“It has gone up sky high because the Fed printed more than the banks could (would?) lend.”
Exactly. It’s a possible precursor to Fed draining the excess liquidity. Whenever the Fed buys a security to hold permanently on its balance sheet it creates the cash to do so. A bit trickier lately, as before 2008 Fed permanent purchases had to be offset by “currency in circulation”, Fed liabilities (to be exactly like Weimar Republic). After 2009 the Fed could buy securities without such an offset and claim that its “temporary”. Nevertheless, currency in circulation component of Fed balance sheet has been growing at 7% pace since 2009.
Anyhow, when these securities go back to the Fed, broad money supply is not growing as fast as it can, and the market indicates the Fed is creating excessive liquidity that should be mopped up. Sure, In case banks
Need this liquidity later, they can quickly get it by reducing reverse repos, but imho such balance is more of a precursor of a permanent balance sheet drain in which the fed will sell securities. Remember Fed’s account is
Blank check. Whenever they sell securities they hold the usd cash they receive disappears.
So, my interpretation is very simple, permanent liquidity Fed created is about to get drained. This will likely pop the everything bubble until such time that the Fed decides to be accommodative again. Fwiw, bank of Canada already drained some of Canadian dollars it created for the pandemic. A drain is different from tapering. It’s what happened in 2019 and why cash crunch appeared and why we had several sharp declines in US equity market. In my view the Fed monetary policy is way too loose for a 7% inflation. Such inflation drains the purchasing power of the economy by the way. The combined effect of Fed drain and inflation on asset prices can be horrific, as rising prices often require the Fed to print more or else there won’t be enough money. When the Fed does not print more, cash crunch appears. Needless to say cash crunch is made a lot worse if they actually drain liquidity. |
