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Markets Are Waking Up to the Fed’s Racket

0 | By Shah Gilani

Now that you know the Fed’s “racket” is buying U.S. Treasuries from too-big-to-fail banks, letting them deposit the cash that they get from those bonds in Federal Reserve regional banks so they can collect risk-free interest, which the Fed siphons off interest that they get from Treasury bonds banks selling them, you might want to know a few more things.

Like how the federal debt and deficits are really being paid.

Like how Modern Monetary Theory, with its advocacy of free tuition, free healthcare, free money for people who don’t want to work, is based on the Fed’s racket.

Like how markets have rallied on the Fed’s game but are starting to understand it has its limitations.

Like how to protect yourself and profit from what’s going to happen as the game enters its third quarter.

So, how about I tell you…

Deficits and Debts Do Matter, Eventually

Economists used to warn us that excessive government spending, which leads to giant deficits, as in more than $1 trillion so far in fiscal 2019, and monumental national debt levels, $22 trillion and counting, “crowd out” private borrowing.

The premise is that interest rates have to rise to attract buyers of mounting government debt obligations and higher rates make private borrowing more expensive for businesses and consumers who will be less inclined to borrow in order to expand producing assets in the case of businesses (reducing supply) and less inclined to finance purchases in the case of consumers (reducing demand), which eventually drives the economy into recession.

But that’s “used to” theory.

Since 2008 the Federal Reserve’s been covering a huge amount of the government’s debt outlays, including at its height stockpiling more than $4.5 trillion of mostly government bills, notes, and bonds on its make-believe balance sheet (its balance sheet is make-believe because the Fed has no capital to buy government debts; it simply generates electronic credits for whatever it buys).

By keeping the cost of government borrowing at historically low levels, the Fed has been able to lower interest rates for businesses and consumers and has effectively underwritten the longest economic expansion in U.S. history and the longest bull market in history.

So much for crowding out.


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That there hasn’t been any crowding out, that interest rates have remained at near record low levels, that there’s no meaningful inflation in sight, that the nation’s debt and deficits apparently don’t matter, gave rise to Modern Monetary Theory, MMT.

In short, the premise of MMT is that a country which owns its own currency can keep printing it to pay for anything and everything its government wants to give its citizens as long as there’s no inflation.

If there is inflation, the same government that deficit spends or does away with any fiscal accounting whatsoever and just has its central bank print money to pay for services like free tuition, free healthcare, free whatever, will simply make better choices about what it gives out for free that won’t cause or add to inflation.

That’s the theory driving so-called “progressive” Democrats’ campaign promises to would be voters.

It doesn’t matter to them that free eventually means taxpayer funded.

And more importantly, and scary as all heck, is the fact that they don’t know that the U.S. doesn’t own its currency.

A private central bank, the Federal Reserve System, owns America’s currency.

Entering the Third Quarter of the Game

Since 2009 markets have benefited from real economic expansion and unreal “wealth effect” manipulation by the Federal Reserve.

That doesn’t mean markets haven’t had hiccups or moments of panic.

In May 2010 equity markets experienced a “flash crash,” losing 9% intraday, but closing down only 3.1%.

In July 2011 equity markets declined 18% within two weeks.

In August 2015 equities declined 11% within one week.

In January 2016 stock markets declined 13% within three weeks.

In January 2018 stocks declined 16% in three weeks.

In October 2018 they declined 12% within three weeks.

And as recently as December 2018, the market declined 16% in 3 weeks.

Nothing too bad or too protracted, as it turned out. But that’s because the Fed stepped in every time.

Markets believed the Fed had the tools, had its hand firmly on the rudder, had the capacity to stem market losses and stimulate the economy if faltering investor sentiment might lead to waning consumer confidence.

That market confidence is about to be put to the test.

It’s already started, and it hasn’t been good.


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The Fed lost control of the Fed Funds rate two weeks ago. It had to resort to emergency measures to flush banks up with cash that they didn’t have readily available. It’s still in the fed funds market doing daily repos with big banks to provide liquidity that they’re missing.

Next, the Fed’s going to announce that it’s going back to expanding its balance sheet, meaning it’s going to have to buy more Treasury bonds from its banks to give them more money to park in regional Fed banks to make more risk-free profits, while they figure out how to end the racket they set up.

Markets are starting to see through what the Fed’s doing. Investors are going to realize the game’s coming to an end. The Fed’s racket strings are warped, there’s no power left in their strokes.

As you see all of this unfolding, you’ll know what’s happening and you’ll know the clock is winding down.

Then it will be time to buy Treasuries for one last rally; time to short banks and lenders who aren’t directly protected by the Fed; time to short junk bonds because when the economy slips into recession high yield borrowers aren’t going to find any buyers for their zombie companies’ debt piles; and time to start stockpiling cash.

If “progressives” with their MMT-laced candy get into office, there won’t be any winding down, the clock will stop, and you better have taken my advice.

Sincerely,

Shah

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