How Long Can Fed Buy Everything?

[Spekulatius]

Here is the most impotent question - when do we know when the gradual shifts to the suddenly? or in other words, when do we know when the gig is up?

Back then in 2008 folks were suggesting a failed treasury auction, but I don’t think that would be it. Besides they I think I have seen it happening with Bunds and it actually wasn’t a big deal.

 

I do think one of those things could happen:

 

1) short term interest rates shoot up

2) USD devalues suddenly against other currencies , most likely Euro or Chinese yuan

 

 

There are probably other unpleasant things but I am not sure which one that might be.

 

I also wonder if in the future the status of the USD as a reserve currency could be diminished , most likely due to the Chinese yuan picking up some market share. For that to happen, the Yuan would need to be freely convertible and also float against the USD (it is now pegged). That would also mean that the Chinese would mean to run their economy differently and give up their mercantilistic ways. At some point,the trade warnt why is going to fan up might force this issue anyways.

 

In any case, the Chinese economy is op going to be the largest economy I the world and with 1.4B people, their current is destined to be a reserve currency. I don’t think they have a choice, the only way this is not going to happen is if the Chinese economy blows up.

[Viking]

My guess is the path of the virus and the economy will be key. If the virus news gets better (vaccine) then the economy can start to heal and everyone (including the Fed) continue to muddle along (like we have for the past 10 years).

 

If the virus news gets worse and the economy remains in depression levels of activity then we will be in uncharted waters. We know the Fed will continue to do ‘whatever it takes‘. We also have a President who also will do ‘whatever it takes‘ to get reelected in 5.5 months (via the Treasury). If more and more unconventional levers are used then the risks of unintended consequences increase.

 

Because the virus is impacting all countries my view is nothing will change in the near term (the next year) in terms of the US and its place in the larger order (reserve currency etc).

 

My big picture concern is if we see hyperinflation down the road (that wipes out peoples savings :-)

[LC]

There is an element of trust in being the reserve currency, in being the lender of last resort, in being the "safe" asset.

 

China's problem is nobody trusts their regime. This is going to need to change for them to take over in the minds of market participants.

 

I actually thought with COVID they would position themselves to address this but it has not really been the case.

[rb]

There is an element of trust in being the reserve currency, in being the lender of last resort, in being the "safe" asset.

 

China's problem is nobody trusts their regime. This is going to need to change for them to take over in the minds of market participants.

 

I actually thought with COVID they would position themselves to address this but it has not really been the case.

Yea, main problem with replacing the US dollar as the reserve currency is that you don't really have what to replace it with. The only real contenders are the RMB and the Euro.

 

The RMB? Yeah, no! The Chinese would have to run their economy in a vastly different way for this to be a feasible option. Maybe one day that will happen, but that day is a very long time from now.

 

The Euro? This may have looked as a reasonable option around the GFC. As in you could talk about it and not sound crazy. But I think this option is a non-starter after the Euro Crisis.

 

So you can say that the US dollar is and will continue to be the reserve currency for the foreseeable future because it is the least bad option out there.

[meiroy]

 

It can be replaced with chaos.

 

[Cevian]

Just finished watching the recent full interview with Druckenmiller.

 

IMO the best quote which summarises my own issue with the Fed's actions: "the Fed is there to solve a liquidity problem...they are not there.....in solving a solvency problem."

[LongHaul]

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

 

Wabuffo - Thanks for the posts.  You seem to really understand how the Fed works. 

 

How do you think this plays out with the Fed over time with secondary consequences?

 

I don't understand squat with this stuff.  How did you learn this stuff and could you recommend some books or articles on this?

Thank You

[wabuffo]

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

[JimBowerman]

  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

 

In my opinion, the private sector is helped if the Fed is clear about its intention to swap lower interest bearing reserves with higher interest bearing treasuries etc.  If they do this consistently enough, the only option for the commercial banks to "rerisk" their balance sheets and make more loans (which increase Nominal GDP)

 

George Selgin talks about how even in the weimar republic, the banks were able to get rid of excess reserves.  Of course our post 2008 world is different because central banks are paying interest on reserves. But this isn't any technical failing of monetary policy.  The failure is paying interest on reserves, which is self inflicted and has kept NGDP below trend since 2008 and led to a subpar recovery

 

"“This is another argument I’ve had with Fed economists. I wrote to the Fed and said: ‘look, you’ve

got it wrong. There is a distinction between the determance of excess reserves and the determance

of reserves. It’s not the same. Banks can, in principal, always have low excess reserves by creating

enough deposits.’ His (a Fed economist) response was: ‘well, when the magnitude of deposit

creation is such, as it was under all three rounds of Q.E., then it’s no longer possible for banks to

make that many loans. There’s not enough loan possibilities out there.’ And I wrote him back and

said: ‘well excuse me, but in the German hyperinflation, the order of magnitude of increase of

bank reserves was many times greater than in Q.E., as fantastic as Q.E. was. Yet, not only did the

German banks expand deposits as rapidly as reserves and keep the same low ratio of reserves...the

German banks actually lowered their reserve ratios. They created more deposits. They’re always

able to get rid of non-interest earning reserves as long as there are other assets that earn more

interest’…He didn’t have an answer to that”

 

(Source w/ time stamp:

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