“It is impossible to bail out Main Street without bailing out Wall Street even more”, Nordea’s Andreas Steno Larsen writes, in the latest edition of his FX and rates weekly series, released right on schedule Sunday, despite his being busy getting married this weekend (congrats).
“Sad but true”, he added, describing an unfortunate state of affairs in which monetary policy acting on its own (i.e., without complimentary fiscal stimulus) is virtually destined to increase inequality.
I wanted to touch on this topic again not so much to beat a dead horse, but rather to remind the general public that there is some nuance to the discussion, something Jerome Powell did not do a very good job of capturing on Friday when, during an online discussion, he responded “absolutely not” when asked whether the Fed’s policies exacerbate the wealth divide.
Let’s be clear: Central bank policy operating in isolation and through primary dealers absolutely contributes to inequality.
Powell knows this just as well as Janet Yellen knows it just as well as Ben Bernanke knows it.
That the blue line in the following simple chart moves steadily higher starting at the beginning of 2009 is not a coincidence.
This is one of the least complicated aspects of the post-financial crisis monetary policy response.
In a world where conspiracy theories spread largely unchecked, the idea that central bank liquidity boosts the prices of financial assets ain’t one of them — so to speak. There’s no conspiracy here. And if you think there is, then perhaps you should consult with Ben Bernanke who, in 2010, said the following about the Fed’s crisis response in a piece for The Washington Post:
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
If this was supposed to be some kind of a closely-held secret that only central bankers (and the fringe blog crowd which flourished after the crisis) knew about, well then Ben Bernanke is the worst co-conspirator in the world. I don’t know about you, but I don’t want to be in a “conspiracy” with a guy who writes an Op-Ed for The Washington Post called “What We Did And Why.”
All of what Bernanke said in his famous Op-Ed is true. The problem, though, is that central banks failed to account for the possibility that the transmission mechanism from monetary policy to the real economy might not be nearly as efficient as the channel through which the same policy actions work on financial assets.
In the simplest possible terms: Flooding the market with liquidity, driving investors out the risk curve and pushing market participants down the quality ladder is an endeavor that is guaranteed to inflate the prices of financial assets. Those assets are disproportionately concentrated in the hands of the wealthy. Have a look:
Due to that disproportionate concentration of ownership, the benefits of rising stock prices don’t accrue in linear fashion. Rather, they accrue exponentially.
On top of that, the effect of driving corporate borrowing costs lower is to encourage issuance of corporate debt. Investors, thirsty for yield, are more than happy to absorb the supply. It’s true that ensuring corporate America has ready access to capital is part and parcel of making sure the labor market is robust, but if those companies use the proceeds from debt issuance to buy back their own shares (as opposed to raising wages or investing in productive capacity), all you’ve done is levitate the value of stocks some more.
In the meantime, voracious demand for corporate supply means corporate bond portfolios rise in value too, which again disproportionately benefits the wealthy. (The share of corporate and foreign bonds concentrated in the hands of the top 10% is above 82%, which is actually down from the late 80s/early 90s, presumably because innovations in financial products have democratized access to corporate credit.)
In the final act, one has to remember that higher-income groups have a lower propensity to consume. So, gains from the simple dynamic outlined above are simply hoarded.
Powell didn’t deny any of this last week. Rather, he said simply this:
The pandemic is falling on those least able to bear its burdens. It is a great increaser of inequality. Everything we do is focused on creating an environment in which those people will have the best chance to keep their job or maybe get a new job.
That’s true. The problem isn’t Powell. Or even Fed policy, really. The problem is the setup, which is plagued by the taboo surrounding monetary financing of government debt.
If the Fed could simply buy Treasurys straight from the source, as opposed to being forced to channel the purchases through Wall Street, the entire game would change. Suddenly, quantitative easing would amount to a direct injection of money into the economy through whatever programs were being funded by the issuance of the debt the Fed bought.
Instead, trillions in conjured dollars ends up as liquidity in the financial system, which is nice to the extent it ensures the system doesn’t freeze, malfunction or totally collapse (as in 2008). But if, after 10 long years, we haven’t learned that the transmission mechanism is far too slow when it comes to producing real economic prosperity to keep up with the comparatively real-time effects on asset prices, then we are apparently doomed to inflate bubbles in those assets much faster than the underlying economy can absorb them.
Along the way, the vast majority of Americans (i.e., the “bottom” 90%) continue on an inexorable descent into financial irrelevancy.
Crucially – and I hope this is by now clear to most regular readers – the main reason this is doomed to perpetuate inequality is because we refuse to acknowledge what is obvious to everyone who knows anything about the setup. It’s debt monetization – just at arm’s length. Once we admit that, we’ll be free to remove the impediment that keeps these trillions in digitally-created dollars either parked or else trapped on the asset bubble merry-go-round.
Coming full circle, Nordea’s Andreas Steno Larsen is correct to say that given the current setup, it’s “impossible to bail out Main Street without bailing out Wall Street even more”.
But it doesn’t have to be that way.
Politicians can fix this situation with legislation, and once the taboo around debt monetization and direct deficit financing is gone, the situation described above will be flipped on its head. Instead of having to wait for the trickle-down “wealth effect” to take hold, money conjured from thin air will go directly into the economy. Wall Street (and financial assets) will benefit as a second-order effect. Just the way it should be.
I’ll leave you with the whole passage from Nordea’s Steno Larsen:
There are still reasons to expect another leg lower in equities once we enter the solvency phase. Bankruptcies in the US recently reached a high not seen since May-09. Markets are aware of it, but the question is if the market is wrong-footed by a prolonged solvency phase. If 42% of furloughed workers aren’t able to return to work at all (as a Becker-Friedman institute study shows), then consumption will take a prolonged hit and leave margins under pressure for a long time. There are limits to how long the Fed can prop up the equity market while unemployment is skyrocketing, even if the Fed’s PR department and now also Jay Powell is trying to convince us that inequality is not driven by asset purchases. Bollocks (Pardon our French)! It is impossible to bail out Main Street, without bail-outing Wall Street even more. Sad but true.