'The global government finance Bubble dwarfs all previous Bubbles. Insatiable demand for perceived safe government debt and central bank Credit has allowed this Bubble to inflate for more than 15 years. Years of massive deficit spending ensure deeply systemic economic maladjustment. Endemic deficit spending has inflated incomes and corporate profits, in the process working to inflate historic securities, housing and other asset market Bubbles.''Throughout history, fractional reserve banking has been at the epicenter of Bubble inflations, boom and bust cycles, and destabilizing bank runs. During the Great Depression, Irving Fisher proposed a full 100% reserve requirement. Milton Friedman in the 1960s was a vocal proponent of fully reserved bank deposits. Some advocates of Austrian Economics have gone much further, arguing that fractional reserve banking is the root cause of instability and tantamount to fraud. Murray Rothbard argued that fractional reserve banking was an inflationary “government-backed shell game” that created “money out of thin air.”
But the expansion of bank deposits was at least somewhat restrained by reserve requirements. With the powerful dynamic of the money markets intermediating non-bank Credit expansion, I began to refer to an “infinite multiplier” effect in the late nineties.To say this analysis was not well received is an understatement. Yet the unrestrained expansion of money market-based Credit was fundamental to the great mortgage finance Bubble inflation. It remains fundamental to the much greater global government finance super Bubble inflation.
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The global government finance Bubble dwarfs all previous Bubbles. Insatiable demand for perceived safe government debt and central bank Credit has allowed this Bubble to inflate for more than 15 years. Years of massive deficit spending ensure deeply systemic economic maladjustment. Endemic deficit spending has inflated incomes and corporate profits, in the process working to inflate historic securities, housing and other asset market Bubbles.
Importantly, Fed monetization (QE), interest-rate manipulation and market intervention have fomented historic market price distortions. Inflationist monetary policy has ensured that government debt has mushroomed without impacting the perception of safety and liquidity (moneyness).
The current Bubble has been inflating for so long that Bubble analysis is easily dismissed. Yet it is important to appreciate that the “basis trade” is the ultimate “Terminal Phase” government finance Bubble manifestation. Only in the perceived safest and most liquid money-like government debt instruments would it be possible to operate at 50 to 100 times leverage. Only after years of recurring Federal Reserve market interventions, open-ended (i.e., $5 TN) liquidity injections and bailouts would speculators attain the confidence level necessary to accumulate egregious amounts of speculative leverage.''Money Market Fund Assets (MMFA) rose another $21 billion the past week to a record $6.263 TN, with a notable four-week gain of $128 billion. MMFA expanded $680 billion, or 12.2%, over the past year, with two-year growth of $1.695 TN, or 37%, and a five-year expansion of $2.899 TN, or 86%. One would think such phenomenal growth in a key monetary aggregate would arouse a little analytical curiosity.
A couple decades back, I argued passionately against the conventional view that “only banks create money.” Sure, it is true that only banks create bank deposits. But what about money market fund deposits and other highly liquid short-term holdings, such as repurchase agreements (“repos”)? As they’ve evolved to dominate finance, non-banks have come to issue Trillions of monetary liabilities. I’ve been amazed at how long the antiquated notion of the Fed and banks’ commanding role in system “money” supply expansion has endured.
While that debate has (kind of) been “settled”, the conventional focus on the banking system persists. Bank loan growth is closely monitored as an indication of general demand for Credit. And the economic community still leans on the M2 monetary aggregate, a narrow definition of “money” that excludes institutional money fund assets and a wide range of monetary instruments. It seems economists don’t know how to approach the analysis of money funds, while Wall Street would prefer not to discuss the issue.
The most common view is also the most simplistic. MMFA is seen as “money” on the sideline, waiting for a good opportunity to buy stocks. Rapid growth in money fund deposits suggests excessive risk aversion – conveniently viewed as a bullish contrarian market signal.
There’s a more insightful framework for analyzing money funds. The money market is the key venue for intermediating finance throughout the contemporary non-bank sector (including broker/dealers and hedge funds). In general, money fund assets expand when non-banks issue short-term liabilities – when their new borrowings are financed by the money fund complex.
It may be helpful to think in terms of traditional “fractional reserve banking” and the bank deposit multiplier. Here a bank takes a deposit, withholds a fraction of it (say 20%) as a reserve, and uses the remaining amount (80%) to fund a new loan. This loan creates a new deposit within the banking system, where it (less the 20% reserve) can be lent to a new borrower – creating yet another new deposit.
Throughout history, fractional reserve banking has been at the epicenter of Bubble inflations, boom and bust cycles, and destabilizing bank runs. During the Great Depression, Irving Fisher proposed a full 100% reserve requirement. Milton Friedman in the 1960s was a vocal proponent of fully reserved bank deposits. Some advocates of Austrian Economics have gone much further, arguing that fractional reserve banking is the root cause of instability and tantamount to fraud. Murray Rothbard argued that fractional reserve banking was an inflationary “government-backed shell game” that created “money out of thin air.”
But the expansion of bank deposits was at least somewhat restrained by reserve requirements. With the powerful dynamic of the money markets intermediating non-bank Credit expansion, I began to refer to an “infinite multiplier” effect in the late nineties.To say this analysis was not well received is an understatement. Yet the unrestrained expansion of money market-based Credit was fundamental to the great mortgage finance Bubble inflation. It remains fundamental to the much greater global government finance super Bubble inflation.
In last week’s CBB, I excerpted from Bloomberg Intelligence Brian Meehan’s research report, “Can Historic $1.1 Trillion Net Short Basis Trade Hold or Crack?” Meehan noted that “leveraged net shorts of Treasury futures have surged to a historic $1.1 trillion in notional value, accelerating 38% ($300bn) in the past four months.”
I’ve been doing this for too long to believe in coincidences. Money Market Fund Assets have expanded $285 billion (14.3% annualized) over the past four months (to a record $6.263 TN).
In a “basis trade,” hedge funds borrow in the repo market to take highly levered positions in Treasury bonds, while hedging market risk through the shorting of Treasury futures. The expansion of repo liabilities creates – or “multiplies” – marketplace liquidity. Similar to how a new bank loan creates a new deposit at another institution that can be used for a new loan, when a hedge fund borrows in the repo market to purchase a Treasury bond, the seller now has new liquidity that will be deposited in the money market complex, where it becomes available to fund another levered “basis trade” repo transaction (or other forms of securities finance).
In the nine (mortgage finance Bubble “terminal phase”) quarters Q1 2006 through Q1 2008, the repo market (Z.1 “Federal Funds and Security Repurchase Agreements”) expanded $1.406 TN, or 37%. Over this period, Money Fund Assets inflated $1.416 TN, or 70%. It’s worth noting that Money Fund Assets expanded a blistering $928 billion in the three quarters following the June 2007 subprime mortgage eruption.
The second notable period was the six quarters Q3 2018 through Q1 2020, where the repo market expanded $1.226 TN, or 34%, while Money Market Fund Assets inflated $1.584 TN, or 50%.
Both above periods of explosive repo/MMFA growth foreshadowed major financial crises. Ponder this: was the historic growth in money market assets primarily the consequence of heightened risk aversion, or was it instead fueled by aggressive late-cycle leveraged speculation? A related issue to contemplate: does inevitable “terminal phase” instability and the certainty of an aggressive monetary stimulus response (lower rates and QE) further promote speculative leverage and extend precarious late-cycle excess?
The expansion of repo borrowings and Money Market Fund Assets in 2007 corresponded with the Fed’s special August 2007 liquidity injections and rate cuts that began in earnest the following month. The 2019 expansions corresponded with the July 2019 rate cut and the September restart of QE.
Over the years, I’ve tried to explain the precarious nature of Bubbles fueled by “money.” A Bubble financed with, for example, junk bonds won’t get too carried away before the marketplace protests, “no more junk!” The relatively short-lived Bubble inflated by the expansion of higher risk Credit ensures it won’t impart deep structural maladjustment.
Unlike junk, “money” essentially enjoys insatiable demand. As such, a Bubble fueled by perceived safe and liquid money-like debt instruments, left unchecked, will inflate over many years and leave a legacy of deep systemic distortions and maladjustment.
Fueled by money-like “AAA” GSE-backed mortgage securities, Wall Street repo liabilities, and an interventionist central bank, total mortgage debt doubled in six years of mortgage finance Bubble excess. Deep market distortion and structural maladjustment ensured the so-called “great financial crisis.”
The global government finance Bubble dwarfs all previous Bubbles. Insatiable demand for perceived safe government debt and central bank Credit has allowed this Bubble to inflate for more than 15 years. Years of massive deficit spending ensure deeply systemic economic maladjustment. Endemic deficit spending has inflated incomes and corporate profits, in the process working to inflate historic securities, housing and other asset market Bubbles.
Importantly, Fed monetization (QE), interest-rate manipulation and market intervention have fomented historic market price distortions. Inflationist monetary policy has ensured that government debt has mushroomed without impacting the perception of safety and liquidity (moneyness).
The current Bubble has been inflating for so long that Bubble analysis is easily dismissed. Yet it is important to appreciate that the “basis trade” is the ultimate “Terminal Phase” government finance Bubble manifestation. Only in the perceived safest and most liquid money-like government debt instruments would it be possible to operate at 50 to 100 times leverage. Only after years of recurring Federal Reserve market interventions, open-ended (i.e., $5 TN) liquidity injections and bailouts would speculators attain the confidence level necessary to accumulate egregious amounts of speculative leverage.
And that this Bubble has inflated so massively and systemically gives the levered players – and markets more generally – confidence that the Fed now has no alternative than to react aggressively to quell nascent de-risking/deleveraging instability (explaining why the market on August 5th priced as much as 148bps of rate reduction by year end). The immediate response to the March 2023 banking crisis bolstered the view that the Fed would inflate first and ask questions later. This further emboldened the “too-big-to-fail” levered “basis trade” players.
Global bond yields reversed higher this week. U.S. house price inflation was stronger-than-expected, as was Conference Board Consumer Confidence. Q2 GDP was revised to 3.0% from 2.8%, with Personal Consumption upgraded to 2.9% from 2.2%. July’s 0.5% gain in Personal Spending boosted one-year growth to 5.3%.
“Dovish pivots” and rate cut signaling are dangerous business in an environment of aggressive levered speculation and enterprising “basis trade” operators. These “Money Machines” are showering Bubble markets and segments of our maladjusted economy with liquidity excess. Financial conditions remain excessively loose, boosting the odds of upside economic and inflation surprises. They’re “Terminal Phase” phenomena, specifically because aggressive speculative leveraging extends late boom cycle excess, sowing the seeds for an especially destabilizing de-risking/deleveraging. Much like fractional reserve banking and bank runs, the money market “infinite multiplier” doesn’t work well in reverse. We have proof (October 2008 and March 2020).'
- Doug Noland,
Money Machines, August 30, 2024
Context (Banking Reform) - 'The current Bubble dwarfs mortgage finance Bubble excess..'(Banking Reform - English/Dutch) '..a truly stable financial and monetary system for the twenty-first century..''.."financial slavery" that grips the world .. are of high human and personal cost..''The "Manic-Depressive" Economy .. spirit becomes corrupted .. are of high human and personal cost..'Phase II 2022 – 2032, Eye opener - To Heal in The Electric Universe