Financial and economic conditions continue to rapidly change and evolve as the coronavirus economic restrictions remain in place.
While the focus of policymakers is to ‘flatten the curve’ as far as coronavirus infections are concerned, there is another curve that is being discussed far less. But, over time, this curve won’t flatten and will end up causing economic and financial outcomes that will be devastating to those who are unprepared.
What curve might that be?
The balance sheet of the Federal Reserve.
For those of you who are new readers of my blog, when the Fed’s balance sheet expands, it means that the Fed is creating money, virtually out of thin air.
The Fed doesn’t manufacture anything to sell so in order for the Fed to get money to buy assets from member banks, that money is just created.
And, now, under the new rules post-stimulus, the Fed can print money to loan to the US Treasury. The US Treasury can use SPV’s, or special purpose vehicle, to buy corporate bond vehicles on the open market by borrowing newly created money from the Federal Reserve.
In effect, this nationalizes more of the private sector and does so through money creation.
Let that sink in, it’s alarming.
The chart on this page shows that the balance sheet of the Federal Reserve will reach $6.4 trillion by April 17 – that’s just one week away. That’s up about $2.5 trillion this year alone!
But, this past week, the Fed took an even more extreme position, stating that they would begin purchasing junk bonds as well. Junk bonds are bonds that are below investment grade and carry more risk than an investment-grade bond.
This from “Bloomberg” (Source: https://www.bloomberg.com/news/articles/2020-04-09/fed-unleashes-fresh-steps-for-as-much-as-2-3-trillion-in-aid) (emphasis added):
As fresh evidence of the economic toll from the coronavirus pandemic floods in, the Federal Reserve unleashed another round of emergency measures, including a pledge to provide support to risky corners of financial markets that have been some of the hardest hit.
The Fed said Thursday it will invest up to $2.3 trillion in loans to aid small and mid-sized businesses and state and local governments as well as fund the purchases of some types of high-yield bonds, collateralized loan obligations, and commercial mortgage-backed securities.
The money comes on top of the massive stimulus that the Fed had already announced and it thrusts the institution into the sort of speculative lending activities it had shunned in the past — underscoring the risks that Chairman Jerome Powell is willing to take to shore up the economy.
This demonstrates how desperate the Fed has become.
As noted above, as part of the CARES Act, the Fed will loan money to the Treasury to buy corporate bond issues. Now, the Fed has announced that the central bank will directly buy junk bonds.
This despite the fact that it is not legal for the Fed to directly purchase any security that is not government-backed.
It also puts the Fed in a position of deciding which junk bonds to buy; essentially putting them in a position of picking winners and losers. This makes the Fed even more political.
What could go wrong?
Money creation is on steroids.
In contrast, the Federal Reserve created about $3 trillion in new money from the end of 2008 to the beginning of 2020. At this rate, the Fed will have printed an equivalent by the first of May of 2020.
That’s as much ‘out-of-thin-air’ money creation in 4 months as has occurred over the last 12 years!
I have been repeatedly warning of a slippery slope and an ultimate Dow to Gold ratio of 2, or even 1 based on my study of history. Now, the path on which we arrive there seems clearer.
As I discussed last week, it seems highly unlikely that we will see the ‘V-Shaped’ recovery for which so many are hopeful. There are many reasons for this, but the primary two are:
- Already anemic corporate earnings becoming even weaker as a result of the anti-coronavirus constraints.
- The primary driver of higher stock prices since the financial crisis, corporate stock buybacks, will now be going the way of the dinosaur given that companies that take money from the government will now be prohibited from engaging in this activity. (Important note: stock buybacks were illegal from 1934 until 1982)
I see stocks as having more potential downside from here – probably significant downside if the anticipated economic forecast holds true. A 30% to 50% decline in GDP in the second quarter of this year combined with a headline unemployment rate of 15% to 25% will be ruinous for stocks.
These are truly historic times.
At the same time, money printing in quantities that could only be described as colossal will have to be bullish for tangible assets at some future point. That is an indisputable fact of history.
The immediate focus of politicians and policymakers has been reacting to the economic chaos. Over the past three weeks, 17 million people have lost their jobs and filed for unemployment. There are many more than this actual but there are lots of reports of glitches in state unemployment systems that have not made it possible for all those who are eligible to file. We expect that this number goes significantly higher before this curve flattens.
We are on the brink of the deflationary depression that I have been warning about since my book “Economic Consequences” was published in 2011. Congress, the president, and the Fed are determined to do whatever it takes to avoid such an outcome. So, they are responding by doing the only thing they know how to do – print, print, print.
Here’s the reality though. The $2.1 trillion stimulus package is not a stimulus package, it a subsistence package. This newly printed money will merely replace some of the incomes lost as a result of the coronavirus constraints.
In other words, this initial package is designed to prevent the plunge into a depression, it won’t provide stimulus. Look for more government packages in the future funded by money creation.
So, when will the inflation hit?
No one knows for sure. But at this point, stagflation seems like the most likely economic outcome.
Again, blessings to all of you in these difficult times. Educate yourself and stay safe.