[Editor’s note: The following is from the latest commentary by Harley Bassman. If you’re not familiar with Bassman, he (literally) created the MOVE – more here.]
Excerpted from “Sending In The Snakes”, by Harley Bassman
My children have accused me of being a “COVID-19 denier”, which is false; all I have said, which I suppose is un-PC, is that this is not some horror movie disease which makes your skin melt off or your eyeballs pop out of your head. Moreover, this will not be a 1918 Spanish flu redux that kills integer percentages of the population; not because this flu is less contagious or dangerous, but rather that science and health management have vastly improved.
As a bit of morbid but relevant trivia, the mortality rate of the Spanish flu peaked slightly before the November 1918 armistice; a war that was fought mainly in tightly packed trenches filled with soldiers transported in poorly ventilated ships and trains – social distancing does work, so do it !
I have often used the shorthand of “QE~” as a snarky jab at the Federal Reserve (FED) to stand for “infinite Quantitative Easing”; but hey, I thought I was just kidding. Presently, a variation of QE~ has been announced: Hhhhmmm….
Thus, to borrow from the Department of “no good deed goes unpunished”, and as a comment I will surely regret at a later date, at some point one must consider whether the FED’s latest cure is worse than the disease.
A few years back, at exactly the wrong time, our dishwasher conked out. (Check that, is there ever a good time ?) In any event, after scrutinizing the fuse box (the extent of my skill set) we called in the repair service. It was quickly diagnosed: A mouse had nibbled the cloth wrapper on the power wire to secure some nesting material for a cold winter.
A few ideas were offered to prevent a reoccurrence, but one that was refused out of hand was sourcing a few snakes to rid the house of mice. Indeed, the snakes would have solved the mouse problem, but then I would be left with a house full of snakes.
As a card-carrying graduate of UChicago, I will stipulate (again) that a fiat currency cannot be created at a faster rate than the growth of the economy without inflation. Over 5000 years of collective civilization, we have no record of the Sovereign printing the coin of the realm at such a pace without the currency becoming devalued.
So, while inflation, as measured by the CPI, has been rather somnambulant over the decade, the –vanadium line– measure of the M-2 money supply should give one pause. For the calendar year 2019, M-2 grew at a 6.5% annual rate; as the first quarter of 2020 closed, M-2 grew at nearly a 35% annual rate.
While it does seem hard to reconcile ten years of M-2 growth at 6.25% with a decade of CPI at less than 2.0%, perhaps we are using the wrong metric.
The FED’s master plan, which I endorsed at the time, was to combine a Zero Interest Rate Policy (ZIRP) with QE to create wage inflation for the middle class. Banks were supposed to be the conduit, but for various reasons unforeseen at the time, the money jammed up and Monetary Velocity collapsed.
Contrary to good public policy, Corporations borrowed these funds and recycled them into stock buybacks that soon funded the purchase of real estate, art, etc. It is the asset market where one can find the missing inflation.
There are many charts on this topic, some reporting this past decade’s stock buybacks as high as $4tn. But for our purposes, this one is informative. Notice the –manganese line– of equity purchases by non-financial corporations as effectively the sole buyer; and to their regret, the –chromium line– household sector has been a net seller.
But away from the FED’s printed money being spent in a less than productive manner, the much greater worry about their recently expanded policies to buy Municipal and High Yield bonds is the introduction of Moral Hazard.
The most important feature of a free market system is not the price of an asset, but rather the signaling process to capital allocators and risk managers. The old expression is that “the cure for high prices, is high prices”.
While the ultimate cost to the environment may not have been fully factored in, the fracking business was built upon four years of oil at $95/barrel.
And while I am no fan of Modern Monetary Theory (MMT), this too is functionally supported by the notion that market prices would offer signals for policy makers to open or close the money spigot.
If the FED starts buying, instead of financing (lending), Municipal and less than Investment Grade (IG) bonds, who will tame the bad actors ? Markets presently deny credit to those with poor character or a weak financial structure, does the FED intend to take on that role ?
More urgently, how will these decision be made ? Will the FED read business plans, or more frightening, will Congress and the Executive branch be given such powers ? Would they have supported Amazon – a firm that did not make a profit over their first five years as a public company ? Would they support Tesla now ?
To quote Walter Bagehot, editor of The Economist in 1873 in reference to the Panic of 1866: “…in a panic…the Central Bank should lend freely, at a penalty rate, against good collateral”.
Lending is NOT buying; perhaps I am being a tad melodramatic, but once the toothpaste is out of the tube, it is nearly impossible to jam it back. (I’m starting to develop some empathy for Second Amendment advocates.)
A decade ago, we were told that the expansion of the FED’s balance sheet was temporary, and that it would be reduced as conditions allowed. The FED has tried twice to pull in the reins, both attempts ended in tears.
To be clear, I fully appreciate the huge personal and financial harm the COVID-19 pandemic has wrought, and while perhaps a bit tardy, this full-throated Federal/State/Local government response is warranted.
But we need to keep our focus on the long-run effects of such policies and have a clear-eyed look at the costs; and I mean more than just financial. Our national nightmare of Opioid abuse was not cut from whole cloth by greedy pharmaceutical manufacturers, it was in part a concurrent reaction to decades of insufficient attention to pain management by the medical community.
Bluntly, I do not have confidence the FED will be able to extricate itself from these policies; no matter how well intentioned and seemingly urgent. You already know my coda: It is never different this time.
In my last Commentary, I suggested the S&P 500 would kiss the November 2016 election day close of 2139, barely 6% below my “fair value” estimate. But with the FED buying almost all debt assets, and the possibility suggested by Janet Yellen last week that the FED should be allowed to buy equities, all I can say is that fundamental analysis is out the window. I have no idea how to value equities, except to suggest it is a challenge to fight the FED and win.
There are lines that should not be crossed because sometimes one cannot revert. As such, let me be clear I think direct purchases by the FED of risky assets is problematic; lending against collateral is fine, but buying is not.
This is quite different from what happened with AIG; there, the Government crammed down the equity holders by 80% before they backstopped the firm. That is not the same as buying at the market price to support the stock.
In addition to introducing Moral Hazard to the financial markets, a Central Bank buying risky assets creates the potential to erode the basic foundation of Capitalism.
It is never different this time.