Placebos Are Powerful Until They Aren’t. We’re Dangerously Close To A Policy Error Based On Misplaced Faith in the Fed.

Placebos are powerful.  Until they aren’t.  Faith in the Fed’s trillions has sustained markets so far.  But the hard-dollar prop holding up the economy is the merely-billion-dollar flow of fiscal stimulus – especially expanded unemployment benefits.  With Congress likely to start turning those taps off in July, our collective delusion about the power of the Fed might not survive much longer.  Like the Cowardly Lion, Scarecrow, and Tin Man, we’ll have to find our way without our Wonderful Wizard of Oz.  That probably gets ugly before it gets better.

The Fed’s money can’t have juiced the markets because the money never touched the markets.  The Fed did create some $2.3 Trillion in new money. And yes the markets have responded as if that wall of money has hit them. But, outside of some swap lines with foreign central banks, that money has never circulated.  Bank lending has been tight.  The Treasury hasn’t drawn down their account. The Fed has made some promises to buy corporate bonds, but what they’ve actually spent has been inconsequentially tiny.  Most of the Fed’s money never left the Fed.  At least not in reality.  In our heads, however, the placebo effect has been massive.

The Man Who Overdosed on Placebo

Several years ago, a published case study describes a 26-year-old man who was taken to the emergency room. After arguing with his ex-girlfriend, he attempted suicide by swallowing 29 capsules of an experimental drug that he obtained from a clinical trial that was testing a new antidepressant. When he arrived at the hospital, he was sluggish, shaking, and sweating and had rapid breathing. His blood pressure was extremely low at 80/40, and his pulse was 110.

Doctors were successful at raising his blood pressure. Over the course of four hours, they injected him with 6 liters of saline solution. His blood pressure increased to 100/62, which is at the lower end of the normal range, but his pulse remained high at 106.

What finally cured the patient wasn’t anything the emergency room staff did. Instead, a doctor from the clinical trial arrived at the hospital. He told the patient that those antidepressant pills weren’t antidepressants because he had been randomized into the control arm of the trial. Yes, that’s right: He overdosed on placebos.


Within 15 minutes, the patient’s blood pressure stabilized at 126/80, and his heart rate dropped to a perfectly normal 80 beats per minute.

We know the Fed’s “wall of liquidity” never hit the markets because we know it never left the building It hasn’t gone into the real economy.  It hasn’t gone into the Financial Markets.  It didn’t even make one round-trip.  It has just sat in the “Fed Savings Accounts” of the US Treasury and the banks.  They have just left it parked there.  Un-moved and un-moving.  The data in the article below are accurate up to mid-June…

So far, since March 11, the Fed has pumped in $2.3 trillion to the economy in new dollars. That is mostly QE (the blue column), with an additional $195 billion in loans (the facilities), offset by a reduction in repo of $163 billion.

Where is that $2.3 trillion? We know exactly where it is, because it is in only two places – bank reserves at the Fed, and the US Treasury’s checking account, also at the Fed. Together, these have risen $2.5 trillion, $180 billion more than the Fed’s liquidity injections.

All that has actually happened is that rates have gone down by a decent-but-not massive amount.  That interest rate cut is something.  It should/could boost markets.  But it is hardly a “wall of Fed money.”  Especially if the banks aren’t actually lending at those rates (or any other rate).  Low rates simply don’t explain enough.  Leaving us back at the Placebo effect.

You might argue “the Fed’s money is funding the Treasury’s various fiscal stimulus programs.”  But the Fed’s only role there is to create additional serial numbers for additional dollars already appropriated by Congress.  Going through the fiction of one arm of the US government printing up new serial numbers to exchange for IOU’s from another arm of the US government.  That is all just an internal accounting fiction within a single entity – the US Government.  The money thus created doesn’t “do” anything until it leaves the US Government and hits the real economy.  It hasn’t.

Moreover, that stimulus money flow isn’t some “trillion dollar wall of Fed liquidity hitting markets.”  It is a measly few-billion dollar dribble of monthly unemployment checks and business loans.  The increasingly maligned, at risk expanded unemployment benefits and PPP loan programs.  Plain vanilla fiscal stimulus.  Libtard Keyensian stuff.

In real-economy, real dollar terms, those few billion dollars of money flow are what is standing between us and disaster. If we all understood that reality, those benefits would be renewed (or raised) at the end of July.  But in our collective placebo-effect fantasy, the magical Fed is doing all the work.  The feckless Congress is just spending our hard earned money on undeserving layabouts who are “earning more on unemployment than they would by working.”  Ignoring some inconvenient facts.

  1. Those checks are flowing straight through those people’s bank accounts into rent payments, car payments, mortgage payments, and retail spending.  Cut those back and you choke off that upstream flow of payments.  That will create a wave of defaults up the chain.  That “free money to the undeserving” is flowing on to keep ALL of us afloat – rich and poor.
  2. There are no jobs for ALL those people to go back to.  Anecdotally and individually perhaps.  Collectively?  No.  They won’t be able to replace the lost benefits with wage income.  It is just a subtraction.
  3. Those checks are also supporting people trapped with kids at home.  Someone has to take care of them.  Because there’s this virus thing killing Grandmas and Grandpas…

Stimulus isn’t about efficiency and who “deserves” what.  It is about getting dollars out and circulating.  So that payments get paid.  So we all stay afloat.  The expanded unemployment program is doing a fantastic job as stimulus.  But it looks increasingly likely those benefits will be cut back.  Risking a plunge into crisis. 

  • I get a sinking feeling some folk’s are hoping that crisis happens – shaking loose some nice assets at fire-sale prices.  A lot of folks made nice returns out of the 2008 crisis.  Maybe they want another bite at that apple?  Precipitate a crisis, but not so big as to fall into the next Great Depression.  Just like 2008.  That is a very dangerous game.  And post-2008 has sucked for most people.
  • Alternatively, we are just too politically blindered to see reality.  Trapped in our information silo echo chambers.  Listening to booming noises about the Fed an imagining it will all be OK even if we cut those programs back.  Which is about as stupid and self-defeating as, say, re-opening the country too early in a mass pandemic.  Are we really that dumb?

I keep coming back to the Wizard of Oz. A study in the power of the Placebo effect.  The Wizard may be a powerless old man, but has a powerful impact on his world.  His simple existence (and their belief in him) pull the Cowardly Lion, the Tin Man, and the Scarecrow along a journey of personal growth.  The good citizens of Oz sleep better at night knowing the Wizard is there to protect them.  It all works until Toto pulls back that curtain.

The Fed today is mostly exercising similar Placebo power.  In reality, it has been pushing on a string since 2008.  Pushing on more of a soggy noodle from 2000 to 2008.  The data show that. The main thing sustaining our faith in the Fed today is no more than… our faith in the Fed.

How will we react when (not if) that collective delusion is shattered?  Eventually, we’ll rise to the occasion.  But we’ll likely flail and thrash through a lot of economic damage along the way.  Or maybe we’ll get lucky and keep that curtain closed…

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