By How Much Can the Fed Reduce its Assets with QT? Fed’s Liabilities set a Floor

The Fed’s big liabilities: reserves, US paper dollars, RRPs, and the US government checking account. Reserves already plunged by $1.03 trillion.

By Wolf Richter for WOLF STREET.

Normally when we look at the Fed’s balance sheet, we discuss its assets: Treasury securities, MBS, repurchase agreements (repos), swaps, SPVs, etc. Under the new regime of Quantitative Tightening (QT), total assets have dropped by $139 billion from the peak, as of its balance sheet released on September 1.

But it’s the liabilities that limit how far the Fed’s assets can theoretically drop under QT. By looking at the path of those liabilities, we can project the theoretical bottom of QT, below which the Fed cannot go.

On every balance sheet, total assets = total liabilities + capital.

Capital is easily dispensed with:  The amount of capital is capped by Congress. Total capital is currently $42 billion, which is minuscule, but that’s how Congress wants it. So be it.

Total liabilities: $8.78 trillion, down by $139 billion from the peak on April 13. Liabilities are what the Fed owes other entities. We’re going to look at the four largest liabilities, which account for nearly all of the liabilities:

  • Bank reserves: $3.25 trillion
  • US paper dollars (“Currency in circulation”): $2.28 trillion.
  • Reverse repurchase agreements (RRPs), total: $2.53 trillion
  • US Government’s checking account at the Fed: $670 billion.

Total liabilities parallel total assets, the only difference being the minuscule amount of capital. But the composition of those liabilities has changed dramatically, as we’ll see in a moment:

Reserves plunged by $1.03 trillion since Dec. 2021.

Reserve balances peaked in December 2021, after the Fed had begun reducing its asset purchases. Since then, reserve balances have plunged by $1.03 trillion, including by $59 billion over the past week:

“Reserves” are cash that banks put on deposit at the Fed. Banks use their reserve accounts at the Fed to transfer money to and from other banks. They’re a liability on the Fed’s balance sheet because they’re money that the Fed owes the banks. Banks on their own balance sheets carry them as assets, and don’t call them “reserves” but “interest-earning deposits,” or similar.

The Fed currently pays 2.4% interest on reserves; they are the most liquid, risk-free interest-paying asset banks can invest in, and they also figure into the banks’ regulatory capital.

Alternatively, banks could invest some of this cash in short-term Treasury securities (Treasury bills). The one-month Treasury yield was 2.49% on Friday. But Treasury bills provide less liquidity than reserves. Banks could also send cash to the Fed via overnight RRPs, but the Fed only pays 2.3% on RRPs.

Reserves are a manifestation of liquidity in the banking system that is now not chasing after other assets.

QE created liquidity that then went chasing after all kinds of assets and drove asset prices higher.

QT drains liquidity from the financial system, and generally speaking, one of the aspects of this liquidity being drained is a drop in reserves.

But the $1-trillion plunge in reserves, after only $139 billion in QT, is due in part to a shift to RRPs via Treasury money market funds. More in a moment.

How far can reserves drop? Fed’s “Ample reserves regime.”

As QT plows forward, reserve balances are going to shrink further. How far can they shrink? We have some history on this.

Under the last QT regime from Nov. 2017 through Aug. 2019, reserves dropped as expected. But when they hit a low of $1.4 trillion in September 2019, the banks stopped lending to the repo market. They had reasons because overleveraged mortgage REITs and some hedge funds that were borrowing in the repo market short term to fund long-term bets were beginning to blow up. Fearing contagion from the huge repo market, the Fed stepped in and bailed it out.

It then said that its monetary policy is based on an “ample reserves regime,” a floor of sorts, meaning it wants banks to have “ample” cash on deposit at the Fed. It didn’t mention a figure, but it phased out its repo market bailout once reserves reached $1.6 trillion.

But this time, the Fed has “standing repo facilities.”

In preparation for QT, the Fed last summer revived its “standing repo facilities” that it used to have before the Financial Crisis, but shut down as QE commenced in 2008. These SRFs for repos and reverse repos allow the Fed to step in real time if the repo market threatens to wobble. So this one is likely not going to blow out again.

So what are the minimum reserves under the “ample reserves regime,” combined with the safety feature of the SRF?

We will find out, and it could be less than $1.6 trillion because of the safety feature. But let’s stick for now with $1.6 trillion as the minimum.

Reverse repurchase agreements.

Under these contracts, the Fed takes in cash and hands out collateral (Treasury securities). They’re a liability because it’s money that the Fed owes its counterparties. The Fed pays 2.3% in interest on this cash.

The Fed offers two groups of reverse repurchase agreements, and both combined total $2.53 trillion:

  • “Foreign official and international accounts,” where foreign central banks park their dollar cash: $277 billion
  • “Others” which are the “overnight RRPs” mostly with Treasury money market funds: $2.25 trillion.

Total RRPs started spiking in April 2021, but since June 2022, have been roughly stable in the $2.5 trillion range.

The overnight RRPs, currently $2.25 trillion, are cash from Treasury money-market funds.

Starting early last year, Treasury money market funds got flooded with cash. They normally would buy Treasury securities with short maturities, but demand was so high that short-term yields dropped to 0% and briefly below 0%. A negative yield is a problem for money market funds because it might cause them to “break the buck,” where a unit’s value might drop below $1, which could trigger a run on the fund, which could spiral out from there, which is why the Fed started offering RRPs, and then started paying interest on them.

And there’s now another reason for the surge in RRPs: Treasury money market funds have started to shift their short-term cash that they need to keep on hand to RRPs, from their bank accounts, because the Fed pays higher interest on that cash. In addition, RRPs offer essentially zero credit risk, which is not the case with large bank account balances.

What this means for the Fed’s balance sheet: A shift from reserves to RRPs, and this could explain why reserves plunged by $1 trillion over the past 8 months, as RRPs have shot higher.

How low can RRPs go?

In theory, they can drop to near-zero as liquidity is wrung from the system via QT. There is no reason for the Fed to maintain a minimum balance of RRPs. This is demand based, and as other interest rates rise and liquidity vanishes, RRPs could drop to very low levels four years from now. So for our theoretical minimum, let’s say this is near $0.

Paper Dollars: after spiking, demand has flattened.

Currency in circulation – the paper dollars in your pocket, aka Federal Reserve Notes – is demand based through the US banking system. If customers demand paper dollars at the ATM or at the counter, the bank must have enough on hand. In other countries, foreign banks have relationships with US banks to provide paper dollars to their customers.

US banks get those paper dollars from the Fed in exchange for collateral, such as Treasury securities. In other words, as demand for paper dollars rises, banks must get more paper dollars from the Fed, and to get them, must post more collateral at the Fed. As the liability of currency in circulation increases, the collateral, such as Treasury securities, also increases the assets on the Fed’s balance sheet.

Before QE, currency in circulation was the primary driver of the increase in assets on the Fed’s balance sheet. And demand has been huge – but not for payment purposes.

Paper dollars are stashed under mattresses, in vaults, and in suitcases around the world. When there is a crisis – or a potential crisis, such as Y2K – in the US, people stock up on paper dollars.

Currency in circulation, after spiking throughout the pandemic, started leveling off in early July, and has now inched down a tad, to $2.28 trillion:

Remember Y2K? Which was a dud. But everyone stocked up on paper dollars, and demand spiked, and after the dud, the extra cash went back to the Fed via the banks:

The bankruptcy of Lehman Brothers in September 2008, which opened up the long-brewing Financial Crisis for all to see, sent people to ATMs, pulling cash out just in case. By late 2009, this was starting to normalize again:

During the pandemic, there was huge demand for cash. Between late February 2020 and December 2021, currency in circulation spiked by 25%. There is some chance that some of this could unwind:

Each time there is an increase in currency in circulation, the Fed’s asset increase by the amount of the collateral that banks post to get the paper dollars.

Currency in circulation will likely continue to increase.

A four-year decline in currency in circulation, as customers take paper dollars back to the bank, though theoretically possible, seems unlikely in normal times.

Instead, over the next four years, I expect currency in circulation to increase at the pre-pandemic rate of about $100 billion per year, thereby adding about $100 billion per year in collateral to the Fed’s assets. So four years from now, we might be looking at $2.7 trillion in currency in circulation.

The Treasury General Account.

The government’s checking account is with the Federal Reserve Bank of New York. The amount that the government has on deposit there is a liability for the Fed because it’s money that the Fed owes the government.

The level of deposits has been swinging wildly, driven by protracted debt-ceiling fights when the government nearly runs out of cash before Congress relents, and by the government’s super-massive debt issuance early on in the pandemic to pay for the stimulus programs. That debt issuance raised a huge amount of cash that took a while to draw down.

And now there is a new element: Raging inflation, which drives up outlays and revenues. Over the years, as larger amounts flow through the checking account, the average balance will likely increase to accommodate the larger flows.

As of the Fed’s balance sheet released on September 1, the government had $670 billion on deposit at the Fed. The green line represents the pre-pandemic trend of the increase of the account balance on average. I made a kink into the green line, starting early 2021, when raging inflation kicked off to show the long-term trend under much higher inflation.

Given the erratic nature of these TGA balances, I’m going to go out on a limb and estimate that the average balance in fours years might be around $800 billion.

The floor for liabilities in four years: $5.2 Trillion

In summary, four years from now, the floor of the Fed’s total liabilities would be at $5.2 trillion:

  • Reserves: $1.6 trillion
  • RRPs: near $0
  • Currency in Circulation: $2.7 trillion
  • TGA: $800 billion
  • Other liabilities beyond the big four: $50 billion

So four years from now, based on these estimates, the floor for total assets on the Fed’s balance sheet would be about $5.2 trillion, below which the Fed could not go. At the peak, the Fed had $8.97 trillion in assets. So my calculus says that the Fed could do a maximum QT of about $3.8 trillion.

This would be a huge reduction in liquidity, and it would sack asset prices. That’s why QT is loathed when its effects become apparent. Look how asset prices have been sagging, and QT has barely started. And something big might blow up before the Fed even gets to the theoretical floor.

But wait… raging inflation may change paper dollar behavior.

If inflation continues to rage, paper dollar holders may get tired of getting mauled, and they might convert those paper dollars into interest-paying assets. If that happens, there could be a significant decline in currency in circulation, and therefore in collateral, that would pull down the Fed’s assets further and would provide for a lower floor.

Decades of relatively low inflation minimized the cost of holding paper dollars, but now that cost is spiking. We might already be seeing some of it because over the past few months, currency in circulation has actually dipped. If this is a trend in the making, a lot of these Federal Reserve Notes might be going back to the Fed, further reducing both sides of the balance sheet, and lowering the floor below which the Fed cannot go.

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  201 comments for “By How Much Can the Fed Reduce its Assets with QT? Fed’s Liabilities set a Floor

  1. Depth Charge says:

    All I see is just a pitiful, piss-poor performance by a central bank which decided to print money to make the rich richer, and destroyed pricing in the process.

    • Wolf Richter says:

      OK, now that you got this off your chest, go ahead and read the article.

      • Depth Charge says:

        I did read it. All of it. I found the paper dollars part most interesting. I just have become horribly cynical over the FED and my comment entered “broken record” territory. I will do better next time.

        • Michael Flair says:

          Recall the QE was in used to save the USA Economy from Great Recession collapse Bernake and Pandemic Economic stop Powell both good causes. While the impact did drive up asset prices, that was not the primary intent, so I do not have a cynical view of our FED.

        • Einhal says:

          That may have been the stated reason, but it wasn’t the actual reason, in my view.

        • ru82 says:

          @MF – At those moments the Fed needed to pick between low employment and high asset prices or 10% unemployment, low asset prices, lots of foreclosures and bankruptcies with a risks of deflation. They hate deflation.

          They always choose the former thinking they can manage the high asset prices after the monetary injection.

      • drg1234 says:

        This is an important article.

        Asset prices for the last decade have been driven almost exclusively by Fed QE. That is now over.

        This article offers a clue for when we might expect the bottom in asset prices, which won’t occur until the Fed changes direction. I sincerely hope this will become a recurring feature from Wolf.

        • SS says:

          This is a very informative article. Let me apply my own probabilistic tuning on it.

          There seems no reason for both govt and people to hold cash as inflation will remain high for years as we are not productive enough to even sustain our debt and need inflation to dilute it.

          So I say that TGA floors to 300 Billion and Currency in circulation to 1 trillion.

          If Fed does stick to QT in principle, overleveraged funds will blow up soon as assets will correct significantly. So banks can then reduce reserves to $1 Trillion.

          With this Fed assets can reduce to $2.4 trillion.

        • joe2 says:

          Sounds like a circle jerk to me.
          “The Fed currently pays 2.4% interest on reserves”
          Borrow money, buy bonds, swap bonds, park money, all at high interest rates. Not 18% like we pay but lucrative.

          I feel like Wolf is just scratching the surface here.

        • Wisdom Seeker says:

          Currency in circulation has a huge portion overseas / outside the US.

          It’s held for many reasons, including that the US is more inflation-resistant than most other countries.

          Factoring in recent exchange-rate changes, dollar-holders overseas are doing much better than if they were holding strictly local currencies.

          We have also seen many occasions where electronic bank accounts and credit cards can’t be used (power outages), or political events cause accounts to get confiscated or frozen. (Just ask Canadian truck drivers…). Dollars in your mattress are immune to any of those shenanigans and are nearly as good as gold for preserving wealth in a portable format.

          So long as the Fed maintains QT and defends the dollar against inflation, I really doubt that Currency in Circulation will drop significantly.

      • gametv says:

        I really loved this article. I never really thought about the other side of the balance sheet, but it tells alot.

        So my understanding of this is that during the initial market reaction to the pandemic the market was selling everything including Treasuries. The Fed stepped in and bought massive amounts of Treasury debt and took all the risk. In addition, the RRPs are also another way of the Fed basically back-stopping the value of Treasury debt by giving a guaranteed rate of return and taking the interest rate risk.

        My question is doesnt this create some form of long term imbalance in the amount of interest they are paying versus the amount they are earning? And to take this further, if the Fed was forced to mark to market the value of the Treasuries it has purchased, wouldnt it need to take very large losses on those bond purchases since the value of the bonds has tanked relative to the price they can sell them at? So as the Fed rolls off the bonds it purchased during the pandemic (at incredibly low interest rates) doesnt it actually lose money on the sale of those bonds?

        Is this is reason the Fed can really only roll off a small amount of debt, instead of selling this stuff really fast? I understand that if the Fed is holding the debt until expiration then it doesnt take a loss, and if they bought very short term debt primarily, then they can just let alot of it roll off, or take very small losses, since the loss on a short dated Treasury is much less than the loss on a long term Treasury.

        So the question also becomes whether the Fed is planning that in order for them to not suffer horrible losses they would need to see interest rates fall in the future?

        Who pays for those losses? If the capital of the Fed is incredibly low, an accounting of the value of the assets versus the liabilities would

        • Wolf Richter says:


          I’m gonna go backwards, from the bottom up.

          “Who pays for those losses?” — The Fed can create its own money, so it cannot fail. It can and will set up any losses as an asset account (in corporate accounting, this would be “goodwill” or “intangible assets” or some such thing), and then amortize it in the future when it is showing income again. Or not amortize it and just keep carrying it.

          “forced to mark to market” – Even commercial banks have two options: 1. securities held to maturity are not marked to market. 2. Securities held for sale are marked to market.

          The Fed doesn’t follow bank accounting (it follows “central bank accounting”), but doesn’t have to mark to market anything because it doesn’t hold securities for sale.

          If it does sell some those securities, it would take some loss on some of them, but it would be small compared to the huge size of the Fed’s interest-earning assets. The Fed earns a LOT of interest income from those securities — $123 billion last year — and any capital loss or operating loss would first ago against the interest income.

          If it books a net loss for the year, it will not remit anything to the Treasury Dept (it remitted $107 billion to the Treasury Dept last year). So that’s money that taxpayers are NOT getting anymore for a while.

          And it will set up an asset account (similar to goodwill in corp accounting when they overpay for something) to carry the loss. This way, the loss won’t hit capital.

          Yes, the Fed has created all kinds of long-term imbalances – but paying interest on reserves is not the big issue. QT is going to unwind some of those imbalances. Paying interest on reserves keeps that cash at the Fed and out of the hands of the markets, and so that limits some of the imbalances. Enough QT will reduce that problem by a lot.

        • gametv says:

          thanks for that Wolf. I went and researched a little and found that as you said if the Fed incurs losses it will merely put those on the balance sheet as an asset and since noone is auditing the Fed for solvency, there wont be any reckoning.

          one other point i found is that the Fed earns interest on the treasury bonds it holds, but no interest on the currency it issues, so it always has the interest rate differential to fall back on. so even with large losses, it will merely need to earn them back over a period of time.

          i guess the Fed survives no matter what unless the demand for dollars plummets. The bitcoin crowd has always argued that the profligacy of the Fed is a reason to hold Bitcoin, and for a short while I agreed with that thesis, but then I realized that although Bitcoin is limited the number of cryptos that can be created in total is infinite and there is little good reason that only one will exist, hence crypto is probably more likely to decline based on a lack of true scarcity.

        • Augustus Frost says:

          Plenty of central banks will become technically insolvent as the declining value of their assets creates negative equity.

          It might (and probably will) become an embarrassment at some point which they hate, but no one can force any central bank into bankruptcy. A central bank can only be abolished by the government.

        • Isaac S. says:

          Wolf, you said “Fed… doesn’t have to mark to market anything because it doesn’t hold securities for sale.”

          however, it holds $2+T of MBS which are securities for sale, right? I mean they’ve been trying to sell them early but Mr. Market refuses to buy them (toxic waste). So, please explain why the Fed would never have to mark MBS to market should housing prices collapse (thus foreclosures soar) long before the MBS maturity dates?


        • cb says:

          Wolf said: “Paying interest on reserves keeps that cash at the Fed and out of the hands of the markets, and so that limits some of the imbalances.”
          I must disagree. Paying interest on reserves is an imbalance in itself. It is manipulation of markets, which I hope people no longer confuse with free markets.

      • amir _Timur says:

        Hey Wolf, fantastic read:
        May I suggest:
        1) If RRPs are the new go-to for current accounts holding dollars, then the floor might not be zero, say if the fixed income funds manage 50 trillion dollars and 2% has to be maintained as liquidity, that would give us a 1 trillion floor.
        2) Do banks have to get back to 1.6 if a lot of their former customers are parking in rrps instead of bank accounts? Does this increase bank instability by reducing the deposits held at banks without reducing the loans given out by those banks?
        3) Does every dollar taken out of the banks and put into rrps have a multiplier effect by way of the reserve ratio banking system?
        4) Where does the Government deficit come into this? If they are spending say 100 bill a month extra, that volume has to be financed by bill issuance. Those bills must either be absorbed by the market, via a reduction in cash, or bank reserves, or rrps. ofcourse it finds its way back into bank reserves so is deficit spending actually stimulative?
        Trying to figure out where the asset bubble starts losing steam. (so far I think that we have tanked on fears of this but not the actual reduction of volume of money)

        • Wolf Richter says:

          Concerning your #1: yes, that’s a possibility. Powell alluded to the potential for cash that would have ended up in reserve balances ending up in RRPs, and if that happens on a large enough a scale, he seemed to say, then the “ample reserves regime” might no longer be needed, or be needed to a lesser extent, and reserves might be allowed to drop more than I anticipate. I hate to even bring this up – and I didn’t in the article – because it’s all just “alluded to” kind of stuff. But it would make sense to see a shift of this type.

          But the cash-on-hand that MM funds need to have is not huge. So it’s not like this gigantic pile of money. So once they put all their to-be-invested cash back into Treasuries, their cash-on-hand at the RRPs wouldn’t be a huge amount.

    • John says:

      Totally agree

  2. Nathan Dumbrowski says:

    The math doesn’t add up. Unless of course we are doing common core. Prior to 2008 using your figures doesn’t support why we would need the figure that was being held at $5T. Reverse repo and MBS

    • Wolf Richter says:

      Nathan Dumbrowski,

      Since YOU cannot do even basic math apparently, here it is again from the article. You can use your fractional fingers to add them up:

      In summary, four years from now, the floor of the Fed’s total liabilities would be at $5.2 trillion:

      Reserves: $1.6 trillion
      RRPs: near $0
      Currency in Circulation: $2.7 trillion
      TGA: $800 billion
      Other liabilities beyond the big four: $50 billion

      And if you didn’t read the article, don’t comment about the article or about what you imagine the article said. Commenting guideline #1

      • Nathan Dumbrowski says:

        Thanks Wolf. The post clipped my response. Basically I had asked how we were able to function prior to the 2008 financial crisis without accounting for the currently in circulation. That is half the figure you have mentioned. Thanks for the reply.

        • WA says:

          This is a good question. Simple answer: Before 2008 financial crisis Fed was not in the business of bailing out big investors at the expense of tax payers.

          So there wasn’t crap loans that needed to be backed by assets. For e.g. Wolf says that banks stopped lending to speculators when reserves fell below $1.4 trillion. The only reason banks have to keep these large reserves now is because they are now lending to speculation in exchange for “funny money” collateral instead of real assets.

        • Yancey Ward says:

          This is what happens when you paint yourself into a corner, or in our case, were lured into the vault seeking a cask of Amontillado.

      • James Hanna says:

        So ,Wolf,the reduction of notes in circulation might add to a liquidity squeeze, at some unknown trigger point? It would seem that QT has unknowable pitfalls? Some part of the system might blow up? Like ,SUDDENLY?

        • Wolf Richter says:

          “Some part of the system might blow up? Like ,SUDDENLY?”

          Yes, there’s a chance. But I don’t think it would be related to currency in circulation. I’m more in the camp of a huge hedge fund or PE firm blowing up and contagion spreading from there.

        • Isaac S. says:

          Wold, re ” I’m more in the camp of a huge hedge fund or PE firm blowing up and contagion spreading from there.”

          Is it likely that China hard landing and/or a sudden Yuan devaluation blow up some too big to fail trading desk? I seem to recall bad high leverage currency bet taking down many firms.

          However, it was rumored (not sure if ever proven) that the massive repo (“not QE”) operations the Fed did in (~2018?) was a hidden/back door bailout of a systemic trading desk about to fail. So, is that all the Fed has to do to always avoid another GFC?

        • Lune says:

          I’d say the notes in circulation are a little different than other assets. Cash stuffed into a mattress isn’t circulating in the economy: it’s not buying goods causing inflation; it’s not buying houses or stocks causing asset price appreciations; it’s not being depositing in a bank where the bank lends it to someone else.

          It’s sort of like collective private market QT: instead of the Fed withdrawing liquidity from the markets, we do the same by taking our money and stuffing it into our mattress.

          So of all the assets on the Fed’s balance sheet, that’s the least distorting form, and whether it stays at $2.5tril, or goes higher or lower, it shouldn’t distort the economy as much as its other assets / liabilities.

  3. SWE Josh says:

    Since the total assets are now at $8.83T and they can only drop to about $5.2T then:

    $8.83T – $5.2T=$3.63T left of QT

    Given the $95B of QT now that the phase in is over, there would be:

    $3.63T / $95B = 38.2 months or 3 years and 2.2 months left of QT at this pace to get down to $5.2T.

    The question is will the Fed keep the QT rate of $95B per month and will they continue for the next 3.2 years? Has the Fed indicated that this is actually their plan? Would the Fed only deviate from their plan if the banks were in trouble regardless of the stock market and housing crashes?

    • Wolf Richter says:

      Yes, but just a little tweak: the $95 billion is the cap, the max per month. Two years from now, when a lot of the assets have already matured and are gone, the roll-off will be frequently below the cap, esp. for MBS. So by then, the roll-off will slow down, unless the Fed changes the plan and for example starts selling MBS outright, which it is considering. I think this will drag out for longer as assets decline and the roll-off gets smaller.

      • gametv says:


        I asked a question about the losses the Fed will be taking when they sell off debt assets in a higher interest rate environment than where they purchased them? Could the limit of $95 billion be a hard cap, since maybe that is an amount where they can afford to offset the loss on the sale versus the interest they are earning on their RRP program?

        I would love any insight into this.

        Isnt this potentially a really big issue?

        I feel like the Fed is really trying to bring down inflation expectations with alot of really aggressive talk, but not really taking that much action because if they truly did rapidly increase interest rates, they would then be selling assets with a larger loss against the price they paid. At some point this becomes a real big problem.

        There have been a few senators that have wanted to audit the Fed. I know this wont happen, but if it did, wouldnt it demonstrate that the Fed is essentially “illiquid” in the conventional sense of the words “higher debt than assets”.

        It seems to me that if we had all financial institutions mark-to-market all assets every quarter, we would stop these BS financial games that are played.

      • Pea Sea says:

        The actual rolloff for MBS is already unlikely to reach or exceed the caps in the near future, no? So if two years from now they won’t be reaching them either, at what point *do* we expect them to actually meet the caps?

        • Wolf Richter says:

          MBS don’t roll off until god knows when. They come off via pass-through principal payments, and they have slowed a lot. But there is still a pretty good flow. An increase in home sales as prices drop, and an increase in foreclosures would speed up pass-through principal payments. If three years from now, mortgage rates drop from, say, 8% to 6%, there will be a wave of refis, and pass-through principal payments will speed up a lot (this happened in late 2018 and early 2019 when mortgage rates came of 5%).

          Pass-through principal payments from MBS are very unpredictable. And that’s one of the reasons why the Fed hates MBS and may end up selling them outright to get them off its balance sheet.

  4. WakeUp says:

    Does the Fed pay interest on the money the government deposits in the TGA?

  5. CuiBono says:

    If, as Ron Paul argues in his 2009 book *End The FED* – how is that possible without massive default?

    The enormity of the problem, against our systemic corruption, leads me to think that it would take a minor trip and tumble to cripple the processes that support the financial system.

  6. Eric says:

    Wolf, I’ve read opinions that SOPR gives the Fed a freer hand in controlling U.S. monetary policy vs. LIBOR. That SOPR could be the Fed’s ace in the hole.

    Can it really be much of an advantage when it comes to dealing with inflation?

    • Wolf Richter says:

      I think you mean “SOFR” the Secured Overnight Financing Rate. SOFR is an average of short-term market rates. The Fed wedges these market rates into a range via its policy rates, including the FF rate, the repo rate, and the RRP rate. So yes it kinda controls those rates and any averages derived from them.

      LIBOR wasn’t based on market rates. It was decided between banks behind closed doors. And the scandals about LIBOR manipulations by banks are legendary.

  7. Graeme says:

    Excellent article Wolf, would it be possible to do a similar one for how high interest rates can be hiked?

    • Wolf Richter says:

      There is no theoretical upper limit to interest rates. But there are some practical limits. In Argentina, the policy rate (“Leliq”) is nearly 70% (seventy percent). And it might go higher still. In the US, I’m currently seeing 4% FF rate by early next year, and if inflation doesn’t go down and stay down, it might go higher. I don’t envision 70% tho.

      • MF says:

        If we assume The Good Times is a good indicator of a healthy balance sheet (ironic, since I thought it was bloated), then the inflation-adjusted goal of QT would be a balance of $5.8T by the end of 2025. This assumes the Fed can trim 1.5% per year off the current inflation trajectory via QT:

        Year Balance (trillions) Inflation (assumed in parenthesis)
        2018 4.5 2.44%
        2019 4.6 1.81%
        2020 4.7 1.23%
        2021 4.9 4.70%
        2022 5.3 (7.%)
        2023 5.6 (5.5%)
        2024 5.6 (4%)
        2025 5.8 (2.5%)

        The usual caveats about the way inflation is measured vs. what things actually cost probably puts that number north of $6T.

        I wonder if The Good Times is somehow the new normal for a hyper-financialized economy? This would be an economy where the calculations in this article are the lower bound, the upper bound is yet to be established via QT, and somewhere around $6T is the Goldilocks figure.

        I can’t believe I’m even considering this concept as rational. I had always assumed we’d have to eventually find our way back to a balance sheet ratio to GDP that was more like it was before the financial crisis.

  8. Amarok says:


    A quick post to thank you. I appreciate that:

    1) You build knowledge methodically over time and multiple posts, challenging the reader without crushing them under complexity.
    2) You ask only that the reader actually reads and set clear expectations for those that comment/ask questions, resulting in a comment section almost as educational as your main post.
    3) You maintain (incredible!) patience/written composure when you engage readers in the comments section, despite their not fulfilling #2.
    4) You are tenacious in your consistency, both in the regularity of your content but also the repetition of your themes.
    5) You do not infuse your posts with partisanship and, where possible, attempt to disabuse commentators of their more toxic notions.
    6) Finally, you “brook no bullsh*t.

    Thank you very much for what you do and how you do it. I’m always learning a lot. I very much hope that the majority of your readers feel similarly and am always heartened to see the occasional comment section posts that offer their appreciation of your work.



    • Degobah Smith says:

      Your comment says everything I was gonna say, so I second that! Thanks “A”, and thanks Wolf. Your insight is very much appreciated.

    • BS(ini) says:

      Your mastery of the English languish is impressive.
      Wolf’s artistry also are masterpieces of communication and the details are very easy to understand.
      Thank you Wolf and I look forward to more comments from Amarok.

    • Wisdom Seeker says:

      Very well said!

      Many of us come for the content, and stay for the dialogue. It’s a great site for both.

  9. Clark Jernigan says:

    Awesome teaching. Thank you.

  10. GringoGreg says:

    Great article Wolf! Unlike EU banks Canadian and American banks get a free lunch from the central bank. Thanks!

  11. Bob Harwell says:

    What happens when we go to a digital dollar?

    • unamused says:

      For TPTB it would revolutionize the global tax evasion industry. For everybody else it would enable detailed surveillance of your finances.

      Libertarians are conflicted.

      • elbowwilham says:

        I don’t see how they can move to 100% digital with 2.7 trillion worth of actual cash floating around the world. Seems the only way would be to hyperinflate the current dollar so those paper dollars are worthless, then reset to a digital dollar.
        But the FED seems like that want to save the dollar at this point.

        • Wisdom Seeker says:

          Central banks have always, and will always, be able to rope in their paper money by declaring that currency holders have to trade in the old stuff for the new stuff. Great example, not too long ago, would be all the EU nations trading in their old currencies for the Euro. Only change in future would be that (a) the paper money wouldn’t get exchanged for other paper money, and (b) there’d be an awful lot more resistance to being forced to switch to entirely digital money. At least until the electrical grid is more reliable and very serious privacy concerns are addressed

      • ToeHold says:

        President Biden would have made a tremendously wonderful and meaningful impact on the American people if he would spend $80 billion simplifying the tax code. Maybe even implement a flat tax. Maybe this would reduce tax evasion. Keep it simple.

    • Wolf Richter says:

      The Fed is struggling with this right now, if it ever happens. What the Fed already said is that a digital dollar will be a liability on its balance sheet, same as currency in circulation. It will be handled similarly. It will not replace currency in circulation, though currency in circulation might decline at that point. The digital dollar would provide for instant direct payments between parties and thereby replace a profitable part of the banking system (transactions), which is a real problem for the Fed, and that’s why it is dragging its feet.

      • cb says:

        @ Wolf:

        Do we not already have many, many, many digital dollars?

        • Wolf Richter says:

          We have none. Zero. What we have are transactions recorded in digital format, and assets recorded in digital format, and liabilities recorded in digital format. The digital dollar will be a “Federal Reserve Note,” just like the paper dollar, and it will have a serial number of sorts, just like the paper dollar, and it will be used similarly to paper dollars, except online (digital).

      • Paranoid says:

        If I stuff dollars under my mattress, it is way more difficult for the government to seize my dollars. If I purchase digital currency, the government just turns off the internet or turns off access to the digital vault and seizes my digital currency. POOF

  12. LordSunbeamTheThird says:

    At some point the Fed will face paying interest on their own printed funds to the commercial banking system.
    The Fed buys treasuries with printed money at a low yield, this enters the general economy (unfairly but whichever) and thence to the US commercial banking system. In order to prevent this money from being spent the Fed needs to pay for it not to be spent, and that is interest on reserves.
    Interest on reserves is higher than the interest on the purchased treasuries. So soon the Fed will be paying -additional- money to the commercial banks in order to stop spending and these losses will be covered by the government/congress. Not a good look politically.
    This situation is already there for the Bank of England, who are insulated from losses as they are underwritten by government, so what used to be profits from printed cash now turn into a loss.
    Equally for the ECB, who provided banks with long term cheap funding, now find they have to provide a higher rate of interest to stop banks disbursing the funds into general spending. Hence the ECB wants a windfall tax on the banks to stop what is direct taxpayer money going to the commercial banking system.
    Btw I did read the article but more full of content than usual and i think a useful summary would be that the way the Fed operates is that it will pay you not to spend a dollar. Maybe its just 4 cents a year or whatever, it dampens spending by paying people not to spend. Now there is all this printed money in circulation without an accompanying debtor to pony up(gov got cheap fixed debt) all of the costs of paying people not to spend are going to fall on the Fed.
    This is IMO. I might be wrong of course.

    • Wolf Richter says:

      Let me just address the paragraph that starts with “Interest on reserves is higher than the interest on the purchased treasuries…

      Check out the chart of reserves. They plunged by $1 trillion since the end of 2021. The interest rate on reserves is now LOWER than the 1-month treasury yield, as I pointed out.

      • gametv says:

        So the question is why would banks hold assets at the Fed instead of buying Treasuries? And my answer (correct me if wrong) is that the banks dont want to hold Treasuries in an environment of higher interest rates because the value of the bonds falls as interest rates go higher. So the Fed is essentially taking that interest rate exposure risk away from the banks in exchange for a slightly lower interest payment.

        Is this correct?

        Do banks have to mark to market the value of Treasuries they hold? I think they changed the rules on mark-to-market on some other types of assets (mortgages) during the last crisis?

        • Wolf Richter says:

          Your assumption compares reserves to Treasuries with long remaining maturities, because that’s where the losses occur. But if you buy a 1-month Treasury and hold it one month, you get interest and principal then there is no loss. Even if you sell after two weeks, the loss is so minuscule you might not notice it. So that should be the comparison, and that’s how banks look at it. The 1-month yield is now higher than the interest on reserves.

          Reserves are more liquid than Treasuries. They have instant liquidity, and you don’t have to first sell them to get this liquidity. And that’s one reason to hold reserves.

          BTW, banks hold LOTS of Treasuries.

        • Wisdom Seeker says:

          Just wanted to add that banks are required to hold a certain minimum level of reserves (it’s called “fractional reserve” banking after all), and can’t ditch those entirely.

          Also worth noting that (IIRC) the mandatory reserves never earned “interest” from the Fed prior to the 2008 crisis. The interest earned by the Fed went to the Treasury and they didn’t pay banks interest on anything. That Great Recession policy change was a huge giveaway from taxpayers to banksters. I’m still disappointed that there weren’t national riots over this and other forms of “bank robbery” of the taxpayer…

    • historicus says:


      Paying people not to spend puts money in their pockets…..which they then spend
      Fair return on savings etc provide many with disposable income
      Interest income is an economic driver

  13. Chinedu Mmaduebo says:

    Thanks Wolf, You really methodically guided me through the future QT part. . Thanks for the taking your precious time to simplify mundane issue for the simple mind to comprehend

  14. Confused says:

    That’s an interesting analysis of the theoretical limit for QT. I don’t want to see any MBS or long-term Treasury bonds on the Fed’s balance sheet when QT ends. In addition, I don’t want the Fed to use any more Enron-like “special purpose vehicles” to get around laws forbidding the Fed from holding long-term bonds.

    • historicus says:

      A good question is why the Fed ever began messing in long term paper
      In 2006 they held no MBSs…now hold 2.7 trillion and circa 35% of all treasuries with maturities over ten years
      The Fed’s duties are present not future IMO

  15. TweedleDum says:

    Wonderful article Wolf. Your breakup of your Liabilities side estimates makes a lot of sense, Also it made me realize that overwhelming focus only on the Asset side of FEDs balance sheet is somewhat misplaced. One doubt

    “In other words, as demand for paper dollars rises, banks must get more paper dollars from the Fed, and to get them, must post more collateral at the Fed. ”

    Assuming reserves have not hit the theoretical minimum (1.6T), then, is it also possible for banks to convert some of the reserves they hold at FED to paper dollars, in such a way that one liability gets transformed to other without affecting the asset side.

    It is teacher’s day here, so many thanks for your daily teachings :). Always grateful for them

    • Wolf Richter says:

      Good question, and I should have addressed it in the article.

      Reserves are bank cash, not collateral. Banks can “buy” stuff with reserves and they use it for transactions between banks, but they cannot post reserves as collateral.

      Banks cannot “buy” Federal Reserve Notes (paper dollars) because these paper dollars are not for sale. Banks have to borrow them from the Fed and post collateral in exchange. The Fed accepts a variety of assets as collateral, but mostly Treasury securities, federal agency securities, and securities from government-sponsored enterprises, such as Fannie Mae.

      • unamused says:

        ‘Banks cannot “buy” Federal Reserve Notes (paper dollars) because these paper dollars are not for sale.’

        They’re called Federal Reserve Notes to remind everybody whose property they are. The Fed is just letting people use them, presumably so they can get into trouble with inflation, overpriced homes, wasteful consumption, and debt.

        • Wisdom Seeker says:

          LOL. Fun comment but of course they’re called Federal Reserve Notes because they’re a liability of the Fed, just as U.S. Treasury Notes (2-10 year bonds) are a liability/debt of the U.S. Treasury.

          Then again, Congress gets into the same kinds of trouble with Treasury Notes as you explained for Federal Reserve Notes! Inflation, overpriced everything, wasteful spending, and that painful debt hangover…

        • unamused says:

          You know me too well, Wisdom Seeker.

  16. LGC says:

    so the Fed has to put trillions of dollars into “markets” to make the markets work which it didn’t need to do before approximately 2008 (not in that size anyway) What part of any of that says we have anything resembling a functioning market???????

    • Flea says:

      As Warren and Charlie stated it’s a casino,and the house wins .

      • NoPrep says:

        Lots of winning. Lots of Charlie Sheen. Even Andreessen-Horowitz house is still winning. They got Adam Neumann back from hiatus on their pitch deck, pitching a brand new scheme.

        The house may win for many years. But such a house, when it’s a house of cards, can crumble very fast. People, analysts, were shocked by Enron. Shocked. How could it be? When Enron turned to vapor, it turned to vapor very very fast.

      • cb says:

        Then Warren and Charlie must be part of the house.

  17. Richie Rich says:

    Thanks again for your continued information and excellent site.

    Can you please point me towards some information that has the current planned time line for the scheduled QT (or Wolf educated guestimate) ?

    I am interested in knowing when the QT is planned to approach, say, $2 trillion, $2.5 trillion and $3 trillion.

    “So my calculus says that the Fed could do a maximum QT of about $3.8 trillion.”

  18. Crush the Peasants! says:

    The life of a Repo man is always intense.

  19. Spencer Bradley Hall says:

    The only tool, credit control device, at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be properly controlled is legal reserves. The money stock can never be properly managed by any attempt to control the cost of credit. Interest is the price of loan funds. The price of money is the reciprocal of the price level.

    In 2010, the PBOC’s RRR went to 18.5% – “to sterilize over-liquidity and get the money supply under control in order to prevent inflation or over-heating”

    As I said: “The FED will obviously, sometime in the future, lose control of the money stock.” May 8, 2020. 10:38 AMLink

    Contrary to Powell, banks aren’t intermediaries.

    And the last vestige of legal reserve and reserve ratio requirements against the Federal Reserve Note, demand deposit, and inter-bank demand deposit liabilities of the Reserve banks was eliminated in 1968. Today the Federal Reserve Note has no legal reserve requirements, and the capacity of the Fed to create inter-bank demand deposits (held at the District Reserve Banks), has no legal limit.

    Then Powell eliminated Legal reserve requirements effective March 26, 2020.

    Powell will never “bring inflation back down to our 2 percent goal”. It’s no longer just a demand side problem. It’s also supply-shock, supply-chain inflation, and natural resource inflation.

    • cb says:

      Spencer said: “The price of money is the reciprocal of the price level.” ???


      I haven’t a clue what that means. As for the rest:

      It’s just money creation. You digitize trillions of dollars and pass it around, then prices go up.

  20. Sporkfed says:

    Does the deflation in asset prices eventually lead to deflation
    in the cost of living ? If not, life is about to get much harder.

    • Flea says:

      Of course not ,the world has been oversupplied with energy,now it’s a political weapon .Energy is the dog ,everything else is the tail. Water is in very short supply . But we stupid humans keep building in desert environments.Can’t fix stupid

    • Die Wurst says:

      Theoretically, yes. However all politics are local… as are asset prices. If you happen to be sitting on real estate, and your house value shot up 40% in the last two years, but now is going to fall 20%, you probably won’t care because it is all paper gains and losses. But if you bought a house at the top of the market, you may have a few more grey hairs, and if you bought at the top of the market with some sort of variable financing… hold on because the future is going to look bleak. That is just one example, but you can imagine how taking the foam off the top of assets (whether they be real estate, mortgage-backed securities, stocks, etc) can have a cascading effect, as real-estate investors decide to dump their properties, people stop buying home improvement supplies, Home Depot lays off 20% of their staff, those people cancel plans to buy a new car, etc. So yeah, you might find a sheet of plywood drops in price 50%, or suddenly used cars start to become more affordable… but behind those price reductions there are going to be a lot of bruised consumers.

    • Wolf Richter says:

      You can have asset price deflation and consumer price inflation at the same time, no problem.

      • jm says:

        And in fact we did in the1970s.

      • Bruce A Forbes says:

        Absolutely – isn’t that we should expect after more than a decade of asset price inflation greatly exceeding CPI inflation? This seems like a good reason to hold cash even as CPI inflation stays high.

        • Augustus Frost says:

          Yes, it should be expected.

          Look at long-term charts of household net worth to GDP and debt to GDP. All debt is someone else’s “wealth”.

          There is nowhere near enough actual production to use more than a minimal portion of this “wealth” in the real world. So, the only way it can avoid losing real value is by never going anywhere.

          Asset values are also going to crash because of “risk off” loss aversion. This is reflected in rising interest rates.

    • Augustus Frost says:

      No, for 39 years, asset prices increased with relatively modest price increases for most goods and services.

      Now it’s time for living standards to decline noticeably due to unsustainable debt borrowed at artificially low rates.

      Look for a long-term major bear market in all major asset classes, noticeably higher price inflation, and much tighter credit conditions at much higher interest rates.

      The majority of Americans are destined to become poorer or a lot poorer.

      • cb says:

        @ Augustus Frost –

        All debt is some other entities extended credit. Debt can be defaulted on, and neither debt nor credit necessarily denote wealth; either can be worthless.

        interest rates currently and for the last several years mostly reflect the manipulation of the FED.

    • historicus says:

      Who has ever seen deflation?
      Price rollbacks after price spikes belong in a different column

      • economicminor says:

        Isn’t that the premise of the 4th Turning..
        And Minsky’s Instability Theorem.

        That everything is personal. People forget and die off and the newer generations have never seen it so they believe it can never happen..

        And then it does.

  21. phleep says:

    So, the injection of play money worked in some ways, ultimately unsustainable, as is finally demonstrated by current inflation. A more “normal” relationship of money to other assets hopefully will follow (not to get complacent in any direction). Is the Fed finally, at last, struck sober?

    It will serve me to re-think expected asset prices. Like a steroid hormone treatment regimen, it had to be withdrawn someday, and someday is now. Asset prices falling (vis a vis US dollars) is part of the rebalancing toward more rational pricing, I hope will happen. To many it will simply look like a loss. I wonder if this normalization will help generational inequality. Who knows?

    I question who the resulting winners and losers will be (apart from the usual suspects winding up in the usual outcomes). My inclination now is first to be mentally limber, on how many dollars I will get as I sell down my assets (as an aging boomer). The point for me is not to be too anchored to the past, especially the recent past play-money era. I still need to be able to pivot and rebalance as it unfolds.

    • JeffD says:

      A normal relation I am looking forward to, is that as interest rates increase, P/E ratios decrease.

    • cb says:

      Phleep said: “So, the injection of play money worked in some ways, ultimately unsustainable, as is finally demonstrated by current inflation.”

      current inflation?

      There has been continuous dollar creation (inflation 1) and rising prices (inflation 2) for decades.

  22. CreditGB says:

    Trying to understand:

    If ‘currency in circulation’ is rocketing upward as that chart shows, doesn’t that toss gasoline on the inflation bon fire? I noted the comment about folks tiring of holding dollars, but seems like any fix is a long way down the road unless $ in circulation can drop quick.

    I hear so much about too many dollars chasing too few products/services is “inflation”.

    • Wolf Richter says:


      Most of the currency in circulation is stashed overseas, often related to illegal activities. According to Fed estimates, about 70% of the $100 bills are held overseas. So this is not a US inflation issue.

      But if these paper dollars were suddenly arriving in the US by the container that then burst open and dump these paper dollars on the streets for people to grab and spend, it would drive up inflation. I doubt that will happen, and if it does, let me know where those containers with cash show up and burst open :-]

      • CreditGB says:

        I will let you know where the 2nd container of cash is shortly after I’ve unloaded the first one. :-)

        Thank you for the clarification.

      • sageWexford says:

        Better bring a bank teller with you when you rush to the open shipping container from overseas, Wolf. The U.S. $100 bill is the favorite currency denomination to counterfeit around the globe. When I get cash from the bank to pay my subcontractors, I try to avoid $100’s each and every time. Currency is indeed a depreciating asset for Americans, but still a reasonable liquidity vehicle.

  23. Ralph Hiesey says:

    I must say, I really have no understanding at all that big money, CB stuff. Reserves, assets, liabilities of the CB are just meaningless abstractions to me.

    But one concrete question comes up for me: in your last paragraph you say:

    “If inflation continues to rage, paper dollar holders may get tired of getting mauled, and they might convert those paper dollars into interest-paying assets. ”

    Please tell me– what are these “interest paying assets?” of which you speak. I would love to know. Stocks? Bonds? CD’s? Hmmm.

    My intuition is that since at least 2008 central banks have discovered that the cure to any asset that gets shaky is just print more money and purchase the crashing asset to get such trouble out of the way. I.e, asset insurance for the rich.

    My instinct is that as “financial assets” for the rich rise to higher and more insane values they are becoming nothing more than cost free, and value free abstractions of numbers, and that trust will eventually disappear for all of them–when no one takes any of them seriously anymore, and none can be used for exchange to obtain any actual value of actual, real products/services. High inflation, with money, stocks, bonds and money all becoming meaningless near infinite numbers of bits in a computer somewhere.

    • Wolf Richter says:

      “what are these “interest paying assets?” of which you speak. I would love to know. Stocks? Bonds? CD’s? Hmmm.”

      Short-term Treasuries (bills) yield between 2.5% and 3.5%. High yield savings accounts are at 2%. Brokered FDIC-insured CDs are over 3%. High-grade (AA) corporate bonds are at around 4.3%. So there is yield out there.

      It doesn’t cover inflation. But that’s not your choice. Your choice is between earning 0% on paper dollars or 3.5% on Treasury bills and x% on other stuff, while inflation is the same for all. So you’re a lot “less worse off” earning 3.5% than earning 0%.

      • Ralph Hiesey says:

        Yes Wolf, as you say Treasuries “don’t cover inflation.” And maybe AA Corporates. If that’s all I’ve got, not a great choice. Good options to lose the least possible wealth!

        • Wolf Richter says:

          “Good options to lose the least possible wealth!”
          Yes, “less worse” is the phrase I used. As opposed to “worse” or “worst.”

          This is a shitty investment environment. I-bonds roughly cover inflation, but you cannot move a whole bunch of money into them all of a sudden; this is something you do every year, at the max level. Most inflation hedges (stocks, RE, cryptos, etc.) either have already failed spectacularly – saddling you with a big capital loss in addition to the loss of purchasing power due to inflation – or have started to fail. Even gold hasn’t performed as an inflation hedge this time around.

        • WakeUp says:

          “Even gold hasn’t performed as an inflation hedge this time around.”

          That may be true for people in the USA, but it isn’t true for people in other countries.

          Gold, despite recently falling in price, has still had one of the better performances over the recent past compared to other asset classes.

          For example, in yen terms gold is up by 4% over the past six months and 20% over the past year.

          And as far as all those US dollars floating around the world outside the USA, they provide a type of free interest rate loan to the Fed and a liability that will probably never have to paid.

        • Will V says:

          Uh, purchase negative ETFs, or puts to hedge your portfolio. As the unwind occurs, begin to sell those products and SLOWLY purchase assets that have upside potential or if commodities go low, another option. Of course must watch decay etc. not for the faint of heart but working well this year. Even if your dont “short” there is nothing that says some SDS/SQQQ can’t be your friend. As the market contracts, sell into their strength and pick up some “weakened” apple?

        • cb says:

          Wake Up said: “And as far as all those US dollars floating around the world outside the USA, they provide a type of free interest rate loan to the Fed and a liability that will probably never have to paid.”
          Actually, if those dollars floating around the world were issued by the FED in exchange for Treasuries, then those dollars provide much better than a free interest rate loan to the FED. The FED is actually earning interest.

      • Jm says:

        Verizon and ATT now pay dividends above 6%. But they have declined 20% in the last few months. So if you’d bought in July for the then 5% dividend, and need to sell to raise cash for some reason, you’d be a loser. Someday they might recover. As the market in general still has a long way to drop, probably too soon to buy just yet.

        • Flea says:

          People not paying their cell phone bills?

        • Augustus Frost says:

          Both companies have garbage balance sheets. Their interest coverage ratio is high because of long-term interest rate suppression but it will grind lower over time organically now that the 39-YR bond bull market is over.

          It will also collapse when their earnings crash in the next economic contraction after which the dividend will be cut big.

        • ru82 says:

          what is ironic is AT@T and VZ are the remnants of the breakup of the AT&T monopoly by the government. The result is a foreign telecommunications company formed by the Japanese SoftBank owned Sprint and German T Mobile now has the most cellular subscribers. Too funny as they were both Allies against the USA in WW2. interesting how the times change.

          But the wall of shame CEOs (Randall Stevens And John Stanley) sure drove AT&T into the ground.

      • Gattopardo says:

        “It doesn’t cover inflation.” Even less so after taxes since that’s ordinary income. You’d think .gov would at least waive income tax on interest income below CPI since real interest rates are largely determined by the Fed. Yeah, right. We know that we won’t see a return to inflation indexing any time soon on cap gains either.

      • Phil says:

        Yes. thanks Wolf! you’ve mentioned this many times. 3.5 is better than zero. ladder in carefully, as you wish going forward, and take your medicine, or be grateful. Hold to maturity. better to get some spending money, than no spending money. yes, it’s rate risk. deal with it, and be happy. do your ladder carefully, and don’t look back. no Fairy God Mother.

  24. Cas127 says:


    I appreciate the amount of work that goes into producing these kinds of posts – tracing the (very) convoluted techniques the Fed uses to operationalize its control/manipulation of the financial overlay of the US real economy is very difficult.

    (Nobody on the inside really cares to make these operations particularly clear, because it doesn’t serve their interest for there to be a general awareness of just how thoroughly DC can control individual financial standing – they basically want to run a fairly centrally managed economy – via finance – without openly acknowledging they are doing so).

    But, at the end of the day, that is *all* the Fed is doing – controlling/manipulating the *financial* *overlay* (well or awfully, as the case may be).

    But the true, base, fundamental economic equation – the one that determines the long term fate of national economies – the productive efficiency linking true international cost of inputs to true intl value of outputs, really only gets diddled at the margins by all the Fed’s *financial* manipulation (it is an *overlay*, the essentially symbolic representation of more fundamental real economic relationships).

    The simplest way to think of this is to realize that in an instant the Fed could (theoretically) alter the “money” supply from $1 to $100 bazillion (or the reverse).

    But…doing so (while truly f’ing up the financial mkts) would 1) leave the immediate real asset endowment of the nation unaltered (although affecting productive incentives *at the margin*) and 2) also leaving the real productive efficiency of the nation (true input cost vs true output value) unaltered.

    This is as it must be – central banks are just shuffling and redenominating *paper* – not altering real economic relationships, except to the extent their expropriations (read inflation) or political gifts/graft (read DC spending) alter individual economic incentives over time (quite frequently for the worse, as economic actors gradually realize they are marionettes under madmen).

    While everybody appreciates how much effort you put into hacking into the head high weeds of Fed operations, the effort it requires makes it really easy to miss the swamp for the weeds.

    Everything you recite above *will* have differential impact on different segments of the financial/capital mkts (that is the Fed’s *goal* after all) but besides always keeping the *real* economy distinction in mind, a ton of *additional* work is required to track (and more importantly, clearly explain) those differential capital mkt effects.

    I don’t think you really do that here (understandably) and it makes it harder to follow 1) your explanation of Fed operations and 2) their capital mkts significance (which is what I guess 90% of your readers care about).

    There is another major point – since the Fed is implicitly endowed by DC to act with a basically shocking degree of caprice in regard to the US money supply (ie every dollar holder’s accumulated wealth) they more or less have infinite tools to that end.

    Although you lay out a detailed argument for a “floor” for QT, I think the Fed is implicitly empowered to simply use some/any other tool to transcend that floor (using current madness to offset earlier madness…).

    For instance, the Fed could simply jack banks’ reserve requirement to “tighten” beyond the floor you describe.

    (The Chinese have manipulated *their* reserve rqmts to profound effect for 20 yrs).

    When it comes to tools of monetary manipulation, central banks have a million of ’em.

    That is why it is so important to mainly keep your eye on the true, underlying real economic relationships.

    (And transnational exchange relationships, since the various CBs don’t manipulate in unison…each pursuing its own ntl interest mainly. Watching trade balances over yrs will tell you more about the underlying health of a nation’s economy than a hundred CB rabbit holes).

    • Nathan Dumbrowski says:

      Bravo! Best comment IMO. Great job covering many points I was thinking

    • economicminor says:

      This thinking implies that the PTB are not humans.

      Humans are selfish and greedy look at everything in relationship to their own privilege/power/position.

      When dealing with humans, those in power always balance the scales on their side. The House Always WINS..

      When you do this in an economic system where debt is an increase in current spending in exchange for a decrease in future spending unless that debt creates an income stream adequate to repay the debt, interest, plus a small profit.  In other words, you have to make a profit off of debt by productive value added enterprise and not just rely upon an inflated increase value of your asset base.

      Borrowing for consumption or grandiose speculation is a hole that will have to eventually be refilled with future austerity. The bigger the hole, the longer the period of austerity.

      This is why Central Planning has never worked long term. Human Nature!

    • ru82 says:

      Yes. There is no floor. There is no ceiling. The Fed believes its job is to drive the economy……right or wrong. I also agree the Fed has multitudes of tools. They are not close to running out. Don’t believe that stuff.

      There is no “stuck between a Rock and a hard place” for the Fed like the media says. The ones stuck between a hard place are the people based on the Feds decisions.

      We are all here on a ride that you cannot get off. So don’t fight it…..ride it.

      The Fed will create many more boom and bust cycles while they pull their financial levers.

      We are in a down cycle…don’t catch falling knifes. Wait until the Fed becomes dovish again when unemployment starts rising too much.

      • ru82 says:

        I don’t want to distract from this great article. There is always a temporary floor and ceiling. Every system has boundaries otherwise it fails.

        I just think the Fed will always come up with something new (QE) that may or may not work for everyone (middle class) but will benefit someone ( top 1%)

    • cb says:

      @ Cas127 “This is as it must be – central banks are just shuffling and redenominating *paper* – not altering real economic relationships,”
      The shuffling redenominating paper is a large component of what alters real economic relationships. It favors insiders and one class over another. It fosters the wealth gap. It boosts private equity and the financial engineers.

  25. And may we suppose that the definition of a liquidity trap occurs while RRPO is still open, [the Fed stopped buying QE bonds but reserves keep climbing, or the need to convert those reserves to collateral] and banks need RPO, cash (dollars – a dollar shortage) and they are willing to swap treasury paper. Fed’s role in all this [used to be] a third party meant to smooth over the gaps in market supply, cash or treasuries. The Fed could drop interest rates and MM rates would follow, and demand, or wait for the transition, moment when the need for dollars exceeds the need for collateral, to lower rates for them, [banks begin loading up on short term treasury paper in order to borrow cash – by selling what exactly? or borrowing what exactly??] Several years ago a CITI analyst said if Fed policy continues one day soon investors will be borrowing money to put it in savings. That sounds vaguely deflationary but with the dollar rising out of context, in relation to debt and spending, maybe not far fetched.

  26. Tom Jones says:

    I don’t believe people with turn in their mattress dollars to earn interest. If anything, the mattress dollars will increase as things become more scarce, and life becomes scarier. People know in a pinch that ATM’s will be the first thing to shut down.

    • Spencer Bradley Hall says:

      “Money has a ‘second dimension’’, namely, velocity . . .. ” Arthur F. Burns in Congressional Testimony.

      The cash/drain factor has fallen from 1.103 on 2/1/2020 to 0.440 on 7/1/2022. I.e., there is a huge volume of saved DDs, excess liquidity, in the economy.

    • Cytotoxic says:

      There’s no reason to believe that ‘things will become more scarce’. Supply chains are healing, store shelves have fewer bare spots. Not perfect but improving.

      • Cas127 says:

        The less trustworthy you make your currency (by manipulating its supply), the less economic actors/investors want to be exposed to your currency (borrowing/lending in it, accepting it as pmt for real economic goods, etc).

        This can cause horrific macroeconomic disruptions.

        So don’t discount DC’s ability to turn macroeconomic mismanagement into an “impossible/unthinkable/inconceivable” outcome.

        (For example, the lavishly funded US military (DC run) only bats about 50% in wars against non-industrialized nations that possess 1/1000th of the material resources of the US mil)

        (Also, see Pandemic, CDC and)

        Remember during the pandemic when the “mighty” US economy (“Richest Country on Earth” TM) not only could not produce anywhere near sufficient face masks (in many ways a pathetically simple real good) but it *never* came close to doing so (so much for WW 2-style industrial miracles. And I think industrial powerhouse GM is *still* working out the bugs on “Freedom Respirator” #1…).

        Now imagine a day in the not distant future when the hundreds of thousands of exporters around the world simultaneously wake up and realize,

        “Hey, these perpetual deadbeat Americans have only ever paid me in this green tinted toilet paper, which they run off at will at the Fed Kinko’s. By the time I can turn around and try to buy some worthwhile US asset (er…) the value of my export proceeds have been debased. So…no more imported soup for you, my American deadbeat friends.”

        Apply that dynamic to the tens of thousands of US imported products the US survives upon. Realize that the US has essentially been surviving on foreign credit for fifty years already – that’s what it really means when you run perpetual trade deficits…foreigners are taking US paper IOU’s (cash or cash recycled into US Treasuries) in exchange for their *real* goods (that require *real* resources to make, not just some political promise from an increasingly untrustworthy foreign gvt).

        If you screw up the currency you are almost by definition going to screw up all the supply chains (as existing economic relations between suppliers/users get terminally warped by price volatility).

        • VintageVNvet says:

          Don’t include exchanging USD for US real estate?
          Anyone seriously wondering why many desirable locations in USA have had HUGE increases in land purchased by folks who are not USA citizens?
          Anyone seriously wondering why many folks are willing to travel from all over the world to be able to pay large money to walk across the borders and disappear into USA?
          Anyone seriously wondering why many people are willing to trade their local currencies for USD almost everywhere on earth?
          ETC., eh

        • Cas127 says:


          Actually I do think a lot of foreign exporters recycle/divert USD proceeds back into US real estate (mainly residential…it is an escape pod for Chinese firm owners fearing the CCP and not wanting their savings held 100% hostage in compelled Yuan holdings).

          And I do think this dynamic is behind a lot of the absurd RE distortions we’ve seen over 20 yrs (soaring home prices despite stagnant US salaries over most of that period). Add in ZIRP and you have a recipe for the toxic stew we’ve seen.

          But I also think it is a trap for those Chinese.

          As the US political system disintegrates, it has become a fountain of rotating diversionary villainies (“Everyone/anybody but our policies are behind America’s economic decline”).

          Sooner or later DC’s Sauron gaze will fall upon foreign owners of US real estate (after turning a blind Eye for decades) and they’ll become the Evil Incarnate du Jour. Huge taxes will be levied – one way or another – on the latest Others…after all the insatiable Maw must be fed.

        • rick m says:

          All the foreigners holding dollars know that size matters no matter what she says. The US dollar dwarfs it’s nearest competitor in world trade, and when lots of richer people than you want the same thing that you do you’ll ride along gratis. They’re your best insurance. Everybody knows that the dollar has it’s issues, so does Microsoft, Boeing, and Walmart, none of them are going anywhere. Because they’re big, and at a point of critical mass they offer safety in sheer size. The US dollar buys their software and airliners and ramen noodles. Lots of energy too. People really don’t want an honest money without arbitrage and leverage and usurious possibilities now anymore than they just want their house to be a domicile and not a daily reminder of their financial acumen. Nobody wants a gold backed anything, no matter what they say. That kind of money tends to cost too much for most. The dollar is doing okay, given it’s many detractors, and is nowhere near it’s oft-predicted demise. Offshore cash is a huge inertial stabilizer, for now at least. $100 bills used to trade for $105-$110 in ones in Eastern Europe. If there’s that many discounted singles floating around, it postulates an immobile cash float that can’t come home quickly, good.
          There’s a few foreign currencies that tie their value to the US dollar too.
          Oligarchs and unbanked gangsters/warlords prefer dollars as well, the logistics of bribery in inflationary times become more challenging when they’re bought with the cheesy local currency. Everybody needs a buck or two.

      • unamused says:

        “There’s no reason to believe that ‘things will become more scarce’.”

        That’s because the planet’s resources are infinite and there’s no way eight billion or even twenty billion people could possibly use it all up, certainly not with the prospect of exploiting those rich lands on the Moon, Mars, and Venus for cheap.

      • The Real Tony says:

        Until the winter rolls around and the midterm elections are over.

        • Cytotoxic says:

          No. There’s no reason to believe in increased scarcity after the midterms either.

  27. nsa says:

    Time and Level. This rate hike cycle should peak in the spring of 2024……coincidentally just in time for the runup to the Nov. 5, 2024, selection and subsequent Jan. 20, 2025, coronation. The actual peak rate achieved is not readily predictable from the charts, except that it will eventually exceed the inflation rate. According to the Taylor rule, the FFR thermostat right now should be 9%.

  28. Gabriel says:

    Yes I too appreciate your articles and I send you a monthly contribution so show my appreciation. I am sorry the contribution does not come close to value of your articles but I am retired and it is the best I can do right now.
    I am still trying to discern the forest from the trees when reading your articles. Is there a flow chart available somewhere that shows how money flows regarding the fed, central bank, banks and the government?

  29. Cytotoxic says:

    What an excellent article! I have an objectively better understanding of the Fed and its balance sheet than I did a half hour ago.

    That being said, man, interest on reserves is a bad idea. As the Cato Institute put it over 10 years ago, it’s not just deflationary but violently deflationary. The ‘big deposit’ regime is terrible. The Fed is not all-powerful; it has to serve so many masters and juggle so many priorities it never had a chance of making any of them really happy.

    • Wolf Richter says:

      QE was the “bad idea” — the original sin. Interest on reserves is just an outgrowth to keep the QE side-effects from spiraling totally out of control.

      • Depth Charge says:

        What can “regular people” like myself do to effect change so that QE is relegated to the dustbin of history? QE is essentially a rich man’s trick to f**k everybody else out of their money and standard of living.

        • The Real Tony says:

          I think QE was supposed to steal from the old people or savers to give to the young people but in the end the young people ended up even worse off that the old people they originally stole from.

        • historicus says:

          Real Tony….
          “I think QE was supposed to steal….”

          stealing a little bit from a huge number is an old game, and the theft was from anyone holding dollars
          If inflation is a Thief, than anyone promoting inflation to any degree (2?) is engaged in theft and are themselves thieves. (note to J Powell) IMO.

  30. Andrew Wangelin says:

    Very interesting and I very much appreciate the break down, but was wondering if someone could provide a bit more color on $800B in TGA.

    I pulled it up on FRED and while I understand the idea of government entities temporarily parking money at the Fed, I’m curious why they started parking significantly more during/after the housing recession and then began to grow those amounts more or less linearly beginning around 2014.

    My expectation would be that the government spends almost all of the funds every year or they are forfeit.

    • Wolf Richter says:

      Andrew Wangelin,

      I explained all that in the article. You have a misconception about the TGA that you need to shed. So go ahead and read the article. I swear, it doesn’t bite.

  31. Johnny5 says:

    Wonderful article Wolf. Bookmarked for many future reviews.

  32. Bnguyen says:

    Concurrent QT and interest rate hikes in a negative GDP environment is insane.

    • Wolf Richter says:


      No. But policy interest rates are way too low in the face of this inflation, and QE should have never happened, and if it happened should have been unwound long ago. So you can kiss the Everything Bubble goodbye. I hope you enjoyed it while it lasted. It was truly spectacular.

      QE and interest rate repression inflated the Everything Bubble. QT and rate hikes have been deflating it. There is now a whole generation of speculators out there who have never seen an environment where markets have to exist without the Fed whipping them higher relentlessly.

      • NoPrep says:

        What bubble ? Marc Andreessen would like to have a word with you at the party this evening Wolf about bubbles. It’s a fine party too- Adam and Rebekah are out there on the pitch deck. Nothing but good times and helping the little folks. Thanks for another solid writeup.

      • Bnguyen says:

        The Fed is trying to use its tightening tools to create a recession-ish state to help it fix the out-of-control inflation. However, this creation is like a big blackhole that can either help to slow down the inflationary inertia of the economy ship or suck the whole ship in, which is more the likely scenario.

    • Mandeley says:

      If Congress wanted to quash inflation they’d order the Fed to crash asset prices and would send people checks until valuations realigned with reality. The Fed doesn’t have the tools or authority to address inequality, or corruption (moral hazard, political bribery). The problem is profound, it’s political, and it’s not the Fed. American democratic institutions are failing or have already failed the majority of the population.

      • cb says:

        “The Fed doesn’t have the tools or authority to address inequality, or corruption”

        Yes they do. They used the corrupt practices of QE and interest rate suppression to build inequality.

  33. Gen Z says:

    TIL that cash in circulation is physical cash in circulation.

    Hoarding dyring COVID.

    But savings rates are going up, so cash in circulation will go down as it will be in the banking system, right?

    What does that mean for the stonks, cryptos, social media NFTs and $10,000 a visit meet and greets with your local TikTok influencer?

    • Nate says:

      I read the article!

      Barely. Thank God we got wolf to think this stuff for us. I’m going to take wolf’s word on it that the fed has a floor for how much it can run off during QT.

      Question: when you say that a max runoff during QT will lead to asset price declines, is this based on logic, gut feeling, historical precedent, or a direct relationship? The reason I ask is because there were a ton of well reasoned predictions about QE the last few times so I am skeptical we have great handle on QT either and the magnitude is unprecedented. It seems like qe at least was a bit slower than rate changes or fiscal stimulus in impacting economy.

  34. gametv says:

    When I read this and try to fully understand it, I start to get a more clear picture.

    The Federal Reserve has basically taken the risk of interest rates away from the banking system and put it on the Federal Reserve by guaranteeing interest rates they pay, while they take the interest rate risk of Treasuries on their balance sheet. Because the value of a Treasury falls when the interest rates go up.

    Fannie and Freddie have taken the risk on mortgage defaults.

    So our government has taken all the risk of the financial markets, and left the financial market players with only the returns.

    Love this socialist capitalist system.

    • cb says:

      “So our government has taken all the risk of the financial markets, and left the financial market players with only the returns.”

      Correction: left Favored financial players with only the returns

  35. Capitalist says:

    Mr. Wolf, thanks for the article.

    A noob question, my understanding is that money market funds take part in RRP but they do not lend to the real economy or invest in stocks / housing. As Fed does QT, the cash from the money market funds will move from RRP to treasury bills. How will that help reduce inflation or reduce asset prices? thanks!

  36. Jeremy says:

    Wolf, Y2K *would* have been a big issue.

    A couple of million programmers spent 5 or 6 years intentionally making sure that it wasn’t.

    I was a developer at the time, and I fixed a few that would have caused big problems.

    • Sdb says:

      Me too !

    • Craig110 says:

      Yes, an incredible amount of behind-the-scenes coding / testing / recoding was needed to turn what Y2K what would have been into the dull (though white-knuckled for us software insiders) turn-of-the-calendar day that it ended up being. I hear the “Y2K was a dud” type of comments now and view them as a great badge of industry success.

      Congrats on your part in that success.

  37. Wolf:

    What are you trying to do: single handedly bring down the cost of college by offering 3rd year economy course work at a fraction of the cost? If so – and I am all for this – have you factored these massive college ‘savings’ into your models? I expect it would drop the currency in circulation (for coffee, if nothing else) substantially and thus the Fed’s floor noticeably. But, then again, since it arrives in real time, I don’t know because I’ve not taken the 2nd half of your course yet.

    I like this new ‘Wolf U’ approach: the Sunday Wolf Street Report large lecture hall, the Tuesday run the numbers labs and the Thursday break out ‘what does it all mean for my weekend?’ behavioral economics feedback queries. This is a much better course than many of the Econ courses I took in the early ’70s (with WAY better grad student course question follow ups in the comments). I shutter to consider the social disruption if your offerings get accredited. I mean, there’s only so many talking heads the internet can absorb (although we are testing this idea) from the ranks of unemployed Econ professors you will produce from your disturbance of the force. Then again, you might just produce a general ‘economic awareness’ to challenge the often nonsense of these talking heads thus producing a demand stabilization conceivably bringing down reserves needs, and perhaps taking your Fed floor down even further.

    But please, no pop quiz just yet as, these days, I am usually a couple of days behind the brighter students in the comments section – which has grown large, louder and informed – finding this time is necessary to fully absorb the many viewpoints produced from the lecture. Is pass/fail an option? Is pass/fail the only option?

  38. RickV says:

    Excellent explanation. One interesting result of QT is that the short term TIPS market has flipped from negative yields where it resided for several years, to positive yields. For example, according to the Wall Street Journal 9/2/2022 prices, the Jan 15, 2023 TIP has a yield of 3.873%. Of course, the September inflation adjustment will be 0, but that still leaves October through December adjustments. I have no idea why this has happened, some market anomaly, I suppose.

  39. dang says:

    Your article has forced rusted gears and un-oiled drive shafts to engage, in my memory, about the basic accounting 101 equation of T accounts:

    Assets = Liabilities + Owners Equity

    Bank reserves: $3.25 trillion
    US paper dollars (“Currency in circulation”): $2.28 trillion.
    Reverse repurchase agreements (RRPs), total: $2.53 trillion
    US Government’s checking account at the Fed: $670 billion.

    I’m trying to decide which one is the most speculative. Promoting speculation has obviously been the main function of the Federal Reserve Bank of the United States for the last X times decades, at least 3.

    • dang says:

      I’m not saying that speculative funding doesn’t have it’s place, as any reasonable citizen would recognize the benefits of productivity improvements to the everyday man and woman, like me.

      I think that the Financial Industry has been promoted at the expense of the everyday man and woman, like me.

      Speculation has been established by the Federal Reserve policies for the last 20 years, establishing Finance as the principal industry of the US, comprising > 65% of GDP. I think that the Fed needs to stop with the policies it has established since RR, that transfers and concentrates wealth to a dis-functional aristocracy.

      • Augustus Frost says:

        Your description of finance as an industry is a major exaggeration.

        It’s bloated and unproductive, but nowhere near that much.

        • dang says:

          I know you view yourself as an expert but that is your problem. lobbing turds over the fence like your general proclamation that my description about the Financial Industry without an ounce of self reflection or a counter argument.

          August, I skim your opinions and consider most of them as bullshit.

      • dang says:

        Since being born, I recognized the basic greatness what my, flawed, old man did one day during the WW2. Whatever he did, being shot in the face, he earned a purple heart, and was awarded a silver and bronze star.

        He lived and had a large family which he fed by living in a society which the GI’s established that provided family level wages and benefits for white people.

        • dang says:

          I’m going to take credit for being the first to say that that the salvation of American Democracy lives in the ghetto where most of the people in America live. I claim to have said it in the late 90’s to a credible witness.

          Your graphical demonstration of the data illuminates the profound intransigence of the so called Federal Reserve. It is dis-heartening to see a formerly proud institution prostrate themselves at the behest of the wall street hucksters.

      • historicus says:

        “ Speculation has been established by the Federal Reserve policies for the last 20 years, ”
        Former Fed Gov Fisher said they pounded long rates to “force” the investor to take more risk. Thus an admission to skewing investment decisions, PE ratio normalities, risk return ratios etc.
        Is that the duty of the Fed?
        It explains their activities in the long end.

      • dang says:

        There is an ingenue, America, that will decide what happens next.

        Old age is different from being young and hardy.

        The transition from QE to QT is like what I imagine a divorce must be like. I don’t know what it must be like, I’m sorta Catholic so, so far, I’m safe. Which is relevant to Wolf’s article in the following description of how dumb I was in 1982, when the guns and butter inflation was raging.

        • dang says:

          I bought a house with an interest rate of 14 pct plus a half of pct PMI. The nesting instinct was dominating the old man’s advice about waiting until the financial world equilibrated. I was 28 or so and full of the joie de vivre.

          Then I lost my job at the local mine that I was working in because the demand for metals had fallen below the cost of production.

        • dang says:

          The strong wind is always a warning to the most feared animal on earth, man. An animal that doesn’t even know it is an animal.

  40. Paul Neil says:

    Thank you for an excellent article. The games government plays get more complicated, but in truth they remain the same- Keep the economy growing. I understood QT to keep and move interest rates low, but now it is time to unwind QT. So the unwind should by themselves increase interest rates. But I expected QT to have a minor effect on interest rates especially at the drawdown rate envisioned. Inflation however, is and will have a major effect on interest rates. I am expecting another 15% drop in our stock market, so your advice on where to park money during this period is again excellent.
    Without inflation, the FED would have hit a bullseye.

  41. Willie Kramer says:

    What happens if QT gets the fed assets to 5.8 trillion and inflation is still 8% ? … GAME OVER ?

  42. Robert Gallagher says:

    Great article! Are we saying here that there is a limit to how long the Fed can fight inflation and raise interest rates? Can they just stop lowering their assets at the limit and continue fighting inflation with high interest rates?

  43. Harry Houndstooth says:

    Certainly this article is one of Wolf Richter’s best. It is a humbling experience to be a part of the enormous wisdom dispensed fresh daily.
    Of course, Wolf Richter has illuminated the path to riches in these days as profiting from the reversing of the asset bubble.

    “I’m currently seeing 4% FF rate by early next year, and if inflation doesn’t go down and stay down, it might go higher.”

    It is time to step on the gas.

  44. Bernhard Weninger says:

    Excellent article as always. Just one point to your second to last paragraph that currency currency in circulation (CCY). will decline poetically as people deposit money for higher interest rates. For one the only way CCY can decline is if the Fed sells (not RRPs) securities to the banks for that cash. All that will happen if people deposit and do nothing with their money other than invest in financial assets such as a deposit is that Miney velocity will decline (and it did massively for that reason as the financial asset bubble exploded in tbe last few years. But more importantly there is a much more dangerous Alternative with regard to inflation potential if people, instead of depositing money for higher j tweet rates, start spending their money because of inflation and inflation expectations – better buy now than tomorrow when things are more expensive. That will ultimately cause the reserves to be drawn down amd the Fed will have little control over it amd suddenly all those reserves wind up as additional CCY amd if that then translates into increased borrowing by banks to meet inflation demand consuming by those very people who decide to buy now instead of tomorrow will translate into M2 increasing while at the same time velocity will increase and all that while real output inflation adjusted will not be growing by much. Then you really get massive inflation. The danger is that inflation expectations will result in those reserves being drawn down by the market as opposed to the Fed deciding when to release them in their effort to increase rates on the long end to positive real rates to break inflation. Imagine the market drawing down reserves – what, around 20% of GDP! – with comparatively essentially unchanged national output/GDP! Raging inflation. That is why Powell will need to get aggressive on QT fast before inflation expectations take a massive hold. Amd his speeches indicate he found religion. So buckle up for massive rate hikes to prevent reserve Armageddon inflation.

  45. Robert Gallagher says:

    Regarding RRPs, why aren’t this a method of drying up liquidity, since the Fed takes in cash with them?

    • Arya Stark says:

      Looks like Europe hit the panic button and is about to launch another massive stimulus due to energy. Seems like hyperinflation in Europe is now baked in. What are your thoughts?

    • Bernhard Weninger says:

      It dies dry up liquidity but only temporarily. It is a collateralised loan with a default risk free principal
      where the Fed borrow a money against giving Treasury Bills as collateral. It has to pay back the loan to the bank it took it from and take back the collateral. It is therefor only temporary liquidity reduction. If the Fed were to sell the T-Bills instead then it would a) affect interest rates as they would need to be sold at market value (try and sell 2 Trillion Dollars worth of RRPs amd you will affect interest rates, prove of T-Bills massively and b) it would then proceed to simply distroy/extinguish the dollars it gets from the buyer of the T-Bills and thereby permanently reduce the money supply. This is what QT does. Read my comment on this earlier on.

  46. historicus says:

    So, the net of this situation is that the Fed finds themselves in a spot they have created but can only partially undo.

  47. historicus says:

    If the Fed dropped the rate they paid on bank reserves, would this not drop the amount of excess reserves at the Fed thus giving them more room to drop the balance sheet?
    They have been paying interest on excess reserves only since 2008.
    That money would certainly flow elsewhere, likely to treasuries.

    • Wolf Richter says:

      They should have never done QE, and now they need to do QT to get rid of this liquidity they created. Paying interest on reserves and RRPs is just a way of keeping that liquidity they created under some kind of control. I’m not going to complain about interest on reserves and RRPs — It’s QE that’s the original sin.

      • Lune says:

        Then I’ll complain about it :-)

        Interest on reserves was a stealth way to recapitalize banks after the GFC. The Fed knew exactly what it was doing when it allowed banks to borrow money from the Fed (and the ZIRP market it created) at zero, and then re-deposit those very same dollars back at the Fed for an interest rate higher than any private market was willing to pay.

        This wasn’t an “oops! I QE’d too much so now I need some other way to mop up this mess!” It was a case of “How much federal money do we want to shovel to banks? And lets work backwards to figure out how much in excess reserves we need to create”.

        If the Fed really wanted to remove excess liquidity, why didn’t it offer similar interest rates to Jon Q. Public? A dollar is a dollar, so instead of paying 0.25% interest to banks for their reserves, why did they not massively increase their reverse repos to provide interest income to money markets that could then pay most of that back to individual people? One scheme — interest on reserves — is only available to entities that are legally allowed to deposit their money with the Fed. The other scheme — reverse repos — are available to pretty much any player. Both accomplish the same purpose. Which one did the Fed choose in 2008?

        (For that matter, the only reason they opened up the reverse repos was — as you mentioned — to bailout hedge funds and speculative REITs, entities that can’t access the Fed reserve window. The fact that the average Joe got a few extra dollars on their money market accounts was a regrettable side effect).

        • Wolf Richter says:

          “Interest on reserves was a stealth way to recapitalize banks after the GFC.”

          No, it wasn’t. Interest on reserves was 0.25% per year. That’s near 0%.

          What was a stealth way of recapitalizing the banks was an environment where banks paid near 0% on deposits (cost of funds) and charged 5% on auto loans and 30% on credit card loans. That huge interest margin recapitalized the banks little by little, year after year – with a capital transfer from depositors, retirees, etc. to the banks. Lots of people here have experienced the capital transfer to the banks first hand when their expected cash flow collapsed in 2008 so that banks could be recapitalized. It was an insidious move by the Bernanke Fed.

        • cb says:

          I will complain about it as well. I am in your camp. The FED had sins before QE, QE itself, and after QE. Giving insiders money and bailing them out, whether interest on Reserves of Reverse Repos, etc. is their stock in trade. They are full fledged Sodom and Gomorrah sinners. They stack the deck and are antithetical to free markets.

        • cb says:

          Wolf said: “It was an insidious move by the Bernanke Fed.”

          Yes it was. One of many by that larcenous bastard, and scumbag Greenspan (the “maestro”; what a joke), Yellen and Powell. and all their fellow conspirators.

    • Dan1467 says:

      As I understand it, there is no longer a differentiation between required and excess reserves, as the Fed eliminated reserve requirements in 2020. Before, there was the IORR and the IOER (interest on required and excess reserves, respectively). Now, there is simply the IORB (interest on reserve balances). The IORB by its nature is set using the same logic as the IORR (that is, to reduce the opportunity cost of holding reserves), so unless that goal is abandoned they will not tinker with interest on reserves.

  48. TK says:

    Wolf, very well done. I always knew that fed policy is the reason for distorted capitalism. But I didn’t know how or why. I read this article at least 5 times and followed that link back to 2019. I have to read the RRP part again. So I get that banks can lend to the repo market for some interest. Now I am working on understanding how hedge funds and REITS can borrow via the repo market. Is it because they hold MBS? I always assumed that only banks can use the fed money to maintain reserves. If REITS/hedge funds can access that cheap money, then assets are inflated by (I don’t know how much-but it’s a lot). So I called my broker and asked why I can’t get 2.3%. They said they will create a ticket and get back to me. Ugh.

  49. Jim Scott says:

    Good Morning Wolf,
    or anyone who has the knowledge…..

    I was wondering as the FF rate rises doesn’t this have immediate impact on the interest the government pays on the US national debt?

    IF so, it seems to me there’s a limited ceiling somewhere on the FF rate, no?

    • Wolf Richter says:

      Only newly issued debt (with the new interest rates) impacts the government’s interest expense. The 10-year Treasury that was issued in Aug 2020 with a coupon interest of 1.6% will cost the government 1.6% per year until 2030. That will not change, no matter what the 10-year yield does during that time. But when it matures and is replaced, the new 10-year note will come with the interest rate in effect in 2030.

      Treasury bills (1-12 months) are being rolled over constantly, at the new interest rates. In addition, the government sells other maturities. Each time they sell one at the new interest rate, the interest expense goes up a little.

      The main reason interest expense has been rising is because the government added $7.4 trillion in debt since February 2020, with the national debt exploding from $23.2 trillion to $30.6 trillion. If the average interest rate on that additional $7.4 trillion is 1.5%, then it would add about $110 billion in interest expense a year.

      Over the next few years, as the old debt at lower rates gets refinanced at higher rates, the interest expense will also rise.

      No, there is no theoretical limit to interest rates. The government borrows over $1 trillion to make ends meet, per year, and it borrowed $3 trillion in just a few months in 2020 to make ends meet, and interest expense just adds to the new borrowing.

      What we need is 6% short-term yields and 10% 10-year yields and interest expense out the wazoo to force some discipline on Congress.

  50. Lawrence Pusateri says:

    Great Article Wolf , I may need to read it another time or two to fully digest. A couple of things —

    1( How was it that FED was able to operate with just an 800 Billion dollar balance sheet prior to Oct 2008?

    2) I don’t think there is any possibility that the FED gets anywhere near that number without something breaking.

    April 13 high –8.965 Trillion

    Aug 31 –8.826 Trillion.

    • historicus says:

      Agree…this is a great article.

      The Fed is much more heavily involved in longer maturities than before 2008. Why….. is a good question.
      And the paying on excess reserves apparently added to the balance sheet as well. Milton Friedman was FOR the Fed paying interest on REQUIRED reserves, but paying on excess reserves is a different animal, done in a time of financial crisis in 2008 but a gift that keeps on giving…to the banks…IMO.

    • Wolf Richter says:

      Lawrence Pusateri,

      Concerning your #1:

      $800 billion in Oct 2008? I think you got the wrong year. By the end of Oct 2008, total assets were $2 trillion (QE had started with Lehman)

      So let’s try Oct 2007, total assets = $884 billion. So add up the liabilities in Oct 2007:

      1. currency in circulation = only $813 billion.
      2. RRPs were close to $0;
      3. reserves = $43 billion required reserves and $12 billion excess reserves (now there are no required reserves).
      4. The government’s TGA account at the Fed had nearly no balance as the government was banking with large banks, such as JP Morgan. During the Financial Crisis that changed, and the government moved all its money from banks to the New York Fed.

      • rojogrande says:

        Re: #4: Thank you for pointing that out. I was wondering how the Fed balance sheet was so low and stable prior to the GFC just given the expected size and fluctuations of the TGA. That explains it.

      • historicus says:

        So when the govt runs out of monrey ie no funds in TGA the balance sheet drops
        When the Fed has no MBSs, the balance sheet drops
        When the Fed stops paying interest on excess reserves, the balance sheet drops

        All decisions by the Fed
        Now who really thinks the Fed wants the balance sheet to drop in a substantial way?

  51. Spencer Bradley Hall says:

    The FED’s tightening because of high inflation, QT, in response to the Covid-19 slowdown, will be different from in Volcker’s time. The DIDMCA of March 31st, 1980, resulted in a contraction in money velocity. There is not a commensurate deceleration this time.

    • sunny129 says:

      Spencer Bradley Hall

      B/c Mr. Powell is NO Mr. Volcker.
      Mr Powell is really dovish in his heart, by his past actions. Doesn’t want to ‘shock’ the mkt, right? When Fed dumps QE in Trillions within a few weeks but when comes to QT, it is baby steps.
      The energy and currency crisis of Europe will spill over soon to rest of the global banking system. This is Lehman moment of 2022! The serious consequences of insane credit creation is winding down and Fed is trapped. Wonder, what will be inflation rate of August?

  52. cb says:

    Wolf said: “That’s why QT is loathed when its effects become apparent.”


    Not by dollar holders and savers. Quite the opposite.

  53. Alfred Olbrycht says:

    Thanks for the great article but I am confused by your statement that in order to obtain paper dollars (Federal Reserve Notes) the banks must post collateral with the Fed, usually Federal Government Securities. The bank’s reserves are Fed liabilities, and the Federal Reserve Notes are also Fed liabilities. What is wrong with just exchanging one liability for another on a dollar-for-dollar basis. That is most efficient. Why does “collateral” have to enter the picture?
    Also, since the Reserve Notes are liabilities of the Fed, why does it make sense for the Fed, the obligor of the Federal Reserve Note liabilities to require collateral from its creditors for its own obligation to pay its creditors? Who ever heard of the borrower (the Fed) requiring collateral from its lenders? It’s the lender that might require collateral.
    I realize this issue was raised Sunday the 5th by Twedledum at 7:52 AM in the comments and you tried to answer it at 10:34. But because this collateral requirement doesn’t make sense to me, I would appreciate the source for the “collateral” requirement, rather than just allowing a lability for liability switch, in regulation, law, or something similar.

    • Wolf Richter says:

      1. The lender of Federal Reserve Notes is the Fed. It lends out these FRNs to banks. Banks borrow them from the Fed and post collateral.

      2. The Federal Reserve Notes are not for sale. Reserves are cash that buys stuff and that’s used for transactions to buy stuff. So the banks could use their reserve accounts to buy FRNs, but since the FRNs are not for sale, they cannot. They can only borrow FRNs, and post accepted collateral in exchange.

      • Alfred Olbrycht says:

        OK. Thanks. Confusing because with US Treasury notes the government is the issuer, not the lender, but with Federal reserve Notes the Fed is the lender. Likewise with commercial notes the named party, the issuer, is the borrower not the lender. Back in the old days national banks would issue their own currency with their names on it and had to deposit collateral with the US Treasury. I suppose as the issuer of the national bank notes they were the borrower not the lender?

  54. NARmageddon says:

    If international holders of paper currency decide to ditch the USD, that 1.7T portion of the floor value may drop quite a bit.

    Nobody knows with certainty how much USD currency is held abroad, but some estimates are as high as 50-60% of the total, or as low as 25%. Either way is no small amount.

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