Because Central Bankers Have No Clue What Else To Do
(AP Photo/Patrick Semansky, File)
Because Central Bankers Have No Clue What Else To Do
(AP Photo/Patrick Semansky, File)
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What’s the harm? Even if it doesn’t work well or much at all, this QE stuff can’t hurt. Sure, it’s a lot of noise but that’s really the point; expectations-centered policy is all about managing expectations, so if the general public is treated to a spectacular show, the bigger the better, eagerly enthused by the entertainment all is expected to be well.

Or at least not as bad as otherwise (jobs saved, in other words).

For those who continue to see all this as real money printing, an historical dilemma allegedly alike only Weimar Germany, therefore what a week to be highlighting these issues. Inflation numbers in China (PPI) were reported earlier to have been the highest in almost thirteen years while the US CPI – as you no doubt heard yesterday – was like something out of the 1980’s; near literally.

These accelerating rates of change are exactly what critics have been warning about since the first American QE (less was made of Japan’s given its “deflationary mindset” had been entrenched for more than a decade beforehand). Reckless money printing would always, always lead to out-of-control monetary inflation and worse. Given not just May’s CPI but also April’s, this makes two straight months of rates unseen in America since George Bush – the father.

Yet, over these past two months really approaching three, this view has been more strenuously rejected in the one place which otherwise would be overeager to sniff out the slightest probability for it. Yes, bonds. The very same instruments which stand to be destroyed should this inflationary fiction ever transform into such horrific reality.

The first tiny credible thread to it would unleash a bond sell-off putting 1994’s “massacre” to full shame.

On the contrary, going back to mid-March in US Treasuries, and earlier, February 25, around much of the rest of the world’s sovereign debt markets, inflation has been priced less likely by the day – a consecutive pair of the biggest CPI’s in decades, rates fall as if they didn’t happen at all.


To some, maybe many, the answer must be QE. Central banks like the Federal Reserve are, right now, buying up tons of these bonds, billions, tens of billions in purchases including US Treasuries undoubtedly keeping rates from rising in that ’94 kind of way. It sounds perfectly plausible; there remains no serious evidence whatsoever for it.

As I’ve written too many times before, the theory’s nice yet useless in practice. Bond yields do and have behaved independently of strictly the bond purchasing aspect of any LSAP (large scale asset purchases, of which QE is the major type). Take US QE1, for example, when LT UST yields immediately rose upon its very announcement in December 2008. They didn’t actually come back down again until the middle of 2010 when it started to become clear “something” was still very wrong in the (money) world (a fact more thoroughly established in 2011 when, following after the end of the second QE, yields plummeted after it was over).

Central bank literature agrees; to a point. What most studies say is that they can’t find any tangible impact on interest rates, maybe a dozen basis points perhaps half a percent (if the LSAP is absolutely enormous). These results actually speak for themselves in that numerous QE experiments have yielded such scant yield influence despite several really big ones.

On the other hand, now more than twenty years after Japan’s first QE, and more than a dozen since the US began experimenting with same, it’s finally beginning to sink in that there really could have been a net negativeimpact from this money-less monetary puppet show.

Inflation, in other words. Presuming that to be the opposite of deflation (it isn’t, but that’s another debate), officials worldwide have let slip the “money printing” - and then stood by helpless as infants as in each and every case it led to only more disinflation as well as, too many times, outright deflation.

Maybe it has been just too terrible to ponder, thus keeping any such rational thoughts from reaching the public sector hivemind. Perhaps this lack of inflation could be partly, perhaps greatly, due to QE itself.

The introduction of quantitative easing corresponds to serious already existing problems in whichever monetary system (though, in truth, there’s really just the one which matters). So, it’s not as if QE is foisted upon an otherwise healthy set of circumstances hastening some previously unwitnessed decay. Got that much going for it.

You can understand the somewhat cavalier attitude resulting; it’s already pretty bad to begin with, so, really, why not give a full go? What does anyone have to lose, it can’t get any worse, can it?

Well, yes, it actually can. There are several ways but the most direct harm comes from the other side of this kind of transaction. The “money printing” fiction focuses too narrowly on only one part of it: the creation of bank reserves. The Fed or whatever central bank buys an asset and issues reserves to the seller that didn’t exist prior. Money printed, QED.

No. The reserves may not have existed before but the asset bought up sure did. In practice, QE or any LSAP exchanges one asset for another from the bank’s perspective which is the only one which truly matters. More reserves, less bonds. It may sound harmless enough until you truly realize how vital these assets are to the monetary system especially its global, offshore vastness beyond the small subset of primary dealers performing the actual debt swapping with the central bank.

The reason I’ve written about this collateral business for such a long time (dead horse, and all that) is because it has taken these many years for all this to finally and truly sink in – in an exceedingly small though no longer zero number of places. Over the past couple years, in particular, a few central banks including the Fed have “allowed” staff members to piece together and publish their findings – which are exactly those we’ve been saying for all those (deflationary) eons in between.

Just last month, Sweden’s central bank became merely the latest to do so. What’s interesting about this particular study, Sveriges Riksbank Working Paper Series #402, published in May 2021, is that the authors focused on an almost perfectly segregated case study while being able to analyze heaps, mountains of extremely granular data to raise the robustness of their conclusions that much more.

To begin with, Riksbank purchased only government bonds allowing researches to isolate essentially a control group, comparing effects in the government market with any in the unspoiled wider private debt marketplace.

What they found isn’t actually surprising; again, we’ve seen – and I’ve written constantly – about it for years on end. There’s no need for a spoiler alert: QE strips collateral, forcing bank dealers to adjust in ways that unilaterally propose a reaction to serious harm to systemic monetary condition and operation.

In the academic literature, this has been called the scarcity effect. Basically, what I just wrote; the central bank robs the private secured markets (repo and derivatives) of a substantial amount of formerly usable, reusable, and redistributable collateral. Past some certain point, and the Swedish authors believe they found it, the negative effects of collateral stripping, this scarcity effect, don’t just outweigh any positive impact from QE’s so-called demand effect (the act of purchasing bonds itself).

Oh no, once a central bank passes that threshold there was, in the Swedish data, a non-linear aspect to the injury surpassing any proposed benefit.

“Importantly, the nonlinearity of the impact of QE on market liquidity may explain why the empirical literature on the impact of QE on government bond market liquidity has found mixed results. We show that the central bank QE has also a significant impact on the usage of security lending facilities by primary dealers, absent which the negative impact of bond scarcity would presumably have been higher.”

A low-level monetary problem leading to a lower-level QE response, maybe there are some small net benefits in market function. While this paper emphasizes “liquidity” in terms of only government bond markets themselves, it doesn’t take much to understand how the same principles apply to money supply factors and “liquidity” in a more general, systemic sense beyond the market for trading in specifically government bonds; repo is, after all, its global monetary backbone.

But it’s actually that last part quoted above which helps us piece together a couple of recent, seemingly inconsistent factors plaguing our CPI-infested contradictions. Sweden’s central bank also employs a relatively robust (by comparison) securities lending program, the “security lending facilities” referred to above.

In fact, studying detailed use of it has helped inform the paper’s conclusions; that dealers, when confronted by artificial collateral scarcity induced by QE, they are left often to hit up securities lending in greater quantity as well as frequency and duration. If you can’t get the bonds/collateral you need because the central bank has taken too much of it, then you really have to go knocking on the central bank’s door to pry some of it back out.

At least rent it.

That sounds quite a lot like one last big topic of conversation in recent weeks and days: the Federal Reserve’s reverse repo.

The latter has registered more than half a trillion, $534.9 billion as of yesterday afternoon. Not just an enormous amount, what’s gained so much attention is how little time it has taken to reach it. If you go back to March 17, for example, not a single dealer anywhere had “lent” the Fed cash in this thing.

Yes, loan money to the central bank. That’s how the reverse repo works if only from the one side of it, the same less interesting side as what’s focused in QE. More to the point, dealers and some non-bank cash-holders (like money market funds) actually lend their cash to the Federal Reserve on a secured basis. This means, importantly, that what’s coming back is US Treasuries collateral of some (specified) kind.

This makes the Fed’s reverse repo a (way) more limited version of Sveriges Riksbank’s securities lending facility. Thus, if in Sweden they found dealers using that program when collateral became scarce, that’s just more evidence to go along with intuition and common sense the same could (would) happen in its US$ counterpart (again, limited).

And collateral scarcity, with all its money-negative, liquidity-damaging consequences, very easily explains the behavior of bond yields in the face of so much inflationary noise. It isn’t some random coincidence that on March 18 that’s the day when the Fed’s dealers starting showing up at the reverse repo window, the very same day that LT UST yields peaked and correspondingly began to drop no matter what inflation data in between.

Jay Powell’s Fed is still buying UST’s and taking them out of collateral circulation at an enormous pace, swapping the banking system instead useless bank reserves as QE’s byproduct. At the same time, Janet Yellen has been forced to refund especially T-bills further exacerbating this shortage by removing even better collateral (the Fed hasn’t been buying more T-bills since the crisis last March, a tacit acknowledgement of having screwed that one up in the same way).

On top of those, risk aversion has rather quickly crept its way back into the general global marketplace as economic circumstances more and more fail (yet again) to resemble the inflationary narrative; in other words, it isn’t just Treasury yields which are falling since March, nearly every major market around the world has reversed away from reflation with several key places, such as Japan’s JGB’s where their QQE is still ongoing, too, putting in new multi-month lows along with UST’s just this week.

Is this the perfect collateral storm?

Even if it isn’t, the reverse repo and its near-perfect correlation with anti-reflation, falling UST yields more than suggests the same negative money undercurrents which have repeatedly undermined the inflation story and whatever its potential year after agonizing year.

There are a number of macro reasons to doubt the surge for the CPI in the US, or China’s PPI, is sustainable. There is also a more powerful monetary reason, too. QE doesn’t help, and it isn’t neutral.

Non-linear is the word here, meaning that beyond certain points – and reverse repo levels do suggest something like this - all that bond buying actually creates more deflationary potential than a stricken monetary system might if alternately left to its own malfunctioning devices. That wouldn’t be good, but why make it worse?

Because they don’t know what else to do!

The data and evidence are all there, and they have been there all along. Because it challenges the existing monetary worldview all the way down to its very core, central bankers have kept undercutting their own efforts, one QE after another, you can’t make this up, chasing the vain hopes this is all just some bad dream the world through nothing more than random good luck just might awaken from before the public truly realizes and appreciates what has really happened. 

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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