A recent article on CNBC suggested that people shouldn’t seek to criticise or fight the US Federal Reserve for propping up stock market valuations, but to instead buy de facto government-backed ETFs.
In a recent interview, billionaire investor Chamath Palihapitiya said that there is “no doubt” the economy is disconnected from the stock and bond markets, as he pointed to bitcoin as an uncorrelated hedge against a looming deflationary cycle.
Aside from the clear departure from economic reality, as Chamath pointed out, there is also a sense that central bankers are telling their friends at various trading desks that they have their back no matter what. As is customary, the Fed and the ECB will be shy and coy at first, but ultimately, they’ll open their arms to give traders and investors on either side a big hug.
Of course, this multi-trillion-dollar tsunami will lead to a flurry of unintended consequences and moral hazards as it turns into a highly- flammable mixture of irresponsibility and distortions the likes of which we’ve never seen.
The Fed has pumped over $6 trillion into the US markets as it removed all limits on its repo-operations to maintain valuations. Recently, the central bank began buying exchange-traded funds that invest in corporate bonds in what it calls a plan to provide a financial backstop for US companies. This is being done via BlackRock – the world’s biggest asset, which will go through three stages – the “stabilisation” phase, then an “ongoing monitoring” phase, and closing with a “reduction in support” phase.
At the moment, the corporate bond market is worth $9.6 trillion. The Fed document states: “Once market functioning measures return to levels that are more closely, but not fully, aligned with levels that correspond to prevailing economic conditions, broad-based purchases will continue at a reduced, steady pace to maintain these conditions.”
As fiat currency and free credit become pervasive, bitcoin is becoming scarcer. The timing could not have been more perfect
This effectively means that corporate socialism is not only alive and well, but guaranteed. Clearly, neither Main Street nor Wall Street learned their lessons, as they repeat the same reckless behaviour that got them into hot water in the first place. The coronavirus pandemic provided both parties the perfect opportunity as it popped the “everything bubble” and exposed unsound fundamentals, forcing central banks to shift money printers into overdrive as CEOs jumped ship in droves.
Wall Street understands how far the Fed is willing to go, making it inevitable for financial titans to push their open positions to the limit on maximum leverage. The question is: if a respiratory illness can make the world’s most powerful institution(s) buy anything and everything at any price, then what happens when the real bust in the business cycle happens?
Currently, the Fed is buying and spending as if it had stumbled upon an unlimited gold mine, despite all facts to the contrary. With virtually no limits on spending, this creates the possibility of a spiralling moral hazard, which occurs when a party participates in a risky event confident it is protected against the risks since another party will bear the costs.
Essentially, too-big-to-fail financial institutions are allowed to play blackjack, poker and Russian roulette knowing that they have no real stake in the game – they cannot lose and they know it. At the same time, corporate bond bailouts mean that the taxpayers are left to pick up the tab due to effects of currency debasement, which all central banks already admit to be doing at no less than two per cent per annum (this figure is much higher in reality).
Economists like Friedrich Hayek believed that the formation of the Federal Reserve System was the premier example of moral hazard in the finance industry. Since the intent of the central bank is to mitigate a financial crisis by rescuing banking entities from liquidity issues, acting as a ‘lender of last resort’, commercial banks are incentivised to extend vast sums of credit. Hayek posited that in a central bank-free economy, excessive credit creation is restrained by fear of failure. In today’s markets, this fear of failure no longer exists.
In a 1925 article, entitled ‘Monetary Policy in the United States After the Recovery from the Crisis of 1920’, Hayek wrote: “It cannot be taken for granted that a central banking system is better suited to prevent disturbances in the economy stemming from excessive variations in the volume of available bank credit than a system of independent and self-reliant commercial banks run on purely private enterprise (liquidity, profitability) lines. In the absence of any central bank, the strongest restraint on individual banks against extending excessive credit in the rising phase of economic activity is the need to maintain sufficient liquidity to face the demands of a period of tight money from their own resources.”
In essence, what Jerome Powell is doing right now risks spawning moral hazards more toxic than nuclear waste.
For decades, critics of the Fed system have lamented that many aspects of the central bank’s policies distort and manipulate reality to no good. From artificially controlling interest rates to inflating the money supply, opponents make the case that the US economy cannot perform without training wheels.
Fed advocates normally point to the long-term achievements of markets and America’s economic standing. However true this is, when you peddle opium to get investors high, asset valuations will inevitably fly to cloud nine as well, opening the door to a massive drop once the money flow stops or slows down.
Funnily enough, as central banks race to the bottom with quantitative easing, bitcoin has just undergone a major quantitative tightening event which ensures that it’s heading in the opposite direction. As fiat currency and free credit become pervasive, bitcoin is becoming scarcer. The timing could not have been more perfect. Books will be written about what’s happening here and how bitcoin played its part in the coming financial revolution.
Christopher Attard’s background is in journalism and finance, and studied psychology at the University of Malta. He has worked in the bitcoin and cryptocurrency space for years and provides services for SMEs in the industry.