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Sunday, December 15, 2019

Politics Aside - What Do We Watch in 2020? -- The Fed (Plus Jim Rickards Thoughts)

By now it has become obvious that the ongoing political war has completely consumed the US media and overtaken virtually every other storyline. This is actually in line with things we have talked about here for some time. Our best guess analysis was that the enormous political divide that exists, not only in the US, but now around the word, would only ramp up in intensity. It seems clear this is exactly what is happening and very likely to continue in the US no matter who wins the elections next year.


Now it's time to set politics aside and see if we can find another major issue that we need to watch carefully headed into 2020. It appears there is such an issue and we have noted it here a few times already.

While everyone's attention in the media seems completely focused on the daily political war in progress related to impeachment and the counter effort to "drain the swamp" of "deep state" activists said to be trying to remove the President from office to protect their own interests, something potentially very substantial continues to play out over at the Federal Reserve. It started this last fall when the Fed began emergency repo market operations. The Fed insists that these operations are temporary and are needed to maintain systemic stability. They say their efforts are working as intended and that there is nothing to be concerned about in regard to these unusual actions they have been taking and continue to take. They have also advised that these actions will now continue to ramp up. These actions have already involved the creation of hundreds of billions in new money and a very rapid surge back upwards in the size of their balance sheet. All this after spending a long time struggling to reduce their balance sheet and to try and get interest rates a bit higher without "popping any bubbles" and destabilizing markets.

Below I am featuring links to a couple of recent articles related to all this because I do think readers need to keep a careful eye on all this heading into an already potentially volatile election year in the US in 2020. Most people understand that tight Fed policies are generally perceived to be an obstacle to a President running for re election while loose policies are generally perceived to provide a wind to the back of a President. So we have clearly have a highly charged political environment in place as the Fed undertakes these unusual market operations heading into an election year. Beyond that, many Fed critics are suspicious that the Fed is actually trying to cover up systemic problems with these actions even as the Fed completely denies that. Whatever the truth really is, I think this may be the most important issue to monitor and try to understand in the coming year. 

In this article on CNBC on December 10th, Credit Suisse predicts the Fed will soon openly announce a new QE policy regardless of whatever you want to call the policy already underway now. Here is a quote from the article:

"The Federal Reserve could be launching another round of money-printing in the next few weeks as problems in the overnight lending markets reemerge and force the central bank into more aggressive action, according to a Credit Suisse analysis."

. . . .

“If we’re right about funding stresses, the Fed will be doing ‘QE4’ by year-end,” Pozsar wrote. “Treasury yields can spike into year-end, and the Fed will have to shift from buying bills to buying what’s on sale – coupons.”

This is a reputable banking institution commenting in an article carried by CNBC. So clearly there is some skepticism about the Fed's assurance that nothing concerning is going on. 

Now lets look at an in depth analysis of all this Fed activity in a non mainstream article. This article by Daniel Amerman notes that the amount of new money created by the Fed since this fall has perhaps been used to fund nearly 90% of the government debt issued during this time frame. This is very in depth analysis so I will just quote a couple of excerpts below and refer readers to the full article here.




"As can be seen in the graph above (see article for the graph), for the last 12 weeks there has been a stunning visual correlation between the yellow bars of the total weekly funding of deficits by the Federal Reserve, and the green bars of the weekly deficit spending by the United States government.

Total deficit spending, the extent to which monies spent by the federal government exceeded taxes collected, was a staggering $422 billion in just the last 12 weeks. In total, $367 billion of the funding for this increase in the national debt was provided at very low interest rates, via the mechanism of the Federal Reserve simply creating the money needed to fund the government spending."


I encourage readers to read this full article. Just the fact that the Federal deficit is exploding to such high levels alone right now is enough to get your attention. If the Fed really is creating a lot of new money to buy up nearly 90% of that new debt, we certainly need to pay close attention to that. We know that Fed has completely reversed course from a long grinding effort to decrease the size of its balance sheet and that since all this started last fall their balance has surged quickly back up over $4 Trillion. So something has changed their thinking for sure.

There are questions we need to ask and follow during 2020:

Why is the Fed having to continue these "temporary market operations" so long into the future?

Is the Fed trying to cover up some kind of serious systemic problem that we do not know about yet?

or

Is all this "nothing to see here" as the Fed continues to say?

What pressure (if any) is the Fed feeling to keep the economy propped up and liquified during an intense upcoming election year?

What happens next year if something goes wrong with all this and the stability of the entire system comes into question somewhat like happened in 2008?  Who will get blamed if something like that happens? How would it impact the elections?

As always, the hope here is that nothing threatening systemic stability happens next year and that whatever the Fed is doing is not an attempt to mask systemic problems. But clearly we have an important issue to monitor here and one that is somewhat being completely ignored by major media due to the obsession with all the daily political fighting taking place. I encourage readers to try to filter out all the political noise and focus on these kinds of issues next year even if they are not heavily covered by most media.

I sent this article to Jim Rickards and he kindly offered me this reply to include for readers here. It is his analysis on this situation and I feel it is important to pass it on. A thank you to Jim for offering it:

"You're right about the importance of this. But, one needs to stay focused on the fact that the Fed is buying short-term notes and bills, not long-term assets. This has to do with avoiding an inversion of the yield curve. If the long-end is falling in yield for economic reasons, the short-end has to fall faster to avoid an inversion. The paradox is that by buying short-term securities (to provide liquidity to the market) the Fed is depriving the market of those very securities (which tends to drive up yields on what's left). By trying to lower yields (with liquidity) the Fed is raising yields (through scarcity). This is another Fed blunder playing out in real time."  -   James Rickards (author of Aftermath)


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Added notes: I sent a link to the first article above in CNBC to one expert who replied with the word:

"Frightening"     

Given the high credibility of this expert, I wanted readers to see that I am not the only one who believes this issue should be watched carefully in the months ahead.

If the second article linked above is accurate, that may be even more "frightening" than the CNBC article. If markets sense the US is having the Fed monetize its debt, it could rattle them at some point.

Added 12-16-2019: Here is another non mainstream take on all this Fed activity from another Fed skeptic worth considering. It is fair to point out that the Fed says they have things under control and there is no need for concern. It's also fair for skeptics to raise these kinds of questions about these unusual operations by the Fed given the huge amounts of new money involved. Time, as always, tends to gives us the answers.

Added note 12-20-2019: Robert Pringle has a new book out called The Power of Money. I hope to be able to publish a Q&A interview here on the blog early next year with Robert Pringle. He has had a long and distinguished career working alongside central bankers around the world so his insights based on that experience are very valuable. He provides a look inside the system that you won't find in most media coverage of these issues.

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