In the classic Giuseppe Verdi opera, La Traviata, a dying Violetta suddenly proclaims to the world that her pain and discomfort have left her body. The euphoria is magnificent, but the anguish returns within moments, and she dies. A similar condition could afflict the U.S. and global economies as central banks around the world fire what seemingly looks like the final rounds in their chambers. To combat the Wuhan coronavirus, these institutions might inject some new life into their respective economies that have been infected by the virus. Still, the Federal Reserve and its cohort of international counterfeiters will only exacerbate the initial problems that could send the global economy into a downward spiral.
And the crowd roared.
After sitting on the sidelines, the Federal Reserve decided to get into the game and start pumping hundreds of billions into the system. The central bank’s actions to combat the coronavirus began with an emergency 50-basis-point cut to interest rates. It followed up with an expansion of its repo markets intervention. As equities cratered more than 2,000 points in a single day, the Eccles Building announced an aggressive $1.5 trillion bazooka and a broadening of its $60 billion Treasury purchases. With the Fed set to meet for its March Federal Open Market Committee (FOMC) meeting, investors are betting that it will cut rates again, inevitably resuscitating the Zero Interest-Rate Policy (ZIRP) environment prevalent a decade ago.
Although the U.S. stock market will not be happy until someone develops a vaccine, the Fed’s monetary easing is enough to spur some type of recovery that can stop the bleeding. Of course, the primary concern is that by implementing all these interventions, it will be out of ammunition for when the next real crash hits. Will Negative Interest-Rate Policy (NIRP) be on the table?
The other main issue is that the Fed is compounding all the mishaps that impacted the fundamentals of the world’s largest economy before the virus outbreak. Everything from the repo madness that had been ubiquitous since September to the numerous bubbles scattered throughout the economy, the Fed’s fourth round of quantitative easing is toxic. This blend of artificially low interest rates, Treasury acquisitions, and repo bailouts can only distort markets and prevent the correction from running its course.
Whenever the coronavirus subsides, the U.S. stock market will be regaining lost ground again as it will be driven by sacrificing long-term survival for short-term gains. And the Fed is complicit in this behavior.
Loonie with Liquidity
Following the Fed’s recent action, the Bank of Canada (BoC) instituted a 0.5% cut to its benchmark rate. After witnessing the Toronto Stock Exchange record its worst one-day performance since 1940, the BoC took even more aggressive action. The central bank announced a second 50-bps reduction, in addition to pumping billions of dollars of liquidity into the system to stabilize equities. One plan involves extending its bond buyback program by allowing dealers to substitute old notes with new ones. The other measure consists in adding new term repo operations with terms of six and 12 months bi-weekly.
BoC confirmed that it is ready to take even more action if necessary. With low rates, it will likely mean a massive fiscal stimulus program by Prime Minister Justin Trudeau and his Liberal minority government. Finance Minister Bill Morneau, who spoke alongside BoC Governor Stephen Poloz, confirmed that they would announce a plan in the coming days.
One of the biggest concerns over the central bank’s intervention is adding kerosene to the already hot housing market. In the U.S., mortgage applications spiked 55.1% in a single week. With Canada’s overheated real estate industry in Vancouver, Toronto, and Montreal, more people will take on monster mortgages – and lenders will provide them amid historically low interest rates.
The other issue is the growing threat of household debt to the national economy. For years, the BoC has warned that consumer debt could eventually crash the Canadian economy. Today, according to Statistics Canada, the average consumer owes $1.74 for every dollar of disposable income – and this number keeps growing every quarter.
If rates are at rock bottom, borrowers are incentivized to borrow and spend since they receive practically nothing from their savings. Canada’s economy was already anemic before COVID-19, so the central bank is injecting some new life into the Great White North.
Now that China has mostly gotten the coronavirus under control, the world’s second-largest economy is rebooting as the country gradually returns to normal. Factories, plants, stores, and facilities are slowly coming back online. Experts are already warning it will take some time for China to rev up growth, but officials reportedly want nothing less than 5% gross domestic product in the next couple of quarters. It is aiming to achieve this through a mix of monetary and fiscal policy.
As part of its first step in the aftermath of the coronavirus, the People’s Bank of China (PBoC) announced a $79 billion stimulus package that effectively serves as a life raft for the private sector. The initiative includes freeing up as much as $78.8 billion by lowering the reserve requirement ratio (RRR) by a range of 0.5% and 1% so banks can lend to businesses. Officials are signaling that they want lenders to target small businesses that typically have a more difficult time accessing credit markets. Reports suggest that the next measure will be a quarter-point cut to its benchmark deposit and medium-term lending rates in the coming weeks.
So, are these actions enough for China to cure its ailments of the past? Unlikely. Although Beijing has ostensibly dismissed reports of a massive $570 billion fiscal stimulus plan, the government will inevitably pull the trigger on such spending. It has no other choice but to stay on life support. Liberty Nation has thoroughly documented the many diseases infecting China, from lifeless state-owned enterprises to the tidal waves of corporate defaults. Since we have short-term memories, markets may forget that these were real problems just a couple of months ago. Whenever any hiccups arise, they may be attributed to the outbreak. But the Internet never forgets.
We may think that the rollout of a coronavirus vaccine will cause champagne to flow from the heavens, and we can dance the Charleston with Rudy Vallee singing in the background. But COVID-19 did not destroy all the troubles that existed in nearly every pocket of the global economy. The repo madness, the derivatives bubble, the ticking inflation bomb, the debt tsunami, and the pending bond market collapse – these are all aspects that will make the dot-com bust, the financial crisis, and the coronapocalypse seem like a cakewalk. And you can thank the smartest men in the room for making everything worse.
Read more from Andrew Moran.