What the Economist article did not say, and I believe is worth noting, is something few are focusing on – the Treasury is required, as mandated by the Treasury Borrowing Advisory Committee in 2015, to keep a cash balance of $400 billion on deposit at the Fed in case of a government shutdown. Think of it as emergency money to pay bills. Later, the Treasury is required to get their account balance back up to $400 billion. The current balance is just $194 billion so the Treasury needs to issue more than $200 billion in Treasury Bills, Notes and Bonds to get back to $400 billion. Investor cash from somewhere is buying the Treasury debt so that is an additional drain on system-wide cash.

The Treasury Borrowing Advisory Committee also said that whenever deficit is higher, the cash balance should also be higher than $400 billion. Well, the government is currently running a budget deficit of more than $1.2 trillion annually (spending more than the tax revenue it takes in). So, the need requirement is higher than the $400 billion requirement but I’m not sure of what the ratio to budget deficit is but it has to be higher. And does anyone see the budget deficit getting better any time soon? I don’t.

When the Treasury draws from the cash kitty, they are injecting money into the system. Think of it as another form of quantitative easing (QE). They are currently pulling money out of the system by issuing more debt. Think of the $200+ billion that is required to get back to $400 billion as quantitative tightening (QT). Last week’s turmoil in money market funds is a warning sign. It is an “Unintended Consequence in a Complex System.”

My guess is that within three months or so the Treasury should be back at the target level. Unless this week’s shock slows the pace. Ultimately, the more liquidity you drain from the system, the more it hits equities. I also believe the recent bond market sell-off is partly caused by the Treasury’s need to issue more debt. I expect a slowdown in earnings, a slowdown in the U.S. economy and a short-term top in the equity markets. Risk remains high.


Global Economics