Tag Archive for: FederalReserveQT

The Price of Easy Money Now Coming Due

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Estimated Reading Time: 4 minutes

The Crazy Stuff & Asset Prices that arose during Easy Money are coming unglued as Easy Money ended.

The era of money-printing and interest-rate repression in the United States, which started in 2008, gave rise to all kinds of stuff, and the easy money kept going and kept going, and all this money needed to find a place to go, and then money-printing went hog-wild in 2020 and 2021. And the stuff it gave rise to just got bigger and bigger, and crazier and crazier. And much of this stuff is now in the process of coming apart, I mean falling apart, or getting taken apart in a controlled manner, and some stuff has already imploded in a messy way.  And we’ll get to some of this stuff in a minute.

All this money-printing and interest rate repression finally gave rise to massive consumer price inflation, and now we have a real problem, the worst inflation in 40 years, and way too much money still floating around all over the place with businesses, with consumers, with state and local governments. This means that this raging inflation has lots of fuel left to burn, and the government is making it worse by handing out hundreds of billions of dollars for all kinds of stimulus spending, from the new EV incentives to $50 billion handed to the richest semiconductor makers.

And some state governments are handing out inflation checks or whatever – in California, households can get up to $1,000. And they’re all spending this money, and thereby throwing fuel on the inflation fire. We’ve already seen automakers raise the prices of their EVs to eat up the EV incentives, and there we go, more inflation.

The poor Federal Reserve has to deal with all this, and it’s out there raising interest rates far more than anyone expected a year ago, and it’s doing quantitative tightening, and it’s saying all kinds of hawkish things, but the markets are blowing it off, and they’re not taking it seriously, which means that the cold water the Fed wants to throw on financial conditions, and therefore on inflationary pressures, isn’t getting there, and it has to throw a lot more cold water on it, so higher rates for longer, and maybe for a very long time.

So now we got all the stuff that money-printing and interest-rate repression gave rise to, and this stuff must have continued money-printing and interest-rate repression to exist, but now we have soaring interest rates and the opposite of money-printing: quantitative tightening.

Perhaps the most spectacular creation of the money-printing era is crypto. It started with bitcoin in early 2009, just after the Fed’s money-printing got started. And the promoters fanned out all over the social media and everywhere and touted it as an alternative to the dollar and to fiat currency in general and to what not, and people started hyping it, and promoting it, and they’re trading it, and the price shot higher.

And then come the copycats since anyone can issue a cryptocurrency. Suddenly there were a dozen of them, and then there were 100 of them then 1,000, and suddenly 10,000 cryptos, and now there are over 22,000 cryptos, and everyone and their dog is creating them, and trading them, and lending them, and using them as collateral, and all kinds of businesses sprang up around this scheme, crypto miners, crypto exchanges, crypto lending platforms, and some of them went public via IPO or via a merger with a SPAC.

And the market capitalization of these cryptos reached $3 trillion, trillion with a T, about a year ago, and then when the Fed started raising its interest rates and started doing QT, the whole thing just blows up. Companies go like POOF, and the money is gone, and whatever is left is stuck in bankruptcy courts globally possibly for years. Cryptos themselves have imploded. Many have gone to essentially zero and have been abandoned for dead. The granddaddy, bitcoin, has plunged by something like 73% from the peak. The whole crypto market is also down about 73%.

Crypto was one of the places where liquidity from money printing went to, and now that the liquidity is being drained ever so slowly, the whole space started to collapse.

Another thing that came about during the era of money printing was an immense stock market mania, and when the money printing went hog-wild starting in March 2020, the stock market mania went hog wild with it.

We at Wolf Street tracked a bunch of these stocks, crazy IPO stocks, and stocks that went public via a merger with a SPAC over the past few years, and they shot higher and they spiked on a wing and a prayer with nothing there, companies that were losing tons of money, that didn’t have a business model, that didn’t have anything, and they were suddenly worth $10 billion or $30 billion or whatever.

It was all driven by what I call consensual hallucination and the effects of money printing and interest rate repression. Those were the fundamentals.

But then in February 2021, when inflation started to heat up, causing the Fed to brush it off, well that February 2021 was when that craziness peaked, and many of these stocks then collapsed by 70% or 80% and over 90%. We tracked over 1,000 stocks traded in the US that have imploded by 80% or more from their highs within the past couple of years…..

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Interest Rate Tightening Will Cause Even More Economic Destruction

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Estimated Reading Time: 4 minutes

Federal Reserve policies attempting to promote economic and price stability are a major cause for the recent acceleration in consumer prices. According to popular thinking, the central bank is supposed to promote both steady economic growth and price stability, the economy is perceived as a spaceship that occasionally slips from stability to instability.

Supposedly, when economic activity slows down and falls below the path of stability, the central bank should give the economy a push through loose monetary policy (lower interest rates and increasing the money supply), which will redirect it toward stable growth.

Conversely, when economic activity is “too strong,” the central bank should “cool off” the economy by imposing a tighter monetary stance, to prevent “overheating.” This involves raising interest rates and reducing monetary injections to put the economy back on a trajectory of stable growth and prices.

Government officials and people at the Fed claim supply shocks due to the covid-19 disruptions and the Ukraine-Russia war are behind Consumer Price Index (CPI) increases. The Fed has thus tried to curb demand for goods and services by raising interest rates to place it in line with the curtailed supply.

Most people believe price increases are inflation and that prices will fall if the demand for goods and services is reduced with a tighter interest rate stance.

But the key factor behind price increases is the money supply increase. Note that a good’s price is the amount of money paid for it. Consequently, money supply increases, all other things being equal, imply that paying more money for goods causes an increase in goods prices.

Once we accept that point, we are likely to infer that the driving force for general price increases is monetary inflation. Now, as a rule, general prices tend to follow money supply increases. It is, however, possible that if the supply of goods grows at the same rate as the money supply, then no general price increase will emerge.

Once we accept that inflation is about money supply increases, we can conclude that irrespective of price increases, the inflation rate will mirror the money supply growth rate. Note that increases in money supply divert wealth from wealth generators to the holders of newly generated money. This diversion weakens the wealth-generation process, thereby undermining economic growth and individuals’ well-being. Conversely, a decline in money supply reduces the wealth diversion, strengthening the wealth-generation process and raising individuals’ well-being.

Strengthening wealth generation requires closing all monetary loopholes associated with the Fed’s asset buying. For instance, when the Fed buys an asset, it pays for it with money generated out of “thin air.” If the asset comes from a nonbank this is going to almost immediately raise the money supply. A widening in the government budget deficit, once monetized by the Fed, will also raise the money supply.

Once various loopholes for money generation are sealed off, the wealth diversion will be arrested. With more wealth at their disposal, wealth generators are likely to enlarge the pool of wealth, laying the foundation for real economic growth.

This runs contrary to a tighter interest stance, which will undermine not only various bubble activities, but also genuine wealth producers.

Like a loose monetary stance, a tighter interest rate stance falsifies the interest rate signals issued by consumers because it leads to the misallocation of resources and weakens real economic growth. Hence, raising interest rates to counter price rises also undermines bubble activities and weakens wealth generators.

The following example could clarify this point further. Consider a parasite that attacks the human body and damages health. The parasite also generates various symptoms, including body pain. To fix the problem the parasite must be directly removed. Once the parasite is removed, the body can begin healing.

The other way to counter the parasite is with various painkillers. These painkillers reduce pain but also weaken the body. The alternative runs the risk of seriously damaging the individual’s health. Instead of addressing the symptoms of inflation, the loopholes for money generation should be closed.

Closing these loopholes will stop the diversion of wealth from wealth generators and strengthen the pool of wealth, making it much easier to handle the various side effects of the liquidation of bubble activities. Consequently, the recession will be shorter.

Most policymakers believe that the Fed must raise interest rates significantly to break the inflationary spiral. Many are certain that a policy of large rate increases during the Volcker era broke the inflationary spiral: in May 1981, Fed chairman Paul Volcker raised the fed funds rate target to 19.00 percent from 11.25 percent in May 1980. The yearly CPI growth rate, which stood at 14.8 percent in April 1980, had fallen to 1.1 percent by December 1986.

Given the high likelihood that the economy’s pool of wealth is in trouble, an aggressive interest rate rise is likely to prolong the emerging recession, transforming it into a severe economic slump.

By freeing the economy from central bank interference with interest rates and money supply, wealth destruction will be arrested, strengthening the wealth-generation process. With more real wealth, it will be much easier to absorb various misallocated resources.

Conclusion

In response to the recent large increases in the prices of goods and services, the Fed has introduced a tighter interest rate stance. If the Fed were to follow the correct definition of inflation (an increase in the money supply), it would discover that a tight interest rate stance will severely damage the economy. What is required to eliminate inflation is to acknowledge that inflation is about money supply increases and not price increases and then act accordingly.

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This article was published by the Ludwig von Mises Institute and is reproduced with permission.

Fed’s QT Kicks Off: Total Assets Drop by $74 Billion from Peak, New Era Begins

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Estimated Reading Time: 3 minutes

QE creates money. QT does the opposite: it destroys money.

 

Total assets on the Fed’s weekly balance sheet as of July 6, released this afternoon, fell by $22 billion from the prior week, and by $74 billion from the peak in April, to $8.89 trillion, the lowest since February 9, as the Fed’s quantitative tightening (QT) has kicked off. The zigzag pattern is due to the peculiar nature of Mortgage Backed Securities (MBS) that we’ll get to in a moment.

Treasury securities fell by $20 billion for the week, and by $27 billion from peak.

Run-offs: twice a month. Treasury notes and bonds mature mid-month and end of the month, which is when they come off the Fed’s balance sheet, which in June was June 15th and June 30th.

Tightening deniers. Last week’s balance sheet was as of June 29 and didn’t include the June 30th run-off. However, the army of tightening-deniers trolling the internet and social media doesn’t know that, and so a week ago, they fanned out and announced that the Fed had already ended QT, or was backtracking on it because Treasuries hadn’t dropped in two weeks, which was hilarious. Or more sinister: hedge funds manipulating markets through their minions.

Inflation compensation from TIPS adds to balance. Treasury Inflation-Protected Securities pay inflation compensation that is added to the face value of the TIPS (similar to the popular “I bonds”). So if you hold a fixed number of TIPS, their face value will rise with the amount of the inflation compensation. When they mature, you will receive the total amount of original face value plus inflation compensation.

The Fed holds $384 billion in TIPS at its original face value. It has received $92 billion of inflation compensation on those TIPS. This inflation compensation increased its holdings of TIPS to $476 billion.

Over the month of June, inflation compensation increased by $4 billion. In other words, until those TIPS mature and run off the balance sheet, the Fed’s holdings of TIPS will increase by the amount of inflation compensation – currently around $1-1.5 billion a week!

No TIPS matured in June. But next week, July 15, TIPS with an original face value of $9.6 billion-plus $2.5 billion in inflation compensation will mature, for a total of $12.1 billion, that the Fed will get paid. After that, the next maturity of TIPS on the Fed’s balance sheet is on January 15, 2023. And the TIPS balance will increase from July 15 through January 15 due to inflation compensation.

The thing to remember about the Fed’s TIPS is that the inflation compensation is added to the balance of TIPS and therefore to the balance of Treasury securities, at around $1-1.5 billion a week currently.

The balance of Treasury securities fell by $20 billion from the prior week and by $27 billion from the peak on June 8, to $5.74 trillion, the lowest since February 23:

  • Note the two run-offs on the balance sheets on June 16 and today.
  • Note the small steady increase of around $1-1.5 billion a week after QE had ended from mid-March into June, which is the inflation compensation from TIPS.

MBS fell by $31 billion from the peak.

Pass-through principal payments. Holders of MBS receive pass-through principal payments when the underlying mortgages are paid off after the home is sold or the mortgage is refinanced, and when mortgage payments are made. As a passthrough principal payment is made, the balance of the MBS shrinks by that amount. These pass-through principal payments are uneven and unpredictable.

Purchases in the TBA market and delayed settlement. During QE, and to a much lesser extent during the taper, and to a minuscule extent now, the Fed tries to keep the balance of MBS from shrinking too fast by buying MBS in the “To Be Announced” (TBA) market. But purchases in the TBA market take one to three months to settle. The Fed books its trades after they settle. So the purchases included in any balance sheet were made one to three months earlier.

This delay is why it takes months for MBS balance to reflect the Fed’s current purchases. The purchases we see show up on the balance sheet in June were made somewhere around March and April.

And these purchases are not aligned with the pass-through principal payments that the Fed receives. This misalignment creates the ups and downs of the MBS balance, that also carries through to the overall balance sheet.

In addition, MBS may also get called by the issuer (such as Fannie Mae) when the principal balance has shrunk so much that it’s not worth maintaining the MBS (the issuer then repackages the remaining underlying mortgages into new MBS).

Tightening deniers. So when the tightening-deniers – including a hedge-fund guy with a big Twitter following – trolled the internet and the social media about QT not happening because MBS balance ticked up by $1.2 billion on the June 23 balance sheet, they got tangled up in their own underwear. The following week, the MBS balance fell by $19.5 billion. That’s how MBS on the Fed’s balance sheet work. These folks just didn’t know, or more insidiously, tried to manipulate the markets…..

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