Global economy is at risk from a monetary policy black hole

Governments should borrow more to stave off secular stagnation

Lawrence Summers

Kristalina Georgieva, managing director of the International Monetary Fund (IMF), pauses while speaking ahead of the IMF and World Bank Group Annual Meetings in Washington, D.C., U.S., on Tuesday, Oct. 8, 2019. Georgieva, in her first major address as head of the IMF, painted a downbeat picture of the world economy and said a more severe slowdown could require governments to coordinate fiscal-stimulus measures. Photographer: Andrew Harrer/Bloomberg
The new managing director of the IMF, Kristalina Georgieva, has warned that economic growth globally is decelerating © Bloomberg

New IMF managing director Kristalina Georgieva’s first speech makes bracing reading for the global financial community as it gathers this coming week in Washington for the annual IMF and World Bank meetings. Ms Georgieva noted that while two years ago growth was accelerating in 75 per cent of the world, the IMF now expects it to decelerate in nearly 90 per cent of the global economy in 2019 to the lowest level in a decade.

This shift into reverse comes as central banks in Europe and Japan have embraced negative interest rates and investors expect further rate cuts from the US Federal Reserve. Bonds worth more than $15tn are trading with negative yields.

If the primary problem were on the supply side, one would expect to see upward price pressure. Instead, despite loose fiscal and monetary policy, central banks in the industrialised world have as a group fallen well short of their inflation targets for a decade and markets project that this will continue.

Europe and Japan are engaged in black hole monetary policy. Without a major discontinuity, there is no prospect of policy rates returning to positive territory. The US appears to be one recession away from entering the same black hole. If so, the whole industrialised world would be providing at best negligible and often negative returns to risk-free savings and falling short of growth and inflation targets. It would also have to maintain financial stability amid increased incentives for leverage and risk-taking.

All this requires new thinking and new policies, much as the rapid inflation of the 1970s forced a reset back then. Once economies are in the monetary black hole, central banks that focus on inflation targeting will be ineffectual in hitting their immediate goal and unable to stabilise output and employment. The policy action has to shift elsewhere.

Today’s core macroeconomic problem is profoundly different from the problem any living policymaker has seen before. As I have been arguing for some years now, it is a version of the secular stagnation — chronic lack of demand — that terrified Alvin Hansen during the Depression. In today’s global economy, private investment demand is manifestly unable to absorb private savings even with negative real interest rates and limited restraints on financial markets. That is why even with burgeoning government debt and unsustainable lending, growth remains sluggish and below target.

Since 2013, when I first argued that we were seeing more than simple “economic headwinds”, interest rates have been much lower, fiscal deficits have been much larger, and leverage and asset prices have been much higher than expected.

Yet growth and inflation have fallen short of forecasts. That is exactly what one would expect from secular stagnation: a chronic shortage of private sector demand.

What is to be done? To start it would be helpful if policymakers acknowledged this week that the policy problem is not smoothing cyclical fluctuations or preventing profligacy. Rather the fundamental issue is assuring that global demand is sufficient and reasonably distributed across countries.

The place to start is by dampening down trade wars — deeds, threats and rhetoric. Trade warriors think they are participating in zero-sum games globally with one country gaining demand at the expense of another by opening markets or imposing protection.

In fact trade conflicts are negative-sum games because there is no winner to offset the demand that is lost when uncertainty inhibits and delays spending decisions.

Given the risk of a catastrophic deflationary spiral, central banks are probably right to attempt to ease monetary conditions. But diminishing returns have surely set in with respect to monetary policy and there is risk of doing real damage to the health of the banks and other financial intermediaries.

Most important governments need to rethink fiscal policy. Government debt or government support for private debt is needed to absorb savings flows. With real rates near zero or even negative, the cost of debt service is very low and low rates can be locked in for decades.

That means that the debt levels that were prudent when rates were at 5 per cent no longer apply in today’s zero interest rate world. Governments that run chronic surpluses are failing to do their part to support the global economy and should be the object of international scrutiny.

There are other possible interventions. Increasing pay-as-you-go public pensions would reduce private saving without pushing up deficits. Public guarantees could spur private green investments.

New regulations that prompt businesses to accelerate their replacement cycles will increase private investment. Measures to create more hospitable environments for investment in developing countries can also promote the absorption of global saving.

Spurring sound spending is the antidote to secular stagnation and monetary black holes. It should be an easier technical problem to solve and much easier to sell politically than the austerity challenges of earlier eras. But problems cannot be solved until they are properly diagnosed and the global financial community is not there yet. Hopefully that will change this week.

The writer, a former US Treasury secretary, is a Harvard economics professor. The article draws on collaborative work with Anna Stansbury, PhD candidate at Harvard

What the Heck is Happening in the Cayman Islands?

Doug Nolan

Another quiet week… When the Fed on Friday announced its “Not QE” balance sheet reflation strategy, the Dow was already 400 points higher on anticipation of a positive trade negotiation outcome.

The Federal Reserve will Tuesday begin buying $60 billion of Treasury bills monthly through 2020’s second quarter. This follows a five-week period where Federal Reserve Credit surged $187 billion.

In addition, the Fed said it will continue with its overnight and term “repo” market interventions, along with reinvesting proceeds from maturing longer-dated maturities.

I have speculated the Fed’s balance sheet might inflate to $10 TN over the course of the next crisis and down-cycle. It’s possible that we could see expansion approaching $500 billion over the next six to nine months.

Announcing its “Not QE” plan as markets were in the throes of an intense short squeeze creates poor optics. Most analysts had expected the rollout to come at the Fed’s end-of-month meeting - or even during November. This is one more example of the Fed acting as if it is facing a serious risk to financial stability.

October 11 – Bloomberg (Rich Miller and Christopher Condon): “…The central bank… stressed that ‘these actions are purely technical measures to support the effective implementation’ of interest-rate policy and ‘do not represent a change’ in its monetary stance. ‘In particular, purchases of Treasury bills likely will have little if any impact on the level of longer-term interest rates and broader financial conditions.’”

There may come a day when bond markets push back against central bank interventions – “purely technical” or otherwise. Ten-year Treasury yields jumped six bps Friday to 1.73% - though this move higher was in response to the markets’ “risk on” mood ahead of the completion of trade talks. Two-year Treasury yields rose 5 bps Friday to 1.60%, up 19 bps for the week (and reversing most of last week’s drop).

The implied yield on January Fed funds futures rose 9.5 bps this week to 1.555% (current Fed funds rate 1.82%). Even with a successful “Phase 1” trade deal with China – not to mention the Fed’s plan to expand its holdings - the probability of a rate cut at the Fed’s October 30th meeting was little changed this week at 71%.

University of Michigan Consumer Confidence was reported at a much stronger-than-expected – and three-month high - 96. The Current Conditions component jumped 4.9 points to 113.4, the high going back to December 2018 (116.1). The St. Louis Fed’s Real GDP Nowcast Model has Q3 GDP at 3.12%. And if the world is indeed at the cusp of a U.S./China trade truce, there is even less justification for an additional rate cut. Yet I am not convinced trade risks – or economic vulnerabilities more generally – are the crux of underlying market fragilities or central bank unease.

It was an unfittingly low-key headline: “Better Data on Modern Finance Reveals Uncomfortable Truths.” The subheading to Gillian Tett’s Thursday FT article was more direct: “It is Unnerving That the Shadow Banking Sector is Swelling, Given its Role in the Financial Crisis.”

The FT’s list of “most read” articles included “Why Investors See Inflation as a Very British Problem” and “TP ICAP Pays £15m to Settle FCA Charges Over ‘Wash Trades.’” Ms. Tett’s insightful piece failed to make the cut. I was however reminded of an FT article from early 1998 highlighting the explosion of trading in Russia currency and bond derivatives, along with Gillian Tett’s exceptional reporting on the proliferation of subprime CDOs and mortgage derivatives late in the mortgage finance Bubble period.

October 10 – Financial Times (Gillian Tett): “What the heck is happening in the Cayman Islands? That is a question often asked in relation to corporate tax. This week, for example, the OECD called for an end to the loopholes that let global companies cut their tax bills in places like the British overseas territory. As the debate bubbles on, there is another facet of globalisation that merits more discussion: the financial flows associated with offshore centres, particularly between banks and non-bank entities.”

“Cross-border lending by banks to non-bank financial institutions, such as hedge funds, has also jumped, from $4.8tn in 2016 to $6.6tn in 2019. More striking, those non-bank institutions have quietly ‘become important sources of cross-border funding for banks, particularly in international currencies,’ the BIS notes.

Yet again, those offshore financial centres feature: almost 20% of banks’ cross-border dollar funding is now supplied by entities based in the Cayman Islands, a ratio only topped by those in the US, while entities based in Luxembourg and the Caymans are crucial in the euro markets. Or as the BIS concludes, ‘Banks’ positions with [non-banks] are concentrated in few countries, particularly financial centres.’”

“Non-bank intermediaries’ share of total financial system assets increased from 31% to 36%” between 2007 and 2017, observes a report from the IESE Business School… Meanwhile, the BIS data shows that banks’ cross-border dealings with non-bank entities has been swelling too. One reason is that banks are increasingly funding governments (by buying their debt).

But their exposure to non-financial companies is also rising noticeably, both to onshore and offshore subsidiaries. ‘Banks lend significant amounts to non-financial corporations located in financial centres . . . [providing] credit to the financing arms of multinational corporations located there,’ the BIS notes, adding that banks’ claims on NFCs [non-financial corporations] in the Cayman Islands are larger than on those in Italy. (Yes, really.)”

Convoluted, murky stuff: The amalgamation of “offshore financial centres,” “cross-border dollar funding,” “non-bank intermediaries” and “offshore subsidiaries,” make CDOs, special purpose vehicles, and other mortgage financial Bubble era “shadow” financial processes appear rather clear and luminous by comparison.

Ms. Tett’s article pinpoints the “belly of the beast.”

The GSEs, securitizations, sophisticated mortgage derivatives, and “repo” finance created the nucleus of the risk intermediation and leverage fueling precarious mortgage finance Bubble excess. I am convinced the mushrooming of government bonds, the proliferation of global “repo” markets and off-shore securities lending operations, along with unmatched global derivatives excess and leveraged speculation, are at the epicenter of the runaway “global government finance Bubble.”

Tett’s article notes the global push to accumulate reliable official data. The BIS (Bank for International Settlements) has expanded data for non-bank counterparties and offshore financial centers. While interesting – and certainly illustrating the enormous scope of offshore finance – I’m not confident that the BIS and global central bank community have a handle on what evolved into colossal global flows intermediated through securities finance and “offshore” finance. The recurring extensive revisions to the Fed’s Rest of World (ROW) Z.1 data informs me that there are major shortcomings and outright holes in the data.

Indeed, What the Heck is Happening in the Cayman Islands?

A few snippets from the BIS’s September 2019 Quarterly Review - International Banking and Financial Market Developments (referenced in Tett’s article).

“Derivatives trading in over-the-counter (OTC) markets rose even more rapidly than that on exchanges, according to the latest BIS Central Bank Triennial Survey… The daily average turnover of interest rate and FX derivatives on markets worldwide – on exchanges and OTC – rose from $11.3 trillion in April 2016 to $18.9 trillion in April 2019.”

“The turnover of interest rate derivatives increased markedly between April 2016 and April 2019, especially in OTC markets, where trading more than doubled from $2.7 trillion per day to $6.5 trillion.”

“The OTC trading of FX derivatives also rose substantially… In OTC markets, the daily average turnover of FX derivatives increased from $3.4 trillion to $4.6 trillion between April 2016 and April 2019.”

Tett’s article also mentioned data from the Financial Stability Board (FSB), whose Global Monitoring Report on Non-Bank Financial Intermediation 2018 (issued in February) includes detail on global non-bank entities through the end of 2017.

The FSB’s tabulation of MUNFI (monitoring universe of non-bank financial intermediaries) has a 2017 ending value of $185 TN, up substantially from the $100.6 TN to close out 2008. FSB analysis focuses on a “Narrow Measure of NBFI” (non-bank financial intermediaries), and then breaks down this category by Economic Function (subgroups EF1 through EF5). EF1 – ended 2017 at $36.7, more than double the $14.2 TN from 2008.

“EF1 includes collective investment vehicles (CIVs) with features that make them susceptible to runs.” This group includes fixed-income funds, hedge funds, money market funds, trust companies, ETS and real estate funds (along with smaller components). “EF1 growth is mainly attributable to the four jurisdictions where most EF1 entities reside – US (with 26.3% of total EF1 assets), China (16.5%), the Cayman Islands (14.3%), and Luxembourg (8.9%).”

Breaking down “Narrow Measure of NBFI:” Investment Funds ($45.4 TN, 13.6% ’17 growth); Captive Financial Institutions and Money Lenders ($25.9 TN, 0.5% ’17 contraction); Broker-Dealers ($9.6 TN, 1.1% ’17 contraction); Money Market Funds ($5.8 TN, 10.2% ’17 growth); Hedge Funds ($4.4 TN, 15.8% ’17 growth); Structured Finance Vehicles ($4.9 TN, 2.2% ’17 growth); Trust Companies ($4.6 TN, 27.1% ’17 growth).

“The resulting narrow measure was $51.6 trillion at end-2017” (from ‘08’s $36.2TN). “The total financial assets of entities in the narrow measure grew in 2017 (8.5%), both in absolute terms and relative to GDP... This growth rate is consistent with the average annual growth rate (8.8%) of the narrow measure over 2011-16. This average growth rate was mainly driven by the Cayman Islands, China, Ireland and Luxembourg, which together accounted for 67% of the dollar value increase since 2011.”

Such heady growth in finance comes with consequences. That growth in non-bank (“shadow”) finance over this boom cycle has been driven by entities in the Cayman Islands, China, Ireland and Luxembourg bodes well for the accumulation of leverage and latent risk intermediation issues – not so much for sustainability and stability.

Other highlights: “The total repo assets of banks and OFIs grew by 9.6% in 2017 to reach $9.4 trillion, while their total repo liabilities grew by 9.8% to reach $9.2 trillion, largely driven by banks’ increasing use of repos.”

“Hedge funds’ assets grew in 2017, based on data reported from 15 jurisdictions. The Cayman Islands continues to be the largest hub for such funds among reporting jurisdictions (87% of submitted total hedge fund assets) where they grew by 17.5%, driving the overall growth of the reported sector.” This passage come with a curious footnote: “There is no separate licensing category for hedge funds incorporated in the Cayman Islands, thus the Cayman Islands Monetary Authority (CIMA) estimated their size based on certain characteristics (eg leverage).”

“China accounted for most trust company assets (88% of global trust company assets) and overall growth. The growth rate of China’s trust company assets has increased over the past three years (16.6% in 2015, 24.0% in 2016 and 29.8% in 2017).”

In a recent CBB, I posited it was no coincidence that instability in Chinese money markets was followed not many weeks later by instability in U.S. “repo” finance. I believe a decade of zero and near-zero rates and unrelenting global QE has fostered unprecedented leveraged speculation on a global basis. I suspect the size of “carry trades” and myriad forms of speculative leverage dwarf that from the mortgage finance Bubble era – having seeped into all corners, nooks and crannies of global fixed-income markets. Moreover, “repo,” securities shorting, derivatives and securities finance more generally are the unappreciated sources of global liquidity abundance – in tightly interconnected funding markets with the nucleus in “offshore financial centers.”

I hold the view that massive leverage has accumulated in U.S. fixed income, in Chinese Credit, European debt, dollar-denominated bonds globally and EM debt more generally. I’ll assume heady grown in “repo” and offshore financial intermediation only accelerated since 2017.

It was no coincidence that U.S. “repo” market tumult followed on the heels of an abrupt reversal in global bond yields. I appreciate how the enormous global buildup in leveraged speculation works miraculously so long as bond yields are declining (bond prices rising).

Furthermore, uncertainty associated with escalating U.S./China trade frictions spurred a historic global speculative “blow-off” and market dislocation. If only bond yields could fall forever – even as debt and deficits expand uncontrollably.

It’s not clear to me how the global system doesn’t turn increasingly unstable, which I believe explains why the ECB and now the Fed have resorted again to QE.

Question: “When you first became chair, you were spotted numerous times carrying Paul Volcker’s book under your arm – and I’m curious what lessons did you learned from Paul Volcker and what lessons are you taking through your chairmanship?”

Jerome Powell, October 8th, 2019, during Q&A at a National Association of Business Economics event in Denver: “I’ve known Paul Volcker since I was an Assistant Secretary in the Treasury in 1992 or 1991. Of course, at that time, he had just relatively recently left the Fed - and I was frightened of even meeting him. I was just so intimidated by this global figure. And he couldn’t have been nicer and more interested in helping me and supporting me and we kind of kept up. He was really a great person to know. I read numerous accounts of his life. This book, if you haven’t read it, really sums it up really well. I don’t think there has been a greater public servant in our broad area in our lifetimes. He really just did exactly what he thought was the right thing – all the time. And he lets the chips fall where they may. He was famously booed at a Washington Bullets basketball game when he had rates very high… He’s a great man. I’m still in touch with him. I actually thought that I should buy 500 copies of this book and just hand them out at the Fed. I didn’t do that. It’s a book I strongly recommend, and we can all hope to live up to some part of who he is.”

Poverty in America

The best way to eradicate poverty in America is to focus on children

This removes the divisive, partisan debate about culpability, says Idrees Kahloon

ELDERLY RESIDENTS of Inez, the tiny seat of Martin County, Kentucky, deep in the heart of Appalachia, can still vividly remember the day the president came to town. Fifty-five years ago, while stooping on a porch, Lyndon Johnson spoke at length to Tom Fletcher (pictured), a white labourer with no job, little education and eight children. “I have called for a national war on poverty,” Johnson announced immediately afterwards. “Our objective: total victory.”

That declaration transformed Fletcher and Martin County into the unwitting faces of the nation’s battle, often to the chagrin of local residents who resented the frequent pilgrimages of journalists and photographers. The story never changed much: Fletcher continued to draw disability cheques for decades and never became self-sufficient before his death in 2004. His family continued to struggle with addiction and incarceration.

Today Martin County remains deeply poor—30% of residents live below the official poverty line (an income of less than $25,750 a year for a family of four). Infrastructure is shoddy. The roads up the stunning forested mountains that once thundered with the extraction of coal now lie quiet, cracked to the point of corrugation. Problems with pollution because of leaky pipes mean that some parts of the county are without running water for days.

“Our water comes out orange, blue and with dirt chunks in it,” says BarbiAnn Maynard, a resident agitating for repairs. She and her family have not drunk the water from their taps since 2000; it is suitable only for flushing toilets. Some residents gather drinking water from local springs or collect rainwater in inflatable paddling pools.

The ongoing poverty is not for lack of intervention. The federal government has spent trillions of dollars over the past 55 years. Programmes have helped many. But they also remain fixated on the problems of the past, largely the elderly and the working poor, leaving behind non-working adults and children. As a result, America does a worse job than its peers of helping the needy of today.

By the official poverty measure, there were 40m poor Americans in 2017, or 12% of the population. This threshold is extremely low: for a family of four, it amounts to $17.64 per person per day. About 18.5m people have only half that amount and are mired in deep poverty.

Children are the likeliest age group to experience poverty—there are nearly 13m of them today, or 17.5% of all American children.

In international comparisons, that makes America a true outlier. When assessed on poverty relative to other countries (the share of families making less than 50% of the national median income after taxes and transfers), America is among the worst-performing in the OECD club of mostly rich countries (see chart).

Despite its higher level of income, that is not because it starts with a very large share of poor people before supports kick in—it is just that the safety net does not do as much work as elsewhere. On this relative-poverty scale, more than a fifth of American children remain poor after government benefits, compared with 3.6% of Finnish children.

Child poverty often leads to adult poverty and all of its problems: psychological distress, exposure to crime and lost productivity. The National Academies of Sciences, Engineering and Medicine, in a new 600-page study on the subject, estimate that child poverty costs America between $800bn and $1.1trn annually because of lost earnings and greater chances of criminality and poor health.

How can one of the richest countries in the world have so many poor people, and what can be done about it? This special report will aim to answer these questions. It will show how poverty is shifting geographically from cities to suburbs and examine the continuing influence of race. It will consider philanthropy and private enterprise. And it will conclude by arguing that heftier anti-poverty spending on children is the best way to make a difference.

For those who disparage the trillions of dollars spent on safety-net programmes as a well-intentioned but quixotic endeavour, the case of Martin County would seem a clear cautionary tale. “We waged a war on poverty, and poverty won,” Ronald Reagan lamented while president. That fatalism remains alive and well in American politics—from both the right, which often sees poverty as an inescapable problem of character and choice that is impervious to government intervention, and much of the left, which increasingly sees it as an inescapable consequence of predatory capitalism.

Both strains of pessimism are simplistic and incorrect. Now, as then, solutions do not adhere neatly to liberal or conservative agendas. The left has, in the past, overemphasised the ability of the government to achieve change. The right, mistrustful of state intervention and too convinced that a free market will automatically bring universal well-being, has done little creative thinking.

Because of this, the politics of poverty have become stuck. America is bogged down in the interminable exercise of separating the deserving poor from the undeserving. Treating the poor as responsible for their predicament is callous; treating them as victims of social structures and bad circumstances robs them of agency and dignity. Fair-minded people can find themselves anywhere in between.

Moreover, settling the debate over personal responsibility is also impossible, at least to the satisfaction of the most committed ideologues. A person who is convicted of a violent felony—a blameworthy choice—could face years of penury, but their childhood in a poor, segregated neighbourhood with little support from school or family—unlucky circumstances—are likely to have contributed to that action.

The partisan debate is focused on whether able-bodied, working-age adults should receive cash handouts. Yet such adults are a minority of the poor population today. Only a small number of them report unemployment or voluntary non-participation in the labour force. Straightforward cash welfare for non-working mothers—the battleground of the Clinton-era debate—is now only a small part of the safety net compared with in-kind programmes (like food stamps or Medicaid, the government health-insurance programme for the poor) and tax credits that boost the wages of the working poor. The main conduits of direct cash are disability payments and Social Security for the elderly which, by definition, do not go to able-bodied adults.

Some see the continued existence of deprivation in America as a reason to shrink the safety net, believing it to have been ineffective. Yet poverty persists today not because of the failure of the net, but in spite of its widespread impact. The correct way to evaluate the success of anti-poverty programmes is counterfactually.

The question is not whether poverty still exists, but how much worse it would be without government action. Answering that is made harder by the arcane way in which America measures poverty. The official level relies on pre-tax income, disregarding aid from safety-net programmes and differences in living expenses, making improvements difficult to register.

When a better tool is used—the supplemental poverty measurement (SPM), which takes these deficiencies into account—the effect of the expanded safety net becomes clear (see article). In 1967 safety-net taxes and transfers barely dented poverty: 26.4% of Americans were poor before, and 25% remained poor after. Without a safety net, nearly the same proportion of Americans, 24.6%, would be poor today as were 50 years ago.

Yet because of greatly expanded anti-poverty programmes, such as food stamps and the earned-income tax credit, which tops up the wages of low-paid Americans, only 13.9% are poor after taxes and transfers. The elderly were once among the poorest groups—and still would be were it not for the old-age cash and health benefits provided by Social Security and the Medicare programme. Now, they do about as well as working-age adults.

Eastern Kentucky exemplifies the evolving nature of poverty in America since Johnson declared his war. Compared with the rest of the country, poverty there remains high. But in absolute terms, the share of poor residents has dropped by nearly half since 1960. When John F. Kennedy campaigned for the presidency in West Virginia, he was horrified not by the state of the roads but by the emaciated people. Out-and-out hunger is much rarer today. However, new social pathologies have sprung up: obesity, joblessness, disability and addiction.

Each new social problem compounds the others. Individual choice and social structure co-mingle, yielding a Gordian knot of pathology difficult for policymakers to cut. The national economy has evolved to one that prizes education, leaving low-skilled workers behind. Deindustrialisation and incarceration have particularly decimated the prospects for black men.

Poor families of all races have become increasingly unstable as a result. Rates of non-marriage and births out of wedlock have risen among this population, leading to many more single-mother families—41% of children in such households live below the poverty line. Drug use, particularly of opioids, has grown exponentially, fracturing families even more.

“I became a mother at 72 again,” says Debbie Crum, who has lived nearly all her life in Martin County. “My great-nephew and his girlfriend had the baby. But they were hooked on drugs. The family had to go all the way back to me before they could find someone who could take care of the baby, who could pass the background check and drug test.” Ms Crum is a loving carer, but not all children are so lucky.

The Bureau of Economic Analysis publishes detailed data on sources of income, public and private. In some counties of Kentucky, federal transfers—through food stamps and disability and old-age benefits—account for 36% of all income. Without them, crises like joblessness and drug addiction would be far worse. Hospitals, schools and local government are often the largest providers of stable jobs. Medicaid, which was expanded in Kentucky through Obamacare, pays for substance-abuse treatment in parts of America hit hardest by the opioid epidemic.

The existence of poverty does not undermine the American dream, but the persistence of it does. The safety net looks stuck in time, even though the problem of poverty has evolved. And now there is a new danger. Because of rising income inequality and housing costs, poverty is moving out of cities and into suburbs, where it is less visible. Poor white and Hispanic Americans are much more likely to live in such places. Combating this looming problem is not at the heart of any political agenda.

That is unfortunate and self-defeating. A wealth of economic and sociological studies show that poor children who grow up in districts of concentrated poverty have profoundly worse life outcomes—their incomes sag, their health deteriorates and their family lives turn dysfunctional. The job of the safety net is to arrest this cycle. If this generation of poor children is to do better than the one before, the net will need to become stronger still.

China makes few concessions in trade truce with US

Beijing believes time is on its side as Trump seeks economic boost before 2020 election

Tom Mitchell in Beijing

Chinese trade negotiator Vice-Premier Liu He. The Trump administration has embarrassed him on five different occasions by discarding understandings he thought had been reached or announcing measures on the eve of trade negotiations © Getty

After five months of constant escalations in their long-running trade war with the US, Chinese officials on Friday finally secured a respite.

In return for a series of modest concessions, most of which had been offered by President Xi Jinping’s administration in previous negotiating rounds, Donald Trump agreed to suspend another set of tariff increases originally scheduled to take effect on October 15.

The truce sets the stage for a series of much higher-stakes negotiations after Mr Xi and Mr Trump’s expected encounter on the sidelines of the Asia Pacific Economic Conference, scheduled for November 16-17 in Santiago, Chile, where Friday’s agreement will be finalised.

The two sides are still a long way from a final settlement that addresses much more contentious issues, such as Chinese government support for strategic industries and state-owned enterprises, which Mr Trump had hoped to reach before his 2020 re-election campaign kicks off in earnest.

Chinese negotiators, however, believe that time is on their side and they can continue to stonewall Mr Trump and his lead negotiator, US Trade Representative Robert Lighthizer, on any “systemic” reforms that they fear would weaken the Chinese Communist party’s grip over the world’s second-largest economy.

In private, Chinese officials say they are lucky Mr Trump waited a year before launching his trade assault in the spring of 2018, giving his negotiators only about 18 months to confront China before domestic political pressures would begin to hem them in.

The US president wants relief for his farm-state supporters, who have borne the brunt of China’s counter-tariffs, and a soaring stock market to help boost his re-election prospects.

“The US economy is under pressure and Mr Trump is facing an election,” says one Chinese official. “Previously Trump wanted to ratchet up tensions but now he needs to lower them.”

Mr Xi faces pressures of his own. China’s third-quarter GDP growth rate, which will be announced on October 18, may have slipped below six per cent for the first time in decades. Authorities are also still struggling to contain an African swine fever epidemic, which has decimated the country’s pig herd and sent prices for pork and other meats soaring.

But unlike the US Federal Reserve, China’s central bank has so far refrained from any significant rate cuts and the country’s trade negotiators, led by Vice-Premier Liu He, are more than happy to appease Mr Trump by boosting purchases of US pork, soyabeans and other agricultural exports.

“The US is faced with increasing downward pressure on its economy and has limited room for [monetary] policy adjustment,” says Xu Hongcai, deputy director of State Council think-tank.

By contrast Yi Gang, head of the People’s Bank of China and a member of Mr Liu’s negotiating team, boasted late last month that “we are not in a rush to ease like other central banks . . . there is still room for normal monetary policy”.

Despite Beijing’s confidence that it has a stronger hand to play than Washington does in the trade negotiations, Chinese officials also remain extremely distrustful of Mr Trump and wary of his administration’s determination to “decouple” the world’s two largest and deeply interconnected economies.

In their view, Mr Trump has embarrassed Mr Liu on at least five separate occasions since he took office by discarding understandings the vice-premier thought had been reached — or by announcing China tariff increases or sanctions on the eve of one of his many visits to Washington.

China’s official Xinhua news agency, for example, only referred to “substantial progress achieved” in a range of areas — a far more cautious characterisation than the US president’s claim that the two sides had reached a “substantial phase-one deal”.

On Monday the Trump administration said it would move to limit US technology exports to eight emerging Chinese tech companies for providing surveillance and other equipment used in a sprawling prison network in the northwestern region of Xinjiang.

“There are no real [non-US] sourcing alternatives, especially for the storage devices critical to surveillance companies,” says one US executive. “[The export limits] could potentially kill companies Beijing regards as potential national champions.”

Even the interim agreement finally reached on Friday was the subject of some last-minute taunting on Twitter by Mr Trump — raising for Chinese officials the possibility that the US President might instead embarrass Mr Liu in person when they met at the White House. “[China] wants to make a deal, but do I?” Mr Trump tweeted on Thursday. “I meet with the Vice Premier tomorrow at the White House,” he added, as if promoting the next instalment in a reality-TV series.

“What are Chinese officials supposed to make of statements like that,” asks Andy Mok at the Center for China and Globalisation, a Beijing think-tank. “Does he want a deal to be done or not?”

Additional reporting by Xinning Liu

Why the Stock Market Cooled to the Latest Trade Move

By Reshma Kapadia 

Hector Retamal/Getty Images

The U.S. and China broke a five-month impasse on Friday in their long-running trade dispute, as negotiators reached a minideal “in principle” that suspended the U.S. tariff increase set for Oct. 15.

But optimism around the high-level trade talks might have been misplaced: Not only did the “deal” not address the thorniest issues at the heart of the dispute, but the conflict between the world’s superpowers widened in ways that could pose fresh challenges to U.S. companies and their shareholders.

President Donald Trump said the 13th round of trade talks reached a “very substantial phase-one deal,” adding that negotiations could include one or two more phases. Trump said it could take four to five weeks to get the deal on paper and signed, with details around enforcement and other issues still being worked out.

China agreed to buy $40 billion to $50 billion of U.S. agricultural products and scrap foreign ownership limits in its financial-services sector. In return, the U.S. suspended a planned increase in tariffs to 30%, from 25%, on $250 billion of Chinese goods.

The administration hasn’t yet decided on the tariffs scheduled for December. Trump also said that the deal included some intellectual property protections and agreements on currency, but he did not offer any details. Earlier, business officials expected negotiations to focus on IP protections around copyright and trademark issues.

The Dow Jones industrialsfinished on Friday up nearly 320 points, or 1.2%, at 26,816, although stocks fell sharply from session highs starting around 3:30 p.m., when investors realized the two countries hadn’t made more progress. The latest agreement could still fall apart, and it lacks a resolution of major issues that would create a more level playing field for U.S. companies.

These include a reduction or elimination of Chinese government subsidies to local companies; cyber theft issues, IP protections for data flows and computer source codes, and addressing technology and license transfers that U.S. companies often are forced to make in China.

Warren Maruyama, a partner at the law firm Hogan Lovells and a former general counsel at the Office of the U.S. Trade Representative, describes the deal as “very preliminary.” “Markets have been extraordinarily gullible,” he says.

Rajiv Jain, chief investment officer at GQG Partners, which oversees $26.5 billion, says market gains on a minideal would likely be an opportunity to sell. Jain doesn’t see a comprehensive deal on the horizon and notes that both sides’ interests are still far apart.

While a trade truce of any sort should be welcome, several new fronts have opened in the U.S.-China conflict. The Commerce Department added eight Chinese technology companies to its blacklist, including the facial-recognition firm SenseTime Group and the video-surveillance company Hikvision, and the State Department put visa restrictions on Chinese officials, citing in both cases China’s repression of Muslim minorities. The administration has also reportedly been considering restrictions on U.S. capital flows into China, which could hurt U.S.-listed Chinese stocks.

Nongovernment entities are rattling Beijing, as well. A tweet by a Houston Rockets official in support of pro-democracy protesters in Hong Kong ignited a firestorm in China this past week, briefly jeopardizing the National Basketball Association’s access to millions of basketball fans. Apple(ticker: AAPL) and the Google unit of Alphabet(GOOGL) had to pull protest-related apps from their digital stores, and a South Park episode critical of the Communist Party reportedly was removed from Chinese social media. These episodes point to a growing conflict for global companies—and their shareholders—between Western ideals of free speech and Chinese nationalism.

“We are already in a trade war and a tech war, and are talking about a capital war,” says Reva Goujon, vice president of global analysis for Stratfor, a consulting firm. “As those geopolitical fissures increase, companies are going to get caught in the middle.”

The global economy has already suffered. In a speech ahead of the International Monetary Fund’s annual meetings this past week in Washington, D.C., Kristalina Georgieva, the fund’s new managing director, said nearly 90% of the world is on track for slower growth. The IMF estimates that the trade conflict could inflict a cumulative loss of $700 billion in global economic output by 2020—roughly the size of Switzerland’s economy.

With less appetite for more tariffs, Goujon says, the U.S. search for leverage has been pushing it into more extremes, evidenced by the expanded blacklists and visa restrictions, which drew strong rebukes from the Chinese government.

“Beijing can’t be seen as bowing to pressure on issues where Chinese perceived sovereignty is under threat,” Freya Beamish, Asia economist at Pantheon Macroeconomics, told clients in a note, adding that tensions were likely to keep boiling.

Global companies will feel that heat. U.S. companies generate $544 billion in annual revenue in China—more than triple what the U.S. exports to China, according Arthur Kroeber of Gavekal Research. What’s more, with a population of 1.4 billion, China is a major source of growth.

As the relationship between China and the U.S. grows more complicated, corporate costs could rise and growth targets might need trimming. Investors might also need to reassess the multiples they are paying for companies counting on expansion in China.

Lewis Kaufman, manager of the Artisan Developing World fund (ARTYX), is increasingly favoring European multinationals like LVMH Moët Hennessy Louis Vuitton (MC. France) for indirect Chinese exposure over the likes of U.S. companies such as Tiffany(TIF), Nike(NKE), and Starbucks(SBUX), whose shares he held in the past.

Any move by the administration to restrict government pensions from investing in China, or to delist Chinese companies trading in the U.S., would be an especially critical line to cross.

“It would signal that it is bad form to own these companies,” says Christopher Smart, chief global strategist at Barings, who formerly worked in the Treasury Department. “That creates a whole new investor risk calibration over and above tariffs on soybeans and technology.”

U.S.-listed Chinese stocks, or American depositary receipts, which are owned mostly by U.S. investors and based in tax-free jurisdictions like the Cayman Islands could be most vulnerable to declines. GQG’s Jain prefers China-listed A-shares, in part because of these risks. He also prefers well-run U.S. businesses trading at 21 or 22 times earnings, versus similarly valued Chinese ADRs such as TAL Education Group(TAL), New Oriental Education & Technology Group (EDU), or NetEase(NTES).

The risk of restricting U.S. government pensions from owning Chinese stocks is still theoretical, but some once-theoretical concerns, such as a technology cold war or visa restrictions and blacklists, have been realized. Investors who put more stock in the latest comments about preliminary partial deals than growing risks to the U.S.-China relationship should take note.

Gold Gifts Traders With Another Rotation Below $1500

Chris Vermeullen

Positive expectations related to the US/China trades negotiations on October 10th prompted a moderately strong upside move in the US major indexes and the stock market. 

Additionally, the precious metals fell in correlation to the upside move in the US stock market and presented another opportunity for skilled technical traders to look for entries below $1500 in Gold and below $17.75 in Silver. 
We can’t stress the importance of this critical $1500 price level in Gold as a key level for all traders to watch.  It has continued to provide key support for Gold since the price rally that initiated in late April 2019.  We believe this level will act as a relatively strong price “floor” going forward and any price activity below $1500 could represent a very opportunistic entry area for skilled traders.

Back in early September, we authored this research post highlighting what we believed would happen going forward 30 to 60+ days for Gold.  At that time, the price of Gold has just rallied above $1500 for the first time in 2019. 

We alerted our followers that we believed Gold would stall near the $1550 level, move briefly towards the $1475 to $1500 level, set up a new momentum base near the $1500 price level and begin a new rally soon after this base was complete. 

You can read this research post here: .

Gold Weekly Chart from Our September 2nd Research Post

This is a Gold Weekly chart from that September 2 research post. 

We still believe our research from that post is accurate and we believe this new move below $1500 is an incredible opportunity for skilled traders that understand the real potential of the future of precious metals.


120 Minute Gold Chart Showing Price Correction Warning Before it happened

This 120 Minute Gold chart showing the early price decline on October 10, 2019 and highlighting the $1500 price support zone in RED illustrates how price has continued to find this level acting as strong support and how price has, in the past, moved through this level and back above it to form the new “momentum base/bottom” near October 1, 2019. 

We believe any move below $1500 (or more precisely – $1495) is a very strong entry point.  Obviously, a price move to lower levels would be even better.  Currently, as long as price stays above the Momentum Base level (near $1463), then we consider the October 1 price rotation the true momentum base “low”.

Current Daily Chart of Gold – Support Zone, and Forecast

This Daily chart highlights the same $1500 price support zone and clearly illustrates why we believe any price move below $1500 is a very strong opportunity for skilled traders.  The next leg in Gold should push prices above $1700 (possibly higher).  Longer-term, we believe the fear and uncertainty in the global markets will not subside until well after the 2020 US Presidential election cycle completes.

Concluding Thoughts:

Therefore, we have at least 12 to 16+ months of continued fear driving investor uncertainty in precious metals and as the US political chaos heats up, so will precious metals. 

At this point, we believe Gold has just started to “lift-off” in terms of the ultimate upside potential over the longer term.  We’ve discussed the potential of Gold reaching above $3750 and we believe this target level is very valid.

Play these moves accordingly.  This may be the last time you see Gold trading below $1500 for quite a while.

Time To Act

Trump's Impeachment Inquiry Is Imperative for the World

By Roland Nelles in Washington

The U.S. flag in front of the Capitol Building: It's time for America to show that it's capable of defending its democracy.

In the battle over the impeachment inquiry, Donald Trump has shown once again just how deft a manipulator he can be. Will it be enough? A failure of American democracy would be a disaster -- and not just for the United States.

America's Founding Fathers bestowed considerable power on the country's president. He or she serves as the head of the Executive Branch, is at the helm of the administration and the military and also determines a large share of foreign policy.

Having just waged the bloody Revolutionary War for independence from the British crown, Alexander Hamilton, James Madison and the other Founding Fathers wanted to ensure, no matter what, that the president didn't rule like a monarch. In 1787, the Constitution established "checks and balances" intended to provide Congress with a major role in government affairs and oversight over the Executive Branch as essentially it's co-equal. At the same time, the president would have to respect the laws and always govern conscientiously and for the good of the people. This includes the duty to not abuse the power of the presidency to one's own advantage.

That's how a great democracy arose in the U.S., one that has been replicated around the world many times over. It is an admirable system and the foundation of America's strength -- and, so far at least, it has always functioned reasonably well. Despite all its weaknesses, the U.S. is a country that its citizens can rightly be proud of.

Deadly Serious

But now, Trump is in power, a president who doesn't seem to care much about norms. He is testing the limits of democracy in the Ukrainian scandal as he relies on tricks, cover-ups and deception. The question now is whether American democracy will survive unscathed and whether it can return to its role as the bright beacon of democracy.

This isn't a game or some kind of cheap show -- these are deadly serious times. Whenever abuse of power becomes the rule rather than the exception, whenever it is left unsanctioned, we see the door opened to despotism. A failure of democracy in the U.S. would be no less than a catastrophe for the rest of world. Just as America served as a positive example for decades, it could just as quickly become a negative role model for the many leaders around the world dreaming of omnipotence. Trump's imitators are already hard at work around the globe, in countries like Brazil, Hungary and Italy. If he gets away unsanctioned, they would be even more emboldened to follow his autocratic impulses.

Trump's greatest strength is his ability to warp his own reality. In doing so, he blinds his followers to the truth, ensuring their continued support. He has a tremendous talent when it comes to manipulating people, and his approach to the current scandal is further proof of that.

Trump wanted to enlist the governments of China and Ukraine to investigate his political rival Joe Biden. With the cover blown on the Ukraine scandal by a whistleblower, Trump is now presenting himself as the victim of a conspiracy hatched by the Democrats. He even described it in a tweet as an attempted "coup." In the echo chambers of the Trump world, at Fox News and on the internet, people are only too happy to lap up these conspiracy theories.

It's ludicrous, really: Trump is many things, but he is certainly not a victim. Now we can see that the world's most powerful man is apparently willing to abuse the power of his office to increase his chances of re-election.

When the House investigates the matter and considers the first steps toward removing Trump from office, it is merely exercising its rights under the U.S. Constitution and doing exactly what the Founding Fathers intended in such cases. This is not treason, as Trump and his followers have claimed -- it's the duty of members of Congress who have given a sworn oath to protect the Constitution -- from external and internal enemies.

Eager Followers Everywhere

The Republican Party's failings are an additional problem in the current crisis. How would the Republicans have reacted if Barack Obama had made calls to Ukraine or China as president in 2010 to order investigations into his then challenger Mitt Romney? The outrage would have been enormous, to be sure.

So, what now? Few Republicans have dared criticize Trump's behavior in the Ukraine affair, so far. Even though it seems pretty clear that the president abused the power of his office in his effort to collect political dirt against a rival, most Republicans are pretending everything is just fine.

Idolatry of Trump is paralyzing the party. Many Republican members of the House and Senate are Trump's disciples and they view the world just as he does. Others don't dare to rebel against him out of fear of losing their seats. It's painful to watch and see how many people are falling for Trump's tricks.

How long can this go on? It's time for America to show that it's capable of defending its democracy against the autocratic abuse of power by its president -- first through an impeachment inquiry and then through impeachment itself, if necessary. In the name of its own future, but most importantly to set an example for the rest of the world.

How RTGS killed liquidity: US tri-party repo edition

By: Guest writer

Daniela Gabor is a professor of economics and macrofinance at the University of West of England, Bristol. In this post she explains how the pressures placed upon intraday liquidity by real-time gross settlement systems led to the creation of the tri-party repo market, which itself proved a central point of failure during the global financial crisis.

In a recent post, Izabella Kaminska argued that Real Time Gross Settlement (RTGS) changed the way in which central banks managed systemic liquidity.

RTGS and expensive intraday overdrafts at the central bank killed systemic liquidity, she argued, because “these systems do not function smoothly unless commercial banks maintain sufficiently large reserves to cover payment settlement risk”.

There is a critical element to complete the puzzle of RTGS and systemic liquidity: the rapid structural change in the US financial system towards securities trading and financing via repo markets, a trend accelerated in the 1980s which spread quickly to European financial structures (as I documented in my paper on the political economy of repo markets).

Evolutionary changes in finance combined with RTGS created what Chicago Fed economists Marshall and Steigerwald described as time-critical liquidity (emphasis theirs):

...a settlement payment, delivery of securities, or transfer of collateral must be made at a particular location, in a particular currency (or securities issue), and in a precise timeframe measured not in days, but in hours or even minutes.

Caught between RTGS and a Federal Reserve committed to monetarist ideas, market participants shifted time-critical liquidity away from the balance sheet of the Federal Reserve, and into the US tri-party repo market, with profound structural and systemic effects that reverberate even today.

The background

Banks rely on central bank money to manage the complex webs of settlement obligations resulting from their daily interactions with each other on behalf of retail and institutional clients. These obligations can be settled periodically on a net basis, or immediately, in ‘real time’ on a gross basis. Banks prefer netting because it allows them to economise on central bank reserves, an asset with significant opportunity costs (at least before the world of Basel III liquidity requirements).

But netting systems weave complex webs of credit relationships that are susceptible to systemic risks. When German authorities closed the small commercial bank Bankhaus I. D. Herstatt KgaA at the end of the business day in Germany on June 26, 1974, the critical flaws in netting-based settlement systems became quickly apparent.

Chase Manhattan, Herstatt’s correspondent bank in New York, decided to withhold dollar payments it was due to make on behalf of the German bank. Herstatt risk, or settlement risk, came on to the policy agenda, as most central banks – the US Federal Reserve a notable exception - operated netting settlement systems. The answer, central banks agreed collectively, was to force banks to settle transactions in real time and on gross basis.

RTGS, however, brought new problems.

RTGS in the time of monetarism

In the late 1970s RTGS system, US banks that lost deposits (as clients made payments) would typically enter an overdraft position with the central bank, unless they could draw on idle reserves in the day’s opening balance. Deposit inflows reduced intraday overdrafts, and vice versa.

Daily overdrafts could in theory be carried overnight, but the Fed discouraged such practices through high penalties and administrative sanctions. Since the banks’ obligation to hold reserves was an overnight obligation, those with overdrafts would borrow from the interbank market or from the Fed at the end of the day. Throughout the day, the Fed would grant credit to those banks in overdraft without charging them.

By the early 1980s, the Fed became increasingly concerned with the rapid growth in intraday overdrafts. Uncollateralised overdrafts exposed the Fed to the risk that counterparties would default after accumulating a large intraday position.

An arguably more important factor was that the large intraday overdrafts made a mockery of the Fed’s commitment to take back control of its balance sheet.

Under the leadership of Paul Volcker, the Fed had been trying to fight stagflation with monetarism. Nowadays there is broad agreement that the control of bank reserves is virtually impossible in a world of endogenous money, and that Volcker’s flirtations with monetarism were a strategy to create political support for the high interest rates judged necessary to bring inflation down – as the ECB’s Ulrich Bindseil documents in this excellent 2004 paper on what he terms the “Reserves Position Doctrine”. Yet at the time, the Fed embraced money supply targets and viewed banks’ reserve positions as a critical policy lever.

The credibility of the lever was weakened by growing intraday overdrafts.

By the mid 1980s, these overdrafts routinely exceeded $60 billion, driven by a growing transfer of securities via Fedwire. Securities’ sales via Fedwire require delivery (of security) vs payment (of cash). A broker-dealer purchasing securities would see its clearing bank’s account at the Fed debited. Without sufficient reserves, the clearing bank’s daily overdraft would increase.

By 1988, four clearing banks together accumulated 70 per cent of daily overdrafts attributable to movements of securities over Fedwire. These were in turn driven by the growing repo market activities of securities dealers.

Indeed, Fed research at the time noted the rapid growth in dealers’ use of repos. Whereas capital requirements restricted bank dealers’ use of repos, non-bank dealers tripled their repo books to around a $286 billion annual average by 1985, with over half in matched books (a.k.a. repo borrowing and lending against the same security, with equal terms to maturity).

Figure 1 Dealers' use of repos, 1981-1985 (annual averages). © Source: Federal Reserve

Securities dealers and their clearing banks found themselves locked in a battle with the Federal Reserve over time-critical liquidity. For market-making purposes, dealers liked to hold large inventories of securities throughout the day to meet customers’ demand, and to fund these overnight via repos. Repos would be unwound in the morning (dealers repurchase collateral), giving dealers access to securities, and renewed in the evening.

As dealers repurchased collateral in the morning, and instructed their clearing banks to pay cash, the clearing banks saw their intraday overdraft positions with the Fed increase. That intraday overdraft would automatically close in the afternoon when dealers contracted new overnight repos (selling securities).

The Fed moves on intraday overdrafts

By 1985, the Fed decided to act. It first imposed a cap at three times the level of regulatory capital. But the cap failed because it did not cover overdrafts generated by transfers of securities through Fedwire. The Fed exempted those as it believed that the liquidity of the US Treasury market, joined at the hip with the repo market, relied on free intraday overdrafts. Even in monetarist times, concerns about the liquidity of the US Treasury market shaped the central bank’s systemic liquidity decisions.

As securities-related overdrafts doubled between 1986 and 1993, the Fed considered other options. The most obvious one was also the least consistent with monetarist ideas. The Fed could have prohibited overdrafts altogether, instead forcing banks to purchase federal funds via open market operations. But this would have dramatically increased the Fed’s balance sheet, rendering visible the fact that financial systems which are organised around securities markets which structurally require large central bank balance sheets.

Rather, the Fed decided to charge clearing banks a fee on daily overdrafts in 1994, imposing an annual 10 basis points charge on April 14. Within six months, overdrafts contracted by 40 per cent as dealers embraced the Salomon Brothers solution to time-critical liquidity – the tri-party repo market.

You can see the collapse in the overdraft use here:

The Salomon Brothers solution: the tri-party repo market

In the late 1970s, Salomon began to notice that it was regularly paying twice to finance its UST securities portfolio.

This is because as market-maker, Salomon received and posted securities throughout the day.

Often, however, it would receive those securities too late to (re)fund them through new bilateral repos.

For example, Salomon funded USTs through an overnight repo with UBS. When UBS no longer wanted to rollover the repo, Salomon would need a new repo lender. But Salomon needed to first receive the security back from UBS and then send it to the new lender via the Fedwire Securities Service.

If UBS sent securities too close to Fedwire closing time, then Salomon would not be able to deliver them in the new repo and would have to use its clearing bank (then Manufacturers Hanover). Like other securities dealers, Salomon Brothers used MH to buy and sell securities, maintaining book entry securities accounts and demand deposit accounts. If delivery to the new repo lender could not be made in time, Salomon would have to pay the interest rate twice, to MH for funding the securities ‘stranded’ overnight in the clearing account and to the new repo lender.

Salomon’s solution was to circumvent Fedwire altogether. Its clearing bank, MH, would instead co-ordinate the exchange of cash and collateral, in what would become a tri-party repo. If Salomon and the new repo lender both had accounts with MH, then MH could simply settle the new repo by transferring the securities from Salomon’s general account to a segregation account without going via Fedwire. This would eliminate the constraints imposed by the time of the Fedwire closure, and saved Salomon Brothers money.

The Salomon solution offered a convenient way out for dealers seeking to circumvent Fed’s expensive intraday liquidity after 1994. You could say, it was the blockchain private sector-led solution of its day.

Dealers could have chosen to reduce the time between unwinding in the morning and the new repo. But the Salomon tri-party solution allowed securities dealers to have control over securities during the day, which was critical to their market-making activities. Indeed, clearing banks would unwind all tri-party repo trades in the morning, between 8 and 8.30am, including those with maturities longer than overnight, and re-wind repos in the evening.

As Copeland et al noted in 2015:

A complete unwind of all repos, and not merely of those maturing, is an operationally simple process. An alternative would be a process by which dealers could substitute collateral (including cash) into repo deals without unwinding them, in order to extract a needed security, possibly at multiple points throughout the business day. Throughout the day collateral substitution is prevalent in European tri-party repo markets. By contrast, the US clearing banks have offered some automated collateral substitution capabilities to US tri-party repo market participants only since June 2011

The US tri-party repo market thus provides us with one of the most extravagant episodes of monetary history: long-term repo agreements were in fact a series of overnight repos. Without the ability to substitute collateral pledged in long-term repos, securities dealers bended time so they could minimise the costs of their market-making activities, and circumvent the balance sheet of the central bank.

Yet the Salomon solution did not solve the problem of time-critical intraday liquidity. Rather, the problem shifted from the Fed to the tri-party clearing banks. The clearing bank would instead provide funding for the securities inventories of the broker-dealers throughout the day.

Tri-party agents become a sort of shadow central bank

As a result of the set-up, tri-party agents replaced the Fed in providing intraday liquidity to securities dealers. Put differently, dealers financed their securities through unsecured loans from tri-party dealers during the day, and by repos during the night. This increased concentration in the tri-party segment. Economising on intraday Fed liquidity required dealers to trade with each other, and with repo lenders via the same tri-party agent.

By the time of Lehman Brothers’ collapse, there remained two US tri-party agents: JPMorgan Chase and Bank of New York Mellon. Although the Fed regulated them as depository institutions, it did not impose additional regulations for such large intraday lending positions, in gross terms equal to assets generated from all other activities. By mid 2008, the two were lending intraday USD 2.8 trillion in their tri-party repo business.

Post-Lehman, the Federal Reserve introduced a series of measures to reduce reliance on intraday credit. These prompted JPMorgan to exit from its tri-party repo business in 2018, leaving BNY Mellon alone in the market just as tri-party repo volumes were increasing again.

Figure 2 US tri-party repo volumes © Source: Federal Reserve

Given the above, it’s hard to imagine how the story of US repo market tensions in September 2019 isn’t connected to the evolution of the tri-party repo market and its role in channelling time-critical liquidity.

The question yet to be answered, is how?

Metals & VIX Are Set To Launch Dramatically Higher

The recent rotation in the US stock market and US major indexes have set up a very interesting pattern in the Metals and VIX charts.  Our researchers believe precious metals, Gold and Silver, are setting up a new momentum base/bottom and are beginning an early stage bullish price rally that may surprise many traders.  If you have not been following our research, please take a minute to read these past research posts :



Our researchers believe the bottom in Metals has already set up on October 1, 2019.  This setup aligns with our earlier analysis that a new bullish price leg is setting up that will propel Gold to levels above $1600 before the end of November – possibly resulting in a rally that attempts to breach the $1700 price level.

Daily Gold Chart

Of course, for Gold to rally in this manner, some type of extended fear must enter the global markets.  We believe this fear could become known to traders within 3 to 10+ days based on our understanding of the schedules and calendars available within the news cycle.  The US/China trade talks appear to be breaking down again.  News that one of India’s largest banks is in the process of collapsing hit last weekend. And news that the US political parties are about to ramp up nearly all levels of activity ahead of the 2020 US Presidential election cycle is sure to throw the markets a few curve-balls.

As skilled technical traders, there are times when we must understand how the news cycles and external events can have dramatic impact on prices and trends in the financial markets.  These are times when we must protect our assets by deploying very skilled trades, proper position sizing and become even more skilled at understanding the global stock market dynamics.

Daily Silver Chart

Silver, or as we have termed it “The Super-HERO of Metals”, will likely move much higher, even faster than Gold.  If our research is correct, the next upside price leg in Metals will see Silver rally to levels well above $20, then stall briefly, then begin a move to levels above $26 (or higher).  The Gold to Silver ratio will likely fall to levels near 65 throughout this move.  That would mean that Silver would appreciate about 11% to 15% faster than Gold will appreciate over the next 60 to 90+ days.

VIX – Daily Volatility Index Chart

And finally, the VIX.  At this point, our research team believes a broader downside price rotation has already begun to set up in the US stock market (with Technology and “unicorn” sectors at severe risk) which may prompt a move in prices to retest the December 2018 lows.  This is why we believe the VIX is very likely to begin an upside price move over the next 30 to 60+ days and attempt to break above the 26 to 27 level as the US stock market reacts to increased fear and uncertainty.  This is, obviously, also why we believe Gold and Silver will begin to move dramatically higher very quickly.


Concluding Thoughts:

Our researchers are attempting to follow all the news and price activity we can handle over the past 4+ weeks or longer.  At this point, it seems all the global markets are unstable in terms of price trends, extended volatility, and uncertainty.  We believe our expectations within the metals markets, us stock market and the VIX predictions are relatively saved expectations given the research we’ve completed. 

It would be wise for skilled traders to prepare for a moderate to deep price correction at this point. 

Price has failed to move higher above historic all-time high price levels and has begun to move lower.  Unless some extremely positive news, event or outcome is reached within the next 90+ days, it is very likely that price will continue to rotate within established ranges attempting to identify true support levels.  This ride could become very volatile – very quickly.

As a technical analysis and trader since 1997, I have been through a few bull/bear market cycles. I believe I have a good pulse on the market and timing key turning points for both short-term swing trading and long-term investment capital. The opportunities are massive/life-changing if handled properly.

Be sure to ride my coattails as I navigate these financial markets and build wealth while others lose nearly everything they own during the next financial crisis.

I can tell you that huge moves are about to start unfolding not only in metals, or stocks but globally and some of these supercycles are going to last years. My simple technical trading strategy using ETFs will allow you to follow the markets closely and trade with it so you never get caught on the wrong side of the market with big losses.