The backdrop of all US Macro

The Truth you Need to Understand first

This is going to be a potentially tedious read.

Introduction

Future posts will often link to this post because there is a reality to the financial situation we are actually in, and the choices it forces the hands that shift the financial levers to make. The media will not tell you the actual truth undergirding the financial markets, they will only tell you the surface level 3rd hand information they receive. The central bank makes an announcement that they are watching the unemployment rate. The media does not ask, “is this true, Are they actually watching the unemployment rate?” And because they do not assess the founding principles of the information that they share, they are always telling you what the central bank wants you to think.

I will break it into sections with headings outlined below, so that you can skip the parts you may already understand.

This will be very dry, but I am making the case for you to understand what the federal reserve is actually doing, and what it is they tell us they are doing, and how it is the media frames what they are doing. If you want, you can scroll down and read the conclusion, which is just a simple paragraph and all you really need to take away from this. You can read the rest of the article later, as I will constantly link to it, especially at the beginning and end of each week as I am outlining the news of that week. Understand that you need to internalize this, before you can really understand the macro at the central bank level. Also understand that this subject is far more complex than how I have laid it out here. I suspect many of you reading may have great insights to add. Please feel free to leave comments and add your own insights.

Table of Contents

1. Simple Examples

2. The Fed Balance sheet

3. An Unfree Treasury Market

4. The Levers of Control

5. Conclusion

1. Simple Examples

Some governments have more guile than others, but almost all governments attempt to live off of money they don’t have. In the more nakedly stupid countries, they just print the money outright, and tell you they are doing it to your face.

Venezuela not trying to hide that they are simply printing money

Article about Turkish Money printing, 15 months before hyperinflation set in

In more sophisticated countries, they won’t just outright tell you that they are printing money. In fact, there are many intellectual traps that are set through which the midwit can convince themselves that no money printing is occurring. So, here in the US, the government explicitly cannot spend money it does not have. So, if our government wants to run a budget deficit, they simply have to sell treasury bonds and pay interest on that debt. This purports a free market through which institutions or regular American citizens like you and me can fund the government and earn a healthy return on investment from the safest known institution on the planet. Many people stop here.

2. The Fed Balance Sheet

Beyond that, if you kept asking questions, Ron Paul, Peter Schiff or Stefan Molyneaux or someone else along those lines may have introduced the concept of the Fed (Federal Reserve) to you. The Federal Reserve is the central Bank for the United States and executes monetary policy in concert with the US treasury. The Fed has always had the ability to participate in what are called OMO (Open Market Operations) in the short term, these operations net out to Zero and a credible argument can be made that they do not amount to money printing. OMO is how the federal reserve and other banks maintain interest rates to within a certain range. So if the Fed claims, they want to hold interest rates on the overnight lending markets to within 0%-0.25%, they essentially buy overnight notes when interest rates stray above 0.25%, and they sell them when the overnight rates get too close to 0. If done with low volumes, a small amount of capital can do a lot of work to stabilize rates. However, in 2010 the Fed used the housing collapse as an excuse to vastly increase the amount of money dedicated to OMO, and they strayed into the longer term notes as well to buy more and more of them to push the interest rates down. They essentially bought government debt, and NEVER sold it back. Or phrased another way, they printed money, gave it to the government, and never asked to be paid back. This is money printing, hidden within activities that institutions are calling more and more normal. This is no different than what Venezuela, or Turkey are doing in long term effects, but we have prettied it up, made it look fancy and stretched it over a long enough time frame that most people lack the attention span to see it.

The Fed began purchasing assets in earnest and held them starting in 2010, and promised that they would unwind them, and sell them back once the crisis had passed and they pushed that repayment date out repeatedly all the way into 2018, when they finally made a weak attempt to begin paying it back. A year later, the bond markets ran out of buyers in September 2019, and by October 2019, The Fed had to reverse course and go back to printing money at a rate of $200B in the first month. Over their entire attempt to “taper” and unwind their position, the Fed managed to reduce their balance sheet from $4.3T in government treasuries to $3.7T in treasuries. They only got to unwind about 10% of the money they printed before the market shit all over them and they had to stop and reverse course because they were unwilling (and unable) to let interest rates actually spike. And since then we have printed a significantly larger amount of money with the balance sheet currently resting at $8.6T. In 2019, what was ostensibly a good economy, we were incapable of unwinding the position that we were promised by the Fed was always a temporary position. If that position was not temporary, and was actually permanent, then we are, by definition, printing money.

From this we can see already the 1st conclusion forming. The Fed is unwilling to unwind the financial position they created by printing money if it means enduring even a minor amount of economic pain. So we can already see, that if there is going to be any cost to the Fed or the government that will result from them unwinding their position, then they will not do it. Coincidentally, this is what they would need to do to fight inflation.

3. An unfree treasury market

Now you might be rather confused by some of the facts I have laid out. Why does the Fed print money into the treasury markets, and not into other markets directly? Two big reasons. As covered earlier, when the government runs a deficit, they have to sell treasuries. Normally, supply of treasuries, vs. demand for safe investment will determine what the interest rate is of these treasuries. They exist in a free market. So if the government wants to run deficits that are far in excess of demand for the treasuries, then the amount of interest they have to pay on each tranche of marginal debt increases. Thus creating a natural feedback mechanism by which a government would either default or manage their debt exposure as a result of natural market mechanisms.

That doesn’t sound like the government you or I know does it? No, of course not. That’s why the Fed bids into the treasury markets, it really doesn’t have much to do with bringing unemployment down, which is what the Fed often claims they are trying to do. They are bidding into the treasury markets, to hold the interest rates on treasuries artificially low, so that the government can run larger deficits than they otherwise would or could in a natural market. The Fed also bids into the securities, and stock markets with some of the printed money, and they view the growth in asset prices as a bonus to these activities. This, they call the wealth effect, and is the correlation between the growth in asset prices, and consumer spending. Consumers essentially spend money or take out loans against their assets to spend, if their home, stocks, 401k etc. grow in value. This is the lever that causes the pain when the Fed attempts to raise interest rates and unwind their treasury position. It is the rock and hard place that they are trapped in between.

4. The Levers of Control

So these are the real levers that are affecting the Feds decision making.

1. Government Deficits must be financed through treasury sales

2. The Treasury market interest rates must remain under control

3. The Wealth Effect caused by asset prices must not be reversed

Notice, there is nothing in there about stopping inflation from getting too high. Inflation is the one pain point that they do not feel, nor do they respond to. Which is why the narrative around inflation is so divided in this country. Some people experience it every day and know it is real. Others can be told what to think and they will disbelieve their lived experience if enough people or authorities around them claim it to be true. Others are incapable of recognizing changes even outside of peer pressure. For those 3 levers to remain in place, mathematically, the government either has to stop running deficits, or the Fed has to let inflation keep running higher. We already know they aren’t going to stop running deficits, so the conclusion is foregone.

Once you are aware of these 3 levers that matter, and the one lever that does not matter, you then have to consider a few things each week.

1. The truth

2. What the markets will be told

3. The markets sentiment about what they will be told

If you only trade the truth, I’m sorry to say, but you’re an idiot. You instead need to trade what it is the markets will be doing instead of the truth. You are not trading a free market, and as such, trading the truth will either burn you, or wear down your patience while you watch everybody else print racks. I have often been told a few things that are very important to keep in mind when trying to trade in this environment.

1. Being right, when everyone else is wrong, looks the exact same as being wrong.

   If you try to trade the truth on the short term, you will get burned, you want to be trading what it is the market is going to do. You want to know what they will hear, how they will interpret it, and how they will trade. That is far more important than knowing what is true and making fundamentally perfect trades.

2. Just because something is inevitable, does not mean it is imminent.

   The fundamentals I am explaining here have been true for at least 60 years, and the market churns on all the same. We are absolutely heading towards a fiscal cliff, but that does not mean that you should be mortgaging your house for a parachute. Do not make large panicked moves because of the fundamental horror that is inherent within the financial foundation our entire lives are built on. The last generation of traders that got to trade an event similar to this decade (the 70s) have all retired and the market kept marching on. Keep that in mind as perspective.

5. Conclusion

The conclusion that you need to take forward from this when trading is this. Market sentiment will overvalue news about Non Farm Payrolls (NFP, employment) and other news related to the employment rate in the US. Market will completely ignore relevant news like CPI (Consumer Price Index, inflation), The Trade Deficit, and planned government deficit spending and weekly treasury auction volumes. Before you focus on knowing whats right, you need to understand what the markets will do. After that, you can identify what is right, and you can identify which long term central bank policies will fail, and you can start to identify when they might fail by watching the treasury auctions and finding divergences within the narrative. And we will have an opportunity to do that this coming year (2022).

Currently the Fed is pushing a narrative that they will taper money printing such that by June 2022, they will no longer be printing money for the treasury markets. I can tell you for a fact that this policy will fail because it is mathematically impossible with the current deficit the government intends to run. When it fails, interest rates within the treasury markets will spike far above the rate the Fed is trying to hold it within. This will force them to quickly reverse in an emergency measure, and then revert the existing policy. This creates a macro-trading opportunity. As the markets believe that tapering will succeed, they will exit the correct trade for the moment of failure and position themselves incorrectly. All we have to do is to identify a 2-3 week period within which that failure will occur and simply position ourselves where the markets will be once they are aware of the failure. And in the meantime, we want to make sure that we are trading with the market and not against them. Remember, you don’t want to be right when everyone else is wrong. You instead want to be right just a few weeks before everyone else figures it out. The weekly updates are to give you the power to know when the markets will be with you, and when the markets are likely to turn. Whatever it is that you invest in (stocks, crypto, forex, comex, etc.), these weekly guides will help you to outperform someone that simply DCA’s (Dollar Cost average) into a position, and will also help you to avoid hitting your stops or getting margin called if you are trading on leverage. You don’t want to have a risky open position during a large news event.

This is the macro-economic cycle that we are in and what we will be focusing on. Once the Fed admits that they can’t stop tapering, our macro-economic strategy will change, and we will talk about that once it happens and what we will be doing next.