It’s happening again. Something weird. Any time you take US$485.3 billion down to the bank to deposit it for safekeeping overnight, something is up. But what? I’ll come back to that in a moment.
First, Monday is Memorial Day in the US. It’s a public holiday commemorating the death of all those who served the US in uniform. In that sense, in spirt, it’s a lot like ANZAC Day.
Today I learned that Memorial Day didn’t officially become a holiday until 1971. Prior to that, it was called Decoration Day. It began back after the Civil War in the 19th century. In both the South and the North, it was a way of honouring the over 750,000 soldiers that died in the war. By 1971, in the middle of Vietnam, there were even more fallen to honour.
Most older Americans still honour it in that fashion today, as a day of remembrance for those who died in battle. Baby Boomers had parents or grandparents who fought and died in the Second World War, Korea, and Vietnam. Gen Xers and Millennials fought and died in the First Iraq War, Afghanistan, the Second Iraq War, and in a seemingly endless string of worldwide operations and engagements associated with the global ‘War on Terror’.
That war is still going on. It may never end, if the Warfare State has its way. Perpetual war — like perpetual emergency — is the surest way to keep the State growing and the people afraid (united in their fear of an enemy, or a virus). There will be more dead to remember next year.
But let’s leave that sombre thought aside for now. Memorial Day also marks the unofficial beginning of the summer holiday season in the US. And there is much to celebrate, apparently. For starters, the seven-day average of new COVID-19 cases is back under 20,000. In fact, it’s down 92% since peaking at over 245,00 per day in January.
Why is COVID disappearing? Is it vaccinations? Is it seasonality? Is it lower testing? Is it changing the way cases are counted?
I have no idea. But as I wrote in the soon-to-be published Bonner-Denning Letter, it feels like a pivot is already underway, from one crisis (COVID) to another (climate). If the people no longer fear COVID — because the back of the pandemic seems to be broken in the US through natural immunity of those who had it and vaccination of those who didn’t — then you must give them something else to fear.
Quick! Make America Fear Again. MAFA!
How about a stock market crash? There’s plenty to fear there. Which brings me back to the guts of the US’ money system. Something isn’t right. But diagnosing the problem — and how serious the condition is — is a little tricky. Here are the facts, and a chart.
Banks parking record cash at Fed overnight. Why?
Source: US Federal Reserve
Last Thursday, overnight, nearly half a trillion (USD) was deposited at the Fed overnight by banks, money market funds, and the various government-sponsored enterprises that supply credit and liquidity to the booming US housing market. The facility which makes such a huge volume of overnight deposits possible is called a reverse repurchase agreement, or reverse repo.
The question is, what in tarnation is going on?
It’s not a clever investment or arbitrate. The reverse repo facility doesn’t pay the bank any interest on the cash it leaves with the Fed. The current interest rate on overnight cash deposits with the Fed is a big fat zero. So what do the banks get out of ‘lending’ that money to the Fed?
It’s complicated. But let’s keep it simple. On the one hand, the cash comes off the bank’s balance sheet overnight. It’s no longer a liability to depositors. And in exchange, the bank gets back something quite useful from the Fed: Treasury bills and notes.
The bank can then lend out those bills and notes — on a very short-term basis — to anyone who wants them. Who would want them and why? That’s complicated too. But the short answer: anyone who uses T-bills as collateral for big margin loans.
In other words, leveraged financial players with big positions in the stock and bond market use T-bills as the collateral for their leveraged position. Without the collateral, they’d either have to sell something else to raise cash. Or they’d have to close the position. When that’s done hastily, because you’re out of cash, it can result in much lower stock prices rather quickly (see the Archegos’ fallout recently, but then apply it to the entire financial system).
The Fed has traditionally used the reverse repo market as a way of controlling the quantity of bank reserves in the financial system. It’s one of its big tools in keeping the Fed funds rate — the rate at which banks charge each other for overnight lending — in line with the target set by Federal Open Market Committee. And now a whole Pandora’s box of worms has been opened up.
Is the Fed losing control of interest rates? Has QE stripped the financial system of quality collateral, threatening a forced deleveraging? After all, the Fed has purchased US$2.5 trillion in treasuries and mortgage-backed securities (MBS) since the pandemic began. Its balance sheet is now over US$8 trillion.
By hoovering up the supply of available safe collateral in the banking system, the Fed is making it so that money market funds are better off keeping money on deposit with it overnight than lending it to one another (at zero, or negative interest rates). A dearth of collateral could result in a collapse in leverage. Are money market funds retreating to cash ahead of what they expect to be a crash in stocks?
No one has any idea. It’s an emerging, novel kind of mess. When you get unprecedented monetary intervention and experimental QE by the central bank, you get unprecedented crises. Distortions abound. Incentives are twisted and mangled until they are unrecognisable. Trust in the financial system — in your counterparties or other lenders — starts to unwind quickly.
The music stops.
What does all this mean? It means that as the COVID-19 emergency seems to subside, and as the days get longer and warmer and good times are here again, there’s something rotten in the state of the US’ financial markets. For the rest of the world — including Australia — that’s bad news.
Editor, The Rum Rebellion
PS: I don’t quite know what to say about Victoria’s seven-day ‘circuit breaker’ lockdown. There are once again only five lawful reasons to leave your home — in a supposedly free and open society. How many times can you defeat the virus and claim you’re still winning? What do you think of the COVID lockdowns? Send us your thoughts with the subject line ‘TRR’ at email@example.com.