Fed Trapped In Endless Easing – Wall Street Underground

By Nick Guarino | September 20, 2015

7 Years of Zero Interest Rates With No End in Sight


Trapped like a caged Lion, there is little the FED can do. Contrary to popular misleading spin, it’s not inflation that has got the FED in a quandary. It’s the global deflation that has central bankers shitting bricks. This knowledge is worth millions to you. Let me explain! The Fed cannot raise interest rates. They are in a liquidity trap caused by the global deflation. Their statement shows what a dangerous game they are playing.

The global Quantum easing, that they embarked upon 7 years ago as a temporary measure, has become endless easing. Their statement reveals that they are clueless in Cleveland. The FED has no idea what to do. This knowledge is life changing and reaffirms our constant warning about the deflationary spiral the world has entered.

The world is about to enter a global depression. You must understand that Interest rates are going to go beyond 0 (zero) and to double digit negative. You have got to grasp these never seen before economic events that are already occurring. Negative interest rates on long term government paper is an economic reality.

I know negative interest rates are for most people a quandary. But you’ve got to understand this. In this report, I will take you to places where indeed interest rates are beyond zero and negative. You will not believe what banks and people are doing. Early 2015, Switzerland’s interest rates turned negative. Not for one year. Not for five years. But all the way out to 10 years, meaning that virtually everyone desiring to park their cash, in supposedly safe-haven Swiss francs, had to pay for the privilege.

And Swiss bonds weren’t unique. Yields on French and German sovereign debt went negative out to five and seven years, respectively, while the overnight Euro Interbank Offered Rate (Euribor), which had averaged about 2% for the previous couple of years, fell below zero and stayed there. By the end of 2015’s first quarter, paper accounting for 31% of the Bloomberg Eurozone Sovereign Bond Index was trading with negative yields.

Even more startling than the numbers was the timing. This plunge in rates occurred in the sixth year of a recovery, during which most of the developed world had run record fiscal deficits, cut interest rates aggressively, and created vast amounts of new currency.

The last thing Wall Street wants you to
understand or prepare for is a deflation
and negative interest rates

Let’s start out by the looking at the Feds work product, their statement from their last meeting.

Federal Reserve’s Monetary-Policy Statement

“The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad. (They mean the Chinese and European wipe out) Inflation is anticipated to remain near its recent low level in the near term. The Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. (There lies the fatal mistake. We don’t have 2% inflation. We don’t have .02% inflation, They are fighting the wrong enemy. It’s deflation that is the crises. They are waiting for an event we will never see again… Inflation.) This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. (It’s never going to happen in your or my life time.)

Federal Reserve officials’ projections for the U.S. economy help to explain why the central bank delayed a rate hike. Fed officials revised down inflation. The median estimate for inflation is now a modest 0.4 percent this year, down from 0.7 percent in the June projections. (STILL WAY, WAY TOO HIGH.) The Fed targets inflation at 2 percent, a level the projections say won’t be achieved in our life time.

This indicates that they’re still waiting for signs that inflation — which has largely faded because of cheaper oil prices, a stronger dollar, plunging stock market and crashing commodities prices.

Fed officials see growth as slightly stronger this year than they did in June. They also anticipate the unemployment rate falling from its current 5.1 percent to a median of 4.8 percent next year.

They are carefully monitoring the slowdown in China and other emerging markets, in addition to struggles by Europe to increase economic growth. Everywhere they look they see deflation.

We are in for decades of no inflation and
NEGATIVE interest rates and crashing economies.

Here is something you urgently need to know. The cat is out of the bag. One Federal Reserve policymaker believes zero interest rates aren’t low enough and is calling for rates to go negative. The official wasn’t identified in materials the central bank released Thursday. But we have been able to confirm the lone honest man at the FED is Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis.

Kocherlakota was an inflation hawk before undergoing a stunning turnaround in 2012 that transformed him into one of the Fed’s strongest advocates for easy money policies. When he figured out that the FED has created a liquidity trap. And the Investment banks manipulations in stocks and commodities created the biggest bubble the world has ever seen, he changed his position and issued his dire warning. See chart of Banker Syndicated loans that are the life blood of the derivatives casino:

Kocherlakota has been outspoken about his concern that inflation is too low and could move lower. As in a deflation and depression. So why has he come out of the closet now? Kocherlakota will be leaving his post at the end of the year … It is easier to be provocative when you are walking out the door.

The Fed has kept the rate it controls near zero since December 2008. The last time they raised rates was 10 years ago.

The Fed has said, if we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context. One way to push short-term rates negative would be to charge interest on excess bank reserves.

The interest rate paid by the Fed on excess reserves, the so-called IOER, is a benchmark for a wide variety of short-term rates, including rates on Treasury bills, commercial paper, and interbank loans. If the Fed pushes the IOER below zero into negative territory, other rates are likely to follow. It is this tool that they will be using in desperation. It will result in double digit negative yields.

You must understand that significantly negative rates — that is, rates below 50 basis points – will create an investment world you have never seen before. You can imagine what will happen when long term interest rates got to a -10%. Don’t scoff, it happened before during the last great depression. Financial innovations, such as CASH special-purpose banks and the use of certified bank checks in large-value transactions will be the norm.

Where in a inflation, you defer payments to payback in cheaper dollars. In a deflation, where cash become more valuable by the day, it’s a whole new ballgame. People will make excess payments to creditworthy counter-parties. Because money will be more valuable, people will prefer receiving payments in forms that facilitate deferred collection.

Such responses should be expected in a market-based economy but may nevertheless present new problems for financial service providers (when their products and services are used in ways not previously anticipated) and for regulators (when novel private sector behaviour leads to new types of systemic risk).

Your friendly banker will tell you negative rates are impossible. Because the last thing he wants is for market participants to be holding cash. You have a BIG advantage as a small player… Under five million dollars. You can easily hold cash and US dollar based treasuries.

But cash is not a realistic alternative for corporations and state and local governments, or for wealthy individuals. The largest denomination bill available today is the $100 bill. It would take ten thousand such bills to make $1 million. Ten thousand bills take up a lot of space, are costly to transport, and present significant security problems.

Nevertheless, if rates go negative, the U.S. Treasury Department’s Bureau of Engraving and Printing will likely be called upon to print a lot more currency as individuals and small businesses substitute cash for their bank balances.

In a deflation, their printing of money will not spark off inflation. In fact, just the opposite. If rates go negative, we should also expect to see financial innovations that emulate cash in more convenient forms. One obvious candidate is a special-purpose bank that offers conventional checking accounts (for a fee) and pledges to hold no asset other than green cash (which it stores in a very large vault). I always dreamed about starting one.

Checks written on accounts in a special-purpose bank would be tantamount to negotiable warehouse receipts on the bank’s cash. Special-purpose banks would only work when interest rates (because break-even account fees are likely to be high), go much further negative (globally) than they are now.

A credit card holder might choose to make a large advance payment and then run down his balance with subsequent expenditures, reversing the usual practice of making purchases first and payments later. In essence, turing his credit card into a debit card with a high balance.

We might also see some relatively simple avoidance strategies in connection with conventional payments. If I receive a check from the federal government, or some other creditworthy enterprise, I might choose to put the check in a drawer for a few months rather than deposit it in a bank (which charges interest). In fact, I might even go to my bank and withdraw funds in the form of a certified check made payable to myself, and then put that check in a drawer.

Commercial banks might find their liabilities shifting from deposits (on which they charge interest) to certified checks outstanding (where assessing interest charges could be more challenging). If bank liabilities shifted from deposits to certified checks to a significant degree, banks might be less willing to extend loans, because certified checks are likely to be less stable than deposits as a source of funding.

As interest rates go more negative, market participants will have increasing incentives to make payments quickly and to receive payments in forms that can be collected slowly. This is exactly the opposite of what happened when short-term interest rates skyrocketed in the late 1970s: people then wanted to delay making payments as long as possible and to collect payments as quickly as possible. Some corporations chose to write checks on remote banks (to delay collection as long as possible), and consumers learned to cash checks quickly, even if that meant more trips to the bank, and to demand direct deposits.

When interest rates go negative, the incentives reverse: people receiving payments will prefer checks (which can be held back from collection) to electronic transfers. Such a reversal could impose novel burdens on payment systems that have evolved in an environment of positive interest rates.

The upshot of all this is when interest rates go negative, financial service providers are likely to find their products and services being used in volumes and ways not previously anticipated, and regulators may find that private sector responses to negative interest rates have spawned new risks that are not fully priced by market participants.

In the coming world of negative interest rates, cash will reign supreme, as everyone rushes to withdraw their “taxed by negative interest rates” bank deposits and keep the funds in the form of paper cash, hidden safely somewhere where the bank has no access, and where no bank can collect an interest rate for the “privilege” of being funded with a negative rate liability. Like in the First National Bank of YOUR Mattress.

Traditional bullshit economic theory says that a combination of massive deficit spending and historically low (not to mention negative) interest rates should produce a rip-roaring boom in which workers get generous raises, prices and inflation rates spike, and interest rates follow. Theory also says that, even in the rare case of nominal interest rates turning negative, the rates can’t stay there because beyond this “zero bound,” savers and investors will withdraw their cash and store it themselves, emptying banks and crashing the financial system. And sparking off a inflationary fire storm. BULLSHIT DONT BE FOOLED! Recent events have proven these assumptions are dead wrong. In fact just the opposite has happened.

Loans have to be repaid with funds that might otherwise go toward investment and consumption. Today’s unprecedented levels of debt thus create an economic headwind that requires commensurately forceful policies (including negative interest rates) to induce more borrowing and spending. “People and governments are now leveraged to the hilt, which translates into lower demand, slower growth, and lower interest rates,” says Ken Shepherd, Prospect Mortgage. Here again, “This is not a business cycle thing. It’s structural.”

When central banks buy bonds with newly created currency, they hand commercial banks more reserves with which to write loans. But the experimental and therefore unpredictable nature of these programs is making businesses reluctant to invest, says Keith Dicker, CFA, president and chief investment officer of IceCap Asset Management in Halifax, Canada.

Because policymakers are improvising, “It’s impossible to know what future monetary policy will be,” says Dicker. “In that environment, will you open a new plant in France? Probably not.”

The combination of rising reserves and reluctant borrowers leaves banks with far more money than they need, or can loan out so that is why they go hog wild in incredible stupid speculations on their own hook… You saw the incredible binge, all that cash bankers are holding creating bubbles in commodities and stocks.

Gerald Jensen, CFA, finance professor at Northern Illinois University “Historically, bank excess reserves (funds deposited with the central bank rather than being lent out) averaged less than 3% of total reserves,” says Jensen. “Currently in the US, that number is 95%. So banks have little incentive to offer higher rates to attract or keep customer deposits.”

And the amount of free or excess reserves the banks are holding is getting worse by the month… See the chart below:

This, in time, will push already crashing interest rates deep into negative territory. What the Fed is doing in a feeble attempt to induce more borrowing and spending will blow up in their faces.

We already are seeing a mass migration out of the stock market and commodities markets and into cash. In response, governments and banks around the world are attempting to marginalize cash (physical currency and deposits) by making it harder and/or less attractive to hold. It’s not working and never will.

In early 2015, JP Morgan Chase forbade some customers from storing cash in safe deposit boxes. Swiss banks refused to allow pension funds to withdraw large amounts of cash from their accounts. Danish legislators proposed a law allowing shops to refuse to accept cash payments. Australia imposed a 0.05% tax on some bank deposits. And France cut the legal limit on cash payments from 3,000 euros to 1,000 euros.

In a June 2015 report, the Bank for International Settlements warned that a policy of persistently low interest rates “runs the risk of entrenching instability and chronic weakness.” Such an environment makes several extreme — and, sometimes, mutually exclusive — scenarios at least conceivable.

As these trends continue, another financial crisis is about to occur, the flow of capital away from risk and toward safety will become a tsunami, sending US bond yields even lower. In fact, double digit negative.

The US dollar will soar in value, drawing the lion’s share of global capital flows and rising against all other currencies. Such a scenario would be a bonanza for the owners of Treasury bonds. But it would be a serious crises for those unlucky or unwise enough to own dollars.

Third world countries and the BRICS that borrow dollars and run its economy in dollars will not pay its debts and default. This group includes a big part of the developing world, where approximately US$9 trillion of dollar-denominated debt was outstanding in mid-2015.

In 1937, the United States was approximately seven years into the Great Depression. Today we are seven years removed from the financial crisis of 2008. By late 1936, as today, the Fed started to worry that excess liquidity and credit growth might lead to accelerated inflation. So it took the initiative to soak up the excess reserves on bank balance sheets by increasing the reserve requirement ratio (the equivalent of tightening the money supply). Rather than absorb the excess liquidity, however, this move forced the US economy back into recession.

As today, banks were still worried about a resurgence of economic weakness and, therefore, wanted to maintain greater reserves to protect against a downturn. So, as the Fed elevated the reserve requirement ratio, banks reduced lending. Between May 1937 and June 1938, US GDP contracted by 9%.

We are about to see the same crises again. From a Fed policy perspective, the lesson here is that the 1933–1937 period is similar to the environment today, while the 1929–1933 period is not. The economy today has had roughly seven years to recover, while the 1930s period had four. Like then, today the global economy is faltering, capital is fleeing emerging markets, and the dollar is rising.

That underlines central banks secret concern that non-existent inflation may yet morph into outright deflation, despite zero interest rates and the masses of liquidity coursing through the financial system courtesy of quantitative easing.

All of this is the reason that inflationary forces are declining. And a massive deflation/depression is right around the corner. And just like in 1937 the FED cannot stop this coming wipe out.

You have been warned.

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Thank you,
Nick Guarino




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