'Easing' Monetary Policy Is Missing a Key Component
(AP Photo/Mark Lennihan, File)
'Easing' Monetary Policy Is Missing a Key Component
(AP Photo/Mark Lennihan, File)
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Financial repression, he admitted, yes, this was neither a mistake nor an unlucky coincidence. It had always been an intentional provocation, the occurrence of ridiculously low interest rates and the negative effects these have on savers. The difference was that Mr. Kocherlakota would never speak so explicitly in public. Like corruption, cowardice comes in many forms.

The President of the Fed’s Minneapolis branch, Narayana Kocherlakota’s tenure at the FOMC was as the typical Economist. In times of trouble, the master neo-Keynesian playbook tells policymakers they had better disadvantage grandparents; discourage saving in any way possible. The fact this is harmful to their financial comfort really is the whole point.

“MR. KOCHERLAKOTA. The comment that I’m tempted to make, but which I have not made yet in public, is that this is actually a feature, not a bug. [Laughter] We’re trying to get them to consume, as opposed to saving, to spend money on their grandkids and lend to that promising young entrepreneur down the street, as opposed to holding money, and so this actually would be a sign of the program working.”

The “sign of the program working”, Kocherlakota had already explained, was the constant complaints and worse hurled at him by the righteously angered who were not always gray-haired retirees. That promising young entrepreneur down the street didn’t exist by 2011’s economy, yet the Keynesians always put them in the future.

And this was September 2011, not a particularly happy time to be associated with the Federal Reserve in any way shape or form; not that you would know it from all the easy jokes and arrogance-laden insults. By then, this was more than enough time. Low rates are never supposed to be permanent.

Yet, September was closing in on three years since the Fed’s Zero Interest Rate Policy (ZIRP) had been announced. Why was it still there, with no end in sight?

At that very moment, on the contrary, the debate around the conference room table centered on what policymakers had to do in order to regain confidence in a situation going very wrong. QE2 (if it works so well, why would you ever have to do it more than once?) had just barely finished up and these Economists were afraid that if they went right into QE3 not even three months afterward it would damage the public’s view of the entire technique.

Not that it wasn’t enough “money”, but that it might leave people wondering what was monetary at all (which would’ve been the correct interpretation).

Yes, though they hated savers during recessions and their recoveries which aren’t recoveries, more important was to leave intact the idea that everything financial, including all interest rates, get decided by these glibly bureaucratic gatherings. When you don’t do money, your only other option is to make the world think you do.

Effective rate control was a huge problem – in many ways – and had really been not all that long before 2011.

One of the primary features of the first Global Financial Crisis (2007-09) was the lack of control over interest rates – even in the short-term end of curves. I’ve written about IOER’s sordid saga many, many times, and still,it bears repeating many, many more. These people really thought that paying interest on reserves would put a floor under federal funds, the direct object of all monetary policy and its actual design, communication, when it achieved nothing of the sort.

But how did they decide what IOER rate to pay? At first, unlike now, there were two rates for interest on reserves – depending upon what type of reserves. Excess or required reserves; the latter never amounted nor amounts to much, so that one really doesn’t matter (today there is only IORB, or interest on reserve balances encompassing both kinds).

The law which authorized these payments on whichever reserves was left ambiguous, probably on purpose. While it wouldn’t matter in 2008, failures all around, by 2011 it probably should have been treated as a much bigger deal.

The statute said the Federal Reserve could not pay higher interest than competing money market rates.

But IOER was set at 25 bps while money market rates all over the dollar spectrum continuously paid far less; closer to zero for most! It had become such a sticky situation, that after serious (and “unexpected”) crisis in the middle of 2011, even 2-year Treasury yields were consistently below IOER. Did the Fed violate the law for several years?

Laws like savings are for suckers.

“MR. CARPENTER. The statutory requirement is that the rate paid on reserves can’t exceed the general level of short-term interest rates.

“MR. FISHER. Short-term interest rates are defined as? 

“MR. CARPENTER. Not defined.”


Not only that, “general level of short-term interest rates” is a fairly open term when you consider that in something like federal funds or repo there really isn’t a single fed funds or repo rate; there are, as Mr. Carpenter further pointed out, trading in those markets going off at all kinds of rates in any given day.

Like everything else at the Fed, policy was just plain made up on the fly; the level of IOER basically picked out of hat. Control? Hardly.

And yet, in trying to decide which avenue toward more “easing” to pursue, further reducing IOER was seriously discussed anyway.

“MR. CARPENTER. Lowering the IOER rate should, all else being equal, provide banks with an additional incentive to lend, because any individual bank could fund additional lending by running down its reserves and leaving the overall size of its balance sheet unchanged.”

This is one explanation put forward for why ever since ZIRP and the first QE banks hadn’t lent; they were only too happy, many “experts” claimed, sitting in reserves getting paid little better than nothing to do nothing. And it sounds reasonable, if you don’t think too hard on it. But was such pittance of twenty-five basis points really sufficient to not lend to some young entrepreneur with a grand idea?

Financial repression wasn’t just meant to ding grandma and grandpa, it is also meant to harm banking institutions, too, so as to spur them into activity (taking things a step further into NIRP if “necessary”).

And why wouldn’t it? In theory, all QE does is swap one asset for another; a UST or MBS security gets sold by a bank to the Federal Reserve in exchange for now a reserve asset. This was never supposed to be the end of QE’s effect (and notice no money is printed); the bank was thensupposed to replace the lost security despite reserve assets with some riskier balance sheet addition, preferably a nice fat loan to aspiring tycoons old as well as young (portfolio effects).

This, of course, misses the true monetary point which points in the direction of bank balance sheets. And that is, balance sheet capacities are governed by rules and constraints which have nothing whatsoever to do with bank reserves, excessive or not, nor the rate paid on them. A loan isn’t just a riskier proposition, it costs dearly in terms of balance sheet space when such space is already perceived too dear.

Going from 25 to 15 or maybe 10 on IOER would, in that situation, change absolutely nothing (as we’d find out in 2018). But if the public believes this means something, then policymakers believe it would accomplish their goal – even if it pissed off savers who are ironically taught to believe the Federal Reserve is in charge of everything.

There were much bigger problems:

“MR. SACK. Money market funds and other investors have continued to pull back from providing unsecured dollar funding to many institutions. At this point, with the exception of a short list of top-tier banks, all unsecured funding has collapsed to maturities of one week or less. Banks that instead rely on obtaining dollar funding by borrowing in euros and using the FX swaps market to convert to dollars have seen their implied funding cost move up sharply…”

All of this despite QE2 having brought the systemic level of bank reserves up to $1.6 trillion, a systemic balance that, at the time, the Fed’s “major” critics claimed was so much money printed it would doom the dollar and ignite our inflationary nightmare.

On the contrary, what was then happening only more of the same deflationary money pressures way too similar – if to a lesser degree – to what had just occurred the few years before. These included, as Brian Sack acknowledged, “It has become more difficult to borrow against less liquid collateral, with investors requiring over-collateralization and higher rates for some transactions.”

When there isn’t enough liquid collateral, the only choice – not bank reserves – is to overpay for what remains workable. US Treasuries. Bills first, but not just bills, also short-term notes like the 2-year.

Remember, also, what was going on over at the Treasury Department during this 2011 dollar funding crisis. As I recalled over this past summer for the same reasons, ten years ago the same debt ceiling problems had also led to a sharp curtailing of bill issuance.

This would cause all manner of problems not just for US$ repo, but, believe it or not, “Banks that instead rely on obtaining dollar funding by borrowing in euros and using the FX swaps market.” This situation described by Mr. Sack is, essentially, a synthetic repo wildly popular with dealers (cash lenders) because it is the most efficient form of cross-jurisdictional dollar funding in terms of sparing precious balance sheet capacity.

I wrote in detail about this in November 2019 (in the wake of that year’s likewise misunderstood repo mess):

“A repo is a loan; therefore, it goes on the balance sheet at par value. FX as a derivative gets booked instead by its market value, which, in almost every form of swap or forward, starts out at zero. It requires no balance sheet space initially, and over time the only way that changes is if the contract value of the swap materially shifts.”

Should the system start messing up again, the contract value of the swap won’t be so friendly to dealer “mathematicals” (the real shadow money). Even the efficiency attributes behind this synthetic repo can reverse causing dealers to pause and stay out of the market (negative elasticity) just when they are needed most.

The value of good collateral, therefore, takes an enlarged premium. The other side of this form of money price is, confusingly, a low yield. Deflation in them, not “stimulus.”

One particularly helpful test for this situation, once you are freed from all the mainstream jokes, is the almighty King Dollar. And yet, here, too, we’re taught all sorts of wrong ideas about how and why the dollar moves the way it does; leading, the vast majority of the time, for the dollar to move in the way it isn’t “supposed” to.

At 2011’s first FOMC meeting, in January, the same Brian Sack had noted the dollar’s ongoing “weakness.” To which he added, “Despite the better sentiment about U.S. growth prospects, the dollar depreciated against most currencies.” This is one version of the Strong Dollar which purports US economic strength as the reason it goes up in exchange value.

To explain Sack’s “despite”, Chairman Bernanke and St. Louis Fed President James Bullard both said, no, the falling dollar, that’s money printing baby! The economy was improving, the pair claimed, and it was because of QE and bank reserves, therefore easy money behind the downward slide in the currency.

“MR. BULLARD. Nationally, prospects for the economy seem to have improved rather markedly relative to last summer. I attribute part of the improvement to this Committee’s asset purchase program. I think that this program did four things. It put downward pressure on short-term real yields, it put upward pressure on expected inflation as measured by market-based TIPS, it contributed to a rally in equity markets, and it contributed to downward pressure on the trade-weighted value of the dollar. In my view, these are classic signs of monetary policy easing.”

Such a happy tone and falling dollar of QE monetary easing in January 2011 had by September fallen into the beleaguered situation across the entire global economy with…the dollar rising (the light tone persisted at the FOMC, of course, because there is no accountability for these gross monetary mistakes even after they pile up year after year).

In other words, low yields and rising dollar equal an inordinately tight global dollar (eurodollar, in reality) situation. It has a lot to do with collateral, in repo and swaps alike, all tracing back to dealer capacities being constrained in some serious fashion.

The level and rate for excess reserves, each immaterial.

Savers get punished on both sides. Not only does real monetary failure keep rates too low year after year (decade after decade), those low rates likewise declaratively signal an unhealthy monetary and financial environment which can only further destroy (deflationary potential) economic vigor and vitality.

Grandma and Grandpa were only meant to suffer for a short while for the “Greater Good” of economic recovery if ever low rates were stimulus like the textbook says. Since they aren’t, well, those at the Fed can and certainly will get to laugh about it and us.

Keep all this in mind as September and Q3 2021 draw to a close while Jay Powell’s Fed portrays one view of “classic signs of monetary policy easing” that, all of a sudden, are missing at least the one key component. Calling it a 2020-21 success story, taper, quite unlike January 2011 and way too much like that September, the dollar’s already been rising for months

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

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