The liquidity gusher is gushing a little bit slower 

Robert Armstrong

This line goes pretty much straight up lately:

 No alt provided

What you are looking at is volume of reverse repo. 

The Fed has been selling, oh, half a trillion dollars in Treasuries overnight for cash, with an agreement to buy them in the morning at a slightly higher price. 

To put it differently, investors have been making very short-term collateralised loans to the Fed. 

This is interesting because at the same time, in a separate operation, the Fed is still buying $80bn in long-dated Treasuries a month.

Here is the New York Fed definition of reverse repo:

In a reverse repo transaction [the Fed] sells securities to a counterparty subject to an agreement to repurchase the securities at a later date at a higher repurchase price. Reverse repo transactions temporarily reduce the quantity of reserve balances in the banking system.

This is a way for the Fed to (in everyone’s favourite phrase) “mop up excess liquidity”. 

There is so much cash in the financial system that short-term rates, including the repo rates, Treasury bills, and the Fed’s policy rate, are all threatening to fall below zero. 

The Fed has long said it does not like negative interest rates, so it has brought out the mop.

Why that is important to investors is that the amount of liquidity in the financial system and asset prices seem to be linked. 

I spoke about this on Monday with Michael Howell, whose research at CrossBorder Capital focuses on global liquidity. 

Howell noted that there is a debate among liquidity watchers as to whether the Fed’s half-trillion reverse repo operation is simply “technical” (a response to a particular issue in market functioning) or is in fact a backdoor way to begin tapering quantitative easing. 

He doesn’t have a strong view either way. 

The point for him is that, in part because of the Fed’s reverse repo, global liquidity growth is decelerating. 

That is very likely to affect asset prices. 

Indeed he thinks it already has. 

Howell sees the imprint of the change in liquidity in the sideways equity markets of the past few months, and in the flattening yield curve. 

There are various ways of measuring the slowdown in global liquidity, but the simplest is to observe, as Howell does, that global central bank balance sheets expanded by $483bn in May, less than half the April expansion and well below the levels of May 2020. 

Howell also provides the chart below, showing the annual change in the global monetary base (in yellow) slowing down from 35 per cent to 20 per cent in recent weeks (the red line is an index of the total stock of savings and newly extended credit in 80 countries): 

 No alt provided

The punchline, of course, is that when the amount of liquidity goes down, investors' portfolio preferences change — they are happy to hold less risk. 

Hence this long-term rough relationship between changes in global liquidity (again, savings plus newly issued credit instruments) and changes in total wealth (stocks, bonds, gold, real estate): 

No alt provided

Howell’s way of thinking about things is new to me, so I’m not sure if I am getting it quite right. 

But it might be useful to think of them in contrast to Robert Shiller’s classic model from Irrational Exuberance. 

Shiller’s view is that the valuation of assets, relative to their cash flows, varies around a fairly stable mean, with the divergences from the mean caused by changes in investors’ level of optimism. 

Howell says the variation around the mean is largely the product of liquidity flows, which change investors’ portfolio preferences. 

Of course the two models may be complimentary. 

Another view on the dollar

On Monday I wrote this:

The US buys a lot more stuff from the rest of the world than the world buys from the US. 

That difference has to be financed; as a matter of mathematical identity, there has to be an inflow to match that outflow. 

There could be inflows in the form of, for example, direct foreign investment in US real assets or, as is more often the case, investment in US securities, most often our sovereign bonds.

I was trying to give a characterisation of one popular view of why the dollar has to fall — the “twin deficits” hypothesis — rather than give my own, considered opinion. 

But still I should have been more careful. 

That paragraph assumes that the trade imbalance causes a capital account imbalance. 

But all we really know is that the trade account and the capital account must sum to zero, as a matter of accounting. 

We don’t know which way the causality runs. 

It could be that the capital account surplus causes the trade deficit.

The person who called me out on this is the financial economist Michael Pettis, in a series of tweets: 

 No alt provided

Thinking about the trade imbalance as the cause is easy and intuitive, as I demonstrated on Monday. 

The story is that Americans are fat, lazy consumers who don’t make stuff any more, but buy lots of things that lean, hard-working foreigners make. 

That drives a trade imbalance that has to be offset by capital inflows to the US — bond purchases by the Chinese, and so on. 

Pettis’ point (put with maximum simplicity if not accuracy) is that there is a lot of excess savings around the world, particularly in China, Germany and Japan, mostly resulting from bad economic policy. 

A lot of these excess savings get funnelled towards the US because there are no other capital markets open or deep enough to take them. 

America becomes the “shock absorber” for the world’s imbalances of savings and investment (or if you prefer, its insufficient demand). 

The capital account, the massive inflow of excess global savings, determines the trade balance, not the other way around. 

This story is hardly intuitive. 

How are US consumers forced to buy stuff, or the US forced to borrow, simply because capital from the rest of the world wants to come to America? 

Well, for one example, foreign capital could find its way into US consumers’ hands, and turn into consumer spending, by way of financial institutions that offer them very cheap loans to finance consumption. 

As the economist Amir Sufi pointed out to be, think of the insane American rebranding of second mortgages as “home equity loans”. 

That’s a symptom of global capital pushing its way into the US and incentivising US deficit spending using good old marketing.  

For our purposes, the point is that if you think US deficits are caused by international savings gluts, rather than by domestic profligacy, you are probably less likely to think the dollar is doomed to depreciation. 

Yet another view on the dollar

On Monday I used a chart from Strategas’ Jason Trennert, showing that price/earnings ratios tend to vary with the dollar in the last 30 years — which makes sense, conceived in terms of global capital flows. 

Ian Harnett of Absolute Strategy Research emailed me to point out that if you go back further, the correlation does not hold at all:

 No alt provided

There was a regime change in this relationship in the late 80s. 

Are we having another now?

The Fickle Charms of Private Global Finance

Despite all the hype, greater access to private international capital has not been much use to most emerging markets and developing countries over the past two decades. The record suggests that solutions to current macroeconomic dilemmas that still rely on net capital inflows are likely to end in tears.

Jayati Ghosh

NEW DELHI – Once again, emerging markets are on the capital-flows roller coaster – one no less dizzying for being so familiar.

And once again, the highs and lows of financial-market swings in these economies are mostly generated by external forces, not national policies. 

But the possibility that even the smallest domestic mistake could send them into a tailspin still looms large.

The past 18 months have provided ample evidence of this. 

According to the Institute of International Finance, total capital flows to emerging markets fell by 13% in 2020, to $313 billion. 

But this headline figure conceals sharp changes, from a dramatic decline in March 2020 to a recovery in the following month and significant volatility thereafter.

These flows have remained strong so far in 2021, at $45.5 billion in April and $13.8 billion in May, mostly to finance the purchase of emerging-market debt securities. 

While total global debt fell by $1.7 trillion, to $289 trillion, in the first quarter of 2021, emerging-market economies’ debt increased by $600 billion, to $86 trillion.

So, the good times are back for such economies, right? 

Well, not really. 

True, rich countries’ rapid and massive monetary-policy response to the pandemic-induced downturn certainly played a role in reviving capital flows to the developing world. 

But as the equally huge fiscal expansion in some advanced economies (especially the United States) takes hold and bolsters the economic recovery, fickle global capital may well look for greener pastures there. 

That will once again result in financial rationing that penalizes economies with higher perceived risk.

Of course, it is misleading to talk of emerging markets as a homogenous group. 

China is now such an outlier – not only because of its economic size and strength, but also because of its effective control of the pandemic – that it really should be treated separately. 

While some countries, like Poland and the Philippines, have used their greater fiscal space and stronger balance-of-payments positions to provide more support to their economies, others, including Argentina, Egypt, and Turkey, face the difficult task of ensuring recovery while dealing with macroeconomic imbalances and a major debt overhang. 

Then there are countries like India and Mexico, which face no immediate external constraints but whose inexplicable fiscal reticence is holding back economic recovery.

Emerging economies regard capital-market integration as a way of obtaining more and cheaper access to private international finance to fund domestic investment and public spending. 

But this gives rise to a number of contradictions and concerns.

For starters, open capital accounts generate both inflows and outflows, meaning that a country may not always benefit from net inflows. 

Malaysia’s capital outflows have generally exceeded its inflows over the past decade, so savings have migrated abroad in net terms. 

And the volatility of such flows, combined with policymakers’ obsession with self-insurance through high foreign-exchange reserves, increasingly means that even net recipients of foreign capital don’t really dare to spend it. 

India, for example, has significantly boosted its forex reserves during the COVID-19 crisis – the volume recently exceeded $600 billion – in the mistaken belief that this is an indication of economic strength.

Large forex reserves are extremely expensive, because countries typically park them in safe assets like US Treasury bills, which provide low rates of return. 

This adds to the more general problem of significant wealth transfers between emerging and advanced economies. 

Moreover, the yield differentials between emerging economies’ gross external assets and their higher-yielding external liabilities often generate large outward income transfers. 

Turkish economist Yılmaz Akyüz, formerly of the UN Conference on Trade and Development, has estimated that in 2000-16, such inadvertent transfers to advanced economies amounted to 2.3% of the combined GDP of the G20 emerging economies each year.

On the other hand, emerging-market economies’ greater engagement with and exposure to global financial markets does not really enable them to undertake such spending. 

In fact, it can actually act as a damper on necessary fiscal expansion, owing to policymakers’ constant (and realistic) fear of credit-rating downgrades and capital flight. 

Even the need to spend more on mounting climate-change threats, for which current adaptation efforts are completely inadequate, is ignored because of such pressures.

The pandemic and the current revival of capital inflows into emerging markets are intensifying the contradictions. 

Many emerging markets and developing countries already face looming debt problems, which will only worsen as they borrow more during the pandemic. 

The private sector in lower-income countries has contracted much more debt than the public sector has, but governments rightly worry that they will have to step in and guarantee those loans when the going gets tough. 

Even when debt held by foreigners is denominated in domestic currency, this does not guarantee stability, because sell-offs and capital-flow reversals driven by changing investor perceptions can lead to currency devaluations and domestic banking crises.

Despite all the hype, greater access to private global finance has not been much use to most emerging and developing economies over the past two decades, much less during the pandemic. 

The record suggests that solutions to current macroeconomic dilemmas that still rely on net private capital inflows could end up merely intensifying the problem.

Jayati Ghosh, Executive Secretary of International Development Economics Associates, is Professor of Economics at the University of Massachusetts Amherst and a member of the Independent Commission for the Reform of International Corporate Taxation.

Plenty of explanations for falling yields, none of them much good

Robert Armstrong

I’ve been away for a week or so. 

The important news since I left is this:

And this: 

Treasury yields have really crashed at the long end, and the yield curve has flattened significantly. 

There has been a matching move in equity markets: the growth/technology stocks have extended their run against value/cyclical stocks.

This looks like a pattern. 

This is what you would expect to see if something has happened to dampen expectations for inflation, economic growth or both. 

But there has been no whopping big chunk of news — or even a tidy pattern of little newslets — to neatly explain why the downward trend in yields and flattening curve that started in the middle of May should suddenly accelerate. 

Let’s see if we can tease out a clear signal.

To start, the move in yields (both in the past few months and in the last week) can be broken down into two roughly equal contributors: falling inflation expectations and falling real interest rates (as revealed in the yields on inflation-protected securities).

The drop-off in inflation expectations is hard to justify. 

Yes, several key commodities have cooled off. 

Lumber has all but normalised and oil has backed off from its Opec-related tizzy (the cartel seems unable to agree to a plan, and the market has reached the conclusion that means members will end up pumping out more crude). 

That aside, though, the inflation data keeps coming in hot. 

Below are Citigroup’s inflation surprise indices for emerging economies, advanced economies, China and the US. 

All are at peaks; the US and the advanced economies are both at long-term highs:


Something else the yield crash is not: a signal of investors shifting to a “risk-off” stance. 

Stocks, and not just the tech-heavy Nasdaq, are up against long-term highs. 

If that’s not enough, the Investors Intelligence bull/bear ratio is at a two-year high. 

Finally, the yields on the junkiest junk bonds have never been lower, and just keep falling. 

Data from the Federal Reserve: 

Risk appetites are razor sharp.

Investors might be keen on risk because they think there will not be enough growth to justify Fed tightening. 

This would explain yields falling, the curve flattening and stocks flying high, given the (possibly mindless) mantra that low rates justify high equity valuations. 

But there is not much recent data to justify growth expectations falling, either. 

The June manufacturing and services industry Institute for Supply Management surveys were a little softer than in May, but activity and orders remain high. 

The pressure seems to be in supply chains, including the labour supply chain. But those problems should work themselves out before too long. 

A more likely, if speculative, story on growth is that investors are simply waking up the fact that growth is peaking now. 

Deceleration, as I have written before, is not as fun as acceleration, however high the absolute level of growth may be. 

It may also be dawning on investors, as they read about the rise of the Delta variant in Europe, that the road to herd immunity may not run straight. 

But neither the fact that growth was always going to peak mid-year, nor the news about the virus, can have really snuck up on anyone. 

It should have been more or less priced in. 

If bond yields are falling and the curve flattening, and neither lower inflation nor lower growth is a particularly compelling explanation, two possibilities remain. 

The moves could be down to “technical” factors — supply and demand changes that reflect investors’ positioning and market mechanics rather than fundamentals. 

Or they could reflect the expectation that the Fed is going to screw things up. 

Let us take each in turn.

Pundits have offered up lots of technical explanations for the directions of the market in recent days. 

I have already written about the procyclical hedging by mortgage investors. 

Another currently popular technical justification is pension funds scrambling to reposition themselves for the possibility that yields will fall still further, or to take profits after a great run in risk assets. 

Then there is the ever-popular seasonal lack of liquidity as summer holidays start.

But it’s hard to know what to do with these and other technical explanations, though. 

Pundits who offer them do not tend to offer them as trade ideas, for example as arguments that bonds are too expensive and will fall. 

Instead, they offer them as reasons to simply ignore the market shifts in question and proceed, tactically and strategically, as before.

And so we move on to the Fed. 

I have argued that the central bank has been quite clear about its plans, but plenty of people disagree. 

Anwiti Bahuguna, who runs multi-asset strategies at Columbia Threadneedle, argued to me that while neither the inflation nor growth outlooks have much changed, a lack of clarity from the Fed has the market pricing in a policy error. 

Traders simply don’t know what to make of the fact that the Federal Open Market Committee’s growth and inflation expectations hardly shifted, but their rate expectations, as expressed in the dot plot, clearly did. 

“The Fed needs to explain, if they are not going to be reactive [to short-term inflation data] why are the dots moving?”

Gregory Peters, a fund manager at PGIM fixed income, agrees, pointing to the fact that much of the move down in real rates has come since the Fed’s meeting last month, and that investors have shifted their expectations for rate increases going forward. 

Why, though, has it taken several weeks to price in the Fed’s internal contradictions? 

The puzzle remains. 

Not much appears to have changed in the world, but markets continue to shift.

Translating Yellen-Speak into Golden-Speak

By Matthew Piepenburg

Given the increasingly politicized interplay (cancer) of central bank policy and so-called free market price discovery, it’s becoming increasingly more important to track the actions of central bankers rather than just traditional market signals alone.

Like it or not, the Fed is the market.

Toward this end, we’ve had some substantive fun deciphering the past, current and future implications of “forward guidance” from our openly mis-guided crop of central bankers, most notably Greenspan, Bernanke and Powell.

But let’s not forget Janet Yellen.

As we see below, translating Yellen-speak into blunt speak tells us a heck of a lot about the future.

The Open and Obvious Debt Crisis

Back in 2018, Janet Yellen (former Fed Chairwoman and current Treasury Secretary, eh hmmm) along with Jason Furman (current Biden economic advisor) observed in a Washington Post Op-Ed that, “a U.S. debt crisis is coming, but don’t blame entitlements.”

As I like to say, “that’s rich.”

As in all things economic, the motives and thinking coming out of DC are largely political, which means they are self-serving, partisan and predominantly disastrous.

As for translating Yellen’s political-speak into honest English, the motives for this 2018 warning were two-fold: 1) Yellen and Furman were making a partisan attack on Trump’s then $1T budget proposal, and 2) Yellen actually believed what she said and that the US was indeed careening toward “a debt crisis.”

In fact, we were already in a debt crisis in 2018, a crisis which has simply risen to much higher orders of magnitude in the three short years since Yellen’s “warning” was made.

Stated otherwise, Yellen will get her debt crisis. 

It’s ticking right in front of her.

Tracking the Debt Trail

Ironically, the most obvious metrics of the current and ever-expanding debt crisis began just months after Yellen’s infamous Op-Ed.

In October of 2018, FX-hedged Treasuries went negative and Powell’s Fed began buying $60B worth of T-Bills/month without calling the same “QE” despite it being…well QE.

That pesky little debt crisis in 2018 then went parabolic a year later when the repo-spike of September 2019 forced the same Fed to crank out the money printers and once again fatten its increasingly overweight and embarrassing balance sheet.

Throughout this period, we consistently reminded investors that some of the best assets in a debt crisis are gold and silver to hedge against the growing and the impending currency debasement.

I also wrote that the volatility (VIX) trade, for those who know how to do it, would be effective in addressing the market volatility that always follows the political volatility (i.e., mistakes) which policy makers create/make in a debt crisis.

Speaking of gold and volatility, history reminds us of the kind of volatility that can occur in a sovereign debt crisis, with Weimar being the most obvious example, yet one for which no one, to their detriment, thinks is repeatable:

Translating Yellen Is Getting Quite Simple: Inflation Ahead

Looking forward, translating Yellen’s political-speak (as opposed to her former Fed-speak) is actually getting quite simple.

This year, she’s already confessed that she believes “we must re-orient our framing of fiscal policy.”

In plain English, that just means we can expect a lot more deficit spending to come from the Biden-Yellen tag-team in DC.

But this time, there’s an interesting twist to the nature and target of that spending, namely, there’s going to be trillions more of it, but it’s heading toward Main Street’s middle class not Wall Street’s upper class.

Regardless of one’s politics, math (thankfully) remains non-partisan.

We know, for example, that fiscal policy (however spent and wherever directed) will have a far greater impact on inflation than just more monetary policy alone.

This is because the deficit-spent money from fiscal stimulus goes directly into the real economy, unlike the fiat-created dollars of monetary stimulus which goes directly into the Fed’s balance sheet.

Extreme fiscal (deficit) spending under the “New Deal-like” Biden-Yellen administration is already multi-trillion in nature, and will continue to be as such going forward.

In short, get ready far more “fiscal stimulus,” more debt, and hence more inflation ahead.

Debt as a Growth Policy?

Needless to say, “debt as a growth policy” is an oxymoron. 

Once national debt to GDP ratios cross the 100% Rubicon, growth is mathematically stifled.

Does Yellen grasp this simple truth?

Like Yellen, I took basic math at Brown University, but I’m surprised to infer that perhaps she’s forgotten such classwork.

Did Yellen combine her math courses with some intro to mythical studies or fiction writing seminars?

Or maybe she snuck over to the RISD campus and gained some course credits in magic lessons, for when there’s more debt than dollars to pay it, she somehow feels that she can always return to her familiar money printer at the Eccles Building and magically create more and increasingly debased dollars to service the same.

Abra cadabra, right?

Well, not really.

Magical Money, Dying Money

The magical fantasy of such magical MMT “solutions” ignores one harsh yet simple reality: It’s a currency killer and openly dishonest illusion.

So, what’s a former Fed Chair and current political Treasury Secretary like Yellen to do in a world of delusion?

Simple, create more delusion.

The New Bretton Woods

With all the politico charm of a cozy bed-time story for America, Yellen is already telegraphing her next move with a warm and fuzzy nostalgia to the by-gone days of the 1940’s and the world’s then much-needed response to the horrors of World War 2 (no comparison at all to the fear-porn era of the COVID horrors)—namely Bretton Woods.

For those who forgot, the Bretton Woods meeting of 1944 is when America’s then gold-backed dollar became the new global currency under Uncle Sam’s military leadership and relative economic strength over the war-ravaged economies of Asia and Europe.

Well, Yellen is now thinking about a “New Bretton Woods” with her equally delusional, political and hence-self-serving cronies at the IMF.

She described these IMF get-togethers “as no less significant than the Bretton Woods meetings in 1944.”

That too is rich…

Translated into honest English, Yellen et al are trying to compare the death rate and economic destruction of the COVID crisis (made more so by policy reactions than daily viral threats) to the unimaginable economic, political and social horrors of the Second World War in which 85 million people perished and national economies simply vanished in the rubble.

That’s real horror, as any of us who know the survivors and victims of that period can attest.

Today, policy makers are trying to compare (or propagandize) the admittedly scary years of the COVID crisis (and its tragic 3.75M death toll) to the far more nightmarish and frankly unimaginable period of 1939-45 suffering and carnage.


Exploiting a Crisis. Hiding from Responsibility. Justifying Excess.

Well, as Churchill said around the same time, “never let a good crisis go to waste.”

In essence, the absolutely reckless authors of the biggest debt crisis in the history of the world PRE-COVID are now using this media-fired and politically-charged global flu as both the cause of, and pretext for, even more debt—all to be paid for with even more fake, fiat dollars.

Only now there’s a twist going forward.

Rather than create currencies out of thin air, the new global “leadership” and their private banking/independent policy makers at the debt-guilty IMF are going to create digital fake money out of thin air.

In short, more debt binges ahead, all likely to be paid for with more fake money ahead—but with far more digital CBDC panache.

Same Ol’ Same Ol’

Ultimately, however, what Yellen and the IMF Wunderkinder are proposing boils down to a distinction without a difference.

In short, their plan is nothing more than the same ol’ delusional, irresponsible and self-serving fantasy that a debt crisis can be solved with more debt.

So, what can we expect in the near-term in this backdrop of the absurd?

First, the direction ahead for Yellen is just as we’ve expected and warned, namely a weak USD policy to help soften the damage of a debt crisis (which she helped create) with increasingly inflated (over-created) and hence debased U.S. dollars.

Powell has so much as confessed to this policy of higher inflation “allowance” (as opposed to “targeting”) for the simple reason that inflation helps sovereigns like Uncle Sam dig out of debt holes created by current and prior “leadership” at the Fed and White House—debt holes which they conveniently blame on COVID rather than the bathroom mirror.

Secondly, we are seeing the slow move away from the USD’s “reserve status” as structured since Nixon welched “temporarily” in 1971 on the very gold standard created at Bretton Woods in 1944. That, however, will take years, not weeks.

Given the foregoing, we repeat our conviction that the current inflationary cycle, despite Fed-speak to the contrary, is going to be anything but “transitory.”

Inflation, Repressed Rates and More Currency Debasement Ahead

Given the foregoing and now undeniable debt crisis and openly telegraphed-changes to come (viz: inflation, currency debasement and artificial yield repression), the foreseeable future is plain to see for any who have eyes to see it.

As for rates and debt, former IMF Chief Economist, Olivier Blanchard, is as “insider” as insiders can get, and he’s no fool when it comes to bailing out his own past mistakes.

If debt is too high, then he knows it’s essential to keep the cost of that debt (interest rates) artificially stapled to the floor.

All Roads Lead to Gold

So, there you have it, straight from the horses’ mouths: Rising inflation and lowering bond yields—the ideal setting for gold in the years ahead.

Frankly, and sadly, bonds will be of little help in this new “ab-normal.” The grossly over-bought and grossly distorted (inflated) credit markets just aren’t the bonds our fathers and grandfathers bought for safety, yield or hedging.

Gold, however, accomplishes, hedging, safety and appreciation with far greater consistency than bonds.

Without exaggeration or echo-chamber bias, we stick to our conviction that all roads, policies and discussions turn back to physical gold and silver.

Again, and in short, the present is obvious: A Debt crisis beyond reason. And without precedent.

The future is no less obvious: More currency debasement, more pro-inflationary policies and more double-speaking politicos/financial foxes pretending to fix an economic henhouse which they’ve already raided/broken.

The Dollar’s Future

Given the harsh reality of our harsh debt crisis, the US is so thoroughly saturated in debt levels of its own making that equally grotesque levels of future spending will be the norm at the open and obvious expense of the currency.

This would explain why Russia plans to cut the USD holdings in its wealth fund to zero in favor of more euro’s and, you guessed it: Gold.

The harsh reality of harsh debt makes the path forward fairly predictable, to the extent anything is predictable.

The Cost of De-Levering

History confirms that when nations get too far (waaayyyyy tooooo far) over their skis in debt, the only way to get their debt-to-GDP levels below the deadly 100% marker (130% for the US today) is to “de-lever” their bloated balance sheet over a 5-10-year horizon.

Such deleveraging would require high-teens GDP growth acceleration against a US debt growth rate of 8.75% CAGR.

In our mind, the Yellen-telegraphed policy of “serial stimulus” ahead to achieve such growth and de-leveraging will likely be inflationary.

In such a tragic yet openly telegraphed setting, gold is prepared.

Are you?