Fed Balance Sheet, Quick AI, Reserve Currency

Fed Balance Sheet

The Fed expanded it’s balance sheet by $390B over the past two weeks as part of the Bank Term Funding Program (BTFP) in response to the collapse of Silicon Valley Bank. Starting in April 2022, the Fed began QT (quantitative tightening) reducing the balance sheet by $623B. Two thirds of that tightening was undone in just two weeks. It’s unfortunate, but not uncharacteristic.

By the time this article is published, we will have another data point that will likely show further Fed Balance sheet expansion. This trend was underway last week and I would have mentioned it, but I missed it because I had LASIK surgery and was on limited screen time. The expansion of the Fed’s balance sheet explains how markets can rally in the face of bank failures. The Nasdaq entered into an official bull market now that it’s up 20% from the December lows. The further expansion of the Fed’s balance sheet is a critical factor to keep an eye on. It may not be a technical definition of QE (quantitative easing), but it impacts liquidity nonetheless. Further expansion almost certainly translates to equity market rallies.

Quick AI Notes

• Levi Strauss announced they are using AI to model clothing. Oddly they mentioned it was for diversity purposes, which made people upset for obvious reasons. I see it as a pure cost cutting opportunity for Levi and all other clothing brands.
• GPT-4 is noticeably better than GPT-3.5. You can access it with a $20/mo ChatGPT+ subscription. Even with all the hype I suspect a most haven’t actually tried it yet. It’s a remarkable innovation.
• Elon Musk suggests we pause on AI development and has started a petition. I don’t agree. There will be unpredictable costs and drawbacks as well as extreme and equally unpredictable benefits.

Reserve Currency

In 1944, towards the end of WWII, the U.S. and 44 other countries established the dollar as the global reserve currency at the Bretton Woods Conference. The conference aimed to create a new international monetary system to promote global economic stability and cooperation after the end of WWII. The U.S. dollar was pegged to gold at $35/ounce, while other currencies pegged to the dollar. In 1971, Nixon abandoned the gold standard. You can visit this website, WTFhappenedin1971, for an exploration of the impact of that decision.

In the 1970s, major oil-producing countries agreed to price and sell oil in dollars globally, which essentially created a consistent demand for dollar reserves. This agreement is known as the “petrodollar system,” and it has played a significant role in reinforcing the U.S. dollar’s reserve currency status.

Recently, China has started pricing and settling oil transactions in yuan instead of dollars with both Russia and Brazil. Changes like this represent the potential for increased volatility across all financial markets. As a result, you can expect more volatility in currency, fixed income, commodities, and other markets. Volatility in fixed income markets is currently at 2008 GFC levels.

Otherwise, the U.S. is still the country of choice for storing international assets. No country is immune from corruption, but the U.S. serves its function reasonably well when it comes to respecting property and asset rights.

Regarding the U.S. dollar’s value, the U.S. Dollar Index (DXY), which measures the value of the dollar against a basket of major currencies, is at extreme highs relative to modern history. This high valuation is putting considerable pressure on all international markets, to the point that it has shown up as a pain point in recent quarters of U.S. earnings. A drop in the dollar would be a healthy correction and could help avoid a potential emerging markets crisis while also benefiting U.S. earnings.