by Chris Black
In o/n repo, HQLAs (high quality collateral, usually Treasuries) are pledged to secure cash (the principal minus a haircut).
At the end of the repo transaction, the collateral and principal payment are returned… plus interest (the repo rate, which is SOFR for Treasury repo).
Interest is the price at which you part with money for a period of time, that is, the price at which you part with liquidity.
It is the time value of money.
In shipping, cash (the freight rate plus a security deposit) is pledged to lease ships, cargo, and containers.
The duration of the loans to lease the ships and fill them up with cargo is a function of the time it takes to sail from port A to port B – the time value of money meets the time it takes to ship foreign cargo from port A to port B. At the end of a cargo haul, the security deposit and ship are returned.
If forces (a cash shortage) were to disturb repo and send o/n rates higher, the Fed steps in as a lender of last resort (libertystreeteconomics.newyorkfed.org/2022/01/the-feds-latest-tool-a-standing-repo-facility/) and conducts o/n repo operations such that rates are capped to the upper bound of Fed Funds (550bps (www.federalreserve.gov/newsevents/pressreleases/monetary20231213a1.htm#:~:text=Conduct%20standing%20overnight%20repurchase%20agreement%20operations%20with%20a%20minimum%20bid%20rate%20of%205.5%20percent)).
Simple. The Fed can restore any problem so long as it is a nominal one.
If forces (a ship shortage) were to disturb shipping and send freight rates and security deposits higher, who is to resolve this?
The answer is of course the U.S. military.
The U.S. military used to be able to restore any real problem, but recent history suggests this ability is waning and this trust is misplaced.
Consider if Iran were to close the Hormuz— would oil skyrocket to $150/bbl in a day?
Would natural gas spike to $20/MMBtu? Maybe.
But this attention could be misfocused.
The tail risk would be for Russia to link gold to Urals (Russian oil) as an off-dollar settlement medium, sharply increasing the intrinsic value of gold and sharply decreasing the value of Treasuries/USD reserves.
It would be a pivot away from inside money and towards Bretton Woods III.
Russia won’t produce more oil, but would ensure that there is enough demand that production doesn’t get shut.
And it would also ensure that more oil goes to Europe than to the U.S. through India.
And most important, gold going from $2,000 to $3,000 or more would increase the value of Russia’s gold reserves and its gold output at home and in a range of countries in Africa (t.me/CIG_telegram/33810).
If its not light sweet crude from Kuwait paid for in dollars, it’s going to be Urals paid for in gold.
The world needs energy to keep spinning…
Such a gold spike would create an overnight nightmare for Western commercial banks active in the paper gold market, which includes most, as their asymmetric liquidity positions (long Treasuries, short gold) would quickly unravel like that of a hedge fund.
At the same time, the Fed would be trapped into doing QE as the LBMA is flooded with synthetic gold (www.bullionstar.com/blogs/bullionstar/what-sets-the-gold-price-is-it-the-paper-market-or-physical-market/) in an attempt to restore price. Samantha Power and the U.S. State Department have already frozen Russia’s FX reserves — surrendering any leverage.
What stops Russia from going broke?
The default answer to this is to say that the U.S. would park its superior military units in the Indonesian straits of Malacca, Lombok, and Makassar, blocking 80% of oil imports from reaching Chinese shores (www.scmp.com/week-asia/article/2186449/explained-south-china-sea-dispute). Check.
However, this ignores the Northern Sea Route (NSR), a path Russia develops explicitly as a means of increasing oil exports to China (www.voanews.com/a/russia-shipping-more-oil-to-chinese-ports-via-arctic-route-/7296018.html).
Pre-Ukraine war, the NSR was mostly used to transport Arctic oil and gas to Europe. But the direction of good deliveries has turned east (www.npr.org/2023/08/31/1197084341/russia-is-sending-crude-through-the-arctic-to-china).
Any response would necessitate blocking Russian sea activity, but this time in Europe.
Does that explain NATO’s paranoia in the Baltics, specifically (t.me/CIG_telegram/41105)?