In The Fed We Trust!
Hope everyone has been safe and healthy out there. As I'm sure everyone has been focused on the coronavirus, the government has also been busy. Congress passed a two plus trillion dollar stimulus package. The Treasury is slowly but surely in the process of sending out some stimulus checks. And behind the scenes, the Federal Reserve has once again had to rescue the financial system. So that's what I'm going to talk about on this week's episode. What has the Fed been doing? What has it been buying? And what are the implications of some of this unprecedented stimulus action?
So really the Fed's bailout, you could call it, has come in sort of two steps. The first was that it set up a bunch of different alphabet soup facilities. That includes a corporate credit facility, a money market liquidity facility, a commercial paper funding facility, and on and on. And when they use the word facility, really what they mean is a mechanism to interact with the Fed directly. A lot of times you'll hear this compared to a window such as a swap window or a discount window. Really the idea is that like when you go to a bank teller, the Fed or the bank is on one side of the window and you are on the other. That is how you do business with them. So each of these facilities serve a different segment of the financial system and they're essentially there to provide liquidity, to make loans and accept collateral in exchange. Basically just to make sure everyone has all the dollars they need. So step two is the actual buying of those assets. In most cases, these assets will take the form of debt, not unlike the mortgage-backed securities that the Fed was buying after the last financial crisis.
So in a lot of ways, this isn't that much different from past instances of the Fed using QE or quantitative easing. Now that involved buying bonds, specifically buying treasuries, but now the Fed has expanded the scale and the scope of what assets it's buying. So the scale, the amount of money that it has spent in dollar terms is much more over a shorter period of time than the Fed has ever done. And most interestingly is that the scope is broader now. So rather than only sticking to the safest securities like Treasury bonds, the Fed is now buying what are considered riskier assets. That includes ETFs, exchange traded funds, it includes municipal bonds, and most worryingly, junk bonds, also known as high-yield bonds. So this is an unprecedented move, and if you remember from my past episode on CLOs, collateralized loan obligations, we know that a lot of risky debt is also highly illiquid, meaning it is very difficult to find someone to buy it, especially at its full value or its current price. So there is a high probability that with a lot of this debt, if it were ever marked to market, meaning it were ever priced at the actual price someone is willing to pay for it, its value would be much lower than it is on the books, so to speak. But none of that has to happen when the Fed just buys it and puts it on its balance sheet.
In a lot of ways, the Fed is ensuring that those bondholders don't have to suffer any losses. So you could say they are picking winners and losers. And that's really my biggest problem with all of this action from the Fed, and we'll get more to this as the episode goes on, but it really destroys the free market. In no way is this a free market. Really, it's socialism for the banks and not for anyone else. Because this does beg the obvious question, how are all of these facilities at the Fed and how are all of these bailouts actually helping Main Street? The obvious answer is that it really isn't, it's scraps compared to what is going to banks and corporations. And that's who the stimulus bill and all of these programs are actually for, that's who it's intended for. And although that's kind of galling, it doesn't mean that there's no benefits for the rest of us.
So one example is public pensions. About one third of public pensions in the US are heavily invested into private equity. So of course, if the Fed did not bail out private equity firms, that means a third of the country's pensions would blow up. Their values would collapse. And so that would hurt all the retirees and all the union workers who are invested in those pensions. Now don't mistake when I'm saying that doesn't mean I think all of this is worth it or is a great idea. That's just one example of how it would be worse for the general public if the Fed didn't step in and allowed the market to shake these things out.
Another one of the big problematic things with all of this is moral hazard. The Fed is creating moral hazard when it steps in and bails out some of these risky investments. The reason that a junk bond has a very high yield is because that is the compensation you get for taking on the greater risk. By contrast, the safest government securities like Treasury bonds usually offer a very low yield. That's the way it normally works. But if the Fed is simply going to step in and ultimately make bondholders whole when risky debt blows up, well, there's not really any risk there, is there? Why wouldn't you buy a high yield bond if you knew that in the end, the Fed was going to save your butt anyway? I think that sets a very bad precedent that is difficult to undo once the Fed crosses that line, and it already has.
Aside from moral hazard, another likely outcome of this is that it will increase inflation. In order for that to happen, this money needs to move around the financial system. The velocity of money would need to be higher. We're not seeing it yet. In fact, for many years, that's why we haven't seen much inflation to speak of. Ultimately, all of these things the Fed is doing should be rather inflationary down the road. Now, that may take several years, but it all but guarantees a greater likelihood of higher inflation in the years to come.
No matter which way you look at it, this episode is going to strain the Fed's credibility going forward. Before any of this happened, what the Fed has done would be described as the nuclear option. Nobody rational would have believed you that the central bank would go this far unless the entire world was burning down. And yet here we find ourselves. That's why I think it's sort of a Pandora's Box where once these policies have been pulled out of the toolbox, they can really never go back in. Banks and corporations will never accept the old normal now that they know that the Fed can just save them. So there really are a lot of unintended consequences that could come of this. And that is something I've been consistently trying to make the point of on this podcast and other media outlets where I'm interviewed.
So again, it will be years before we know what all of the outcomes of this binge buying by the Fed will be. But at some point, those chickens will come home to roost. Several years later, we will see some of the consequences. I think the two biggest ones will be inflation and a lack of stability in the financial system. So I hope you found all of that informative.
We will move on to our question from the listeners. This week's comes from Orin doesn't say where. Orin asks, what is the all time high gold price? Well, that's definitely a relevant question given that in many currencies besides the US dollar gold is already at an all time high price. If you look at Australian dollars, Japanese yen, I think even the euro and the British pound, gold is at all time highs. In terms of US dollars, the nominal all time high for gold was about $1,900 an ounce back in 2011. Now you should make note that that was 2011 three years after the beginning of the 2008 financial crisis. But that is an incomplete answer anyway. When you adjust for inflation, the all time high price for gold was actually in 1980 when gold was over $800 an ounce. 40 years ago, the purchasing power of the dollar means that translates into over $2,000 an ounce for gold in today's dollars. So an interesting bit of trivia there for you. There might kind of be two answers. That wraps it up for this week's episode. I want to thank you so much for tuning in. Really appreciate you listening. Be sure to check out our next episode where I'll be discussing the oil price war involving Saudi Arabia and Russia.
Everett Millman
Everett has been the head content writer and market analyst at Gainesville Coins since 2013. He has a background in History and is deeply interested in how gold and silver have historically fit into the financial system.
In addition to blogging, Everett's work has been featured in Reuters, CNN Business, Bloomberg Radio, TD Ameritrade Network, CoinWeek, and has been referenced by the Washington Post.