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John Maynard Keynes was no fan of gold. Neither he nor any human being could eat it, and the amount of effort and labor expended at times to dig the metal up out of the ground seemed to him, and then his followers, weird to the point of harm. Yet, the inescapable conclusion remained: whatever costs expended they were clearly worth it.

Not just to the individual or group working with picks, shovels, or eventually explosives striking it rich on discovery and successful removal. The systemic benefits are historically validated, as Keynes wrote in his General Theory:

“At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available our wealth suffers stagnation or decline.”

The latter certainly classified Europe’s Great Bullion Famine of the 14thand 15th centuries – and also the small waves of monetary innovations (money of account, or ledger money) which attempted to restore some currency elasticity in the absence of precious metals (silver, too).

The question for economic thinkers was whether there was a better medium. The costs of going underground for a shiny metal were openly welcomed because gold was not wealth but rather a valuable commercial tool. Therein lies its intrinsic benefits, irreducible though they may be especially to modern sensibilities.

Gold has been gone for a long time, however, banished from monetary agency. Its role has been taken by that which once sought to supplement its scarcity: the ledger.

Keynes’ argument against using gold as the primary form of medium was that there were better, more suitable alternatives. For one thing, on the topic of dearness, it all came down to what many Economists believe is the irrationality of gold hoarding. Such grave matters should not, they reasoned, be left to individual decisions, rather concentrated in a public utility.

The central bank.

As Keynes had written more than a decade before, in the early twenties, the greatest monetary evil is this: the shortage of money and its deflation which quite vigorously savages labor most of all. The entire economy suffers, of course, but it is the unfortunate single worker who has no protection from these far-reaching and, from the worker’s perspective, incorporeal ills.

Whenever money is too dear, the actual wealth of any nation is undercut because money rather than sustainable enterprise is prioritized. Heightened liquidity preferences reorient the very nature of business; risk taking, or animal spirits, diminish if not disappear near entirely.

Acting on behalf of the entire system, proper central banking might offer currency elasticity which would mean a legitimate offset to “when but little of it [money] is so available our wealth suffers stagnation or decline.”

Or so it is in theory.

The chartalists (forerunners of today’s MMTers) of the 1920’s presumed that money was nothing other than the government’s plaything, and that politicians then and before had unwisely failed to appreciate their great power left unused. Subsequent crisis at the Great Collapse of 1929-33, proving once again the disaster of short supply money, the monopoly ideagained strength.

In practice, it wasn’t that at all; the very opposite, in fact. The Federal Reserve imperiled and chastened by its horrific performance during the Great Depression remained a total joke throughout most of the twentieth century. The Great Inflation of the seventies merely proved the wisdom of treating the Fed as a useless bureaucracy ill-suited to any mandate.

All the while private ledger money proliferated in the absence of a functioning gold exchange or any official acknowledgement (benign neglect). While ostensibly private, this was very different than a gold system, too, in that the keepers of the ledger were checked to a very narrow select group: global dealer banks.

The end of the Great Inflation in the early eighties saw, then, one of the most confounding and accidentally ironic combinations in economic history: the Volcker myth. Suddenly, we are told even now, these formerly hapless officeholders surrounded by gross failure just a minute before radically transformed into the Wise Stewards of Socratic Judgement practically over night without any explanation of what or how.

Their only answer was the monopoly. According to the myth, Volcker’s method was to exercise it and thereby conquered the previously unconquerable out-of-control inflation.

This was not to be a tyrannical turn toward complete monetary overlordship, rather like Cincinnatus an intermittent demonstration of their ultimate power to be used sparingly and only in those more dire situations the enlightened few decided met with Keynes’ standard.

Keeping with nominally free market principles, the Federal Reserve would not directly rule or even operate but occasionally influence and cajole (“moral suasion”). Only in the extreme case would monopoly authority get exercised; even in the face of the nineties stock bubble then-Greenspan’s group remained on the sidelines since the implication of that bubble was too much rather than too little.

The more extreme outwardly deflationary collapse of 2007-09, a global financial crisis if only because this global bank-centered monetary system made it that way, it had simply exposed these assumptions for all their numerous fallacies. The banking system retreated and thus money became dear, but what grew too short did not include the Federal Reserve’s byproduct of reserves.

Monetary monopoly had always been with the dealers the entire time. Post-Volcker, the Fed merely led a public campaign for what remains one of the greatest lies of omission in history.

In practice, this had meant something slightly different from what Keynes had imagined (or Volcker, Greenspan, and Bernanke, for that matter). It wasn’t the “irrational” and “dangerously” emotional public hoarding gold or any effective money medium this time around. And there was no true central bank which could take front of its monopoly because that didn’t exist.

For the first time in history – that I can find – the “when but little of it is so available our wealth suffers stagnation or decline” was the banking system’s ledger. The 2008 crisis was a bank run but of only banks running away from opening it up and adding new names and amounts to it. An interbank panic of just banks panicking.

Yet, subprime mortgages, to this day such fact remains unappreciated if not wholly undiscovered, the Federal Reserve and the world’s monetary regimes conspiring to add another layer to the lie of omission. The Era of QE.

The actual and primary function of bank reserves was to reestablish the plausibility of their proclaimed money monopoly; don’t fight the Fed! Because this wasn’t in actual fact plausible, the first GFC in 2008 wouldn’t be, couldn’t be a single, one-off event. The fundamental substance of the system would remain unaltered, its functioning diminished.

Speaking on the topic of the unusual bond market events of October 15, 2014, Fed Governor Lael Brainard in July 2015 wandered off the official track if only briefly. What happened in the Treasury market that day the previous Autumn was, she pointed out, “intraday movement in Treasury prices was 6 standard deviations above the mean.”

Improbable to the point of being impossible, yet there it was. She continued:

“Of course, other developments may be affecting liquidity in financial markets. For example, market participants have indicated that changes in participants' risk-management practices may be contributing to reduced market liquidity. In particular, the experience of the financial crisis may have led many participants to reevaluate the risk of their market-making activities and either reduce their exposure to that risk, become more selective, or charge more for it, thereby reducing liquidity.”

Let me paraphrase: bank reserves, as it turns out, might not be that important if the banking system has little use for them. Flooding the accounting with them, though, makes a great and happy fairy tale to sell the public on forgetting about any legitimate details apart from how big the QE’s might get.

What that had meant for the specifics of the one specific October 15 in Treasuries was repo and derivatives collateral; an untamed “buying panic” so monumental 6 standard deviations later there’s no good explanation any official can possibly put forward that doesn’t give away the whole ballgame (which is why the official Treasury/Fed report on the subject blamed computer trading!)

Even then, UST’s as useful collateral are merely the currency here, not the gold-like money.

Balance sheet capacities and capabilities, in other words. Collateralelasticity is one possible offshoot, performed under the banner of securities lending and the like. When it becomes in too short supply, the consequences are like Keynes said.

There are any number of factors which govern dealer balance sheet construction and maintenance, the real private money of the last three-quarters of a century; an aggregated view of the system, that is the ledger.

To put it briefly, having been burned and having watched in horror as contemporaries like Bear Stearns were snuffed out in what the Fed claimed was a successful bailout changed everything. Bill Dudley said – out loud – in the few days after its demise, “the fact that they [banking system] just saw Bear Stearns go from a troubled but viable firm to a nonviable firm in three days…I need more liquidity, I need to be less leveraged, and that lesson, from what happened to Bear Stearns, isn’t going to go away.”

Yet, it did go away…if only for the public from the central bank worldview, to be replaced by the narrative about the coming flood of otherwise extraneous bank reserves.

With no real use for that flood, and with Bear (as well as Lehman and AIG) forever fresh in their minds, bank dealers can grow skittish, and have several times, each time closing the ledger. Not all at once, even the first GFC was a multi-year process of reversal, but in incrementally withdrawing balance sheet capacity this has the effect of creating these negative, deflationary symptoms in collateral as well as in other things such as a rising dollar exchange value.

Earlier this year, in the beginning of January, while everything was supposed to be going just perfectly for the first time seemingly in forever, the dollar – clear out of the blue - stopped falling against most of the rest of the world’s currencies. COVID vaccines, monumental Uncle Sam helicopter drops, trillions more in QE’s globally, and yet there began this contrary indication.

Even as the Treasury market itself (along with global sovereigns elsewhere) caught reflationary wind, rising nominal yields and their overhyped selloff, deeper within these monetary shadows something was off in the real money monopoly.

It came to a head all the way back on February 25, this time as the Treasury market routed bringing up again the topic of liquidity in that market. Though the price action was in the opposite direction from October 15, 2014, there were more similarities than not. Why prices could move so far and fast, whichever the direction.

What had sparked the liquidations was an historically poor 7-year note auction. From Reuters (Analysis: Big moves and liquidity woes in a U.S. bond 'tantrum without the taper') on the February 26:

“The poor auction ‘was indicative of primary market dysfunction,’ wrote analysts at TD Securities. Secondary markets were also showing signs of stress, they said, with bid-ask spreads widening…There is no liquidity,’ said Andrew Brenner, head of international fixed income at NatAlliance Securities.”

In other words, another example of what happens when dealers take a step back (like September 2019). And in the case of February 25, they did so, and did so in such obvious fashion, because of a technical glitch in Fedwire the day before (which I wrote about extensively at the time).

That glitch on the 24th wasn’t really the problem, otherwise a small little nothing that because of the way things really are when it comes to the keeping of the ledger quickly and very publicly spiraled out of control into something bigger than it should. And not just the Treasury auction of the 25th.

All this time, still the fragile system far, far more attuned to the long lost ghosts of Bear than whatever latest huge QE. That there has been a string of QE’s is itself a useful clue along these lines.  

How could everything which seemed to be going right end up the way things seem to be heading now? Why would Fedwire and the next day remain so distinct on practically every chart closing in on seven monthslater? The same reasons, really, October 15, 2014, would stay relevant years afterward.

Even the once-rambunctious US inflation numbers have already begun to come back down to earth. Transitory, thus not inflation.

More and more around the world it’s becoming too obvious to keep overlooking the latest version of Keynes’ “when but little of it is so available our wealth suffers stagnation or decline.” Yet, ignored anyway. The problem is, even today, hardly anyone knows what “it” is and just why there might be so little.

On the contrary, in keeping up the omission, all we’ve heard this year is how there’s “too much money.”

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

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