I often refer to the fact that the stock market is rigged. For a long time the Fed did the heavy lifting, pumping $100 billion in cash every month, and sometimes more, into the accounts of the Primary Dealers.
Then in the past few months, we have talked about the US Treasury getting into the act. I had written since early 2015 about the US government building up a “rainy day fund,” on the recommendation of the Treasury Borrowing Advisory Committee (TBAC). This is a shadowy cabal of Primary Dealers who collude with the US Treasury market to rig the Treasury Market to the best advantage of the US government.
It also makes ancillary “recommendations.” For instance,”Thou shalt build thyself an ark containing $500 billion of cash in small denominations, 2×2. And it was done so. The Treasury built the cash ark, 2×2 over 2 years, reaching about $450 billion at its peak late last year.
When I say 2×2 I mean that they did so in small amounts, flying under the radar. But since I have tracked Treasury cash and TBAC recommendations for many years, we knew exactly what was coming and reported on it every step of the way. I even surmised back in November that Don Trump would spend it to boost the market. We saw instant evidence in the Daily Treasury Statement immediately after the Inauguration, and we tracked the spending all the way down. Most of it was used to pay down debt, which stuffed cash back into the greasy pockets of dealers and other investors.
Twice quarterly, the TBAC advises the Treasury how much the government will need to borrow. It sets forth a recommended financing schedule, with specific amounts for each specific issue. We have made good use of that schedule through the years. It helps to know how much supply is coming over the next 4-5 months, as the TBAC recommends. The Treasury usually sticks fairly close to the schedule.
All financial assets are exchangeable with one another. Institutional Investors, hedge funds, and in particular dealers, are constantly adjusting their portfolio mix. In the case of dealers it’s really an inventory mix. So when Treasury supply increases or decreases materially, that impacts how much cash investors, traders, and dealers have available to buy stocks. Knowing what’s coming from the Treasury, the 700 pound gorilla of the bond market, is a big help.
When the US Treasury handed that cash ark over to the Trump Administration, it wasn’t much different from handing matches and a can of gasoline to a pyromaniac. Trump lit the can and burned all the cash in a matter of 7 weeks. We’ve seen the results all around, as the stock market ignited to new bubble highs, and the economic data got goosed a bit too. Trump the rooster now got to crow, cock a doodle doo, my market is bigger than yours. My jobs are bigger than yours. My… never mind.
Was that the Fed’s fault? No. The Fed stopped actively rigging stock prices to rise, back when it ended QE in late 2014. It continued to passively support the bubble’s expansion by maintaining zero or near zero interest rates, free money for speculation to all comers.
It also allowed the trillions in excess cash that it had pumped into the Primary Dealer accounts over the course of QE to stay in that system. Religious economists said that cash wasn’t making it into the economy. That was bull. The cash was there circulating in the banking system, but the economy couldn’t use it.
The economy needs what it needs. It grows at the rate it can grow. All that extra cash is meaningless, really even detrimental to economic activity. Structural demographics, social and technological trends drive economic growth. The Fed could have continued printing money forever, and it would not have caused the economy to grow one iota faster than it otherwise would have.
So what happened? All of that excess cash drove massive asset bubbles. Remember, the Fed pumped that money into the system via the trading accounts of the Primary Dealers. That’s the only conduit for transmitting money to the banking system. The Fed makes policy and prints the money. But its agents of policy transmission are the Primary Dealers. They control the distribution of the cash based on their trading strategy, and their inventory markup strategies and tactics.
The dealers directed some of the cash back to the US Treasury when they purchased newly issued paper at the next Treasury offering. That round robin went on from 2009 to 2014. The Fed printed, the dealers got cashed out, and the next week they bought more Treasuries. The Treasury spent the borrowed money to fund its operations. It’s called deficit financing. So, yes, some of the money made it into the economy. It didn’t just “sit there on the Fed’s books, as some foolish people claim. But the bulk of the cash went toward speculation, which caused asset inflation, both in stocks and bonds (aka bubbles), and commodities from time to time, as well as housing inflation.
The money had to go somewhere, and we know where it went. The economy, particularly that portion of economic activity attributable to federal government deficit spending got some of it, but the financial markets got the lion’s share by far.
The Fed finally realized that all of the free money it was handing out was absolutely useless as a tool to stimulate economic growth. It took them long enough! We moaned and groaned about it from the very beginning. I’m not an economist. But I did spend the night at Holiday Inn. And I have observed markets for 50 years, since I was a teenager. I knew that when you give dealers and traders free money and keep printing more and more of it, along with an intrinsic guarantee that prices will only rise, that they will use that money to speculate until the cows come home. Why invest in productive economic activity when there’s easy money to be made with guaranteed carry trades. Big, big money. That instantly became a disincentive to productive investment.
It only took 5 years for the Fed to show signs of awakening. They seem to be even more cognizant of these facts now as they begin to move toward a return to more rational interest rates. Rational cash returns on real capital investment ceased to exist 8 years ago. So rational investment in productive activity also became extinct. Perhaps the Fed recognizes that there must be a return of rational incentives of risk and reward in order for there to be healthy productive investment, rather than just the cancer of mindless, risk free speculation.
Or perhaps I give them too much credit.
But the fact is that the Fed is no longer the real problem. Nor is Don Trump, with his asinine spend down of all the Treasury cash he was entrusted with. Yes, he got a stock market blowoff. Yes, he’ll use that to throw his considerable weight around to get the feckless Republican Congress to bend to his every insane whim. But that money is now gone.
So the US Government is broke, and the Fed is on the sidelines, having recently rediscovered old time economic religion. Who does that leave to fund the stock market bubble? Look no further than the Fed’s cohorts, the ECB and BoJ, who continue to pump the dollar equivalent of around $150 billion per month into the worldwide cash pool.
All financial paths ultimately lead to Wall Street. Some of that money will continue to make its way to the US. It will end when the confidence game finally collapses, or Kuroda and Draghi finally return to some semblance of sanity. Who knows when that will be.
This report is derived from Lee Adler’s Wall Street Examiner Pro Trader Monthly Macro Liquidity Report.
Lee first reported in 2002 that Fed actions were driving US stock prices. He has tracked and reported on that relationship for his subscribers ever since. Try Lee’s groundbreaking reports on the Fed and the Monetary forces that drive market trends for 3 months risk free, with a full money back guarantee. Be in the know. Subscribe now, risk free!