End of QE-4: Fed’s Repos Drop Below Oct 2 Level, T-Bills Balloon, MBS Fall, Total Assets Down to Dec 25 Level

Total repos on the Fed’s balance sheet of February 5, released Thursday afternoon, have plunged by $85 billion from the peak on January 1, to $170 billion, below where they’d first been on October 2:

Under these “repurchase agreements,” the Fed buys Treasury securities and mortgage-backed securities (MBS), guaranteed by Fannie Mae and Freddie Mac, or Ginnie Mae, whereby the counterparties commit to buy back these securities at a fixed price on a specific date, such as the next day (overnight repo) or a longer period, such as 14 days (term repo). Repos are by definition in-and-out transactions. When a repo matures and unwinds, the Fed gets its money back, and the repo on the Fed’s balance sheet goes to zero.

By buying these securities, the Fed adds liquidity to the market for the duration of the repo. When the repo matures and unwinds, the liquidity gets drained from the market. When a new repo transaction occurs, the process starts over again, but with a different amount and with a different maturity date.

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Who Are the Current Main Players in the Federal Funds Market?

When the Federal Reserve conducts monetary policy, it announces a target for the “federal funds” interest rate. The implication is that if this specific rate rises or falls, it will affect other interest rates throughout the US economy; for example, like federal funds interest rate moves closely together with other key benchmark interest rates, like  the interest rate for overnight borrowing on AA-rated commercial paper. However, the identity of the parties borrowing and lending in the “federal funds” market has changed dramatically since the Great Recession. 

Read more here: http://conversableeconomist.blogspot.com/2020/01/who-are-current-main-players-in-federal.html

Exponential Growth in Fiscal Irresponsibility: Federal Deficit Grows $342 Billion in First Two Months of 2020 Fiscal Year

Introduction

Congress, the Grand Stewards of the Federal Government’s treasure chest, have continued down the road of fiscal perdition. How? For the first two months of the Fiscal year of 2020, the United States Federal Government’s deficit has grown $342 billion, per the Congressional Budget Office. This represents a 12 percent increase over previous periods. Based upon the CBO, the Federal Deficit will average $1.2 Trillion per year between 2020 and 2029.

What Does This Mean?

With the proliferation of federal government spending, combined with ever increasing budget deficits, this leads to more activity of the growth of the government debt. Debt security instruments, such as United States treasuries, are sold to obtain cash in order to “true up” the deficit. Purchasers of Government debt can be foreign nations, but on the domestic side, The Fed is the largest purchaser of Government Securities. Back to the transaction, once this transaction takes place, this expands the money supply. It is expanded with injecting the cash, by the sale of the treasuries, into the money supply when the fed purchases them. The Fed’s balance sheet continues to grow along with the ongoing purchasing of debt securities. A quick reminder of the concept of inflation: It is the expansion of the monetary base.

The Road of Fiscal Perdition

With the expansion of the federal government entitlement programs, such as Medicare, Medicaid, and Social Security, it only makes sense that the deficit will average $1.2 trillion per year over the next decade. As the baby boomers begin to draw down social security benefits, the demand for health care will rise. This will place a strain on resources, pushing health care costs upward.
Also: Inflation has a deleterious impact upon savers and individuals that are on a fixed income. Since the value of the currency declines, this reduces the purchasing power for goods. This creates a situation that more individuals become more dependent on Medicaid and other Government social programs.

Conclusion

Due to the overwhelming use of government resources, the deficit will continue grow. This will lead to more borrowing, which will lead to more inflation, which leads to more individuals struggling to cover their expenditures. Good luck building wealth in this economic environment.

Excursus

Read the CBO report here: https://www.cbo.gov/publication/55551%20%C2%A0

Chinese Currency Manipulation and Price Controls

Introduction

The curious claim made against the Chinese about “Currency Manipulation” is gaining momentum. Many believe that the United States are “losers” in trade relations with China.  Somehow these modern day mercantilists believe that this impacts the trade deficit with China. In reality, the United States benefits from China’s “currency manipulation”, at the expense of the Chinese citizens. To have a deeper understanding why this is true, “currency” must be analyzed as a good, and the Chinese government, in effect, is placing price controls on its currency. When analyzed under this light, the outcome is pretty clear: the Tax Payer class in China pays the economic cost of this action.

Economic Theoretical Considerations of Price Controls

In economics, there are two types of price controls. The first type is where the Government places a price maximum on a particular good or service. When this happens, the price maximum is above the equilibrium price. Based on the law of demand, the stock of the goods will increase, thus creating a surplus of that particular good. An example of this is the “ghost” cities in China. There are many buildings that are empty because the prices of those buildings are above the equilibrium price. The second type of price control is where the Government places a price minimum on a particular good. In the event of having the Government implements a price control that is below the equilibrium price, a shortage occurs. An example of this situation is the long gas lines that occurred during the 1970s when the Government implemented price controls.

Currency Manipulation is a form of Price Control

To move forward in this analysis, one must look the currency as a “good”. Looking back at the claim that China is manipulating its currency, let us look at the ways that this falls under the two forms of price controls, as mentioned previously. When the Central Bank decides to increase the money supply, based on the Central Bank’s estimates, and not what the market demands, it is placing a price maximum on the currency. This creates a surplus of currency in circulation. On the other hand, if the Central Bank decides to remove currency out of the circulation, but not based on what the market demands, it is creating a price minimum on the currency.

The Case with China 

The Chinese currency, relative to the US dollar, in this exchange, is a victim of price controls. There is an exchange ratio between the US Dollar and the Chinese Yuan. That ratio is “fixed”(sort of). When the Chinese central bank increases the Yuan supply, it creates a surplus of Yuan in circulation. Since there is an increase of Yuan in circulation, this devalues the Yuan, in terms of the US Dollar. Since the US Dollar is not commonly used by the vast majority of the Chinese citizens, and those citizens use Yuan to purchase goods and services, the Chinese citizens pay the price for the increase in the money supply. This is inflation. The Chinese citizens will see the prices, as expressed in Yuan, increase. This also usurps their savings, and it impacts citizens that are on fixed incomes. The goods they normally purchase take more Yuan to purchase, yet the dollar becomes stronger, relative to the Yuan.

Who Benefits from Chinese Currency Manipulation? 

It is obvious that the Chinese citizens are not benefiting from currency price fixing. The savers lose out, and the folks on fixed income also lose too. But, the folks who can hold US Dollars are “winners” in this scenario. Why is this true? Since the Yuan is being held to a price maximum, and a surplus is created, this drives down the value of the currency. Yet, assuming the US Dollar stays constant, this raises the value of the Dollar, relative to the Yuan.  The holders of the US Dollar, who live in China, they all benefit greater than the other residents who use Yuan.

Conclusion

This dynamic is simply an expression of Gresham’s Law. The higher valued currency, drives out the lower valued currency, albeit in a “black market”.  In this case, the US Dollar and Gold are held by a minority of individuals, political class and the tax consumer class–and the Chinese Tax Payer is using the devalued Yuan to use to purchase goods and services. This entire scheme is all set up by the Chinese central bank and Chinese government.