The market / policy response to the coronavirus shock is expected here to result in a strong pick-up in global narrow money growth, signalling a robust rebound in economic activity in H2 2020 and 2021 assuming Chinese-style virus containment and a gradual loosening of control measures. It may also contribute to a trend increase in broad money growth – this would be consistent with cycle analysis suggesting a medium-term rise in inflation.

Monetary and fiscal policy measures announced in recent days arguably represent larger-scale stimulus than delivered during the GFC. Interest rate cuts have been smaller but the QE response has been much bigger and faster – see first chart. More importantly, banks are being incentivised / compelled to expand their balance sheets – in contrast to the misguided emphasis on boosting capital ratios during the GFC. The rise in fiscal deficits, meanwhile, is likely to exceed the increase then and may need to be financed by even more QE.

Posts here years ago argued that QE would deliver a smaller boost to broad money growth than claimed by its “monetarist” advocates because of offsetting behaviour by banks under pressure to limit balance sheet expansion. A key offsetting mechanism was that banks sold government bonds as their reserves at the central bank increased – such sales effectively “sterilised” the impact of QE on broad money holdings of households and firms.

The past monetary impotence of QE is illustrated by Japanese experience – the largest bond-buying programme globally in terms of share of GDP failed to shift annual M3 growth out of a 2.0-3.5% range.

With the balance sheet constraint on banks relaxed, however, QE may now have a more powerful impact on broad money. The combination of QE and large-scale fiscal expansion, moreover, implies a direct injection of monetary demand whereas QE alone has an uncertain indirect effect.

Why would a rise in broad money growth carry more significance for medium-term inflation prospects than a narrow money pick-up? For short-term forecasting (six to 12 months ahead) of economic turning points, (real) narrow money gives more reliable signals than broad money. The velocity of narrow money, however, is more variable than that of broad money over the medium term, resulting in a looser relationship between narrow money and trends in nominal GDP and inflation.

This is illustrated by the second chart, showing G7 narrow and broad money velocity on a quarterly basis and as five-year centred moving averages. Broad money velocity has trended lower since the 1960s, albeit with occasional interruptions in the decline. Narrow money velocity, by contrast, rose between the 1960s and 1980s but fell from the 1990s, with the decline accelerating since the GFC.

The difference in velocity behaviour mainly reflects the greater sensitivity of narrow money demand to interest rate changes. Rising / high rates in the 1970s / 1980s encouraged money-holders to switch out of currency and demand deposits into interest-bearing time deposits and notice accounts, included only in broad money. The shift reversed with the decline in rates from the 1990s, accelerating after the GFC as the interest pick-up for holding money in non-narrow form fell towards zero.

The third chart, showing annual rates of change of nominal GDP and narrow / broad money, illustrates the earlier point that narrow money is better at signalling peaks and troughs in GDP momentum. Broad money trends, however, are a better guide to the medium-term level of nominal GDP growth and, by extension, inflation. Broad money growth displayed a clearer downward trend during the disinflationary 1980s and 1990s and moderate, stable expansion in the 2010s signalled that inflation would remain subdued.

Broad money growth rose during 2019, hinting that medium-term inflation prospects were shifting before the coronavirus shock. A joint surge in narrow and broad money growth would be reminiscent of the early 1970s, ahead of a major upswing in global inflation to a peak in 1975. The judgement here is that this marked the last peak of the approximately 54-year Kondratieff long inflation cycle, which is scheduled to reach another top around 2029.

The extent and duration of the economic damage from the COVID-19 crisis are unknowable. A wild guess is that global GDP will be 40% lower for six months. This would imply an income hit of 20% of annual GDP.

Governments are likely to act as insurer of last resort and pick up most of the tab to limit corporate failures and job losses. The speed with which stimulus / support programmes have been announced, and the acceptance that a wartime-scale rise in debt is inevitable, have been striking. There remain many gaps but these will probably be filled as administrative capacity allows.

Similarly, central banks have reinstated within days the full range of support measures developed over months during the GFC (ZIRP, mega-QE, multiple liquidity / credit support programmes). Those measures needed to be large-scale then because of the (stupid) policy of forcing banks to raise capital ratios, which worsened the credit crunch. Now, banks are being supplied with guarantees / cheap funding and encouraged / forced to lend to all-comers.

Dislocated markets will be unable to absorb the huge rise in government debt issuance as deficits blow out, implying that most of it will end up on the balance sheet of the banking system – mainly central banks – with a corresponding large boost to broad money. Japanese-style yield curve control may go global. The helicopters have arrived.

The above considerations suggest that global money growth will explode to much higher levels than reached during / after the GFC.

The new role of government as income-insurer and the fusion of fiscal and monetary policy set precedents and are likely to be popular in the short term. The era of independent inflation-targeting central banks is over.

Global (i.e. G7 plus E7) annual narrow money growth is estimated to have risen to about 7.5% in February, the fastest since April 2018 and similar to the level in November 2008 after Lehman’s September collapse. It subsequently rose to 10% in March 2009, when equity markets bottomed, peaking at nearly 14% in August. An early increase to 10% is possible and would be a positive signal.

The medium-term investment message is clear: consider buying inflation hedges, many of which have cheapened dramatically in recent dysfunctional markets.

Major countries are now adopting radical social distancing policies, which may or may not be as effective as the lockdown in China’s Hubei province in late January. If they are, the Chinese experience suggests that global ex China daily new infections will peak in about 11 days, though at a significantly higher level than currently. Italy locked down earlier and could be a leading indicator.

Caveat: the following observations are made by an economist with no expertise in epidemiology.

The Wuhan lockdown was announced on 23 January and extended to other cities in Hubei province the following day. It is assumed here that the lockdown was effective from 25 January. Chinese daily new infections peaked 11 days later on 5 February (excluding a spike on 17 February due to a reclassification of existing cases), embarking on a trend decline thereafter. New infections rose by 730% between the start of the lockdown and the peak – see first chart.

The restrictions on travel and commercial / social interactions imposed in Italy and now being rolled out across Europe and in major US cities could be more or less effective in halting virus spread than the Chinese lockdown. The disease may have had greater momentum in China because of increased travel and social interaction ahead of and during the Lunar New Year holiday.

If an effective global lockdown began today (16 March), a repeat of the Chinese pattern would imply a peak in daily new infections on 27 March. A 730% rise from the current level would suggest peak infections of about 90,000.

The Italian lockdown was announced on 9 March. Assuming that it became effective the following day, peak daily infections might be reached around 21 March – second chart. The Italian numbers will be key for assessing the extent to which global experience is mirroring the Chinese pattern.

The Chinese peak on 5 February occurred just after a stock market low on 3 February. Several daily activity indicators (e.g. coal consumption at power plants, passenger traffic, property sales) bottomed out over the following two weeks.

Chinese February money / credit numbers are hopeful, signalling stable monetary conditions despite the coronavirus shock. Policy easing, including state-directed bank lending, is expected to lift money growth significantly by mid 2020, with real growth boosted further by a moderation of food inflation.

Annual growth of the official M1 measure bounced back from zero in January to 4.8% in February, the highest since July 2018 (the January spike down reflected a lunar new year timing effect but was wrongly interpreted by some as a negative signal). M2 growth also firmed, to 8.8%, while growth of total social financing (TSF) was stable at 10.7%.

The preferred money measures here are “true” M1 and non-financial M2, with six-month rather than annual growth rates emphasised. True M1 adds household deposits to the official M1 measure; non-financial M2 strips out deposits of non-bank financial institutions, which are less relevant for assessing economic prospects.

The first chart incorporates February estimates of these measures; the final numbers – usually available within a week of the headline release - are unlikely to change the story. Six-month growth of the money measures, as well as of TSF, appears to have bottomed out in late 2019 / early 2020. Nominal GDP will plunge in Q1 but monetary stability suggests a rapid rebound.

The monetary numbers are consistent with other evidence that the policy response to the coronavirus shock has prevented a follow-on tightening of credit supply. The credit conditions index in the Cheung Kong Graduate School of Business survey of private sector firms was higher in February than December – second chart – while commentary accompanying the manufacturing PMI report noted a positive impact of policy measures to support SMEs.

The six-month change in real true M1 remained negative in February, with the coronavirus shock serving to sustain high food inflation – third chart. An eventual normalisation of food prices will give a big boost to real money growth.

The UK government and central bank have launched massive fiscal and monetary stimulus at a time of near-full employment. This is unlikely to end well.

The package of fiscal and financial measures targeted at mitigating damage from the coronavirus shock is welcome. The necessity of a half-point Bank rate cut and the wisdom of “the largest sustained fiscal loosening since the pre-election Budget of March 1992” are strongly in doubt.

The OBR’s characterisation of Chancellor Sunak’s package does not take into account the additional £12 billion (0.5% of GDP) lobbed in at the last minute as a coronavirus response.

Fiscal / monetary easing is being combined with further large increases in the minimum wage against a backdrop of coming negative supply shocks from tighter immigration controls and Brexit trade frictions. The medium-term consequences could be strongly inflationary.

UK policy-makers would make better decisions if they were attuned to the roughly 18 year housing market cycle, which is due to reach another peak later this decade. Inflation usually embarks on a major upswing in the years preceding peaks.

The post-war pattern has been for Prime Minister / Chancellor duos – usually Tory – to embark on significant policy easing as the cycle starts to accelerate, exacerbating later inflationary problems. Think Heath / Barber and Thatcher / Lawson. Johnson / Sunak fits the pattern perfectly.

Bank of England Governors, for some reason, are rarely credited for their role in the historical boom / bust debacles. Mark Carney will deserve an honourable mention if events play to script.

Monetary trends have been weak but may now strengthen significantly, confirming rising medium-term inflation risks.

The coronavirus shock has resulted in a major and probably unjustified cheapening of inflation hedges. Today’s UK policy moves are likely to be mirrored globally and suggest an emerging buying opportunity for such hedges.

The baseline expectation here remains that the market / policy response to the coronavirus shock – compounded now by an oil supply shock – will result in an early and strong pick-up in global real money growth, setting the stage for a solid rebound in economic activity during H2 2020 and above-trend growth in 2021.

PMI results for February confirm a dramatic weakening of economic activity driven by supply-side disruption. The global manufacturing PMI output index plunged to a recessionary level but supplier delivery times lengthened to an extent typical of boom conditions. Production shutdowns led to a rise in order backlogs despite a sharp drop incoming bookings – see first and second charts.

Economies usually recover swiftly from supply-driven shocks. Japanese industrial output plunged 16.5% in March 2011 following the Tohoku earthquake / tsunami but had recouped 70% of the loss three months later – third chart.

The coronavirus shock has depressed demand as well as supply and markets are fearful of a negative spiral of income losses, further spending cut-backs, credit tightening and layoffs. Policy-makers recognise the risks and are likely to provide cash flow support and incentives for banks to extend credit lines.

Chinese policy actions are already yielding results, judging from the February PMI report: manufacturers’ year-ahead output expectations reached a five-year high, reflecting “proactive macroeconomic policies and … support for small and midsized enterprises”.

The market response to the shock, meanwhile, will, on the view here, deliver significant demand stimulus, with lower risk-free yields and commodity prices offsetting equity market weakness and higher credit spreads.

G7 narrow money growth had already recovered in response to the fall in yields through late 2019; the recent further plunge could turbo-charge the revival – fourth chart.

US six-month narrow money growth is estimated to have risen in February, based on data for the first three weeks, while mortgage applications were surging before the latest yield decline – fifth chart. Japanese six-month M1 growth reached a 25-month high last month.

The oil price collapse, meanwhile, will give a significant boost to real money growth. Based on current levels, global (i.e. G7 plus E7) six-month consumer price momentum could fall by more than 1 pp (not annualised) from its January peak – sixth chart.

The long-standing view here has been that a rise in global six-month real narrow money growth above 3% was needed to signal an economic recovery. The failure to reach this level in late 2019 and a subsequent relapse prompted a negative reassessment of economic prospects (e.g. here).

With real money growth at 1.7% in January, the combination of a nominal pick-up and plunge in inflation is judged likely to result in the 3% level being reached in March / April.

Coronavirus developments, of course, will be key for the timing of an economic rebound. Investors should be wary of economists posing as epidemiologists but the declines in daily new cases in China and Korea suggest that containment / delay measures can swiftly yield significant results – seventh chart.