While those who know little about how monetary policy works might be happy with the half-point rate cut the Fed laid down on Tuesday, those in the know are left bewildered.
There have been only a handful of Americans that have been diagnosed with the COVID-19 coronavirus, but much of the country has been gripped by its effects nonetheless. This virus has actually infected much of the world already, but instead of poisoning our bodies, like what happened to the almost 100,000 people that have contracted the physical virus, the real pandemic is a secondary infection that affects the mind, an epic outbreak of paranoia.
In the midst of this, we had hoped that we could count on the Federal Reserve to take a more sensible view of the matter than most, and that they would at least think first before drawing their swords and attacking the Fed rate like so many assumed that they would.
The Federal Reserve has a long history of bonehead moves, and bear much of the blame for past economic disasters, including both the Great Depression and the Great Recession. They usually err on putting rates up too much or too soon, and this is the sharp side of the interest rate management blade, and usually at least act to put them down with careful consideration.
Today’s Fed under the leadership of Chairman Jay Powell has impressed us lately with their patience and their appreciating that these are bullets that we only want to use when really needed, and even though the three rate cuts last year were questionable, they weren’t too unreasonable.
Since then, they have been telling us that they have done enough and wish to stand pat for a while, at least until this virus infected the world’s minds, which sadly, has included theirs.
Some may think that our getting 75 basis points cut in 2019, instead of a lesser amount, was needed, but the numbers we had didn’t justify much, which is why the Fed positioned them as a preventative measure. When you look at the economy and see things as all coming up roses, we should rightfully ask what they are actually trying to prevent that was actually real and not some apparition caused by fear.
Some were worried at the time that the trade war with China would continue to escalate, and that we should get ahead of that to manage the risk of contraction, but the economy was hardly bothered by the effects of what had already been done, and we don’t ever want to use monetary policy to fight things that may or may not happen, because there are real consequences if you end up wrong.
The reason why we need to be careful isn’t just that these actions may stimulate the economy too much, it is that we will eventually need to put them back up, and that’s the part of the process that causes the real problems.
If we are in an economic downturn, and we do nothing, the economy will pick up again one day and get back to more acceptable levels of growth. Monetary policy seeks to smooth over these cycles and avoid the credit crunch that steers us toward declining economic conditions, but this must be used with great care lest we end up in a worse place down the road when we get the eventual organic recovery.
In opposition to the cheers from the uninformed masses, those who do have at least a good understanding of how monetary policy works are all coming out against these cuts, seeing them as not only ineffective, but foolish. We would go as far as calling this absolutely stupid, and it is hard to believe how these folks who are supposed to be experts on monetary policy could pull such a thing and at the same time genuinely believe they are doing good.
This emergency cut may not be the worst or most dangerous thing that the Fed has ever done, but it is clearly the most foolish. Expanding credit can help quite a few things, but it is useless against the economic issues that are in play here, which are happening in a completely different country and completely outside the scope of American economic policy.
The only potential effect of this would be to further strain the Chinese economy by weakening the dollar. The effect of this is the same as imposing tariffs on Chinese imports, where it puts up the cost of these imports, reducing Chinese exports and also making things more expensive for Americans.
American banks being able to borrow money more cheaply just isn’t a story that plays in China, or any other country, since these countries do not borrow from the United States Federal Reserve. It’s not even that Chinese companies need to borrow more from anyone, as their crisis is one of a temporary labor shortage stemming from the massive quarantine that China put into effect to manage the infection rate, so this issue is not even about borrowing at all.
The Fed can’t stimulate spending in China, although China can, but this isn’t even the problem. They can’t get China’s factories back up to full capacity, but China can, and they are working on that on their own.
There are some people worried that this will turn into a major crisis in America somehow, in spite of this so-called pandemic outbreak going on for 6 weeks now even though it has only affected 1 in 2.67 million people thus far. We’re talking 124 people so far in a country of 331 million people, and whether this gets to 1000 cases or even the 80,000 cases that China has seen is just not a meaningful enough event to even bother about.
The chances of getting to 80,000 or anything even close in the U.S. is extraordinarily improbable, because the level of infection in the U.S. is so low compared to the extremely higher concentration in Hubei Province. Even Chinese provinces in close proximity to Hubei had far less cases, and we also know that they will have far less cases in the end because the situation has already played out in China and this coronavirus is nearly dead.
The United States is a whole ocean away and surely does not have quite the same risks as these other Chinese provinces, but even if they did, this still shouldn’t even register on the radar. South Korea is leading the way as far as infections outside of China goes, breaking the 5,000 mark recently. They have 51 million people, and whether 0.01% of their population gets this, or it doubles eventually to 0.02% or even triples to 0.03% of their people with the coronavirus might be interesting to some, but it is completely meaningless from an economic perspective.
Emergency Cuts Need to Be for Real Emergencies, Not Imagined Ones
None of this is even the issue when it comes to the Fed’s emergency cut, because even if this did develop into a much bigger deal than it has, monetary policy does nothing to fix or even improve any problems that result.
If we had a million people die from this in the U.S., being able to borrow money at lower interest rates just isn’t going to help. While this would have a real economic impact as the workforce would be reduced by that amount, these lower rates won’t bring these people back to life and the most we can do is stimulate full employment.
We already have that now though, which is the real reason why last year’s cuts were so questionable. Rate cuts make it cheaper for companies to borrow, so they can expand and hire more people, but if we’ve saturated this already, there just aren’t the workers out there to hire.
If business slows down because there is less demand in China or in other countries, rate cuts aren’t going to help that because this is not a decrease in production that you can borrow your way out of, so being able to borrow more won’t help from an economic standpoint. The companies may borrow anyway, and use the money to pay out more dividends or buy back stock, but none of this helps increase economic output and may end up seeing it decrease once rates go up and the expense of borrowing for this steals some of a company’s ability to expand.
There’s also the supply shock that this virus has caused in China, but the Fed can’t do anything to help this, to get Chinese workers fully back to work and producing like normal again. Only time can.
The only thing that this emergency cut will do is allow for debt to pile up even more, and while we are at manageable levels right now, adding to this could be a real problem when rates inevitably go up. The Fed has added a full half point of pain to this to go along with the three quarters they did last year. The cuts last year may not have been all that useful, but this latest cut is useless from an economic standpoint. We would have hoped that the bar would be higher than this.
The last time the Fed used an emergency rate cut was back in October 2008. These things are normally used for actual economic emergencies, and that was certainly one of them. We had a massive liquidity crisis from all the defaults. Defaults reduce the amount of credit in the economy, otherwise known as the money supply, and rate cuts increase credit and the money supply, so this tool was completely appropriate and necessary for this particular emergency.
We’re not sure what the emergency is supposed to be this time, but whatever it may be seen to be, it is not something that increasing the money supply can possibly address. If your house is burning down, buying more flood insurance won’t help, because this only helps if you have a flood.
Increasing U.S. money supply just doesn’t do much for us if we want to buy more things from China but cannot, because they just aren’t making enough now, or not making enough things to be used in end products made in other countries, including the U.S.
Increasing the money supply also won’t help from the effects of a drop-off in worldwide demand due to the fear that this is causing, because they could spend the money if they were not so afraid. Rate cuts don’t have much of an effect upon fear unfortunately so all of this will also be unaffected.
Both the supply and demand shocks will have to resolve themselves in time. The consensus view is that the Fed has wasted these two bullets, and not only will be a price to pay down the road for this, their emptying their gun so foolishly leaves them with only 4 of the 6 bullets they had to start the week.
There are times where these bullets are not only very important but necessary, and rate cuts helped us recover from the financial virus that hit us in 2008. If our economy actually contracts significantly, if we do get a recession, the Fed is now less able to help us, and will be even less able if they waste more bullets on this bad movie.
If You Hate Low Yields, This Nightmare Is Real
Some have also pointed out that we have already had plenty of rate cuts from treasury yields tanking, and treasury yields going down does a lot to stimulate borrowing. Increasing the money supply is completely about increasing borrowing. With such a huge drop with treasuries, this makes it cheaper for companies to issue bonds, so they issue more. The decline in yields since the coronavirus hype started to build have been truly massive, and we just didn’t break the record, we shattered it.
Bonds just don’t move that fast in any direction, and the bullish market for treasuries in 2019 was nothing compared to the last 3 weeks. In the history of the country, with everything that has happened, including some big real emergencies, the yield on the 10 year has never been below 1.32%. On Tuesday, it slipped below 1% for a time and is sitting right there now.
Some think that this cut was about helping stocks, but nothing scares stocks more than a yield crash with treasuries. This story was scary enough before this big cut, and the nightmare just got worse, thanks to this cut.
The market normally loves rate cuts, but when this puts treasury yields down significantly, they hate this more than they like the cuts. We saw this last August, but what happened Tuesday left yields from back then completely in the dust and caused recessionary fears to spike right along with the bond prices.
Treasury yields going down is expansionary, but ironically, many believe that this is somehow contractionary, and justify this with reasoning only worthy of a fool. When we have a recession, treasury yields are low, treasury yields are low now, so therefore, there will be a recession. They are lower than ever, a lot lower, so that’s seen as especially bad.
This belief has rattled the markets before, and sure did on Tuesday, turning a positive start into yet another major down day. The market actually liked the Jay Powell show, and leapt in delight, but when it cast its eyes on dropping yields, the bottom fell out of this wet box.
Rate cuts put bond yields down as sure as day, and big emergency ones like this put them down quite a bit even though they were already in free fall from expecting it. The 10 year has shed 38% of its yield in just the last 3 weeks, which is a truly shocking amount. If dropping yields scare you, this is a true horror movie to you. If more cuts are on the way, this will further subtract from yields, and inspire more fear. The market is already pricing in further cuts.
Bonds right now are so overbought that they are toxic to anyone but traders. If you are buying treasuries here, you better get ready to run when this ends up resolving, and it will, and sooner rather than later. This is as far from Grandpa and Grandma as you can get, or from any investor for that matter.
If things just get back to where we were a year ago, when the 10 year was yielding 2.72%, given that the benchmark iShares 20+ ETF is up 38% now year over year, getting back there will mean losing 38%. The 2.72% of a year ago is a historically low yield, and as the yield moves up over time, people holding these investments should be feeling the same way that stock investors are feeling right now.
If there is no emergency, and no real reason to be that concerned, and your big cut doesn’t help against these particular things even if this were real, it’s natural to wonder why they did it. It can only be from their watching too much television, which is alleged to brainwash people, and there’s your proof. Just a single infection can make the news, like the Amazon employee in Seattle getting this, but when there are so few victims to report on, every one counts it seems.
We are also hearing that this is not a matter for the Fed but for health authorities, but we wonder what there is to do with the potential impact of this being so minimal. They are working on vaccines for this, even though wanting to vaccinating the country and the world against a virus that is so medically insignificant is absurd on a whole different level.
These vaccines bring some harm in themselves, and if they did vaccinate everyone, the vaccination program would definitely cause overall harm on a much bigger scale and magnitude than any coronavirus could ever dream to.
There is nothing at all to do in the United States but wait for this little wave to pass, and try harder not to imagine it being a tsunami. We expect more from Jay Powell and his merry band of rate slashing men though. When the Fed, the economy’s physician, succumbs to the temptations of coronavirus panic, there’s no one left to look out for the economy’s health in the way that we need to.
You can’t just stick these things on for a brief time and then just take them away, because that involves making people pay more for the money they borrowed, and causes damage to our money supply and serves to contract our economy in a particularly unpleasant way. Too much contraction and you get a recession. This is what the Fed’s bullets are for, to fight these things, but instead of saving them for when it makes any sense at all to use them, they are firing them in the air.
These bullets do come down to earth eventually and end up hitting us, so the benefits do need to outweigh the costs. We need to instead be at least shooting at something we can hit. When you are trying to fight a phantom and not even use a weapon that works against this phantom, and have so little care about the downside involved, this is not what we call acceptable leadership from the committee that we entrust so much to.