The Federal Reserve Bank Has No Clothes

We’re all pawns in a confidence game.

Somewhere along the way, central bankers took on the airs of economic overseers, acting as if they could, and should, pull levers that create economic activity whenever they deem it appropriate. The idea makes no sense.

The Fed controls money, not desire. The central bank makes it easier for people and businesses to satisfy their desires to spend more money by making credit more readily available, or making debt cheaper to service.

But that’s not the same as creating the desire or want in the first place. If you don’t want to buy a new car, then the financing rate won’t matter to you.

Which brings us to the coronavirus and the current confidence game.

To stem the tide of the virus, governments around the world are asking, and in some places demanding, that consumers not congregate in shopping areas, rail stations, movie theaters, etc. The lack of consumption is weighing on businesses large and small, as there’s only so much take-out food and Netflix that people can take in. Most of the missed sales won’t be recaptured.

On the production side, companies that can’t get workers to the factory floors to plunk out more stuff, or can’t get their goods delivered, or can’t receive raw materials, will be hard-pressed to make up lost sales when things return to normal.

The drumbeat calling for central bank intervention grew louder last week as equity markets around the world fell and analysts lowered their GDP forecasts. By the weekend, the drumbeat had become a deafening roar, with President Trump joining the mob demanding that the Fed do something.

What, exactly, are the central banks going to do to fix this? The answer is nothing, but they might make you feel better.

By lowering interest rates, the Fed and other central banks can make it cheaper to buy things that we finance. Whether they use newly-printed currency to buy long maturity bonds, cut the overnight interest rate, or do both, the result is always the same.

When buying bonds, central banks pump more money into the financial system, which increases the amount of funds available for lending and, theoretically, makes it easier to get a loan. The mechanism is different than pushing down interest rates, but the goal is the same, to entice borrowers who might have been on the fence to take the cash and spend it.

None of this changes your basic want for goods and services, it just makes it cheaper to buy them. In the case of the current virus, it’s hard to see how the Fed, or any central bank, will make a concrete difference.

But maybe that’s not what people are after. Perhaps instead, they want the appearance of control.

We’ve been in tough economic conditions before, and each time the Fed cut rates, printed cash, or both, and the equity markets responded. We didn’t necessarily see the economy rebound in a meaningful way, but when the equity markets turn from red to green, people feel better, and maybe that’s the point.

The Fed might be a financial emperor with no clothes, but as long as people believe, then they can keep the fantasy going.