The 2022 Monetary Conundrum
Less "money printing", more "asset swapper" go brrr
Just as Concoda was about to do a deep dive on the “glamorous” topic of Quantitative Tightening (where the Federal Reserve slowly reduces the number of government bonds, agency paper, and mortgage-backed securities it chomps on each month), none other than MacroAlf released a piece on that very subject. Not only did he do it justice, but in the process debunked the most destructive monetary myth present in today’s collective mind-boggle: that quantitative easing (QE), the reverse of QT, is somehow “money printing.” Using his Covid office computer, via copy-paste, Fed Chairman Jerome Powell is ostensibly going apesh*t on the Greenback, setting the stage for a modern-day replay of the Weimar Republic.
Fuming at how this economic fable has continued to spread over social media airwaves, Concoda took to Twitter to set the record straight:
When you cut out the politics, conspiracy bunk, and other noise, the Federal Reserve is as uninteresting and opaque as it is corrupt and bureaucratic. It’s an enormous global clearinghouse, an intermediary between the buyers and sellers of American dollars, connecting the U.S government to a diverse mix of financial institutions, both foreign and domestic. Acting more like the world’s cashier than “the world’s central bank”, the Fed is a public-private hybrid that serves the international banking class, at the benefit — and in many ways the expense — of global citizens.
Even after all the rampant insider trading, bailouts, and other hijinks, the majority of U.S. citizens still support this system. Over the Average Joe on the street — and now shadowy members of the crypto elite, like Changpeng Zhao and Sam Bankman-Fried — we choose crooked megabank CEOs and Fed officials, such as Jamie Dimon and Robert Kaplan, to operate the monetary apparatus. We cling to this demonstrably debased status quo, overlooking the ever-collapsing confidence level in our institutions, because we know that if we give a bunch of even more sinister bad actors free reign over the most essential public good, money, this will create even more of a societal, political, and economic hellscape.
Thanks to recent past fiascos, like Albania’s laissez-faire “experiment” in the 1990s, stability-smitten governments already know what happens when they grant too much monetary sovereignty to dubious characters. Hint: it never ends well. So we bypass the vast plethora of conflicts of interest within financial power structures, because, despite its imperfections, the Federal Reserve system delivers enough stability to make modern society bearable. Effectively, we’re long the Eye of Sauron and short Gordon Gekko.
The monetary system, of course, is massively flawed in many ways, as the last decade or so has demonstrated effortlessly. QE, once a temporary plughole, now acts as an intermittent bailout machine and covert inequality booster, and has slowly become the U.S central bank’s de facto tool for conducting monetary policy. Contrary to popular opinion, though, the Fed does not simply print money and issue monetary handouts to the financial elite. That could only occur through the U.S. Mint. Instead, by engaging in “duration swaps” with financial institutions, the Fed loads up on different assets, expanding its balance sheet, to stimulate lending and provide interbank liquidity. Until the Wall Street colossus and the global economic machine have had an adequate feed, the QE money-trough remains full to the brim.
This process sounds crooked, but it’s not as insidious as ZeroHedge or crypto bros suggest. It’s simply “better” than any other proposed “scheme” out there. For the masses, a system where Tether prints billions in fake money out of thin air, loses hands down to the ominous paradigm of fractional reserve banking; a system so complex that its intricacy produces mass falsehoods and misinformation, both parroted in the mainstream and in “finance bro” circles.
The best way to quickly understand it is to track the flow of a run-of-the-mill Treasury bond from its inception to its extinction. First, as the Fed, by law, can’t purchase bonds directly from the U.S. government, the U.S. central bank mandates primary dealers (banks, broker-dealers, etc.) to indirectly purchase Treasury securities on its behalf. Through the Fed’s proprietary trading system, “FedTrade”, financial behemoths like Goldman Sachs participate in auctions, where they swap bank reserves — “outside money” that only commercial banks can hold, which they use to meet reserve requirements and settle payments between each other — for government bonds.
Think of the Federal Reserve System as a glorified digital ledger or online accounting system, in which bank reserves are the “asset” and Treasuries are the “liability”. If you own $100 in assets minus $100 in liabilities, both sides of the balance sheet cancel each other out, and you’re left with a $0 net increase in financial assets. That’s what’s happening here.
Next, comes the QE jamboree. Within the interbank system, the Fed creates new bank reserves (out of thin air, ex nihilo) and swaps these for U.S. Treasuries with primary dealers. This time, “money” has been created, but it’s merely bank reserves, which financial entities under the Federal Reserve’s voodoo can’t spend or lend into the real economy. These transactions increase the interbank money supply but on a temporary basis. Eventually, during quantitative tightening, these bank reserves will disappear from the system. No money printing, just a “duration swap”, will have occurred.
If you refuse to end up like the ocean of economists and experts who simply resort to yelling “money printing,” instead of trying to understand how QE and QT really work, then look at this graph (Chad Kroeger emphasis added):
After the Fed finally kicks its asset-purchase habit, acquiring zero Treasuries and MBS from the secondary market, that will become the climax point where we’ll find out, once again, if all this monetary alchemy has created a stable financial system. If we’re honest: fat chance! The last time the Fed refused to chew on high-quality “risk-free” assets was back in September 2019, when a liquidity crisis in money markets sent repo rates into the exosphere.
In the months before, the market’s demand for “repo loans” (which Concoda covered in an earlier piece) kept climbing, while the Fed’s first shot at Quantitative Tightening shrank the supply of bank reserves in the system. The result was a mad rush for the same, scarce repo investments, which caused repo rates to soar. But by restarting the QE machine in response, the Fed came to the rescue, pushing repo rates (RRP) below the Fed Funds rate (EFFR), which restored stability. Traders reacted to this panic and subsequent Fed alchemy with a bizarre (but expected) bullish bias, with risk assets rallying to all-time highs — until “you know what” hit the headlines.
Today may create an episode of Déjà vu for anyone active during that period, but this time it’s different. With the Fed’s Standing Repo Facility — the bailout mechanism officials created to save repo markets in 2019 — now ready in waiting, and the market more equipped to absorb massive incoming issuance of Treasuries, QT might not produce the same kerfuffle.
Instead, the real quandary is whether or not the U.S central bank will be able to meaningfully raise interest rates thereafter, without causing yet another collapse in risk asset markets. The counterargument is that with the Fed’s new array of backstops and bailout mechanisms, we could easily go beyond a few rate hikes before any disruption or true "tightness" emerges in money markets. Yet each time the Fed has ratcheted up interest rates, the ceiling on the rate collapse-o-meter has sunk to an increasingly lower level. Every time markets crash, the “asset swapper” — not the money printer — kicks the can down the road by increasing private sector leverage, leaving the monetary system ever-more vulnerable to higher rates.
Knowing this, the market has gone all Pepperidge Farm, with the Fed’s “dot plot” showing that traders have little faith in the Fed’s ability to raise duration. (Whatever JPMorgan’s Jamie Dimon was smoking when he predicted five to seven rate rises, Concoda wants in):
Recent economic data also supports this poor morale. As China, Europe, and “emerging markets” release optimistic data after a long economic malaise, the U.S economy has suddenly hit the breaks. Both the ISM Manufacturing and Services purchasing manager’s indices, the hallmark measures of American business confidence, have not only peaked but plunged during January this year, the “biggest point drop since April 2020,” as Bloomberg put it. The Empire State Manufacturing Survey also posted its worst month-over-month decline, plunging from 25.0 to -0.7 (above zero points signals positive growth), while the National Association of Homebuilders (NAHB) Index likewise topped out. At least, for the sake of most Americans’ nest eggs, building permits have gone through the roof (pun intended).
Minus commodities plagued with inflation-inducing shortages, the only other market failing to signal “doom and gloom” happens to be the bellwether of risk-off sentiment: U.S. Treasuries. According to supposedly the savviest market on the planet, alongside the Eurodollar futures — the rate at which banks lend to each other in offshore dollar markets — positive sentiment remains intact, with higher rates equalling more demand for riskier offshore credit:
These rate rises are a signal of “easy money”, but they could also be a false positive and the result of short-term disruptions in the financial system caused by the Fed’s tapering. “The QT Timebomb,” as Fed Guy Joseph Wang calls it, could be playing out as we speak: “An aggressive QT will both rapidly increase the supply of [Treasuries] to the market while at the same time rapidly reducing the cash balances of banks. The combination of a positive supply shock and negative demand shock can eventually again lead to violent dislocations.” So if you’re wondering why yields have started to skyrocket, even after a peak in growth and inflation expectations, QT could be the answer.
Though a crisis has yet to erupt in bond markets, higher yields have started to threaten other asset classes, primarily wreaking havoc on “narrative stonks” and duration. With the now-collapse of SPACs, cryptocurrencies, “Cathie Wood stocks”, and recently the Nasdaq, we could be about to witness more monetary alchemy from the Federal Reserve’s laboratory, depending on the emerging crash’s severity.
Whatever trouble arises this time around, the Fed will be ready and waiting, prepared to change the rules of the game to keep the system functional and stable — plus expenses. With global citizens relying on the world’s premier cashier to prop up the majority of their net worth, tied to stocks and real estate plus what’s left of their newfound crypto fortunes, everyone will submit to the monetary madness, ignore the heinous corruption and criminality involved, and play along to make it to the other side, alive, and in one piece. When they say “we’re all in this together,” it’s no longer some loony conspiracy, but reality. Since the bankster class and the proles have been forced to dip their fingers into the same gluttonous monetary pie, the future of finance is likely to be socialized losses and privatized gains on tap. Will there be money printing? Not likely, but the Fed’s “asset swapper” is guaranteed to go brrr more than ever before.