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How Long Can Fed Buy Everything?


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Anyone want to chime in about how long the Fed can continue expanding their balance sheet at this rate until the capital markets start to go south?

The Fed says they don't have a limit.

This is pretty fascinating stuff as far as how long their buying everything (including junk bonds even buying etfs) even talk of buying equities at some point.

I think their balance sheet is up to about $7 trillion. So the Fed's balance sheet is about 1/3rd of GDP. I'm not sophisticated enough around macro economics as far as what point the capital markets will no longer be propped up. 50%? 100% 200%?

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There’s an interesting interview with Howard Marks on Bloomberg and he talks about this. His theory is the markets are a plastic ball hovering over a jet of water held by the Fed. Once the Fed turns off the jet, it’s pretty obvious what will happen to the plastic ball.

 

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The BOJ’s balance sheet is already above 100% of Japanese GDP and their economy/markets are not blowing up, so I imagine the Fed can keep going for a while if they want to (and Congress supports them). I don’t know how far they can go though. I would certainly keep an eye on Japan for clues if this interests you.

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A fascinating aspect is that central banks have allowed to be put on a path that leads to overt, direct and explicit monetary government financing.

 

An incredible amount of effort has been put into blurring lines.

 

These issues are mostly irrelevant when reading footnotes of financial statements but there's got to be a point (depends on the definition of margin of safety i guess) when this would be considered bothersome.

 

Analogy from an anecdotal perspective. One of my daughters just finished a relationship and we’ve been talking. It was a relationship that was not made to last and i was (secretly) hoping that it would end earlier than late (lasted about 18 months). At first, she talked about the triggers and then we moved to the slippery slope aspect which (she now realizes) started a while back. Relationships based on poor premises should be ended earlier rather than late.

 

The timing is unclear but I’ve become increasingly convinced that appeasement of financial markets will eventually be considered as one of the most colossal failures of modern times.

Disclosure: Stuff I’m reading these days is related to the dynamics that led the Japanese army leaders to develop the kamikaze strategy. I humbly suggest that they should have inverted. But it’s not easy.

 

Today is shaping up to be a sunny day. :)

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The BOJ’s balance sheet is already above 100% of Japanese GDP and their economy/markets are not blowing up, so I imagine the Fed can keep going for a while if they want to (and Congress supports them). I don’t know how far they can go though. I would certainly keep an eye on Japan for clues if this interests you.

 

yeah, was going to say to just look at Japan. The test will be if the Fed is able to take the foot off the gas with the market not throwing another taper tantrum that kept QE going on seemingly indefinitely.

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They will go until they lose control. Then they will cancel debt/loans/finance the government. The hyperinflation will have already caused great poverty so they can go in reverse then and claim things are getting better. The history of the world and human nature often repeats and people have short memories. How many zeroes did they cut off currencies in former communist Eastern European countries and Russia? People lost all their money. Then they start again. But trust in government gets worse and worse and then , well..chances are you've already lived your lifetime before even a part of this cycle plays out for you )

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Why couldn't the Fed just keep pumping money in until vaccine is created? Showing my ignorance here but does Powell make the final decision or is there a vote at these Fed meetings? If one person makes the decision, I would imagine that pumping unlimited amounts make that more possible.

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If inflation ever exceeds 2.5% that would the point of them stopping (or at least reducing a lot) and that is when the capital markets will behave violently.

Jay Powell is doing a hell of a job as far as keeping the markets flowing.

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That seems the likely stopping point (vaccine). I think they have already expanded their balance sheet by 2-3 trillion since March so if a vaccine happens in summer of 2021 and able to be mass produced then I suppose we are looking at a Fed Balance Sheet of another 12-15 trillion or about 110-120% of GDP.

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The BOJ’s balance sheet is already above 100% of Japanese GDP and their economy/markets are not blowing up, so I imagine the Fed can keep going for a while if they want to (and Congress supports them). I don’t know how far they can go though. I would certainly keep an eye on Japan for clues if this interests you.

 

yeah, was going to say to just look at Japan. The test will be if the Fed is able to take the foot off the gas with the market not throwing another taper tantrum that kept QE going on seemingly indefinitely.

 

Que the 80's song "we are turning Japanese now"

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And here it is. Unemployment claims came in and futures spike up. I guess they expect Jay to come on later today and throw a couple more trillion to the market.

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Anecdote ALERT:

 

My neighbor owns a paint & body shop.

 

He told me this morning, that he was GIVEN 10 weeks worth of payroll with no strings attached.

 

On another note, the boat launch down the street from me was barren yesterday for the 1st time in months.

Everyone must be back at work.

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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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The BOJ’s balance sheet is already above 100% of Japanese GDP and their economy/markets are not blowing up, so I imagine the Fed can keep going for a while if they want to (and Congress supports them). I don’t know how far they can go though. I would certainly keep an eye on Japan for clues if this interests you.

 

Theres an argument that since the US Dollar is the reserve/strongest currency that we should be able to go higher than anyone else and not blowup. 100% didn't kill Japan, so could the US go to 150 or 200%? If so the Fed still has lots of "ammo" and we might have 5+ years or until the next recession in 2030 before we have to push the envelope again. 

 

Theres also an argument that because we are perceived as  the reserve/safest/risk free currency we don't have as much leash before people start questioning our reserve status. In that case we are going to run into problems in the next 15 months at current Fed runrates as the fed balance sheet will approach 100% by that time.

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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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How did you go bankrupt?

Two ways. Gradually, then suddenly.

 

( Ernest Hemingway)

 

Yep, hard to predict the timing of when the fed hits major problems but no doubt it will happen very suddenly and the sentiment will flip on a dime!

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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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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.

 

...

 

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. 

 

 

wabuffo

 

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.

 

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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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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

 

I quite did not follow how the last statement (in bold) follows from the rest of your message. Could you please eloborate?

 

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.

 

My understanding is quite limited, so please excuse my ignorance if something I say above makes no sense.

 

Vinod

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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

 

I think bci23 has his/her own thoughts on this, but I’m hearing quite a few people voice concerns about how quickly money supply has been going up recently:

 

https://fred.stlouisfed.org/graph/?g=r1v3

https://fred.stlouisfed.org/graph/?g=r0TQ

 

Their main concern is that if this trend continues we are going to have a lot of inflation (or worse).

 

(You are right of course that the connection between the size of the Fed’s balance sheet and money supply is much more subtle than one might expect.)

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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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