America is heading into an irresponsible financial boom

Markets may be missing the big story. Professor Tim Congdon of the International Institute for Monetary Studies said the Fed is aiding and abetting the monetization of America’s deficits. “What do they think they’re doing?” he said.

Growth in the money supply may seem modest at first glance, but the true scale is belied by the fact that U.S. money market mutual funds grew by 15 percent last year to nearly $7.4 trillion.

The critical point is that these funds are allowed to purchase only one type of asset: short-term U.S. Treasury debt that has less than a year to maturity. A $900 billion increase in such deposits last year erased half of Trump’s $1.8 trillion borrowing needs.

“It is clear that money market funds are now vital to financing the U.S. federal deficit,” Congdon said.

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Congdon also said two-thirds of the entire deficit was monetized in one way or another. US officials are creating a new spasm of inflation a year or two from now and risk repeating the big monetary mistake made in the early phase of Covid. “They don’t seem to have learned anything,” he added.

US Treasury Secretary Scott Bessent called this practice carried out by the Biden administration last year a scandal, flooding the debt market with a record number of short-term treasury bill issuances.

The US Treasury is essentially acting as a rival central bank and doing its own QE. Stephen Miran, Trump’s economic guru and now his man at the Fed, said last year that this trick of the hand was “backdoor stimulus” and was “equivalent to a one-point cut in the Fed’s policy rate.” Really.

But now the Fed is joining the party by halting QT and preparing to become a net buyer of US debt. In a way, it’s a justified move. Money market rates have become unstable.

The stress was also reflected in the secured overnight financing rate. The difference over this rate was 16 basis points above the interest the Fed pays on bank reserves; this is the highest level since the financial shakeups at the beginning of COVID.

The Fed has been burned before. A sudden rise in money market rates in 2019 damaged the company’s reputation for competent management.

The Truss event in 2022 terrified central bankers around the world because of the dangers hidden in the dark corners of the derivatives market.

Bank of America’s Cabana said the Fed’s fresh bond purchases would not be QE, but markets might conclude that it is. The Treasury’s issuance of more treasury bills and their immediate closure by the Fed could “appear coordinated” and give the impression of “fiscal repression,” even if that was not the intention.

So what exactly are the Fed’s intentions as Trump loyalists move through the agency and the White House puts pressure on former Biden appointees?

Bernard Connolly, senior Fed advisor and author You Always Break What You Love: Central Banks and the Murder of CapitalismHe said the Fed was on the primrose path to financial dominance.

“I don’t think they are deliberately trying to close the deficit, but what they are doing may have that effect. They don’t want to make it harder for the Treasury to sell debt, so they are stretching a little bit,” he said.

“Eventually, central banks almost everywhere will face the challenge of bailing out their governments. Fiscal dominance is inevitable,” Connolly added.

If you back off, the situation is already beyond weird. The Fed’s balance sheet today stands at $6.6 trillion, or 22 percent of GDP.

This is higher than US$800 billion (6 percent of GDP) since the start of the QE offensive after the Lehman crisis. But Fed insiders now say a larger balance sheet is needed to keep up with economic growth.

The ratio of reserves to bank assets is still 12 percent, a level classified as “abundant” by the New York Fed itself. Banks just reported higher earnings.

The Fed has been burned before. A sudden rise in money market rates in 2019 damaged the company’s reputation for competent management.

But the Fed says the financial system needs more energy. As the French say, ça cloche.

In its latest Fiscal Monitor report, the International Monetary Fund estimates that the U.S. general government deficit will rise to 8 percent of GDP by the late 2020s and remain stuck at 7.6 percent in 2030.

By then the debt ratio will rise 20 percent to over 143 percent of GDP and decline, surpassing Italy and Greece.

The pitfalls of this were expressed two years ago by a man named Stephen Miran while at the Manhattan Institute: “We Eat Our Corn: Runaway spending is eroding America’s ability to respond to future economic crises.”

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He warned that if the United States falls into another recession with a deficit above 6 percent of GDP and triple-digit federal debt, it will lack the countercyclical punch to fight its way out of the crisis. “Running a procyclical fiscal and monetary policy is a terrible idea,” he said.

It’s hard to imagine a more cyclical mix of prime pump policies than the US’s 2026 menu. The fiscal impulse will shift from a net drag of 1 percent of GDP this year to a net drag of 1 percent of GDP next year.

The US Treasury makes nearly a trillion a year through the back door. The Fed is reducing interest rates to combat rising inflation. Soon, an extra “coup de whiskey” will be added to fresh treasury bill purchases. And all in time for the midterm elections in November 2026.

Forgive me for being an old cynic, but I would suggest that America is headed for an irresponsible financial boom akin to the final coup of the Roaring Twenties and Roaring Nineties. The adulteration trade is still young.

Telegraph, London

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