With its move into corporate bond buying, the Fed is undoing free market capitalism even faster than Rep. Alexandria Ocasio-Cortez would.
Has anyone ever seen Fed Chair Jerome Powell and Rep. Alexandria Ocasio-Cortez in the same room?
Given the radical turn the Federal Reserve has taken, it’s getting hard to tell them apart. President Donald Trump might as well have nominated the socialist congresswoman from the Bronx to chair the Fed.
The Federal Reserve Bank of New York announced on Monday that the central bank would begin buying corporate bond ETFs (exchange-traded funds) in early May.
Soon after that, the Fed will start purchasing corporate bonds directly. These unprecedented leaps in Fed policy are part of its emergency lending efforts.
But these radical stimulus efforts are precisely the kind of socialist economic policies that Jerome Powell criticized as recently as last year. So why is Powell suddenly doing his best Alexandria Ocasio-Cortez impression? He’s creating unlimited money, then lending it out to socialize capital markets via central planning.
Last year, Alexandria Ocasio-Cortez boosted the ideas of economist and Bernie Sanders advisor Stephanie Kelton. She’s an advocate for what she calls “Modern Monetary Theory” (MMT). The idea is that the Federal Reserve can create unlimited amounts of money to fund social programs – unless there’s inflation.
An added kick to the theory is that if there is inflation, the Fed shouldn’t fight it by raising the target federal funds rate. Instead, MMT advocates say Congress should whip inflation by raising taxes to pull money out of the economy.
At the time, Fed Chair Jerome Powell bashed Modern Monetary Theory in Senate testimony, calling it “just wrong”:
Powell took his critique further and said:
In addition… our [the Fed’s] role is not to provide support for particular policies… It is to try to achieve maximum employment and stable prices.
But the Federal Reserve’s move to back certain corporate bonds and bond ETFs is nearly as “particular” a policy as one could imagine. Not only is the Fed suddenly unleashing liquidity along modern monetary policy lines, but it’s also using the money to pick the winners and losers in the marketplace.
We are living in Bernie Sanders land now, not a free market USA.
“I’ve abandoned free market principles to save the free market system.” –President George W. Bush during the 2008 financial crisis
The free market is a system of incentives grounded in the realities of demand, scarcity, production, and risk. When a private investor ventures money to buy a corporate bond or bond ETF, they’re delaying present consumption of resources they’ve accumulated by producing something.
They’re also forgoing other opportunities to invest or hedge that money, which economists call opportunity cost. And they’re taking a risk with their own hard-earned wealth. That incentivizes private investors to buy securities carefully. The Fed doesn’t have that skin in the game.
This incentive limits the flow of capital to the more productive corners of the economy. It helps prevent the loss of massive inflows into disordered, unproductive (you could say “corrupt”) systems.
The Fed has always bent this free market system by pumping money into the economy through the banking sector, creating disastrous asset bubbles along the way. But in the wake of coronavirus, the central bank is taking it an enormous step further.
The Fed’s move into bonds is already creating perverse incentives for private investors (via Bloomberg):
Investors have piled into bond ETFs in anticipation of the Fed’s purchases. BlackRock’s $20 billion iShares iBoxx High Yield Corporate Bond ETF, the largest junk-debt ETF, attracted a record monthly inflow of $3.7 billion in April. Meanwhile, the $46 billion iShares iBoxx $ Investment Grade Corporate Bond ETF has rallied roughly 12.5% since the Fed’s initial announcement in March.
Mark my words, this is another asset bubble in the making.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The above should not be considered investment advice from CCN.com. The author holds no investment position in corporate bonds.
Last modified: September 23, 2020 1:55 PM