Add Scott Minerd, the chief investment officer of Guggenheim Investments, to the growing list of financial professionals who understands that capital markets no longer exit, and it's all thanks to the Fed.
In his latest letter to investors Minerd writes that "if you go back 10 years to when the Fed started quantitative easing (QE), the debate was about how long QE would last and when would an exit strategy begin. I remember saying to people at the time, “The Fed will never be able to end quantitative easing; it’s here forever.” And now the new Fed backstop for credit for corporate America is here forever." It's funny, because we said the exact same thing on that fateful day in March 2009 when the Fed announced QE1.
So here we are now, and Minerd now fears that "this policy blunder will have long-term implications for our society. The Fed and Treasury have essentially created a new moral hazard by socializing credit risk. The United States will never be able to return to free market capitalism as we knew it before these policies were put in place."
And there you have it: the US is now (and has been for the past decade) just a more dignified form of USSR-style central planning, one where prices are set by decree and a decline in asset levels is prohibited for one simple reason: with financial assets over 6x global GDP, any crash in markets would result in a depression that would promptly spiral in social collapse.
Among the various other points Minerd makes is his gloomy forecast that it "four years from now the economy will most likely recover to the same level of activity that it was in January" adding that "to think that the economy is going to reaccelerate in the third quarter in a V-shaped recovery to the level where gross domestic product (GDP) was prior to the pandemic is nrealistic."
As this realization becomes clearer that the US economy has years to go before it recovers "we will be nearing the era of recrimination. Monetary and fiscal policymakers are pulling out all the stops to keep the economy and citizenry afloat during this crisis... but ultimately we will likely discover that they are insufficient, misdirected, and full of unintended consequences."
Minerd predicts that policy responses—including trillions of dollars of Federal Reserve emergency lending and debt purchases, direct payments to individuals, grants and forgivable loans to particularly hard hit industries and small business—will fail because economic restrictions on the economy of some sort could last until 2022.
As a result, Minerd expects the "finger-pointing to begin", although we are confident that once again it will be broken down by party lines instead of targeting the real culprit behind the bursting - and reflating - of yet another bubble: the Federal Reserve.
And while people are accusing each other of crashing the economy, the unemployment rate could rise to as high as 30% and could still be in double digits by the end of the year, Minerd wrote, adding that while it took "nearly 10 years for the unemployment rate to return to levels we saw before the Global Financial Crisis, and this labor market shock will likely be between three and five times more severe."
Consumer confidence, meanwhile, is set to take a massive hit as half of all Americans were unprepared to weather the storm, with less than $500 in savings. As a result, "few people will immediately go out and buy automobiles and return to movie theaters. The damage to the household sector is so severe that it is going to impair living standards for most of the decade."
Efforts to help small and large businesses will also fail, because they are not taking into account the likelihood that coronavirus and its weakening effect on the economy will be here until a vaccine can be safely and widely distributed.
"I can’t fault the Fed for the good intentions of trying to do virtually everything in its power in a time of crisis, but the unintended consequences of its policies are considerable,” including propping up zombie companies that aren’t economically viable and preventing the sort of business turnover that is the hallmark of innovative capitalism.
Meanwhile the damage to the household sector is so severe that it is going to impair living standards for most of the decade, writes Minerd, adding that "this problem is compounded by the fact that the most financially vulnerable households are experiencing the majority of layoffs. Young, hourly workers in lower-paid service industry jobs are bearing the brunt of economic pain, and these are the people least able to deal with an interruption to income, which will compound the economic pain from layoffs as consumption falls even more sharply. Meanwhile, the disruption in corporate cash flows will be pervasive and will rebound unevenly. There will be few positive outcomes in credit as companies are encouraged to accumulate more debt in the already overleveraged corporate sector. These failures will stunt the eventual recovery and make it much more uneven" and eventually result in even more destabilizing policy responses.
Going back to the Fed, Minerd writes that the "central bank will never be able to get back to normal. The Fed’s balance sheet has expanded from $4.5 trillion to $6.6 trillion in just about a month, and it is likely on its way to over $9 trillion soon."
Our central bank will never be able to get back to normal. The #Fed’s balance sheet has expanded from $4.5 trillion to $6.6 trillion in just about a month, and it is likely on its way to over $9 trillion soon. https://t.co/jcbtrJNFHk pic.twitter.com/sjEWiB2Xhr— Scott Minerd (@ScottMinerd) April 27, 2020
The Fed is not alone in this endeavor: "As Ed Hyman of Evercore ISI pointed out, G7 central banks collectively purchased in March $1.4 trillion in financial assets. This annual rate of $17 trillion is nearly five times the previous monthly record set in April 2009."
And so, as we enter this era of recrimination, it will have broad political and social implications: "as the death toll mounts it will be used as political fodder. To say “These people died from coronavirus because of mistakes made in Washington” is an effective tactic. After the Civil War, politicians used the image of the Bloody Shirt to remind voters that honoring fallen Union soldiers demanded a Republican vote. Deservedly or not, today’s Republican administration will have a hard time fending off that argument. As the Hoover Administration bore the consequences of the economic collapse of the 1930s, so quite possibly the pandemic will be viewed as Washington’s failure."
His concluding thoughts are the same that we uttered almost a decade ago - namely that the Fed is setting the stage for bloody conflict within the US (a conclusion for which Time magazine mocked us at the time):
Eventually, a populist revolt to address the current massive inequality of income and wealth, will happen. Soon pressure will mount on policymakers to bolster the social safety net and increase things like healthcare and job security and maybe even institute a guaranteed living wage. My only concern is that it will be done in a way that is not productive for long-term growth. These programs will create incentives that will reduce overall productivity, Instead, policymakers should address fundamental reforms in the economy to restore growth and reduce inequality.
They should... but they won't. Instead the fiscal and monetary programs that are being put in place are fundamentally redefining how the government interacts with businesses and individuals, warns Minerd adding that "some programs will work, and some will not, but they will remain in some form or fashion forever."
Well, not forever. That paradigm of central planning the USSR eventually collapsed. And so will the USSR's replacement: the United States.
Full note here.