For better or worse, we are passing through one of the great moments in history. Never before has every major economy in the world slowed so suddenly and in near-perfect lockstep. A recent report from the International Monetary Fund estimates that the pandemic could cost world economies upwards of $9 trillion in cumulative lost output in 2020 and 2021 or about $13 billion per day between now and the end of next year. The price tag of this crisis is staggering.
They say that great moments in history reveal great leaders. Think Churchill during the Battle of Britain or Eisenhower on D-Day. Over the past six weeks, our current crisis has revealed great leadership, too, and in the most unlikely of places - the United States Federal Reserve.
It is clear from the Fed's recent actions that they learned a few things from the 2008 financial crisis. Back in 2008, they dithered, fretting over which policies were appropriate as the global financial system teetered on the edge of the abyss. With the coronavirus, the Fed wasted no time throwing everything they had at the problem.
The Fed fired its first salvo on March 3 when it lowered the Fed Funds target rate by half a percent. In its press release, the Fed stated, "The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy." On Sunday evening, March 15, they showed they were good for their word.
In a series of moves that most Fed watchers would consider breathtaking, the Fed simultaneously fired the biggest guns in its arsenal. It was the monetary policy equivalent of "shock and awe." In one stroke, the Fed cut the Fed Funds rate to near zero, extended dollar liquidity to key central banks, reduced bank reserve requirements to zero, pushed banks to use their excess reserves to fund loans, and encouraged banks to use the Fed's discount window to meet any unexpected funding pressure. In the past, the Fed's discount window was where troubled banks went to get last-ditch financing. In the COVID-19 world, the Fed welcomes discount window borrowing as a natural and normal practice.
The Fed's interventions have continued, including facilities to support the liquidity and stability of money market funds and new loans to support small and mid-sized businesses. On March 23, the Fed announced it would buy Treasury bonds and mortgage-backed securities "in the amounts needed" to support the proper functioning of financial markets and to facilitate its monetary policy objectives. The Fed has made good on that promise, too. According to Bloomberg, in the week ended April 15, the Fed was buying bonds at a rate of nearly $41 billion per day.
You might wonder why the Fed is being so energetic in its response. The answer is captured by one word: fear. Central banks are deathly afraid of deflation and economic depression. Unchecked, a global economic shock like we are experiencing right now could easily produce both.
You can think of money flowing in a modern economy the way blood flows in the human body. In our bodies, if blood suddenly stops flowing-even for a short period-we can suffer irreparable harm or even death. Likewise, an economic shock that squelches the flow of money can devastate an economy. Everything the Fed has done has been geared toward pumping liquidity into the economy much like doctors would treat blood loss with a transfusion.
But the Fed's transfusion is only first aid. It does not solve the underlying problem, nor does it pay for the huge costs of joblessness and bankruptcy that are sure to follow from an extended lockdown. The current strategy may flatten the curve, but left in place too long, it will reduce our economy to rubble. The only viable path forward is to figure out a way to reopen the economy while managing the threat associated with the coronavirus.
The next step will difficult-possibly the most difficult of all. It may require sacrifice including temporary limitations on personal freedoms as we balance the safety of society's most vulnerable with the broader economic realities. Whichever course we choose, our next step will be another opportunity for bold and courageous leadership.
Steven C. Merrell is an investment adviser and partner at Monterey Private Wealth Inc., in Monterey. Send questions concerning investing, taxes, retirement or estate planning to Steve Merrell, 2340 Garden Road Suite 202, Monterey 93940 or [email protected].