Interest rates are as low as they can go, realestate’s becoming unaffordable to many, there are less $50 dollar notes in circulation than ever before (probably under mattresses), a lot of home owners are mortgaged up to the hilt and they feel like interest rates are going to rise, people are edgy about the markets awaiting a seemingly inevitable COVID correction (unfounded or not), our GDP may well face a world that doesn’t want Carbon with their fries and we’ve also elected a lot of seemingly self absorbed people. From what little I understand this seems to tick all the boxes to edge Australia into a stagnant economy, decades of low rates but zero growth, money under mattresses and a sludgy retail sector, a booming tourism industry to keep us going as long as it doesn’t all catch on fire/flood/bleach/pandemic again. This seems to be referred to as a liquidity trap and Japan still hasn’t found a way out. I’m not usually such a pessimist but foresight is the full half of the glass when money’s involved. 👍
- ‘Uneducated novice’
Are we in a liquidity trap? How close are we to a technologically induced deflationary spiral? Is crypto propped up by a liquidity trap? What happens to crypto in a deflationary spiral?
Looking at the current monetary policy with ultra low interest rates and high savings rates, this seems to fit the definition of a liquidity trap.
Is this a permanent issue? And has America ever been in a liquidity trap before? And if so, how did we get out of it?
Hi All,
I thought it would be good to share a theory I have been working on for the last couple of months which may explain why we are seeing significant price movements after periods of low liquidity.
TLDR: Low liquidity is the SHF's worst enemy as this limits opportunities to reset FTD's and also means that it becomes harder to directly control upwards price movement. As the pool drains through retail we then see upwards movement in order to generate liquidity in an attempt to allow people to exit.
Previous Periods of Low Volume:
6/14 to Present - Average of 5.73mn shares traded per day
4/28 to 5/12 - Average of 3.04mn shares traded per day
2/16 to 2/21- Average of 13.81mn shares traded per day (Bear in mind that the price was 1/5th of current)
From what I can see we have had 3 periods of lower than average volume which have given warning to significant price jumps from periods of lower volume.
A quick note on the GME ATM offerings:
From April 5th through to April 26th GME completed the 1st ATM of 3.5mn shares (approx 15 trading days)
From June 9th through to June 22nd GME completed the 2nd ATM offering of 5mn shares (approx 10 trading days).
In the first offering period we saw a phase of GME where the price remained roughly stable and yet we know the offering was being completed through the higher percentage of dark pool trades (happy to go into detail on the data behind this in a follow-up post). We can reasonably say that on average 233,000 shares were put into the float on a daily basis which were swallowed up by retail.
I have taken this number to give us some insight into what I think happens on a near daily basis although the price is now 50% higher than the first ATM offering so the true figure for liquidity leaving the pool may be closer to 150-200k shares daily.
What I think is happening behind the scenes:
Short Hedge Funds need liquidity to do two key things:
- Reset Fails to Deliver, I tend to agree with the DD that says that T+21 and T+35 are a real issue for SHF's but in the case of June I am of the opinion that they opted to reset fails early because of the liquidity provided via the At the Market Offering which means that we may see the current cycles pushed back by approx. 10 days.
- Control the price, during periods of high liquidity, SHF's find it easier to locate borrows for shorts and also can purchase larger blocks of options in order to gain access to shares without significantly altering the
- Lack of security means Canadians continually save money
- Lack of income, leads to continual credit leveraging against security and deposited money
- Deflation of assets is not the perogative of central banks,
Central banks, if they were concerned about the affrontness of human welfare would begin pricing hikes consistant with realistic expectations of post-covid stagnation.
Central banks are more concerned about the paper trail deception that IS the model, than how household, individual, business and family budgets currently look.
The stock market is NOT the economy.
The housing market is NOT the economy.
An economy is there to deliver needs, services and occassionally wants. If it cannot do that...
It is NOT an economy
“Don’t fight the Fed.” That mantra is repeated as fact amongst almost every market participant across the globe (other than Davey Day Trader, who doesn’t know what a central bank is). Based off of that logic, one could reasonably assume that the Fed and Jerome Powell are the reasons for this recent market rally. All of WSB is bullish, and you can’t go more than four posts on WSB without seeing some exhausted money printer meme or a pro-Powell love fest. After a week of reading economic research papers nonstop, I think I have stumbled into something that the market and the Fed won’t see until it is too late to stop.
Full disclosure: I am not an expert and this post should not be construed as anything other than my opinions and theories. This will be an extremely long and conceptual post (with a lot of references to research papers) that focuses more on economics than any financial analysis. It is not hard to understand, but be prepared to read.
Fed Reaction to Coronavirus
The Fed’s reaction to coronavirus was extremely quick. After seeing what worked to stop the financial crisis in 2008, the Fed used the same playbook. Lower rates to near zero, buy treasuries (quantitative easing), buy mortgage backed securities, cut the reserve ratio to 0%. That playbook didn’t work though, the market kept selling off though. The Fed then did something unprecedented, they started buying corporate bond ETFs. They only bought high grade corporate bonds at first, but quickly realized that they had to buy junk bonds in order to keep the corporate bond market stabilized. Recently, the Fed quietly announced a ramp up of their Main Street lending program, along with guaranteeing 95% of the loans instead of a range of 85-95%. This implies, to me, that banks don’t want to give out loans unless the Fed backstops them more. That will become important later in this post.
The Fed has also been buying commercial mortgage backed securities. These CMBSs are facing extremely high levels of delinquency. According to that article, 7.6% of all CMBS loans are delinquent as of May, along with 19.3% of hotel loans and 10% of retail loans. A [whistleblower report](https://www.propublica.org/
... keep reading on reddit ➡The idea has not held up. As I write the rate on 6-month T-Bills is 0.06%. That is pretty close to zero, right?
And yet everyone is debating what will happen with the rate of price inflation. No one is claiming it is indeterminate, as the simplest liquidity trap models suggest. Nor, with rising rates of price inflation, can it be argued that inflation inertia is dominant. Instead, it is obvious that the Fed has let the current inflation happen. It is true that the inflationary pressures stem from (roughly) coordinated acts of monetary and fiscal policy, rather than monetary policy alone. But no one is doubting that the Fed is in charge of forthcoming rates of inflation.
(And if the T-Bill rate is ever so slightly above zero, rather than at or below zero, that too seems to stem from higher expected rates of price inflation in the first place.)
I agree with those individuals who suggest that the currently higher rates of price inflation will not be with us 4-5 years from now, and that is because the Fed does not want that to happen.
Paul Krugman recently wrote (NYT):
Seriously, both recent data and recent statements from the Federal Reserve have, well, deflated the case for a sustained outbreak of inflation. For that case has always depended on asserting that the Fed is either intellectually or morally deficient (or both). That is, to panic over inflation, you had to believe either that the Fed’s model of how inflation works is all wrong or that the Fed would lack the political courage to cool off the economy if it were to become dangerously overheated.
In other words, the Fed to a considerable degree can indeed control the rate of price inflation, and with nominal T-Bill rates very close to zero. Thus the liquidity trap doctrine is dead, discarded once it no longer provides an argument for an ever-more expansive fiscal policy.
The post Liquidity trap for me but not for thee? appeared first on Marginal REVOLUTION.
> Keynes argued for aggressive fiscal expansion during the Great Depression on the grounds that the fical multiplier was likely to be much larger in a liquidity trap than in normal times, and the financing burden correspondingly smaller. In today's coronavirus crisis environment in which economic activity in many advanced and emerging markets economies is expected to remain subdued, rates of price and wage inflation are low or even absent, and equilibrium real rates are close to or even at record-low levels, there is again a strong case to be made for fiscal stimulus as monetary policy is constrained by its effective lower bound (see for example chapters 1 and 2 in IMF (2020) and the discussion in Gaspar et al., 2016) and may have limited scope to provide suffiient stimulus to the economy through unconventional policy tools.
> In this context, the recent academic literature has promoted a new type of tax-based policy which may stimulate growth while being self-financed. In order to distinguish it from the conventional fiscal policy advocated by Keynes that is spending-based, this strategy has been referred to as unconventional fiscal policy. It builds on the important theoretical work by Correia et al. (2013) and a key ingredient in it is a gradually higher path of the sales tax. A credible commitment to a higher future sales tax boosts domestic demand by reducing the wedge between the actual and the potential real rate; it increases the equilibrium real rate and lowers the actual real rate through higher inflation and inflation expectations. According to the consumption Euler equation, this policy thus increases household's consumption today. Moreover, by boosting economic activity this strategy also increases tax revenues (through higher tax rates and expanding the tax bases), shrinks the public deficit and reduces government debt as a share of GDP.
> Another conventional fiscal policy which has received significant attention (see for instance Bussiere et al., 2017, and Bouakez et al., 2017) is higher public infrastructure spending. Top IMF officials responsible for fiscal policy issues (Gaspar et al., 2020b) recently urged policy makers to increase public investment to combat the COVID crisis and strengthen the recovery. From a policy perspective, there are at least two good reasons why such spending may be beneficial to soc
... keep reading on reddit ➡Does rapid increase in M2 money supply and low velocity of money suggest liquidity trap or is it temporary covid lockdown effect?
What would happen if it is a liquidity trap, people don't spend the money due to pandemic traumas, GDP and employment doesn't rise to expectations? Will FED keep printing, with the hope of breaking the liquidity trap someday?
Will the direct transfer of stimulus to end consumer make the velocity of money surge in comparison to previous QE policies?
If the velocity does increase sharply post-covid era after vaccination, but GDP doesn't increase proportionally, as per quantity theory of money will it not unleash the prices? Because I doubt FED shall take counterproductive action, by immediately responding with rate revision, instead it would let loose the prices for quite a while IMHO.
I am not from economics background, just trying to make sense of the theory and situation.
Probably too dumb a question for askeconomics.
Banks are being conservative which might suggest that all of this is "priced in".
They're borrowing like crazy with the Fed rate at 0.25% and they're using that capital to pay down old, higher interest liabilities i.e. collectively, they're handing it back to the Fed. None of that looks good or sounds good from a short-term perspective; and little of that QE will actually hit mainstreet -- at least in the period when it matters. But paying off debt is the only way out of this spiral -- especially when investors are scared (saving vs spending mentality), credit risk is poor, and economic growth is stifled. This is a deflationary spiral that could last 3-5 years; and QE can only mask the bleeding so much before it becomes detrimental to our future. Just look at Japan in the 90's. You can't fight lack of demand without meaningful control of the price lever.
Point being, the following realities are inevitable:
- People will hoard the money supply
- Lending will freeze despite a near-zero interest rate
- Economic growth will be stifled as demand/investing remain low
- Most of the money supply will be spent on commodities and debt obligations
- New bubble will form when the real value of certain assets (housing etc.) gets distorted. This will also form the basis for our breakout
This is a liquidity trap. There will be a run on the market -- JPow has been printing to "price" all that in. For the past three weeks, the Fed has been acting as ballast to buy time for monetary policy to pivot. Now banks are in a strong cash position with foreknowledge of what to expect. So we should expect the floodgates to open and the carpet to finally get pulled. Stocks will crash again (hoarding cash), and harder; followed by a multi-year theta market marked by incremental inflation until we transition to a much needed growth period. Or we'll try and print our way to inflation -- with consumer spending as the operative variable.
Welcome to the debt bubble! FYI, whatever medicine we use to resolve this will ultimately form the cause of our next bubble. So on and so forth...
- Globalization created cheap external labor which spurred economic investment/growth. This bubble created wage imbalance
- Wage imbalance resulted in risky/unregulated/low interest lending which was a boon for big banks and consumer spending for nearly two decades. This bubble created debt
- Debt caused the mortgage crisis of 2008 which resulted in a massive recession second only to the Great Depressi
This BIS paper analyzes the effectiveness of cutting interest rates near the effective lower bound (ELB)—the liquidity trap.
TLDR: The results show that a short-term rate stuck near zero does not prevent a central bank from spurring credit growth if it seeks to do so—promoting credit and releasing liquidity constraints matter more than lowering the level of interest rates.
Summary:
- The article compares the effects of monetary policy shocks (action by central banks) in situations where the short-term interest rate is near the ELB with situations where the interest rates are not near the lower bound using state of the art techniques.
- In this paper ELB times are periods where both the level and the standard deviation of the short-term interest rates are close to zero. Jan 2009–Dec 2015 for the U.S. economy, July 2012–Present for the Euro area and January 1996–Present for Japan.
- The analysis of the effects of monetary policy when rates are low is important because interest rates may remain at or near the ELB in the decade ahead of us. As we write this paper, the Fed has reduced its interest rate by 75 basis points from the 2018 peak in the interest rate cycle. Neither the ECB nor the Band of Japan (BoJ) are likely to lift the short term rate into positive territory for several quarters. It is therefore necessary to measure the effect of monetary policy shocks when rates are near the ELB.
- The results show that these policies have stimulated economic activity and inflation during ELB times. They show that a short-term rate stuck near zero does not prevent a central bank from spurring credit growth if it seeks to do so—promoting credit and releasing liquidity constraints matter more than lowering the level of interest rates. They find that during a deep recession, credit maybe unbounded and, unconventional monetary measures have sustained the effectiveness of monetary policy.
Detailed Results:
United States:
- Both in normal and ELB times the credit spread falls and the monetary aggregate rises after an expansionary monetary policy shock. The effects persist during both sub-periods although the effects seem to last longer during ELB times.
- For both sub-periods, output rises slowly, reaching its maximum after more than 20 months in normal times and around 10 months in ELB times. While the long-run effects on output turn out to be much stronger in normal than in ELB times, output reacts much faster during ELB times. Data indicate
Primer on a Krugman's description of a liqudity trap:https://web.mit.edu/krugman/www/japtrap.htmlLet's hold two premises for discussion:
- Japan is in a liquidity trap and has been for the last decade.
- Europe has entered a liquidity trap.
Moreover, let's posit that the probability is greater that America follows Japan and the EU towards a liquidity trap because as those trading blocks are unable to climb out of their traps, it'll drag America into its own.
Holding those three supposition it begs the question on what the Fed has to do. The answer, as Krugman has argued is to preemptively apply monetary stimulus aka an insurance cut.
Therefore, if we see the Fed cut by 50 basis points, it flags the prospect for a US liquidity trap in 2020, and the Fed is applying Krugman's recommendation.
If the stock market stagnates or starts to fall. What can the government and FED really do to stop us from getting caught in a liquidity trap? Interest rates at 0, so lowering them below 0 won't stimulate the economy any more. Injecting money into the system only works if people spend them and if we look at the savings rate right now people are already starting to save heavily.
The question is. Are we actually in the beginning of a liquidity trap? If not, why not ? If yes, why? Other opinions?
If everyone would rather just hold the money at the zero lower bound, nobody would invest. But if a firm needs money, then it will offer to borrow at a slightly higher rate than 0. Competition between investors will never drive the price of capital to a true 0, because no investor is willing to offer a 0 interest rate. The true lower bound of the interest rate would be the cost of setting up the investment. And firms that are borrowing will always give a slightly higher interest rate than that lower bound. So how could a liquidity trap ever occur at close to 0 interest rates?
I'm trying to understand this paper by the St. Louis Fed on QE during a liquidity trap but I don't really get the theory behind QE being effective in a liquidity trap: https://www.stlouisfed.org/publications/regional-economist/third-quarter-2017/quantitative-easing-how-well-does-this-tool-work
Specifically this quote here:
>Bernanke’s view was that, with short-term nominal interest rates at zero, purchases by the central bank of long-maturity assets would act to push up the prices of those securities because the Fed was reducing their net supply. Thus, long-maturity bond yields should go down, for example, if the Fed purchases long-maturity Treasury securities. Bernanke then argued that this was “accommodation,” in the same sense as a reduction in the fed funds rate target is accommodation. Thus, QE should be expected to increase inflation and aggregate real economic activity.
I get why nominal interest rates are zero and why prices would rise and why the Fed wants to increase inflation, but everything about how yields are related to inflation makes no sense to me. For reference, I've only taken an intro Macro course.
(Where there are so many assets and people waiting to invest that they all end up with low returns)
So apparently they’re a problem because people start hoarding all their cash and refuse to buy bonds. Isn’t that what the government wants, though? They increase the money supply buy buying off bonds at higher than normal prices and drive down their yields/interest rates, all so that there’s more M1 money.
Obviously people wouldn’t want to buy new bonds when they purposefully make those bonds unappealing.
Why is this an issue?
