Debate rages this week about the impact of the interventions of the Federal Reserve, ECB and other central banks. The argument surrounds the impact of the central banks buying government bonds. Here is Joe Weisenthal of Bloomberg.
“.…………, the Fed can’t make the money printer go brrrrr like we need it to right now. At least not under its existing legal structure. Because while it can create reserves at the stroke of a key, it does so buy buying assets from the private sector. So if the Fed, say, buys $1 billion worth of Treasury bonds, then yes, some entities in the private sector get $1 billion in reserves. But they’ve handed over $1 billion worth of Treasury bonds to the Fed. And so the net wealth position of the counter-party hasn’t changed. All those charts you see of the Fed’s balance sheet you always see are assets that the Fed has TAKEN away from private holders, leaving their overall balance-sheet position roughly the same.”
This is flat out wrong. Here’s why.
- Central banks are only intervening because there are no other bidders in the market
- If market participants need overnight cash in this market they would need to sell a $1m bond at a huge discount to balance sheet valuations
- The market says it’s worth say, $900k, if I sell to the Fed I get $999.9k back in the morning
- These bonds cannot catch a bid
- Without the Fed my balance sheet would take a 10% hit (in this example) it is propped up by The Fed buying at fanciful prices
- Those fanciful prices arise because the Fed must keep bond prices high to keep interest rates low
A better example exists in Europe where the ECB is now buying the previously off limits government debt of Greece. They are junk bonds, the only meaningful buyer is the central bank itself. The wealth of European people held in Euros is being systematically destroyed by this kind of thing.
So, Wall Street balance sheets are being propped up by the Fed. The market is speaking loudly and once again, it is silenced with the money bazooka.
I repeat, frequently, that United States government bonds are not worth the money they are being sold for. Proceed with extreme caution.
The record high in question is the Federal Reserve balance sheet. Having spent many years around the $1 trillion mark, it exploded in the last financial crisis and grew to $4.3 trillion. Then, in 2018, the Fed attempted an unwind which exploded spectacularly with the repo crisis and they once again began buying assets in late 2019.
That new level of buying would have meant a record balance sheet at some point this year. Recent emergency interventions mean it happened virtually overnight. Now stands at $5.2 trillion, 25% of US GDP.
In 2008 the balance sheet expansion continued for six years, resulting in a four fold increase. I have no idea where the current expansion will end but in excess of $10 trillion doesn’t seem unreasonable, that we might even get there this year doesn’t seem unreasonable either. If we reach the $10 trillion mark, that would be $75,000 for every American in work, even today it’s $50,000 per worker. I should point out, this number is an entirely different one from the American national debt, it is more of a proxy for the amount of cumulative currency debasement.
The mechanism of the balance sheet is simple. If the Federal Reserve buys assets, the balance sheet assets go up. The Fed doesn’t actually have money so they use a computer to produce it. For example, if a bank sells a $100 government bond to the Fed, Fed assets rise and that bank gets $100 in their account thanks to the Fed computer. This video is instructive, this is Chairman Bernanke explaining the process. Please watch it, it is incredible.
Why is this happening now? Well, banks are normally willing to lend to each other on an overnight basis. Bank A and bank B will swap bonds for money and charge a small fee. However, in current circumstances banks will not lend to each other. Simply, the credit markets have dried up, trust is gone because each participant suspects the other may go bankrupt. Anyone who has money is keeping it and anyone who needs money must go to the Federal Reserve with their assets and draw down. You might recognise these behaviors in your own recent decisions, i.e. “I’ll just sit on some cash for a bit”.
Historically, the only assets accepted by the Federal Reserve have been government bonds. The idea being they have the best credit and the Fed (who represent the holders of US dollars) will have their monetary value protected by only holding the best assets. However, in this crisis the Fed now accepts commercial paper, that is, the less credit worthy bonds. This new window is known as the “Commercial Paper Funding Facility”…….and it’s temporary (like QE was/is).
The market is the market though. If it says the interest rate should be 50% on bonds like these then that is what it should be. The more they intervene, the worse things will get. The price of money continues to be distorted with each new “window” the Federal Reserve creates. It simply prevents the system from cleansing itself. A lot of people would go bankrupt, yes, but the means of production would still be there. Like Boeing, if they simply went bust their planes and manufacturing plants wouldn’t disappear, but their debt would and we would all be much better for it.
I’ll leave it there though and wait for a $10 trillion balance sheet. Perhaps it will fix things.
Staying in America, things are getting difficult. A country with a minimal safety net and a health system that looks fragile to many foreigners, is about to be put to the test. One proposal to help ordinary Americans came from Congresswoman Rashida Tlaib, it works like this:
- Congress orders the US Mint to produce two $1 trillion coins
- Congress directs the Federal Reserve to purchase those coins at full face value
- Every adult American would be issued with a debit card pre loaded with $2,000 drawn from the money the Fed prints to buy the coins
I am not making this up. It is a serious proposal and can be reviewed in full on the website of the United States Congress.
Most people can see through these arrangements, that they are simply money printing. The Congresswoman’s proposal though is no different to the Federal Reserve lifelines. They are providing money for bonds and commercial paper at face value, many of those bonds are worth very much less in the open market, just like buying a one inch disc of platinum for a trillion dollars.
Needless to say, she has been widely mocked, predominantly by people who do not understand monetary policy. Specifically, by people who do not understand that exactly this process is undermining their own dollar denominated wealth right now and has been since the end of the gold standard. Indeed, her idea may even have some merit in that at least it gives money to individuals rather than Wall Street. It is exactly how fiat currency works, she has just spelled it out very clearly and people don’t seem to like it.
Such is the depth of the economic issues we now face, the concept of Universal Basic Income or UBI is making very strong headway. The idea is that it gives a guaranteed amount of money to each individual each month. Focusing only on the monetary element, simply giving away $2,000 per month per person does not make a nation richer. It may be re-distributive but it does not create wealth.
Even more critical is how this is done. If a government announces a new tax to fund the UBI, then this becomes a matter of distribution. Simply those paying the tax redistribute to those receiving the income, the total stock of money in play does not change. This may in fact work well in countries where inequality is high.
The alternative is that the money is simply summoned up, printed and handed out. This mechanism plays out in a different way. Now the stock of money is higher, that stock of money will chase the same pool of goods. It will push prices higher, particularly of every day goods. Higher prices will hurt the people the policy was designed to help.
Last week I wrote about the deflationary cycle we are in, that predominantly relates to financial asset prices, clearly we are seeing them decline sharply. However, I think we could start to see very high inflation in consumer products quite soon as this invented money starts to chase what is a smaller stock of goods thanks to the disruption in the supply chain. Could we even see price controls on basic essentials? I would say so.
An example of UBI was announced in the United Kingdom this week. Those people left out of work by the Covid-19 restrictions will have their monthly wages paid by the government up to £2,500 per month. The cost of the policy depends on the amount of time for which it is run but estimates run from £30 – £100 billion. That policy alone, aside from everything else that had already been announced, could amount to 3% of GDP. Yet there are no new taxes, it is simply paid for in monetary debasement.
No country has announced a single tax to pay for anything that is going on. They are taxing you through monetary debasement.
Inflation has been forgotten in all of this, we haven’t had it in any real form since the 1980’s but it is coming back. Once we clear through this cycle of debt and liquidations, look out.
Trillion dollar announcements are every day fare now. Until last week they were very rare, we only really mentioned the trillion denomination when talking about total US debt, otherwise it was simply too large to be relevant.
To me the ‘trillion’ is the harbinger of hyperinflation. The Fed’s overnight window is now a trillion dollars, elected representatives want to “mint” pretend trillion dollar coins. Once you get to this stage here is what happens. I’ll give you two examples.
1. The 10 billion Dinara Yugoslav note, it’s not a trillion but it’s very large and symbolised the collapse of Yugoslavia.
2. 100 Trillion Zimbabwe dollars. The same story there.
The lesson is simple, you cannot print money successfully. That is not how it works. We know that from history, we know it from recent history. That will not stop our governments trying though and currently they are trying extremely hard.