The Economy

One day, people will start to understand.

This is the Federal Reserve's balance sheet.

That is the tool they are using to distort the debt markets. The mispriced debt they enable = leverage. The rationale for that somehow is that it is "stimulus." The reality is that it is a visual representation of moral hazard. From that period in 2008 until this year, when the Fed took its balance sheet as high as $4.5 trillion, monetizing debt to essentially price fix yields at artificially low levels, forcing savers to make riskier and riskier loans to get the return they were being robbed of, companies borrowed billions upon billions of dollars and used it like you would expect when someone gets "free money" and is led to believe they won't bear the consequences of their decisions. A lot of it was loading up on debt and buying back their own stock to drive the price higher, mostly in the face of an economy that was stagnant and earnings that went nowhere.

See that period heading into 2020 on the graph, where the balance sheet came down a bit? The Fed was pretending that they could unwind the mess they made, but just with that halting attempt to try to undo the mess they had gotten themselves into, the stock market buckled every time. Think of it like a heroin dealer. You take away the smack, and the junkies go through a nasty withdrawal. What we are still facing.

They had already panicked and begun to pump in more liquidity via their "repo operations" that began in 2019 (where the balance sheet started to expand again), and that was what had stocks making new highs into February of this year.

Of course, with unemployment where it is, with the economy having fall off a cliff, with earnings having collapsed, with credit defaults picking up despite the Fed now buying up corporate debt and even junk bonds to prop up everything, if the stock market wasn't being artificially fixed by them, it would have collapsed way farther than it did and it would be in the doldrums.

But all that matters right now is that the Fed doubled the size of that balance sheet in just a few months (compare it to how little they unwound it before they woke up to the fact that they are trapped), and have pumped $3.5 trillion into the banks they operate through, which are treating that money like chips at a casino table. Frankly, the fact that the insane amount of credit they have created has given the market only that much lift, is what should tell people how bad things really are.

As for stocks grinding higher in this environment, of course it is fucked up. But it's actually not irrational. The money doing this (this is largely not individual investors, it is being driven by computers that are programmed to trade on those money flows) is essentially betting on moral hazard. That because the Fed has created an environment where there can be no failure, you are safe to ignore everything else and bet on no failure.

The problem is that when it collapses again, and it is going to, the devastation they are going to leave behind in the real economy is going to be worse than it would have been every step of the way if they had just stopped. They have been reduced to answering a self-created debt bubble with schemes to enable more and more debt lopped on top, in order to keep a credit crisis from happening. The longer they can do that, the worse the credit crisis -- which is inevitable.

Regardless, if you want to know what is going on in the stock market right now, there is no nuance to it, despite the Jim Cramers of the world. It's the vertical line in 2020 on that balance sheet graph. They are conjuring trillions of dollars out of thin air and buying junk bonds, for Christ's sake. In that kind of "prop up everything" environment, one could argue it makes more sense not to fight the wizard of oz until someone finally pulls away the curtain.

 

Here is Mohamed El-Erian talking about it this morning. FWIW, there were plenty of people pointing this out in the years after the financial crisis, when they put us on the lose-lose-lose path he is talking about. Most people remain clueless, others rationalized it in political, instead of rational, terms. We're our own worst enemies, but we give institutions like this a lot of power over our lives, and they create most of the disparties that I believe we are now seeing in the protests and riots. There are no free lunches. By trying to have them, we have really hurt ourselves.