Since September, the Fed has been assisting the “repo” market by lending overnight and other short-term funds to keep short-term rates from spiking higher.  A “repo”, or repurchase agreement, is a form of short-term borrowing for dealers in government securities.

I have hesitated to write on this topic because, frankly, I don’t fully understand what is going on. Federal Reserve officials have tried to give explanations for the need to step into this market.  They say it was a perfect storm.  They said that there were quarterly corporate tax payments in September, coupled with dried up liquidity from monetary tightening.

I don’t buy the corporate tax payments excuse at all.  Why is this time any different than any other time?  Why didn’t short-term rates in the repo market spike up in September 2018 or September 2017?  And if this is really an issue, why is the Fed continuing to lend money into this market?  If it was a corporate tax issue, it shouldn’t have lasted more than a few days.

Since October 2017, the Fed was allowing a certain portion of maturing securities to not be rolled over.  This went on into part of 2019.  This equated to a small (relatively speaking) reduction in the Fed’s balance sheet.  It was mild monetary deflation, but this had stopped before the repo issue appeared.

With the balance sheet reduction, there was a sizeable reduction in excess reserves held by commercial banks.  Still, the excess reserves are at a total of about $1.3 trillion, which is nearly $1.3 trillion more than what existed in early 2008.  Prior to 2008, the total excess reserves were measured in billions, not trillions.

If there is still a huge pile of excess reserves held by the commercial banks, why did the repo market explode like it did?  Why are banks desperate for liquidity?  Why would you need to borrow overnight funds if you have massive excess reserves?

If anyone has a good answer to these questions, please let me know.  I have not heard a good explanation yet.

The best that I can guess is that there are certain financial institutions that are in trouble.  It is probably more than one.  For all I know, maybe these are foreign institutions.  We don’t know for sure.  Maybe the Fed is helping to support failing European banks.  Maybe there is a major bank in the U.S. that is in crisis, but they don’t want to tell the general public.  Maybe it is the government-sponsored entities – Fannie Mae and Freddie Mac – that are in trouble.

Again, if all of the major banks had significant excess reserves, then I don’t see why they would need to borrow overnight.  The Fed has not explained this.

A Rose By Any Other Name

Fed Chairman Jerome (Jay) Powell has insisted that this is not QE4.  He says that the Fed will need to be accommodative, but that we should not consider this as quantitative easing.

The FOMC released a special statement on October 11, 2019.  One of the points stated the following:

• In light of recent and expected increases in the Federal Reserve’s non-reserve liabilities, the Federal Reserve will purchase Treasury bills at least into the second quarter of next year in order to maintain over time ample reserve balances at or above the level that prevailed in early September 2019.

I take this to mean that the FOMC, in its statements, will not be specific as to the target of money creation, as it was from 2008 to 2014.  In other words, the Fed isn’t going to specify that it will buy $30 billion (or whatever number) in Treasury securities every month. There is not going to be a set amount as before.  The Fed will just buy securities (create money) on an as-needed basis to keep short-term rates in its target range and to gradually expand its balance sheet.

I don’t see a significant increase in the adjusted monetary base yet, although it has ticked up slightly. It did go up by about $100 billion in a couple of weeks time.  The Fed is not on a monetary inflation spree as it was from 2008 to 2014, or at least not yet.  But it looks like the Fed will be expanding its balance sheet again, even if it is just gradually (again, relatively speaking).

The way I see it, this is QE4.  If it’s not already here, it is coming.  The Fed will be a net buyer of government debt.  It buys this debt by creating digital money out of thin air.  It is not necessarily the actual printing of dollar bills.  It is digital accounting, but it is still monetary inflation.

It was actually because of the Fed, under Ben Bernanke, that the term quantitative easing began widespread use.  I believe they thought this would deflect the critics from calling it monetary inflation or money printing.  It was a more technical sounding term that didn’t sound as harsh.

But the Fed critics quickly adopted the QE term, so it now has a negative connotation.  This is as expected.  The people who talk about the Fed are usually critics. I am not counting the establishment figures at the Fed itself or in the establishment financial media.

The reason is because anyone who studies the Fed and talks about the Fed is going to understand that the Fed is an enemy to the average person.  The defenders are people in the establishment who directly benefit – financially and through power – from the system.  This is why they defend it.  Anyone else who understands the system is probably going to criticize it because they know that they, and a majority of people, are getting the short end of the stick.

So even though the Fed started the widespread use of the term “QE”, now they are trying to avoid it.  You can call it whatever you want, but the Fed is creating money out of thin air.  This serves as a bailout and benefit to certain special interests.  For the rest of us, it means a misallocation of resources and a reduction in living standards as compared to what they would have been.

Whether it’s called QE or not, the American people are poorer for it.