EC The Fed, Zombies, & The Pathway To Japanification

We recently penned an article discussing the “moral hazard” fostered by the Fed’s ongoing monetary interventions. However, this story is fraught with zombies and the path to “Japanification.” 

The Fed recognizes their ongoing monetary interventions have created financial risks in terms of asset bubbles. They are also aware that most policy tools are likely ineffective at mitigating financial risks in the future. Such leaves them being dependent on expanding their balance sheet as their primary weapon.

Such was a point they made last year, which bypassed overly bullish investors.

“… several participants observed that equity, corporate debt, and CRE valuations were elevated and drew attention to  high levels of corporate indebtedness and weak underwriting standards in leveraged loan markets. Some participants expressed the concern that financial imbalances-including overvaluation and excessive indebtedness-could amplify an adverse shock to the economy …”

“… many participants remarked that the Committee should not rule out the possibility of adjusting the stance of monetary policy to mitigate financial stability risks, particularly when those risks have important implications for the economic outlook and when macroprudential tools had been or were likely to be ineffective at mitigating those risks…”

That was in January 2020. Just a couple of short months later, markets were in the worst drawdown since the “Great Depression.” 


The Unseen

With Central Bank interventions, it is not what is “seen” that is important, but what isn’t.

We “see” the trillions of dollars of liquidity having positive effects on asset markets.

Fed Zombies Japanification, The Fed, Zombies, & The Pathway To Japanification

However, what most overlook is what is happening elsewhere in the economy.

We previously discussed how the Fed’s interventions made the top 10% wealthier while bypassing the bottom 90% of income earners.

Fed Zombies Japanification, The Fed, Zombies, & The Pathway To Japanification

But the more insidious effect has been the rise of “zombie” companies. These companies survive only due to the Fed’s suppression of interest rates and creating a speculative investment climate for bond issuance. As discussed in “Recessions Are A Good Thing:”

“‘Zombies’ are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing. 

Such is a macroeconomic problem. Zombie firms are less productive, and their existence lowers investment in, and employment at, more productive firms. In short, a side effect of central banks keeping rates low for a long time is it keeps unproductive firms alive. Ultimately, that lowers the long-run growth rate of the economy.” – Axios

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William K. 3 weeks ago Member's comment

It seems to all point back to the Federal reserve people taking care of their rich friends. The smell of moral corruption is just as bad now as the stench of stupidity It should have been clear that dropping the interest rate made it cheaper to borrow instead of improve. Unfortunately the fools in the federal reserve have been busy taking care of their rich friends for way to long, and the damage is quite a lot. So what is needed is a deep house cleaning, WITH Extreme prejudice, taking all of the old-guard out of the fed and explaining to their replacements just what it was that got them removed, so as to avoid any repeats of the same.

Monica Kingsley 3 weeks ago Contributor's comment

history moves in waves, and with a revolution, one (astronomically) ends where they started...

William K. 3 weeks ago Member's comment

I certainly hope that the revolution coming will not be excessively violent. And of course the problem with revolutions is always that the wrong people wind up being on top afterwards.

To quote that last line of that famous ballad, "BABA O'Riley, " Meet with the new boss, Same as the old boss."

Monica Kingsley 3 weeks ago Contributor's comment

When you're in a hole, stop digging - a wise piece of advice not leading to capital malinvestments and lowering potential GDP output.