The following article comes with a surprising revelation — possibly an alarming revelation — at the end. Something big is happening at the Fed — the largest movement of “cash” in history. I don’t know what to make of it, because the Fed has been completely silent about it, and the mainstream financial press has missed it entirely. Crickets.
I published this article as a Patron Post exclusively for those who kindly support me at the $5 level or above before I knew anything about the big money moves that suddenly appeared in Fed data. I found those moves right after researching for this article. Because they prove the article’s theme, I added them after publication. (Patrons may want to make sure they’ve read the latest additions.)
Because these addenda may have great importance, given the scale of monetary change and the total quite on the Fed’s part about it, I promised all readers I’d share this article later with everyone for free and write another Patron Post just for patrons, but they got it days ahead of others because they support this site. I am, however, about helping as many people as possible, so here it is.
I’ve left the article below unchanged in substance, except for the updates at the end, but you’ll grasp the importance better if you don’t jump to the ending:
When I proclaimed last spring “The Fed is Dead,” I clarified, of course, that the Fed is dead in terms of its ability to single-handedly raise the stock market or the economy. In October, a former Fed head agreed:
While not nearly as provocative as his mid-2019 op-ed, in which former NY Fed president and Goldman partner Bill Dudley urged the Fed to crash the market to prevent a Trump re-election, which had the dramatic effect of a loud fart in a crowded room as countless “serious” pundits did everything they could to avoid discussing the fact that a former Fed official admitted that the central bank is i) more powerful than the president and ii) can arbitrarily manipulate markets at will … Bill Dudley took to his favorite media outlet … and in a Bloomberg op-ed … was forced to “explain” that the Fed is not bluffing when it begs Congress to inject trillions into the economy because – you see – after a decade of the Fed doing just that and enabling the terminal political dysfunction and polarity observed in US politics, the Fed no longer can do it.
As Dudley puts it, while no “central bank wants to admit that it’s out of firepower… unfortunately, the U.S. Federal Reserve is very near that point. This means America’s future prosperity depends more than ever on the government’s spending plans — something the president and Congress must recognize.”
That is exactly what I stated last spring when I was probably the first to starkly state “the Fed is dead” while everyone else continued to believe the Fed could still single-handedly lift stocks and stimulate the economy. A few months later, ZH joined me in laying out how dead the Fed was. Now, I’m joined by a former Fed head.
That is why we have, ever since, seen the Fed dithering about doing anything apart from a joint fiscal operation with the US government. Simply put, the Fed is not leaping at the opportunity to prove, as it demonstrated last March, that in can no longer lift the stock market in any sustainable way on its own.
After all, every time the US economy needed a quick sugar high, it was not Congress but the Fed that stepped in to inject trillions in liquidity, or cut rates, or both, and since this calmed markets, it remove all political incentive and desire to take the difficult and in most cases, unpopular political decisions that would have created a Congressional tradition of passing fiscal stimulus when the need arose, in the process helping the economy not the markets.
The path is now more difficult because the Fed must convince congress to take action by holding itself out of the game until congress does add its own force. This, we are seeing again, as the Fed remains aloof while congress now dithers over whether to pass another stimulus bill, same in size as the bailout bills that were first passed during the Great Recession.
As I noted from the start of the Fed’s efforts, over which I began this blog, and as ZH says it also noted back then …
While Dudley will never admit any of this, he at least concedes something else we have said for the past 11 years: by pulling demand from the future by cutting rates and injecting liquidity, the Fed has merely doomed the economy to even more pain in the future. Note – not the market, which is at all time highs – but the economy, as even Dudley admits. This is how Dudley hopes to convince Congress that after doing everything to push stocks up, even if it meant zero impact for the economy, it no longer can do even that:
Dudley states without equivocation,
There’s always something more that the Fed can do. It can push down longer-term interest rates by buying more Treasury and mortgage-backed securities, or by committing to keep buying for a longer period of time. It can…. But this misses a crucial point. Even if the Fed did more — much more — it would not provide much additional support to the economy.
David Stockman has also long said that for the next go-around, which is now this go-around, the Fed is out of dry powder. Dudley lays out why that is in specific detail:
Interest rates are already about as low as they can go, and financial conditions are extremely accommodative. Stock prices are high, investors are demanding very little added yield to take on credit risk, and a weak dollar is supporting U.S. exports. The rate on a 30-year mortgage stands at about 3%. If the Fed managed to push that down by another 0.5 percentage point, what difference would it make? Hardly any. The housing market is already doing very well.
Even Dudley now gets how doing all of that over the past ten years just pulled our future buying power forward so that we don’t have any buying power left now that we have hit a true crisis:
… the stimulus provided by lower interest rates inevitably wears off. Cutting interest rates boosts the economy by bringing future activity into the present: Easy money encourages people to buy houses and appliances now rather than later. But when the future arrives, that activity is missing. The only way to keep things going is to lower interest rates further — until, that is, they hit their lower bound, which in the U.S. is zero.
I always said the Fed would learn that lesson too late. That’s why I’ve written my blog all these years to keep making it clear that this could be seen coming for the day when it finally got here. My hope has been that the Fed won’t get away with saying, “No one could have seen this coming.”
Rather, everyone should have seen it coming. If you use up all your stimulus powder pulling future buying power into the present to goose the present even when you are claiming the economy is basically strong, you have no reserve capacity left when you really need it.
Dudley even states that it is now inevitable that future returns on stocks will be lower, not higher, because there is no push or pull left to get the prices up.
In other words, in a world in which stocks must rise every year to boost the net worth of the average (if not median) American, the Fed has set the seeds for the next market crash.
That doesn’t mean there won’t be some temporary goosing that gives the market a nudge up here or there by extraordinary means, but the economy will not rise to support such valuations for years, and the free money from the Fed to keep squeezing things upward along a climbing path is increasingly is not easily doable now that it requires getting Republicans and Democrats to agree on stimulus and has some serious downside effects at this point in the diminishing-returns curve, which I can lay out in very simple, easy-to-understand terms below.
In terms of the agreement problem, if Democrats take the senate in January, there could be one more partial year of successful goosing because the government will become unrestrained in adding its full fiscal muscle to all the Fed can do.
The problem with the diminishing-returns curve, however, was already laid in and is essentially now unsolvable because the Fed made sure the economy and stock market are both fully addicted to full-on Fed stimulus all the time, as even Dudly now says:
When interest rates stay low for long enough, the policy can even become counterproductive. In the U.S., monetary stimulus has already pushed bond and stock prices to such high levels that future returns will necessarily be lower…. As a result, people will have to save more to reach their objectives, be they a secure retirement or sending their kids to college. That leaves less money to spend.
Save? How do you do that when savings offer zero interest? You longer you save, the more you lose … just to inflation. The Fed has made certain of that; but now it is caught in a trap because, as I also noted this year, we are finally entering a time when inflation could go up.
For years, I’ve completely avoided saying inflation was any risk for the year on this blog, always maintaining inflation would go nowhere each. year because money was not circulating in the mainstream economy. This year, however, I moved off of that position because getting the government involved means finally pushing money into the hands of the masses where it can rapidly cause general inflation.
So long as the government only pushes enough mass money to replace what people are not making due to unemployment, inflation may not be a problem; but if they yield to the new realization of their powers too far in the present environment, it will quickly become a problem because COVID shuts down a lot of production and transportation and even retail, resulting in too much money chasing too few goods, which is the classic formula for high general inflation.
The alternative way of looking at that is that, if the Fed and government both realize this, the inflation problem curtails how much support they can and will give, which can leave the utterly dependent stock market flailing and the economy stuck in the mire. In that case, you get moderate stagflation as the government tries not to spin the tires while powering through the mud, getting occasional tire spin (which is the inflation-no-growth part).
Dudley seems to recognize that his savings plan cannot possibly work because the Fed has cut itself off for good from the option to return to taking interest rates where they need to be in order to keep ahead of inflation:
Low returns will eventually take a toll. State and local pension funds, for example, will fall even shorter of what’s need [sic.] to cover their obligations. To make up the difference, officials will either have to raise taxes or cut benefits for pensioners. Either action will leave people poorer, depressing consumer spending and economic growth.
This brings us into exactly the catch-22 situation I’ve said throughout writing my blog the Fed’s solution to the Great Recession would lead to. I’ve noted from the outset, the Fed’s Great Recovery program was an “unsustainable” program, so it ultimately does not lead to real recovery, but only to eternal dependence.
You cannot lower interest rates forever; but the catch-22 is that, once you create an economy that is dependent on low interest because raising interest will crash businesses and individuals under all the debt your years of low interest enticed them into, then you have to keep going with low interest. You have to starve savers who need to save because low interest no longer is enough even to support overinflated stock prices. The Fed, I always said, was boxing itself (and the nation and the world with it) into a corner.
With that, Dudley (as I predicted last spring you would find to be the case) cries out to congress to supply the additional fire power necessary to sustain this Ponzi scheme a little longer:
What to do? No doubt, Fed officials should still commit to using all their tools to the fullest. But they should also make it abundantly clear that monetary policy can provide only limited additional support to the economy. It’s up to legislators and the White House to give the economy what it needs — and right now, that means considerably greater fiscal stimulus.
Therefore, as the Fed sits this week to decide what on earth to do, you can expect its actions, besides holding the present line of continued support forever, will be something that comes in cooperation with federal government support. With the additional muscle of nearly a trillion dollars in government support being co-concidered this week, the joint action of Fed and feds can move the market again if they can get to the point of cooperating, which I think they will realize they must do.
Without that combined force, any Fed action is likely to effect only a brief market bump, and then the next big market move will most likely be the Santa Claws plunge that claws back the November rally and the bump. With joint action, Santa may be all cherry-nosed one more time.
We are past the days when the Fed can move mountains on its own and achieve anything more than a reflexive bump — if that. That is the new paradigm to understand — the new financial environment for which the groundwork was laid throughout the Great Recovery.
UPDATE 1: Something is seriously wrong at the Fed. Do you want some SOLID PROOF of just HOW DEAD THE FED IS?
HERE IT IS:
The Fed and/or its members banks MASSIVELY increased cash money supply (M1) in the last two weeks of November, and you probably didn’t even know it happened! No one even noticed. And what did stocks do? They essentially held flat along the same ceiling throughout the time of this monetary mainlining.
Expanding that graph out, it looks like this with the last two weeks being the final almost-straight leap at the end, steeper than ever seen:
That is a massive amount of new cash money — historically massive — done almost covertly in the quickest burst ever — and yet it did not even cause the stock market to blink! The value of the dollar barely changed its slow decent (so far), and bonds barely budged.
Here is what the US stock market did from the time when M1 money supply skyrocketed:
You’ve seen graphs of the Fed’s increase in its balance sheet over the years with its huge jolts of QE. The graph above (and especially the one below) of actual M1 money supply are a little different. They show how little all of that QE actually impacted total “cash” money (M1 money supply) — the stuff that actually circulates on Main Street and in your home — over those same years. You see only a steady rise, no big jolts from QE.
That, as I pointed out all along the way, was because much of the Fed’s new money creation was locked in reserves or just circulated in financial assets. Because it never moved into the general economy it created no inflation.
All of that changed with COVID. The government finally stepped in because the Fed was unable to accomplish anything for weeks in March, as the article I referenced in my lead laid out. With the government finally joining in, M1 (cash) money supply skyrocketed (the first big surge in the graphs above) because the government put the money directly into consumer’s pockets and into business payrolls. Still no inflation because they were mostly making up for money lost due to unemployment.
The graphs, however, make it clear why inflation under the new regime could become a much more serious problem than the limp moves seen over all the years of the Great Recovery, the difference being how fast the Fed’s QE is now converting into cash (which means coins, bills, checking accounts and other demand deposits that can be immediately spent) — the most liquid form of money:
You can see the balance sheet over that same time period (the differences made by QE) and can see no big difference has happened in the last month:
Why have stocks not skyrocketed during this latest huge cash expansion? It may in part be because the federal government has not yet joined the Fed in the stimulus effort as it did when it added its muscle to the shover earlier in the year when stocks soared. All market eyes are on what the government is going to do this week, proof the Fed is now impotent in the stock market, until the government adds its muscle.
More importantly, why did such an enormous surge in money supply happen in the last two weeks of November with no financial articles being written about it and no statements from the Fed about it? What is going on behind the scenes at the Fed and/or US treasury right now?
It’s a little bit alarming in that it looks like something serious is breaking down behind the scenes. Maybe it is just due to the Fed implementing policy approved last spring with funds that remained unspent, but it all happened without a sound. The Fed’s policy notice subsequent to its November meeting contains no explanation, and the Fed likes to claim transparency.
The Fed did not increase QE or cut interest rates at its November meeting. Powell mentioned no policy changes at all in his presser. Yet, the burst in “cash” money supply after that meeting is unprecedented. Such a big rise in M1 without any increase in QE or cut in interest rates would indicate existing less-liquid money was suddenly turned into cash, but M2 didn’t change much.
Was cash jolt for emergency reasons? The Fed completely eliminated reserve requirements back in March as a COVID response, allowing banks to use reserves at will for emergency cash management, which is why the Fed requires banks hold reserves … so they can be deployed during dire times. (See: “Federal Reserve Eliminates Reserve Requirements.”) So, my first thought was that banks suddenly had have a massive need for emergency cash and moved money from reserves into circulation, but the Fed’s graphs indicate reserves plunged earlier in the year when the reserve ratio was eliminated, but that they have started recovering since then:
I’ve consulted economic discussions to see if I can find anything about this rapid increase in M1, and I have written to other financial writers, but I have found nothing but guesses. I did glean, though, that the M1 money supply shot up without the velocity of money rising. That, too, is a bit odd, but it indicates the money is being parked away somewhere where it is not circulating, except that stock and bond prices have barely budged, so it’s not going there. They would have to change a lot in order to absorb so much money and remove it from circulation by keeping it in financial circles. Plus buying stocks just makes the cash money someone else’s cash as you take the less liquid stock asset, and the cash you traded for it sits until someone else figures out what to do with it.
I’m still trying to dig out what is happening; but, as I say, I can’t find any reportage on it other than the data/graph that shows it happened. I’ve put in an information request with the Fed to find out how they explain this large anomaly, and I’ll let you know if I hear anything useful back.
UPDATE 2: The Fed has spoken, and it did nothing this week — nothing that lifted the market, no change of substance in any of its policies. It did as I thought it would and continued to wait until the federal government does something because The knows but does not want to prove it cannot move markets or the economy without the government’s muscle working alongside of it, just as I and ZH and Dudley have said. So, it sat on its hands at the last two meetings, waiting for the feds to join it.
The market barely budged in response to Fed insignificant actions, but that is big response of its own. Over the past decade, the market has been extremely attentive to the Fed and always slavering for more support. The fact that it barely moved, closing almost flat with its opening, is yet another indicator the Fed is losing its mojo. (Fed and feds when they apply their muscle synchronously, however, remain a strong force for the time being.)
Since the last update, I’ve done more research on other Fed programs, but there is no explanation for the big shift in money supply in those numerous programs either:
The Fed’s Special Purpose Vehicles are just idling on standby. Five of them go out of existence at the end of the year thanks to US Treasury Secretary Steven Mnuchin, who says they are not needed anymore (the PMCCF, SMCCF, MLF, MSLP, and TALF programs).
Fed corporate bond purchases are almost dead (down in hundreds of millions, nowhere near even one billion). Corporate bond ETFs have been out completely since July.
All Fed Repos have been cleared off the balance sheet — as in zilch. That, too, happened back in July and has remained near zero since.
Central-bank liquidity swaps have drained to almost nothing. Those exchanged liquid dollars to foreign central banks for their US treasuries. They are down to less than $10 billion per month — small potatoes on the Fed’s multi-trillion-dollar balance sheet.
And, as shown in the graph above, the rate of QE hasn’t changed since its first expansion at the start of the pandemic ($80 billions in US treasuries per month plus $40 billion in those dastardly mortgage-backed securities — a QE rate 50% higher than QE3). In fact, I think it backed off on its MBS purchases. The only change the Fed made in its December meeting this week was to clarify its present QE rate will continue until inflation hits and holds at the Fed’s target and the unemployment gets back down to where the Fed wants it. It also said that amount of QE could go up if needed, but that is not something the Fed sees happening unless the pandemic becomes much worse.
So, where has all the money gone? Looking over the Fed’s balance sheet, I could see no moves that cone close to that amount in those weeks. Be vigilant for inflation because big shifts into money’s most liquid form can create huge inflation IF we wind up with too much money in the hands of actual consumers or business operating accounts chasing too few goods. The cash is there, but where is there? I’m still looking for it.