The response to critics is the same today as it was after the 2008 crisis: that the Fed is doing whatever it takes to prevent a depression.
But the risk is that each new chapter tightens a doom loop in which the US sovereign must eventually reckon with the ever-widening class of risk it is underwriting.
America’s national debt is already past 100 per cent of gross domestic product for the first time since the Second World War. It nearly doubled after 2008 and is rising sharply again.
As Japan has shown, high indebtedness need not trigger a crisis. Its national debt is well over 200 per cent cent of GDP. But as the issuer of the world’s reserve currency, the US must guard its role carefully.
The most visible threat, however, is to US political stability. The Fed’s quantitative easing boosts wealth inequality by increasing the net worth of those who own financial assets, chiefly of stocks and bonds.
The top 10 per cent of Americans own 84 per cent of the country’s shares. The top 1 per cent own about half. The bottom half of Americans – the ones who have chiefly been on the frontline during the pandemic – say they own almost no stocks at all.
The further up the scale you go, the greater the gains. The S&P 500 showed a return of about 16.2 per cent in 2020. Its global luxury index yielded a remarkable 34 per cent.
To be sure, many of the equity market’s gains have gone to big tech companies, such as Amazon and Netflix, which have benefited from the partial closure of the physical economy. But their gains have heavily outweighed losses in the worst hit sectors, such as cruise liners and oil drillers.
All that money must find some place to go. At the start of last year, five-year Treasury bonds yielded 1.67 per cent. By the end, it had fallen to 0.37 per cent.
The Fed’s inescapable bias towards asset owners has combined with the financial sector’s preference for size to produce a very skewed recovery. This has benefited big companies, even junk-rated ones, at the expense of small businesses, including financially sound ones. And it has boosted wealthy individuals over median households.
After 2008, the economic recovery coexisted with a so-called “main street recession”. Today we call it a K-shaped recovery. The majority of people are suffering amid a Great Gatsby-style boom at the top.
Whatever we label it, the political reaction is unlikely to be positive. The coincidence is unfortunate for Democratic presidents. Just as Barack Obama inherited the Great Recession, Joe Biden is walking into the Great Pandemic. In Obama’s case the backlash to his two-speed economy triggered a Tea Party populism that eventually brought his presidency to a halt.
Not much of fiscal note happened after his initial $US787 billion stimulus in February 2009. That meant the Fed had to go on doing the work of keeping the economy afloat.
In 2013, then-Fed chairman Ben Bernanke announced plans to reduce the scale of its bond-buying program, known as quantitative easing. He was quickly forced to reverse after the market went into a “taper tantrum”.
Biden could find himself in a similar two-speed economy. Last month, Congress passed a $US900 billion stimulus, which will tide over most unemployed Americans until March and send $US600 cheques to individuals earning less than $US75,000 a year. But his chances of passing a far larger “build back better” relief package after he takes office look slim.
By contrast, Jay Powell, the Fed chairman, has said the central bank’s support could be indefinite. The Fed will continue to buy $US120 billion of debt a month for the foreseeable future.
Here are the potential seeds of America’s next populist crisis. The Fed is pledging to do what it takes, while America’s elected officials seem unlikely to agree on fiscal policy. The right emphasis, as Powell keeps reminding Congress, would be the other way round. Monetary policy is a blunt tool. Spending, by contrast, can be targeted at those who need it and help lift America’s growth potential.
Alas, the chances are that the Fed will remain “the only game in town”. This would be both a missed opportunity and pose a severe danger. The opportunity is for the US government to borrow long-term funds at near zero rates and invest it in productive capacity. The danger of not doing that can be expressed in a simple equation: QE – F = P.
Quantitative easing minus fiscal action equals populism.