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When The Fed Has To Print Money Just To Print Money
While the topic of net Fed capital flows, and implicit balance sheet risk has recently gotten substantial prominence some three years after Zero Hedge first started discussing it, one open question is what happens when we cross the "D-Rate" boundary, or as we defined it, the point at which the Fed's Net Interest Margin becomes negative i.e., when the outflows due to interest payable to reserve banks (from IOER) surpasses the cash inflows from the Fed's low-yielding asset portfolio, and when the remittances to the Treasury cease (or technically become negative). To get the full answer of what happens then, we once again refer readers to the paper released yesterday by Morgan Stanley's Greenlaw and Deutsche Bank's Hooper, which discusses not only the parabolic chart that US debt yield will certainly follow over the next several decades, but the trickier concept known as the Fed's technical insolvency, or that moment when the Fed's tiny capital buffer goes negative. In short what would happen is that the Fed will be then forced to print money just so it can continue to print money.
From Crunch Time: Fiscal Crises and the Role of Monetary Policy, first the big picture:
Departures from the baseline, such as large-scale purchases continuing past 2013, or a more rapid rise of interest rates (a distinct possibility given the analysis presented in Section 3) would saddle the Fed with losses beginning as early as 2016, and losses that in some cases could substantially exceed the Fed’s capital. Such a scenario would at very least present public relations challenges for the Fed and could very well impact the conduct of monetary policy.
And more to the point, what happens when the Fed's Net Interest Margin goes negative. For the sake of simplicity, in the section below "creating new reserves" means quite simply "printing money" (purists will argue it is low-powered, base money, but realists will respond that since all money is fungible and a dollar is a dollar when buying a share of AMZN, as we have shown previously, it doesn't matter one bit how money printing is defined).
What would a negative remittance from the Treasury to the Fed look like? That is, if the Fed’s net income fell below zero, how would it fund its interest payments on reserves, and its operating expenses? Would it have to draw down its capital or take out a loan from the Treasury, asking the Treasury to issue new debt to do so? No, under the Fed’s new accounting practices adopted in January 2011, when net income available for remittance to Treasury falls below zero, this does not eat into the Fed’s contributions to capital or threaten the Fed’s operating expenses. Rather, the Fed would create new reserves against an item called the Fed’s “deferred asset” account on the asset side of its balance sheet. For example, to pay interest on reserves, it would simply credit the payee bank’s account at the Fed with the interest being paid, thus creating new reserves. The deferred asset account being run up in the process would serve as a claim on future earnings or remittances to the Treasury. The idea is that when the Fed subsequently returns to earning a profit, rather than return that profit to the Treasury, it would use the funds to run down the deferred asset, and the extra reserves having been created in the process would be run down as well.
Ok: so the Fed can't technically go broke - after all it can print money all it wants right, or as the paper says "create new reserves" (just so it can go back to its baseline operation since 2008 which is... creating new reserves)? Well, not really.
The Fed's (low-powered) money is good and accepted by banks only as long as these banks deem it appropriate and profitable to onboard the Fed's liability on their balance sheet. And to do that, the Fed will have to offer ever higher and higher rates on excess reserves. To wit:
In the present environment, when the demand for excess reserves is infinitely elastic, the creation of new reserves would not be a problem. But in the baseline exit scenario we are discussing, short-term assets have a positive yield and the demand for reserves would not be infinitely elastic. To persuade banks to hold a higher volume of excess reserves in such an environment, the Fed would need to increase the interest rate paid on excess reserves, otherwise the new reserve creation could, on the margin, become inflationary. It should be noted that this reserve creation is a second-order effect of the selling of assets by the Fed with the aim of running down excess reserves (and raising longer-term rates) in our baseline scenario. The capital losses incurred in this case would push up the deferred asset account enough to offset only a relatively small part of the intended reduction in reserves. However, even if the Fed were able to create additional reserves with no effects on the interest rate on those reserves, a cessation of positive interest payments from the Fed to the Treasury for a significant period could bring Fed policy decisions under greater public scrutiny, potentially leading to controversy that could even threaten central bank independence.
In other words, as the MS and DB strategists put it so tongue-in-cheekly, once it becomes public knowledge that the Fed itself is broke in all but one technicality, and the resolution to said technicality is to go fully Weimar retard, the only hope the Fed will have to keep demand for dollars is if it gets caught in a closed loop of hiking rates ever higher just so banks keep onboarding reserves allowing the Fed to preserve the myth it is solvent, in the process pushing its NIM even lower, and needing to create even more "new reserves", rinsing and repeating.
Or, said otherwise, print more money just to be allowed to print more money.
In simple terms: a positive feedback loop which starts once rates begin ratcheting ever higher, and which ends, well, once the dollar loses it reserve status, and the initial goal of the Fed - to inflate away some $40 trillion in global excess debt is attained.
Ok, but this who knows when this happens right?
Well, yes and no.
As we showed last week, the rate at which NIM goes negative and the above feedback loops begins would be at approximately 4.5% on December 31, 2013. The "breakeven" rate unleashing the inflationary cycle would then decline by about 1% each year assuming the Fed's balance sheet continues rising at a pace of $1 trillion per year.
So the good news for all those who have been wondering just how much longer the Fed can continue doing more of the same while providing a free lunch for all is that we now know there is a temporal bound: the longer the Fed does nothing to change the status quo, the lower its "rate buffer."
Of course, there is a resolution: the Fed simply begins to sell its assets, and in doing so, destroys the reserves created when said assets were onboarded on the Fed's balance sheet. But there lies the rub: because the second the Fed enters open deleveraging mode, everyone will sell everything they can to lock in the profits generated from the past 4+ years of Fed balance sheet expansion. Furthermore, at that moment, the market will begin pricing in the unwind of some or all of the $15 trillion in central bank liquidity which is the only reason the S&P is where it is today. The result would be a market crash so epic it would make the market response to Lehman and AIG's failure seem like a walk in the park by comparison.
Which is where you come in dear retail investor, and the whole myth of the "Great Rotation." Because unless there is someone who will start providing a bid into which the banks can offload their securities in exchange for cold hard cash, as was explained earlier, the entire stock market ramp of the past 4 years will have been for nothing. It is also why day in and day out the media bombards everyone, as it has in the beginning of every year for the past three, that the time to enter the market is now, and there has never been a better time (ignoring that the market is now more expensive on a forward multiple basis than it was at the last market peak in 2007). Of course, one of the amusing tangents here that the media and the Fed hope and pray everyone forgets is that the Fed is monetizing debt not equities: and that to do what the Fed does one should be buying the 30 year, not some Div/0 P/E stock.
Either way, unless the greater fool comes in and is once again willing to become the bag holder of last and only resort for the smart money, then all those firms, such as the abovementioned Morgan Stanley and Deutsche Bank, whose chief strategists penned the paper referenced above, will start getting nervous, and asking themselves: how much time is there before everyone else appreciates the risk of the D-Rate and sells first.
Because while as a ponzi scheme works on the way up as long as there is at least one more marginal buyer, the inverse is far more troubling, and it is here that the old bastardized Prisoner's Dilemma comes into place: "he who sells first, sells best."
And the biggest irony is that soon it will be the very act of the Fed continuing to expand its balance sheet at the current breakneck pace of $85 billion per month (or more), that is what will make banks ever more and more nervous.
Could it be that we are finally approaching the end of the lunch, and suddenly the realization that it was never free hits everyone at the same time?
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No Ponzi here, honest.
Just put your money in the mawkets and move along.
These MBS are paying principal and interest. That cash flow will be enough to prevent NIM from going neagtive even if they have to rearrange the books a bit.
Instead of wasting energy on angry verbal assaults we should use common sense to figure out what kind of money system is an appropiate substite for the current Ponzi scheme. Otherwise after the crash will be before the crash.
Sapere aude
Printing just to print ....
Is that like when 45 went to 85?
Could be a sign of exponential growth in something. Is 109.99 coming soon?
See http://www.zerohedge.com/news/2012-12-14/qe-4-folks-aint-normal-what-you...
Chalk this up next to death and taxes:
As long as the current world order ("Pax" Americana) persists, the Fed will never shrink its balance sheet. It will never even stop expanding it. If it did, the federal government would have to shrink or die, and neither is acceptable to the people who control it and the Fed.
Only when they're done with the United States, when the parasite has moved on to the next host and we're left like Britain 1945, a hollowed out former super-power, will this end. Only then will they stop printing and let the federal government be forced to shrink, since they'll have a new dupe ready to take over the job.
Gold is the only REAL money ....
What can i say, i loved this read so much <3
WE ARE ALL FUCKED! Whether you are in the US or outside...
Prep up..
major averages are a flat market now...a dead market ever since new years
With graphs like these, Morgan Stanley must be long Arms manufacturers
: "the Fed will be then forced to print money just so it can continue to print money"
As long as OPEC sells their oil for U.S. dollars, the Fed can print all the money it wants to.
Absolutely correct.
That is the only that matters.
Once a country goes down this path, there is no turning back.
As the Democrats try to expand their Voter base by putting more people on Government support, thru Welfare, Disability, Food Stamps, Section 8 housing, no Taxes are paid and there is Money going out and not comming in. As anyone on Government Support is not a Tax paying Citizen anymore.
Also with the new Health Care laws and every worker restricted to 30 hours a week, you restrict Taxable Income.
Is it any wonder there is not enough Money to fund the Government?
Maybe Bernanke should concentrate on lowering and or limiting Welfare. This could push people from total dependency on the Government to paying Jobs where they would contribute Tax Dollars to support the system instead of the system supporting them.
No one will want to own stock in a company like that. Instead of learning from Lehman they became a Lehming. Got a gang of morons working at the FED with The moronsky Bernanke running the show.
All this lending and no collateral, so it's phoney money. This will end soon, and then they'll need gold as collateral. Er, of course, .Gov does "own" vast tracts of "American" land west of the Mississippi. But that's really "ours", right? The "law" sez so. And besides which, how could they transfer it to the owners of the FED. "Laws" against that, too. Can you imagine the "public relations" problem that would cause? They wouldn't dare. They'd have to do a whole lot of lying.
Gold.....The only REAL money. Got Gold
Sadly while that may be true for individuals, it isn't for empires.
Sorry.
Unemployment rate finally explained..
+55 zillion.
But what about the "disabled", early retirees, college grads that haven't found their first jobs, etc? Third base > 22%.
Suppose I put together an "army" and went and "liberated" some "land". No, I don't "steal" the land, no way, dude. The native people can stay just as long as enough of them agree I have "liberated" them, OK? I simply make sure that the "mineral content" of the land is delivered in a way suitable to the "markets".
Can I use this as collateral? Even if I simply ascertain that the minerals are there and don't remove them, yet?
[Important note: by mineral content I do not mean "oil". The world's oil supply has all been discovered and there isn't anymore even in the places where no one has looked, yet. For more information, see the oildrum.com.]
Perfectly legal as long as you send some "Settlers" in there to settle the land.
No. That is not what you do. Leave the natives their agriculture and way of life. Just steal the Xenite, as they used to say on Star Trek. Prime directive. Land they know. They don't know Xenite for shit. They'll never miss the Xenite.
It's not stealing if you give the Trogglytes gas masks -- just saying.
The (bankster) authors say:
-- This is Stockholm Syndrome and it's BULLSHIT. Banksters are (allegedly) worried that the "excess" in excess reserves will translate into excess lending, thereby causing inflation so they propose giving MORE money to banks to bribe them against lending. "We don't really want more money, we really regret having to take it, but, you know, it's in your best interests". Say what? FUCK OFF.
-- Here's a better idea: crank up the minimum reserve requirement in direct proportion to the size of fresh reserves being created as the Fed exits its accumulated asset position (at a loss). Ie, make the banks eat their shit. This deletes the "excess" in "excess reserves", costs nothing, and can be done with the stroke of a pen. China has done this many times producing a short-term spike in SHIBOR as banks cut interbank lending to bulk up their own reserves (it washes through quickly).
-- Better yet, slowly reverse all Fed purchases at the original prices and make banks slowly eat the the shit that they dodged in 2008 by pushing it all to the Fed. Some of those assets are in the black (hence the true reason that banks cry for their IOER), others are deep in the red. Net it out, push the deltas back to banks and let the chips fall where they may. Many banks will be killed off in a controlled manner as they should be.
-- But no, we get the old bullshit line about having to use IOER as a tool to contain inflation. The truth is that IOER is a trickle bailout and it has nothing to do with inflation dampening. They say "inflation dampening" as double-speak to make it seem legitimate because they all know that, being afraid of inflation, suckers will fall for the lie.
-- Along with myriad other trickle bailouts (each small enough that they hope you don't notice, but together making a solid flow) the hole that Wall St dug for itself is steadily being filled by the Fed while Main St gets nothing, resulting in asymmetry and a transfer of wealth, aka, theft.
-- Now regular readers of ZH will know that this whole conversation is merely academic. Neither IOERs or increased minimum reserve requirements, or increased (traditional) banking regulation are able to curtail inflation. Why? Because whatever limitations are placed on traditional banking will immediately be offset by an expansion of fraud in shadow banking. To be effective, limits on credit must apply across both traditional AND shadow banking.
-- "Reserves" in traditional banking are money. "Reserves" in shadow banking are anything at all (provided it can be declared as an "asset" with some kind of "market value" (usually a lie)). The equivalent of increasing minimum reserve requirements in the traditional banking system is to limit rehypothecation in the shadow system and increase collateral requirements. Rehypothecation is the money multiplier in the shadow system, it is unconstrained (in London anyway) by any "minimum reserve" for underlying assets. This is a primary source of the excess credit that destroyed the world economy.
-- I say to hell with it, put a stop to all this fraud once and for all. A fully enforced 100% reserve requirement and a full ban on rehypothecation of any form stepped into linearly over 10 years to contain the carnage. If banks and shadow banks want to gamble then they will have to do it with their own assets, or with the assets of willing speculators who know the risks of signing on, not with the assets that belong to depositors.
The Fed has one option not mentioned. The Fed never paid IOR before 2008, anyway. This was only done to keep the bank interest margin positive. The Fed has the power to set reserve requirements for all banks. They can start hiking those reserve requirements without increasing IOR at all. Then the Fed can hold its T-bond stash to maturity and would never lose money. The cost of this option could be some bank failures, though.
I'm surprised at how many people here don't realize the role of the Fed. The Fed is a "ghost". It has no "obligations", nor "liabilities". It plays the middle-man with an axe. The Fed is deliberately accumulating the nation's debt because the Fed has the power to collect on that debt. When the SHTF, a few people are going to become mega-rich; taking everything from the American people, especially all private and public lands.
+1 gazillion. These bastards are purchasing the world with CNTL-P. No gold standard means no accountability.
Absolutely correct.
'Morton's Fork'
[the high road?] status quo = positive loop
[the low road?]savoir`faire = negative loop
Isolated in a economic financial grid, both axis seem suitable-- it is only when an exogenous event trips the Qe ground-fault... that the SHTF! Whereas, simultaneously an endogenous [in?de]flationary rubicon event renders the vault'd fail`safe, null-n-void-- in what has to be a classic case of carpe`diem, aphorism du`jour!?
Paradoxically, a self induced pyrric, haphazardly languishs near the closing timeline threshold of reality... whilst, a delusional state of grandeur seemingly presents, in all, of but... mankind's foiblely sordid glory of a skeletal phoenix [a]rising.
Summary: This is where we are today... 'caught between the horns of a dilemma'-- 'a rock and a hard place'... drowning mentally in a 'Scylla and Charybdis' folly-- caveat... but one has no choice[?], for all that life is, is,... but a closed loop, and, what you make of it in an open or closed mind?!
jmo
@Zero:
The Fed is a reserve bank, not a depository bank, it doesn't have a capital structure or make a profit (or take a loss, either). Capital only becomes an issue when (notice I didn't say IF) the central bank offers loans in excess of stated collateral, that is, makes unsecured loans. So far, the Fed has been very careful not to do so.
Only then is the central bank insolvent, and when it is so it is so permanently (under conditions where private sector finance is insolvent). This is why nominal gross-domestic-product targeting (NGDP) is a problem: the central bank makes unsecured loans ... and becomes a large commercial bank with insufficient capital by doing so.
When the central bank exceeds its portfolio in this manner there is no guarantor of bank liabilities or lender of last resort. There are bank runs as the only collateral for the entire defunct banking system is currency deposits (unsecured loans to banks). There are ongoing depositor runs in Europe and Japan right now, this indicates there is unsecured central bank lending. There is tension between what the central bank seeks do gain and what it wishes to avoid: It wants to support non-deposit asset prices (which is a bank run) at the same time defend the private sector banks against the consequences of bank runs.
People buying gold, FOREX, airlines, overseas companies, Picassos and expensive houses in LA are all 'slow' forms of a bank run. Peeps doing all at once when they otherwise wouldn't do so is the sort of money panic that the central bank was created to remedy: peeps pulling cash out of China, buying Phoenix or Vancouver real estate, Japanese companies buying US firms w/ dollars, Italians buying CHF. Beware of what the central bankers want, they might get it.
Meanwhile:
Insert irrelevant hyperinflation argument here! We've had a +30 cycle of inflation, of loans being extended. We are entering a long cycle of loans being repaid ... by borrowers, lenders or the greater public as a whole. The extension cycle is inflationary, the repayment cycle is deflationary. Any and all central bank lending at this point is the feeble, last ditch attempt to extend the lending cycle, to pretend to offer more credit, to add loans to a stockpile that has grown to become unservicably large.
The demand for repayment is a decision the borrowers have already made, there is no turning back by the central banks.
Net interest margin is irrelevant b/c the Fed doesn't have to earn a profit, it isn't a depository institution. What the Fed offers is credit to a Fed account, there is no (currency in) circulation unless the holder of the account is facing a demand for reserves, that is, the depository institution's own balance sheet is collapsing and there is a run on that institution. At that point, institutional liabilities will HAVE TO exceed reserves! The bank will close and the (slow) depositors will lose all their deposits!
What the Fed is actually doing by way of QE Latest is to guarantee the marginal bank deposits, (by appearing to leverage against the same deposits, btw).
This -- not spurious currency inflation -- is the real danger. The Fed is creating incentives for depositor flight by implying a guarantee of bank liabilities against the effects of such flight.
Is there something wrong with the banks we should know about, Mr. Bernanke, that you must guarantee $45 billion of bank deposits every month?
Believe it or not, this article indirectly makes the same argument Paul Krugman made last year when he argued banks were reserve constrained (and central banks are capital constrained). In reality, central banks are collateral constrained: there can be no central bank derived inflation or 'money printing'. The 'Fed money printing' argument is simply peak oil denial.
Private sector finance prints money by making unsecured loans (30X capital), it becomes invariably insolvent by doing so. It must because the only way finance companies can support their own balance sheets is to increase leverage.
Keep in mind, the banking system ledger is being unwound: repayment is underway. As the Fed balance sheet expands, the private sector balance sheet shrinks faster ... abetted by futile moves of the Fed. Unfortunately, until the Fed can produce four or five new Saudi Arabias and do so quickly, all it has to offer are more futility-plus-watching and wringing hands.
It can cry, too.
I think it is as simple as nothing really mattters or will change in Washington or Wall Street as long as the dollar is the reserve currency.
It appears to me that this article makes a major assumption....that the Fed is operating in its own little vacuum or universe.
As we know from the current race to debase, the Fed is also subject to pressure from the actions taken by other countries. That element is fairly important as a rising $ will eventually lead to the crushing of our few remaining manufacturers as imports undercut them even more.
(re-posting)
Based on my observations, I think QE is dead. I'm expecting the Fed in march to signal the end of it.
There's nothing left to buy and own, nothing real or productive is left to trade. Stocks, commodities, houses are currently all owned by Gov+ CBs + Primary dealers/major world banks and placed in storage. Directly or indirectly the govs already own everything, no need to print more money.
Legally this is equal to expropriation, and a reminder to everybody, expropriation is legal in the western world.
http://en.wikipedi...wiki/Expropriation
I DECLARE: QE IS DEAD
We are left with two options:
Option 1 - one or two primary dealers/major world bank get pulverized (one or two of deutsche bank, merryll lynch, rbs or all 3)
Option 2 - wall street closes shop
I think option 1 is about to happen, extremely soon, extremely fast.
Question: Isn't the level of IOER actually entirely at the discretion of the Fed? Noted that if IOER goes up to 4.5% that NIM goes negative and the discussed scenario becomes plausible, but the present IOER is closer to 0.50%. Conversely, they were discussing actually lowering the IOER to 0.25% or even 0% a couple of months ago. I doubt the "inflatioary" argument from the article is likely to be an issue: IOER at 0.5% is just as unlikely to keep the reserves held as any other percentage; any "inflationary" pressure that the Fed may be concerned with from the excess reserves is almost certainly already in the system.
The IOER certainly can't be made negative, since the member banks would then never agree to additional reserves, but on the other hand I can't see them concerting to push the rate all the way up to 4.5%, certain not in the timeframe we're talking about.
I enjoy the irony of a situation where the Fed has to print money to print money, but I'm not convinced on the plausibility of the scenario: this seems more like a hypothetical intellectual exercise than a genuine possibility.