|Central Banks Have Gone Crazy (click to enlarge)|
It could be argued that these are necessary liquidity injections with the intent of preventing chaos in the markets. Banks have a way of failing us when we need them most and that is a big part of why liquidity is generally the first casualty in a financial crisis. Without them, it appears the whole financial system could seize up. This is occurring at a time central banks across the world are engaged in playing a similar game. After years of monetary easing it appears the markets and economy have become hooked on constant injections of stimulus.
|Who Has Been Adding (click to enlarge)|
A prolonged contraction in the flow of new credit in any economy or a contraction in business investment are key factors that often lead to a recession. These decrease demand and alter how people feel about the future. Like many of you reading this I struggle with seeing just how this will play out but it is difficult to see much good resulting from the injection of more liquidity into a distorted situation where many assets are already overvalued and debt is constantly hitting new records.
Many questions exist going forward. A few of these appear below.
- Can monetary or fiscal stimulus turn around a recession and if so just how large will they have to be? A hundred billion US dollars do not have the impact they had years ago.
- How much of this is aimed at keeping the already strong dollar from going through the roof as other countries open wide the spigots of credit? The Federal Reserve has become the great enabler and is responsible for allowing the world to embark on a huge and rapid expansion of debt and credit during the last decade. A key role of a reserve currency is to force other currencies to toe the line or pay a stiff price.
- What is causing the current liquidity crisis? Where did all that other money go? It appears it went to creating more debt, credit, and increasing leverage. Debt creation to fund current expenditure is spiraling out of control.
- Was the Friday announcement by the Fed intended to send the market higher, to head off a looming recession or get in front of a liquidity crisis that might spin out of control over the weekend? I think it was the latter.
- Will this address the problem and stop it, and if so for how long? Maybe for a while, but it most likely only prop up the unpropable, and yes, while no such word exists it should.
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Other tools are available to the Fed such as slowly raising interest rates while keeping liquidity high. This is easier said than done and fraught with risk. Much of the problem the Fed faces is that low-interest rates have not created the financial environment they had hoped it would. Instead of investment in productivity, innovation, and new services that create wealth we have seen consumers and government increase debt on things of little value. To make matters worse these rates have hurt savers and massively added to inequality driving it to the highest level since 1929. While it is out of date, the chart to the right gives us a glimpse of what this is doing. We have become decoupled from financial reality.
A strong dislike and distrust of the Fed should not blind us to the idea this may still play out in many ways. A huge number of our economic problems are rooted in the economic tool known as leverage. The same massive gains leverage brings, also showers us with huge losses that rapidly paralyze both individuals and financial institutions. With this in mind, we should consider the possibility we have entered the period that may someday be referred to as "The Great Reset" where values might be shaken to their core. If so, the ramifications are that certain assets such as stocks could take it hard on the chin and not recover for decades.