One of the issues I speak about often is Federal Reserve credibility. Personally, I don’t think the Fed has any credibility anymore. They miss every recession, they can’t calculate inflation properly nor do they understand it, they constantly misread any and all market signals, their policies are completely misguided, and so on. 

The latest issue is that if the economy is really as good as Trump claims it to be, and really as good as the Fed thinks it is, there really would be no reason to suddenly pause rate hikes. If the Fed planned all along to do 1% last year and then pause for 6 months before resuming this coming July, that would be a different story.  But this was a very sudden policy reversal to stop rate hikes and also taper off and stop asset sales.

As I’ve said in the past, it leads any rational individual to believe that the economy is not what government officials and CNBC want you to think and that the Fed is merely preparing for the next round of quantitative easing and rate cuts.

The newest policy proposal just takes the cake, though. It's not a new idea, rather, it's a new presentation of an old idea.  But as they say, you really can't put a pig in lipstick.

Even though the St. Louis Fed published this completely tripped out, a whackadoo idea on Wednesday, March 6, 2019, just two months ago, I haven’t heard one single word about it in any financial media. And you won’t hear anything either…Not CNBC, not the Wall Street Journal or IBD, and certainly not from your financial advisor. I admit that I missed it at first.  But now that I know about it, I want to make sure you know about it too, because the implications are, as The Teflon Don says, “yuuuge”. In fact, it's exactly what he's been publicly telling the Fed to do.

But you’re hearing about this from me.

St. Louis has proposed something called a Standing Repo Facility (SRF). Make no mistake about it, this is just a game for the Fed, known as QE and rate cuts. They’ll be able to roll both into one action and keep it hidden from your news feed and markets, and that is probably why they’re suggesting to do this in veiled fashion. Why? In a word, inflation. The government is desperate to create more inflation because the government is the biggest debtor in the world. And inflation benefits debtors at the expense of its creditors.

Here’s how it works…Step one is that the St. Louis Fed has filed its complaint that banks want to hold too much cash on reserve in order to pass stress tests or real stresses. Like depositors demanding to withdraw their deposits. Imagine...depositor who want to withdraw their deposit? Remember though, banks are required to hold cash reserves (about 10% of deposits) in order to be able to satisfy demand for cash during stressful economic times. So step one is St. Louis is complaining about federal banking monetary policy which the Fed itself created, making it look like banks holding reserves to meet depositor demand is a bad idea.

Step two is to make the case that “Presumably these banks would not want or need” all these reserves of nearly $1T because the Fed itself is paying about 2.4% on reserves held at the Fed, whereas treasuries that yield more are seen as more desirable. In the words of the St. Louis Fed itself, this would be especially true if the Fed could guarantee an interest rate above the Fed Funds rate. The Fed, therefore, is proposing to promise to up the ante by making that incentive a reality.

Step three is that if banks know they can be comfortable to hold treasuries to accommodate reserve requirements instead of cash, then the banks will commensurately reduce their cash reserves in exchange for treasuries.

Step four is banks no longer hold cash reserves. Instead, they hold only treasuries.

Here is what this all means, according to the St. Louis Fed, linked above. It will eliminate the bad optics of QE and rate cuts. That means the Fed knows that it’s game over for QE policies, and this is a hidden attempt to continue QE programs without having to announce it to the public. Secondly, it will allow the Fed to grow the amount of cash in circulation.

So let's have a closer look at this policy proposal, starting with step one. Recall in step one, the St. Louis Fed complained that banks keep reserves on hand to pay out cash to depositors. This policy actually makes sense, because believe it or not, depositors actually demand to withdraw their deposits.  And it has happened in the past, both in America and abroad, that depositors actually demand their money and all at the same time. That's known as a bank run. It's just good policy to require banks to hold reserves.

In step two the Fed is making the assumption that banks don't want to keep cash reserves, and instead would rather hold something just as safe but offers a higher yield. The issue I have here is 1) you never assume, because even without the Fed requiring reserves, banks would keep cash on hand for the very purpose that the law requires anyway, 2) treasuries hold more risk than cash because the market price of treasuries fluctuates in direct inverse proportion to the yield, and 3) if a depositor goes to the bank because he wants his cash back, he will not accept a treasury that may hold lower value than the face value in addition to the extra steps it would take to convert it to cash. When is the last time you paid for groceries with treasuries? And so too, the banks would not want to hold paper that may quickly lose value when the redemptions come in from depositors, causing banks losses.

In step three the Fed gives a guaranteed higher yield on treasuries than the Fed Funds Rate, causing banks to dump their cash for those treasuries. besides the issues I've noted above in step two, the problem here is that this is where the Fed monetizes debt without the public announcement of doing so.  Imagine if the Fed is able to sell $1T worth of bonds to the banks in exchange for all the cash. And the banks would earn interest on the bonds as well. Banks would just roll everything over as it matures, including all the interest.  It looks like tightening at a glance, but when everyone comes to take out their cash to make home improvements, buy stuff they do and don't need, and live off the cash during hard times, all that money goes right back into the economy, back into circulation.

In step four, banks hold treasuries in place of reserves. Did I ask what happens when people want their cash?

All this means is we are in for higher inflation than we have seen until now, and with good reason. The Fed knows that policies like this are the rocket fuel for inflation to soar. As I said a few days ago, inflation is the expansion of the money supply (check), greater circulation of that money supply (check), and the perception that prices will rise, which in due time the Fed and other government officials can telegraph to us through their puppets on CNBC. 

The Fed is probably the single biggest threat to the economy and your asset portfolio. Its track record since its inception in 1913 says as much.

It's for this reason that I’ve been recommending gold, with interest paid in more ounces.

That’s it for now, and thanks for reading Volume 74 of The Macro Market Wrap Up With The Mad Genius. Make sure to leave any questions or comments below. Until next time remember that there is always a bull market somewhere in the world, and on the opposite side of every crisis there always lies opportunity.