The reverse repo market is in the news again, reaching a record $2.4 trillion. As inflation stays high, this number will grow exponentially. Unfortunately, most people need to learn what it is and how dangerous it is to their portfolio. The chart should let you know we are in uncharted territory. This article will simplify the idea and explain the repo market.
The repo market is how the Federal Reserve manages the amount of cash in the system. The repo market is short-term loans of assets or cash from a bank to a bank or a business. Repo loans usually last 24-72 hours but can last a week. The repo market consists of two parts: repo and reverse repo. Reverse repo transactions can be, but are not necessarily, short-term loans. Repo stands for repurchase agreement.
For the sake of this article, we will primarily focus on the market exchanges between the Central Bank and smaller banks. However, let’s use a bank-to-business example to understand the bank-to-bank model. Suppose you are a trucking company. You have completed the delivery but still need to be paid the $300,000 on the purchase orders. Tomorrow, you will have $250,000 due in payroll and need the cash to pay. You would use the $300,000 purchase orders as collateral for a short-term loan to solve your liquidity problem.
You would repay the loan and a slight interest, and the bank would release the purchase orders. This would be a repo transaction. The trucking company needed cash, so they temporarily sold an asset (the purchase orders). When the trucking company got paid, they repurchased (“repo-ed”) their P.O.s and repaid the loan.
If a bank needs cash, it will behave similarly to the trucking company. It will trade assets to the Central Bank, usually Treasury Bills, for a short-term loan. The bank agrees to repurchase the Treasury Bills at an agreed-upon higher price, known as the repo rate, a few days later. If the bank has too much cash on its balance sheet, it will make the opposite transaction and trade cash for Treasury Bills. This is called reverse repo. At the time of this article, the repo rate is 3.25%, and the reverse repo is 3.05%. The current repo and reverse repo rates can be found here.
Understanding the Reverse Repo Market
Reverse repo transactions happen when a bank has too much cash. The bank is exchanging cash for Treasury Bills. It may seem odd to think a bank has too much cash, but it is about accounting. When a deposit is made into a bank, it becomes the bank's liability. When a bank makes a loan, it becomes an asset. Banks don't want large amounts of cash sitting on their balance sheet. Inflation quickly destroys cash, and the banks want the money to be making money. Banks want to change their liability into an asset as quickly as possible. Banks buy Treasury Bills because Treasury Bills are considered the safest asset on the planet. A Treasury Bill is a highly liquid short-term loan to the government for one year or less. Investors consider Treasury Bills safe because the government can always print more money to repay it, and there is a very short time horizon. If the bank needed cash for a withdrawal, they would resell the Treasury Bills in the repo market.
Since banks don’t want large amounts of cash, banks encourage businesses and corporate accounts to deposit their money into money market funds (MMF). MMF are low-risk, low-return accounts that buy primarily safe assets like Treasury Bills. Last year, several news outlets reported banks doing precisely this.
It is not in the government's best interest to rely too heavily on short-term financing like Treasury Bills. It is too expensive. The government prefers Treasury Notes and Treasury Bonds. Treasury Notes have a duration between two-ten years. Treasury Bonds have a duration of usually 20-30 years. The longer-term instruments make funding cheaper in the future. This accounting tug-of-war translates into a high demand and low supply of Treasury Bills as banks try to clear cash from their balance sheets.
Why Is It Important?
Warning: Some of the following content is scary and may sound conspiratorial.
The constant back and forth of the repo and reverse repo markets is like a game of three-card monte. To figure out what is going on, you must always know where the cash is. Like three card monte, the dealer (the Fed) has cohorts you don't know working against you. When the Fed was doing quantitative easing, they bought $120 billion worth of Treasuries monthly. When the Fed holds all the Treasuries, the banks have the cash. Banks have a time-sensitive and vested interest in getting cash off their books, so they want to make as many loans as quickly as possible. In this situation, it makes sense that interest rates are low, and loans come easy. However, the Fed is now selling its Treasuries and raising interest rates.
With all the cash creation over the last few years, ask yourself, “who has the cash?” The Fed has the cash! If the Fed has the cash, then the banks have the Treasuries. The Fed has a record $2.4 trillion in the reverse repo fund. When you get it, it should give you a scary realization. The Fed will raise rates until they break everything and immediately infuse $2.4 trillion into the system! It is a pre-planned boom and bust of the economy hiding in plain sight.
Wealth cannot be created or destroyed, just transferred. We are watching the setup for the most significant transfer of wealth in human history. Rising interest rates will transfer the wealth of stocks and bonds. Retirement accounts will be transferred. Investment accounts will be transferred. Housing prices will be transferred. Unemployment will be astronomical. Where will the destroyed wealth go? It will go to the bankers and the politicians who are privy to the timetable. The everyday investor will get poor. It is a high-stakes game of musical chairs against the people controlling the music. The most logical thing for a dishonest banker is to collapse the entire economy to rubble. When the economic pain is so great, and asset values are entirely in the toilet, do an about-face, infuse all the money back into the economy, and drop interest rates to nothing. Exceptionally few people other than the bank would be able to buy any assets. The bank would successfully remove competition, buy assets on the cheap, and then could quickly prop up prices through the boom cycle laughing the entire time.
For everyone’s sake, let’s hope the Fed is honest. From my vantage point, they are either corrupt or incompetent. If I am correct, then either way, woe to the world. If you trust a group of private bankers with a license to print and demand taxes, you should probably stay in cash to ride the current storm out. Is it possible that the Fed is planning to use its $2.4 trillion market bazooka for personal gain? If so, then you should probably protect yourself with precious metals. The game is the back and forth of paper like a game of hot potato. You take the cash, no, you take the cash. You must get outside the game to avoid being a pawn in the paper-shuffling high-finance two-step. Many investors want to put 5-20% of their net worth into precious metals. Get outside the game with precious metals today.
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