What a month. After a completely ill-advised, virtue signaling response to effectively assassinate the world economy, the financial markets experienced the fastest 30% fall ever. $15 trillion gone. The Global Elite, never ones to let a good pandemic go to waste, have seized on the opportunity under the guise of monetary momma birds. Let us take you under our wing after we’ve effectively foreclosed on your nest. Yes, the greatest financial hijack has just taken place – most just don’t realize it yet.
So, what just happened? 5-dollar words like the Monetary Policy and Quantitative Easing are social media talking points. Stimulus and Bailouts have become punchlines. We’re going to try to somehow break down all this fiscal jargon and provide a back-of-the-envelope explanation. Tall order but let’s start from the beginning.
How can markets fall so abruptly – 10-12% in a day – and from all-time highs? I have said many times it’s like a bunch of teenagers all rushing for the door when the cops bust the party. There are no buyers, only sellers. When you have such severe market dislocations, price discovery becomes impossible. Market makers (the ones taking the sell orders) know this. They smell panic and are in no way going to help you get out at reasonable prices. Imagine you own a brand new, $50k car, but suddenly lose your job. You are desperate for cash. Someone senses this seeing the for-sale sign on the car and makes you an offer of $30k. You take it. You have been liquidated. Same thing for stocks & bonds. I saw AAA Indiana School Muni Bonds get knocked down 10% in a day – those are the safest investments on Earth. It was a mad dash for cash – in particular the US dollar (more on that later). The entire world experienced one huge margin call.
This is where the Federal Reserve steps in. The 1913 Federal Reserve Act was passed by President Woodrow Wilson to ensure economic liquidity, stability & low unemployment. It granted power to the board of governors to set interest rates, extend banks lines of credit, and buy & sell treasuries. Oh, and yes, print money. Though that’s considered crude verbiage. The white shoed bankers would prefer a more East Coast term: Quantitative Easing. Think back to your grade school days when a classmate, without warning, would puke in the hallway. Out from the dark depths of some unventured hallway a custodian would sprinkle a peculiar smelling dust on the accident to dissolve the foul odor. Nothing to see here; keep moving. The Fed is our Schneider the janitor.
Well, after the markets effectively threw up, the Fed decided to do all of the above and more. In an unprecedented move, they actually communicated what a lot of us have been murmuring since 2009. They have become the buyers of last resort: mortgages, bonds and now stocks. Ladies and Gentlemen, that thud you just heard was the casket closing on free capital markets. Don’t get me wrong, without them effectively back-stopping the world, the markets could be down 60-80% and society, as we know it, would be Mad Max. And yours truly reduced to writing unsubscribed, snarky newsletters & raising chickens.
What is the historical precedent for all this? While the Federal Reserve has been setting interest (discount) rates and extending member banks lines of credit since its inception, the actual purchase of assets is a new trick they learned during the 2008 financial crisis. But that was child’s play compared to what is happening now. The US Federal Reserve bought around $700 billion of assets then. Now, I would guess, when all is said and done, they will eventually buy 10 times that or whatever’s necessary. The G-7, which consists of a bunch of global Schneider wannabes like the Bank of England, ECB and Japan are all feverishly working in concert with the US to put out monetary fires. See the graph below to contrast – remember: this is just getting started.
Where do all these trillions come from? This is where is gets a bit wonky. There are actually 2 mechanisms to pump money: from the Federal Reserve and from the Treasury. When stimulus checks are sent, that is the Treasury selling bonds (IOU’s) which is then added to the Federal deficit (23 trillion and growing). But the Fed’s methods are a bit more cryptic: they buy treasuries and other assets from banks who then extend credit and liquidity. The Fed then creates a credit on their balance sheet out of thin air. Recall the Wizard of Oz & pull back the curtain: you’ll see Schneider pushing all sorts of buttons & levers.
Now, you might ask how can they get away with all this without defaulting. Two words: King Dollar. The United States is currently blessed with the world’s reserve currency. This is by virtue of having the strongest economy, military and political stability (ha). Until someone knocks us off the hill, the Fed can print as much as it wants. The latest crisis re-affirmed that: the entire world sold everything to buy dollars. Not the Chinese Yuan, German Franc or English Pound. Go try to buy groceries with gold. The rest of the world holds over $12 trillion-dollar denominated debt. The US wants to keep fueling liquidity because they need to provide assurance to debt buyers it’s a liquid market. This dynamic will eventually change but unlikely in our lifetimes. We can debate the moral hazard later.
The Fed’s playbook is pretty simple: stem the panic, keep the financial pipes moving and try to kick start a recovery. The last part is easier said than done. The Fed’s monetary bar is running an open tab but no one is drinking. Simply flooding the markets with dollars does no good if there is no velocity of money – everyone is just hoarding them. What’s really needed is human ingenuity and spirit. The totalitarian, big government has to get out of the way. After all, they created this mess in the first place.
Fiscal Fitness is a publication of Houlihan Asset Management, LLC for the benefit of its clients and friends. Houlihan Asset Management. Wealth Counseling/Asset Management. Copyright 2020