wabuffo
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Posts posted by wabuffo
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Have you read much from Scott Sumner or George Selgin?
Scott Sumner - no
George Selgin - yes, I have his book Floored! His main point seems to be that the Fed should abandon the floor system with all these excess reserves and go back to old corridor system with minimal reserves. I basically agree with him on that. I really like his critiques of current Fed policy and monetary management.
wabuffo
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QE can be deflationary if a central bank insists on paying interest on reserves. I know it's in fashion to say that private banks create most of the money, but this isn't true in a practical sense. The nominal anchor is still the monetary base and that is controlled by the Fed
Under normal open market operations (OMOs), the Fed injects 0% yielding reserves in place of say 2% yielding treasuries. This makes a commercial banks balance sheet a bit less risky. Since reserves are "stuck" in the commercial banking system, the only thing these commercial banks can do (as a whole) is make more loans, etc to bring their balance sheet metrics back in line
However, when the Fed insists on paying interest on these reserves, now the open market operations are swapping say 2% treasuries for 2% yielding reserves. There is no incentive for banks to "rerisk" their balance sheet and hence the banks have very little reason to make more loans. Of course this will look like "hoarding" of money, etc and result is lower economic (nominal GDP) growth.
Jim - interesting take. I think we both agree that reserves are basically inert. Where we disagree is that somehow reserves lead to more lending, if only the Fed were more accomodative (ie, lowering interest rates). I just don't think there's any relationship between the two. More importantly the data backs it up. Bank credit is a function of collateral and regulatory capital requirements.
Here's a long run chart of the ratio of bank credit to reserves since early 80s. The chart merely reflects that bank credit grew even as reserves fell during much of the period from the 80s to 2008. Then the Federal Reserve changed its interest-rate targeting and reserve policy and the ratios since 2008 reflect that. One (bank credit) has very little to do with the other (reserves). Its apples-and-rutabagas - no relationship at all. Indeed, some central banks operate just fine with zero reserves (Bank of Canada).
Even the traditional reserves-are-10%-of-deposits doesn't show any relationship. It almost looks like reserve balances are independent and disconnected from deposits or bank credit.
We will probably have to agree to disagree on this, but in my view, FWIW - reserve balances at the Federal Reserve serve only two purposes:
1) Payment settlement.
2) Meeting reserve requirements (per bank safety and soundness regs).
Reserve balances are not used for:
3) Money creation
4) Bank Credit extension.
Most of the theory about money multipliers and base money just haven't shown any traction in reality and practice. That's why so much of the expectations of what the Fed can do to stimulate the economy (or slow it down) are bound to fail. It really is the height of arrogance by the Fed officials that they act as if they do. If one wants to stimulate the economy, the only lever is fiscal policy through the US Treasury. Small changes to Fed interest rates have only minor effects. The rest is risk-appetite/risk aversion by the private sector.
So for me, the order of influence on the economy is:
1) Risk Appetite
2) Fiscal Policy
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3) Fed Policy
But I do enjoy reading your stuff (most of the mechanics, I think we agree on).
wabuffo
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It seems sort of surprising that Dimon doesn’t exactly know the red line in terms of reserves. One would think that the rule for clearing payments and the reserves are crystal clear,
Spek - from what I can tell, I think the rules are pretty clear, but what creates uncertainty is volatility in daily payments. I think you have some experience working in manufacturing companies - so you can relate to how manufacturers try to set their inventories of finished goods to meet sales orders. Their supply chain people get demand forecasts from sales, orders on hand plus production schedules and calculate required inventory levels/targets. But of course, demand forecasts can be wrong and production can sometimes come up short vs the schedule. So inventories must have an extra level of safety stock to ensure high service levels to customers are always maintained and no sale is missed.
I think of reserve levels the same way. Dimon probably knows that, on average, he needs $60B of reserves to meet daily expected fluctuations, but he feels his bank needs an extra $60B of safety stock. That leaves him with zero available to lend out. When JPM was holding $200-$300B, the $60B + $60B of safety stock left him ample reserves to lend.
I think the real wild card is the actions of the US Treasury when it comes in with either big spending or big withdrawals (taxes). Here again, pre-GFC, the Fed and the US Treasury used to have a better system and would coordinate their activities.
For one, the Fed was in the fed funds market in order to maintain its interest rate target and so it had to get information from the US Treasury every week on what it was planning to do with spending, taxes, debt issuance/redemption. For another, the US Treasury used to keep account balances at not just the Fed - but also in the commercial banking system. These were called Treasury Tax & Loan Acounts (TTLs). The Treasury's account at the Fed would hold $4-$5B and the TT&L accounts would also hold maybe $20-$50B in balances. Thus, if there was a big tax withdrawal day, the cash would stay at the commercial banks and just move deposits from households/corporations to the Treasury's commercial bank accounts - no initial impact to bank reserves at the Fed. The Fed and the US Treasury would then co-ordinate when the Treasury would withdraw the money from the commercial banking sector so as not to create big ripple effects.
Today - the US Treasury holds no commercial banking deposit accounts - the TT&L accounts were phased out after the GFC. Instead, the US Treasury is holding all of its cash in its account at the Fed and every move swings reserves back and forth from bank reserves. Frankly, the Fed and US Treasury had a pretty good system to operate monetary policy before the GFC, now they run a clunky and bloated system that is a bureaucratic nightmare for the banks.
wabuffo
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Seems like treating a toddler prone to meltdowns with candy and Ice cream each time when a tantrum is due.
Spek - I may agree with your general comment overall - but as I indicated, the Fed is a side-show. Its like the Wizard of Oz - its voice booms over the economy, but it is a meek little man behind the curtain who can't even do his basic job sometimes (as in the Sept repo mess).
Its unfortunate that the Fed runs its affairs the way it does - with excess reserves and an interest rate on excess reserves. It is probably the only central bank that does this -- and it is totally unnecessary. So it draws oohs and ahs when its balance sheet expands. As I've said before, I think the Fed could run with zero reserves, no problem.
It would then retreat into the background, and economic conspiracy theorists would have to find something else to point to...
The real heavy hitter to pay attention to is the US Treasury (and Congress). But they like to avoid the spotlight and push the Fed to take the slings and arrows.
wabuffo
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The U.S. government literally ran out of cash dollar lenders for their Treasury securities; both domestic and foreign. In reality, the root cause was that the U.S. government ran out of lenders. Foreigners, pensions, insurance companies, retail investors, and finally large banks and hedge funds, simply weren't buying enough Treasuries at that point compared to how many Treasuries the government was issuing, at over $1 trillion annualized. They had no excess dollars from which to lend to the U.S. government at those rates.
Vinod - her explanation of the Sept repo crisis is just goofy....and wrong. I don't think she totally understands how any of this works.
In order to understand the Sept repo "crisis' - you have to understand that this was the Federal Reserve causing a self-inflicted wound to itself by not keeping its eye on the ball when it comes to its most important function - running the US payment clearing system between banks.
US PAYMENT CLEARING SYSTEM:
The Federal Reserve manages the US payment clearing and settlement process between federally-chartered banks and thrifts (also includes a few other financial firms but also the US Treasury, of course). Banks have checking accounts at the Fed and those balances (reserves) are used to make sure all inter-bank payments clear and no bank overdraws its account during daylight hours. Despite all the focus on FOMC meetings, etc - this is the single most important reason why the Federal Reserve system exists.
So what is the sum total of financial transactions processed in a day, a week, a year? The Fed provides this data for the two major payment clearing systems (Fedwire - which is run by the Fed) and (CHiPS - which is run by ~50 big US banks and the US subs of foreign banks but does the final settlement with the Fed). Here are their transaction volume summaries:
FEDWIRE:
https://www.frbservices.org/resources/financial-services/wires/volume-value-stats/monthly-stats.html
CHIPS:
In 2019, Fedwire processed $696t in US payments while CHIPS processed $417t in US payments. That's a total of $1.13 quadrillion in annual financial payments cleared (vs $21t US GDP) There are also a small amount of transactions settled in cash but we can ignore those. That's over $3.1t per day. But I do like to say "$1 Quadrillion Dollars!"
ROLE OF BANK RESERVES IN PAYMENT CLEARING:
All inter-bank payment clearing happens at the Fed. To participate in this activity, banks have "checking accounts" at the Federal Reserve. The key question is what is the right amount to keep at the Fed given the very high transaction amounts. What governs the amounts banks have to have there is the Federal Reserve itself (including its regulations and practices). Let's use our own experience with a checking account and how we would manage our finances - one with overdraft protection and one without. Since we are all investors, we would prefer to keep the minimum possible in this checking account because there is an opportunity cost to keep large balances vs holding stocks, etc.
So on a particular day, we have a large bill payment to make but we are also expecting our bi-weekly pay via direct deposit to come in that day as well. What we don't know is the order in which these transactions will hit our account (plus there could be a surprise outflow we forgot about). If we keep the balance low and the bill payment goes out before the pay comes in, we'll go into a daylight overdraft and get hit with large overdraft fees by the bank. But if we have overdraft protection from the bank, we don't care what the order of transactions is, because the bank will cover us for any short-term negative balances.
Banks manage their reserves with the same thought process - do they lend out reserves to other banks for some income or do they play it safe. This is where the Fed, its interest rate management policy and its regulatory rules come in. Pre-GFC, the Federal Reserve would allow banks to run negative reserve balances intra-day (which the Fed would cover) so long as they ended up at the end of each day with a positive reserve balance. If some bank looked like it was going to be short, it would try to borrow reserves from banks that would be over. This might cause interest rates for Fed funds (reserve balances) to increase. If this was threatening to make the Fed funds rate to rise above the target of the Fed, the Fed would come in with a repo operation - supplying reserves for Treasuries to get the interest rate back to target. This Fed interest rate targetting is called a corridor system (ie, the interest rate on fed funds stays within a band target set by the Fed and the Fed intervenes when it threatens to break above or below the band - thus the "corridor")
But back then, the total excess reserves at the Fed were less than $10B - to clear daily payments of $2-3t per day. Just like us with overdraft protection at the bank, the banks had daily overdraft protection at the Fed and ran with extremely low reserve balances.
After the GFC, the Fed changed the rules for banks. Daylight overdrafts were no longer permitted (the Fed would cover in an emergency because the Fed must ensure no payment ever fails to clear, but basically the bank CEO would lose his/her job), In addition, there were other rules imposed - there were "living will" requirements that forced banks to hold reserves to cover a certain number of days of payment clearing, etc.. In addition, the Fed expanded its balance sheet to force reserves to expand in size. (remember its the Fed, and not the banks, that control the size of total bank reserves). Now the Fed changed its interest rate management strategy. It no longer needed a corridor, since there were more reserves than banks needed - it went to a "floor" system and paid an interest rate on excess reserves. Fed repo operations basically ceased. The problem for the Fed is no one really knew where the 'floor' was anymore. I mean when you have trillions in excess reserves - how can any payments not be cleared?
JPM MORGAN CHASE & RESERVES/REPO:
JPMorgan is the biggest and most important bank in the US. It also has the largest amount of bank reserves since the GFC and thus is, at the margin, the lender of last resort to other banks who need reserves. Here is a chart that shows quarterly bank reserves for JPM since the GFC (these are from the FFIEC's quarterly bank Call Reports).
So a few things to note about this chart. Prior to the GFC, JPM managed its payment clearing at the Fed with only $2-4B in reserves. Payment clearing volumes have not changed much over that time - total payments grow in line with GDP growth. Then when the Fed started doing all of its QE, JPM's reserves grew to a peak of $450B (over 100x pre-GFC) in March, 2015. As the Fed began to shrink its balance sheet in 2016-2019, total bank reserves began to shrink (and JPMs reserves shrink too). But where is the redline? Especially under the new regulations? At what point do individual banks like JPM think - I don't feel that I have any excess reserves to lend because of the new rules and regulations?
Well - it turns out that point was reached in mid-Sept 2019! All it took was three days (Sept 13, 16, 17th, 2019) of large tax payments by the US private sector to the US Treasury (in excess of Treasury daily spending) that moved a net $125B from bank reserves to the US Treasury's general account at the Fed (data from the US Treasury Daily Statements for that period). On Sept. 11, 2019 - total bank reserves per the Fed H.4.1 report stood at $1.458T. Normally (125/1458 =) a 8.6% short-term reduction of bank reserves shouldn't push the payment system from Defcon 5 to Defcon 1 in the space of a few days. But unbeknownst to the Federal Reserve, the regulations and rules imposed on the banks limited their ability to deploy their excess reserves to help each other square up at the end of each of those days. JPM's reserves stood at ~$119b at June 30 and Sep 30, 2019 (which were their lowest levels since the GFC). The signs were there, though, at previous quarter-ends there were very brief spikes in fed funds rates but nowhere near what happened on Monday and Tuesday Sept 16 and 17.
Here's JPM's Jamie Dimon on his Sept 30 earnings conference call:
..we [JPMorgan Chase] have a checking account at the Fed with a certain amount of cash in it. Last year, we had more cash than we needed for regulatory requirements. ... But now the cash in the account, which is still huge. It's $120 billion in the morning, and it goes down to $60 billion during the course of the day and back to $120 billion at the end of the day. That cash, we believe, is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into repo market, which we'd have been happy to do."“... we believe the requirement under CLAR and resolution recovery is that we need enough in that account such that if there’s extreme stress, during the course of the day, it doesn’t go below zero. You go back to before the crisis, you’d go below zero all the time during the day. So the question is, how far is that as a red line? Was the intent to regulate it between CLAR resolution to lock up that much of reserves in account at the Fed. And that will be up to regulators to decide. But right now, we have to meet those rules. And we don’t want to violate anything we told them we’re going to do."
So there you have it. This was a bureaucratic and regulatory FUBAR that forced the Fed to resume its repo operations (and thus go back to a 'corridor' system from a 'floor' system in terms of controlling the fed funds rate). Nothing more or less than that. It wasn't because the US Treasury was issuing too much debt -- quite the contrary, the cause was actually the opposite - i.e, the US Treasury running a small 3-day surplus. I'm not a conspiracy theorist - but as the biggest bank, did JPM force the Fed's hand here? Was Jamie Dimon chafing at holding too much cash at the Fed and wanted a little loosening of the regulations? I would never want to accuse Jamie Dimon of anything here, but nor would I want to play poker with him. But if I had to bet between the bureaucrats at the Fed vs Jamie Dimon, I know who I would bet on.
Once again, sorry for the long-winded response but my wife always jokes that she doesn't want to ask me the time, because I go into explaining how the watch is made.
wabuffo
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Suppose trade deficit is zero and the govt runs a fiscal deficit equal to 10% of GDP every year. As soon the treasury issues debt, the fed immediately buys all the debt by printing money. So in this situation by using wabuffo's analysis, private domestic savings =10% of GDP every year. So to increase domestic private savings, govt can simply run massive deficits and the fed can just monetize the govt debt. Naturally something is wrong with this scenario.
Munger_Disciple, nothing is wrong with this scenario. The Fed in this hypothetical scenario is not monetizing govt debt. It is removing excess reserves that would pile up in the banking sector and drive interest rates to zero. The US Treasury does this too when it issues Treasury debt. You can get this if you do a debit/credit accounting of these transactions. Let's just rename the fiscal deficit as $1t instead of 10% of GDP and let's make it happen in one single transaction:
1) The US Treasury buys $1t of goods and labor via its Treasury general account at the Federal Reserve. The funds flow through a)the Fed, then b)the banks, to c)the private sector.
Federal Reserve:
US Treasury General Acct liability: -$1t
Private Sector Bank Reserves liability: +$1t
Commercial Banks:
Private Sector Bank Reserves asset: +$1t
Private Sector Bank Deposits liability: +$1t
Private Sector:
Bank Deposit assets: +$1t
Private Sector savings equity: +$1t
You can see how this transaction creates new bank deposits/financial assets out of thin air (think about the recent mailings/direct deposits of checks to every US taxpayer as part of the CARES Act). But the effect of no US Treasury debt issuance is that bank reserves at the Fed = the amount of US Treasury debt issuance that should've been issued but wasn't. These reserves are stuck on bank balance sheets since they are inert and trapped in a deposit at the Federal Reserve because they can only move between accounts at the Fed (and US Treasury). This drives all interest rates to zero because there are more reserves than are required to meet regulatory requirements and payment clearing.
So there are two options to remove the excess reserves that have piled up in the banking system:
a) the Federal Reserve can remove the excess reserves via a reverse-repo operation (trading US T-bills/bonds on its b/s to banks for their excess reserves), and/or
b) the US Treasury can issue Treasury debt to remove the bank reserves and give the private sector a savings vehicle beyond its deposits in checking accounts.
Note that these activities (a and b) are bank reserve maintenance functions. They both set govt risk-free interest rates - the Fed for short-term rates and the US Treasury for the rest of the yield curve.
So let's look at the accounting/funds flow of both of these options.
2) The Federal Reserve (in order to keep its interest rate at target) performs a $1t reverse-repo operation with the banks (assume that in previous years the Treasury issued debt so that there is more than enough Treasury debt supply on the Fed's balance sheet from previous years' repo operations):
Federal Reserve repo:
US Treasury Debt asset: -$1t
Private Sector Bank Reserves liability: -$1t
Commercial Banks:
Private Sector Bank Reserves asset: -$1t
Private Sector Bank Tsy Bonds asset: +$1t
3) The other option is the more normal one - the US Treasury issues debt and this activity also removes the excess bank reserves via the private sector exchanging its cash for a new type of savings vehicle with higher interest income (say, a 30-year bond).
Federal Reserve:
US Treasury General Acct liability: +$1t
Private Sector Bank Reserves liability: -$1t
Commercial Banks:
Private Sector Bank Reserves asset: -$1t
Private Sector Bank Deposits liability: -$1t
Private Sector:
US Treasury bills/bonds asset: +$1t
Bank Deposit asset: -$1t
These transactions also demonstrate that operation 1) is the only one that increases private sector financial assets. Operations 2) and 3) only swap assets and leave everyone where they were before with no greater savings (just the form of the savings changes).
The bottom line is I think we all are learning that the Fed Govt via US Treasury deficit spending has more fiscal capacity than anyone truly realized. This is also partly because the foreign sector is also demanding USD assets. There is always a risk of inflation if the US Treasury tries to commandeer too much of the private sector goods and labor. We might be testing that limit in 2020.
wabuffo
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CB - bringing up the savings rate is another very interesting aspect of the effects of US Treasury deficit spending.
As I indicated upthread, US deficit spending adds new bank deposits (and therefore new financial assets) into the private sector. So it is therefore, an accounting identity that:
1) Public sector (federal govt) deficits = Private sector (households and business) surpluses (ie., savings)
2) The private sector = US domestic private sector + Foreign sector (which "saves" USD assets via running a trade surplus with us).
The period from 1997-2007 provides some interesting data that seems to highlight how the Federal budget surpluses in 1997-2001 and the increase in trade with China (through China's entry into the WTO in 2001) delivered a 1-2 punch which forced the US private sector to increase its borrowing to maintain its consumption - and the main source of that borrowing was via the housing market.
First, here's the calculation starting with the year 1994. The federal deficit that year was -2.51% of GDP. Thus, the private sector surplus was equal +2.51% of GDP. The private sector in 1994 saved an amount equal to 2.5% of GDP. But there is a foreign private sector and a US domestic private sector. In 1994, the foreign sector ran a trade surplus = 1.63% of GDP. So if total private sector had savings of 2.51%, the US domestic private sector had 2.51-1.63 = savings of 0.89% of GDP.
That's how the calculations work. Here's the table for every year from 1994-2016 (I did this a few years ago and haven't updated the numbers since - probably should do that!)
This table shows how starting in 1997, the Federal deficits started to tip over into a surplus. As it goes from nearly zero to a surplus of 2.42% of GDP in 2001, the private sector starts to get squeezed and begins to run a deficit (ie, take on debt) to maintain its consumption. But because the trade deficit is persistent (the rest of the world needs to net save a portion of its growing wealth in super-safe USD assets), the domestic US private sector gets really squeezed. This leads to the recession of 2000-2002 with the worst year being 2000 (US private sector runs a deficit of 6.3% of GDP). In the far left, I start a cumulative effect column which mathematically adds the deficits in a cumulative fashion (I'm not sure this is actually mathematically correct but it indicates the level of falling savings/rising debt that the US domestic private sector is feeling).
The recession of 2000-2002 tips the US federal budget from surplus into deficit and this relieves a bit of the pressure of US households and businesses in 2002-2004. But the growing effect of trade with China (plus a rising oil price which the US still is a net importer of) continues to press down. Paradoxically, the US budget deficit starts to shrink again in 2006-2007 just as the trade deficit hits its peak at 5-6% of GDP.
This delivers the coup-de-grace to the US private sector in 2006-2007 as debt once again increases. This of course leads to the Great Financial Crisis of 2008 and the opening of US Treasury deficit spending in 2008-2012. You can see that both the combination of the deficit plus the GFC impact on foreign trade relieves the savings pressure on the US domestic private sector and savings rates zoom higher. The cumulative effect also improves - though not quite getting back to 1994 levels.
Here's another chart that shows for the same 1994-2016 period: US GDP, Household Sector Debt and Business Sector Debt. This chart highlights the tremendous growth in leverage and debt that peaked in 2008 - particularly for households (but also business sector too).
One final table - this time comparing the deficit/surplus with the effect on the dollar (as measured by its price in gold). People worry about deficits leading to inflation. Even MMTers admit that the size of the deficit (even with a Green New Deal or Jobs Guarantee) will always be limited by inflation. But inflation as measured by the CPI is a flawed concept, IMHO. I watch the gold price instead as a measure of currency debasement. Whatever you think of gold (and lots of value investors hate it or ridicule it) - it has an important attribute - stability in its supply. Annual gold production, year-in and year-out averages 2% per year vs above-ground inventory. No other commodity (or currency) has that kind of supply-to-inventory ratio (though I guess Bitcoin follows the same 2% limit on annual supply growth rule). This makes gold an excellent measuring stick from a collateral value perspective. Anyhoo - I just wanted to highlight that when the US ran a persistent surplus in 1997-2001, the gold price fell. This means that there was an undercurrent of monetary deflation happening. Its also interesting to note that when the deficits-to-GDP grew large in the late 2009-2012 period, gold ran up significantly in price. These days, deficits are climbing again and will probably go above 10% of GDP - for how long? who knows. But gold is rising again.
What can I say - I'm a monetary theory nerd. Sorry for the long post.
wabuffo
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I would imagine most of the COBF board members would not be changing their spending habits if interest rates on savings are 1 or 2% higher, if they notice them at all.
Macro forces are powerful and sometimes you can't feel them as they move slowly. But as I showed earlier the numbers are quite large.
Ok - let's try this a different way. Think of it from a pension perspective - similar to a defined benefit pension plan.
Lower rates increase the future liabilities in present value terms due to the effects on discount rates.
Lower rates also affect expected returns on current assets. They are lower.
The effect of lower returns on assets and higher present value of liabilities for a pension (or for someone trying to save for retirement) is the requirement for more cash to be put into the retirement plan. This diverts from consumption.
Again I point to how as the Fed was raising rates in 2018 led to higher quarterly GDP prints (3-3.5% per Q). After the Fed did a U-turn and starting dropping rates in 2019, quarterly GDP fell to the 2-2.1% per Q range. No doubt, the US economy is complex and subject to a multitude of forces - but I am convinced that lower rates hurt the economy more than they help.
We can agree to disagree. Its an interesting question, though, to ponder that the Federal Reserve could be hurting the US economy when it thinks its helping by lowering rates. This is different than its effect when it is acting as a lender-of-last-resort (which has nothing to do with rates) as it has been in this crisis.
wabuffo
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This is helpful to the economy the way I see it. With QE, Treasury is not borrowing money from the public to pay the interest. So how is the public missing out on the interest income? Public did not lend money and they are not getting interest. So no effect in that regard.
The US Federal Govt spends first, then borrows. If not, how does the private sector ever get the govt's money? Taxation and other forms of payment to the US government create the private sector's need for the government's money which the govt provides via spending. It then borrows to remove the reserves it has created in the banking system.
States and municipalities can't do this since they are not allowed to issue their own currencies. This is why the Eurozone has so many problems - nations like Greece and France can no longer issue their own currency and must balance their budgets. Even here it is interesting to watch states like Illinois and California sometimes get into severe budget crises and then issue IOUs which they give value to (in order for vendors to accept) by allowing these IOUs to extinguish state tax and fee obligations.
This proves the model that US Federal govt's money is basically an IOU that the private sector needs to extinguish its tax liabilities - except its more formal and systematized such that we don't even think about it at all. It follows that the Federal govt (after creating the tax obligations, must spend first in order for the private sector to be able to pay its taxes - just like a municipal bus system must issue tokens first, so that riders can exchange them for bus rides).
Now, instead of borrowing from the public (via selling of Treasuries), it gets money from the Federal Reserve (indirectly via the Banks) and what does it do with the money? It spending it on the public. Especially all the COVID programs. They are spending it without either taxing the money from the public or borrowing from the public.
So why is that not massively helping the economy? Yes, the concerns about this seemingly easy way to fund the Government programs are valid, but we cannot say it is not helping the economy.
I'm not following what you are saying here. Could you re-phrase?
wabuffo
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Take a simplistic case of savers being all billionaires and debtors being all poor households.
Vinod1 - let's move from the hypothetical and go right to the film. From the Fed's Z.1 report:
https://www.federalreserve.gov/releases/z1/20200312/z1.pdf Cop a squint at p.152
From that page, here's a high-level balance sheet for US households (Q4, 2019 - $billions):
ASSETS:
04. Real Estate (households - owner-occupied).....$29,326
11. Time and Savings Deposits...........................$10,163
12. Money-Market Fund Shares...........................$ 2,148
LIABILITIES:
33. One-to-Four-Family Residential Mortgages.....$10,610
34: Consumer Credit........................................$ 4,191
So let's ignore the effect of low rates on pensions and post-retirement benefits. This household balance sheet snapshot at the end of last-year shows about $12.2 trillion held in short‐term rate‐sensitive instruments like savings accounts and money market funds.
On the liability side, most household liabilities are fixed‐rate mortgages, where payments are unaffected by rate changes. Consumer credit is made up of credit card debt and car lease payments and totals $4.2 trillion, most of which is also fixed. But let's assume that 25% of the household debt can be made variable interest.
Net, net - (assuming 75% of the liabilities are fixed rate) we can estimate that households have about $8.6 trillion in exposure to short‐term interest rates, so a 1% change in rates adds about $86 billion to annual income. Thus, I maintain that lowering rates punishes households more than it helps them. Its not a coincidence, IMHO, that GDP growth took off in 2017 and 2018 when the Fed started to raise rates and slowed down in 2019 when they started to lower them again.
wabuffo
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Maybe there is a differentiation between gov't and Fed since the Fed is technically independent?
Nope - they are both agencies of the Federal government. The Federal Reserve is basically the US Treasury's bank. They co-ordinate their policy. They have to.
Government debt in inflationary upon issue and deflationary upon service and repayment.
I don't think so. US Treasury deficit spending creates excess reserves in the banking system, US Treasury net debt issuance soaks them up - without the debt, the banks' reserves would equal the size of net debt held by the public (over $19t - instead of the current $3t of bank reserves at the Fed). That's because US Treasury spending creates a new deposit in the banking system (and a new bank reserve for that bank). US Treasury debt issuance is an interest rate maintenance activity - it sets the long-term risk free rates along the yield curve by replacing a private sector bank deposit (and reducing the corresponding bank reserve) with a Treasury bond - while the Federal Reserve sets the short term risk-free rates via its interest on excess reserves. The Federal Reserve and US Treasury together set benchmark risk-free rates along the entire yield curve at whatever they want them to be - since the alternative would be $19t of bank reserves getting zero today.
There's also arguments like the more the government spends on interest is less money the government can spend on other things
Nope - no such thing as "crowding out". The US Treasury has no constraints other than courting inflation. When you pay your taxes in cash, the US Treasury/Fed shred the bills (so much for needing taxes in order to spend).
wabuffo
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1) QE should *raise* rates, not lower them.
Huh? You should tell that to the Fed. They think they are doing long-term yield curve suppression. The Fed lowered short-term rates to zero. The talk now is over yield curve control.
2) There may be some minor interest income that is lost, but the overwhelming factor is the increase in lending that can result.
It is not minor - cop a squint at the Fed's Z.1 report and then think through which rates tend to be fixed (credit cards) and which variable and look at household assets and liabilities. It is pretty major hit to income. And that's before the effect on pensions and other forms of saving.
There are problems with the money multiplier...
Money mutliplier is a flawed concept because it tries to use to different currencies (private sector money and bank reserves). Monetary base includes reserves which don't flow to the private sector and are controlled by the Fed (now that we have massive excess reserves). Reserves are inert. Banks do not and have not needed reserves to lend since a new loan in the banking sector creates a deposit simultaneously. Bank lending is driven by whether banks can make money given the credit risk, collateral quality and capital costs. If the economy slows as it will under QE, there will be less risk appetite, not more.
wabuffo
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I think he used a poor choice of words - instead of deflationary, I think he's not talking about a monetary vector, but an economic one. He means slower growth - and not monetary deflation such as occurs in a financial debt panic.
The reason for QE being an economic growth suppressant, in my view, is for two reasons:
1) QE tries to push rates down. But, low interest rates punish savers more than they help debtors. The low rates force savers to save even more, thus cutting consumption, which slows economic growth.
2) QE replaces interest expense from the US Treasury - which flows to the private sector as income. The Fed swaps Treasury debt held by the private sector with reserves held by the banks. While the Fed pays the banks interest on their excess reserves, it stays in the reserve accounts at the Fed and does not flow to the private sector. So QE takes interest income away from the broader economy and doesn't replace it with any other forms of income for the private sector - so its a net loss of income
Both of these factors hurt the economy - despite the intention by the Federal Reserve to try to stimulate it.
wabuffo
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Druckenmiller says the government's massive stimulus push is more likely to be deflationary than inflationary.
I have no idea what he is talking about - I don't think he does either..... 8)
I remember a line from a great Motley Fool poster (howardroark) that has stuck with me over the years that I think describes Druckenmiller, Tepper, etc. I view them as great investors who seem to also be great traders with an ability to zig and zag at many of the right times ....
"I sometimes think of those few investors who are actually great as having only slightly more attentional control over their talents as Eric Dickerson [NFL Hall-Of-Fame RB] did over his stride -- that much of the fancy talk is after-the-fact mere description, and that often the key decision process is mostly magic even to the decider."
wabuffo
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How did you learn this stuff and could you recommend some books or articles on this?
https://macromusings.libsyn.com/144-peter-stella-on-debt-safe-assets-and-central-bank-operations
This is a good podcast on the Fed and central bank monetary operations. It was recorded before the repo mess in Sept and the current crisis but its a good overview of the Fed and US Treasury's actions during and after the GFC.
The Fed's website also has a lot of good background as well. You should familiarize yourself with the H.4.1 report as well as the US Daily Treasury Statement. They connect at the US Treasury's General Account balance every week.
Hope this helps - I'm a bit of nerd for this kind of stuff. If you have any further questions, I could try to answer them - though I'm always learning too.
wabuffo
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I don't have much to add to the ROIC/depreciated PP&E value question - except to make a couple of points about manufacturing facilities.
Land is land and doesn't depreciate. Buildings do not wear out even for fifty years. When it comes to production lines and manufacturing equipment, there is regular maintenance capital, but I would argue that production lines get replaced more likely for changes to the companies product offerings, new product introductions, or labor-savings than because of wear and tear. Sure, things break down or new safety or environmental standards might require upgrades - but for the most part capital expenditures are made to earn a return and that requires new sources of production volume and/or incremental margins.
This brings me to my major point. Here I will quote Benjamin Graham (Security Analysis, 1940 ed, Ch XXXVI):
"Factories do not actually wear out; they become obsolete. In nine cases out of ten, plants are given up because of changes in the character of the industry or status of the corporation or locality where the plant is situated or for other reasons not related to actual depreciation. These developments represent business hazards, the extent of which is not susceptible of any engineering or accounting measurement.Stated differently, the long-term depreciation factor is in reality overshadowed and absorbed by the obsolescence hazard. The risk is essentially an investment problem and not an accounting problem."
I've worked for major public manufacturing-oriented companies. Plants are closed while they are still very functional and productive and not due to degraded equipment. They are closed because volumes are down and two plants can be consolidated into one. In addition, I've seen companies make investing mistakes (from a shareholder return) building new plants in low-growth industries when the old plants were working just fine.
When I look at manufacturing companies, I adjust the concept of maintenance capital to mean, not how much capex must be invested to maintain the equipment, but rather how much must be invested to maintain the company's current production volumes and competitive position. In some cases (particularly in the tech sector), I would even argue that acquisitions are often maintenance-related in that they cover for a declining base business and only maintain current profitability (rather than enhancing or growing it). HP was a good example of this - the ample free cash flow kept getting plowed into acquisitions to cover for a declining core business.
The point is, don't get overly focused on depreciation and ROIC as accounting questions, they need to be looked at as competitive positioning questions and factories are just assets that need to be evaluated in that context.
wabuffo
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To me it looks like Fed and Treasury seems to be working very well together. Fed is indirectly funding the Treasury. Since Treasury cannot all the bonds that it wants to sell without higher yields, Fed is buying them.
Vinod, the US Treasury is having no problem selling US Treasury Bonds to the public and doesn't need the Fed to buy any of them (in fact, the Fed is prohibited from buying any of the Treasury's debt directly - it must buy the debt from the open market). The Fed is buying them for its own purposes.
That's why I used the example in an earlier post about how the Fed, in carrying out its QE program, is converting long-term US Treasury debt issued at fixed and low yields at issuance into short-term reserve liabilities of the Fed at variable yields that could go a lot higher than the yields of the bonds the Fed just purchased. If you combine the interest expense paid by both the Fed and the US Treasury as basically federal government spending - the "savings" are being dissipated.
So in total, they are un-coordinated since the Fed is partially reversing the debt management strategy of the US Treasury.
wabuffo
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The reserves will end up on the balance sheets of the large banks only after they have been spent by the government (the initial recipients of that money). This is the "deficit spending", and in the short term it does create broad money. The problem, however, is that this process is inflationary, and tends to make investors (and indeed those banks) less willing to lend of their own accord, meaning that there is less cash available for investment - causing destruction of broad money in the longer term.
Basically agree with this - US Treasury deficit spending creates new financial deposits in the banking sector (via Fed reducing reserves in US Treasury general account and increasing bank reserves by same amount).
I wouldn't say that this process is necessarily inflationary unless deficits as % of GDP are greater than:
- annual GDP growth (2-3% per year) as one yardstick, or
- the annual increase in new gold supply vs above-ground inventory (~2% per year), as another possible yardstick.
Of course, this year we are going waaaay above these levels. How high? No idea - but it will be over 10%, maybe approaching 15-20%.
But again the Fed is not doing any heavy lifting here - its all due to the US Treasury. Even if the Fed gets all the attention and infamy.
wabuffo
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Yep, hard to predict the timing of when the fed hits major problems
I'm not sure what this means exactly? What "problems" will the Fed "hit"? Nothing it does affects anything except interest rates. It doesn't affect the supply of money at all.
wabuffo
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The whole operation makes no sense to me.
Here's an example -- everyone is saying the US Treasury should issue long-term bonds (20-year, 30-year) while interest rates are so low (and, hey! - lock in those low rates!).
But then the Fed comes in and buys those long-term bonds under QE and replaces them with reserves on which it pays interest at SHORT-TERM variable rates.
Thus, the rates are no longer locked and will fluctuate (possibly a lot higher over the next 20-30 years).
They are sucking and blowing at the same time....
Fed and US Treasury monetary needs a major re-think. The Bank of Canada runs the entire monetary operations of Canada with basically ZERO bank reserves (though even the BoC is starting to do a minor version of QE, ...ugh!).
wabuffo
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The size of the Fed balance sheet is irrelevant - we're already at zero rates.
The Fed typically owns ~10-20% of the net debt issued to the public by the US Treasury (BTW this is a normal range for the Fed). Per the May 6th Fed H.4.1 report, the Fed owns $4t of US Treasury debt out of $19.2t total US Treasury debt o/s. (you can find this number on the US Treasury Daily Report for May 6th).
But even if it bought 100% of all the US Treasury debt outstanding that it didn't already own (19.3t - 4.0t = $15.2t), the only impact would be to increase the size of reserves held by the banking sector. Essentially the Fed would buy $15.2t of Treasury debt in exchange for $15.2t of new bank reserves via the US banks as intermediaries (as it must - since only federally-chartered banks, a few other financial companies and the US Treasury have accounts at the Fed). Those bank reserves are deposits in accounts at F.R banks and can't circulate outside the Federal inter-bank clearing system. They are really check and e-payment clearing accounts.
So the net effect would be to consume the balance sheets of US banks with reserves and drive all interest rates to whatever the Fed pays on excess reserves (currently zero). US bank reserves on May 6th were $3.2t which corresponds to "Cash Assets" of $3.2t in the Fed's H8 report - "Assets and Liabilities of Commercial Banks in the United States".
US banks total assets on May 6th were $20.3t. Thus the Fed would force US banking sector cash balances to go to $3.T + $15.3t = $18.3t This would essentially liquidate the entire US banking sector and turn it into a huge cash box ($18.3t/20.3t = 90% of bank assets would turn into cash on deposit at F.R. banks).
I think in this hypothetical environment, what would the economy look like with a zombified banking sector and no available US Treasuries for anyone, anywhere? It basically demonstrates that the Fed can buy anything it wants, but its only currency is a very specific one that you and I can't access. Therefore, it is taking out liquid assets (Treasuries, IG bonds, stocks?, baseball cards?) and replacing them with illiquid assets that must sit as a cash asset in the banking sector via a contra-liability account at the Fed. The more the Fed balance sheet grows, the less safe, liquid assets exist for the rest of us. I don't see how that helps the private sector and I think it actually hurts it.
The reality is that the Fed isn't the major factor in money creation since it can only lend via swapping assets for bank reserves. It is the US treasury and its deficit spending that is the major money creator. All of the attention on the Federal Reserve is misdirected.
It also shows how disjointed monetary operations are when you have two players (the Fed and the US Treasury) that often work at cross-purposes and neutralize each other.
wabuffo
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Do you guys know of any books about the market in the 70s?
What specifically are you looking for?
I recommend:
1) Paper Money, by 'Adam Smith' (George Goodman) - the Money Game and Supermoney are good too - but cover more of the 60s. Buffett makes an appearance in Supermoney (before he was broadly known and famous) IIRC.
2) Money Masters, by John Train (also covers Buffett's early years)
3) A Random Walk Down Wall Street, by Burton Malkiel - more of a investing strategy book but covers the times a little.
4) How to Buy Stocks, by Louis Engel
5) The Only Investment Guide You'll Ever Need, by Andrew Tobias - kind of a personal finance book written with humor and plain talk (but talks about the inflation, taxes and stock markets of the 70s).
6) Winning on Wall Street, by Martin Zweig
Not sure if this is what you are looking for - but this is what I remember as covering the 1970s. None of them are stock market history books if that's what you are looking for.
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It’s niche - but still used in some medical devices (pacemakers, heading aids). Many types of industrial sensors.
It’s not growing but it generates 65% FCF margins and yields over 7%. Cash rich - $14 of cash per share.
wabuffo
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NVEC.
I love a company has a buyback program but only buys shares when they are really cheap. They bought shares in late 2015, early 2016 and then stopped. They didn't buy in Jan or Feb this year but in March they started buying again!
Quite the contrast to other mgmts that buy back shares mechanically EXCEPT during market swoons when mysteriously, they stop buying back their own shares at the lows.
wabuffo
What sectors will do best in an inflation era?
in General Discussion
Posted
It seems to me that the FED's 4bn per day QE is way bigger than the prior 3 QEs.
Narrator: "Its not"
The Fed's share of total US Treasury Debt is not significantly higher than the past going all the way back to 1970. There is no "monetization" going on.
wabuffo