Will we experience Hyperinflation?
The global crisis continues, Coronavirus is still spreading worldwide, oil price and markets keep going down while the Fed prints more money in order to try and save the U.S. economy.
This week, the Fed has officially released its bazookas, three four-letter solutions, and two more to bail out entities and give them the liquidity they need.
Before I get to these solution’s implications and what it means for everyone, I will explain each one of them.
Here are the five solutions the Fed’s offering straight from their playbook in 2008:
The second solution offered is the Money Market Fund Liquidity Facility(MMLF), also known as the Money Market Mutual Fund Liquidity Facility.
Last but not least is the Discount window, where they’ve also made some subtle changes creating big differences.
My purpose with this article is not just to explain all these crazy abbreviations and four-letter Fed solutions and how they work, but also to help you realize that as the Fed’s balance sheet grows with these new facilities, they’re creating additional deposits in the real economy which can lead to inflation.
Fed’s solutions explained
Primary Dealers Credit Facility (PDCF)
Investopedia defines it like this:
“PDCF is an institution created by the Federal Reserve to provide overnight loans to primary dealers through their clearing banks in exchange for eligible collateral. The PDCF provides loans that settle the same business day and mature the following business day. The facility closed in 2010.”
However, the facility was recently reopened to take the primary dealer’s devalued assets off their balance sheet and put them into theirs in exchange for reserves, meaning the Fed is bailing them out or playing Plunge Protection Team.
The first thing you need to understand for this whole explanation’s sake is primary dealers have bank accounts where the Fed injects or deposits all the money they print so the primary dealers can get them into the real economy, those accounts are called reserves.
Today, the primary dealers have over $1,5 trillion in excess reserves they can use to go into the stock market and corporate bond market and buy stocks and bonds, as shown in the image.
This means whenever they purchase an asset it goes right into their balance sheet, at first, and the funny money the Fed printed and gave to them in the form of reserves, goes to the entities the primary dealers bought their assets from, usually hedge funds, financial institutions, and retail investors.
These asset sellers usually take their money and deposit it at their retail bank, so as a result, the number of deposits in the real economy grows and so does the money supply, potentially leading to inflation.
But there are two things I want to point out here, first and foremost, the primary dealers have to do something in order for the deposits to increase in the real economy. Their actions and purchases are needed because the Fed can’t inject money directly into the economy without the primary dealers taking action.
At first, the corporate bonds and stocks go to the balance sheets of the primary dealers, but then the Fed offers them a “loan” for those assets and the primary dealers accept, which means those assets go from their balance to the Fed’s balance sheet.
After this, the Fed prints more money and deposits it into the primary dealer’s reserves. The Fed usually calls it a loan, but it’s almost a zero percent interest rate loan which they can probably roll over to infinity.
This allows us to ask, if this is a zero percent loan and they’re able to roll it over to infinity, is it really a loan or is the Fed buying corporate bonds and stocks through the mechanism of the primary dealers?
What the Fed is saying is they’re taking these stocks and corporate bonds the primary dealers have already purchased, off their balance sheet and giving them a “loan” so they have more liquidity.
But even if we chose to believe this, that this is the Fed wanting to increase the primary dealer’s liquidity by taking their assets off their balance sheets, these stocks, corporate bonds and a variety of other assets have been defeated over the last 30 days.
So who’s to say the Fed isn’t just taking them off their balance sheet at a hundred cents to the dollar to make them whole?
Peter Schiffs says this could be a bailout for the primary dealers just as easily as it could be the Fed playing the Plunge Protection Team (PPT) through the primary dealers themselves, as I mentioned before.
Money Market Fund Liquidity Facility (MMLF)
The MMLF is a facility that works taking cash from businesses and retail investors and going into the corporate bond market and the commercial paper market to buy debt.
This means the money they take goes from the MMLF to the balance sheet of any corporation participating in the commercial paper market and able to issue debt.
This debt becomes a liability in the corporation’s balance sheet and an asset for the MMLF.
The MMLF balance sheet usually has corporate bonds and commercial papers on the asset side, and on the liability side, they have the IOU to the businesses and the retail investors.
This is how the MMLF works on an ideal world, but, with our reality today, it looks a lot different.
The MMLF doesn’t know if any corporation will be in business for the next two to three months because of the Covid-19 crisis.
What they do know is it will be a rocky and risky road, so they stop lending money to corporations.
This decision makes the demand go down, and interest rates up.
Because interest rates go up the corporations start to have a hard time staying in business because the funding they need to manage their day-to-day operation gets more and more expensive.
Also, as soon as the retail investors hear how the market is behaving, they ask for their money right away because they’re not willing to take the risk, they don’t have any income coming in and they need to pay their bills.
The only way the MMLF can respond and give them their cashback is if they sell their corporate bonds and the commercial paper off their balance sheet and back into the market.
This selling will create more asset supply taking interest rates even higher into a Buzz Lightyear system where interest rates go up and up completely crashing the system.
The Fed already knows this, which is why they ask the MMLF to stop selling their assets and lends them the money needed to pay the investors with a supposedly a 90 days maximum loan they can likely rollover with a zero percent interest rate.
The bottom line for this facility is the Fed lends them the money to pay off the investors, and the Fed’s balance sheet now has the MMLF loan along with the additional reserves.
How did they get those reserves?
By printing the money they had to give to the MMLF.
The money goes from the MMLF to the investors who are most likely to deposit it into their retail bank accounts, and the reserves for the retail bank are held at the Fed, this is why the Fed’s balance sheet stays in balance.
On the other hand, the MMLF balance sheet now has smaller IOU’s to the investors and the Fed’s loan as a liability, but more importantly, they still have the assets of the corporate bonds and the commercial papers because they were never forced to sell it into the market, increasing interest rates.
This way the Fed artificially keeps those interest rates low.
Notice they’re still expanding their balance sheet by having to print more money and creating more reserves in the real economy because the transactions aren’t just with the primary dealers, they’re also with the MMLF, the retail investors and the businesses.
It’s very important we’re always remembering these temporary facilities or permanent facilities, are creating additional deposits, therefore, additional money in the real economy.
Commercial Paper Funding Facility (CPFF)
To explain this solution I will start with an example.
Let’s say a corporation’s CEO asks the Fed for help because they can’t make a $2,000 payment and the only thing they have on the asset side of their balance sheet is equipment and goodwill.
The Fed comes in willing to help and asks the corporation to issue some debt so they can exchange it for money through the Commercial Paper Market.
So the Fed gives the corporation a “loan” for $2,000 or the money they need, which leaves them with the equipment, goodwill, and cash on the asset side. On the liability side, they have less debt because they were able to make their $2,000 payment, equity and the loan from the Fed.
Of course, after this, the Fed’s balance sheet will continue to expand.
They now have a corporate loan on the asset side and more reserves on the liability side.
How did the reserves get there?
Same exact thing as the MMLF example, they printed up more money, the deposit went to a certain corporation which moved its deposit into the bank account of whomever they owed the money to.
Wherever the deposit comes to rest, the reserves have to be held with that bank, and that bank’s reserve account is with the Fed.
The Fed’s balance sheet continues to grow more and more.
This solution already existed, but the Fed made some changes to try and drop the interest rates, and I am pretty sure they did.
Generally, in order to get cash from the discount window, entities need to pay a premium, and in addition, carry the stigma attached to it because the market assumes that if a certain corporation or bank goes to the discount window, it means they’re out of business.
So some of the primary dealer banks, I’ve read, have started to use the discount window, just to eliminate the stigma.
But the main idea is the Fed lowered the rates to where they are paying Fed funds, so all of the banks outside the Fed’s umbrella, or the “loser banks”, can now have access to the Fed’s funds at the same rate as all the “cool kid banks” who are under the Fed’s umbrella.
FX swap lines
About this solution, you just need to understand how it works.
It starts with the Fed printing funny money, again, and giving it to the central banks in exchange, in this case, for Euros and Yen.
Now, my main objective with the explanation of each of the Fed’s solutions is you understand these transactions, the facilities transactions, are much different from the ones the Fed does exclusively with its primary dealers because the last ones don’t create additional deposits, just reserves.
On the contrary, every transaction the Fed does through all of these facilities turns, in other words, in additional deposits in the real economy, meaning more money will be flowing in the system.
Fed’s solution’s consequences: Will this cause hyperinflation?
Notice the Fed’s balance sheet has gone to infinity and beyond.
They’ve taken all the primary dealer’s assets off of their balance sheet, and even the ones from the “loser banks”.
This means, in other words, those assets don’t need to be sold. That’s key.
In addition, they’ve given loans to the MMLF so they wouldn’t have to sell their debt or assets, and they gave loans to certain corporations so they can continually pay their bills and issue more debt.
In essence, the Fed has taken all the debt and the equity from the private sector and put it into its balance sheet.
But why is this important?
Because the Fed is the only entity that doesn’t care about profit and loss, they can keep the loans, or keep rolling them over on their balance sheet forever. They can keep all assets, the mortgage-backed securities, the treasuries, the stocks, the corporate bonds or whatever is on their balance sheet forever.
They can never have to sell. This way, markets will never need to go down.
But it props up the pension funds because there are no sellers in the market, there are only buyers, and that’s the Fed.
This means all problems can’t be solved by the Fed, especially because once they start, how are they supposed to unwind everything?
As Peter Schiff said when they started quantitative easing, “it was the monetary roach motel, once you come in, you can never leave”, and I think it’s the perfect analogy.
If the Fed has all the stocks, bonds, and everything else on their balance sheet, how do they unwind it without creating an additional collapse?
They most likely won’t be able to, so the only release valve is to continually print more and more funny money.
We’re already starting to see inflation in consumer goods due to the Covid-19 and the supply chain crisis. In Frank Holland’s, from CNBC business news, words:
“Trucking demand increased 18% last week from the previous due to the Covid-19’s response. Nine Swift, the nation’s largest trucker and other with large domestic networks outperformed the broader market this week.
That’s largely due to the demand for van load trucks that deliver about 70% of consumer goods and jumped by 31%. Think hand sanitizer and toilet paper. Demand for refrigerated trucking, think food and perishables spiked by 33%”.
Let’s also remember the Fed is increasing the money supply, while at the same time, the increased money could be chasing not only the same amount of goods and services but fewer goods and services due to the supply chain disruption we can see from the Covid-19.
If the situation continues like this, we could definitely see domestic inflation, meaning the cost of goods and services in the United States will go up while at the exact same time the dollar, its value, outside the country and relative to other currencies, will go through the roof.
It’s very common to hear from Peter Schiff saying we’re going to have inflation and potentially hyperinflation in the United States, but he never really explains how he gets from A to Z. He doesn’t always connect the dots.
The good news is I interviewed Peter on and asked him all about it, specifically of domestic inflation. You can check it out here.
When will we see hyperinflation?
Taking it back to our question, my personal opinion is we won’t see hyperinflation in the short term or midterm, but maybe in the long term, five to ten years from now.
If you define hyperinflation by a 50% devaluation per year of the United States dollar, midterm, I think we could definitely see a 1970’s type of inflation, as shown in the chart, in two to three years, and in the short term, I don’t think we could see this type of inflation neither hyperinflation.
I do think consumer goods, the cost of what you buy every single day will definitely go up while at the same time high ticket items like cars, are going down along with asset prices unless the Fed buys everything in sight and puts it on its balance sheet.
Different from this, I don’t know what will happen and I have no way of giving you a prediction other than stay tunned, It’ll be exciting and interesting, and let’s all watch it together.