Reservecurrency,deficitfinancingandlensofMCPF

News about the US stimulus package has been the market favoured muse for some time now. The equity markets rise when the deal looks likely and they wobble when some strident remark appears on the wires. Yesterday the stocks also rose when the news came that the two parties are going to start the discussion (again). However, the news in the evening that Treasury Sec Steve Mnuchin has written to Fed on letting some key pandemic relief programs expire on Dec 31^st and then return the unused money which is some USD 455-bn to congress. This proposed winding up of the backstop arrangement for the main street firms impacted the stock futures which traded lower.

Now let’s take a step back from this daily tussle about the structure of stimulus relief programs whether they are in US or in Eurozone (PEPP) or in India (Atmanirbhar Bharat Packages 1,2 &3) or somewhere else. Readers would do well to put some thought on why this struggle exists in the first place. The struggle exists because the govts don’t have infinite money, any lavish relief has to be funded by big borrowing or tax increases. We have written in the past about how the US is a special case because the US Dollar is the reserve currency of the world. But the US is an exception not a norm, practically every other country has to think about their deficits and a way to fund it. Hence the conservative approach.

Authors Vijay Kelkar and Ajay Shah talk about a critical concept about public finance thinking in their 2019 book In Service of the Republic. The concept is called the Marginal cost of public funds (MCPF). Whether for disaster relief or running a subsidy program the author duo tells us that cost of a dollar of public spending on a society is not one dollar but much more. Any spend by the govt has to be earned through taxes (either present or in future to repay the borrowing). The tax increase distorts the public behaviour (devising new ways to save tax), increases compliance costs (raids, litigation, increase in criminality), distorting public debt management practices (increase in compulsory buying of govt debt) etc. All these factors contribute to high inefficiencies in the economy. Final word being that every Rupee which govt scoops from public to spend on it has cost implications beyond a Rupee. Authors write that in India the MCPF is around 2.5 to 3.5 or more (estimates only), in developed world the same is around 1.5 to 2. Hence next time someone offers a Keynesian remedy we should use the lens of MCPF to scrutinise the same.

In other news the number of initial jobless claims went up to 742k from 711k filed a week earlier. The increase when seen in conjunction with rise in corona cases across the US depicts a grim short-term future for the job seekers. Other important news came from Turkey where the Turkish Central Bank hiked its key interest rate by 475 bps to 15 percent signalling its fight against inflation. The Turkish Lira rallied 1.5% post the news, currently trading at 7.56 having touched highs 8.51 in the first week of November. The South African Reserve Bank on the other handheld the rates constant at 3.5%. The Rand rallied from 15.52 to 15.40 post the decision.

In India we saw the special OMO (operation twist) auction yesterday for 10k cr INR, the cut-offs were on expected lines. RBI announced that the next leg of another 10k Cr INR of OT will happen on Nov 26^th. Rupee opens around 74.11 in the morning trade.