Monetary inflation: the next step

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by Alasdair Macleod, GoldMoney:

Earlier this month the US Treasury released its plan to flood the financial system with cash by reducing its balance on its general account at the Fed by $1.229 trillion by not renewing an equivalent amount of T-Bills.

Separately, the Fed will continue with its QE at the rate of $120bn every month, which combined with the Treasury’s plans means an inflation of the money supply totalling $1.829 trillion [(120×5 months)+929+300] is in progress from the beginning of this month until end-June. This does not include the planned stimulus of $1.9 trillion.

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The banks do not have the balance sheet capacity to take this expansion on board, and if they are forced to turn new depositors away it will almost certainly be by charging for deposits (imposing negative interest rates). That being the case, not only will the US economy be flooded with unprecedented levels of inflated money, but commercial banks will implement negative rates without the Fed having to do so.

To prevent this outcome, the Fed will have to extend the temporary exemption from the supplementary leverage ratio due to end in March and remove the $30bn reverse repo limit on money funds, allowing them all to access the Fed’s reverse repo facility and avoid “breaking the buck”. At this late stage there is no sign of the SLR being extended, and a policy with respect to money funds may or might not be forthcoming.

But with the Bank of England signalling that it will introduce negative rates later this year, leaving the dollar as the only major western currency at the zero bound, it appears that the solution is indeed to flood the markets with dollars and force the US’s commercial banks to adopt NIRP on the Fed’s behalf.

And with dollar term rates already rising, not only is it likely to be too late for the Fed to succeed with an operation twist, but the bubbles in financial markets risk being undermined by rising bond yields, taking the dollar down with it in the style of a John Law combined bubble and currency collapse.

Gold does not discount this outcome and can be expected to drive its fiat price substantially higher.

Introduction

It is extraordinary that anyone who pretends to know something about economics thinks that inflation is something that happens only to prices, loosely connected to changes in the money quantity. And for xenophobes, it is an unfortunate condition which only afflicts minor, foreign currencies.

When so-called economists deny a firm connection between reckless monetary expansion and rising prices, you would have thought that the empirical evidence would act as a check-stop. But no, in support of statist planning economists rely on supressed evidence and economic models which are programmed to assume every extra dollar benefits economic activity without contrary effects, and that every fall in interest rates is an encouragement for the expansion of economic activity.

The parameters which guide policy decisions have become wholly artificial. The CPI is now so tamed that the consequences of monetary inflation for rising prices are barely visible. And GDP, no more than an inflated money total, substitutes for the genuine economic condition. Now that the true consequences of money-printing are suppressed, the mantra has become to inflate or die.

Inflating the quantity of money in circulation has become the most important objective for monetary policy. The other stuff about interest rates, quantitative easing and yield curve control is little more than supporting flimflam, even diverting attention from the inflation objective which reeks of confirmation bias. Confirmation bias is reinforced by the increasing dependency of the state on this form of financing. The fact it is apparently free money, justified by its alleged stimulative qualities, makes monetary inflation highly addictive.  An understanding of the damage it causes is casually dismissed and along with it the painful alternative of cutting government spending to escape a downward spiral into the financial gutter. As an inflation addict, the US Government is edging closer to that gutter, now with the addition of an intensified socialistic modern monetary theory adopted by the Biden administration.

MMT is just another form of confirmation bias for inflationary financing of government spending, and there is nothing modern about it. Since time immemorial governments and their epigones have sought to escape the limitations of unpopular taxation and justify access to a free money tree. Only the language has evolved. The accumulating evidence is that the US Government, claiming a renewed democratic mandate, has become so addicted to money-printing that its escape from the consequences of debasement has become well-nigh impossible. It is this that led me recently to accuse America of already being in a state of hyperinflation: my definition is that of a state which has embarked upon a course of inflationary financing which accounts for most of its income and becomes practically impossible to reverse. Since last March, both these conditions have been fulfilled.

Unless you are blinded by economic models and neo-Keynesian macroeconomics, you will see that it is now just a matter of recognising the waymarks illuminating the route to monetary and economic ruin. We passed the first, where inflation stimulates the economy – utter nonsense when the hidden consequences are taken into account. We passed the second, where the supposed stimulation has become continual, only succeeding in transferring wealth from the productive economy and savers to the unproductive state. Then there was the third, where the state became dependent for the majority of its finances on money printing — the hyperinflationary condition that happened under the cover of covid. And now we have embarked on the fourth, the final destruction of money and the descent into monetary hell and economic ruin. Virgil’s Facilis decensus averni, indeed. But we can now surmise that the combined ambitions for the Treasury and the Fed to print money are about to exceed the capacity of the banking system to accommodate it.

The Yellen Treasury and negative interest rates

The Biden administration, and in particular its Treasury secretary, Ms Yellen, appears bent on a course of accelerating MMT policies in a desire to rapidly inflate the economy. That comes as no surprise. Follow the dogma, and you understand the next step is negative interest rates as the policy designed to stimulate the US economy out of its post-covid slump. The dollar and sterling are the only two major Western currencies whose central banks are yet to embrace this policy, yet the Fed remains reluctant. This appears to be the immediate objective behind a policy of overdosing the US economy with so much money, that the banks without the balance sheet capacity to absorb it will have little option but to discourage further deposits by charging depositors for the privilege, by moving their rates into negative territory.

We can’t know what private conversations have taken place between the US Treasury and the Fed, but this new twist to monetary policy bears the hallmarks of a combined operation that permits the Fed to duck the tricky decision to impose negative rates on bank reserves. If there is a plan, then negative rates will be achieved instead by the US Treasury flooding money markets by transferring its accumulated balance on its general account with the Fed into the financial system. Figure 1 below is extracted from the US Treasury’s Sources and Uses Reconciliation Table published earlier this month and illustrates the starting point whereby negative deposit rates can be achieved.


On 1 February the cash balance on the government’s general account at the Fed was $1.729 trillion, and by 31 March the Treasury planned to reduce it to $800bn, implying that $929bn will be injected into the financial system in the first quarter. At the time of writing, the most recent balance available is for 17 February at $1.567 trillion[i], which tells us that by the end of March $767bn was still to be added into the economy from that date, with a further $300bn in the quarter following.

There are two ways in which the balance on the US Treasury general account at the Fed can be reduced; either by spending it or by reducing outstanding Treasury bills by not renewing them as they mature. Given the very short timeframe between the administration assuming office in late-January these plans are almost certainly a policy of paying down T-bills ahead of the new $1.9bn stimulus, which is likely to be directed entirely at supporting consumers and businesses in the economy.

Our immediate consideration is the monetary effect on the financial system. With $929bn of T-bills not being rolled into new ones between 1 February and the quarter-end, the same amount of cash is liberated to be placed elsewhere by a combination of foreign central banks, money market funds and commercial banks acting for both domestic and foreign accounts. As Zoltan Pozsar in a note for Credit Suisse points out[ii], a foreign central bank can swap T-bills for deposits at the Fed’s New York branch, or it can use the foreign repo facility. No problem there, then. For money market funds there is little alternative to a reverse repo with the Fed, but these are limited to $30bn for each counterparty and not all money market funds have access to this facility. Furthermore, the rejection of large deposits by the banks lacking balance sheet capacity will encourage inflows into money market funds, which cannot invest in negative-yielding instruments and have the same problem as the funds they attract.

The reduction of holdings of T-bills by central banks and money market funds might push term rates down to the zero bound out along the curve for a year or so, and commercial banks will end up with larger balances in their reserve accounts at the Fed. But it seems likely that a significant portion of this liberated cash will increase customer deposits at the commercial banks anyway. These will include the proceeds of T-bills held by pension and insurance funds. Additionally, we must consider the position of foreign private sector holders of T-bills, reflected in foreign banks holding $1,132bn in UST-bills and certificates, according to figures from the Treasury’s TIC latest available data in December.[iii]

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