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Thursday, May 14, 2020
Economic Chasm and Policy Crisis in a Time of Pandemic
ANBOUND

The Covid-19 pandemic has caused a global economic crisis and impacted the capital markets in major countries around the world. Judging by the U.S. stock market’s performance however, the impact on the capital market does not appear to be much different from the past, with the U.S. stock market rebounding after a month-long plunge of 30%. From its low on March 23 this year, the Dow Jones Industrial Average had rallied more than 25% through May 13. For stock market investors, this means the brunt of the pandemic has been eased and things are starting to look up.

Unfortunately, in the real economy and the real world, countries worldwide are still suffering from the pandemic. Billions of people around the world had to be socially isolated and were unable to work because of the pandemic; the global supply chain had also been hit hard and many industries were paralyzed. In fact, a large number of enterprises in the aviation, tourism, hotel, and consumption industry have gone bankrupt too. With 33 million Americans out of work, the unemployment rate has soared from 4% to 16%, the highest since 1948. Emerging markets are likely to face a new round of shocks as the pandemic continues to spread rapidly in countries such as Russia and India.

It is clear that the much-expected rapid rebound in the U.S. stock market along with the optimism that rose in its wake stands in stark contrast to the pain in the real world and the real economy. Why the difference? During an internal situation analysis meeting at ANBOUND, some researchers had expressed strong doubts about the logic of the V-shaped rebound in the U.S. stock market - If optimisms surrounding the capital market is a reflection of the pandemic’s impact on the real world, that would mean the number of 1.4 million infected patients, 85,000 deaths, and 33 million unemployed people in the U.S. are insignificant, and that the capital market is still able to binge after a brief setback.

Then again, the cost of life and economic losses in the real world tells us that the optimism in the stock market is clearly unreal, or at least it does not fully reflect the real world we live in. As The Economist notes, the V-shaped rally in the U.S. stock market represents a world away from Wall Street, with a widening gulf between Wall Street and Main Street that threatens our world.

Why is there such a marked difference between financial markets and the real economy? Much of that is thanks to the Federal Reserve. In the wake of the U.S. stock market correction triggered by the pandemic, the Fed adopted the most aggressive and dramatic policy response of any central bank in the world. In addition to cutting its benchmark interest rate to zero, it opted for unlimited quantitative easing; the Fed had promised to buy more corporate bonds, even high-yield junk. In the past six weeks, U.S. companies have issued US$ 560 billion in corporate bonds, twice the normal amount. With abundant funds, not only have a few tech giants (Microsoft, Apple, Amazon, Facebook, and Google) become capital targets, even luxury cruise companies that have been hit hard by the pandemic can raise capital easily, and their stock prices have risen a lot.

Chan Kung, the chief researcher at ANBOUND, has been questioning the Fed's policy since March. In terms of policy response, the Fed's approach is to issue unlimited amounts of money because "there is a need to support liquidity." In the words of Fed Chairman Jerome Powell, the goal is to "provide credit where credit is not available." In this context, the core of the Fed's rescue policy is to protect the U.S. capital market and the interests of Wall Street. To some extent, the current rally in U.S. equities is the "Fed market", with the Fed propping up stocks with unlimited liquidity and luring global capital back to the U.S. market.

Whenever a crisis occurs in a world of excess capital, markets and governments tend to rely on central banks’ credit expansion even more. This has been the case since the 2008 financial crisis with the central bank’s bailouts and the "recovery" of the world economy. Due to the Covid-19 pandemic, the world has not been able to get out of a large-scale quantitative easing mode. That leaves the Fed with virtually no choice. The central bank's stimulus of excess liquidity with credit expansion is part of the "crisis triangle" theory, which states that urbanization à excess capital à economic crisis, before going back to urbanization and starting all over again. Such is the development of the human society.

Represented by the Fed, the gap between Wall Street and the general public is widening under the central bank's bailout policies, and that poses future risks. The Economist has identified three risks that cannot be ignored: First, the aftershock from the pandemic that will further hit the economy, which will result in many small and medium-sized enterprises facing bankruptcy, thereby further suppressing demand. Second, the liquidity flooding under the credit expansion policy will aggravate the financial fraud driven by cheap capital and financial engineering in recent years. A major corporate fraud like Enron Corporation could cause confidence in the U.S. markets to waver. The third is the risk of political opposition. While the spread of the pandemic will hit small businesses hard, it will strengthen the position of a few large companies and worsen the problem of excessive concentration in certain industries, which leads to a series of political objections.

Overall, the Fed's rescue policies, and the problems they create, are exacerbating the divergence between financial markets and the real economy. This is pretty much a worldwide problem. During a major economic crisis, it is hard for our world rid of its dependence on central bank credit expansion. If this was merely a financial crisis, as it was in 2008, an unlimited supply of liquidity might temporarily ease the crisis in financial markets. But when faced with a depression-level economic crisis, where individuals and businesses are presented with survival problems, excess liquidity alone can only temporarily rescue asset trading, not the crisis.

Final analysis Conclusion:

The Covid-19 pandemic has not only created a public health and economic crisis, it has also put governments and central banks at the forefront of public policy crises. Any errors or deviations in policy choices will undermine the recovery and prolong the pain of the crisis.

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