Hail The RRP; Savior And Destroyer

Now that the FOMC has announced its intentions, it has to sit back and wait to see if it can actually do anything. This is the direct consequence of using the federal funds rate as the primary target, as it is a dead market that nobody really uses anymore. The only reason the Fed is still leaning on federal funds is you; namely the economist/policymakers don’t want you to get confused should they have switched to some other more relevant money market rate. Monetarism is psychology more than anything now, so the fact that the federal funds rate “communicates” what the Fed wants you to think about its intentions is all that matters to them.

Well, not quite all, because money markets do exist and remain vital. To bridge this communication/practical trading divide the Fed has developed and tested a number of different programs. Primary among them was its reverse repo (RRP) update which now includes several categories of financial participants that were prohibited from monetary policy exercise prior. The idea of a reverse repo is relatively straight forward in its philosophy, as it amounts to private money market participants “lending cash” to the Fed in exchange for UST collateral sitting in the Fed’s SOMA portfolio; huge stockpiles of UST’s that showed up via the QE’s.

In terms of monetary policy, then, “lending cash” to the Fed is the same thing as the Fed “soaking up” money; idling it at the Open Market Desk and thus away from the private money markets. If that was the beginning and end of the potential considerations the Fed wouldn’t need so much testing and self-assurances. There are, as with all things in the real world, great complexities to consider.

If this seems entirely different from the last time that the FOMC wished to “tighten” policy that is because the system now is entirely unrecognizable to what it was in the middle of 2004 when Greenspan was so puzzled by a conundrum. In fact, Greenspan’s conundrum goes quite a long way toward explaining why the Fed in 2015 cannot act like the Fed in 2004; money markets had already undergone radical transformations by then but had at least kept prior faith and some pathology about more traditional operations. That operative environment was, understatedly, highly unstable as was revealed starting August 9, 2007 – the radical transformations were proved the operative condition/problem.

In other words, money markets weren’t actually behaving as Greenspan thought they should and would, leading to his conundrum and then to a total system reset (panic; but a panic, importantly, of only banks by banks within money dealing and market conduits). What happened starting in mid-2007 was that money dealers in this new(ish) money market construction simply stepped away from the global liquidity table. There were numerous factors at work leading them to do so (and I won’t list them all here), but that left a gaping hole in the monetary fabric of not just the domestic system but really the global financial system first.

The end of Bretton Woods in 1971 was really the last step in a transformation that had begun in the 1950’s, and what replaced gold exchange was not the dollar but a credit-based eurodollar – all the emphasis you can possibly muster on the term “credit.” That leaves global trade and, after 1995, global debt speculation (bubbles) dependent upon bank balance sheet factors for liquidity and even what might fairly be called the true money supply of this arrangement.

When banks stepped out in 2007 and 2008, central banks were forced to step in. Obviously, that was not a smooth transition, nor would it ever be. Between A and B was a great chasm, one that we experienced as a panic and crash. Since then, encompassing now seven years, we are stuck at B though not for lack of trying. Central banks have here and there attempted to hand back “money supply” responsibility to A, the dealers, but the dealers have only intermittently and half-heartedly accepted it.