Falling in the Liquidity Trap
After suffering four circuit breakers in March due to panic from the Coronavirus epidemic, the S&P 500 closed out April over 12% percent higher. April was one of the largest returns the market has seen in a single month.
Was this due to forward looking investors who eye an end to the crisis or an ocean of liquidity that the US government has dumped on the markets?
Being grateful to the Federal Reserve’s quick response to one of the biggest pandemics in history, Wall Street was filled with hot money in April.
Although the long-term effect of addressing market liquidity will be satisfiable, it is hard to know if such stimulus is working well in the short run and the question must be asked as to whether this mountain of money will misguide the economy to a liquidity trap?
A liquidity trap describes a situation in Keynesian economics when the interest rates are near zero and investors don’t want to hold debt because there is no yield.
So investors clamor for cash over a market with virtually no yield. In this situation the monetary policy loses efficacy as the intention of propelling scared investors back into the market fails.
It is the hitch in the process of turning monetary liquidity to funding liquidity.
On one hand, there are signs showing that we may be in the trap?
A marker of a liquidity trap is the near-zero interest rate. There was a liquidity trap during 2009/2010, in the immediate aftermath of the global financial crisis. Now we are in a similar state.
Though the S&P 500 has recovered a lot of its losses from the sell off, the Russell 2000, a representative small-cap index, did not. The Russell 2000 experienced a return of around -11% from the beginning of March to the end of April.
Why? Cash is king.
But now small and mid-sized businesses lack the cash to pay for their accounts payable, especially in the services and retail industries.
Even some big plants are struggling for funding liquidity. An increasing number of companies have had to shut down branches, lay off workers or even file for bankruptcy protection. All sectors have been affected.
On the other hand, monetary policy is indispensable in the current situation.
Due to the public health crisis, millions of citizens are losing their jobs, while farmers are dumping milk and euthanizing their animals.
The high unemployment rate and economic recession are signals for a rescue. Obviously, a $1200 stimulus check is not enough, and citizens are expecting more. Only the government and central bank have the power to turn the tide.
“Another shock, followed by more Fed action, may be needed for stocks to push higher”, said Barry Bannister, chief institutional equity strategist at Stifel ,“To coax the Fed to do ever more, we believe the market must first experience a deflationary shock, such as another yield curve inversion in the second quarter, to which the Fed would react.” The market is also calling for a new round of quantitative easing.
Hence, expanding the money supply to save business is inevitable even though it would harm its efficacy. We are in the vicious cycle and at the end of the cycle, it is the bottom of the liquidity trap.
Indeed, money printing brings monetary liquidity.
Why does the monetary liquidity not change to funding liquidity?
Besides the low investment returns, another reason is that investors lack confidence in the market. The health crisis as well as the economic recession have not gone yet. There is still an atmosphere of tension in the market.
Additionally, the adage “sell in May and go away” may double the tension in such a volatile environment. These change the liquidity preference and lead to consumers hoarding money.
More governors’ actions are expected to relieve the situation, but many states are bankrupt themselves and lack the capital to help their constituents.
Only when the monetary liquidity fully transforms to funding liquidity and ameliorates the low production rate, will the world pass through this downturn. A possible accelerator of this process is the breakthrough in the medical field to defeat the Coronavirus. If the disease is cured, global investors’ anxieties are addressed from the source.
To avoid falling into the liquidity trap, more policies should be applied.
Luckily, the US Treasury is initiating loans of over 1 trillion dollars to small and middle-sized businesses.
Although it may not be enough, it would address the funding liquidity problem partially.
A small challenge is the potential of stagflation. Stagflation represents the combination of stagnation and inflation in the economy. Obviously, the inflation rate would increase as the money base grows stronger. But currently there is no inflation as people don’t have money to buy anything. We are seeing deflation in a number of areas.
The abnormal negative GDP in the first quarter(-4.8%) is the result of the staying home policy. Now with a high unemployment rate, the GDP may not perform as well after the stay at home orders end, which might see stagflation, though this is unlikely, more policies might be needed to address such problems.
Depression is probably more likely than stagflation.
If we have a depression mixed with a 0% yield in bonds will stocks be the only area for investors to hunt for yield?
In the short term, the market may not be very liquid since we are still undergoing this crisis. However, in the long term, with appropriate policies at appropriate times, the stock market would become attractive again.
My Experience With Coronavirus
Why did Coronavirus Spread so Fast?
Coronavirus and Globalization Moving Forward
Disinfecting Surfaces Against Coronavirus
Contagion Risks from Coronavirus
Coronavirus Oxygen Supplementation 101
Coronavirus: The Global Economic Impact
Coronavirus Causes Long Term Problems?
Online Coronavirus Scams Proliferate
What Is The True Coronavirus Case Fatality Rate For Young People?
How Likely Are Young People to be Hospitalized With Coronavirus?
Living On The Edge of A New Society
Coronavirus Will Test the Limits of Our Hospitals
Coronavirus Catapults Global Testing Innovation
Spain Suffers Under Coronavirus
Data, Models & Misinformation on the Coronavirus
Coronavirus Travels the Silk Road
Coronavirus Attacks Italy's Sick and Elderly
Is the New Coronavirus Drug a Cure?
What is the Mystery of Germany's Low Coronavirus Fatality Rate?
The World Will Be More Technologically Advanced After the COVID-19 Pandemic
Why has the Coronavirus Not Exploded in Japan?
Italy's Coronavirus Death Rate is Falling
Coronavirus Speeds Up Robotic Revolution
Economic Depression Will Destroy More Lives Than Coronavirus
Can Hydroxychloroquine be Used to Treat Coronavirus?
Northern Italy & Wuhan: Partners for Better or Worse
The Race for the Coronavirus Cure
How Did Taiwan Manage the Coronavirus so Well?
What is the US Coronavirus Fatality Rate?
Travel Ban Saves Airlines Billions
Deep Learning Detects Coronavirus
Singapore's Coronavirus Patients Have a 0% Mortality Rate So Far... Why?
AI is Mapping the Coronavirus and Inferring its Possible Economic Impact
Coronavirus: Fact from Fiction
Death From Covid-19 is Not From the Coronavirus:
An Interview With NYU Langone Health Professor & Rheumatologist Dr. Gary Solomon
Coronavirus Attacks Italy's Sick and Elderly
Interview with NASA Astronaut Scott Kelly: An American Hero
Why Choose Machine Learning Investing Over A Traditional Financial Advisor?
Interview With Home Depot Co-Founder Ken Langone
Interview with the Inventor of Amazon's Alexa
Automation and the Rebirth of American Retail
China Debuts Stealth Unmanned Combat Aerial Vehicle
Sweden's Economy Embraces AI & Automation
Austria's Automated Ai & Robotic Future Is Now
Nuclear Submarines: A 7,000 Lb Swiss Watch
Ai Can Write Its Own Computer Program
On Black Holes: Gateway to Another Dimension, or Ghosts of Stars’ Pasts?
Egypt's Artificial Intelligence Future
Supersonic Travel: The Future of Aviation
Shedding Light on Dark Matter: Using Machine Learning to Unravel Physics’ Hardest Questions
When High-Tech Meets Low-Tech Economy: Ai & the Construction Industry
Aquaponics: How Advanced Technology Grows Vegetables In The Desert
The World Cup Does Not Have a Lasting Positive Impact on Hosting Countries
Artificial Intelligence is Transforming the Forex Market
Do Machines Dream? Inside the Dreams of a Machine
Can Ai Replace Human Ski Coaches?
Faster than Sound and Undetectable by Radar
The Implications of Machine Learning on Condensed Matter Physics & Quantum Computing
Crafting Eco-Sustainability: WTC and Environmental Sustainability
Argentina's AI Future: Reversing a Century of Decline
Tennis & Artificial Intelligence
Peru's Ai Future Will Drive Economic Growth
The Colombian Approach to the AI Revolution
How AI Can Explain Its Thinking
Brazil & Artificial Intelligence
Can Ai Replace Human Ski Coaches?
Written by Junping Chen, Edited by Michael Ding & Alexander Fleiss
Stéphane Lhuissier, et al. “Does the liquidity trap exist? ” April 08, 2020, BIS Working paper, https://www.bis.org/publ/work855.htm
Sandy Kemper. “How to solve the $16 trillion small business liquidity trap. ” April 08, 2020, Startland News. https://www.startlandnews.com/2020/04/sandy-kemper-liquidity-trap/
Thomas Heath “Wall Street powers through waves of bad economic news to its best month in decades.” April 30, 2020, The Washington Post, https://www.washingtonpost.com/business/2020/04/30/stocks-markets-today-coronavirus/
Gillian Tett “US stock market rally confuses liquidity with solvency .” April 30, 2020, Financial Times, https://www.ft.com/content/cc31fe38-8adb-11ea-9dcb-fe6871f4145a
William Watts. “Why a stock-market bull who nailed the April rally now refuses to lift his S&P 500 target.” May 01, 2020, Market Watch, https://www.marketwatch.com/story/this-stock-market-bull-called-the-relief-rally-that-took-the-sp-500-to-2950-but-now-hes-reluctant-to-raise-his-target-2020-04-30
Mark DeCambre. “After the best April for the Dow and S&P 500 in 82 years, is ‘sell in May’ in the coronavirus era a smart strategy?” May 02, 2020, Market Watch, https://www.marketwatch.com/story/after-a-blockbuster-april-for-the-dow-and-sp-500-is-sell-in-may-in-the-coronavirus-era-a-smart-strategy-2020-04-30?mod=article_inline