Day 36: Feds $4.5 Trillion is Permanent


The portfolio was down slightly today (-0.40%) for a LOSS of -$2,446.22 on the day. The overall portfolio GAIN to date stands at +$2,737.81 (+0.45%).

Once again we're having a renewed discussion about deficits in Washington. Maybe that isn't the single most important topic that you pull out of the daily news, I know Ivanka having her line removed from Nordstrom's was a biggie, but from a high level that's what I keep hearing. My brain is simple and needs simple words, so let me see if I have this straight. Basically the discussion goes like this; "If we're really smart and think more like business people we can reduce the deficit and get the Fed to reduce it's balance sheet". That Fed balance sheet now stands at $4.5 Trillion dollars. Remember those bonds that so many people just love to own are nothing more than debt. Trillions of dollars of debt. $4.5 Trillion sounds a little puny compared to the $20 Trillion the Federal Government has built up, but hang in there and let's look at the numbers in a way that I'm sure most politicians would prefer we didn't. As a student of history I like to start from that perspective, so let's look at what each administration has done with respect to the deficit and then let's look at what Janet Yellen and the FOMC have done. Here's the whole history of the U.S National deficit since 1789.

FY 1789 - FY 1913 - $1 billion surplus

FY 1914 - $0 billion

FY 1915 - $0 billion

FY 1916 - $0 billion

FY 1917 - $1 billion

FY 1918 - $9 billion

FY 1919 - $13 billion

FY 1920 - $0 billion

FY 1921 - $1 billion surplus

President Woodrow Wilson: Total = $22 billion, a 775 percent increase

FY 1922 - $0

FY 1923 - $1 billion surplus

President Warren G. Harding: Total = $1 billion surplus, a 6 percent decrease

FY 1924 - $1 billion surplus

FY 1925 - $1 billion surplus

FY 1926 - $1 billion surplus

FY 1927 - $1 billion surplus

FY 1928 - $1 billion surplus

FY 1929 - $1 billion surplus

President Calvin Coolidge: Total = $5 billion surplus, a 26 percent decrease

FY 1930 - $1 billion surplus

FY 1931 - $0 billion (slight deficit)

FY 1932 - $3 billion

FY 1933 - $3 billion

President Herbert Hoover: Total = $5 billion, a 30 percent increase

FY 1934 - $4 billion

FY 1935 - $3 billion

FY 1936 - $4 billion

FY 1937 - $2 billion

FY 1938 - $0 billion (slight deficit)

FY 1939 - $3 billion

FY 1940 - $3 billion

FY 1941 - $5 billion

FY 1942 - $21 billion

FY 1943 - $55 billion

FY 1944 - $48 billion

FY 1945 - $48 billion

President Franklin D. Roosevelt: Total = $194 billion, a 186 percent increase.

FY 1946 - $16 billion

FY 1947 - $4 billion surplus

FY 1948 - $12 billion surplus

FY 1949 - $1 billion surplus

FY 1950 - $3 billion

FY 1951 - $6 billion surplus

FY 1952 - $2 billion

FY 1953 - $6 billion

President Harry Truman: Total = $5 billion, a 2 percent increase

FY 1954 - $1 billion

FY 1955 - $3 billion

FY 1956 - $4 billion surplus

FY 1957 - $3 billion surplus

FY 1958 - $3 billion

FY 1959 - $13 billion

FY 1960 - $0 billion (slight surplus)

FY 1961 - $3 billion

President Dwight Eisenhower: Total = $15 billion, a 6 percent increase

FY 1962 - $7 billion

FY 1963 - $5 billion

FY 1964 - $6 billion

President John F. Kennedy: Total = $18 billion, a 6 percent increase

FY 1965 - $1 billion

FY 1966 - $4 billion

FY 1967 - $9 billion

FY 1968 - $25 billion

FY 1969 - $3 billion surplus

President Lyndon B. Johnson: Total = $36 billion, an 11 percent increase

FY 1970 - $3 billion

FY 1971 - $23 billion

FY 1972 - $23 billion

FY 1973 - $15 billion

FY 1974 - $6 billion

President Richard Nixon: Total = $70 billion, a 20 percent increase

FY 1975 - $53 billion

FY 1976 - $74 billion

FY 1977 - $54 billion

President Gerald Ford: Total = $181 billion, a 38 percent increase

FY 1978 - $59 billion

FY 1979 - $41 billion

FY 1980 - $74 billion

FY 1981 - $79 billion

President Jimmy Carter: Total = $253 billion, a 36 percent increase

FY 1982 - $128 billion

FY 1983 - $208 billion

FY 1984 - $185 billion

FY 1985 - $212 billion

FY 1986 - $221 billion

FY 1987 - $150 billion

FY 1988 - $155 billion

FY 1989 - $153 billion

President Ronald Reagan: Total = $1.412 trillion, a 142 percent increase

FY 1990 - $221 billion

FY 1991 - $269 billion

FY 1992 - $290 billion

FY 1993 - $255 billion

President George H.W. Bush: Total = $1.036 trillion, a 36 percent increase

FY 1994 - $203 billion

FY 1995 - $164 billion

FY 1996 - $107 billion

FY 1997 - $22 billion

FY 1998 - $69 billion surplus

FY 1999 - $126 billion surplus

FY 2000 - $236 billion surplus

FY 2001 - $128 billion surplus

President Bill Clinton: Total = $63 billion surplus, a 1 percent decrease

FY 2002 - $158 billion

FY 2003 - $378 billion

FY 2004 - $413 billion

FY 2005 - $318 billion

FY 2006 - $248 billion

FY 2007 - $161 billion

FY 2008 - $459 billion

FY 2009 - $1.16 trillion. ($1.413 trillion minus $253 billion from Obama's Stimulus Act)

President George W. Bush: Total = $3.293 trillion, a 57 percent increase

FY 2010 - $1.547 ($1.294 trillion plus $253 billion from the Obama Stimulus Act that was attached to the FY 2009 budget)

FY 2011 - $1.300 trillion

FY 2012 - $1.087 trillion

FY 2013 - $679 billion

FY 2014 - $485 billion

FY 2015 - $438 billion

FY 2016 - $600 billion expected

FY 2017 - $441 billion projected

President Barack Obama: Total Projected Plus Actual Deficits = $6.575 trillion, a 56 percent increase.

(Source: "Table S-5. Mid-Session Review Fiscal Year 2017," Office of Management and Budget, July 15, 2016. "Table 1.1—Summary of Receipts, Outlays, and Surpluses or Deficits: 1789–2021," Office of Management and Budget.)

Now let's take a quick look at what the Fed has done with various programs to keep interest rates at artificially low levels. Granted this was done in response to the financial crisis; extraordinary measures and all. In the spring of 2016 Credit Suisse's Zoltan Pozsar wrote a note titled "What Excess Reserves". The former New York Fed analyst proposed that the Fed's balance sheet will never shrink again. It's permanent! Just take a look at the graph below to see what has happened to reserves in just the last few years.

The premise is very simple. Since the Great Recession and financial crisis banks have been required to hold reserves capable of covering losses on bad debt. A basic structural shift took place in our economy where bank reserves have now replaced bonds as the primary source of bank liquidity. Why should any of us care? There are several important take away's from this change; 1) Banks don't want to lend or simply can't because their cash is tied up in reserves. Lending means stashing away more cash in reserves, 2) When banks can't lend they earn money from fees, 3) When lending is reduced and fees are maxed out banks will take greater risks to continue to produce the earnings that they need to produce in order to stay in business, grow and provide shareholder returns (think mortgage backed securities and excessive loans to oil companies when oil was at $100 a barrel). Finally, the FOMC needs banks to use reserves for liquidity so that they don't have to unwind that massive $4.5 Trillion dollar balance sheet which would likely create a bond market crash and send us into the next recession and financial crisis.

Look, the only way to unwind the balance sheet is to get all that debt off the books. The Fed sells bonds removing currency from the economy. When the Fed buys bonds they are adding currency to the economy. When the Fed sells bonds the price of bonds tends to decrease as the supply of bonds increases and vice versa. Bond prices and bond yield rates have an inverse relationship. So if the Fed starts selling off the bonds on their balance sheet the result should be a massive increase in the yield and a collapse in bond prices. In a previous post I discussed a threshold of 3.03% as the cliff we don't want to pass and fall off of. Nope, can't do that. So what's the alternative so that banks can lend again and the Fed doesn't induce the next recession? I think it's an all of the above scheme where the balance sheet grows but with more direct purchasing of corporate bonds.

Get use to it, The Fed's Balance Sheet is Permanent. If anything it's going to increase.

Stay Invested,

Clay Baker

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© 2016 by Clay Baker all rights reserved