Postcards: Explain Central Banking as If I'm a Small Child... or a Golden Retriever

The film Margin Call reminds us that explaining modern finance is complicated... It's better that we try to find a metaphor - and this one doesn't involve music or dancing. ͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­͏   ­ Forwarded this email? [Subscribe here]() for more You are a free subscriber to Postcards from the Florida Republic. To upgrade to paid and receive the daily Republic Risk Letter, [subscribe here](. --------------------------------------------------------------- [Postcards: Explain Central Banking as If I'm a Small Child... or a Golden Retriever]( The film Margin Call reminds us that explaining modern finance is complicated... It's better that we try to find a metaphor - and this one doesn't involve music or dancing. [Garrett {NAME}]( Apr 3   [READ IN APP](   Editor’s Note: Today, I’m explaining what is happening in the market… based on a breakdown of a piece I wrote this morning at Republic Risk. [I want you to take a minute to read a breakdown of the modern artificial intelligence market]( and the smarter way to profit from it… without the risk and the insanity of today’s wild price swings. Without this investment… [the entire system is a house of cards.]( Dear Fellow Expat: One of the problems - and my publisher agrees - is that I get into the weeds. Central banking is a language that I understand. This stuff might as well be in Latin - something I became fluent in for some reason in high school. Then, I chose an even more “damaging to your health” profession in modern finance. People's eyes glaze over when they hear terms like repo market… money market… reserves… and Treasury General Account. As we move into April, I’m expecting a lot of choppiness due to the impact of tax payments on the money markets and banking reserves… something I’ve been highlighting since mid-March. Pull liquidity out of the market, and things can get tricky. In the film Margin Call, John Tuld (probably no relation whatsoever to real-life Lehman Bros.’ CEO Dick Fuld) is the CEO of a bank on the brink of collapse. He asks one of his young risk managers to explain to him the dangers he’s discovered in his financial models. Tuld says: "Please, speak as you might to a young child…or a golden retriever. It wasn't brains that got me here, I can assure you of that." Let’s give this a go… [Upgrade to paid]( The Economy Let’s think of the economy as a massive garden. I own an acre of land and grow all sorts of fruits and vegetables representing companies and others in need of what? Water. The money market is the irrigation system that waters the plants. Now, a garden can’t have too much water. It has to be just right to grow properly. Water is the lifeblood, just like capital in an economy. So, this money market is a sprinkler system that aims to distribute these precious resources evenly across the acre. The good news is that in tough times, it can inject more water… And when it’s already raining, and plants are growing… it can inject less water. This ensures the plants (businesses and consumers) get the right amount to thrive. Hey… we’re off to a pretty good start here. What About Banking Reserves? Okay… this is a little tougher… Banking reserves (the banks' capital) are storage tanks that feed those sprinklers. The tanks hold water, and the garden’s grand caretaker (the Fed) controls how much each tank must hold and how much can be used to water the garden. I hope you’re following me. The Federal Reserve tells banks how much money they can and should hold in reserves… all of the banks in the Fed system. In this case, one group (a central authority like the Fed) would monitor all the farms to decide how much water can be stored in tanks to water these gardens. It’s pretty much the same thing… only the golden retriever is more interested in the latter. When the central gardening authority thinks the plants need more water (basically, the Fed argues that the economy needs more stimulus), it may lower the amount of water that needs to stay in those tanks. This is like the Fed’s banking reserve requirements. So… again… you have a big garden (the economy), a sprinkler system (the money markets), and water tanks (banking reserves)… all being directed by a central gardening authority (the Fed). Now to the Repo Market Oh boy… Now we’re starting to lose oxygen this far up the mountain… The repo market is like a system in which a gardener running low on water in his tank could borrow water from a neighbor’s tanks overnight. Then, the gardener promises to return that water in the morning, plus some extra water to the other gardener. Banks - that might need cash - will borrow from this overnight market. It’s the interest rate that is the tricky part… A spike in the interest rate is like an increase in the amount of water the gardener owes to the neighbor’s tank. Why have this? Because you want to ensure that you have water… The gardener might expect rain to come (a bank’s income), but we have to ensure that all of the gardens in the neighborhood are watered without having to change all of the sprinkler systems. Tax Payments in April Okay… this will get easier for a minute… This all brings me to the challenge over the next few weeks. The United States economy is strong (based on GDP numbers), and we had a very strong market rally in 2023. This is similar to what happened in 2021. Markets did great. But in April… Americans owe taxes. In 2022, $600 billion in taxes were paid, which weighed on the money markets and banking reserves. Dealers like a very specific level in reserves—about $3 trillion as a threshold. We’re at $3.5 trillion now. So, a big tax payout in April could drain money from banking reserves and the money market… putting pressure on banks. Let’s go back to the garden… In April, the gardeners would need to give up some of their stored water (tax payments) and return it to the local reservoir (Uncle Sam) as a tax payment. Now… all of a sudden, there’s less water available to the plants. That can slow their growth… just like a lack of available capital can slow an economy’s growth. What happens is that the Grand Gardener of all the farms (the Federal Reserve) will determine if they need to add more water back into the system to ensure that there isn’t a massive slowdown in plant growth. If there’s a big economic slowdown due to large tax payments… they’ll get creative and look to provide stimulus. It turns out that the Fed is on the verge of tapering its Quantitative Tightening program - which has effectively let water evaporate from the reservoir without replacing it. Treasury General Account and Liquidity Oh, shoot me now… Finally, there’s the Treasury General Account (TGA). Think of this as the massive reservoir where the government stores the collected water - you know, the government's money. This tank's water can affect how much is in the rest of the system. If the caretaker decides to store a lot of water in the TGA, the sprinklers are less available, making all gardens drier, ie, reducing liquidity in the economy. On the other hand, if the caretaker uses water from the TGA to water the garden, it adds liquidity, making it easier for plants to grow. Now, this all matters because a big increase in the TGA isn’t positive for the economy's liquidity unless the government’s outflows surpass what is coming in. So it all comes down to how much money the U.S. taxpayers owe this year. There is one last caveat, though. If those tax payments come in on the low side, that can also weigh on concerns about the state of U.S. Treasuries… as America faces a flood of debt in the future and deficits in the 10% range in the 2030s. That’s where… you don’t want to be a farmer… let alone a person sitting on cash.  Of course, there’s a big X-factor out there - the impact of artificial intelligence on our entire economic and monetary system. It’s going to have an immense impact on all the “gardeners” out there in the economy. Anyone and everyone with cash in the market needs to [really understand what lies ahead](. Check out [this recent letter written by one of the top voices]( in all of financial research.  Stay positive, Garrett {NAME} Disclaimer Nothing in this email should be considered personalized financial advice. While we may answer your general customer questions, we are not licensed under securities laws to guide your investment situation. Do not consider any communication between you and Florida Republic employees as financial advice. Under company rules, editors and writers cannot recommend their positions. The communication in this letter is for information and educational purposes unless otherwise strictly worded as a recommendation. Model portfolios are tracked to showcase a variety of academic, fundamental, and technical tools, and insight is provided to help readers gain knowledge and experience. Readers should not trade if they cannot handle a loss and should not trade more than they can afford to lose. There are large amounts of risk in the equity markets. Consider consulting with a professional before making decisions with your money.   [Like]( [Comment]( [Restack](   © 2024 Garrett {NAME} 548 Market Street PMB 72296, San Francisco, CA 94104 [Unsubscribe]() [Get the app]( writing]()