Transcription
Kevin Watch, the good Fed Chairman that Donald Trump nominated himself, hoping that once Kevin took office, he would surely lower the policy interest rate for the United States. He even joked, "If you don't lower the interest rate, I'll sue you," jokingly, of course.
But then, on June 17th, when Kevin Watch actually sat as chairman, what he did, besides not lowering the policy interest rate, was to keep the policy interest rate at 3.5-3.75%. Furthermore, 9 out of 12 members of the FOMC indicated that they wanted to raise the interest rate before the end of 2026. So, what now? Should I sue? Just kidding.
Seeing this, many people probably thought, "Then I'll wait. Donald Trump will surely come out and criticize Chairman Fed through social media." But it turned out that the social media of the President of the United States this time was not heated. He was not angry at Kevin Watch because inflation rose to 4.2%. How could the Fed lower the interest rate at 2%? No, no. Moreover, Donald Trump himself said, "I love inflation."
So, the question must continue: "Really, Mr. Trump? Because if the Fed doesn't lower the policy interest rate, and the stock market falls, becomes red, will it affect your votes in the midterm elections?"
If we were to explain this in depth, we could answer that it won't affect it. Because the stock market, even if it falls, will only fall a little. Even if it turns red, it will only be a scratch, not a deep red, not a bright red, not an aggressive red. Because today, there is a way that even if the Fed doesn't lower the interest rate, even if the Fed doesn't print money, even if the Fed doesn't inject money into the system, someone will inject money into the system for the Fed instead, and the result will be very similar.
By changing the rules and keywords, the SLR rule relaxation. Support the S Money Monster channel with this QR code, or support the Sai channel very easily. Like, share, comment to chat. Or anyone who wants to support us long-term to make clips, news, and content freely like this, you can become a member. But becoming a member of this channel, what do you get? You get nothing. Anyone with good ideas can suggest them. But most importantly, if you haven't subscribed yet, please subscribe. Thank you.
Let's start this clip with the villain of the US economy right now, which is inflation. Because inflation is the root of all problems happening in America right now. If you ask, then who is the villain that caused such severe inflation? The answer is, there is no one. No one made mistakes in management. Nothing happened that was an economic management mistake at all. The only villain is the war in Iran. And what we did was sign an MOU for a ceasefire. So, inflation is temporary. It's over. It's good.
And the next point we will discuss is, "Oh, Kevin Watch didn't lower the policy interest rate. He kept the interest rate at 3.5-3.75%. Doesn't that displease Trump?" Well, it probably doesn't displease him, because Donald Trump himself said, "I love inflation."
But suppose, suppose Kevin Watch did the opposite of what actually happened. For example, Kevin Watch announced, "We are lowering the policy interest rate." What would follow is that media outlets worldwide the next day would have headlines like a comic book: "Kevin Watch, Fed Chairman, Puppet, Trump's Lackey, Lowered Interest Rates Because He Was Ordered." The image would not be beautiful like this.
And not only would the image of Kevin Watch, the Fed Chairman, look not so good, but the market wouldn't look good either. Because if the government bond market, if interest rates are lowered, you'll see on this chart that it bounced up once. If interest rates are lowered again, it will bounce up again. How much it will bounce, we don't know because it hasn't actually happened. But it will cause the 2-year Treasury bond, which is currently at 4.1%, to surge much higher. And higher Treasury yields mean falling prices. The bond market will collapse. And when the bond market is about to collapse, yields will become much higher. And that will become a burden of increased interest. And that increased interest will interfere with various sectors of the economy. Then it becomes an interest burden for both the government and the private sector. And finally, it will end up in the stock market, which will be bad anyway.
Therefore, on the day when inflation is at 4.2%, the Fed cannot lower the policy interest rate. Kevin Watch must make the economic figures look good first. They must decrease first, whether it's inflation or employment rates. They must be excellent first. So that on the day when the policy interest rate is actually lowered, Kevin Watch can say with full confidence, "Finally, the numbers indicate that it is appropriate for us to lower interest rates." That's much cooler.
So, let's start. What are the methods to bring down inflation figures? Start with what?
Point 1: The MOU for a ceasefire that was just signed between the United States and Iran. That will be the one to manage the global villain of inflation. Throw it off this board, at least temporarily.
Point 2: AI. Kevin Watch wrote an article in the Wall Street Journal that AI will be what's called a massive disinflationary force. This means that AI can work efficiently in place of humans, allowing companies to reduce employment and production costs. And that is reducing inflation.
And Point 3: What Kevin Watch just announced on Wednesday, June 17th, is that from now on, the United States will conduct monetary policy in a hawkish manner. The Fed will reduce the quantity of its balance sheet, reduce its balance sheet by doing what? It will reduce the size of its bond holdings. If the Fed doesn't use money to buy bonds, there will be less cash or liquidity in the system. That's the same meaning as the Fed not printing money and the Fed not injecting money into the system.
And if the Fed does this, will Trump be angry? No, why would he be angry? The answer is, even if the Fed doesn't print money or inject money into the system itself, there is still money that can be injected into the system, no different from how the Fed does it itself. That is the method of changing the rules or the keyword that was mentioned: the relaxation of the SLR rule. I will explain what it is later. But I must say first that the Fed has to do this because the Fed, the central bank of the United States, has the duty to fight inflation, yes, but it does not have the duty to destroy the US market. Therefore, the duty that the Fed must perform now, in order to align with the President of the United States, might be the goal of: Okay, we have to fight inflation, but we also have to fight the debt crisis, and we must not let the government bond market collapse, and we must not let the US stock market collapse. Get it? It's not easy, but it seems like it can be done.
Okay, okay. Now, the keyword we mentioned is the relaxation of the SLR rule, right? We will gradually look at it step by step. Let's start with the steps to reach the relaxation of the SLR rule. That is what Kevin Watch talked about at the meeting on June 17th. He said that the Fed will have a policy to reduce its bond holdings, which can also be interpreted as reducing the size of the Fed's balance sheet. This means that when bonds are issued, it's debt. If the Fed doesn't buy, there will be no cash circulating in the economy. This is equivalent to saying the Fed is not QE, not injecting money into the system.
And another thing that will happen is that if the Fed doesn't buy bonds, normally it would be bad luck for the government bond market. Because if the Fed doesn't buy, yields will decrease, right? And it will be a significant factor that causes the yields of long-term government bonds to increase further because there are fewer buyers. Normally, this is not good, but this time it might be good. Because this might be an intention to make the interest rates of long-term government bonds higher to allow banks to make more profit.
Let's look closely. If the Fed sells bonds and causes the yield or return of long-term government bonds to increase, it will create what's called a steep yield curve. Look at this graph. The dashed line is the return on long-term debt. The solid line is the return on short-term debt. If the dashed line gets higher, meaning the return on long-term debt gets higher, the gap here, this gap, is where banks can make profits. By banks borrowing money short-term at low interest rates (the solid line is low) and lending it to the general public, who usually borrow long-term, and making a profit from this gap.
You ask, what is it like? I don't see it clearly. Banks always borrow short-term. But if you ask the general public who borrow from banks, what do they borrow for? Large amounts, for houses, for cars, which are very long-term. Therefore, the way banks make profits is to borrow short-term at the lowest possible interest rates and want the return on long-term interest rates to be the highest. Banks can make profits from this gap. Get it? Is it explained clearly?
Conversely, this steeper curve, suppose the short-term return, the solid line, is not low, or the long-term return, the dashed line, is not high, it will make this gap narrow. If it's very narrow, it means banks can make less profit. Or if the short-term return exceeds the long-term return, if the bank lends, the bank will lose money. If this happens, banks will find it very difficult to lend, or they might not lend much.
Now, back to if the Fed reduces its bond holdings and causes the return on long-term government bonds to yield more, banks will have more opportunities to earn profits. This will incentivize banks to want to lend more. Now, we can move on to the next plan for SLR relaxation.
What is SLR? SLR stands for Supplemental Leverage Ratio. It's a rule established after the 2008 crisis that requires banks to have assets as a buffer against their total assets. And in that proportion, there must be Treasuries or government bonds. But in the SLR rule, they don't allow holding too much. There's a proportion of how much banks can hold in Treasuries or government bonds, it's limited, not like they can hold as much as they want. And in the total assets of a bank, there are many things. For example, suppose a bank has loans, which is money lent out, plus repos, which is short-term borrowing between banks, plus reserves, and whatever is left is what they can use to hold government bonds. Something like that. Actually, there's a formula, but I'm not good at it. Let's skip it.
At this point, when Sai reads this, Sai feels like, "Hmm, why would banks want to buy so many government bonds that they have to limit it?" If they don't limit it, will they buy a lot? Well, I looked it up. The answer is, government bonds are a favorite of banks. Because, first, they have liquidity comparable to cash, meaning they are very liquid. Second, they can be easily used as collateral for borrowing, and they are very good collateral. Therefore, if the SLR rule is relaxed, which limits the proportion of bonds that banks can hold to a certain amount, if it's relaxed, allowing banks to buy more bonds, or buy as much as they want, it will be hidden QE. It will be injecting money into the system without shouting, without shouting technically, but it might actually be shouting. Because even if the Fed says, "The Fed is reducing its bond holdings," but the Fed relaxes SLR, so the buyers of bonds don't have to be the Fed. It can be commercial banks. Therefore, the result will be no different. When there is debt, which is bonds issued, and the Fed doesn't buy, meaning no money enters the economy, right? But if banks buy, money is injected into the economy. And the Fed doesn't have to do QE. Get it? Simply put, it's a method of QE that doesn't come from the Fed, but it's QE that comes from commercial banks. Wow, right? With this method, the Fed can say, "We are not injecting money. We are not printing money. We are reducing our bond holdings. We are reducing the Fed's balance sheet. We are hawkish. We are fighting inflation." And let the banks compete to buy bonds, letting money flow into the system from the banks instead. And when banks are the buyers of bonds, absorbing Treasuries and so on, the Fed can reduce its own balance sheet.
Now, what happens is that the commercial banking sector will grow. And the result for the market will be no different from the way the Fed itself prints money and injects money into the system. Let me explain it again briefly: by just changing the rules by relaxing SLR, the Fed can say, "We are conducting hawkish policy, fighting inflation, while the capital market will not collapse because money is flowing in from commercial banks." And the bond market will not collapse because why? Because commercial banks are buying. And the economy will grow because banks make profits from lending, so banks tend to lend more, and the commercial banking sector will grow bigger. It's expanding, it's great.
And all of this means that, "Oh, then Donald Trump's midterm elections, the market shouldn't turn deep red. If it turns red, it might just be a scratch, not aggressively red, or maybe even green." So it shouldn't affect his votes that much, right?
So, there's a follow-up question: "Hey, then is this method good? Does SLR seem to win everything?" Has it been done before? Yes, it has been done. During COVID, in 2020, Treasuries were excluded from the SLR calculation. That is, SLR was relaxed temporarily for one year. What happened then? Look at the graph. Banks poured money into buying Treasuries immediately. The amount of Treasury holdings increased immediately. As bank holdings of Treasuries increased, what happened to the bond market? Bring up the bond market graph from that time. Yields on bonds went down beautifully. Yields went down, bond prices went up. Wow, the bond market. It answers the question, doesn't it? Why do banks hold so many government bonds?
We're almost there. And then in 2021, as I said, the temporary relaxation was only for one year. The SLR relaxation expired. When it expired, the bond market, which had falling yields and rising prices, went in the opposite direction. After that, yields gradually started to rise again, and prices fell from 2021 until around March 2023. What happened? Does anyone remember? Banks failed, right? Starting with Silicon Valley Bank. Silicon Valley Bank failed, and then within just 48 hours, others followed. Signature Bank followed, then First Republic Bank, then Silver Gate Bank.
You ask, were there other factors that caused them to fail? Yes, there were many factors. But one of the important factors that caused them to fail was holding bonds. Because since 2021, bond yields have risen sharply. 2-year Treasury yields rose from 0.2% to 5%. 10-year Treasury yields rose from 1.5% to 4%. And rising yields cause prices to fall, right? Yes, bond prices fell by 20-30%. And when the assets that banks hold are bonds, and their prices fall by 20-30%, what happens? It causes what's called unrealized losses, accounting losses. Normally, if they don't sell, they will have accounting losses like that, and there will be no problem. The problem is that investors see it. They see that the bank has so many unrealized losses, "This is not good. I'll withdraw my money." And when someone starts to realize it, and a group of people withdraw, then other groups withdraw. And then a large group of people withdraw in a rush, leading to a situation called a bank run, until the bank fails. When people rush to withdraw money like that, what was previously an unrealized loss, not selling is okay. Finally, they have to sell. And when they sell, it's no longer unrealized. It becomes a real loss, a real deficit, until the bank fails.
This is what happened in the past. I'm not saying it will happen again. I'm just telling you what happened when they did something like this.