The Fed and The State of The Economy with David Scranton and Harry Dent

The country is cautiously reopening after months in lockdown due to the coronavirus pandemic, but obviously no one is celebrating quite yet. Uncertainty is still the dominant feeling for most Americans, and about a thousand questions have yet to be answered. Many of those questions revolve around whether the Federal Reserve’s economic relief and stimulus efforts in response to the crisis will be sufficient to prevent a long, deep recession and another major stock market drop. However, another question many economists are asking is: “Will the Fed’s overuse of artificial stimulus for the past 10 years actually end up making this crisis worse than it might have been?”

Fast Action and Unprecedented Measures

To its credit, the Fed acted quickly to try cushion the economic blow of the pandemic, first by lowering its benchmark interest rate to zero. The move is aimed at reducing borrowing costs and keeping the banking system flowing. But with the pandemic creating an unprecedented economic stoppage, much more Fed intervention was needed. That, of course, meant more bond-buying, a.k.a. quantitative easing—a tool the Fed and other central banks have used time and time again since the Great Recession. Just a week before the coronavirus crisis, the Fed had set a limit on its bond-buying programs. However, that limit is now gone, and the current QE program is open-ended.

Quantitative easing basically allows the Fed to print money and flood the economy with it. That sounds like a good plan in an emergency, but it has flaws, which I’ll address later. In addition to more easing, the Fed is also lending money to 24 large financial institutions and to smaller banks through two programs revived from the Financial Crisis. For this crisis, the Fed has also launched new programs and strategies aimed directly at helping businesses and workers, starting with the creation of two new lending facilities to support highly-rated US corporations.

The overall goal of these and other programs is to allow companies access to credit in order to maintain operations in the face of quarantines, forced closures and other changes caused by the pandemic. Or, as Dr. Ben Carson of the White House Coronavirus Task Force has explained it, the government is trying to build a bridge to help maintain the country’s economic infrastructure during the worst of the crisis. In addition to the Fed’s efforts, that bridge also includes $3 trillion dollars in congressional aid, but is it enough? Will the Fed need to do more, or has it already done too much?

Negative Interest Rates and ‘Distortions’

One thing some people (including President Trump) would like to see the Fed do is lower interest rates below zero. Other central banks have moved to negative interest rates, and some economists and businessmen have argued it would help in the U.S. Although the concept is strange, in theory negative interest rates are a way to help spur more business and commerce.

However, Jerome Powell has stated he opposes negative interest rates, telling 60 Minutes he believes they cause “distortions in the financial system” that would outweigh their potential benefits. Well, with all due respect to Chairman Powell, to me his argument sounds a bit ironic when you consider that quantitative easing also causes distortions in the financial system. Yet the Fed has had no problem using QE over and over again since the Financial Crisis, even to a reckless extent.

Like negative interest rates, quantitative easing sounds good on paper, since it basically allows the Fed to print money and flood the economy with it. All the textbooks say that’s how you stimulate growth, but what the textbooks fail to consider is: What if nobody spends or borrows that money? What if they just hold on to it or use it to pay down debt (which they’re probably more apt to do in times of great uncertainty such as now)? Well, what happens is that QE ends up having a very limited effect on the economy but a huge effect on the financial markets.

The stock market has basically been addicted to easing for a decade, which explains the huge disparity between stock market growth and GDP growth over all that time. The market has skyrocketed while economic growth has been average, at best. It’s as though Wall Street has been anticipating five or six percent growth each year since the Great Recession, and every time it doesn’t happen the Fed floods the system with more cheap money to buy more time. By that, I mean time before the overvalued stock market is forced to make fundamental sense again with a major correction. Can unlimited QE and all the Fed’s other efforts continue to prevent it from happening, even in the face of the country’s greatest economic challenge since the Great Depression?

Walking a Fine Line

During his interview with 60 Minutes, Jerome Powell walked a fine line between optimism and frankness while discussing the coronavirus crisis and the nation’s prospects for recovery. Every Fed chairman has had to walk this same tricky line, but it’s become even trickier in the age of quantitative easing because the stock market has become so strongly influenced by Fed’s actions and words. In fact, during the interview, moments after Chairman Powell said he believed the recession recovery might stretch into next year, interviewer Scott Pelley informed him he had just received a news post on his phone that read: “Dow Tanks More than 500 Points in Wall Street Selloff after Fed Chair Warns Economic Recovery Will be Long and Bumpy.”

Naturally, it wasn’t that the idea of a prolonged recovery was coming as a surprise to Wall Street. In fact, most analysts have consistently forecast that rebounding from this crisis will be a long and difficult process. Nearly 40 million Americans are out of work, and estimates for economic shrinkage in the second quarter run as high as 30 to 40%. Yet for all that, the stock market is—as of this writing—down by only about 10%, having rebounded by roughly three quarters from its initial drop of nearly 40% in March when the crisis first hit. But why? What’s changed between now and then for the economy? Has the data improved or have the forecasts from most economists gotten any rosier, even now that states are cautiously reopening?

Not at all. If anything, the data has gotten worse, and now social unrest has further increased the air of uncertainty. The main thing that’s changed, of course, is that the Fed has come to the rescue once again with more quantitative easing (unlimited this time) and a lot of other of other artificial fixes. That’s why when the Fed chairman says bluntly on national TV that this recovery will be prolonged despite all that stimulus, Wall Street pays attention. The big question is: how long will it be before reality really takes hold and the stock market is forced to make fundamental sense again with a major correction?

The Good News

The good news for everyday investors is that there is still time to help protect your retirement! With the markets still holding on, there is still time to decrease your risk by switching your financial focus from portfolio growth to retirement income!

Connect with an advisor in your area to find out if your retirement is on track.