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Why This QE Is Different In One Chart

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Robin Hood traders don’t bother reading.

The latest round of central bank balance sheet expansion, which will reaccelerate soon as Biden’s COVID bill is passed, needs some context.

By the way, we did some rough approximations late last night and found the Fed has taken down about 35 percent of the new issuance of Treasury notes and bonds since the end of 1Q20.  As the US Gs deficit exploded again, the Fed had to effectively monetize a big part to keep the Treasury adequately funded without a huge spike in interest rates.

Today’s ugly 7-year Treasury note auction may be a signal that percentage may rise unless rates are allowed to move much higher to entice buyers.

QEs of Christmas Past

Many believed that the last QEs should have led to inflation because the “money supply” would explode.  Too much money in the system leads to dishording the excess money balances and eventually finds itself in the market for goods and services.

First, the problem is defining money. Economists can’t even agree on what constitutes money.  We are hearing echoes of the debate over Bitcoin as a viable alternative currency.

Endogenous Money

There is also “endogenous money”  created by the financial system through the expansion of credit.   During QEs past, endogenous money was either shrinking or barely growing due to an impaired financial system and a banking sector in the process of healing from the Great Financial Crisis (GFC).

Endogenous money is an economy’s supply of money that is determined endogenously—that is, as a result of the interactions of other economic variables, rather than exogenously (autonomously) by an external authority such as a central bank. – Wikipedia

The Fed’s digital printing press was essentially offsetting the collapse in endogenous money as sort of a zero-sum game.  Much of Fed’s money often referred to as “high powered” money as it can be converted into a multiple of endogenous money was locked up at the FED as banks earned interest of the excess reserves.

The interest rate on excess reserves held at the Fed is now 10 bps.

Lot’s of high-powered money now in the system earning 10 bps.

Current Environment

The Fed deserves some kudos for not letting the financial system collapse during the early days of COVID but the risk of much higher inflation is now at hand.   There is just too much money created by the Fed and the credit markets chasing too few assets, goods, services, and, yes,  semiconductors.

Can the Fed continue to rescue the stock market?   We don’t know, nor does anyone else but a lot of people have put on mucho risk betting they will.

Stay tuned.


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