Monday, June 15, 2020

The Fed's Grand Bargain Has Finally Imploded

The Fed has backed itself not into a corner but to the edge of a precipice.
Though the Federal Reserve never stated its Grand Bargain explicitly, their actions have spoken louder than their predictably self-serving, obfuscatory public pronouncements. Here's the Grand Bargain they offered institutional investors and speculators alike:
We're taking away your low-risk, high-yield investments by slashing interest rates to near-zero, but we're giving you endless asset bubbles as a new way to notch reliable gains. This trade-off has worked for 20 years as the Fed hyper-inflated one asset bubble after another until they finally inflated everything to precarious extremes: The Everything Bubble of 2019 that started unraveling in September 2019, long before the pandemic.
The Everything Bubble includes: stocks, housing, commercial real estate, corporate debt, junk bonds, CDOs, CLOs, bankrupt companies, phantom companies, etc. The Fed inflated all these assets bubbles as a "can't lose" proposition for yield-starved institutions that can't survive on low-risk 1% Treasury yields.
These institutions include: public union pension funds, insurance companies, mutual funds, wealth management entities, hedge funds, banks and 401K retirement fund managers.
Asset bubbles are not a substitute for Treasury bonds and AA-rated corporate/municipal debt for one reason: risk. Despite all the extravagant claims about risk being hedged, the reality is that risk cannot be made to disappear, it can only be transferred to others.
Asset bubbles are intrinsically unstable and therefore risky. All bubbles pop, period, and whomever is holding the bag as the bubble pops will suffer catastrophic losses. The Fed and its countless apologists / lackeys claim the Fed has our back and so bubbles will never pop because the Fed will print as much money as needed to reflate any bubble that's losing air.
After unprecedented asset bubbles popped in 2000 and 2008, the Fed apologists / lackeys all claimed the bubbles only popped due to a policy error. If only the Fed had (insert policy: waved more dead chickens over the bonfire, danced the humba-humba with Paul Krugman, bought bat-guano futures through offshore proxies, etc.), then the bubble would have continued expanding to infinity: Dow 100,000, yee-haw!
This fantasy ignores the dynamics of bubbles: when bubbles reach extremes, they implode regardless of policy tweaks and media appearances.
The Fed lowered rates to bring demand forward and lower the cost of additional borrowing by households, companies and governments, the goal being to stave off recession and encourage speculative gambles in housing and stocks that would generate the wealth effect to further stimulate imprudent borrowing and spending.
Don't put off buying that new pickup, the Fed screamed; buy it now while rates are near-zero. (Buying what you would have bought next year right now is bringing demand forward.)
The problem with bringing demand forward is eventually there's no demand or credit left to buy more stuff because all the demand was brought into the present and only the most marginal borrowers (and those who refuse to borrow more no matter how low rates go) are left.
Goosing stocks to ever-higher valuations even as revenues and earnings stagnate or collapse reaches the same end-game: by the time stock valuations have completely lost touch with reality (in March 2000 and again now in February - June 2020), the delusionally euphoric belief that stocks will continue to loft ever higher because the Fed has our back is only credible to the last few greater fools. Once the pool of greater fools is drained, stocks crash.
The same can be said of corporate debt, which has reached unprecedented levels around 50% of GDP. Once again, greater fools are buying potentially worthless junk bonds because the Fed has our back, even though the Fed's junk-bond buying is a leaky bucket compared to the tsunami of defaults that's about to wash away the entire junk bond sand castle.
The Fed's primary job has been to transfer risk from the most ferociously parasitic and predatory speculators to its own balance sheet, which expands as the Fed buys the fetid garbage of a speculative bust through proxies. Whatever risk can't be buried in the Fed's foul cellar of financial sewage is off-loaded onto the hapless taxpayers via soaring federal deficits.
The Fed's shameless army of apologists/lackeys claim the Fed can always start buying stocks directly as the final measure to goose stocks to ever more absurd highs. But the apologists/lackeys never follow through to the logical end-game of their folly: eventually the Fed owns most of the assets it has goosed to the moon, leaving nothing for private-sector capital to earn a return on.
If the Fed ends up owning most long-term Treasury bonds, most corporate debt, most of the mortgage backed securities (MBS), most of the stock market, etc., then what's left for the tens of trillions in private-sector capital that sold all its risky assets to the Fed? What's left to invest in that's low-risk and high-yield?
The answer is: nothing. Simply put, inflating asset bubbles is not a substitute for low-risk, high-yield investments such as Treasuries, and buying the guaranteed-to-default sewage of corporate junk bonds doesn't make new junk bonds any less risky or any less prone to default.
The Fed has backed itself not into a corner but to the edge of a precipice. It cannot allow interest rates to rise enough to offer institutions low-risk alternatives to gambling in asset bubbles, and it can't goose the insanely over-valued asset bubbles it's inflated any higher without triggering political blowback as the Fed's asset bubbles are the primary driver of soaring wealth inequality.
Buying stocks directly won't create low-risk, high-yield returns for institutions; all it will do is bury the risk in the Fed's ballooning balance sheet while stripping insurers and pension funds of the returns they need to remain solvent.
Yields will remain near-zero while all the asset bubbles implode, destroying tens of trillions of dollars in phantom capital. The Fed's grand bargain--offering inherently risky asset bubbles as a substitute for low-risk, high-yield bonds--has collapsed. Everyone with a stake in an asset bubble is about to have a Wile E. Coyote realization that the risk they thought had vanished has emerged as gravity.
It's a long way to the bottom of the canyon, and the impact will be devastating. This impact is the dreadful price of avoiding healthy business-cycle recessions in 2000, 2008 and 2016 that would have cleared the economy of speculative deadwood and toxic zombie companies.
Recent Podcasts:
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.
Thank you, Spike T. ($100), for your outrageously generous contribution to this site -- I am greatly honored by your steadfast support and readership.
 
Thank you, John D. ($20), for your most generous contribution to this site -- I am greatly honored by your support and readership.

Terms of Service

All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.


Our Privacy Policy:


Correspondents' email is strictly confidential. This site does not collect digital data from visitors or distribute cookies. Advertisements served by a third-party advertising network (Investing Channel) may use cookies or collect information from visitors for the purpose of Interest-Based Advertising; if you wish to opt out of Interest-Based Advertising, please go to Opt out of interest-based advertising (The Network Advertising Initiative). If you have other privacy concerns relating to advertisements, please contact advertisers directly. Websites and blog links on the site's blog roll are posted at my discretion.


PRIVACY NOTICE FOR EEA INDIVIDUALS


This section covers disclosures on the General Data Protection Regulation (GDPR) for users residing within EEA only. GDPR replaces the existing Directive 95/46/ec, and aims at harmonizing data protection laws in the EU that are fit for purpose in the digital age. The primary objective of the GDPR is to give citizens back control of their personal data. Please follow the link below to access InvestingChannel’s General Data Protection Notice. https://stg.media.investingchannel.com/gdpr-notice/


Notice of Compliance with The California Consumer Protection Act


This site does not collect digital data from visitors or distribute cookies. Advertisements served by a third-party advertising network (Investing Channel) may use cookies or collect information from visitors for the purpose of Interest-Based Advertising. If you do not want any personal information that may be collected by third-party advertising to be sold, please follow the instructions on this page: Do Not Sell My Personal Information


Regarding Cookies:


This site does not collect digital data from visitors or distribute cookies. Advertisements served by third-party advertising networks such as Investing Channel may use cookies or collect information from visitors for the purpose of Interest-Based Advertising; if you wish to opt out of Interest-Based Advertising, please go to Opt out of interest-based advertising (The Network Advertising Initiative) If you have other privacy concerns relating to advertisements, please contact advertisers directly.


Our Commission Policy:

As an Amazon Associate I earn from qualifying purchases. I also earn a commission on purchases of precious metals via BullionVault. I receive no fees or compensation for any other non-advertising links or content posted on my site.

  © Blogger templates Newspaper III by Ourblogtemplates.com 2008

Back to TOP