JEFF SNIDER: My name is Jeff Snider. I work for Alhambra Investments. I’m the head of global research there. It’s a registered investment advisor based
out of Florida. What I do is, as the head of global research,
is I focus in on the monetary mechanics, the plumbing, so to speak, behind what actually
goes on in the world. I take a particular focus on something I call
the Eurodollar system because as a global currency, it really is the global reserve
currency. Because it’s a global reserve currency, what
that does is that touches pretty much every part of the global economy in almost every
part of the global markets. The way in which that happens is it’s a lot
of times very complex. A lot of times, it’s hard to decipher, but
what you should know is that the Eurodollar system is everywhere. It’s out there, it’s happening, it goes on,
and very few people pay attention to it, and a few still understand what really means and
what it really does. It was way back in early part of my career,
I started looking at bank balance sheets, for example, as an equity analyst, as a return
a portfolio management firm. You take a look at banks, and what you found
out was that the way the banks operate and the way that individual banks balance sheets
were put together was not what you were taught in school. There was all the things going on, on these
balance sheets and in this monetary system that was very different from what everybody
was saying, what everybody believed in and so I started investigating that. What really drove me to look at it was the
fact that nobody had any answers for these things. These things would happen, you could see them
on balance sheets, and you could see that there was more behind them but when you stop
to talk to people who were supposedly in the know, people were supposed to know these things. You listen to central bankers and economists,
for example, it was very clear they didn’t have a very good understanding. For me, it just drove me further and further
that hey, maybe someday this will be important. Of course, first you had the dot-com bust
and then of course, what happened in 2008. You started really to think, okay, there’s
something really going on here that’s worth investigating and worth understanding in a
particular level, because there’s a lot that’s attached to it. Well, what literally happened last week was
the repo rate shot up. Because it shot up, there’s various linkages
between the repo market and the Federal Funds market. Monetary policy at the Federal Reserve operates
on Federal Funds so as Federal Funds rose in the range, and then actually broke out
of the target policy range, that caught the Fed’s attention. They can’t any longer ignore something going
on the repo market that’s spilling over into Federal Funds. That’s literally what happened, was that these
report rates skyrocketed because of a lack of liquidity, which forced the Fed to respond,
which they did with these overnight repo operations that have become daily, which are now sprinkled
in with term repo operations simply because there’s a lack of liquidity in the system. We’re not really sure why. The Fed doesn’t know, most people in the mainstream
don’t know, there’s really not a whole lot of answers about what’s really going on there. There’s certainly been a lot of theories,
but there hasn’t been a lot of answers. For what I said, what I’ve been saying for
a long time is that this didn’t just happen out of the blue. We’ve been talking about Fed funds repo, for
in this particular case, for over a year and a half. In fact, the Federal Reserve knew something
was going on because they have been altering their mechanics, just a little slightly here
along the way. Going back to June of last year, for example,
June of 2018, they changed IOER for the first time. They dropped it five basis points below where
it was. The idea was that that would help liquidity
in the marketplace, that would get banks to lend some of their free reserves into essentially
repo and then have that trickle down into Federal Funds. That never happened. They kept on adjusting IOER expecting that
this little nothing of a problem would just go away. They kept finding out that, hey, there’s something
going on here. There’s something else going on here. Really, that’s the big message behind all
of this. When you stop and look at what’s going on
in the repo market, Federal Funds and some of the wider issues with the fixed income
marketplace as a whole, what you keep coming back to is there’s something going on here. First, you say there’s something missing. Obviously, there’s something missing. We saw that last week. There’s a big piece of liquidity missing,
but there’s something else going on here because this keeps building and building, and what
happened last week was it finally broke out into the open so that everybody started paying
attention to what was essentially something that had been happening for quite some time
beforehand. IOER is the rate the Fed pays on excess reserves. Going back to 2008, the Fed has created excess
bank reserves and it pays a specific rate on those reserves to the banking system. The idea is that helps the Fed control money
market rates like the Federal Funds rate. The reason it is because where they place
IOER in the range of their policy range or in the range of actual transactions gives
banks alternatives of where they can put free cash or free funds, however you want to call
bank reserves. The idea is if I lower IOER, that means I’m
going to pay banks– as the Fed, I’m going to pay the banks a little bit less to give
them a little bit more incentive to go into repo or Federal Funds that will bring those
rates down and add a little bit more liquidity to the system where it’s supposedly needed. That didn’t happen. Every time they reduced IOER, you didn’t see
much of a response in either repo or Federal Funds. Federal funds kept rising inside the range. In fact, earlier March of this year, Federal
Funds broke above IOER for the first time and they responded by just lowering IOER again
expecting, again, the idea that will pay banks a little bit less on their reserves so that
they’ll chase a higher return which was by then a much higher return in Federal Funds
and repo. Again, we come back to that same question,
why didn’t the banks do that? Where were they? What are we missing here? Thanks for not taking that advantage of what
should have been of much higher incentives to add liquidity into repo and Federal Funds
and these other places. They weren’t doing it. What we’re really talking about here is banks
being constrained. The reason they’re not going into these marketplaces
is because they don’t want to there. There’s something else going on in the system. I think it goes back to last year. If you look at May 29th , 2018 for example,
what happened on May 29th , 2018 was nothing more than interest rates tumbling. They fell sharply. What that said was that the market was concerned
about something. Something happened on May 29th . We may not
know exactly what it is, but because it wasn’t just US Treasury yields, you had German bond
yields and other yields of sovereign bond yields around the world tumbling on May 29th,
what it did was it announced that something had just happened in the global system. Again, we’re talking about a global reserve
currency, therefore a global monetary system. Something happened on May 29th that wasn’t
good that forced mostly banks in the system to buy and value Treasury bonds, German bonds,
those types of instruments. What happened after that point is, and you
see this in all of the charts, all the charts that matter anyway, May 29th turned out to
be an inflection point. Everything changed after. Inflation expectations for example, before
May 29th, it was going along the way– the TIPS market was going along the way that Jay
Powell said it was. The economy was booming, everything was great,
we’re going to have an inflationary breakout, inflation expectations in the TIPS market
were rising. May 29th happens, that’s no longer the case. Inflation expectations plateaued and then
they have been falling ever since. Something changed on May 29th, and because
it was US Treasury bonds, because it was German bonds, what that suggests is that there was
a problem in collateral, which is the other side of the repo market. The repo market has a cash side and also has
a collateral side. You can’t go in the repo market and fund whatever
you’re trying to do if you don’t have the acceptable collateral that the repo market’s
looking for. What we know from May 29th is something happened,
and likely happened in the collateral system, that ever since that point, ever since May
29th of last year, these banks, this global banking system, this global monetary system
has been increasingly reluctant to respond whenever you see these other opportunities,
let’s call them, to offer liquidity to offer to funds. They don’t want to do it, they’re staying
out of it. Again, something’s missing, something is absent. I think a lot of it has to do with the collateral
side in the repo market. The collateral side is not an easy thing to
explain because it’s one of those things, it’s part of the global framework of modern
money. It’s just, again, the stuff that you were
never taught in school how it actually works. It’s a very complicated, almost bizarre, weird
place. A lot of different things happen on the collateral
side. It’s something called securities lending,
but even the idea of lending securities is probably foreign to most people because it
sounds fantastic. Why would you be lending securities? Oh, by the way, we’re not just lending securities,
we’re also transforming securities. We have collateral lending, we have rehypothecation,
we have collateral transformation, we have all these weird things going on, that these
dealer banks know is going on. Not only do they know what’s going on, they
probably have a decent idea of who it’s going on with and they also have an idea of how
much this is taking place. If there’s an issue in the collateral system,
we can suspect, again, we don’t have any direct evidence for these things because it’s hidden
in these offshore spaces of this global marketplace. We can begin to suspect by what we see in
market prices and dealer bank behavior that there’s some concern about all of the things
that were going on the collateral side of the repo market, may be in danger of creating
bigger problems. That might answer, in my view, probably does
answer at least a good part of why dealers are reluctant to step in when they should
be stepping in, when they should be taking, hey, I got lower IOER, why am I not taking
advantage of the spread to repo or Federal Funds? Well, if I’m worried about all these other
things, I’m probably going to be shy about everything. In many ways, we’ve never recovered from 2008. Before 2008, as people know, from the term
subprime mortgages, mortgage bonds were a very big part of the collateral chain, they
were a big part of the collateral system in the repo markets. Once the financial crisis became severe enough,
those mortgage bonds were no longer really acceptable in repo. What we were left with is pristine collateral,
which is the top layer of collateral out there, it was nothing more than US Treasuries and
for a while, it was all the European sovereigns until 2011 when those Portuguese, Italian
and Greek bonds suddenly, they were no longer acceptable either. What we’re really talking about here is, the
availability or supply of collateral in the system has been impaired and has been cut
back since 2008. Nothing has ever been done about that, at
least not an official level. Now, the banking system has tried at various
points along the way to deal with what is essentially a systemic or chronic shortage
of collateral, which is what we’re really talking about here with Treasuries and German
bonds. The way that they’ve done that is by various
points along the way, they’ve transformed other forms of collateral, lesser forms of
collateral, using the limited availability of the top tier stuff, the pristine collateral,
and attempting to essentially get around what is this chronic shortage. When you do that, you’re adding elements of
risk to the system and the way collateral trades and the way the collateral is redistributed
is almost like– it’s almost currency like in its own behavior. There are times when dealer banks are more
than happy to do all these lending and transformations and all that stuff. There’s also times when they’re shy about
it. It’s almost like there’s a collateral multiplier. I know that’s weird to say and that’s weird
to contemplate, but that’s really the truth here. When the collateral multiplier is big, or
pot big, largely positive, the repo market’s fine. There’s plenty of collateral, I don’t want
to say plenty, but there’s collateral out there in the system, it’s distributed, it
flows where it needs to go or where it largely needs to go. On the opposite times when banks are a little
bit less sure of things, more aware of the risks involved, that collateral multiplier
tends to collapse a little bit and that causes problems because what do you do in that case? Where do you go to if you don’t have good
collateral? Well, the one thing you do is you buy the
top tiers. You buy US Treasuries. You buy German bonds. The insiders in the system, because again,
we have very little– we can’t really see what’s going on in this offshore system because
a lot of it takes place outside of the purview of anybody. There’s not any statistics. Basically, the only people who know what’s
going on are the people involved in it, the big banks and the banks who deal with the
big banks in this global dollar redistribution scheme. If they’re looking at what’s going on out
there, we don’t really have a direct way of observing what’s going on out there. If they’re acting quite shy about what they
perceive is going on, or what they know is going on, that’s a pretty clear signal that
something must be going on and something is making them reluctant to take advantage of
what should be an easy arbitrage in Federal Funds or IOER, therefore we should take from
that the idea that, hey, something’s going on out there that they probably see that they’re
reacting negatively to that it’s got to be a substantial thing. Oh, by the way, it’s preventing them from
reacting in a way that would allow for this normal functioning in these other markets
that people are paying attention to in the places that we can see. Regulations definitely have played a role
here. They played a procyclical role, which is obviously
the opposite of the intent. The regulations, when you’re talking about
basal three, the liquidity coverage ratio, HQLA, all that good stuff, it codified what
banks were doing anyway, which was they were holding more of a pristine collateral inventory
on their own anyway but yes, the regulations did play a role in making banks hold even
more. There’s already an existing liquidity margin
that has built into whether it’s perception or regulation, that’s already built into the
system in the post-crisis era. You also have to factor in quantitative easing,
too, which was the Fed essentially were raising some of that collateral by buying it up and
storing it into its summer portfolio. It’s a multi-dimensional problem that is a
chronic problem, a systemic problem but it’s not a straight line problem. It shows up in these different, in these discrete
periods along the way, but regulations definitely did play a role. They have made banks hold probably more collateral
than they might have otherwise. No, it’s definitely hand-waving. The reason is, look, the Fed did overnight
repo operations daily. They have been since last week, and it hasn’t
had much of an effect. The repo rate isn’t as elevated as it was
in the middle of last week, but that was just because that was a seasonal low point on the
calendar. All that happened that brought the report
back down where it was before was that the seasonal bottleneck had passed. Before the bottleneck, you had the repo rates
and the Federal Funds rate elevated suggesting lack of liquidity. Then after there were the bottleneck, you
had elevated repo rates and Federal Funds rate. Not as elevated as middle of last week, but
still elevated this week. Oh, by the way, there are now standing repo
facility, but there are now overnight repo operations, and these term repos along with
it. They accomplish much, because the repo market
Federal Funds is in the same shape as it was before the bottleneck. That hasn’t really done much in the answer. The reason is because the Federal Reserve
is looking at this from the perspective of only bank reserves. They’re all in the large part doing it because
they’re only looking at it from the perspective of Federal Funds. Monetary policy is only concerned about whether
or not the Federal Funds rate, the effective rate stays within their range. The only reason we got overnight repo operations
was because it broke out of that range. They’re looking at it from the perspective,
a narrow perspective of just Federal Funds, just bank reserves, and therefore, the idea
is maybe we need to keep Federal Funds in this range and the way we do that is through
a standing repo facility, which is only bank reserve. Has nothing to do with collateral, has nothing
to do with why dealers are sitting on their hands when they should be acting in the marketplace. It’s only allowing some variation in the level
of bank reserves. What I tell people is well, if we go back
to the pre-crisis era, there were no bank reserves. There was maybe 10 billion in the system. For a multi-trillion dollar system, there
were no bank reserves in the system before 2008. Yet the repo market functioned fine. What was the repo market using to settle this
liquidity when there were no bank reserves, or was using other forms of liquidity, other
forms of bank driven liquidity? The answer in the repo market today can’t
just be bank reserves, because the repo market encompasses so much more than just what the
Fed is offering. The Fed is offering a small slice of what
might help the repo market. We’ve already seen that the problem is much
bigger. Again, going back to May 29th, why are dealers
refusing to act in these places? That’s the real question, has nothing to do
with a standing repo facility, nothing to do with overnight repo operations. It’s why are dealers not being involved when
they should be? Everything, everything in the marketplace
says these guys should be acting. You see the repo rate skyrocket to 10%, why
are you sticking at 2.1 in IOER? You should be in the repo market. There’s tons of opportunity there. That’s the real issue here. It’s not the level of bank reserves. It’s not standing repo facilities. It’s why are banks refusing to get involved
here? Well, I think people are focused rightly because
nobody knows, nobody really understands the system as it actually works. That includes policymakers, by the way, sadly. The fact is that monetary policy is not a
money policy. It’s not about understand liquidity and understanding
this global system. Monetary policy is only about managing people’s
expectations. That’s what the Fed’s doing. What happened last week was the Fed found
out it’s hard to manage people’s expectations when you have an obvious problem in a way
that everybody’s talking about it. If you have a situation where the Federal
Funds Rate breaks out of its range, it’s hard to manage people’s expectations positively. In fact, the economy in a positive way is
policymakers expect if you have this problem in repo. In fact, everybody keeps talking about this
problem repo because it raises uncomfortable questions, and you don’t have the answers
to why, what is going on in repo? Why is it still going on in repo? If you don’t know, it makes it much more difficult. The idea here is that the level of monetary
expertise, the level of expertise about the monetary system as it actually functions is
very low. It’s even lower in the general public because
for a very long time, nobody paid attention to these things. Everybody just thought, well, Alan Greenspan’s
got it covered. Ben Bernanke’s got it covered. We don’t need to understand repo because somebody
out there does. Therefore, nobody’s ever asked any real questions
about the monetary plumbing of the system. That includes policymakers who thought we’ll
just do some QEs or something. Whether it works or not, as long as people
think it works, then good enough for us. Overall, it’s a lack of understanding about
how things actually work. That’s not a small thing because again, as
I touched on in the beginning, this is a global monetary system that affects every part of
the global economy and a lot of global markets. I think it’s also important to point out that
this is not the first time we’ve seen this tightening. This is actually the fourth time this has
happened since 2008. The first one, obviously, everybody knew about. That was the Global Financial Crisis in 2008. Everybody focused in on subprime mortgages,
but that was only maybe the catalyst which kicked things off. We know from things like the dollar swaps
that the Federal Reserve did with the foreign central banks. What really happened in 2008 was a global
dollar shortage, same kind of dollar shortage we’re talking about today. What has happened over the last dozen years
or so, is we’ve had these intermittent dollar shortages show up. Last year and a half is just the fourth in
a series of them. There was a second one in 2011-2012. There was another one in 2014-2015, lessens
in early part of 2016. Then this one showed up early on in 2018. Well, everybody’s been talking about trade
wars. Before anybody paid attention to repo, everybody
was experts in tariffs in Chinese goods. No, this stuff is just repeating. We see that consistently across these markets,
the same market signals that we have today telling us that there’s a dollar shortage
going on now that’s leading up to repo and collateral, all this other stuff we talking
about. We saw the same market behaviors three times
before now. It’s important to understand that this isn’t
the first time that’s happened. The reason we want to understand that is because
we want to understand what the real problem is. It’s a systemic issue. Collateral is only part of the story. Again, it’s a systemic thing, where it’s causing
a negative effect again across the entire global economy. It’s leading to uncertainty in a lot of marketplaces. It’s leading on to just generalized uncertainty
in whether you’re talking about politics and social factors. What I’m saying is that what people have focused
in on trade wars and trade wars are not helpful. That’s a negative. That’s definitely a negative pressure in the
real economy. What’s happened in the global economy overall
is more about a dollar shortage, a repeated dollar shortage and is about trade wars. The reason people are focused on trade wars
is because there’s a lack of any alternative explanation. What else could it be? Nobody else has any real answers. Again, like the repo thing, what else could
it be? Nobody has any answers. Because nobody really pays attention to these
things. Even after 2008, there’s been a lack of curiosity
about the global monetary system, which is to me is strange, but it makes sense because
most people just want to believe that Ben Bernanke, Janet Yellen, Jay Powell, they all
have it covered. We don’t know how they haven’t covered, but
we want to believe that they do. Therefore, they say everything is fine, it
must be trade wars, because we don’t have an alternative explanation but in truth, the
dollar problem showed up before the trade wars did. Not only that, this is just the fourth iteration
of the same event. People are attributing the effects of this
dollar shortage to trade wars because they don’t have any other explanation. Well, it’s a systemic issue, because we go
back to the pre-crisis era, banks would just expand and part of that expansion was liquidity,
money. Well, it’s difficult if not impossible to
define money and liquidity but we know that was there, because everything was going gangbusters
in the pre-crisis era. Subprime mortgages were a symptom of that
expansion. It was a monetary expansion. It was a global monetary expansion. Even the authorities knew what was going on. They just misunderstood. Ben Bernanke in 2005 called it a global savings
block. It wasn’t a global savings block, it was a
global monetary block. They just happened to take place offshore
outside the US jurisdictions. Then this just crisis happens. Starting in August of 2007, the banking system
began to doubt itself. Why wouldn’t it? Because a lot of what was going on was going
on based on myths and short hands and perceptions about things that weren’t real. As the banking system began to ask real questions
about the stability of everything, bank behavior changed, especially once Bear Stearns failed,
or nearly failed, was turned into a “merger”. What happened with Bear Stearns was it reminded
everybody that there was suddenly a very real downside to doing all of these things that
they used to do exponentially. The downside was, hey, you really can go out
of business here. They could take the entire bank with it. Then, of course, that message was reinforced
later in 2008 with Lehman Brothers, AIG and all the rest. The system began to doubt all the things that
it used to do before the crisis, all these liquidity things, securities transformation,
repo markets, commercial paper. All those things that happened before the
crisis era, banks began to attach real risk to them, and then they didn’t really want
to do them anymore. Then the problem was that the global system–
because remember, this is a globalizing economic system up until 2008, it required those things
to be done, it needed the monetary and financial resources in order for the economy to move. If the banking system says I don’t want to
do those things anymore, all of the sudden, it’s hard to do all the things that would
in economic terms as well as market terms, that happened before the crisis era. If the bank don’t want to create the liquidity,
you’re going to have a constant liquidity problem. In an overview sense, what it is, is the system
was unstable to begin with. It operated for a very long time, because
everybody assumed it was stable. They also assumed that the Federal Reserve
was behind it, which turned out to not be true, too. A lot of these assumptions have been challenged
and proven false and then it’s led to this situation where we have this constant malfunctioning
system that requires banks to expand when they’re no longer willing to do that. This fourth eruption, what we’ve seen over
the last year and a half, and what we saw last week in repo is just an extension of
that problem. When there’s an opportunity for banks to extend
and create liquidity, they’re saying we don’t want to do it. Yeah. It’s two different things, or two things that
are related to each other. Number one, 2008 was not a one-off event. Everybody assumes it happened, it’s over with,
we’re onto something else. No, it was an inflection point. The system that existed before 2008 no longer
exists today. It’s still in place, but it doesn’t work. It doesn’t work for the people inside it,
it doesn’t work for the people outside it. Because very few people are aware that it’s
there, very few people are aware of what it does, it hasn’t received the recognition that
requires and it deserves. The other thing is that what was going on
in the system that existed before 2008, as I said before, was unstable. It was a ridiculous system because it rewarded
all the worst behaviors. In some ways, it was like a spinning top. A spinning top that spins fast seems stable
but as soon as it starts to slow down, it wobbles and falls down. The banks that operate this– because what
we’re really talking about here is a credit based global monetary system, and credit based
means something. It means that it requires bank balance sheet
capacities for this thing to operate in at least the appearance of stability. If the banks aren’t willing to put in the
resources, to put in liquidity, to put in the balance sheet expansion for that system
to operate, it is inherently– the inherent instability in it shows up and it shows up
in these discrete periods that we’ve talked about, these four different dollar shortages
that have erupted along the way. 2008 was a monetary break, was a systemic
break and collateral is just one part of that systemic break. A lot of it has to do– we all come back to,
again, we’re asking the question, where are the banks? Why are they sitting on their hands? That’s the reason. If you’re looking at it from an overview perspective,
going back to 2008, the system was never ever fixed. That’s the real point here is that there’s
really survivability at stake here, because that’s what we saw. Bear Stearns went out of business. Yes, Bear Stearns was merged and as far as
the Fed was concerned, that was a successful rescue. If you’re a manager at Bear Stearns, you’re
a shareholder at Bear Stearns, that’s not how you view it. You lost everything. The partners of Bear Stearns and shareholder
of Bear Stearns, they saw what the downside of this is. That message was transmitted to all the rest
of the banks. They understand post-crisis, there’s no Fed
behind everything, liquidity is shaky, you know what, we don’t really want to do this
anymore. Even when the repo rate is 10%, that’s not
really enough, because we’re aware of the potential downside and the potential risks
that could be out there. Oh, by the way the Fed isn’t. The main takeaway is simply that something’s
going on. Even if you don’t know exactly what it is,
you got to say, hey, something’s going on here and it doesn’t seem like our policymakers,
the authorities have a whole lot of answers. That’s important too because you have to realize
that what’s going on in the system, what may be going on in the system, if there’s nothing
behind it, if there’s no backstop behind it, which everybody’s thought from day one– the
Fed is the lender of last resort. What if there is no lender of last resort? That’s a very different risk spectrum. Then if you thought, well, Jay Powell will
just do a standing repo facility and we’ll forget about this stuff. In other words, there’s something going on
here, it’s a substantial thing. It entails risks, not just to the repo market,
not just to Treasury markets, which would be a positive thing for Treasury markets because
people would go into those markets, interest rates would fall further. We’ve already seen the effects in the global
economy. Think about what happened in 2018, or what
was supposed to happen for 2018 to 2019, authorities were saying the economy’s booming, inflation
is going to break out, we’re going to do more rate hikes in 2019. What happened in 2019? The opposite. We’ve got questions about a global recession,
and some economies that look like they’re already in recessions, important ones like
Germany, that already looked like they’re in recession. There’s no inflation, inflation expectations
have fallen, as I said before, since May 29th . Oh, by the way, now, the Fed’s cutting rates
and they’re not the only ones. It’s global, central banks around the world
are all cutting rates. We’ve already seen the effects of the global
monetary tightening. What we’re really talking about here is a
global monetary tightening in the system that very few people understand. It’s already had serious effects in the entire
global economy. What does repo rumble or whatever it was last
week, it just emphasizes this fact that there are negative monetary risks that have very
real implications for pretty much anywhere around the world.