For Bitcoin investors, last year was a bonanza. The cryptocurrency started January 2020 at 7.194 dollar and surged above 34.000 dollar at the end of last year – a more than 360% annual return.
Courtesy of the US Federal Reserve, asset buyers in general have had a stellar pandemic. Whether it was US treasuries or junk bonds, equity portfolios or high-end property, the free money gusher has lifted all asset prices. Nor is the Fed inclined to stop the party. This year could offer a similar kind of boom to last.
Even if they do not trigger high inflation, the Fed’s extraordinary interventions will come with steep price tags. No doubt these would be far lower than the Fed not having acted at all – particularly in the short term. Had it forgone the more than 3 trillion dollar expansion to its balance sheet since last March, the US economy would most probably have gone into freefall. Corporate bankruptcies would have piled up and there could have been a 2008 – style financial meltdown.
The response to critics is the same today as it was after the 2008 crisis. That the Fed is doing whatever it takes to prevent a depression. But the risk is that each new chapter tightens a doom loop in which the US sovereign must eventually reckon with the ever- widening class of risk it is underwriting. America’s national debt is already past 100% of gross domestic product GDP for the first time since the Second World War. It nearly doubled after 2008 and is rising sharply again. As Japan has shown, high indebtedness need not trigger a crisis. Its national debt is well over 200% of GDP. But as the issuer of the world’s reserve currency, the US must guard its role carefully.
The most visible threat, however, is to US political stability. The Fed’s quantitative easing (QE) boosts wealth inequality by increasing the net worth of those who own financial assets, chiefly of stocks and bonds. The top 10% of Americans own 84% of the country’s shares. The top 1% own about half. The bottom half of Americans – the ones who have chiefly been on the frontline during the pandemic – say they own almost no stocks at all.
The further up the scale we go, the greater the gains. The S&P 500 showed a return of around 16% in 2020. Its global luxury index yielded a remarkable 34%.
To be sure, many of the equity market’s gain have gone to big tech companies, such as Amazon and Netflix, which have benefited from the partial closure of the physical economy. But their gains have heavily outweighed losses in the worst hit sectors, such as cruise liners and oil drillers. All that money must find some place to go. At the start of last year, five-year Treasury bonds yielded 1.67%. By the end, it had fallen to 0.37%.
In our opinion, the Feds inescapable bias towards asset owners has combined with the financial sector’s preference for size to produce a very skewed recovery. This has benefited big companies even junk-rated ones, at the expense of small businesses, including financially-sound ones. And it has boosted wealthy individuals over median households. After 2008, the economic recovery coexisted with a so-called “main street recession”. Today we call it a K-shaped recovery. The majority of people are suffering amid a Great – Gatsby – style boom at the top.
Whatever we label it, the political reaction is unlikely to be positive. The coincidence is unfortunate for Democratic presidents. Just as Barack Obama inherited the Great Recession, Joe Biden is walking into the Great Pandemic. In Mr. Obama’s case the backlash to his two-speed economy triggered a Tea Party populism that eventually brought his presidency to a halt. Not much of fiscal note happened after his initial 787 billion dollar stimulus in February 2009. That meant the Fed had to go on doing the work of keeping the economy afloat. In 2013, the Fed chair, Ben Bernanke, announced plans to reduce the scale of its bond-buying program known as quantitative easing (QE). He was quickly forced to reverse after the market went into a “taper tantrum”.
Mr. Biden could find himself in a similar two-speed economy. In December Congress passed a 900 billion dollar stimulus, which will tide over most unemployed Americans until March and send 600 dollar cheques to individuals earning less than 75,000 dollar a year. His chances of passing a far larger “build back better” relief package have dramatically increased, but will consume time. By contrast, Jay Powell, the Fed chair, has already said the central bank’s support could be indefinite. The Fed will continue to buy 120 billion dollar of debt a month for the foreseeable future.
And here we see the potential seeds of America’s next populist crisis. The Fed is pledging to do what it takes, while America’s elected officials need to agree on fiscal policy. The right emphasis, as Mr. Powell keeps reminding Congress, would be the other way around. Monetary policy is a blunt tool. Spending by contrast can be targeted at those who need it most and help lift America’s growth potential.
Alas, the chances are for now that the Fed will remain “the only game in town”.
The opportunity is for the US government to borrow long term funds at near zero rates and invest it in strategically productive capacity. The danger of not doing that can be expressed in a simple equation: QE – F = P
Quantitative easing minus fiscal action equals populism.