The Federal Reserve is prolonging the trade war, keeping the biggest financial bubble in history going – and risking the entire global system

By fuelling a market rally every time talks stall, the Fed has extended the trade war and made the asset bubble bigger. If a crisis erupts outside the US or China, the bubble may burst – with disastrous consequences for the world

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Traders work on the floor of the New York Stock Exchange as Federal Reserve chairman Jerome Powell gives a news conference on September 18, the day the Fed cut interest rates by a quarter of a percentage point. Photo: Getty Images/AFP

Published: 6:00am, 6 Dec 2019Updated: 7:35am, 6 Dec 2019

After the interest rate surged in the dollar repo market in September, the US Federal Reserve stepped in with US$260 billion to bring down the rate, essentially bailing out the distressed borrowers behind the move. They were probably from the shadow banking system.

This new quantitative easing has led to the US market setting record highs again, and for good reason. If the Fed could bail out the shadow banking system, why not the stock market? So, speculators should not worry.

Ever since the US-China trade war began, the financial world has been in constant fear of the world order crashing. China and the US have accounted for most of the growth in the global economy in the past 10 or 20 years. Their symbiotic relationship has sustained global growth.

The US economy is based on debt-financed overconsumption, while China’s is based on debt-financed overinvestment. They lean on each other for balance, like two one-legged men walking along with interlocking arms. The renminbi’s peg to the dollar is both the symbol and substance of this mutual dependence. If this relationship breaks, the world is likely to go into a prolonged adjustment to reach a new equilibrium.

The uncertainty in the world order is occurring amid the biggest bubble ever in the global financial world. Quantitative easing by China and the US in response to the 2008 crisis led to massive debt build-up and asset appreciation along the way.

As asset markets have become so large, relative to the real economy, their turbulence determines the economic outlook and not, as is normally the case, the other way around. This is why the Fed has cut interest rates during the trade war, even with unemployment at historic lows. It views the ensuing market turbulence as a threat to the economy. The Fed has gone from the financial bubble’s hostage to its guardian.

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