Macroeconomic Update – Fourth Quarter 2020

Brandywine Global: Our view continues to be that growth is likely to surprise on the upside given the tsunami of stimulus measures undertaken around the world.

    Francis Scotland

    Francis Scotland Director of Global Macro Research, Brandywine Global


    Last quarter, we used the fictional story of “The Wizard of Oz” as a metaphor for the global macro outlook. The pandemic of 2020 blew the world economy into the magical world promised by Modern Monetary Theorists, much like the tornado carried Dorothy from Kansas to Oz. In the blink of an eye, central bankers invited politicians to a free lunch of massive deficit spending and money printing without concern for the balance sheet or how to repay ballooning debts. It is hard to overstate how exceptional these actions have been. Central bank balance sheets, money supplies, and government deficits have increased by trillions of dollars. The torrent of support has encouraged breakeven inflation rates to recover and unleashed massive gains in equities, corporate bonds, emerging country sovereign bonds, and commodities, aided and encouraged by a falling U.S. dollar.

    Extraordinary for sure, perhaps even insane. Whatever label history will put on these policy decisions, we all know that it will be very painful when the party ends. Timing is everything, and there are a lot of moving parts. At some point, the tab for all this spending must be paid. The first and most likely significant macro development to spoil the party would be anything that encourages central banks to turn off the fire hoses, flooding the world with high-powered money.

    So far, no major central bank has blinked. Instead, the punchbowls were topped up late in the year. The Federal Reserve (Fed) in mid-December provided clear guidance on its plans for another multi-trillion-dollar expansion of its balance sheet for 2021, and Vice Chair Richard Clarida more recently stated that tapering the balance sheet for 2021 was not consistent with his economic outlook. America’s political leaders delivered a large but indiscriminate package of fiscal stimulus that was big on politics but poor on economics. The Georgia election results increase the probability of more stimulus to come. Elsewhere, comparable if not greater policy support continues to grow almost everywhere in the developed world. Emerging countries remain more constrained, while China continues to march to the beat of its own drum, reminding us we have evolved to a multi-polar global order.

    Extreme events lead to extreme reactions. These developments have no historical comparison, nor does the policy response. The lockdowns brought on a contraction that rivaled the Great Depression. The remedial policy goal was to go big and go fast. So far, the response has been very successful. It looks like the contraction lasted two months, with the world economy exiting 2020 on a solid recovery track. The remarkably stimulative mix of monetary and fiscal policies has added mightily to these developments.

    2021 RESET: WHAT KIND?

    This year we may learn if the world of the Modern Monetary Theorists is as big a humbug as the Wizard of Oz himself turned out to be, or whether these extraordinary policy conditions morph into something more permanent. A buzz has grown around the thesis that the world’s policy elite want to use the economic crisis caused by the pandemic to “reset” the global economy. On the agenda is flattening the curve of income and wealth inequality, which many believe foments populism. In addition, there is a strong push for more sustainable development to confront climate change with ESG-compliant private sector capital pools already building quickly. Furthermore, there is a growing consensus among the macro-intelligentsia—people like Larry Summers and Ben Bernanke—of the need for a shift in thinking on the role of fiscal and monetary policy. For 50 years, the macro policy status quo has been to use fiscal policy as a counter-cyclical tool and monetary policy to head off incipient inflation. That perspective may have collapsed in the aftermath of the pandemic. In its place, a view has emerged that sustained large budget deficits are needed to combat a world of secular stagnation. Monetary policy, too, must shift to a perspective in which falling inflation is perceived to be a bigger threat than the opposite. That view is now institutionalized at the Fed with its shift to an average inflation target.

    The success of the Democrats in the recent U.S. election significantly increases the chances of this agenda being implemented. A Biden-led multi-trillion-dollar green energy infrastructure program and redistributive tax measures could be the tip of the fiscal spear for addressing the confluence of populism and concerns over climate change and sustainability. The low cost of capital, advances in technology, and private capital already pivoting into this space would play big supporting roles. One thing is for sure. The Democrats will want a booming economy heading into mid-term elections two years from now to sustain their razor-thin control of Congress. We expect big government is going to get bigger.

    An equally potent if not bigger reset for 2021 and 2022 could come if the vaccines are a success. This is the part in the story where Dorothy goes home to Kansas. Restoration of confidence produced by the vaccines would turbo-charge an already expanding economy. A recovery in growth and sentiment would severely test the willingness of central banks around the world to keep the monetary floodgates wide open.

    Recoveries to date have been V-shaped and faster than predicted by the central banks, governments, and supranational agencies like the International Monetary Fund (IMF). Some moderation in the pace of activity is expected at the start of the year owing to social isolation measures implemented near the end of the year in Europe and North America.

    Our view continues to be that growth is likely to surprise on the upside given the tsunami of stimulus measures undertaken around the world. Historically, many of these relationships would flag strong growth conditions for 2021 were it not for the drag caused by fear of the virus and the impact on jobs and incomes in the service sector. Hence, consumer confidence will be crucial. An even stronger economic recovery is likely if vaccine success manifests in reopening of the service sector, rapid job hires, and improved consumer confidence. It is quite possible during this phase that inflation could surge more than expected. Demand will be strong, but the supply side of the economy has been damaged in areas that will be reopened, paving the way for what could be short-term but abrupt surges in inflation, depending on the policy response.


    China is one country that clearly took advantage of the pandemic for its own reset. The explosion of the crisis in the West provided distraction for the Chinese Communist Party to introduce Hong Kong’s new security law and effectively end the “one country, two systems” principle 27 years ahead of schedule. Throughout most of 2020, the world’s second-largest economy and its policymakers have been marching to a very different beat than in the developed countries.

    China’s economy may be six to nine months ahead of the U.S. and Europe. It has essentially achieved normalization back to pre-pandemic levels by relying on compliance with social isolation instructions as only China could enforce. There was never the scale of policy support during the crisis as was the case in the developed world. So confident are the authorities that the crisis is over that they are withdrawing policy support. Short-term rates have risen 100 basis points, the 10-year bond yield has renormalized, and the Chinese currency is up roughly 10% against the dollar since May. Following their annual policy planning exercise, the authorities want to recalibrate social financing and money growth more in line with nominal gross domestic product (GDP) growth—a non-trivial adjustment lower. This move is part of the Dual Circulation Strategy, which includes capping loan growth to the property sector and redirecting savings and credit to the high-tech manufacturing industry in order to lessen the country’s dependence on western high-tech imports.

    These policy developments could be very important later this year. President Xi Jinping will want a strong economy heading into July in time for the 100th anniversary of the Chinese Communist Party. However, growth later in the year could begin to soften. The leadership’s concerns over mounting leverage and the size of its consolidated budget deficit have encouraged policymakers to retreat from persistent priming of the credit pump in order to sustain forward growth. Too fast a retreat from last year’s measures could unlock renewed deflationary pressure and take some of the wind out of the global recovery. What would make a big difference is if the authorities were prepared to allow a financial ecosystem to grow internally to tap into the productive segments of the economy that cannot get access to credit from the state-owned banks. This change shows no sign of happening. The regulators’ pulling of the Ant IPO and subsequent investigation of Alibaba underscore Beijing’s determination to retain control over financial intermediation. Even the experiment with a digital currency emphasizes the desire of the Chinese Communist Party for control. Extensive use of a digital currency would give the Chinese government incredible control over targeting and directing infusions of digital fiat money wherever it wants.

    Another factor that could weigh on China’s growth outlook will be trade. The Biden administration is not expected to lift tariffs. China’s unwillingness to play by the rules of the international order, or at least the order needed to trade with the U.S., such as industrial subsidies and forced technology transfers, remains the outstanding issue. For China’s part, there is strong belief that they do not really need the rest of the world and are racing to develop domestic demand and build out a high-tech infrastructure. In the meantime, China and the EU have secured an investment agreement that gives EU businesses a level playing field in China while allowing Chinese companies certain market access.


    Improving global growth conditions should continue to support emerging markets for a while longer and as long as dollar weakness promotes stronger local currencies.

    Over the course of January and February, it is possible that the global growth impulse could drop a notch due to the resurgence of social isolation measures in a variety of important countries around the world. However, such measures are unlikely in the two anchor economies of the world—the U.S. and China. Moreover, governments in the developed world continue to show no restraint in deficit funding during this time.

    Overall, we expect the world economy to be stronger by the end of the year, with vaccine success and fresh government stimulus from the incoming U.S. administration and Europe boosting a world economy that was already recovering strongly.

    Why have Treasury yields not already risen? One explanation is financial repression courtesy of the participation of the Fed and other central banks in deficit funding. The other explanations are fear and jobs: confidence is depressed, and the unemployment rate is still significant. Fear of the virus keeps people from going out, which feeds back into the persistent depressed state of the service sector. As a result, the high personal savings rates and household cash stockpiles have tended to accumulate in bank deposits and fixed income investments. These behaviors underscore the significance of an improvement in confidence on the back of the vaccines being rolled out.

    We anticipate a potential dollar correction at any time. What is so different about this cycle is the stance of the Fed and the orientation of the incoming Biden administration. Perpetual stimulus, deficits, redistributive income policies, and negative real interest rates are not the bailiwick of a strong currency.


    Modern Monetary Theory (MMT), not widely accepted, has the following basic attributes: A government that prints and borrows in its own currency cannot be forced to default, since it can always create money to pay creditors. New money can also pay for government spending; tax revenues are unnecessary. Governments, furthermore, should use their budgets to manage demand and maintain full employment (tasks now assigned to monetary policy, set by central banks). The main constraint on government spending is not the mood of the bond market, but the availability of underused resources, like jobless workers.

    A V-shaped recovery is characterized by a quick and sustained recovery in measures of economic performance after a sharp economic decline. Because of the speed of economic adjustment and recovery in macroeconomic performance, a V-shaped recovery is a best case scenario given the recession.

    A supranational organization is a multinational union or association in which member countries cede authority and sovereignty on at least some internal matters to the group, whose decisions are binding on its members. In short, member states share in decision making on matters that will affect each country's citizens.

    The Dual circulation strategy involves China’s emphasis on growth through exports is being bolstered by a focus on domestic demand as the international trade environment comes less supportive.

    Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it.

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations. Looked at another way, the Treasury yield is the effective interest rate that the U.S. government pays to borrow money for different lengths of time.



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