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The Fed, balance books, and Unwinding

Since I’ve been watching markets, I’ve noticed that central bank actions have been broadly explicit, and predictive of giant market moves.  So it could be well worth trying to decipher their actions and market implications.

(For instance, everyone knew the Fed was going to print shitloads of money, starting in 2009.  And predictably, the stock market ballooned.  Everyone knew they were going to stop printing money in 2014, and predictably, the dollar shot up, and oil crashed.)

A few days ago, I wrote in shock about discovering that central banks were buying up equities, and had bought $1.7 trillion of equities in the first half of 2017.

Part of the reason why I was shocked, was that I thought central banks didn’t do that, that it was against the rules (which they write.)

After poking around a little, I’ve realized that this is indeed against the charter of the US Fed.  The Fed has a $4.5 trillion “balance book.”  Of that, about $3.5 trillion was created since the 2008 crash, by the Fed “buying” US treasuries, and crappy mortgage backed securities.

This “balance book” is the thing they would be using to buy stocks and corporate bonds, if they were doing that.  However, we don’t know what they are doing, since they “refuse” to be audited.

But the public language of the Fed is that they intend to “unwind” that balance book.  If so, surely it’s not heavily invested in stocks, since that action would crash the stock market.

Let’s get back to some guesswork about that “unwinding.”

Who bought $1.7 trillion of stocks?

The buyers I’ve found are mainly the European Central banks (ECB), the Bank of Japan (BOJ), the Swiss National Bank (SNB), the Central bank of South Africa, and maybe a few other minor league central banks.  Apparently none of them have that annoying “charter” like the US Fed, forbidding this kind of meddling in free markets.

And of course the Chinese Central bank famously meddles in its free markets, but I don’t have any info about their holdings or purchases.  I’m assuming they are not part of the $1.7 trillion in purchases in 2017.  Unless that figure accounts also for the Chinese central bank buying Chinese stocks.  Come to think of it, probably it does.

The BOJ bought exclusively Japanese stocks.  The balance of ownership in the Nikkei is interesting.  Almost ALL buying of Japanese ETFs since 2008 has been the central bank.  Other ownership has remained nearly flat.

The SNB is an odd duck.  I never thought about it before.  But that is the one that was easiest to find an accounting of exactly what they bought.  For instance, their biggest purchase was $800 million of Apple stock in Q1 of 2017.

And they have been accumulating Apple stock for years.  They own around $2 billion of Apple stock.  Weird, but still only a small % of Apple.  Less than 2%.

Here is the total stock portfolio of the SNB.

Unwinding the Fed balance book

The Fed has said it wants to reduce it’s balance book from about $4.5 trillion down to anywhere from $3 trillion down to $1.5 trillion.

The idea is that, from 2009 to 2014 they printed $3.5 trillion by buying government bonds, and mortgage backed securities, as a stop gap measure to prop up the economy.

As the housing meltdown caused $ trillions in disappearing money, because mortgages defaulted, the Fed stepped in and replaced that money by buying up debt themselves…in order to keep the money supply constant, or slightly growing.

The story line is that this is an emergency measure.  If the economy was healthy, private businesses and individuals, and other governments, would take on this debt to grow with the economy.

So when the economy recovers, and starts growing again, the Fed would not hold these vast assets of their “balance book.”  They would let private business and people and other governments take up the slack. Because they are the good guys, right?  They aren’t planning to buy up and own everything, supposedly.

When the US Fed say they are going to “unwind the balance book,” they are presenting themselves as a paragon of propriety, in a world seemingly run amok with profligate central banks, who are spending their balance books buying stocks, and so presumably don’t intend to “unwind,” (unless they are saying the same thing, that they’ll inflate stock prices, then wait for the public to pay up to buy them back at a higher price or later date.)

The Fed has said that it will start by reducing it’s balance book, probably in December of 2017, by about $6 billion per month.  They will ramp up quarterly, until they are reducing by $60 billion per month.  Obviously unless something goes wrong.

So my understanding is that, as bonds come due for renewal, when they say that they are not intending to rebuy the government debt, or mortgage back securities, they are expecting the public to buy them instead, or other governments.

That is the reason they are raising rates.  Because if rates are zero, no one in their right mind would buy these bonds, in a normal market.  (Although for years there have been buyers, even when they have to pay to hold the bonds.)  So this is all a posture of normalcy.  Or predicting or planning for normalcy.

However, we know that one of the “policies” central banks have followed lately, is to make the economy get better by forward “guidance.”  Which means, they will just say it will get better, and therefore it will.

Anyway, assuming the whole story is on the up and up (and this all starts, conveniently, right before Yellin’s term ends), this means they need the economy to be able to absorb an extra $6 billion per month, ramping up to $60 billion per month, on top of the economic activity it’s currently supporting, just to stay even.

When Yellin confirmed all this in the press briefing Wednesday (June 14) , after raising rates to 1% as anticipated, the markets sold off, rightly anticipating this Fed policy would likely lead to a contracting money supply, falling stocks, stronger dollar, weaker economy, etc.

Shortly after that, the market mostly recovered, because this isn’t happening now exactly.  The tiny rate hike isn’t particularly significant.  But when the balance book “unwinding” starts, if it starts, there is a high probability of bear markets in stocks and bonds.

Who is going to buy this debt?

My understanding of  China’s US treasury debt buying, is that it reflects our trade deficit.  When Chinese companies make profit by selling to the US, they turn these dollars in to their central bank.  The central bank exchanges the dollars for yen, then uses the dollars to buy US treasuries.

If this is correct, it seems to me, we would need to increase our trade deficit, to get China to absorb extra US Treasuries.  This of course supposes that China doesn’t have an economic crisis.

If rate hikes lead to a stronger dollar, then that would normally decrease our exports, so slowing GDP, but increase our imports, strengthening China’s GDP.  So maybe this strategy will work.  China would buy more of our debt…but will the US economy have enough oomph to maintain its momentum with less exports?

The elephant in the room is probably the EU.  Of the big three, the EU seems most poised to implode.  Possible triggers and scenarios in Europe deserve more attention elsewhere.

Conspiracy theories

What I’ve written and understood so far is a combination of stuff I’ve read and rationale and guesses.  Because, in spite of the new leaf in central bank transparency since Bernake, although the broad strokes are described, the mechanics and details are harder to come by.

I am certainly a central bank conspiracy theorist.  It seems to me that, if central bankers control the world’s money (which they do), and the rise and fall of most secular enterprises, personal fortunes, large businesses, political access, and so on, it would be foolish to imagine that they don’t conspire.

There are probably back room meetings between the central bankers buying stocks, and the US central bankers, who ostensibly don’t do this.  They probably have plans that they are not sharing with the public.

Whether that means they might be completely misleading the public, and they have no intention to “unwind their balance book” or not, I don’t know.  But I would guess that really is their intentions.  In general, they have announced to the public their large moves.

I think it’s important to try to understand consensus reality, before diving in to conspiracy theories.  And good to keep in mind that while central banking conspiracies almost surely happen, it doesn’t mean that most theories are correct.  In fact, if most conspiracy theories were correct, the conspiracies would not be very successful.

So the takeaway is to plan for economic slowing or contraction, that would start at the point when the Fed announces the “unwinding” has begun.

If that announcement happens, and causes a market downturn, it may not get bought back up as quickly as we’ve come to expect since 2009.


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