Throwing money the wrong medicine

Editorial | Mary Ma 17 Mar 2020

It was dreadful to hear US Federal Reserve chairman Jerome Powell declaring a set of moves - which included the most drastic interest cut since the last financial crisis and reactivation of quantitative easing - in a single strike rather than multiple ones.

It's shocking not because of the announcement's timing prior to a regular Fed meeting but because of the massive dose being rolled out.

After cutting the benchmark interest rate to zero, Powell has emptied one of his sleeves - unless he's prepared to venture into the negative interest rate zone that may mean little due to the sudden credit seizure caused by a stoppage of human activities due to the coronavirus pandemic.

As people stop traveling or hanging out, businesses are instantly hit by a crash in cash flow that threatens to drown many employers unless they are thrown a lifeline.

If the freeze lasts longer than is hoped for, airlines, travel agencies, eateries - indeed, any kind of commercial operation - may go bankrupt and lay off workers. That, in turn, would threaten the banking system due to a surge in default cases.

It's no wonder the Hong Kong stock market and its peers in Asia and Europe plummeted on Powell's unexpected announcement.

Had the announcement been timed for a relatively normal day, the markets would have lifted like a rocket in view of the Fed's massive booster dose. But investors were scared, thinking there must be some systemic woes that central bankers are usually the first to notice.

Even during financial tsunamis, human activities carried on as normal as people continued to fly and dine out.

What we're seeing now is like the clock stopping. Although the pandemic seems to have been contained in some parts of Asia, the disease is raging Europe and America while gaining a foothold in Africa.

It's worth noting that, besides the interest rate cut and the relaunch of QE to buy treasuries and agency-credited mortgage-backed securities, the Fed has also cut the reserve requirements for numerous banks to zero. It has also slashed the cost of emergency lending at the discount window for banks by 125 basis points to 0.25 percent while lengthening loans to 90 days.

All these actions were taken on a single day whereas, during the financial crisis, they were rolled out over several months.

The uncertainty is whether the massive easing of liquidity will smooth credit flow to households and businesses in need at a time when employment hangs in the balance and companies are in danger of collapsing due to a sudden disappearance of normal cash flow.

During the last financial crisis, much of the extra liquidity did not reach where it was intended. Instead, it created bubbles in commodities and fixed assets.

It's a cause of major concern that the extra credit may again not reach where it should.

If markets were excited a short while ago by the Fed's cutting of the interest rate by 50 basis points early this month, they failed to respond positively at all this time around.

Investors may be trying to tell Powell that, after having been fooled once, they're not going to be fooled a second time.

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