The Investment Scientist

Fed “Printed” $3 Trillion and Promised More …

Posted on: June 24, 2020

40397946-close-up-view-of-cash-money-dollars-bills-in-amount.jpg“Since the beginning of March, the Fed’s balance sheet has expanded by just over $3 trillion, with the bulk of it from central bank purchases of Treasuries and agency mortgage-backed securities.” This is a quote from a MarketWatch news piece titled “Fed’s Daly Defends $3 trillion in Asset Purchases …”

After my last newsletter article, you should understand that balance sheet expansion is just an economic jargon of money creation. Today I am going to give you three reasons why the Fed needed to “print” money to prevent a Great Depression scenario.

In my previous articles, I’ve argued many times that the dollar is the new gold. During the onset of this pandemic, it proved itself to be the safe-haven currency again: the whole world hoarded the dollar, so much so that even very safe assets like treasury bills and gold tumbled in value. Literally a trillion dollars were withdrawn from circulation by panic hoarders so much so that it caused a dollar shortage! If this shortage had not been immediately addressed, the economy would have come to a screeching halt, especially in the US. The Fed’s money printing prevented a massive economic crisis.

In the financial market, the panic caused not only a steep loss of value of all assets, but also a deep freeze in the debt markets. Many US corporations are leveraged up to their noses since money has been so cheap. They rely on a functioning debt market to rollover their debts – basically taking out new debts to pay off old ones. They suddenly found there was no money available to lend to them. If this had lasted for any longer duration, we could have seen a wave of corporate collapse. The Fed’s money printing and injection into the debt markets just prevented that.

Dollar hoarding is deflationary and self-fulfilling. Let’s say the US economy needs $5 trillion to function, and $1 trillion was put under the proverbial mattress so that those panicky people could sleep better. For the economy to operate at the same level with 20% less currency, goods and services would have to be 20% cheaper. Once this expectation is formed, this would actually create a strong incentive for folks to hoard their dollars even more since money will go further in the future. (In fact, this is the root of the negative interest rates in Japan and Europe. People are willing to pay to move their money into the future.) Of course, if everybody stops spending all at once, we would genuinely be staring into the Great Depression scenario. To counter this deflationary expectation, the Fed didn’t just print money; it also signaled to the world that it would print an “unlimited” amount! Essentially, the Fed is shouting to the world: if you don’t take your money out from under your mattress and spend it, I am going to make it worthless!

In summary, the Fed was able to kill three birds with one stone:

  • Keep the economy humming.
  • Preempt a bankruptcy wave.
  • Counter deflationary expectation.

Truth be told, the Fed has never before undertaken such drastic measures like signaling unlimited money creation. Are there negative consequences, like runaway inflation? We will discuss them in the next article.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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