The collateral squeeze should no longer be a problem

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.

7 thoughts on “The collateral squeeze should no longer be a problem

  1. I don’t know how you can punish savers for everything bad happens in economy last years. The fact that I didn’t spend every earned penny means I’m stupid? Is getting up early stupid? Is hard working stupid? Everyone have a chance to do this, are you saying those who did are stupid?. There is always another day on a beach and everyone has the same chance to place his/her towel on a sun lounger if she/he wants to.
    Savers are not elderly people. Savers are those in 20s, 30s, 40s who decide not to immediately buy new home, new car or new iphone with credit card but to invest part of their income to make more in the future and buy everything they want on their own. That demand is only delayed in time so have not negative impact on the economy in the long run.
    In normal times those savings are transfered by middlemen like banks to people who decide to spend more than they earn or to the companies which decide to invest. But banks don’t care anymore about savers and tries to finance credits on their own at levels which are not sustainable. Ideal situation for them is that everyone spends everything they have and even more, but when everybody have already bought a new house, who is buying next?
    Savings are also an life insurance. If you have resources for a darkest hour, you are not that much afraid about what happens tomorrow – job lose, broken leg or something else which otherwise would be total disaster. Also your creditor (bank) not decides anymore about your life or death while you are waiting for new credit to pay the old one. You can deal with things on your own not waiting in a street line for a free meal.
    If someone buys an insurance against natural disaster and others do not and that disaster happens and government decides to pay everyone without insurance for their losses would you blame that one man for his stupidity?

    Savers are not sacred cows but they are not stupid lambs ready for a slaughter either.

      • In negative interest rates environment debtors would benefit “disproportionately”.
        You prefer the soft way of negative interest rates which is in fact reset of the financial system by returning savers and debtors to the starting point.
        But why anyone would want to be a saver anymore when they knew that not bring any further benefits to them due to negative interest rates which will occur earlier or later? From where startups and households would get new capital and credit when all the cash sits on existing companies accounts?

  2. @homeless
    This seems to be a widespread confusion over negative rates.

    A negative rate doesn’t mean that there is no reason to save at all, it only affects behaviour at the margin.
    Say $100 saved is turned and turned into $98 in a year in a negative rate environment, rather than $102 in a positive rate one.
    Your argument is that under negative rates, people would choose to save £0 and have £0 in a year rather than £98.

    If we take the motivation for saving the desire to spread consumption over time, is it clear enough that there will always be a reason to save, regardless of the rate regime?

    • Well, I disagree🙂

      Money have not internal value for people as owning 100$ bill don’t make them happy itself (unless someone is a money addict). The real value have things which money can buy. At the end of the day all savings are spent earlier or later (unless someone wants to be richest man in a cemetery). The ultimate goal of savers is not to maximize their savings but to maximize their spending (!!!). So, it’s not about save 0$ and have 0$ vs 98$ but buying something today vs buying more in the future.

      Spreading consumption over time only makes sense when you expect higher further consumption than you can afford today. If you can buy small house today or bigger (better) one in the future you can make decision to save but if you can buy small house today or the same or even smaller in the future there is completely no reason for you to live with your parents anymore – you go and buy what you need. It’s the same with cars, phones, trips, etc. Also it could be buying one vs buying two. Even if you can’t afford something now, it’s better to get a credit (with a negative rate!) rather than save.

      Both savers and non-savers have the same needs (both are people) but the former choose to stifle those needs for a while expecting further reward. That also involves some opportunity costs – emotional costs when you choose not consume goods which you need (and everyone else do it). So, it would be something more than just lose 2% (that’s what I mean saying “punishment”). I think that negative rates environment would completely distort incentives for saving.

      The only two cases which I can see at this moment when people still save are:
      1. Savings as form of insurance – some money which could be needed when bad things come true (not so much)

      2. No need to buy anything – but I think people needs are endless (marketing) and perspectives of a guaranteed lose on savings due to negative interest rate environment could force people to seek for “hard assets” same as in times of high inflation or at least put money in the mattress🙂

      Sorry for a long read but I tried to be clear about what I think🙂

  3. Hello Izzie,
    A question on this “savings glut (during a period of over production)” …

    Accepting that every bit of money that is desired to be saved today, has been lent/borrowed in the past.
    Can we say that this `savings glut` was preceded by a `lending/borrowing glut`~?

    (I’m not trying to make a point particularly, just get to the source of the problem)

    I also note … because I made the mistake typing this comment, that there would be a big difference between a `savings glut` and a `saving glut`.
    Maybe this is the better question – Are you referring to a `savings glut` (too many digits out there); or a `saving glut` (too many people not wanting to spend their digits)~?

    Hello again.

    • A savings glut relates to money (a.k.a. Claims over physical objects) being spent and then rather than being respent by that party again being LENT for the purpose of generating a return over time.

      If too many people lend dollars rather than spend them, when there isn’t enough productive return out there, you get a savings glut.

      The only thing that would transform a savings glut into a balanced situation is if there was more than enough productive return out there.

      For example if savings accumulated in the west and those savers decided to lend to EM that may resolve the glut. BUT the risk/return would have to be appropriately priced.

      The savings glut developed from the fact that developing countries became funders of developed countries. But there was no risk less return to be had in anything other than rent-seeking assets, such as mortgages.

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