I’m not an economist, I don’t play one on TV, and staying at a Holiday Inn Express wouldn’t help me one iota. But these days, anytime I hear the words ‘Federal Reserve‘ and ‘print money‘ in the same sentence, I start paying reeeeaaal close attention.
I carved out as much of the economics minutiae in the article below as possible, to make it easier for everyone to follow, …including me.
“…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 [***which the ZeroHedge guys refer to as the “D-Rate” ].
In short what would happen is that the Fed will be then forced to print money, just so it can continue to print money.“
Hey, THAT doesn’t sound very good! And this sounds worse:
“Ok: so the Fed can’t technically go broke – after all it can print money all it wants,… 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), right?
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.”
And this process will necessarily keep happening, faster and faster. Which begs the question: “how could the Federal Reserve stop this inflationary cycle?”
I’m glad you asked:
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.
One more quote from the guys over at ZeroHedge:
…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 above-mentioned 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?
And the answer to “what happens THEN” is pretty simple. To paraphrase Frankie Valli: Greece is the word.