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The Financial Express

When the Fed Chair talks everyone listens


Appearing on a network morning show on Thursday (March 26, Federal Reserve Chairman Jerome Powell gave a message of first containing the pandemic, then opening for business  - in contrast to Trump's call to get economy 'roaring' by Easter (April 20).     —Photo: Reuters Appearing on a network morning show on Thursday (March 26, Federal Reserve Chairman Jerome Powell gave a message of first containing the pandemic, then opening for business  - in contrast to Trump's call to get economy 'roaring' by Easter (April 20).     —Photo: Reuters

If you watch the dynamics of a near perfectly competitive free market (stock market), a monopolistically competitive market (oil market) or a government regulated bond market and you have some semblance of economic literacy, you can make a diagnosis of a brewing global recession in general and in the US economy in particular.

In early March, J.P. Morgan (JPM) informed its clients of a 90 per cent likelihood of an impending recession - one that is defined by at least two consecutive quarters of economic contraction. What prompted JPM to make such a prognosis?

It was impelled by a despairing and disorderly behaviour in the bond market - a signal flashed by 10-year Treasury Security when it saw a jaw-dropping yield of 0.4 per cent - an all-time low.  Investors were rushing to sell off riskier assets such as stocks to marquee in 10-year Treasuries. The global economy essentially began bleeding "from a one-two punch to the face" - an epidemic originated in China morphing into global pandemic and an oil price war between Russia and Saudi Arabia, both blending to morph into an economic pandemic.  

The world has a glut of oil right now and the Saudis decided not to scale back production after Russia flooded the market with extra oil. The price of oil plummeted to $30 a barrel on  March 08, 2020 - lowest one-time drop since the 1991 Gulf War - due to the demand slack caused by spreading of Covid-19 and an oil price war between Russia and Saudi Arabia. With oil trading around $30 a barrel - one that is near or below cost - most energy companies outside Saudi Arabia can't survive on, including many in the US.

The bigger looming threat to the economy is the potential cascading loan defaults - both personal and corporate. In a bid to preempt such an inevitable debt debacle the Congress ($2.2 trillion) and the Federal Reserve ($4.0 trillion) crafted the  $6.2 trillion "Emergency Relief Package" (ERP) as  designated by Senate Majority Leader Mitch McConnel.  No sooner did the ink of signing of the $2.2 trillion ERP dried out the Congress has started thinking of another contingency package.

As people lose jobs and low-wage workers are forced to stay home because of Covid-19 and they don't get paid, they will struggle to pay their bills. Around 40 per cent of Americans said they were having trouble paying their bills before Covid-19 hit, and many of them will be under even more pressure now.

Consumer spending accounts for 70 per cent of the US economy (significantly higher than the global average of 63.64 per cent). It is therefore no wonder why economists say that American economy is consumer driven. As people see layoffs and workers are lining up for unemployment checks, anxieties about losing paychecks overwhelm their psyches, forcing a cutdown on spending.  That sets-in the inertia of defaults in credit card, mortgage, automobile and other consumer loans, which sets a downward economic cascade. In the US the unemployment claims last week already soared to 3.5 million and counting. 

While the economic downturn and escalating unemployment is inescapable the Fed has also lined up with the Treasury Department to free up frozen credit markets. The programme involves funding to businesses of all categories and sizes through buying corporate bonds and other assets - a first ever.  Powell said the Fed is aiming at "places where credit is not being offered where it should be offered." Additionally, the Fed has also launched its quantitative easing (QE) - an open-ended buying of bonds as warranted - reminiscent of the activism pursued during the 2008 Great Recession to help markets and the economy function properly.  

In a rare live TV interview with NBC's "TODAY" show on March 26, Fed Chairman Jerome Powell said, "When it comes to this lending, we're not going to run out of ammunition. We still have policy room in other dimensions to support the economy." Beginning with the first week of March, the Fed has already set its overnight interbank lending operation at near zero interest rate (the federal funds rate: RFF). With reference to the economy's struggle as the escalation of if the virus bringing the economy to a near standstill Powell emphasised that this is not a normal downturn brought on by a crisis in a particular sector of the economy. Powell said growth had been strong preceding the Covid-19 pandemic and he ushered the optimism that growth will continue once the virus is brought under control. "We're trying to create a bridge from a very strong economy to another place of economic strength," Powell said. "That's what our lending does."

The Fed's recent policy activisms and near open door credit facilities are what were absent during the October 29, Great Stock Market crash of 1929 which many analysts and economists blamed as the cause of the Great Depression. It started in September and ended late in October, when share prices on the New York Stock Exchange (NYSE) collapsed. The NYSE collapse was followed by the collapse of the London Stock Exchange, triggering the beginning of the Great Depression of the 1930s. The debate over if the 1929 stock market crash had driven the economy to the beginning of the Great Depression is being debated even to this day. 

In a widely acclaimed article in 1998, The Economist argued that the Depression did not start with the stock market crash, nor was it foreseen at the time of the crash that a depression was forthcoming. The Economist asked, "Can a very serious Stock Exchange collapse produce a serious setback to industry when industrial production is for the most part in a healthy and balanced condition?" The Economist, however, did not dismiss the occurrences of some economic setback and slowdown but failed to find sufficient evidence to justify that stock price collapse would necessarily produce a general industrial depression.

However, The Economist and many Great Depression economists in the US in recent times argued that bank failures and reserves distressed banks fail to extend credit to commercial and industrial enterprises were mostly responsible for the Great Depression.

With the Fed and the Congress standing ready with all the monetary and fiscal arsenals at their discretions, the sliding of the economy into a short-lived recession may be unavoidable while that of a Depression is not in anyone's thinking - even remotely. Covid-19 is playing harm with human lives but the factories and infrastructure are standing tall and intact as before. 

Even though the Covid eruption is escalating exponentially across state and national borders as I write this piece, the fear contagion-inflicted people everywhere around the world are watching TV with the optimism that a preventive vaccine and some miracle pill will soon be developed to save life.  If that happens, the exuberance will be so overwhelming that people will feel reliving again with a new lease of life and the economy will rebound faster than anything we have witnessed.

Dr Abdullah A Dewan, formerly a physicist and a nuclear engineer at Bangladesh Atomic Energy Commission (BAEC), is Professor of Economics at Eastern Michigan University, USA.

adewan@emich.edu

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