The Next Phase Of The U.S. Just Started

Kevin Walsh was nominated as Fed chair by Trump. From day one, there was a clear vision of what Kevin was supposed to do. Trump wanted him to lower interest rates because Trump wants the economy to grow. Jerome Powell did not want to lower interest rates because the US has a huge debt problem. The plan was to solve these problems without triggering a crisis.

Three-Step Plan from Luke Growman03:32

Step one: Kevin Walsh lowers interest rates. The Fed only controls the short-term interest rate for bonds like the two-year treasuries. This makes borrowing cheaper in the short end, loosens the economy, and gives Trump the growth story heading into the midterms. Step two: At the same time, the Fed starts shrinking its balance sheet, meaning the Fed will stop holding as many bonds. Normally when the Fed sells bonds, that pushes long-term interest rates up, which is actually intentional here because it creates a steeper yield curve. A steeper yield curve means banks can borrow money cheaply in the short term and make more money in the long end. This is free money for the banks through the spread they rely on to make money. For this to happen, short-term rates have to be lower and long-term rates have to be higher.

Supplemental Leverage Ratio (SLR) and Bank Deregulation05:02

Step three is to deregulate the banks by removing the capital requirements that limit how many Treasury bonds banks are allowed to hold. This regulation is called the supplemental leverage ratio or SLR. It is a post-2008 financial crisis rule that required banks to hold a certain amount of money as a buffer against their total assets including Treasury bonds. Banks have hit a wall because they want to buy more treasuries but the regulation says it is full. When COVID hit in 2020, the Fed temporarily exempted treasuries from the SLR calculation for about a year. Banks instantly piled their money into treasuries and the bond market started to function very smoothly. When the exemption ended in March 2021, banks had to lower their treasury holdings and the bond markets did not like that. Kevin Walsh's plan is to make that COVID exemption permanent or at least significantly loosen the SLR so banks can hold way more treasuries without it counting against their capital requirements.

Effect of Removing SLR Limits06:31

Once those limits come off, banks pile into treasuries with huge amounts of leverage. They will borrow money cheaply, buy bonds, and pocket the spread. By doing that, the banks absorb all the Treasury bonds the Fed will sell. The Fed shrinks its balance sheet and the commercial banks expand. The net effect on the bond market is almost identical to the Fed just buying the bonds itself. This is basically quantitative easing, or money printing, but laundered through the commercial banking system instead of the Fed's balance sheet. If someone says the Federal Reserve is printing money again and that it is inflationary, the Fed can say they are not because they are reducing their balance sheet. By removing the lending constraints on the banks, they can now buy treasuries and lend money to Main Street. Kevin Walsh can say he is doing productive deregulation, the banks are helping small businesses, and it is helping Main Street, not Wall Street. At the end of the day, it is a Rube Goldberg machine for money printing.