A Savings Multiplier? 1/19
Why is the demand for assets so high?
About the Fed’s reverse repurchase program, Timothy Taylor writes,
from March 2021 to September 2021, this backup expanded in size from $8.7 billion to $1.6 trillion. Any shift from a few billion to more than a trillion is a huge deal. Apparently, there is $1.6 trillion or so in funds that large-scale market participants want to lend short-term, overnight, and the Fed is the only party in the market willing to be the borrower–the borrower of last resort, if you will.
I am not convinced that I understand all this. I am not convinced that Timothy Taylor understands all this. I am not convinced that the authors of the Richmond Fed article to which he links understand all this. I am not convinced that anyone at the Fed understands all this. The Fed may have evolved into such a Rube Goldberg banking operation that only if something terrible happens will anyone ever put in the effort to really understand all this.
Here’s one question: If the Fed is borrowing $1.5 trillion more in September than it did in March, why don’t interest rates go way up?
One possible answer, very speculative and quite possibly illogical:
Congress authorized trillions in new government spending during the pandemic. This creates paper wealth without producing anything.
The businesses and households that received this paper wealth had nothing in particular to spend it on in the short term. So they saved it. Some people in charge of this new wealth decided to save it by investing in crypto assets, GameStop, start-ups with no due diligence, Tesla, and other momentum plays.
The rest of us looked around for safe places to park our paper wealth. We are the ones who ended up, indirectly, doing repos with the Fed. That is, out banks and money market funds lent money to the Fed, using securities as collateral. Of course, the Fed really shouldn’t have to post collateral, since we know that the Fed is not going to default on these loans. A reverse repo is the same thing as a repo, just viewed from the other side. That is, if the Fed borrows from banks via the repo mechanism, the Fed is said to be doing a reverse repo.
The people who put their excess savings into momentum plays drove up the value of the investments they bought, creating more paper wealth and more excess savings. Some of this new excess gets plowed back into momentum plays, and some of it goes looking for safe assets. In a sense, you get an excess-savings multiplier, sort of analogous to the consumption-income multiplier of Keynesian economics. Savings increases paper wealth, which generates more savings, and on and on.
Eventually, this multiplier process will stop. Some of the excess savings gets absorbed by spending, and hence we have inflation. More ominously, what if the momentum in the momentum plays slows down, or goes into reverse? Interest rates on safe assets could be held down, because people substitute out of momentum and into safety. Or interest rates could go up, because people mark down their wealth and reduce their purchases of safe assets.
Think about Bitcoin doing this. Some people buy Bitcoin. The price goes up. They feel richer, so they buy more Bitcoin. Rinse and repeat. Until, as Herbert Stein famously said, something that can’t go on forever, stops.
I have not tried to write down equations to see if this savings multiplier story really works if you keep track of everything. Caveat emptor.