Back in October, the Fed already knew there was a liquidity problem. This is why in September, the Fed began a new round of quantitative easing to essentially bail out the repo markets.
Naturally, the Fed’s defenders, both inside and outside the Fed itself, insisted that this was not QE. Both Bloomberg (”When the Fed Fixes Repo Markets, Don’t Call It QE“) and the Wall Street Journal (”The Fed Is Buying Treasurys Again. Just Don’t Call It Quantitative Easing“) ran articles using lots of big words and technical language to explain how only hopelessly unsophisticated observers of the Fed’s magic would possibly think the Fed was going down the QE road again. The message was clear: “everything is fine. move along.”
All along, the Fed used words like “strong” and “solid” to describe the state of the economy. Even as late as March 2, Jerome Powell insisted: “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity.”
Of course, by late March, it was no longer possible to keep up the ruse, and what was already a fragile and illiquid market went into a tailspin as governments around the world began to force their economies to a standstill in the name of battling COVID-19.
This, of course, is a shining example of how the Fed always insists that everything is fine until it is blatantly obvious to even the laziest observer that things are not fine. By March 23, the Fed committed to buying everything from Treasurys to securities in order to “support smooth market functioning.”
The Federal Reserve said Monday it will launch a barrage of programs aimed at helping markets function more efficiently amid the coronavirus crisis.
Among the initiatives is a commitment to continue its asset purchasing program “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.”
That represents a potentially new chapter in the Fed’s “money printing” as it commits to keep expanding its balance sheet as necessary, rather than a commitment to a set amount.
The Fed also will be moving for the first time into corporate bonds, purchasing the investment-grade securities in primary and secondary markets and through exchange-traded funds. The move comes in a space that has seen considerable turmoil since the crisis has intensified and market liquidity has been sapped.
There was no fundamental qualitative difference between the repo bailout and this current round of QE Infinity. The end result is the same: the Fed is buying assets because there are not nearly enough holders of cash interested in buying those assets. Without Fed purchases there would be massive asset deflation. The portfolios of hedge funds and banks might collapse. Financial firms might go bankrupt.
As we’ve seen, however, the Fed is in the business of propping up the financial sector at the expense of all other sectors. This is a political elite absolutely committed to financializing the economy. Thus, enormous amounts of asset purchases were a given once the Fed realized what was happening.
This means that the Fed’s balance sheet got a lot bigger. When the repo QE started, the Fed reversed a small downward trend in its total assets. Assets began to inch up again toward the all-time highs reached during late 2014.
Now total assets have reached more than $6 trillion. That’s up nearly 35 percent from the 2015 peak. It’s up by more than $5 trillion since the 2008 financial crisis took hold.
Interest Rates and Zombies
Meanwhile, the Fed is using some of these purchases to push down interest rates. This is necessary because in spite of all the claims about how strong the US economy was over the past decade, the fact is that the US (and the world) was quickly becoming populated by “zombie corporations.” These are companies that don’t actually produce enough revenue and profit for growth. They grow by taking on more debt. Only if interest rates remain low is this feasible. As a 2019 report from the Bank for International Settlements concluded:
The overall landscape is one of a global economy that has been unable to jettison its debt-dependent growth model. Indeed, aggregate debt (public plus private) in relation to GDP, while it plateaued in the past year, is much higher than pre-crisis.
In other words, after an alleged decade of “strong” growth, the world’s corporations (and also households, by the way) are deeply in debt, and will quickly become insolvent if interest rates go up.
This is why the Fed never dared raise the target federal funds rate above 2.5 percent—and that was only for a few months—all while claiming the economy was “strong.”
Now, understanding that much of the world can’t pay its debts, the Fed is ensuring that the target rate falls back down to what we saw in the wake of the 2008 financial crisis. But that’s just the target rate. With so much newly printed Fed money sloshing around, the effective federal funds rate is now down to 0.05 percent. Apart from a few days in 2009, we haven’t seen it lower than this.
There clearly isn’t any end game here for the Fed. The idea at work seems to be to just stave off total disaster (from the government and financial sector’s perspective) and hope that some sort of economic miracle sets everything right again. After more than a decade of rock-bottom interest rates, companies, governments, and households are highly leveraged, yet lack the income to pay their bills.
As we saw from the liquidity crisis with repos, there were already serious economic dangers arising in late 2019. But now the COVID-19 panic has made things far worse. Even if political leaders in the US and elsewhere allow businesses to open up again, it is by no means a given that the economy will start to produce nearly enough to allow households and companies to pay their bills. The only thing that can prevent a wave of insolvency, bankruptcies, and foreclosures will be more monetization of debt and immense amounts of asset purchases, possibly for years.
