The 10th Man

Complaint Department

June 18, 2020

A few days ago, the Federal Reserve announced that it would buy a “broad portfolio” of corporate bonds, to go along with its ETF purchases.

Because of the Fed’s actions, corporations will be able to borrow at lower rates.

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What could be wrong with that?

First, let me say that complaining about the Fed is its own genre of financial commentary. Some people elevate it to an art form. I usually don’t engage in it, because it’s unproductive and not conducive to making money.

Some commentators call the Fed an arsonist. If that is true, then go find some marshmallows.

Still, there is something about the corporate bond purchases that is a bridge too far.

Let’s think about what a Fed-free world would look like. Interest rates would be higher! Some corporations wouldn’t be able to service their debt, and would go bankrupt. If companies went bankrupt, layoffs would certainly follow.

Isn’t this well-intentioned, to try to prevent millions of layoffs?

It may be well-intentioned, but the unintended consequences are horrifying. These are bad companies, and the longer they stay around, the more capital gets misallocated. We should want that capital to be allocated to better uses.

As for the layoffs, we have a dynamic, free-market economy, and people can get jobs somewhere else. For that matter, there is also unemployment insurance. I don’t mean to be glib, but we’ve long accepted this sort of thing as a possible consequence of capitalism.

Firms die, and new ones are born. This is how we achieve economic growth.

What the Fed is doing keeps zombie companies alive. Companies that should be bankrupt.

So far, the Fed has already manipulated the Treasury market, pushing risk-free rates lower, so everyone can borrow at lower rates—including you and me. People buy cars and houses that they ordinarily wouldn’t be able to.

So some people get to buy houses—what’s the big deal? That is also a misallocation of capital. Maybe some people have no business buying a house.

The Seen and the Unseen

It is all about the seen and the unseen.

People only look at what is seen—companies get to borrow more cheaply. People get to keep their jobs. But they don’t look at the unseen, which is how this capital could be better used somewhere else.

This is how capitalism works. You can’t have capitalism without failure.

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This country was literally built on failure. It was built on the past mistakes of entrepreneurs. Nobody dies. People lose money, and they get smarter. That is how capitalism works.

The reason the US economy is so spectacular is precisely because we allow failure to an extent not allowed anywhere else in the world. If older firms don’t die, younger, better ones can never take their place. When you don’t allow failure, you lose dynamism from your economy.

When you talk about the Fed, people typically focus on the effects on inequality—which Chairman Powell himself denies. But it’s more than that, and more insidious.

Up until this point, we had the most dynamic economy in the world. And we were killing it.

This, however, is not capitalism. What we had twenty years ago was capitalism, though some people argue that we haven’t had capitalism since 1971—the year President Nixon suspended convertibility of dollars into gold.

Laissez-Faire

When was the last time you heard the words “laissez-faire?” It’s been ages. Today, everything requires an interventionist approach. It’s all about trying to preserve the status quo. And it comes from a fear of change.

In a crisis, everyone wants to do something. Instead, we should do nothing. I am fond of saying, “don’t just do something, stand there.”

When you are talking about large, complex systems (like the global economy) that are too complicated to understand, you are better off leaving them alone.

In middle school, I learned that the reason the Soviet Union failed was central planning—the idea that someone, somewhere can successfully direct the activity of millions of people. The invisible hand does a better job of that.

The Federal Reserve doesn’t have perfect knowledge of where interest rates should be. In the beginning of the crisis, when yields on corporate bonds blew out to double digits, we should have left them there. Things would have been fine.

At the time, the Fed was concerned that markets had “ceased functioning,” and they needed to provide liquidity. Liquidity would have returned over time. Double-digit yields have a tendency to attract courageous capital.

Everything the Fed has done has benefited the big over the small. The top ten companies in the S&P 500 will be the top ten companies in the S&P 500 ten years from now. Nothing will change, and discontent will grow.

You work in this business long enough, and you lose your capacity for outrage. I am not in charge, but I can tell you, if I were, things would be a lot different around here.

And Finally

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Jared Dillian

 

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Comments

steve.elves@gmail.com

July 4, 9:19 p.m.

You say, “people can get jobs somewhere else” - but can they? And if they do, will they have the same income and health care as before?
The system is perfectly constructed to bind employees to companies who are prepared to treat them as serfs or disposables.  Fear of losing your job is bad - but not nearly as bad as losing your job and your medical insurance!
It’s much like the old days where you worked for “the man” in his company town, and if you got fired for any reason, you not only lost your job but your house as well!
This kind of thing eventually leads to bloody insurrection, almost every time.

kennetl7@live.com.au

June 18, 10:46 p.m.

As I understand it, Central Banks are ultimately backed by taxpayers via Treasury. Therefore, buying company bonds or stock seems to amount to nationalisation by stealth, which must end in central planning. The cronies get those central planning jobs.

donsoards@gmail.com

June 18, 7:35 p.m.

Demand does not automatically exist because production assets have been reallocated.  See Progress Dollars from the Production Parabola.

Jeffrey Calkins

June 18, 1:56 p.m.

I agree.  US form of capitalism was dynamic, although a bit harsh for my taste.  Better to strengthen the safety net of workers, however, than try to bail out companies.  I share your fear that we are headed towards a Japan-like zombification.

The only semi-rational explanation I’ve heard is that all of this stimulus, both Fed and fiscal, is to provide a “bridge to a vaccine.”  Maybe it will, maybe it won’t, but either way I don’t see how we get out of the debt box we are in without massive inflation/defaults down the road.

How does Mauldin’s “Great Reset” take place?  I’ve often wondered what the effects would be if the central banks (Fed, BoC, EU) just wrote off the billions of govt debt they hold.  The Central Banks would broke and have to be recapitalized, but no individuals lost money and the nations’ budget situation become much better because of interest savings. We might find out.

tkendyalfree@gmail.com

June 18, 11:48 a.m.

Failure in business is like a fire in the forest.  Destructive, but necessary for new growth.  I wish the Fed would have let the failures occur in 2008. I think our country would be stronger. People need to LEARN risk.

tkendyalfree@gmail.com

June 18, 11:43 a.m.

Amen…zombie companies have lined the pockets of the politicians.  The politicians seem to feel they must do something.  Tragic…studied economics in the 1980s…it seems so far ago and the basics of capitalism are gone.  Keep writing and spinning

Frederic MARI

June 18, 11:19 a.m.

Yeah, look, it’s a nice sentiment, though I doubt you’re actually right.

There’s plenty of capital available for a young startup with a bright idea these days. VCs have shit tons (scientific term) of dry powder, begging for deployment.

But even better. I believe we tried your approach before and it gave us the Great Depression, Hitler and WWII. Hey. Creative destruction. We made it through anyhow, right? Sure but 40M people didn’t and might have preferred an interventionist Fed…

pietro@autodataitalia.com

June 18, 10:21 a.m.

A voice in the desert…
This is the year 1905.
For immediate publication.
Our horse-driven cart business, The Great American Cart Co., is suffering the competition of those disgusting, foul-smelling contraptions called “automobiles”.
While I’m sure that in due time these awful “vehicles” will eventually be refused by all law-abiding American citizens, we are suffering diminishing sales in the short term.
Already we had to discontinue the production of our covered wagons, which, let’s be frank, contributed so greatly to the expansion of our great nation. A good part of our workforce will have to be let go if soon a solution is not found. So many highly experienced carpenters, ironsmiths, leather workers will lose their job and the whole nation will lose their expertise.
Where will we find their replacement when the public will be clamoring for more buggies and rockaways?
We demand the prompt intervention of our federal government:
1) by law all state offices and agencies must be forbidden to acquire any non horse-driven means of transportation.
2) A heavy taxation, in all possible form must be levied on ALL non animal-driven carts.
3) We demand a prompt infusion of free cash and that all workers salary be paid by the federal government, 6 months at a time, anticipated and renewable every 6 months.
4) we require that from now on we shall receive loans at 0 % interest, no question asked and re-payable when and if we deem possible. If not repaid those should be forgiven after 5 years.

We ask every worker, every citizen, to rally behind our request: write to your Representative, write to your Senator!
Let’s make America great again! Let’s make America more equal!

P.S. So that our elected representatives waste no more time in future, suggest that they establish a permanent institution charged with those highly necessary tasks. They might want to call it Federal Reserve. A reassuring moniker to remind everybody and the world that we mean business and the nation cares about its workers!

annettemrogers@msn.com

June 18, 9:34 a.m.

Might your anger be misplaced? The fed is a convenient “whipping boy” for government’s failure to govern. In buying corporate debt, the fed has returned to what it was meant to be. Fed banks were designed to stimulate the economy by buying short-term private debt. The corporation paid down the debt or the bank was head of the line in liquidation.

It takes politicians to really screw things up. Congress forced the fed to buy government debt during WW1, and we’ve not looked back since.

nwinn52@gmail.com

June 18, 9:21 a.m.

The move toward a totalitarian democracy resplendent with a ruling class oligarchy is well underway - the aspirations of the Bilderberger Group recognized. For surely the supernational sovereignty of an intellectual elite and world bankers is preferable to the national auto-determination (self government) practiced in the past.