Fed injects $278 bn in the US interbank market: Is it the dawn of recession?

Sankalp Shangari
Oct 4, 2019 · 5 min read

After more than a decade, Fed experienced the need to intervene in the US interbank market by injecting a total of $278 billion within 4 days. Fed will continue to inject $30 billion every week until October 10 making the total figure touch an approximate of $400 billion. This step was taken after the repo rate reached 8% from 2% implying some banks, probably a big one, ran out of liquidity and was in desperate need of cash to stay in business.

This would have created a negative impact on the Fed rate as well which is supposed to be between 2 to 2.25% (it had already touched its higher mark before Fed stepped in). This interest rate was beyond our comprehension since the interest rate of the repo market should be lower than the interest rates of unsecured markets as the former market deals in oh-so-secure and “risk-free” US treasuries.

Then what led to this interest rate increase and what prompted the intervention of Fed? Although Fed officials dismissed this liquidity breakdown as a hiccup which resulted from an unfortunate combination of events in the bonds market and tax payments system, I and several others choose to believe differently. It is hard to believe that it was just a ‘hiccup’ when there are other economic warnings glowing in red including the negative yields of $17 trillion of the bond market, the heated China-USA trade war and the emerging recessionary indicators of the manufacturing industry.

Let me shine some light on the not-so-risk-free nature of US treasuries which is the underlying cause of this liquidity breakdown. The fact that a bank was ready to borrow money at a 10% interest rate against the US treasury which yields an interest of approximately 2% or less indicates the lack of trust of major banks in the US treasuries. Why weren’t other major banks ready to lend money against collateral like US treasury which is considered highly risk-free?

In 2018, the IMF estimated that the same US treasury was asset was used at least 2.2 times. This implies, roughly 3 people believe that they own the same asset implying there are more US treasuries on paper than they are in reality. This shows how fragile the traditional financial system is and also that major banks are aware of this fact. That is why they stopped lending as soon as they witnessed a fellow bank running out of liquidity to ensure they are not caught in the fire.

The first step that Fed takes in the case of run-on repo is injecting money into the market. In 2008, when the liquidity crisis occurred, Fed injected $800 bn (twice of what is being injected presently). Things might not seem as bad since the equity market is still stable but it remained stable during the start of 2008 liquidity crisis.

From the look of it, things are not as rosy as they seem to be and we might be overlooking another big recessionary period that may come sooner or later. So, is it time that we shift our attention to Bitcoin for good?

In such an inching environment towards an economic slowdown, Bitcoin can either prove itself to be a safe haven like gold prompting a major growth of its total buyer or it can become a dump and run asset. Eventually, everything comes down to trust. Presently, at exactly this second, Bitcoin is a mainstream asset and in the wake of its upcoming halving and the introduction of likes of Bakkt, it is overlooking a potential rise in its value.

After the exhibition of first obvious reaction i.e., holding cash, people might start realizing the value of Bitcoin and start pumping even minuscule amounts of investable money into crypto. If such a scenario occurs, Bitcoin’s value will turn around and jump at a great pace. Especially with the nearing of Bitcoin halving that is scheduled to occur in May or June, Bitcoin’s value would increase by at least 50% if not more.

Additionally, people and major banks will turn to distributed ledger technology with more seriousness to instill transparency into the financial system which is so badly missing in the traditional financial system. This recession, if it comes, will teach the world some major lessons in favour of Blockchain and its implications.

The banks, financial institutions, and people, in general, will be far more keen to have a transparent exchange of value via digital assets instead of hundreds of fractional reserves or IOUs as they call them. These are nothing but a chain of derivatives. As a common man, you would rather settle everything immediately via a distributive ledger technology in a transparent manner instead of opting for an opaque system that the private and central banks are employing presently.

As we now know, banks are not even able to calculate who owns how many derivates which is a very scary situation and erodes our trust in the system. In the end, everything comes down to trust and trust boils down to a payment mechanism or a stable coin which could be a non-sovereign corporate stable coin or a mix of stable coins. The greater implications of the current economic scenarios are yet to be discovered. Nothing will be visible immediately and it might take more than a decade before one stable coin emerges as the winner with a massive adoption.

This also implies that if this recession comes, it’ll be here to stay for longer than previous recessions. Parallelly, gold will observe a surge in prices as people are pulling their money out from the market in light of negative yields and they are looking for a safe and profitable investment option. Until Bitcoin gains the trust of the market, people will put their money in gold which will always be the winner in any recessionary scenario.


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Sankalp Shangari

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Investment banker turned tech entrepreneur and investor. Author, speaker, investor in startups

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