do this OMT program.

Bianco: Well, the Germans are now arguing that they might be willing to accept OMT, or to put it in a stark term to give you an idea what they're thinking about. They're ready to go Y-Mark here, the Germans are, and let the ECB just print money and start buying bonds in order to help finance the bailout.

Bianco: Why? Because their thought process, I think, is we could go OMT and have the ECB buy bonds and countries can issue them so that they can help with the bailout and then we can turn it off. But if we create a Coronabond program, that goes forever, that gets redefined, that gets away from us. We could never control it.

Bianco: So, I think they're faced with two terrible options and they're taking the least bad of the options, is that they're willing to let the ECB's balance sheet go in terms of the larger, in terms of letting the ECB just start buying Greek bonds, started buying Italian debts, start buying Spanish debt. Let them issue more to bail themselves out.

Bianco: Then we got the ability to turn that off at a later date where if we give them this Eurobond program called Coronabond, they could do that for the rest of eternity for as long as the EU continues to exist and then they could run themselves into breaking all of their agreements like Maastricht and everything else in terms of their budget deficits and to stow way off on the deep end.

Bianco: So, I think that there's been a wholesale rethink. And the final thought on this. I know we didn't touch upon this, but I'll just say this in regards to Europe. When you're in a middle of a crisis, nobody thinks about retribution. So, in October of '08, no one was thinking about, "You know, we have to punish Wall Street or we have to punish the government." It was only after the recovery started that we thought about it and then we created Occupy Wall Street, we created the Tea Party Movement, and we got really made about the bailouts.

Bianco: The Germans, when they said that they would be willing to write checks to the Italians, we're kind of saying, "Look, we created the European Union to be a union. And now, here is in the history of the European Union, the biggest time of need for one of our members. If we're not there for them, when this is over with, they have every right to leave and the Spanish have every right to leave." And that's the end of the European Union.

Bianco: If you're a part of the union, then you've got one of your parties that's in dire trouble, step up. If you're not going to step up, what's the point of the union then at that point? So, I think that that's what the Germans are also trying to suggest too, that this virus, I think it's the defining moment of this generation. And we're forever going to refer to this as the pre-virus and post-virus era-

I think that that's what the Germans are also trying to suggest too, that this virus, I think it's the defining moment of this generation. And we're forever going to refer to this as the pre-virus and post-virus era.

Beckworth: Interesting.

Bianco: ...and this where the Germans, I think, are when it comes to what's happening in Spain and what's happening in Europe. I'll repeat myself. If they don't help now and they start talking about budget caps and deficits of 30% and all that other noise, then the Spanish and the Italians have every right to leave the EU. They shouldn't be part of it if they're not going to be there for when they really need them.

Bianco: All the other stuff was playtime. This is the real game here when they really need them. So, either you're in as a union or you're really not a union. You just say you are but you're not when the chips are down.

Beckworth: Very interesting. So, we are now living in the post-virus period?

Bianco: Yes. I also think that that's what financial markets have been doing over the last six weeks. Unlike anything else we've ever seen, there is January 2020 and there was, "This is what we thought about the economy, this is what we thought the valuations of financial markets were, this is what we thought the outlook was."

Bianco: Virus hits and then we all of a sudden wake up one day and say, "Send all of those assumptions to the history department." The economics department now is going to start thinking about what does the post-virus era look like, lower growth, less globalization ... I've said that a few times already.

Bianco: Let's go reprice there immediately, and that's what's got markets in a tizzy. We're not ready to go reprice there. We were hoping that such a repricing would take two years, not six weeks, and that's what we're going to be doing. We're trying to do it in six weeks and that's why we've got all these problems in financial market because we're viewing this as a major demarcation line in economic history, just like there's the pre-war and post-war and the pre-crisis and post-crisis. We've got pre-virus and post-virus as well too.

Beckworth: Well, on that note, our time is up. Our guest today has been Jim Bianco. Jim, thank you so much for coming on the show again.

Bianco: Thank you, I appreciate it.

Photo by Lance Nelson

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.