March 2020. I remember clearly predicting “Hurricane Covid-19” on METAR while making the decision to stay away from the gym and not fly cross-country to visit family.
I remember clearly the stunning blows to the financial system. I remember thinking that the financial stress index would spike off the chart and that there would be a market collapse and deep, prolonged recession.
Amazingly, the Federal Reserve and Congress cooperated in unprecedented ways to save the economy.
**March 2020: How the Fed Averted Economic Disaster**
**As markets plunged, Jerome Powell and his colleagues vastly expanded the reach of the central bank, with implications that will be felt for years to come**
**by Nick Timiraos, The Wall Street Journal, 2/18/2022**
**The Fed’s pledges to backstop an array of lending, announced on Monday, March 23, would unleash a torrent of private borrowing based on the mere promise of central bank action—together with a massive assist by Congress, which authorized hundreds of billions of dollars that would cover any losses. [Enabling the Fed to lend to junk-quality companies that they never loaned to before.] ...Most controversially, Mr. Powell recommended that the Fed purchase investment vehicles known as exchange-traded funds, or ETFs, that invest in junk debt. ... [This was monetary stimulus that went to banks, cities and corporations. - W]**
**Altogether, Congress approved nearly $5.9 trillion in spending in 2020 and 2021. Adjusted for inflation, that compares with approximately $1.8 trillion in 2008 and 2009.... [This was fiscal stimulus that mostly went to consumers. - W]... Disoriented supply chains and strong demand—boosted by government stimulus has produced inflation running above 7%....**
**Powell saw the risk. Having crossed familiar boundaries, there was a danger, he understood, that lawmakers would come to the Fed later and say, “Fix climate change” or “Use your digital printing press to finance every highway repair.” Mr. Powell told his staff, “There will come a time when we’re saying ‘No’ to people.” ...** [end quote]
This is a long article which discusses moral hazard (the expectation of market players that the Fed will always rescue them, so they take more risk) and the high cost of financing the debt when interest rates rise. (The Congressional Budget Office forecast in December 2020 that if rates rose by just 0.1 percentage point more than projected in each year of the decade, debt-service costs in 2030 would rise by $235 billion — more than the Pentagon had requested to spend in 2022 on the Navy.)
But the key issue is whether the Fed will always create more fiat money to buy Treasury debt at the same time that Congress promises to spend endlessly. Mr. Powell has said that he won’t. The Fed plans to stop buying long-term Treasuries and gradually let their existing book mature and go away, returning to their non-emergency situation.
If the Fed doesn’t buy long-term Treasury debt (which the Fed never did before, except during the 2009 and 2020 emergencies), Treasury debt will be auctioned in the free bond market, as it always was before. Without the Fed’s immense thumb on the scale, interest rates for the 10 year Treasury will probably rise to their historic level, about 2% over the inflation rate.
That would cause tremendous losses in the existing bond market as well as disruptions in the stock market.
Only time will tell whether the Fed will have the spine to let the capitalist free market for the most important commodity – money – return to the non-emergency normal when the free-money addicts begin wailing and screaming.