Dalio 7600-word long article: What does zero interest rate mean?

Source: Wall Street News

Guide: Dalio believes that a decline in long-term interest rates to zero means that almost all assets will go lower, because the positive effects of interest rate cuts no longer exist (at least not very effective). Zero interest rate means that almost all the Reserve Bank's interest rate stimulus tools (including interest rate cuts and yield curve guidance) will be invalidated.

01

When I want to express my thoughts to you, I want to emphasize that I have not and cannot anticipate the most important things that will happen in the market, because the current situation is extremely rare.

Although I don't know much more than I know, I will tell you what I think, you decide whether to accept or not according to your personal preference.

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Presumably you all know that for some time, I have been worried that when the next economic downturn comes, the interest rate will reach the lower limit of 0%. At the same time, there will be a large amount of outstanding debt, a huge wealth gap and political differences, like Like in the 1930s. Corona virus is what triggered the economic downturn, which surprised me.

Although this is a very serious infectious disease and it can do a lot of harm to the economy, these things do not scare me. However, when these things are combined with long-term zero interest rates, this really worries me.

Falling long-term interest rates to zero means that almost all assets will go lower, because the positive effects of interest rate cuts no longer exist (at least not so much). Zero interest rate means that almost all the Reserve Bank's interest rate stimulus tools (including interest rate cuts and yield curve guidance) will be invalidated.

At present, what the central bank can do, such as printing money and buying debt assets, is almost certainly not feasible. Because the price of bonds cannot be pushed higher, and it is unlikely that these bonds will be sold to buy other financially troubled assets.

In addition, in a zero interest rate environment, deflation due to lower oil prices and other commodity prices, economic weakness, and other credit issues, may make real interest rates higher.

If it evolves in the classic way, rising interest rate spreads will increase the loan payments of entities with poor credit quality, while at the same time, contraction of credit lending activities will increase credit crunch, deflationary pressure and negative growth pressure. Countries that have these problems and whose exchange rates are still rising have received God's help.

I'm trying to imagine how all this will evolve. Based on current market prices, my great team and I imagine what would happen if everything went as it is.

For example, for pension funds, insurance companies, and other companies with long-term liabilities, they are funded by stocks and similar stock assets. I use the market value method to calculate the present value of their debt and the expected return on the assets used to pay off the debt. They will do so soon.

I imagine what they have to do-sell assets and pay. For oil producers (countries and companies), their expenditures are much larger than their income. Imagine what they have to do-cut expenses, sell assets.

I imagine what many other entities in a similar situation mean to economic activity and asset prices, which is indeed worrying.

These are just a few of the things I'm thinking about, and I'm pretty sure that what I'm thinking about is just the tip of the iceberg of the upcoming financial disturbances. Keep in mind that the vast majority of investors are long assets (that is, holding assets in the hope that their prices will rise), and they are operating in the form of leverage (borrowing). Therefore, when asset prices fall, the financial impact is greater than when there is no leverage.

Contrary to popular belief, the impact of the market on the economy is greater than the impact of the economy on the market. Because of this, the most important thing is to figure out who is in which position and figure out what they need to do in those positions (eg, cut expenses, sell assets, etc.). This is what we are trying to do, and not enough.

However, I am pretty sure of the following.

02

Large-scale fiscal stimulus and monetary policy are needed to cope with low risks, but this has not yet happened.

Our greatest economic risk comes from the possibility that our elected officials (officials controlling fiscal policy) will handle them improperly. That's because it's difficult to know how to do the right thing and take bold action even in the midst of a major crisis, even without split politics.

In divided politics, this may not be possible. Despite some fiscal stimulus measures, these measures were not large enough or concentrated enough to offset the spread of the virus's economic and market impact. These policies are currently under debate.

However, there are signs that some important decision makers may adopt a "at all costs" stance. If so, then we will have to consider whether these measures are effective in such limited circumstances as described above. More specifically, this is what is happening.

In the U.S

So far, fiscal and monetary responses have been too little and too late, but there are signs that some groups are entering a "at all costs" mode. What will happen in the future is still being worked out. Things change every moment. This is the situation now.

So far, there have been few financial responses, including:

$ 3 billion for research and development of vaccines, test kits and other treatments

$ 2.2 billion for the Centers for Disease Control and Prevention (CDC) to control the outbreak

$ 1.2 billion in funding to the State Department to help curb the spread of the virus overseas

$ 1 billion for medical supplies, healthcare preparations, and community centers

Authorized a grant of $ 1 billion to the Small Business Administration (SBA) to subsidize SME loans

$ 500 million for Medicare providers to provide telemedicine services

$ 300 million to ensure that vaccines are provided to individuals at very low or no cost

Some people talk about lowering the payroll tax, and this is not the problem. It mimics the pattern of 2011-2012, with a reduction of about 0.6% of GDP (a similar reduction today is estimated at 0.75% of GDP).

However, we have heard President Trump support a full pay holiday until after the November election (though not specified, it is speculated that it will include contributions from employers and employees, estimated at about $ 500 billion).

This plan may not be implemented because Congressional Democrats and some Republicans do not support the plan (because the reduction in payroll taxes is gradual, it will destroy social security funds, and reducing part of the payroll tax paid by businesses is considered too business friendly ).

However, this suggests that President Trump may be aggressively stimulating, although there is no indication that it will target where it is needed most or reach the scale it needs.

Regarding Trump's priorities as president, he faces serious risks of doing too late and too little. Whoever is trying to be re-elected as president does not want a big financial stimulus in the election year, so I think he will take action and join the "whatever he can" camp. Over time and further deterioration of conditions, he may support more relevant tax credits.

So far, no emphasis has been placed on relatively more targeted measures. I think this is the most important because specific areas need the most help to avoid the spread of debt / economic issues.

I'm not saying that nothing has been done because the US government has increased SBA subsidized loans to SMEs, provided sick leave to affected people, and covered most of the virus for people without health insurance (possibly using FEMA funds) Cost of treatment, increased funding for state and local health care services (using FEMA's economic and disaster relief related funds), expanded unemployment benefits, and increased other direct transfer funds (such as food stamps for people in hard-hit areas) ).

The House of Representatives voted on a range of targeted measures last week (including free testing of the virus, expanded unemployment insurance and sick leave for affected people, and subsidies for meals for students eligible for free school lunches) .

But these measures will be relatively small, providing weak support for those with financial problems. The intensity of these measures will need to be expanded.

So far, although no debt support has been provided for industries that could go bankrupt due to the shock, President Trump has called on Congress to approve $ 50 billion in additional subsidies to SMEs through the SBA. This could release hundreds of billions of dollars in loans. However, the scale is not large enough, and it is unclear whether the measure will be supported by Democrats in Congress.

So far, industries that are likely to go bankrupt due to the shock have lacked substantial debt support (except for SBA-subsidized loans, which appear to be small). Probably the best way is to let fiscal policy makers guarantee the safety of new bank loans, which is the government's protection of new loans (a move that is politically challenging). We have seen that some troubled companies have used their existing credit lines to obtain funds.

Although this may not be what banks want (I suspect they want to take more credit risk when the economy deteriorates), it is a way for capital to flow into those squeezed businesses. Raising funds from target companies is not the task of the Federal Reserve, but it can provide banks with liquidity to fund these loans when needed.

My suspicion is that we will see more of what I call a "protected loan scheme", as the European Central Bank does (like TLTRO), where the Federal Reserve provides ultra-cheap currencies to banks that provide loans And protection. The heavy use of credit lines by businesses suggests this. All that is needed to control financial leverage is to protect banks from bankruptcy. However, not all squeezed companies have pre-existing credit lines, so there may still be large gaps, and they will incur huge costs.

I don't know yet whether the President and other fiscal policy makers have stress-tested companies and sectors of the economy like we did, or whether their test results are similar to ours, but I am seriously concerned about what I see Many companies and industries will face debt problems, which is likely to lead to restructuring.

Perhaps the market expects that these companies will continue to operate through the bankruptcy process, although this may weaken the company and produce adverse chain reactions, as monetary policy will be ineffective and political divisions will be large and may cause volatility. If handled incorrectly, this can become a major political and social issue. If I were President Trump, I would be very generous and compassionate, and especially in this politically sensitive period, the news would get worse and worse.

I expect political struggles to prevent doing what is best for the country, because the primary goal of both Democrats and Republicans is to take power.

As for the Federal Reserve, it just did all the stimulating work it could do, instead of adopting what I called monetary policy3 (monetary policymakers worked with fiscal policymakers to monetize their deficits).

The first (and preferred) monetary policy (MP1) primarily uses interest rates as a control mechanism. When this method stops working, they print money and buy financial assets I call MP2. When this approach no longer works, the central government will have to run a huge deficit and sell the resulting bonds to the central bank (I call it MP3). This comes in many forms.

I explained this in the book, "Principles of the Great Debt Crisis" (available free of charge from www.economicprincples.org). We are now at that stage of the long-term debt cycle, and we will have to see whether fiscal and monetary policymakers can coordinate, do this, and then see how it works. There is nothing else you can do. In theory, the Fed could buy other assets such as stocks, but this approach would not be adopted because it is highly controversial. Under the Federal Reserve Act, this approach is suspicious (it may need to be approved by Congress) and will not have much impact in any case.

As far as I know, the best way is to do all these things I just mentioned, coupled with the support of the financial sector, to provide financial protection for banks, which will help those who need the credit most to get credit.

in Europe

The European Commission is expected to give maximum flexibility based on EU rules, and most importantly, the fiscal rules related to the Stability and Growth Pact. Consistent with this, Europe's announced fiscal responses are usually targeted at supporting health services and hard-hit areas, sectors and small and medium-sized enterprises.

These include tax and fee reductions, debt repayments, and compensation for employees who shorten working hours. The industries that receive the most attention are tourism, transportation, and the automobile industry, but the scope of support may be wider than that.

France and Italy have been working on further coordination efforts at the intergovernmental and supranational levels. However, there is no consensus on the policy direction or the joint commitment of deficit spending.

The European Commission has just proposed a modest 25 billion euros of EU investment funds for targeted measures to support healthcare, SMEs and the labor market. It is funded by the European Commission, which redistributes 7.5 billion euros from its budget (funded from its structure and cohesion fund), while EIB will provide up to 25 billion euros.

At the next official meeting of the Euro Group (Treasurer of the European Monetary Union (EMU)) on March 16, the parties may take further policy coordination measures. My guess is that each country will eventually carry out financial activities at all costs, but it will not substantially help other countries and regions. The European Central Bank will do nothing, which will cause serious problems.

This means that in regions with significant fiscal stimulus and deficits, they will have to sell more bonds. Without the ECB's purchases, interest rates would rise. We saw this last weekend as Germany announced a significant stimulus to fiscal policy. If this does happen, only God can help us.

The European Central Bank cannot do much because it cannot lower interest rates and it does not have the power to buy the required amount. Of course, although its officials will not speak directly, they are communicating this message as loudly and clearly as possible through their actions and what they say.

Christine Lagarde expressed this in her own way on Thursday. More specifically, she kept the ECB's interest rate at -0.5% and took a series of steps to mitigate the economic impact of coronavirus: by buying 120 billion euros ($ 133.9 billion) in bonds by the end of the year Liquidity and more credit and launch a new plan to provide banks with cheap loans (interest rates as low as -0.75%, lower than the ECB's negative deposit rate). But it is clear that the ECB will not do anything other than increase liquidity because it cannot.

The European Central Bank cannot do this because there is reason to worry that further reductions in interest rates from current levels (-0.5%) do more harm than good. The Nordics are opposed to lowering interest rates and revising restrictions on the purchase of sovereign debt.

European Central Bank President Christine Lagarde said her officials were seeking to provide "super cheap" funding and to ensure that liquidity and credit would not run out. She then made it clear that the response to the new crown virus must be “first financial”, noting that, so far, the total commitments of governments in the euro area have been only 27 billion euros ($ 30 billion).

The measures of the central bank can only work if the government also supports them. The European Central Bank will take steps to ensure that banks continue to lend to businesses in the affected areas. I totally agree with her.

As for what might happen next, the European Central Bank may consider increasing the liquidity of SMEs by reusing existing TLTROs or similar new plans, but this will not do much.

The most important test of their willingness to "do something" is whether they have raised bond purchase limits to control interest rates and credit spreads. If you want, you can take some time to make up for the deficit, but it will not be enough in the long run. And if you don't, it's very worrying.

in Italy

So far, fiscal stimulus packages have accounted for about 0.4% of GDP, but they will expand and should be even larger. It now includes targeted tax cuts for affected industries such as transportation, hotels, and exporters; supports healthcare services; and provides tax credits for companies with a 25% reduction in revenue.

In my opinion, this is a good policy that other countries should consider, because the bankruptcy of good companies and their secondary effects are threatening economic recovery.

But this is not enough. The Italian government is also preparing a set of structural measures to encourage foreign direct investment and investment, but this remains a problem after the crisis. Because these policies are raising political issues and the opposition says more should be done, doing more on the domestic political stage is clearly more politically secure.

Not surprisingly, it is reported that the government is currently seeking to more than double the size of the stimulus to a total of 25 billion euros (1.2% of GDP), which will bring its deficit to 3.3% in 2020. However, I expect that this estimate of the size of the deficit is too low, because taxes will be destroyed.

Although the EU shows flexibility to Italy in deviating from its debt reduction path, the amount of its borrowing will affect its overall debt sustainability. Italy's finance minister asked the European Central Bank for support in this matter. We will have to see how all political actors (most importantly the European Commission and the Italian government) address this issue.

in Germany

At first, the Germans responded to the crisis with their usual frugality, which prevented them from creating a lot of money and credit in the face of financial pressure, but now it seems that they are turning to the direction of "at all costs", which will greatly Increase its demand to sell bonds.

This means that the European Central Bank has a responsibility to buy these bonds. However, restrictions imposed by the Germans will prevent the European Central Bank from buying its bonds.

Citing a statement from the German Treasury: "The German government is taking decisive and powerful action to deal with the economic impact of coronavirus."

The German government has agreed that it will take a "far-reaching package to protect jobs and support companies. The government is setting up protective shields for employees and companies. The goal is to provide companies with sufficient liquidity so they can spend their time in good shape crisis."

They continued to announce some details, but there will be more. These measures include reducing working hours for employees and employers, and compensating for these reduced time and liquidity through public investment banks. They also include deferred payment of taxes, cancellation of fines for late fees, etc.

This will also create a "protection shield" for companies including KD commercial loans and loan guarantees. In my opinion, this seems to be a wonderful way of both scale and focus. They will need more borrowing to raise funds for it, and this is back to the ECB. The ECB needs to keep interest rates down and make whatever purchases it needs, which means that control must be lifted (this is doubtful).

What is interesting is how Germany will deal with its own constraints, such as "black zero" (a promise to guarantee a balanced budget), to limit the size of any potential stimulus, rather than just using automatic stabilizers and extracting existing surpluses. It must also deal with "debt suppression," a constitutional provision that limits structural deficits to 0.35% of GDP.

However, if most MPs determine that additional expenditures are needed to address "natural disasters or very emergency situations beyond national control," there is scope, and this is the case with COVID-19.

In France

So far, the focus has been on credit payment assistance and various forms of regulatory relief (for example, credit payment assistance for 70% of loans, cancellation of late fee fines and tax obligations for public contracts). However, the Minister of Finance has initiated emergency economic measures. The last time such measures were implemented, these measures accounted for about 0.4% of GDP expenditure and income changes.

France's institutional structure is more centralized than Germany's, and fiscal conservatism pressure in its culture is not so strict. This means weaker policy barriers to aid, allowing the government to strengthen deeper policy cooperation between various sectors of the economy.

The government is also responding faster to people screaming (some people will say that they are grumpy), so we should expect more as local conditions worsen. However, as France's budget deficit is already large and it violates EU fiscal rules (3.2% of GDP), there has been little discussion of expanding fiscal stimulus measures. However, I do hope that will come. We are waiting for the announcement.

In Japan

To date, the government's fiscal response has been designed to support medical services and affected individuals and companies, especially small and medium enterprises.

For example, two spending plans totaling 450 billion yen were recently issued to fund the opening of new medical clinics and improvement of medical facilities, to assist working parents who have been forced to take time off due to school suspensions, and for small and medium-sized enterprises provide support.

In addition, the government will provide special funds of 1.6 trillion yen to help SMEs and other enterprises affected by the outbreak. These seem good to me, although they are generally not enough. These measures use existing "rainy" government funds. Wouldn't it be great if they had such a fund?

The government is also seeking legislation to authorize the Prime Minister to declare a state of emergency when necessary. These measures complement the 13.2 trillion yen fiscal stimulus package announced in December. The expenditure will be phased over several quarters. According to reports, the Japanese government is considering a fiscal stimulus in April with a scale of 10-20 trillion yen, which may include issuing cash directly to households.

The Bank of Japan is more squeezed than other central banks because it has the same problems and a strong currency (which exacerbates deflation and negative growth pressures).

However, it has greater flexibility in the type and amount of assets it can purchase. Every day the Bank of Japan intervened in the market in March, it bought about 100 billion yen of stock ETFs, compared with about 70 billion yen in previous purchases. It also provides the market with sufficient liquidity through repo operations. The Bank of Japan is likely to raise its annual target for ETF purchases at its March meeting.

in China

The most targeted and appropriately sized fiscal and monetary countermeasures come from China. This is because it is a country with greater ability to coordinate fiscal and monetary policies, faster dispute resolution, and very intelligent economic decision makers.

So far, a series of fiscal measures have been announced, accounting for about 1.2% of GDP (excluding infrastructure investment).

These measures include exemptions and reductions in social costs (such as corporate pensions, unemployment and workplace injury insurance), reductions in medical insurance contributions, reductions in value added tax for certain businesses, and reductions in electricity and gas bills for business users. A series of smaller financial support measures (including subsidies) have also been announced at the local level.

At the national level, the government has introduced a series of measures to support selected industries. In addition, the government has introduced regulatory tolerance policies (for example, delaying the recognition of some banks' non-performing loans).

The People's Bank of China has more room to maneuver because of the position of interest rates and it has more ability to increase or decrease loans. It recently lowered specific interest rates, cut reserve requirements, provided liquidity, and launched a $ 79 billion support package to virus-affected companies.

In addition, it has changed its official position to "cautious and appropriate flexibility" and introduced 30 measures to support businesses affected by the epidemic, with a focus on SMEs, such as refinancing and rediscounting for banks. Looking at the whole picture, I think this is appropriate.

03

All in all, I believe 1) The lower interest rate limit of 0% and the lack of other effective central bank tools means that greater fiscal stimulus will be needed to reach the most important pain points, while the central bank needs to lower interest rates and provide ample liquidity;

2) So far, the scale, focus and coordination of the response measures have not been sufficient, but the responses have varied from country to country;

3) In the past few days, there have been signs that fiscal and monetary policy makers are taking greater action to do their best.

4) The wealth and political divide will test the ability of social and political cooperation and help, rather than hurt each other in solving these problems.

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