A very convenient conviction is rising in the panicked financial markets that the Federal Reserve will “save the market” from a COVID-19 collapse. But they won’t.
“Buy-the-dip” punters are placing bets on the belief the Fed can’t possibly let the current bubble pop.
Oh yes they can and yes they will. Why?
It’s about control. Here’s what I mean…
Just as the Fed gets panicky if interest rates start getting away from its control, the Fed also gets nervous when its speculative bubbles get away from it, even though it causes them in the first place.
When speculators no longer fear a downturn because of their faith in eventual Fed “saves,” the Fed has lost control. And that’s not what the Fed wants.
The COVID-19 pandemic is actually a godsend to the Fed.
To reestablish control, the Fed must let the current euphoric faith in its “guarantee” to rescue markets crash to Earth.
The Fed’s foolish but not stupid. They understand speculative bubbles always pop, so the COVID-19 pandemic is just the excuse they needed to let the air out of the current grossly unsustainable bubble.
All bubbles pop. That leaves the Fed with an unsavory choice: Either be viewed as responsible for the bubble bursting or engineer some fall guy to take the blame and give the Fed cover for its incompetence.
It’s also instructive to note, as many have, that the Fed enters this global recession with very little policy ammo.
Interest rates are so near zero already that a couple of rate cuts will do very little good in the real economy.
Panicky punters expect the Fed to blow its wad on saving their hides, but what would that leave the Fed for the real recession that’s just getting underway? Nothing. If the Fed starts cutting now, it’ll have nothing left.
Would the Fed be so shortsighted and stupid as to blow their last ammo just to save speculatively insane punters from the inevitable bursting of a moral hazard-driven bubble?
In a word, no.
What about the possibility of negative interest rates?
Japan and Europe have effectively proven that negative interest rates do essentially nothing to boost spending in the real economy.
All negative interest rates accomplished was further boosting speculative bubbles and wealth inequality, which threatens to destabilize the social order — something the Fed cannot control.
The reality is the COVID-19 pandemic promises to be much more consequential than the run-of-the-mill financial excesses of the past 20 years, but we already know one important thing:
All bubbles pop.
We also know this: The greater the excesses, speculative euphoria and moral hazard, the greater the reversal.
Charles Hugh Smith
for The Daily Reckoning