The Free Market is Dead
Unfettered markets have not been a reality in the past century. Or two centuries. Or even longer. We can go all the way back to the Panic of 1792 to see the US government helping out when things got really bad.
But there has always been restraint from the regulators, with the goal to minimize the solution necessary to prevent catastrophe. Unfortunately, the Federal Reserve has now gone stark raving mad with printing money, and the stock market has completely broken its tether to the economy at large.
Before we get into the current predicament, let’s review how we got here.
A History of Catastrophe
Prior to the Great Recession, the Federal Reserve’s biggest tool was manipulating the Federal Funds Rate, which is the interest rate for overnight transactions between banks. When a crisis hits, cash freezes up. The Fed drops the rate, allowing those in need of cash to borrow it at a lower interest rate, freeing up liquidity.
You get the idea.
This has worked pretty well since the 1950’s. The rate slowly crept up from near-zero in the post-World War II booming economy to almost 20% in the early 80’s. Over the past 40 years, it has steadily decreased down to the near-zero level again.
The Fed didn’t step in to save individual companies that screw up. They just managed the interest rate.
The problem with this low level is that there is nowhere else to go if we run into another crisis (negative interest rates notwithstanding). And that’s just what happened during the Great Recession.
The Great Recession
When the economy started faltering in 2007, the Fed started reducing its interest rate from just above 5% down to 2%. When things really started falling apart, they instituted the Zero Interest Rate Policy (ZIRP) and dropped the rate to almost nothing.
The recession was so bad and the financial problems so toxic, that low interest rates weren’t going to cut it. What happened next goes by many names, but in essence the Fed just started printing money to buy up mortgages and anything else that seemed to “toxic” for other banks to hold onto.
Four rounds of quantitative easing (QE) later, and the Federal Reserve had grown its balance sheet (i.e. printed money) by over $3 trillion by the end of 2015. For next three years, the Fed started increasing the interest rate incrementally, which was followed by its attempt to sell off some of its assets.
The result of QE is that the Fed effectively saved individual companies from going under, negating the overarching principles of the free market. There are arguments both for and against this action, but regardless, it was done.
The Fed saved the day. And it set a broad precedent.
The COVID-19 pandemic, however preventable by government agencies, was completely unforeseen by financial markets. That being said, the recovery from the Great Recession was now in its 11th year, so companies should have been ready for the inevitable downturn that was coming.
The US completely flubbed the pandemic response, putting markets in a tailspin and obliterating market gains from the past decade. But once again, the Fed was there to save the day.
Just like last time, ZIRP was instituted and talk of asset purchases was everywhere. Over the course of March and April, the Federal Reserve rolled multiple programs to loan money or buy assets.
Yahoo has a great primer on the slew of actions the Fed has taken.
We’ll get to the “alphabet soup” in a minute, but the overarching point is that the Federal Reserve is the 800-pound gorilla in the monetary room, out-punching even the executive and legislative branches of the federal government.
Take a look at these numbers provided by the COVID Money Tracker, showing how much money has been allowed to be spent by each government section.
From the detailed explanations deep into the Money Tracker, we get this quote.
This expansion is on top of the already historic explosion of the balance sheet from about $800 billion in 2008.
The tail is truly wagging the dog.
How the Fed is Propping up the Market
Here is a brief summary of the technical processes that have allowed the Federal Reserve to prop up the market. For a thorough analysis of the actions and programs that the Federal Reserve has implemented, check out the Money Tracker mentioned above and this article from Yahoo Finance.
Here is a list of the programs that the Federal Reserve has instituted over the past several months.
And here is the list of “facilities” to ensure liquidity in the economy.
So far, 14 facilities that have been set up to loan to just about everyone and their brother. But don’t be fooled. The Fed is probably not done yet. There has even been talk of buying individual stocks for companies that are deemed “too big to fail” (remember that term?).
This would basically be the Federal Reserve picking winners and losers on the open market.
Capitalism, we barely knew ye.
What Does It All Mean?
For the average investor, this may mean very little at first. But scratch a little deeper, and you’ll find that it might actually impact your entire financial world, starting with your investment portfolio.
The Fed’s intervention is also going to have an impact on your everyday finances, including incomes and government safety nets.
Thanks for reading my stuff! If you’re interested in staying up to date with the newest articles, click here to join my e-mail list.
Send this article to a friend: