We live in an age of monetary largesse. Never before, in modern history, has the cost of money been as cheap as it has been in the last decade and a half. Not only are interest rates low, but central banks, in the name of supporting financial stability, have really come to ‘own’ the title of lender of last resort.
‘Greenspan put’ morphs to the ‘Everything’ put
Since the era of the infamous ‘Greenspan put’, the ability of central banks to underwrite risk in financial markets has been relatively unchallenged. What has changed has been ‘WHO’ the central banks are lending to.
In the middle of the last century, central banks were still a lender of last resort, but primarily this was reserved for other banks. One could argue that while this hasn’t changed, that the focus that central banks now pay to financial markets (as a result of the wealth effect), has implicitly changed this role. The 1987 Greenspan put has morphed into the Bernanke, Yellen and Powell put as well.
This expectation of monetary largesse has become baked in. In almost 35 years, we have not had an era where the Fed (and now other major central banks in tow) were not prepared to shore up financial assets in the name of financial stability. Let’s unpack this.
The ‘Bump’ in the road
We all know that rates have fallen precipitously since the heady Volker years to the effective ‘Zero-lower bound’ with negative rates in many geographies now a reality. But its not just about interest rates or the price of money. It is also about how plentiful money has become.
The prevailing narrative more recently is that 20% of all dollars created were done so in the last year. This is not technically incorrect. When using M2 or even the broader measure of money supply, M3 (which includes some less liquid instruments), total US money supply has lurched from around $15tr in 2019 to around $20tr today.
Over time, the average annual rate of expansion of monetary supply was in the region of 6-7%. During the early 1970’s it rose sharply to around 15% as the US exited the gold standard. As a decade, the 70’s notably increased the average growth in money supply to around 9% (a 50% delta on the previous run rate) before lower M3 growth started normalizing this trend through the 90’s.
Thereafter, not even the 2009 global financial crisis noticeably changed the slope of the M3 curve. The exponential increase in the first chart prior to the pandemic response, is largely a product of a larger base rather than an increasing rate of change in real terms.
Compare the logarithmic chart below for reference. But notice the ‘bump’ in the log curve at the tail end. This is material! To see a ‘bump’ on a logarithmic curve implies that the rate of change has noticeably increased.
Chasing the paper
We have already established that its not just about the price of money but also the supply. The other part of the equation is what’s happening with all the ‘debt’ being issued by government. Enter central bank balance sheets. Remember the ‘Greenspan put’ we spoke about. Well, in recent times, its about more than supporting rates by buying bonds.
Central bank mandates globally have expanded. The Fed currently buys $80bn USTs and $40bn Mortgage-Backed Securities per month. The Bank of Japan’s mandate includes the ability to purchase exchange traded funds. The ECB has been underwriting the debt of less credit worthy Eurozone member nations since the Eurozone debt crisis with an expanded toolset. The list goes on.
Will all this asset buying, it’s no surprise that the balance sheets of major central banks continue to swell. This coordinated push by global central banks is what has largely given rise to the ‘anti-fiat’ movement. (We’re talking fiat currencies here, not the automobile company). This movement is made up of the followers of Austrian economics, Gold bugs and even more recently, the creators of the original crypto currencies.
Admittedly, the latter has devolved into a smorgasbord of utter rubbish and meme-worthy joke coins. These detract from the original intent and ethos of this initiative. For more, see my piece on central bank cryptos. Also, watch the video I did for the CFA Society on the Ethical dimensions of legalizing crypto.
Watch the Taper of the Paper
Now that we have covered the swelling balance sheets of major central banks, lets close the loop. Financial markets are dependent on this largesse. Let us not pretend that the market is anything close to reasonably valued at these levels. We look at Shiller ratios and other risk flags in this piece earlier.
However, I like to look at the ‘delta’ or change in metrics to understand what the marginal move is informing the trend. When we deconstruct these, we can see that the Fed is always leading the charge. They did so in the GFC and similarly now. The are the first to act, utilize scale and are usually the first to pull back.
The ECB and BOJ tend to follow suit although not always in lockstep. These divergences in relative stimulus between regions gives rise to some tactical opportunities in FX and relative economic growth rates which tend to manifest in underlying financial assets.
Even helicopters need to land to refuel
The longer-term trajectory will be informed by whether aggregate global stimulus gets pulled back. I have just written an article for Finweek, discussing the market reaction to the Fed and the role the Dot Plot plays in driving the narrative and short-term movements. Keep an eye out for it, published later this week.
I choose to focus on the potential for an asset taper before a lift off in rates. Remember that a taper is merely a slowing pace of asset purchases. It is not an asset sale or shrinking of the balance sheet.
If the 2013 taper tantrum and commensurate policy moves are a potential guide, this implies a 2 year time horizon at least. The aggregated stimulus from central bank balance sheet growth is still around 20% on a rolling 12 month basis, but is falling. This means that the foot is easing on the accelerator but we’re not yet on the brakes.
Stay awake, stay cautious. Stay close to the door in case the music stops playing. And remember that in an era of helicopter money, even helicopters need to land to refuel from time to time.
- Source on all charts: FED, BOE, ECB, FRED – Moe-Knows.com