I thought the Financial Times had a more in-depth analysis of the structural reasons behind the spike in the REPO market than I've seen elsewhere. I've seen a few sources point out the tax payment due on the 15th, and the settlement of a large treasury sale, but as the article says:
"...Analysts say these two things alone should not cause the deep cracks in the repo market that we have seen this week. The underlying issue is more structural.
The Fed has been reducing the size of its balance sheet, letting the Treasuries and mortgage bonds it bought following the financial crisis roll off. In turn, that reduces the amount of cash reserves banks hold at the Fed...
'We have had tax payments in the past. What is different this time is that it has followed a period of quantitative tightening,' said Jon Hill, an interest rate strategist at BMO Capital Markets. 'Companies sucking cash from the market was just the tripwire that brought things falling down.'”
My understanding is that Treasury took in an additional 80+ in cash against their stated goal of having 350B cash on hand (by quarter end I think). Obviously this is a very large draw of liquidity out of the system and is likely the single biggest reason for the squeeze.
Not quite 2/3 of collateral at the Fed operations has been treasuries the rest mortgage paper with a tiny amount of agencies.
The financial system/world runs on repo and it is troubling this is happening at all. My gut is Mnuchkin knew this would happen and is trying to force the Fed into backdoor easing through another round of QE before gradually releasing the cash back into the system by slightly lower than expected issuance of new debt.
> The Fed has been reducing the size of its balance sheet, letting the Treasuries and mortgage bonds it bought following the financial crisis roll off. In turn, that reduces the amount of cash reserves banks hold at the Fed.
I'm somewhat skeptical that the reduction in Fed balance sheet is the impetus for the recent surge in repo rates, especially since the Fed ended its balance sheet unwind in August.
From August 2014 to January 2018, the Fed held $4.4 trillion in assets [0]. From 2014 to 2016, overnight repo rates remained stable and low [1]. In December 2015, the Fed began its hiking cycle. From this point onwards, repo rates began drifting up, consistent with an increasing fed funds rate [2]. It would appear that the changes in repo rates were not driven by Fed balance sheet during this period.
Starting in January 2014, banks held $2.4 trillion in excess reserves at the Fed, peaking at $2.7 trillion in August 2014 [3]. By January 2018, excess reserves held at the Fed had fallen to $2.1 trillion, independent of any change in the size of the Fed's balance sheet. In 2016, repo rates remained steady, despite a $400 billion decrease in excess reserves. In 2017, overnight repo rates drifted up, despite an increase in excess reserves of $200 billion. Here, repo rates do not exhibit any obvious impact from fluctuations in excess reserves.
As Fed balance sheet declined by $700 billion in 2018, excess reserves declined by roughly the same amount. However, even as Fed balance sheet continued shrinking in 2019, repo rates held fairly steady, corresponding to the stable level of the effective fed funds rate.
Given all this, it doesn't look like reductions in Fed balance sheet have been the sole driver of declining excess reserves, nor does it appear that the quantity of excess reserves correlates strongly with overnight repo rates. Furthermore, the Fed announced an August 2019 conclusion of the balance sheet unwind in July's FOMC statement. Finally, excess reserves held at the Fed are now 1000x greater than they were in 2007.
In short, the recent spike in repo rates happened despite a massive overhang of excess reserves and in the absence of a shrinking Fed balance sheet. I wonder if the decline of the interbank loan market, which serves as a source of short term funding for banks, is related. At the time the Fed discontinued reporting interbank loan volume (2018), volumes had declined ~75% from precrisis levels [4]. Such low volumes were last seen in 1979. This, in part, explains the large amount of excess reserves held by banks. If they do not have confidence they will be able to borrow when they need to, they must maintain such reserves.
The constant low (but steady) inflation that we now see as normal under the 2% inflation targeting in a major contributor to the significant rise in prices for interest-rate sensitive assets. (Interesting tangent: John Taylor on why he selected 2% as a target: https://economicsone.com/2018/01/09/the-feds-inflation-targe... )
Except inflation is actually significantly higher the basket is just poorly assembled and exclude major drivers like food gas real rent and most importantly medical costs
I am curious what inflation would be with universal healthcare, a healthy amount of affordable housing, primarily renewables for energy, and EVs negating the need for gas/oil. It feels like central banks are going to lose against technology deflation, but I'm not an economist so I can't say for sure.
I suppose it depends on how those programs are funded/achieved. If they are funded via something that acts as monetary stimulus (just print the money to pay for it) then I imagine there would be a heavy burden of resulting inflation.
Hi, I’m Joshua Konstantinos the author of this post.
I’m sorry if you don’t like the quality of my article. But I felt I should respond to the insinuation that I’m doing something underhanded to “somehow” get to the top of hacker news.
I did absolutely nothing to get to the top other than submit the post this morning.
I have been working on my book as a passion project for two years. It is very unlikely that I will ever recoup the money I spent writing it, printing copies, researching etc.
Now that I’ve finished my book I’ve been posting articles on economics and geopolitics because it’s a topic I enjoy. I don’t have ads on my site, and honestly I probably lose money on hosting costs. I have had some success on hacker news and Reddit which has been a pleasant surprise - but Cassandra Capital is just me writing about what I enjoy writing about.
I will say that people get hell-banned for seemingly self-promoting on HN. Might be good to mix up your submissions with other articles you find interesting, so it doesn't appear as though you are only posting your own writings.
I have submitted a few news article that I've found interesting (from Bloomberg etc) that have also done well on here lately. But you're right. I will make an effort to mix up my submissions! Thanks!
Er I don't know the right etiquette as far as original post, but I shouldn't have quoted/included "somehow", that's entirely fair. I think you've had great success to my eyeballs for placement on HN, but did not need to insinuate that it wasn't on the up-and-up.
No hard feelings! No one has been more surprised than me by the response I’ve gotten - I can see why you might be suspicious. I will make an effort to post from other sources more frequently moving forward.
Japan, Italy, and Greece are in the same category of heavily indebted countries as a percentage of their GDP. But, you’re absolutely correct that a key difference between these countries is that Japan controls its own currency (unlike Italy and Greece).
Having a central bank by bonds directly from the treasury is the very definition of monetization. It would add a substantial amount of currency to the economy and is very different from what is happening with QE.
As for how Japan has been able to build up debt to their levels without seeing bond yields rise and sparking a crisis - it’s because the Bank Of Japan has used just about every outstanding government bond for QE. But they Japanese in particular are reaching the limit of QE. I go more into this argument here: https://www.cassandracapital.net/post/quantitative-easing-ha...
If I understand you correctly, your argument is that QE is not inflationary because the banks don't have bonds in their balance that previously they had, instead they have reserves.
First, reserves are not inflationary (1). The quantity of reserves in the system is not important if that money is keep in the Central Bank and it's not spent. As the current QE exercise has show, adding reserves to the system don't make firms and households ask for more credit. If the real economy don't want to spend, you can add all the reserves that you want and nothing will happen (except lowering the interest rate that it's already at minumum).
Now, fiscal policy, it's the right tool if you want to stimulate the economy, but, for political reasons, it's not done.
Second, please, explain through what mechanism banks don't owning a quantity of bonds equivalent to the reserves in the system will create inflation. All the point of selling bonds (by the central bank to the banks) is to retire reserves from the system.
Monetization of the debt don't cause inflation. What causes inflation is spending in the economy. That it's precisely what the politics in, for instance, the Euro-area refuse to do.
I think we agree that QE is not inflationary (and obviously despite years of QE inflation is low)
However, monetization if the debt (which is very different from QE) is definitely inflationary. Would you suggest that every country could simply print fresh currency and pay off the national debt without causing inflation?
Please, note that I'm not saying that QE it's not inflationary (it's not), I'm making a more general statement: adding reserves to the bank system it's not inflationary.
You probably agree with me that what create inflation is the spending in the economy.
One thing is the public deficit and another is the public debt. The deficit happens when the government spend in the economy. If the government (or the private sector) spend too
much in the economy inflation will happen. The other way inflation can happen is by some kind of supply shock.
The public debt is just the accumulated of the money that has been already spent in the economy. So, the public debt can't be inflationary. That money is already in the economy!
Paying the public debt it's just not emitting new debt and waiting until all the debt mature.
Could that be done (if we forget for a moment the rules currently in place)?
Yes, the government just could spend what they need without emitting bonds. The real restrictions in the government spending would be the same: don't spend more than the economy can provide or you will get inflation.
The public debt number is basically irrelevant. This is true for countries with its own currency and the debt denominated in its own currency, otherwise the issue it's very different.
We are not going to see a crisis created by a public debt problem of countries that have their own currency, but the public debt, of the countries in the Euro, is a good candidate for the source of the next crisis.
Respectfully, I think that Lehman brothers was a major part of why the great recession was the great recession. I’ll quote economist Allen binder:
People argue that if it wasn’t Lehman Brothers it would have been something else,” ….“I don’t buy that. I don’t mean everything would have been great if we had bailed out Lehman. We were in a financial crisis before Lehman. But it had a shock value that just caused everything to fall off a cliff. If you look at data on almost anything – consumer spending, investment spending, car sales, employment – it just drops off the table at Lehman Brothers and I don’t think we needed to have that.
He seems to be saying that if we had known what was going to happen before it happened, we would have been able to prevent it from happening. Well, maybe. But isn't that like saying "if the French had defended the Ardennes, they would have stayed in the war much longer"? That seems like a reasonable guess (as does "rescuing Lehman could have taken the bite out of the Great Recession") but I would say that, actually, no one knows what would have happened in these imaginary scenarios.
The broader point here is that events like Lehman's collapse and its aftermath (or the invasion of France) are essentially defined by their unpredictability. If we could predict them, they wouldn't even be events.
And even if, somehow, these events were predictable, does anyone really think that economists have some theory that lets them make decisions like "who to bail out" or answer questions like "what will the consequences will be if they don't bail X out?" I believe that economists make better calls than a man on the street (me), but I have my doubts.
> The broader point here is that events like Lehman's collapse and its aftermath (or the invasion of France) are essentially defined by their unpredictability.
Unpredictability is a dangerous word because it has two meanings here.
On the one hand, you are using it to mean nobody could possibly know ahead of time that it would be Lehman and even if they were told that fact it would still have been impossible to pick the date (or the year for that matter). Nobody could argue.
On the other hand, billions to trillions of dollars of wealth that everyone thought existed turned out not to be there. It didn't disappear; it was discovered in the financial crisis that it never existed and the crisis was when that fact became uncontroversial in the mind of the general money manager.
That part was clearly predictable in an emperor-has-no-clothes fashion and probably years in advance as well. It seems highly likely that if the people with power didn't see it shaping up then they were choosing not to see. Much like government debt-to-GDP in today's article. The people profiting cheer-lead bad long term decisions and everyone else sits quiet hoping that they won't have to pay for it. Which would be fine if the responsible people were made to pay in the end, but 2008 showed that not to be the case; taxpayers stepped in. The financial bloodbath was not matched by an equal sack-everyone-involved-and-bankrupt-the-investment-banks bloodbath of sufficient magnitude. A failure like that should have reamed out the entire sector; if they weren't ready for it replace them with new blood and ideas.
I suppose the point I want to make is that there is a frame here that 'saving Lehman' would have been a win. It wouldn't be a win. They were complicit in mis-allocating resources; 'saving' them just gives them more time to redirect real effort into bad causes, and makes the final reckoning more painful when people need to call on real resources that turn out not to be there. The books were misleading; protecting them would just have let more people make bad decisions based on misleading figures. Markets work best when people don't do that, and I understate by an order of magnitude or two when I say that.
> On the other hand, billions to trillions of dollars of wealth that everyone thought existed turned out not to be there. It didn't disappear; it was discovered in the financial crisis that it never existed and the crisis was when that fact became uncontroversial in the mind of the general money manager.
> That part was clearly predictable in an emperor-has-no-clothes fashion and probably years in advance as well. It seems highly likely that if the people with power didn't see it shaping up then they were choosing not to see.
I don't think it was predictable in any useful sense. First, I don't think anyone knew that (or when) "the general money manager" would "become aware of the facts". Second, I don't think anyone knew that would happen if they became aware of the facts.
So maybe it was predictable in a "there will definitely be a recession...sometime" sense, but that's not helpful.
Even if some people did identify "billions to trillions of missing wealth" and predict the crisis (and apparently some people did), there wasn't any way to know which of those predictions was correct. There is no one who predicts things who is always right and there is no agreed-upon theory to tell us when these things are going to happen before they happen with any precision.
To put it another way: there are smart people who predict financial crises that never happen all the time.
> I suppose the point I want to make is that there is a frame here that 'saving Lehman' would have been a win. It wouldn't be a win. They were complicit in mis-allocating resources; 'saving' them just gives them more time to redirect real effort into bad causes, and makes the final reckoning more painful when people need to call on real resources that turn out not to be there. The books were misleading; protecting them would just have let more people make bad decisions based on misleading figures. Markets work best when people don't do that, and I understate by an order of magnitude or two when I say that.
This is a different argument. I guess there are two things to worry about:
1. Making the responsible parties pay for their malfeasance (justice)
2. Making decisions that will benefit the economy (pragmatism)
It's entirely possible that bailouts ticked the second box but not the first. But, as you argue, in the long run, not bailing out the lenders might tick both boxes because it will teach them a lesson. However, that's a hard sell for Americans living between 2008 and 2012, who probably did benefit from the bailouts, even if they were unjust and even those bailouts only deferred some larger, inevitable crisis.
I don't envy the people who have to make these decisions.
Respectfully, I think the risks from Italy leaving the euro are extremely underrated.
Italy defaulting on it's debt would be substantially worse than just "bond holders losing money." Italy has an extremely large amount of debt - if that debt dropped in value (like mortgage debt did in 2008)it would be catastrophic for every country in Europe. Who would bailout the entire country of Italy? That's the problem with sovereign debt, it's too large and there is no higher entity responsible for bailing it out.
What specific, concrete events would occur, and why would the occurrence of these events constitute a catastrophe? Why would anyone need to “bail Italy out”? If they decide not to pay back their debt and start using their own currency, the problem is solved from their perspective. Sure, they’ll have to pay a much higher interest rate if they want to issue further bonds, but so what?
Again, please avoid abstract terms when describing this supposed “catastrophe” that would follow a default.
If Italy was to leave the Euro, and pay back their debts in a devalued currency:
First it was be a massive deflationary shock to have that debt fall in value (very similar to how mortgage debt falling in value was a shock). Banks in France and Germany would see massive losses. Because of the leveraged nature of sovereign debt in the European banking system it would be extremely deflationary.
Secondly, the debt of every other nation in Southern Europe would also be put into question. If Italy is going to devalue, how long before Spain, Portugal, Greece, etc. do as well? And the scale of all this debt is much larger than subprime mortgage debt was.
Beyond that - imagine the monetary chaos if nations start to leave the euro and issue their own national currencies again? Will people be hoarding Euros? Selling them?
If you look back at the reporting from back in 2010 when the European Sovereign debt crisis was at its peak - you'll see that just about every serious economist agreed that a sovereign debt crisis and the idea of defaults had the potential to be very bad.
I can’t reply to your last reply for some reason, so I’m replying here. I’ll read the article you linked to, but I don’t expect anything other than more econobabble and fear-mongering.
If a country’s entire economic system is based on a stupid assumption—in this case, that a sovereign nation will never default on its debt—then it ought to collapse. Still, I don’t believe that collapse would actually occur. I think that a lot of people would lose a significant amount of money and be quite upset. And then, the next day, the sun would rise, and people wouldn’t be starving in the streets, and life would generally go on.
But I think if you look at how the people of Greece have already suffered since almost having a sovereign debt crisis you’ll agree the potential is there for it to be quite bad in Italy.
I’ll read both of those articles later; they’re behind a paywall. I’m not an economist, and I’m open to being shown that I’m wrong, but I still think that if Italy were to default on its debt, there would only be two inevitable consequences: French and German banks would lose a lot of money, and Italy would have serious trouble borrowing at a reasonable rate in the future. I don’t see how anyone could call either of those outcomes “catastrophic” with a straight face. But I can easily see why those who stand to lose a lot of money would want the public to believe that a default would be catastrophic.
The Resignation of the Italian prime minister last Tuesday will likely lead to the dissolvement of parliament and elections as early as this fall.
With the right-wing League party soaring in the polls there is a very real chance that they will be able to form a majority government without partners .
This is a risk to the EU and the euro because the League has been vocal about their plan to issue a parallel currency to the euro called the miniBOT. Having such a currency will enable the Italian populists to achieve where their Greek counterparts failed - because the EU will not be able to ensure compliance by threatening to freeze the banking system and paralyze the economy.
