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The Unintended Consequences Of A COVID Stimulus

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Shortly after the World Health Organization (WHO) declared Covid-19 a global pandemic, governments everywhere unveiled massive monetary and fiscal stimuli (over $15T globally) in a bid to forestall an economic fallout. The U.S. federal government stepped in with a broad array of measures, including a $2.3 trillion package designed to support financial markets, state and local governments, employers, and households. Democrats are pushing for yet another $3 trillion package to shield eligible Americans from the effects of the pandemic.

But now, a Wall Street expert is warning that these generous packages could later come back to haunt the markets and end up doing more harm than good.

New York Times bestselling author and founder of 'The Bear Traps Report' Lawrence ‘Larry’ McDonald has warned of the ‘cobra effect’ whereby the stimuli designed to save the economy  will instead ‘‘...cause a hyperinflationary economic collapse.’’

The Cobra Effect

Larry has sounded an eerie warning of signs of a “Lehman-like drawdown’’ developing in the markets and that “...we are at the early stage of the biggest cobra effect in the history of economics.”

The cobra effect that Larry is alluding to is the school of thinking that says that every human decision brings with it unintended consequences.

The cobra effect in modern economics has its origins from an anecdote of India under British rule. The story goes that a plague of deadly cobras once afflicted Delhi so badly that it forced the colonial masters to hatch a plan whereby they offered a bounty for each captured serpent. This worked well at first; however, it was not long before wily entrepreneurs figured they could just as well breed cobras en masse and present them to the government for compensation. The British wisened up to the ruse and quickly cancelled the program. The unintended consequence: The breeders released their now worthless snakes to the wild thus making an already bad problem much worse.

A hilarious real-life example of the cobra effect: Airbus decided to make its planes as quiet as possible so as to improve the flying experience for its customers. Unfortunately, the experiment worked so well with the A380--the world’s largest passenger jet--that passengers could hear with much clarity the going-ons in the planes’ bathrooms.

Another not-so-hilarious one: The broken U.S. healthcare system is a product of two governmental decisions whose consequences the government could not have foreseen at the time: 

  • During World War II, the law prohibited employers from raising wages, which led to employers compensating by including health insurance as part of employee benefits;

  • In 1951, Congress declared that employer-provided health insurance benefits would not count as taxable income. This led to employees preferring wage hikes in the form of tax-free insurance benefits rather than in the form of increased taxable wages. Consequently, modern workers not only receive health insurance through their employers (unlike, for example, home or car insurance), but these health insurance plans tend to be more generous than they would otherwise have been had Congress never granted them special tax treatment

Short-lived Stimulus Benefits

There’s no denying that monetary stimulus has played a key role in helping the stock markets quickly rebound from their disastrous crash. 

The S&P 500 has managed to pare back all of its March losses, with the MSCI World Index nearly there as well.

Source: CNN Money

Source: CNBC

The bad part: The positive effect of these stimulus checks is likely to be short-lived.

Indeed, Larry sees no way out of this conundrum. According to the economist, any attempts by governments to reverse their course of action is likely to result in a much more severe deflationary depression than if they had not acted at all.

The good part: Larry says the global economy will not only survive but thrive after the painful adjustment phase.

By Alex Kimani for SafeHaven.com

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