The late, great Walter Wriston once said, “Capital goes where it is welcome and stays where it is well treated.”
Once you understand that axiom, the seeming chaos and finer details of economics and monetary policy begin to tell a story. Albeit a Shakespearean tragedy. So when I use technical and data I’m just telling the story of how money is trying to find a place where it is welcome and where it can stay unmolested.
A great example of this is what we call Yield Curve Inversion. Since the 1970’s an inverted yield curve has predicted recessions with 100% accuracy. It may take a few years to happen, but ultimately it does. So what is yield curve inversion?
We pick up our story in March of 2022, where the yield curve was flat. That means interest rates for bonds that trap your money for a year and bonds that trap your money for ten years gave you pretty much the same amount of interest. A few weeks later, the Federal Reserve raised interest rates. Investors were happy to lock up their money for 5 and 10 years because they believed that the Federal Reserve would lower interest rates soon as a recession approached. Said another way, investors predicted that any 3 month treasury yield would be temporary, so let’s lock in 5 and 10 year money.
However, the Federal Reserve had to contend with out-of-control inflation. So, instead of lowering or holding steady on rates, they went hard in the paint. On June 16 of 2023, they finally paused after a historically rapid and aggressive series of rate hikes. What we are left with is 3 month treasury rates kissing 5% and 10 year rates at around 3.76%. That means investors believe that 3.76% return is a fair trade for being trapped for 10 years.
If your IRA only returned 3.76% over the next 10 years, would you feel that your money was well treated? That’s quite pessimistic. This is why yield curve inversion is a bond investors way of saying the Federal Reserve will steer the economy into a recession.
In February and March of 2023, people started realizing that their money wasn’t well treated at their local bank. Essentially, they were getting 10 year treasury yield on their cash, in the 3% range or less. So people at banks like Silicon Valley Bank and elsewhere looked around and realized they could find a better deal in money markets. By May of 2023, over $1 Trillion dollars had left the commercial banking system. What’s left are banks with old, low yield treasuries that they have to sell at a loss while deposits are fleeing. They can’t compete with money market mutual funds because they’ve been left high and dry by rapid Fed rate hikes.
This is a very, very bad thing. But remember, money flows where it is appreciated and stays where it is welcome.
In a free market, there’s not much we can do about money finding a new happy home. However, in a toxic relationship we can use a few other techniques. First, we can use fear and let investors know that money market funds are not FDIC insured. Never mind that the FDIC has spend all it’s money year to date on ongoing bank bailouts. Second, we can use guilt. We can tell people it’s the right thing to do to support your local bank. Kind of like “two-weeks-to-flatten-the-curve” but for yield instead of infection.
Then we can use force. But let’s not call it force. Let’s call it “friction.” Let’s implement fees for money transfers. Let’s impose longer “settling” dates so that it takes longer for your money to actually be available for spending or transfer. And then finally, let’s call for a patriotic moratorium on leaving the bank. Kind of like staying together for the kids even though your spouse is abusive.
If you hear terms like bank friction or smart liquidity, beware the traps. Keep in mind that your capital is welcome but it is not being well-treated.
Related: My Twin Flame Janet Yellen