Ben Bernanke and his cohort central bankers built a Brave New World (SOMA, SOMA, SOMA!) where central bank money printing would boost stock prices and the wealth created would trickle down to workers and cause a booming economy. If you doubted that, you are now seeing proof that maybe this world was a little bit of Lewis Carroll’s Alice in Wonderland along with the Aldous Huxley. Here’s what that could mean for your trading and investments now.
The Fed’s balance sheet remained virtually unchanged last week as the central bank finished up its regular mid month MBS purchase settlements, offsetting some creative and mysterious spaghetti pushing that cut assets. The Fed recorded a $15 billion drop in other assets, along with a long footnote about a few of the old alphabet soup programs that were instituted in the wake of the financial crisis. Most of these have been consolidated into the Fed’s standard balance sheet line items. The $15 billion reduction in “other assets” smells like a write down of the dregs of those special purpose programs that were never repaid. In today’s balance sheet terms, that’s not even a rounding error.
And so the games go on. The Fed entices the banks to move money from their regular deposit accounts (aka reserves) to RRP accounts or Term Deposits with the incentive of an extra basis point or two above the interest paid on excess reserves (IOER). They are supposedly testing the “operational readiness” of these programs as tools to raise interest rates. In reality, shifting excess funds from one balance sheet line item to another, with only difference between them being an infinitesimal difference in the required holding period, is a shell game. To the holders of the funds it’s all short term money, readily accessible, if not in an instant, in a day. And since they are excess funds for which they have no use, what difference does it make what they are called or whether they are demand deposits or 7 day term deposits?
If the FOMC really thinks these measures will work to raise interest rates by PAYING banks more income on excess funds, then the Fed is even crazier than I thought. Of course, the stock market seems likely to make the whole question of raising rates moot for the foreseeable future as stocks plunge and Treasuries rally.
Once the Fed stopped outright purchases last October, stock prices started to top out. But the BoJ continued to print, and the ECB started printing in March. Since all major central banks pump into one worldwide liquidity pool, and all the plumbing leads to the US sooner or later, we had wondered whether that would be sufficient to bolster US stock prices.
Since this long term QE business is all historically new, we had no basis on which to judge. We also wondered whether after 6+ years of seeing QE send stock prices higher, if at some point that would no longer work. I viewed the collapse of gold and oil as templates or signals that at some point the same thing might happen to stocks, but we couldn’t be sure.
It was the same when the Fed started outright purchases of Treasuries in March 2009. I thought it would work to push stock prices higher, but couldn’t be sure until we saw it working. By April 2009 it was clear to me that the fix was in, that it was working and would continue to work. The technical analysis told us that.
Now we are seeing the mirror image. We had wondered whether central bank money printing by two of the Big Three, with the Fed sitting on the bench, would be enough to keep stock prices bubbling away. The answer is now clear. They are not. The technicals are unequivocal, as I have chronicled in our Daily Market Updates. The money created by the BoJ and ECB isn’t sufficient to counter the capital destruction being forcibly exported out of China by the Margin Call Heard Round The World.
The biggest players in the China pool are outlawed from selling there so they use the rest of the world as a liquidity sink. The margin calls that have already happened have extinguished massive amounts of margin debt, and margin debt is money. That’s money that is no longer available to goose markets. The illusionary collateral that backed it has disappeared.
Regardless of how long the actual margin destruction goes on, the mindset of the major dealers and leveraged speculators around the world has shifted from generating bubble profits by marking up prices, to generating profits on the short side, and if conditions are adverse enough, to self defense. That entails deleveraging, thereby extinguishing money.
With collateral devaluation and diminished appetite for risk on the upside the world has changed. QE has been defanged. The players who have access to it will now use it largely to pay down other debt, and thereby extinguish the money that came into being when that debt was issued. At best we will be on a treadmill but the potential is great for the unfolding of the worst bear market in modern history.
The game of central bank market rigging has run its course. This brave new world we have witnessed is really the same old world, only stretched and distorted beyond recognition. We who have believed that when you stretch conditions too far, they revert violently, are probably in the process of being proven correct.