The greatest trick the Fed ever played was convincing the world that he did not taper.
First, a quick note to say that Brad DeLong has convinced me that despite everything, in the grand scheme of things, the negative-rate conditions brought on by a QE-fuelled collateral squeeze are not necessarily a bad thing after all.
Do they rock and compromise our traditional understanding of value in our current system? Yes.
Do they compromise the preferential position of savers in the economy? Very probably.
Are they ultimately part of the solution rather than the problem? Most definitely.
Whichever way you look at it self-imposed negative rates help to transfer wealth from savers to debtors and in our current situation this is exactly what the economy needs.
In short, so what if money market funds can’t defend the buck.
Is the economy/market ready to accept that this is the sort of wealth transfer it needs? Probably not.
This is probably because the market continues to see it (incorrectly) as wealth transfer that disadvantages one party over the other, rather than wealth transfer that benefits both parties in absolute terms. The truth is no-one really loses out in material or relative terms from such a transfer in our current economic position. We would only all step up the ladder together, in tandem.
Nevertheless, because the misunderstanding causes the market to act daft, the Fed has been forced to take mitigating action to stop risk averse capital owners from having a hissy fit/crisis of confidence that brings down the market.
Indeed, what only a few people have noticed is that the Fed did not really back down from tapering at all.
The Fed’s fixed-rate full allotment reverse repos for non-bank participants in the market is really what tapering was all about, and this is going ahead as early September 23.
Reverse repos are undoubtedly a form of sterilisation and thus a form of tapering.
The Fed probably realised the market had incorrectly equated tapering with tightening — rather than a policy move designed to alleviate collateral pressures — meaning it had to clarify as best it could that it would not be tapering in the tightening sense while going ahead with a policy that was tapering in everything but name.
Tapering as the market understood it — as some sort of crescendo to the end of accommodative policy — was probably never on the Fed’s agenda.
While QE may be continuing, it will no longer be coming at the cost of a collateral squeeze that charges savers a negative rate. That makes it a very different type of QE.
Whatever liquidity the Fed gives out from now on, it will stand ready to take back from the saving community (on demand) at a rate that protects their wealth from apparent capital destruction.
From now on the “downside” effects of QE on savers will be monumentally neutralised. There will be a genuine floor on rates.
As Scott Skyrm noted on his blog on Friday:
In August, the Fed dropped a bombshell on the market when they partially announced a new Fixed-Rate Full-Allotment Reverse-Repo Facility (FRFARRP). There was considerable debate as to what the July FOMC minutes really meant. Problem solved! It was announced today. The Federal Reserve issued a Press Release describing the details of the new program. Here they are:
The Fed will begin FRFARRP operations on September 23 (this Monday) and a trial period will extend through January 29, 2014
The Fixed-Rate will start at .01% – one basis point – and be allowed to increase as high as .05% – as authorized by the FOMC.
Each reverse-repo counterparty is allowed to invest up to $500 million cash at the Fed, with the counterparty limit possibly increased to $1 billion. I counted 49 different reverse-repo counterparties on the Fed’s website. That means the FRFARRP can put between $24.5 billion and $49 billion in securities into the market on any given day.
The trades will only be overnight
The facility will be active between 11:15 am to 11:45 am each day – the Fed brought back “Fed Time”
As he notes, this is what all that really means:
The Fed is attempting to put a floor on general collateral rates. At lease a floor up until 11:45 am each day. It doesn’t mean that GC rates can’t drop into the negatives later in the day. As of Monday, the GC rate floor is set at .01%, but it could be raised as high as .05%. Clearly, the Fed is worried about the impact of QE purchases on the Repo market. Throughout June and July GC was trending toward 0% and the Fed was worried about possible Repo market distorts. No doubt they are conscience of preventing a collateral shortage. And, I’d like to note, the FRFARRP is not about planning for a fed funds tightening in 2014. The Fed announcement stressed not just once, but twice, that the facility does not imply any kind of policy change in short-term rates.
In other words the Fed is trying to have its QE cake and eat it.
With the reverse repo facility now in place there really will be no downsides to QE. (Though there may be less advantages associated with it as well.)
QE will now just be a liquidity churning device designed to keep rates happily anchored at zero. A dollar’s worth will be set at no more and no less over time, meaning noone should on the surface be disadvantaged (even if in reality they will be massively advantaged).
It makes sense on that basis why gold prices should now be falling. This is simply not the sort of QE that will stifle collateral markets enough to make gold an attractive refuge from negative collateral rates once more. There are no longer any negative rates to be running from.
On the whole, we have to give it the Fed. Very well played.
Just two issues to worry about now:
1) to what degree does this kill time value of money (TVM) and unhinge the usury business altogether?
2) how do you keep money supply growing in line with potential output and penetrating beyond the now protected capital-owning classes, in a world where there is no upside in being involved in the usury (lending) business at all.
Without some form of fiscal, welfare, basic income or socially backed lending intervention (that is to say, some form of continual wealth transfer — which, as we noted, is not really a wealth transfer in relative terms at all) wealth concentration and inequality will continue to soar. Savers will be incrementally advantaged (even tho they don’t realise it) to the detriment of the rest of the economy and everyone else in it.
It’s not about taking away from savers to give to debtors or those without. It’s about ensuring that claims held by savers do not disproportionately rise in value relative to everything else.
It is about ensuring, in other words, that risk averse savers do not outperform the economy relatively. That they don’t get something for nothing forever (I.e. beyond what they should be compensated for inflation) just because they happened to be early entrants into the capital game.
Here’s the best analogy I can think of:
Savers are akin to the stereotypical myth of the German who likes to get up especially early to secure his right to a sun lounger at the pool by placing a towel on it. As more and more people arrive, those saved (and often frustratingly unused) spots benefit the early rising German ever more obviously. The Germans increasingly have something while more and more people have nothing. Their early efforts to secure the spots look increasingly worthwhile in relative terms and the payoff for getting up early rises with every new person that arrives at the pool looking for a sun lounger.
What the Fed does is adds more sun loungers to the pool so that everyone can be satisfied. And this is fair enough, especially if the fed has the spare capacity in the system to keep producing sun loungers.
Does this compromise the value of the original sun loungers secured by the Germans? That is to say, are the Germans materially worse off because of the Fed’s actions? No!
All that’s happening is that more and more people are getting a sun lounger, and in that sense more people are better off.
The reason the Germans are bitter (and for Germans read savers) is because the constant supply of sun loungers is compromising the pay off associated with their initial efforts to secure something they thought would end up being scarce but turned out to be plentiful after all.
But why should the economy be punished because some people think their early (and ill judged) efforts should be rewarded with favoured positioning forever more?
Who cares if u arrived early if there’s more than enough sun loungers to go round!!
Unfortunately for the economy, the latest Fed move acts to protect the Germans.
It’s the equivalent of new sun loungers being added to the pool, but rather than being distributed to new users, being handed to the Germans instead — on the naive hope that they the Germans will act rationally and share the surplus with new users rather than see it go to waste (and do so of their own accord).
Since there’s a fat chance of that happening, I fully expect that this could be nothing more than a Fed slight of hand.
Indeed, the Fed may be happy to keep the hierarchy of the pool in tact because it knows its partner, the US Treasury, will soon be forced to open an entirely separate and parallel pool — complete with an endless supply of sun loungers — just around the corner instead.
As long as the Germans don’t notice that demand for their chairs has dropped off a cliff because everyone is now being serviced by another source, and believe they are still receiving a pay off, it hopefully won’t matter that other people are benefiting from sun loungers on the other side of the fence as well. The Germans will be no wiser.
(The other source being, of course, welfare, fiscal policy or some other form of wealth distribution strategy.)
Most importantly the Germans (read savers) won’t feel their crack of dawn activities were a total waste of time, and hopefully won’t destabilise the holiday by being resentful and mean to everyone due to their sudden realisation that they what they thought was originally a clever move to advantage them relative to everyone else actually ended up costing them (due to lack of sleep). What’s more, that they have only themselves to blame for the mis-assessment of the conditions and are thus wrong to take it out on fellow holiday makers.