Federal Reserve Banks’ reserve balances explode!
Fortunately for you I’m not sharing a recording of me singing the Bread classic, “If a picture paints a thousand words”. However, I am sharing an incredible chart on the failure of QE. As we, at Kamp Consulting, have shared in previous posts, QE by itself is not stimulative, as the swap of bonds for reserves actually removes liquidity from the economy, as higher yielding bonds are removed for lower yielding paper. For QE to be stimulative, there needs to be a second derivative effect achieved through cooperation from the banks via lending. The link (picture) that we share today highlights the fact that the reserves received through the QE bond swap have not been lent at the pace necessary to produce the outcome that QE intended.
The markets are fearing tapering, but we suggest that their concern is unfounded. There has been little stimulus provided by the QE program to date. “Exaggeration is a blood relation to falsehood and nearly as blamable. ” ~Hosea Ballou
An interesting idea floating around, most recently heard through Mark Grant, is that the US Treasury should retire the Treasury debt currently held on the Federal Reserve’s balance sheet. Mark believes that the retirement of $1 trillion of the slightly more than $2 trillion in Treasury notes and Bonds on the balance sheet would eliminate near-term debt ceiling discussions and potentially reduce rates in the short-term. We at Kamp Consulting Solutions like this idea very much. Chuck DuBois, a former partner of mine while we were both at Invesco, has been touting this idea for a while, too. We believe that the entire debt could be retired at once, but there are many investors who like the idea of holding US Treasury bonds and notes for investment purposes.
There are many market participants who fear that the retirement of the US debt would be inflationary, but in reality the swap of bonds with reserves actually reduces liquidity because the bonds are higher yielding. Furthermore, many of the bonds are being used as longer-term investments, and it is likely that the reserves received in the swap would be reinvested in longer-dated securities and not used for short-term economic activity.
I’m tired of hearing about the debt ceiling, and the debates in DC as to whether this artificial ceiling should be raised. I suspect that you may be, too. Let’s retire some of the debt today, and eliminate this conversation from happening for a while.