What now? by Tuomas Melinen

The current economic and financial contraction started before the coronavirus outbreak. The outbreak has made it worse, and notwithstanding all the government debt and central bank funny money, the economy is unraveling. From Tuomas Melinen at gnseconomics.com:

A year ago, we published a piece entitled “Where from here?” In it we envisaged that the central banks were “effectively out of means to stimulate”. While this certainly may have been true as global economic growth sputtered into the end of 2019, they most definitely were not “out of means” to bail-out the financial markets, or even corporations.

We have reached such extremes in central bank and government meddling that it is now impossible to speak of a “market economy” any longer. Many, erroneously, blame the coronavirus pandemic for this. However, Covid-19 was merely the ‘trigger’ for desperate central bank action to save the fragile financial system they themselves helped to create.

And—let’s remember that we have likely been in a new global financial crisis since September, 2019.

GFC, part II

The new financial crisis started with the implosion of the repurchase agreement, or the “repo” market, on 16 September, 2019. Repo-markets ‘blew-up’ because of the massive leverage built into the financial system through constant central bank support which made them unstable.

Central bank quantitative easing programs altered the balance sheets and money market activity of banks in a way that encouraged the hoarding of U.S. Treasuries. Hedge funds had also been increasing their leveraged positions using repo. The very low interest rate environment, also caused by the central banks, forced hedge funds to employ very high leverage ratios to obtain decent returns.

The instability of the repo-market, combined with the high liquidity needs of state and local governments, was an accident waiting to happen.  One day in September the big banks did not show up to lend to the repo-markets. A crisis of confidence and a drastic liquidity shortfall instantly developed.

The crisis was stopped from engulfing the world economy by the Fed through its emergency repo-lending program, It had previously been used during the Global Financial Crisis (GFC), a decade ago.

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