Direct market intervention by central planners is inserted between consumer price inflation and the push and pull of interest rates. Decisions made one day can result in ongoing punishment the next. The Fed’s monetary policy mistakes yesterday created today’s unfavorable situation.
If you remember, during the quantitative easing (QE) rampage that occurred through the repo frenzy and the coronavirus fiasco, the Fed exploded its balance sheet. It increased from $3.7 trillion in September 2019 to $8.9 trillion in May 2022.
In effect, the Federal Reserve created credit out of thin air and used it to purchase U.S. Treasury bonds and mortgage-backed securities. Moreover, the Federal Reserve, drawing on the collective wisdom of thousands of economics PhDs, has determined that it is appropriate and appropriate to purchase these assets when yields are at 5,000-year lows.
The consequences of the buying spree of low-yielding assets are highlighted each week in the Fed’s H.4.1 data. today May 30thRevenue remittances to the U.S. Treasury amounted to minus $171.9 billion, up 163% from the same quarter last year.
To be clear, negative remittances are similar to operating losses.
Finance 101 courses in junior colleges around the world teach simple natural laws. When interest rates rise, bond prices fall. This is fundamental to how capital markets work. Having overlooked this basic insight, the Fed now carries around a list of Treasury bonds underwater.
By contrast, in the pre-coronavirus world, the Fed’s operating profits flowed to the Treasury in the form of remittances. This amount is now deducted as a negative remittance, effectively becoming a liability to the taxpayer.
Consider that if you work, earn wages, and pay taxes, you are financing the Federal Reserve’s operating losses. Does this give you that warm and fuzzy feeling when you wake up at dawn on Monday morning to start your work week?
tune in tokyo
Monetary central planners sometimes meet to question their past actions. What went right? What’s wrong? How can financial intervention make the world more prosperous?
This is the type of question considered as part of the continuous improvement process (CIP) for monetary policy makers.
This week on May 27th and 28th, the Institute of Monetary Economics held its annual Bank of Japan meeting. BOJ-IMES Conference, in Tokyo. This year’s spotlight shone with the theme ”. “Price Dynamics and Monetary Policy Challenges: Lessons for the Future.”
Lessons Learned are a key part of the Hollow Enterprise CIP. Changes must be communicated to prevent mistakes from being repeated. In practice, the lessons learned help spread responsibility for specific problems from individuals to the organization.
The idea is that if responsibility is sufficiently distributed, as in the division of subprime debt, no one will be held accountable. This model works great until mistakes and lack of accountability pile up to the point of failure.
At this week’s BOJ-IMES meeting, European Central Bank Executive Director Isabel Schnabel played a role in contributing to the conversation by providing lessons learned on the topic of QE. Schnabel’s aspectpolicy maker “You need to carefully assess whether the benefits of purchasing an asset outweigh the costs.”
Like the Federal Reserve, the ECB is operating at a loss on bonds it purchased just before interest rate hikes following the coronavirus outbreak. In fact, the ECB recorded a loss of €1.3 billion in 2023. This was the ECB’s first annual operating deficit since 2004.
lesson not learned
A downturn in ECB finances has consequences. For example, this led the ECB to eliminate dividend payments (remittances) to central banks.
These dividend payments, amounting to €5.8 billion from 2018 to 2022, are typically passed from central banks to euro zone governments. According to Schnabel, the 2023 losses aren’t that bad compared to previous gains.
“These losses need to be weighed against the profits the central bank earned before the rate hike, but they may still be putting a strain on the reputation and credibility of the central bank.”
Perhaps the lesson Schnabel has learned from central planners is not to use QE to stimulate growth when interest rates are low. But shouldn’t this really be a lesson and common sense?
As far as we can tell, Schnabel’s lesson is more of a lesson yet to be learned. What happens if nominal interest rates are high but real interest rates are low due to inflation? Does this mean central banks are allowed to purchase assets?
The real lesson learned from all of this is that QE is a colossal failure.
Unfortunately, Federal Reserve President Michelle Bowman and her colleagues appear to have lost this lesson. At this point, she is focused on unwinding past QE, i.e. quantitative tightening (QT), so that future QE can be better utilized in future financial crises. Bowman speaking at the Tokyo conference Advert:
“It is important to slow the pace of balance sheet outflows as reserves get closer to sufficient levels, but in my view we are not there yet. In my view, it is important to continue to reduce the size of the balance sheet to ensure sufficient reserves as quickly as possible while the economy is still strong. Doing so will allow the Fed to use its balance sheet more effectively and reliably to respond to future economic and financial shocks.”
The Fed’s disastrous efforts to find sufficient reserves
Bowman’s comments contradict recent comments from the Federal Reserve. Implementation Notes. The document states that the Federal Reserve will reduce its monthly balance sheet drawdown of U.S. Treasury securities from $60 billion to $25 billion starting June 1. The maturity limit for mortgage-backed securities remains the same at $35 billion.
that much FOMC minutes It shows that a small number of participants preferred to continue the current pace of balance sheet contraction. Bowman’s comments indicate that she is one of these few.
At the heart of the problem is the concept of ‘sufficient’ reserves. No one at the Fed or anywhere else knows how much reserves there are. But nonetheless, this is what the Fed is looking for.
The lesson learned from the last round of QT is that when the balance sheet shrinks below an unknown level of sufficient reserves, bad things like repo madness happen.
If you remember, the overnight repurchase agreement (Repo) interest rate hit 10% between the night of September 16, 2019 and the morning of September 17, 2019. Short-term liquidity markets have essentially collapsed. Before long, the Federal Reserve was pumping out hundreds of billions of dollars of credit every night to keep credit markets flowing.
Soon this was completely overwhelmed by the coronavirus panic. This is where the Fed hit a wall and expanded its balance sheet by $5 trillion. By the end of May 2022, the Fed’s balance sheet peaked at more than $8.9 trillion. And consumer price inflation has reached a 40-year high.
The Federal Reserve’s balance sheet currently stands at approximately $7.4 trillion. It fell by about $1.5 trillion. And the Fed is getting nervous.
So this time, they want to tread lightly on the arduous process of searching for sufficient reserves.
Nonetheless, the Fed will not know that it has reached a point where its reserves are sufficient until they are no longer sufficient. But by then this would have triggered the next great financial crisis.
[Editor’s note: Are you prepared for the next mega financial crisis? Most people aren’t and they are missing out on a huge opportunity. For this reason, I recently prepared a unique publication titled: “Blood In The Streets, How to Make Investment Riches During the Chaos of a Global Financial Crackup.” >> Click Here, to access a complimentary copy.]
thank you,
minnesota gordon
for economic prism
A return to the economic prism from the Fed’s harrowing search for sufficient reserves.
