- Fed Economist Michael Kiley has prescribed $3.5 trillion more in QE to prop up the US economy.
- The problem is, there aren’t $3.5 trillion more in Treasuries for the Fed to buy.
- This is probably why Fed Chair Powell is urging another massive spending bill, because otherwise, the Fed has no more Federal debt to buy and can’t print any more money.
- The Fed could buy more private securities, but it already owns about 30% of the entire US mortgage market.
- QE is now up against a wall.
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As a kid, one of my favorite card games was hearts. The objective of the game is to get the least amount of points in 4 rounds, 26 points per round. There’s one catch though. If somehow you manage to collect all 26 points in a round, all your opponents get 26 points and you get zero. A player who does this successfully is said to have “Shot the moon.”
If the monetary system is a game of inverse hearts and dollars are the points, then the Federal Reserve is about to shoot the moon, collect all the points and end up with nothing. The most efficient way for investors to protect themselves and profit from this is to buy real assets. China is already doing this in record numbers, according to Bloomberg, with soybeans, oil, copper and other commodities. But the most efficient and profitable way to protect yourself is to buy the most liquid, value-dense real assets, chiefly gold and silver, and only secondarily agriculture and energy.
What evidence is there that the Fed is very close to shooting the moon? The Fed likes to talk often about what it calls the “ELB” or “ZLB”, the effective or zero lower bound for interest rates. What it doesn’t talk about is what could be called effective upper bound, the EUB of quantitative easing. What many do not realize is that the EUB has already been hit. In other words, substantially more QE from here from buying Treasuries is, for all intents and purposes, impossible. Here’s why.
The Effective Lower Bound of Interest Rates vs. the Effective Upper Bound of QE
The ZLB or the ELB refers to the inability (or at least the unwillingness) of the Fed to push nominal interest rates into negative territory, even though real rates across all maturities are already deeply negative. In a new paper dated August 31, Fed macroeconomist Michael Kiley grapples with the ELB, suggesting that the only way to “stimulate” the economy further given the estimated 10% drop in GDP for 2020 is to flood the monetary system with $3.5 trillion more in new money. Kiley writes (page 4):
QE equal to 30 percent of (nominal) GDP, or about $6½ trillion dollars, is required to offset the impact of the ELB. Note that the Federal Reserve initiated purchases of securities and a number of 13(3) facilities following the onset of COVID-19, and its balance sheet had increased by $3 trillion between February and the end of June 2020.
$6.5 trillion needed and $3 trillion already added, putting the remainder still required according to him at $3.5 trillion to combat the effective lower bound of interest rates. What is not considered is the EUB. There is a limit to how much the Fed can theoretically buy before it buys it all. That may sound purely theoretical and far off, but it’s not. In fact, we are already there, and the Fed, particularly its Chair Jay Powell, likely already knows this to be the case.
Consider, according to the latest Treasury data, there are $13.148 trillion (see “Outstanding” tab) in marketable Treasury notes and bonds outstanding. According to the latest balance sheet statistics from the Fed, the H.4.1 report that details the asset breakdown, the Fed already owns $3.815 trillion of this balance, 85% of its total Treasury balance. The breakdown is below.
Plus, according to the latest Treasury International Capital figures, total foreign ownership of US Treasuries as of July stands at $7.0872 trillion, down from a peak of $7.226 trillion before the pandemic began.
Notes and bonds as a percentage of total foreign official ownership of Treasuries are around 90% consistently. If we assume a similar breakdown for total foreign ownership, then the total figure for foreign ownership would be around $6.38 trillion, give or take a few hundred billion.
We can assume this figure to be broadly accurate because the outstanding Treasury bill supply has nearly doubled from $2.6574 trillion in March to $5.0767 trillion (see previous link) as of the latest data available, and yet, total foreign ownership of US Treasury securities generally is up only 2% over the same time frame. So, essentially, zero of this new bill supply has been absorbed by foreign buyers.
This circa $6.38 trillion, if bought by the Fed, would certainly not be “stimulative” in the sense Kiley has in mind, as foreigners selling this stockpile back to the Fed would simply destroy the dollar’s reserve currency status. So, when Kiley is talking about $3.5 trillion more in purchases, he is not talking about monetizing Treasury debt held overseas – he’s talking about buying domestically available supply.
So, if we add the $6.38 trillion off limits to the Fed’s current hoard of $3.815 trillion, we have a total of about $10.2 trillion that’s out of bounds. If we add Kiley’s $3.5 trillion QE prescription, then that amount goes up to a whopping $13.7 trillion. That is already higher than the total Treasury note and bond supply outstanding as of August of $13.148. In other words, in order to pull off another $3.5 trillion in Treasury purchases, the Fed would have to purchase more domestic marketable notes and bonds than actually exist. Whoops.
Perhaps Kiley is aware of this, though he doesn’t say so explicitly. In his paper, he encourages the purchase of private securities rather than government bonds as more “efficient” in propping up the economy. He writes (page 5):
Within the model, QE in private securities is more effective, on a per-dollar purchased basis, than QE in government bonds. This finding is directly from Gertler and Karadi (2013) and stems from the assumption in the model that the limits to arbitrage imposed by the balance sheet constraints of financial intermediaries are larger for private securities.
It would be more straightforward if he simply admitted that the Fed buying $3.5 trillion in government paper is mathematically impossible, but that’s another issue.
Perhaps Fed Chair Powell is also aware of the EUB, though he does not say so explicitly either. He is certainly on record as urging more fiscal stimulus, but he never publicly admitted that it is needed because the Fed is literally out of Treasuries to buy otherwise.
A Chicken and Egg Paradox
But there’s another problem here. In order for the Fed to even buy the debt Powell is urging Congress to spend, the commercial banks have to buy it first. In order for them to do that, they need more reserves, as there are only $2.8 trillion in reserves in the entire US banking system. Certainly not enough to buy $3.5 trillion more in QE. In order for the commercial banks to have more reserves though, the Fed has to buy more Treasuries, and we’re in a chicken and egg paradox.
What to do? The dollars are going to have to come from existing stockpiles abroad, which is essentially foreigners selling down their Treasury holdings. Again, this is not stimulative, but it will push down the dollar on foreign exchanges – pretty hard, I think. This will make imports much more expensive in dollar terms, driving up consumer price inflation, and with it, the prices of real assets, as gold and silver pull away faster and faster from the rest of the commodity complex.
What About More Private Securities?
And what about private securities, which, as Kiley suggests, are more “efficient” in stimulating the economy? Well, the Fed already owns $1.982 trillion in mortgage-backed securities, about 30% of the market, according to Bloomberg. That’s a relief, because by that math, at least the Fed has about $4.62 trillion in mortgages it can still buy to stimulate things before it reaches that EUB there and owns the entire real estate market, now riddled with commercial mortgage-backed securities in forbearance, delinquency and default.
Shooting the Moon
In order for the Fed to keep “stimulating” with QE, Congress needs to keep spending money the Fed prints, but the EUB is already in the way. If and when the next bailout bill passes and the Fed adds another few trillion to its balance sheet, the Fed will own about half of the US economy, its balance sheet ballooning to about 50% of 2020 GDP. What happens to the dollar then?
I believe it is completely reasonable to say that if and when the next bailout bill passes, foreigners will see the writing on the wall and start selling their remaining Treasuries to the Fed and fast, exchanging the dollars they receive in return for real assets that they will simply hoard, as China is already doing. Gold, silver, copper, oil, agricultural commodities, whatever it may be.
The time when the world finally realizes that the Fed has shot the moon is now rapidly approaching and could be only months away. Prepare for it now by selling dollars for real assets, and I sincerely believe you can fundamentally change your position in life for the better if you do this now.
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Source: Seeking Alpha: The Fed Is Almost Out Of U.S. Treasuries To Buy