[This blog post is an excerpt from a recent TSI commentary]
Last week, a highly paid (we assume) JP Morgan analyst opined:
“When it comes to market developments, we believe that the Fed’s action last Thursday represents a pivotal moment in this crisis. Powell’s statement included that “we will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery” and probably the most important, historic statement, “We should make them whole. They did not cause this.” This crisis is different from any other in recent history in that it was not caused in any way by businesses or investors. Unhindered by moral hazard, the response of fiscal and monetary authorities is and will continue to be unprecedented, with the goal of essentially making everyone ‘whole.’ We believe the significance of this development is underestimated by markets, and this reinforces our view of a full asset price recovery, and equity markets reaching all-time highs next year, likely by H1. Investors with focus on negative upcoming earnings and economic developments are effectively ‘fighting the Fed,’ which was historically a losing proposition.”
Well, if moral hazard was the only thing that prevented the Fed from acting in the past to eliminate everyone’s losses, then why has the Fed never bothered to eliminate poverty? After all, not every poor person is in that situation due to having done something wrong. In particular, none of the children living in poverty are to blame for their predicament.
Taking a broader view, if it is possible for the central bank to make everyone “whole”, then why are some countries poor? These countries have central banks that are capable of doing what the Fed is now promising to do.
The problem, of course, is that the central bank cannot add real wealth to the economy. It cannot produce anything of real value. All it can do is conjure money and credit out of nothing, thus setting in motion countless exchanges of nothing for something and distorting the price signals upon which markets rely. This is a recipe for more poverty and generally lower living standards in the long term.
At some point during the second half of this year, the release of pent-up demand as restrictions are removed and people go back to work, combined with the flood of new money generated by the Fed, could make it seem as if there has been a ‘V’ bottom in the economy and that the entire recession lasted only about four months. This could enable the SPX to return to within 10% of its February-2020 all-time high before year-end. However, the price distortions that have been and will be caused by the effort to make everyone “whole” will prevent a sustainable recovery.
The deluge of new money will boost asset prices and the prices of life’s necessities, but many businesses that closed their doors during March of 2020 will never re-open and many people who lost their jobs will remain unemployed (and thus dependent upon government handouts). Also, many of the people who do end up with jobs will find that their real incomes have fallen, because there will be an excess supply of labour and the currency’s loss of purchasing power will be reflected to the greatest extent in the prices of things that are in relatively short supply. For the majority of people, therefore, the post-shutdown economy will never be as good as the pre-shutdown economy, not despite the Fed’s efforts but largely because of them.
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