The Hammer and The Nail

9/11 changed our way of life. It eroded our liberties. The Patriot Act made us slaves to a new reality in which we now gladly accept to be taken pictures that penetrate our clothes by the TSA with the sole objective of confirming we will not hijack our plane and slam it into a landmark.

COVID19 will erode our liberties too. Just like 9/11 makes us willfully pose naked in exchange for the right to fly, COVID19 will eventually and make us gladly share our location to cross-reference it with healthcare databases to know if we've been exposed to infected people in exchange for the right to walk into a restaurant, a stadium or visit grandma at the nursing home.

Just like life on the streets went on after 9/11 --it in a slightly different way-- life will go on on the streets after COVID19 --in a slightly different way.

The change in the world of economics will be more pronounced, though.

The stock market represents the present value of the cash flows to equity, not the true state of the economy. In other words, it doesn't matter how long the breadlines at the food bank are these days, the stock market cares about how much money it flows to the capitalist (aka the stockholder). And both realities, unfortunately, can diverge. Grossly.

That Donald Trump gauges his success (or lack thereof) by how high or low the stock market goes belies his purported advocacy for "the forgotten man". The fact that he's successfully persuaded the poor and uneducated that he is there for them might go down as the greatest, cleverest con ever perpetrated on this country. But I digress. Thanks to the FED and its infinite backstop of the financial markets, money will keep flowing to that corner of the economy whenever there's a twitch of insecurity that the path to economic "recovery" is threatened.

This pandemic, however, has finally laid bare a couple of fallacies Central Banks have relied on for decades:

1. that more money in the system inevitably leads to more inflation, and 
2. that printing money to finance government spending should not be done. 

The lack of inflation after the explosion of the FED's balance sheet in the wake of the 2008 recession should have alerted people to this puzzle. But collectively accepted ideas --even those adopted by supposedly intellectually cogent people-- are hard to shed despite hard evidence to the contrary. The burden of proof in order to disproof tends to be placed too high when intellectual coalitions are built around the adoption of such totemic ideas.

The fact is inflation --as measured by the PCE and the one targeted by the FED -- is nowhere to be found. And this is clearly because printed money does not find its way to chase the precise basket of goods and services captured by the PCE. In other words, the "transmission mechanism" is faulty, which is just a fancy way of saying nobody really knows the relationship between money printing and inflation. This tenet (money printing=inflation) is a revered ghost nobody really knows it exists anymore. Just like nobody really knows if the Phillips curve (the supposed inverse relationship between unemployment and inflation) holds, or like nobody really knows where the NAIRU (the rate of unemployment below which inflation kicks in) is at a given time (or how to even calculate it).

So, in light of this intellectual void (whether they publicly acknowledge it or not), and in the face of an induced economic coma, the FED has found the perfect moment to break with everything it has ever done and plunged into an absolute new world by issuing its own "whatever it takes". Only problem is this "break" is just one of magnitude, not of direction. When all you have is a hammer, everything looks like a nail, I guess. The stimuli the FED has enacted in the past (QE's 1 through 3) have always been finite. This one is infinite. Past QE rounds bought financial securities issued/backed by the government in the open market. This one just broadened the scope to the next incremental category of risk (corporate bonds). Even the programs themselves are reenactments of ones used by Bernanke et al in 2008 (the program to support the commercial paper market, the money market funds, the USD swap lines with select foreign Central banks).

Don't get me wrong. This intervention was needed. The engineered economic collapse had to be arrested to prevent a financial crisis. And thanks to Jerome Powell's proactive and quick actions, one seems to have been averted (thank you Obama's 2008 Bank capitalization regulations, BTW). But by doing more of the same (now ad infinitum) this has jacked up the entire system's fragility. The FED has averted the proverbial fall by kicking the can down the road for another time, exacerbating the divergence between the financial markets and the real economy. Infinite money printing might not have (and most likely will not) spike inflation, but boy has it spiked inflation of another kind:

NDX is the index that follows Tech stocks. RTY follows small companies.
That hockey stick shape happened just when the FED put pedal to the metal.

If there's something this pandemic will cause, is for this country's recent trend to be exacerbated: More economic inequality. The newly minted money by the FED will directly go to inflate asset bubbles in financial securities owned by the richest (the top 1% owns 50% of the market). The "transmission mechanism" works like a charm there.

Congress has, however, unexpectedly brought about (despite their rancorous bickering) a stimulus fiscal package with a much better "transmission mechanism". Those $1,200 checks are going to be put on the checking accounts of people forming in line to get the meal of the day from the food bank. Forget for now about deficits. The moment is that dire. Welcome to MMT. The US is not alone in this embrace of "novel" economic thinking. The UK's Central Bank has literally extended an overdraft line to its Government, bypassing the market. Europe is all in as well. Yes, the moment is that dire.  

Of course placing the power to dole out money to the population in the hands of a politician with short-term electoral objectives is obviously dangerous, which is why Central Bank independence is needed to begin with. But the cost of that independence is the dilution of the "transmission mechanism" that blunts (in many cases even negate) the intended effects of monetary stimulus. Given the circumstances, one (fiscal profligacy) is much better than the other (monetary asset bubble inflation).

Time to truly think outside the (fiscal) box. Yes. The moment is that dire.