The Federal Reserve has injected $280 billion into the economy in the past seven weeks, equivalent to 32.56 million Bitcoin (BTC) and $40 billion more than the market cap of the entire crypto space. This massive operation was required so that the Federal Reserve would not lose control of the fed funds rate, which is its primary tool and halted a recessionary chain reaction that started due to a lack of liquidity. Also, it seems some extra was thrown in and liquidity is now so high that the fed funds rate is drifting lower, which is not supposed to happen, and this has helped drive stocks up to all-time highs.
In short, the Federal Reserve has propped up the stock market with a buying operation that used far more money than exists in the entire crypto space. This will be explained in detail in the following article in addition to how this impacts the crypto space.
In the middle of September, a seismic wave went through the financial markets, in the form of overnight general collateral repo rates skyrocketing to 10% where before they were hovering near 2%.
The repo market is essentially a way for banks and investors to get short term loans where treasury bonds and securities are traded for cash, and then, at some date in the future, usually the next day, the borrowers buy back the bonds/securities and pay some interest. The general reason that repo rates skyrocketed in mid-September was due to a lack of liquidity, meaning that creditors had no cash available to participate in the repo market, resulting in a mad scramble for cash among the borrowers. The reason banks that usually fund the repo market suddenly had no cash is likely due to rapidly rising debt and risk burdens.
Simultaneous to the repo panic, the fed funds rate jumped five basis points above its upper bound. The fed funds rate is the primary tool of the Federal Reserve and essentially determines the cost of money, i.e. how much it costs for top banks and corporations to borrow funds.
The fed funds rate can drift a little, but it is supposed to stay within the upper and lower bounds that the Federal Reserve sets. However, in mid-September, it jumped above the upper bound, suggesting that the Federal Reserve was losing control of its primary tool and, by extension, the economy.
The Federal Reserve responded to this crisis by funding the repo market to bring repo rates back to normal and cutting the fed funds rate the next day, which lowers the cost of borrowing money and provides more liquidity to the economy. At the end of October, the fed funds rate was cut again — the third rate cut in only three months, driving the fed funds rate downwards from 2.25%-2.5% to 1.5%-1.75%.
Notably, the fed funds rate of 2.25%-2.5% is right in the middle of the range for annual fiat inflation which is 2%-3%, essentially meaning that creditors earn nothing from loaning at that rate and are loaning money for free. Now, at the rate of 1.5%-1.75%, creditors are losing money when they loan, at least on the inter-bank level where the fed funds rate applies, meaning borrowers make money for taking a loan.
Essentially, the top banks and corporations all get free loans now and actually profit a bit too. In order to supply this free money, the Federal Reserve began a program of monetizing Treasury Bills to the tune of $280 billion over the past seven weeks, driving the Federal Reserve’s balance sheet over $4 trillion.
Monetizing Treasury Bills is basically money printing without having to turn the printer on. The Federal Reserve issues a credit to one of its member banks that holds the Treasury Bills, and then the Federal Reserve puts the Treasury Bills on its own balance sheet. The money printing part is that the Federal Reserve literally creates the credit paid to member banks out of thin air.
The member banks then use this credit just like cash and loan it out to corporations and banks that need it, increasing liquidity. Also, this increases demand for stocks and other assets since banks and corporations often use the money to make more investments.
This is probably why the stock market has risen to all-time highs, with the Dow Jones Industrial Average (DJIA) rallying from 26,000 points at the beginning of October to 27,800 points currently. The government is literally printing hundreds of billions of dollars and putting it right into the hands of investors.
In-fact, the Federal Reserve has created so much liquidity that the fed funds rate is approaching its lower bound. However, the only ‘problem’ this causes is an asset bubble, and in this case, it’s an increase in the massive asset bubble that already exists.
The biggest problem with the Federal Reserve monetizing Treasury Bills and increasing liquidity is that at some point in the future the Treasury Bills mature, and the government, specifically the Treasury, has to pay the Federal Reserve for them. The government is running massive debts and deficits, so the Treasury cannot simply pay back Treasury Bills that mature, and the Treasury has to auction off more Treasury Bills to raise this cash.
This increases the supply of Treasury Bills on the open market, and in order to convince investors to buy all of the supply, the Treasury must increase interest rates. This makes United States debt more expensive to pay back, raises interest rates in general, and sucks liquidity out of the markets as investors choose high yielding Treasuries over other assets.
Now the problem is coming full circle. The 2008 Great Recession was only halted by the Federal Reserve increasing its balance sheet from $0.5 trillion to $4.5 trillion by purchasing treasuries and mortgage-backed securities with money that did not exist, in addition to other governments around the world doing similar programs.
The Federal Reserve believed the economy was strong and the crisis was far enough in the rearview mirror that this tremendous balance sheet could be reduced. There was plenty of talk about the Federal Reserve slowly unwinding its balance sheet to $2.5 trillion, and somehow, this would all work out.
Unfortunately, as soon as the Federal Reserve balance sheet dropped just below $3.8 trillion, the mid-September liquidity crisis struck, with repo rates soaring and the fed funds rate going out of control.
This is because the attempt at unwinding the balance sheet revealed that there is barely any natural liquidity in the market, and the liquidity that does exist is from the government printing money and giving it to banks and corporations.
The promise during the 2008 Great Recession was that all of the trillions of dollars of money printing would be paid back and unwound one day, but now the Federal Reserve knows that it is an impossible situation.
Therefore, even though the Federal Reserve has gained back control of the fed funds rate in the short term, it has ultimately lost control of the situation. The trillions of dollars of government debt that has been monetized to prop up the economy can never be paid back, and the economy is ready to collapse unless tens of billions of dollars continue to be pumped in every week, and whenever a crisis happens hundreds of billions of dollars more will be required.
Theoretically, this system could go on for a long time, as it has been. The result is an overinflated stock market that is disconnected from the health of the actual economy. The economy can dry up in the real world, meaning sales, manufacturing, and transport drops, and tons of stores close, but then the government simply injects cash into the banks and corporations at the top level, and stocks keep going up.
Aside from the government printing so much money to do this that it causes significant fiat inflation, the main problem is that the economy could literally collapse in the real world, and the stocks will not even react, so the government will do nothing about fixing the real world since everything appears good in the market data.
Indeed, this is already happening as explained in a recent CryptoIQ article with consumer loans defaulting, transport dropping, home sales declining, and people en-masse literally not being able to pay their bills. The retail apocalypse is underway with 15,000 stores closed, and 75,000 more expected to close in the coming years.
Quite simply, the Federal Reserve is fixated on keeping liquidity high for corporations and banks and maintaining the stock market at record highs while the real ground-level economy crumbles.
However, a point may come when the real economy is so bad that a default chain reaction begins. If enough people default on their credit cards, loans, mortgages, etc., it will take tons of money to prevent banks and corporations from going bankrupt. Such a debacle would be so publicly obvious that investors would likely get spooked and dump stocks, accelerating the default chain reaction. That being said, the government would likely do the same thing they did in 2008, i.e. printing as many trillions of dollars as it takes to save the corporations and banks.
How Does This Impact The Crypto Space?
As for the crypto space and Bitcoin (BTC), there are several different ways this Federal Reserve policy could have an impact. First off, eventually fiat inflation could go out of control due to the Federal Reserve approach of printing as much money as it takes to keep corporations and banks intact, and this could spark a crypto rally as people seek Bitcoin (BTC) as a safe haven against inflation.
Simultaneously, those in the real economy will see decreasing income as stores close and good jobs dry up, so small to medium investors could end up dumping their crypto just to survive, and newcomers to the crypto space may have little to no money to invest.
Also, eventually the real economy could get so bad that the stock market finally has no choice but to go down for some time. This could also happen if markets in other countries begin to collapse. At that point, crypto will appear very enticing as stocks and other securities begin to spiral downwards, and crypto would probably rally.
Finally, there is nothing stopping banks and corporations that get free money from the Federal Reserve from investing into the crypto space. It is possible that a corporation or a bank will at some point buy a ton of crypto with the free money, especially since it is so easy to spark a rally in the crypto space due to low liquidity as explained in a recent CryptoIQ article.