Everything seems to be lining up perfectly for individual investors with Joe Biden and Kevin McCarthy making a debt ceiling deal. In fact, a sentiment poll reflects an ebullient investor class. According to an Investors Intelligence article titled "Assume the Positioning" (reprinted in Almost Daily Grant’s, June 1, 2023), “Just 23.3 percent of respondents are bearish on stocks, the lowest since January 2022, [when] the market scaled the summit of the everything bubble.”
But that same debt ceiling fix will unleash a torrent of US Treasury issuance that will overwhelm the markets leaving stock investors in its wake. Cem Karsan of Kai Volatility Advisors told Maggie Lake on Real Vision, “By most estimations . . . we’re going to have to issue $1.4 trillion in debt before the end of the year. That is a massive sucking sound out of asset markets.”
“There’s got to be buyers of that debt,” Karsan said, stating the obvious, “which means that money is going to come from somewhere. And if that means interest rates go higher, as that supply comes on the market, demand has to be met. That means equity markets or somewhere else, some other risk asset has to reduce liquidity.”
Another expressing concern about liquidity is Eurodollar University‘s Jeff Snider who says those who think the Fed is just printing money are missing the real story. Snider told Raoul Pal on Real Vision,
Nobody ever stops and thinks about what are these bank reserves and what do they actually do? Are they actually a form of base money? And the answer is no. And they haven’t been in decades. In fact, this was a major problem that Paul Volcker confronted in the late 1970s and early 1980s. Banks had found different ways of doing money in liquidity that didn’t involve these bank reserves.
The hyperfocus on the size of the Fed’s balance sheet and in turn that its increase obviously means more money has been created is wrong, says Snider, who points out that people don’t see the money destroyed in the shadow system. He also points out that it’s not the amount of the money stock that’s important but the circulation of money and credit in the real economy.
This year money is leaving the banking system and not returning. According to Reuters, “The FDIC said the $472 billion in deposit outflows in the first quarter was the largest it had recorded since it began collecting such data in 1984.” This deposit exodus in search of higher yields likely continued in the second quarter.
While we’re left believing that the Fed has printed a bunch of money that’s highly inflationary, in certain circumstances—especially 2008, 2009, and to a degree 2020, 2021, 2022, and now 2023—we know that there’s more deflation in the monetary system than whatever the Fed might have created in terms of bank reserves. Snider says banks are supposed to do intermediation as well as money creation but haven’t done either since 2008. Banks, he says,
want to just hold to the safest and liquid assets, and just try to pick up as many nickels as they can. Understanding that whether it’s in a couple months or a couple years, they’re going to go through another liquidity problem again, and have to worry more about safety and liquidity than they do about risk-taking.
In the simplest terms, banks just haven’t created enough money. Murray Rothbard explained how banks create money in The Mystery of Banking. Banks create money by lending to individuals and businesses, not, for instance, by parking money at the Fed’s reverse repo facility, where balances have grown from zero in March 2021 to over $2.1 trillion currently, earning 4.3 percent.
So, in Snider’s view, “Even though the Fed is creating all these trillions of bank reserves, there isn’t enough bank money around in the Eurodollar system which leaves it susceptible to what should be nothing. The smallest little thing can set off this major issue, because it’s that fragile.” Banks aren’t taking risks, and neither are money market funds, which are looking for safety before return.
If this reminds you of 2008, it should. According to Snider,
The 2008 crisis wasn’t really about subprime mortgages. That’s just where it began. And once it started to infect all of these major functions in the banking system, it led to the situation that we’re confronting now, where money didn’t circulate freely throughout the global Eurodollar system, which led to all sorts of problems.
Likewise, falling commercial real estate prices are infecting other things, leading to disruptions in the market, which leads to a lack of liquidity and more risk aversion. And more risk aversion means more lack of liquidity in these markets. Don’t count on the Fed to fix this mess. As Snider said, “The Federal Reserve and central banks are always looking backwards. They don’t see these things coming so there’s no help from them either. And pretty soon before you look around, markets are illiquid. Banks are struggling for funding. Some more of them are failing.”
Lyn Alden is another who is being kept up at night worrying about liquidity. She tweeted on June 1, “However, now that the Treasury cash drain is finished, and we start looking ahead past the debt ceiling, we are potentially encountering the next period of negative liquidity (rather than sideways liquidity).”
She wonders what will break next. Last September it was the United Kingdom gilt market and nearly the US Treasury market. In March a few regional banks with unusually high duration exposure and uninsured deposit exposure failed, and now she says we have to watch the small banks and the Treasury market.
Jeff Snider has his eye on September for a liquidity crisis. “So, if you’re thinking ahead, there’s probably a really good chance that something happens in September, if not beforehand.” Karsan echoes that view: “It’s not a coincidence that mid-August into mid-September is often a scary time.”
You can talk with your registered investment advisor about your stocks’ fundamentals, but as Karsan says, “It hasn’t been about fundamentals for decades now. That’s the narrative you hear on CNBC.” It’s liquidity that moves stock prices.
Stock investors—danger lurks, and Uncle Sam is going to crowd you out.
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