The Federal Reserve and other major central banks around the world have cast themselves as the next action heroes in a Hollywood blockbuster, firing off hundreds of rounds and never running out of ammunition. As they flood global markets with cheap money in the boom and bust phases of the business cycle, central bankers might believe they possess infinite power in a fantasy world. But when reality seeps in, they will learn that they are out of bullets. So, what happens when the next economic meltdown unfolds? Well, it’s hasta la vista, baby for the global economy – until the sequel.
Easing for You Is Easy Living
The Federal Reserve may have paved the way for the rest of the world to initiate or maintain an accommodative monetary policy. Federal Reserve Chair Jerome Powell cut interest rates for the first time in a decade and hit the pause button on unwinding its $3.8 trillion balance sheet. Financial markets widely anticipate that the Federal Open Market Committee (FOMC) will reduce the target range by another quarter-point as early as next month, and large swaths of the investing population think the Eccles Building will go to as low as 1% by the end of next year.
India, New Zealand, and Thailand announced larger rate decreases soon after. The People’s Bank of China (PBOC) is readying to bring rates down. Japan, Switzerland, and Sweden are all residing in subzero territory, and Tokyo and Stockholm could go deeper.
But what is happening elsewhere around the world is irking President Donald Trump. He thinks the Fed is a greater problem for the US than China (he is right, but for entirely different reasons). Trump is proposing a full-point cut “over a fairly short period of time” and “some quantitative easing” to debase the US dollar’s strength and jolt the economy.
Will the Fed capitulate? History suggests yes. The Eccles Building has been known to heed the White House’s directives for the last 80 or so years. The Powell-Trump connection is no different.
Although Powell told reporters following the August policy meeting that it is not the start of a series of easing, bearish signals – at home and abroad – might make his itchy trigger finger flinch. Remember, New York Fed Bank President John Williams posited in a speech that “it pays to act quickly to lower rates at the first sign of economic distress.” The Fed dismissed these remarks as not being official policy for the central bank, but if you believe that, then we have Ben Bernanke’s beard trimmings to sell you.
The $64,000 ($600k) Question
So, if central banks are employing all sorts of conventional and unconventional stimulus measures during the expansionary chapter, what happens when there is a real downturn? That is The $64,000 Question (or $600,000 in 2019 dollars).
As we witnessed in the aftermath of the economic collapse, the Fed sprang into action by slashing interest rates aggressively, unleashing three quantitative easing (QE) programs, and bailing out American and foreign financial institutions. The Fed never before, in its 100-year history, had been this aggressive. There was a period where it looked like the Fed was normalizing monetary policy, albeit at a snail’s pace. But at the first sign of pain, the Fed has panicked and returned to the Bernanke and Janet Yellen era.
Rates are going back down, the money supply has expanded, and there is talk of more QE. Ditto for other institutions around the world.
By the time the next recession (or depression?) hits, the Fed, the European Central Bank (ECB), and the Riksbank will have exhausted all their accommodative inventories. The last resort would go deeper into subzero terrain, requiring vast money-printing and bond-buying since what investor would buy negative-yield debt? The primary reason Treasuries remain attractive is because of the incompetence of everyone else.
Common sense would dictate that these central banks need to unwind their balance sheets, offloading bonds onto the open market. Common sense also would decree that there would be very little appetite for these investment vehicles; $15 trillion, or one-quarter, of the bond market is negative-yielding. This might be the inflation time bomb that will go off, forcing the smartest people in the room to jack up rates, similar to the 1980s when then-Fed Chair Paul Volcker raised rates to as high as 20% to fight the soaring inflate rate that peaked at 13.5%.
Peter Schiff, president and CEO of Euro Pacific Capital, summed it up nicely in a recent podcast: “The world is going to drown in an ocean of inflation.”
Save Us, Gummint!
Surely, the federal government would step in and rescue the nation from economic hardship. But Washington obtains money three ways: taxing, borrowing, and printing.
The American people are taxed to death, being penalized on everything from the beverages they drink to the houses they own. Foreign governments and investors are floating in Olympic-sized swimming pools filled with Treasuries; the Treasury Department plans to auction more than $800 billion in US debt. The Fed is working the printing press overtime after giving it nights and weekends off for the last couple of years.
So, no, the Republicans and Democrats will not stave off a downturn with some expensive stimulus package. The federal deficit will top $1 trillion this fiscal year, the national debt will surpass $23 trillion, and a $200 trillion tsunami is on the country’s threshold, just waiting to consume the nation.
Waiting for a Headline About Breadlines
Lately, the mainstream media have been peddling a recession, something anchors, journalists, and pundits are clamoring desperately for, eh, Bill Maher? After the yield curve inversion, network personalities were gleeful about a pending economic contraction because it would hurt President Trump’s re-election odds. But they will be severely disappointed because a downturn will unlikely happen before November 2020. The Fed and its global partners are about to fire on all cylinders, eventually fuming out and triggering a financial crisis that will be worse than the 2008 collapse.