“In the long run, we’re all dead.”
John Maynard Keyes once said, “I do not know which makes a man more conservative — to know nothing but the present, or nothing but the past.”
It is hard to say which is weighing more heavily on Fed policy makers in the midst of the global pandemic of 2020: the opaque view of the world in the time of COVID-19 or the still fresh memory of the Great Recession of 2007–2009.
Regardless of the direction of their vision, one might imagine that even the father of Keynesian economics would be at least a little uneasy about the breadth and speed of the aggressive actions the US Federal Reserve has taken in recent weeks to shore up the economy in the midst of a global pandemic.
Federal Reserve Chairman Jerome Powell has stated firmly and clearly that the Fed will lend as much as it can across the U.S. economy to keep liquidity and credit flowing through the duration of the pandemic. “When it comes to lending, we’re not going to run out of ammunition. That doesn’t happen,” Powell said.
While the Fed’s balance sheet still hasn’t fully recovered from the previously unprecedented Quantitative Easing used to prop up the economy after the Great Recession, the U.S. Federal Reserve is working to show that it has as much ammunition as a gun-toting hero in an action movie from the 1980s.
Here is a highlight list of the Fed’s actions in the past 30 days:
Federal Reserve Actions
On February 29, 2020 there were approximately 86,000 confirmed cases of the novel coronavirus — the vast majority in China.
The U.S. Federal Reserve issued this statement:
“The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”
By March 3, the number of confirmed cases had risen to 93,000 and the Federal Reserve lowered the target range for the federal funds rate by ½ percentage point to 1 to 1.25%, and said the committee was “closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.”
Less than a week later on March 9, the number of confirmed cases had risen to more than 114,000 and the Federal Reserve issued a signaling statement to U.S. lenders, encouraging them to “meet the financial needs of customers and members affected by the coronavirus.”
By March 15 as confirmed cases neared 170,000 globally and cases in the United States neared 3,500, the Fed took strong action in an effort to support its mandate to “foster maximum employment and price stability” through several aggressive actions:
1. Cut the federal funds rate to 0%.
2. Worked with several foreign central banks to lower pricing on existing U.S. dollar swap arrangements in an effort to improve liquidity of the U.S. dollar.
3. Cut the Federal Funds Requirement to zero. By lowering banks’ capital requirements, the Fed hoped to support banks using these funds to increase borrowing for American households and businesses.
4. Encouraged use of the Discount Window as an emergency source of funding by lowering the primary credit rate by 150 basis points.
5. Announced a new round of “Quantitative Easing,” in which the Fed stated they would spend up to $800B over coming months to purchase a wide range of long-term securities in order to prop up liquidity and confidence in the financial markets.
Two days later, the Fed stood up a Commercial Paper Funding Facility (CPFF) that had the authority to purchase commercial paper from large corporations who might not have otherwise been able to find a market and a Primary Dealer Credit Facility to support the corporate bond market.
The next day, March 18, the Fed added a Money Market Mutual Fund Liquidity Facility designed to offer loans to large banks that buy assets from money market mutual funds in a move designed to encourage investment in the highly liquid money market mutual fund market.
As Congress worked through the “Coronavirus Aid, Relief, and Economic Security (CARES) Act,” the Fed continued to roll out new programs to stimulate the economy, most notably on March 23 they announced an expansion of QE to include purchases of mortgage-backed securities, and launched three new emergency lending facilities with support of up to $300B (Primary Market Corporate Credit Facility, Secondary Market Corporate Credit Facility, and the Term Asset-Backed Securities Loan Facility).
On March 26 as the number of confirmed cases of coronavirus in the United States rose to almost 84,000, the New York Federal Reserve announced that it would purchase up to $4B in mortgage-backed securities.
And there — in a single month — the Federal Reserve launched the economic equivalent of “shock and awe,” as it fired its entire arsenal of demand-side weapons as an opening salvo against the global pandemic. While Chairman Powell insists the Fed will not run out of ammunition, it is hard to imagine what else it might have in its war chest to battle the yet unknown economic perils that lie ahead.
The Perpetual Motion Myth
The “dismal science” differs from physical sciences in that its practical application necessitates a blend of scientific method, philosophy and psychology; while the physical sciences traffic in provable facts. In the physical sciences, dreams of alchemy, perpetual motion machines and time travel are quickly booted out of the mainstream; but there is no equivalent in economics. Monetarists, Marxists and Keynesians all have a seat at the table with none any more disprovable than the other.
Economic policies drift in and out of favor like seasons, but the pre-eminent school of economics in the United States and much of the Western world since the Great Depression is based on the demand-side economics of Keynesian theory. Keynesian economics, which focuses on government adoption of activist fiscal and monetary policy to create aggregate demand to disrupt or prevent economic downturns, suggests governments should increase spending to bolster economies in the short run.
The Keynesian approach has proven successful “in the short run” for more than 80 years now. Keynes wrote his master work, “General Theory of Employment, Interest, and Money,” during the Great Depression; and his policies were adopted (and modified to some extent) by Franklin Delano Roosevelt as he sought to lift the U.S. out of the depression of 1929–1933. In FDR’s famous “first hundred days” in office, he launched the Works Progress Administration (WPA), Civilian Conservation Corp (CCC), and the National Recovery Administration (NRA), all massive government projects that transformed the American economic landscape. Unemployment dropped and demand increased (spurred by aggressive government spending). Roosevelt also stood up the Federal Deposit Insurance Corporation (FDIC) and Securities and Exchange Commission (SEC). FDR and Keynes were seen as heroes of the new economy by most — and how could they not be? They had brought the country out of a global depression.
But what had they wrought?
On March 18, 2020, the Fed’s balance sheet sat at $4.7 trillion — a number so staggering it is almost meaningless to most of us. But when compared to Fed-owned assets before the financial crisis of 2007–2009, which sat at $870 billion, the number is a little more relevant — and alarming. Years of Quantitative Easing ballooned the Fed’s ownership of assets more than five times the pre-crisis rate.
The payoff of the Fed’s actions has been a steadily growing economy, near record unemployment, and historically cheap borrowing. The unprecedented activities of the Fed drove the economy for a decade, and were directly responsible for the longest bull market in US history. The measures were supposed to be temporary, and the Fed was supposed to work to restore its balance sheet to pre-crisis levels once the economy “returned to normal.”
For a decade, the Fed operated to fuel the economy in the short run with no real out in the long run. Fed policymakers had invented the economic equivalent of a perpetual motion machine. Like infinite energy, the Fed’s unending supply of funding kept driving the economy month over month over month for years on end.
But physics has proven that perpetual motion is impossible. The first rule of thermodynamics states that energy can neither be created nor destroyed. In an era of fiat currency; however, money is not held to the same standard. But what is the economic equivalent to the first law of thermodynamics? What is the cost in the long run?
Perhaps it doesn’t matter because as John Maynard Keynes said himself, “In the long run, we’re all dead.”
The Fed’s actions along with the passage of the CARES Act do seem to have served as something of a counterweight to the rapid downfall of global financial markets. However, the momentum of the downward slide and the unpredictable path of COVID-19 continue to keep investors and consumers on edge. To many, the Fed’s actions have been decisive and aggressive, and have offered a refreshing counterbalance to the sluggish and inconsistent actions of the Executive Branch of the U.S. Government. But just as no one knows where the pandemic will go in coming months, it is still unclear what effect the Fed’s actions and their timing will have on the economy in the long run.
For those of us who were still waiting for the other shoe to drop after the QE efforts of the last decade, the concern is even greater.
It seems we’re all Keynesians now. But unless we’re living in Shangri-La it is hard to imagine the gravy train of magical money runs on forever with no bill ever coming due. I guess we’ll leave it for our grandchildren along with the consequences of the rest of our shortsighted and selfish decisions.