Like The 1990’s, But Better
Primary bull market trends are fuelled by money. In this piece, we elucidate where this money comes from, and how today’s market setup is similar to the 1990s, only better.
Where Money Comes From
Money enters the economy from two sources: the Treasury net-spending (spending-taxation), and from bank credit. The former is more “powerful” money than the latter because it does not carry a liability when it enters the private sector (it does not have to be taxed back). Bank credit, on the other hand, is a deposit that is offset by a liability; it is temporary, “less powerful” money because, sooner or later, it must be paid back and cancelled…plus interest.
Green and Yellow Dollars
The SOMA (Federal Reserve balance sheet) does not involve the creation of money like deficit-spending and bank credit does. It is an asset swap; one kind of dollar for another (called quantitative easing, or QE). The securities that the Fed takes in are dollars that were created by the net-spending (deficit) of the government and were sitting in a type of “saving” account called a Treasury bond that pays interest — Kelton calls these ‘yellow dollars’ because the physical bonds themselves are yellow. So, when the Fed exchanges green dollars for yellow dollars, there is no net-creation of new-dollars and there is no change to the wealth of the private sector — just like moving money from a savings account to a checking account does not change your wealth. There is also no change in the distribution of the wealth within the private sector.
Since March, when the reserve requirement in the banks’ lending ratio was re-instated, the Fed has been conducting an overnight reverse repurchase operation (ON RRP) which is the opposite of the QE described above; ON RRP involves taking in green dollars (draining reserves) and swapping them for yellow dollars (Treasuries). Essentially, the Fed is buying Treasuries at one window (QE), and then selling them at another window (QT). It is doing this ‘machination’ so the banks can work around the huge deposit liability that was created by the unprecedented government net-transfer and the reinstatement of the required reserves rule. It does not create money directly, but allows the banks to create loans.
The chart below shows the increase in the banks’ own capital (which allows them to increase their loan assets) since the start of ON RRP.
Source: ANG Traders, stockcharts.com
One of the fears in the investment universe these days, is that the Fed will stop QE and start tightening (QT). As we have outlined above, the Fed has already started to do a kind of QT via the ON RRP. Since this type of QT has the off-setting effect of increasing bank credit, and since it is likely that the spending bills get passed (even as smaller versions) and the (insane, self-harming) debt-ceiling is raised or eliminated, we expect that there won’t be the serious pullback that is feared. However, when the Fed announces the reduction in the SOMA balance sheet, there will likely be a “headline trade” that creates a “dip” which we will buy.
Long-term, we continue to expect the current primary bull trend to continue like the dot.com bull market did in the latter-half of the 1990s…only more so! In the 1990s, the Clinton administration ran a budget surplus (first chart below) — by taxing more than it was spending — and bank credit increased to fill the resulting ‘hole’ (deficit) in the private sector. Bank credit is what fueled the dot-com bull, and that is what eventually killed the bull; debt levels in the private sector became unsustainable and had to be unwound (Note, in the second chart below, the debt was not completely unwound until the GFC) .
Source: ANG Traders, FRED
Household Debt Load
Source: ANG Traders, FRED
Today’s situation is different. Private debt is historically low, and net-spending is historically high. These fund flows, combined with the explosion in AI, biological/medical, space, environmental and climate technologies will drive the market higher than most can currently imagine. Investing in this thesis is possible by going long broad-spectrum ETFs such as SPY, DIA, QQQ, IWM.
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