Too much liquidity with no place to go

[7 min read]

And that’s a wrap on the first half of the year 2021, perhaps the last of the greatest bubble era. As Americans nurse their bacon, burger, and bourbon hangovers from Independence Day (when we showed the British the door in 1776), they can reflect on new stock market highs. It seems to be about the only thing that matters to many people.

But there IS a lot to celebrate. The S&P 500 closed at a record high on Friday (for the second day in a row). It was up 8.2% for the quarter and is now up 14.4% year-to-date. The Nasdaq — America’s technology bellwether, was down on the day. But it too, is up just under 14% for the year.

This is what life is like when seasonal COVID-19 infections are on the wane. Lockdown life eases up. And central banks get even busier. Their work? Pumping fake billions into the economy to keep stock prices high and bond yields low. Speaking of which…check out the chart below:

There is something gurgling in the guts of the financial system. The chart above shows the size of overnight reverse repurchase agreements with the Federal Reserve. A reverse repo is when a money market fund or large investor deposits cash with the Federal Reserve overnight. Last Thursday, reverse repo volume was nearly US$1 trillion.

What’s going on?

There’s too much liquidity with no place to go. That’s the problem. Most of the money in reverse repo market is from money market funds. Money market funds tend to invest in short-term government Treasury bills and corporate debt. Money market funds in the US currently have over US$4.5 trillion in assets under management.

Money market funds need to make a nominal yield on their cash holdings to cover their operating costs. But remember, the Fed is pumping US$120 billion into bond markets each month. That lowers yields on fixed income across the board. And THAT makes it harder for money market funds to find an adequate yield of the cash.

So, they go to the reverse repo facility from the Fed. And as you can see from the chart, volumes are near the top of the chart. It means there’s too much cash chasing too little yield. In the guts of the American financial system, there’s a giant cash bomb.

In the meantime, if investors DO want higher returns, they have to take higher risks. And that’s what explains the new highs on the S&P 500 and Nasdaq. Fixed income has been cut off at the knees. Fund managers and asset gatherers have only one realistic strategy: buy stonks!

Stonks it is. But what kind of a world is it where there’s so much money that it has no place good to go? That’s the world central banks have created. O brave new world with such yields in it!

In the meantime, in the non-financial world, we’re beginning to reckon with the idea of lockdowns for other emergencies, like the so-called ‘climate emergency’. It’s a subject I took up in the latest Bonner-Denning Letter. Have authorities (financial and political) used COVID-19 to create a permanent state of emergency that justifies extraordinary interventions in your private and economic life?

Pretty obviously, the answer is yes. In fact, New South Wales Health Minister Brad Hazzard has warned of too much ‘kissing and cuddling’ in private homes during the outbreak of the ‘Delta variant’ in Australia. Not only is the government putting millions of Australians under virtual house arrest, but it’s also telling them what they can and can’t do inside the house (and under the doona).

Fascinating doctoral theses are going to be written about how public health experts managed to take a whole nation hostage. It couldn’t have been done without the help of a complicit media. And the leading cheerleaders for lockdowns are politicians and public service officials who are swimmingly drunk with their newfound power.

Now you can see why they’re talking about ‘climate lockdowns’. That’s where the government would have the authority to ban private vehicle use, commercial air travel, and even regulate the thermostat inside in your own home. All to save the planet from humans and climate change.

Once you go down this rabbit hole, there’s virtually no limit to what kind of ‘emergency’ the government could use to justify other lockdowns. Obesity lockdowns — closing fast food restaurants for fat people. Or booze lockdowns — where pubs and bars are closed to drunks. Or information lockdowns, where websites (or e-letters) spreading ‘misinformation’ and ‘conspiracy theories’ are shut down.

British microbiologist Siouxsie Wiles, who now works and lives in New Zealand, explained how this new government ‘soft power’ could be used to address all sorts of ‘emergencies’ in public life. She says:

‘I hope that you know, people take from our responses that we can do this for other things too, you know, we can do this for the other, ah diseases that we have here in New Zealand, we can do this for climate change, umm and I think we should not underestimate actually, the kind of soft power now that New Zealand has, that we can really be an exemplar for how to be a good society, how to use evidence in the right way, you know and we’re not doing it for everything, so I, I think we, you know, we can show actually, why wouldn’t we do this for other things?’

Other things? What other things, Siouxsie? Who decides? Who makes the rules? Once the Rule of Law is gone, and once parliaments no longer hold executive power in check and accountable (here’s looking at you, Dan Andrews), there’s almost no limiting the policing power of government. Everything in your life becomes regulated (sometimes legal, sometimes not legal depending on the current emergency status).

Here from the sunny US on the Fourth of July, with the stock market booming and travel back to pre-COVID levels, it’s inconceivable that we could have ‘climate lockdowns’, much less ‘fat lockdowns’ or ‘booze lockdowns’. But winter is coming. And the fear of the Delta variant is being ramped up.

Until then,

Dan Denning,
Editor, The Rum Rebellion

The Bonner-Denning Letter is co-authored by Port Phillip Publishing founder Dan Denning and legendary investment writer and publisher Bill Bonner. It connects the dots between markets, politics, and history as one of the only macroeconomic, ‘top-down’ newsletters in Australia. For a big picture perspective on the past, the present, and your investment future, click here for details on how to subscribe.

The Surrender of Inflation?
Bill Bonner

We have all been reassured. Inflation can be easily defeated by the Federal Reserve. And according to economist Paul Krugman, it is already in retreat.

‘The current wave of inflation is real,’ concludes Adviser Investments, ‘but it’s not a long-term trend.’

Today, we look at reports from the front.

Whoa! Here’s CNN:

‘America’s factories are struggling with supply chain issues and material shortages. Now, that’s showing up in prices: in June, manufacturers reported the biggest price jump in 42 years.

‘The Institute for Supply Management’s manufacturing price index rose to 92.1% last month, up 4.1 percentage points and hitting its highest mark since July 1979. It was the 13th straight month of price increases in the sector.

‘“Record-long raw-material lead times, wide-scale shortages of critical basic materials, rising commodities prices and difficulties in transporting products are continuing to affect all segments of the manufacturing economy,” said Timothy Fiore, chair of the ISM’s manufacturing business survey committee.’

And what’s it like in the trenches? Let’s check with our dear readers. Here’s Marius M:

‘My company […] builds high-pressure washers for the oil industry. Beyond having to wait two or three months for components, like pumps, motors, and engines, prices for them went up, on average, 250%. Steel, which we use to build the structure on which we assemble an installation, went up 220% so far.

‘Even when we complete such an installation, that should be shipped to the customer, the wood to build a pallet went up 320%. And the cost of shipping itself went up 400%. That’s inside the U.S. We have installations ready to ship to Dubai and Abu Dhabi, but we cannot find a shipper at any price.

‘Finally, who do you think is gonna pay for all this mess? Granma Yellen? Just look in the mirror and find out!’

House or home?

Meanwhile, in the housing market…this is the report at Yahoo! Finance:

‘Home price growth in the U.S. surged in April at a pace not seen in more than 30 years.

‘“April’s performance was truly extraordinary. The 14.6% gain in the National Composite is literally the highest reading in more than 30 years of S&P CoreLogic Case-Shiller data,” said Craig J. Lazzara, managing director and global head of index investment strategy at S&P Dow Jones Indices, in a press statement.’

And here’s a frontline report from another dear reader, Roger L:

‘In 1973, my apartment in a major metropolitan area (Chicago) cost $200/month. Rent varied slightly but was similar in other large cities. As a young, freshly minted college graduate, my salary was $13,000/year.

‘Presently, equivalent rents are $2,000–2,500, a multiple of 10. Salaries for new college graduates start at maybe $60,000–$70,000, a multiple of 5. The frustration among millennials is palpable.’

Housing is a bridge between Wall Street and Main Street. For most families, it figures prominently both on balance sheets and expense ledgers.

As we explored last month, to an investment outfit like Blackstone, with US$619 billion in assets, including the 17,000 residential units it recently purchased from Home Partners of America, a house is just another asset to be leveraged, shorted, hypothecated, and so forth.

But to most people, a house is a place to live. Mortgages or rents must be paid. Upkeep and utilities, too. Families typically spend about a third of their income on housing. So when house prices rise, inflation invades household budgets in a major way.

And now — like the US Army crossing the Ludendorff Bridge in 1945 — inflation is rushing across the housing market to establish a major bridgehead in the consumer economy.

Business Insider explains how the bridge was captured:

‘The onset of the coronavirus pandemic — and its intense economic fallout — prompted the central bank to use its most powerful tool and set its benchmark interest rate near zero. Looking to further aid financial markets, the Fed also began purchasing $120 billion in assets per month, including $40 billion in mortgage-backed securities.

‘This kind of outsized support wasn’t anything new. The Fed had previously combated recessions with rate cuts and emergency asset purchases. But where the housing market was ground zero during the Great Recession, the Fed’s actions made it an unexpected beneficiary during the COVID-19 downturn.

‘The rate cuts dragged mortgage rates to historic lows, and asset purchases further boosted the market. Sales boomed through 2020 as Americans fled cities and capitalized on low borrowing costs. But then supply tumbled to all-time lows and persistently high demand has led prices to climb at a record pace. Other indicators flashed their hottest readings since the mid-2000s bubble, leaving some to question just how long the market can boom before homes simply aren’t affordable anymore — and what the Fed will do about it.’

Ready to surrender?

Inflation has battled its way from the ‘canyons’ of Wall Street into the suburbs…where it is boosting house prices at an unprecedented rate.

But wait…the Fed could bring out its big guns — interest rate hikes — any day. And lumber prices are plunging…down more than 40% in June.

Does this mean inflation is beaten already, as Paul Krugman says?

Or is it just trembling in its boots, seeing what it is up against — Jerome Powell and Janet Yellen…some pretty tough hombres, for sure?

Is it ready to hand over its sword, like General Robert E Lee at Appomattox…and go home…?

What do you think, dear reader?

Regards,

Bill Bonner,
For The Rum Rebellion