The Albrecht family of Germany is one of the richest in the world. They earned their wealth from innovations in price-slashing for European grocery shoppers. Their Aldi grocery chain is now spreading across the United States and bringing savings to millions of lower- and middle-income families. I profiled Aldi in this recent post.

Rather than bashing the rich, Bernie Sanders, Elizabeth Warren, and other liberals should be praising wealthy entrepreneurs and corporations, such as Aldi, that are reducing poverty through aggressive market competition.

Aldi was the subject of a fascinating profile in the UK Guardian. Snobby British observers did not think Aldi would succeed because they assumed consumers didn’t mind high prices. Aldi proved them wrong. UK grocery chains were used to fat profits. Aldi eliminated them. Sanders and Warren take note: open markets and intense competition transfers wealth from corporations to moderate-income consumers.

Here are some excerpts from the Guardian piece by Xan Rice:

On a Thursday morning in April 1990, in the suburb of Stechford in Birmingham, a strange grocery chain started trading in the UK. It only stocked 600 basic items – fewer than you might find in your local corner shop today – all at very low prices. For many products, including butter, tea and ketchup, only a single, usually unfamiliar brand was offered. To shoppers accustomed to the abundance of Tesco and Sainsbury’s, which dominated the British grocery sector with thousands of products and brands, delicatessens, vast fridges and aisles piled high with fresh fruit and vegetables, the range would have seemed dismal.

The managers of this new shop, which was called Aldi, had not bothered to place a single advert announcing its arrival – not even an “Opening soon” sign outside the store. Strip lights illuminated the 185 sq metre store, and from the ceiling hung banners listing prices for the goods stacked on wooden pallets or displayed in torn-open cardboard boxes on metal shelves.

… most people were confident they would fail in Britain, where there was a discernible snobbery about discount stores. When a reporter from the Times visited an Aldi store in Birmingham the following year, he thought it represented the “anonymous, slightly alarming face of 1990s grocery shopping”, without any pretence of sophistication. “One looks in vain for avocados or kiwi fruit.” The British supermarket giants, whose 7% profit margins were the world’s highest, were even more dismissive.

… But today, the boasts of Tesco and Sainsbury’s read like a classic example of business hubris. While the major supermarkets dozed, convinced that many people would not be seen dead in a discount store, the German chains quietly turned the sector on its head. Nearly two-thirds of households now visit an Aldi or Lidl branch at least once every 12 weeks, according to the research firm Kantar Worldpanel.

… By sucking in shoppers and, as former Aldi UK CEO Paul Foley puts it, “sucking the profitability out of the industry” – profit margins of 2–3% are now the norm – the two German-owned companies have forced the “big four” supermarkets to take drastic measures.

… The stores’ overall feel is still more gritty than pretty. In the latest Which? magazine survey of its members’ favourite supermarkets, published in February, shoppers ranked Aldi third overall, behind only Waitrose and Marks & Spencer, despite giving it only one star out of five for store appearance. Merchandise is still displayed on pallets, in plastic crates or cardboard boxes – or arranged haphazardly, as in the case of the one-off, bargain-priced goods found in the “middle aisle”, which hosts a rapidly rotating assortment of ultra-discounted oddities.

… Packaged products in all supermarkets come with a barcode, which the checkout assistant will locate and scan. But look closely at a packet of Aldi toilet rolls and you will see not one but four barcodes: two long ones down the sides, and one on each large flat surface. A container of butter has three barcodes; a bag of carrots has two. For kidney beans, a pinstripe barcode is wrapped around half of the can. This means that whichever way the assistant holds the product the scanner will register it.

… what Aldi managers describe, straight-faced, as “the thrill at the till”: your trolley full of goods has cost less than you thought it would. The rushed, no-frills experience isn’t something you merely endure for the sake of saving money; the awareness of your savings makes that experience a pleasure in itself.

… Aldi managers were expected to make continuous improvements to the company’s processes, a business philosophy also used by Japanese manufacturers, where it was called kaizen. In their book “Bare Essentials”, Dieter and Nils Brandes argued that Aldi’s embrace of kaizen, its lean management structure and just-in-time approach to inventory – taking delivery of stock only when needed, to cut holding costs – made it the “most Japanese” company in Germany.

… “The rest of the industry hated us,” said Paul Foley, who was the company’s third employee in the UK, and chief executive from 1999–2009. “I heard us called parasites, leeches, and ‘a plague of locusts landing on our shores’” – because of the company’s record of dragging down prices and profit margins in new markets. “It means nobody will help you: nobody wants to rent you space, organise transport for you, or sell you product.”

… Today, new Aldi store assistants receive industry-leading pay of £9.10 an hour, and £10.55 an hour in London – the London living wage – while a graduate accepted on to the area manager programme starts on £44,000 and gets an Audi A4 company car. Paying well obviously helps attract and retain staff, who might otherwise go to chains where the pace of work is slower. But it also serves to drive up wages across the industry, which, because of Aldi’s lower overall employee costs, hurts its competitors more.

You’ve always had the power to go back to Kansas.

–the Good Witch of the East, to Dorothy, in The Wizard of Oz

(This is the conclusion of a two-part essay. For Part 1 click here.)

Equipped with some historical background, we can now consider ways in which the Fed might get the Treasury and Foreign Official Institutions (FOIs) to revive their pre-crisis practice of parking surplus dollars somewhere other than at the Fed. In fact, most of the necessary means are already at hand. Fed officials only need to recognize and take advantage of them. They need, as it were, to click the heels of their ruby slippers together, and repeat three times that, so far as foreign dollar pools and big Treasury balances are concerned, “There’s no place like somewhere else.”

Just how can the Fed get the Treasury and FOIs to take their business elsewhere? Broadly speaking, their options are: capping their Fed deposits, or making those deposits less remunerative, or taking steps to restore the attractiveness of alternative investments that don’t gobble-up bank reserves.

Draining the Foreign Repo Pool

In principle, limiting FOIs’ use of the Foreign Repo Pool (FRP) is very easy, because the Fed is free to set any rules it likes for that facility. Specifically, as Matthew Klein observes in his Barron’s piece, “The New York Fed has the right to ‘manage the overall size of the foreign repo pool’ to ‘maintain orderly market or reserve management conditions’.” The Fed could, therefore, restore the limits it once placed on the pool. It could even scrap the facility altogether, since it operates the FRP as a courtesy to FOIs, and not because the Federal Reserve Act obliges it to do so.

Why shouldn’t the Fed take one of these steps? According to Zoltan Pozsar, it may be reluctant to cap the FRP because other central banks offer similar facilities without capping them. Consequently, he says, the “optics” of the Fed either limiting or discouraging the use of the FRP would be bad. Caps would deprive FOIs of an unlimited and relatively remunerative safe haven for their dollars when private banks come under stress.

These arguments aren’t all that convincing. Optics? Those of the Fed’s recent repo-market tribulations, of its deciding to renew its asset purchases, and of the huge balance sheet it must possess by continuing along its present course, are themselves far from appealing. A “safe haven” for FOI dollars? Should the Fed make it easy, during times of financial stress, for FOIs to yank their money, not just from particular U.S. banks, but from the U.S. banking system as a whole? Isn’t it supposed to protect U.S. commercial banks, not Foreign Official Entities?

Still, the Fed has reasons to avoid ruffling foreign feathers. So, it’s important for it to be able to take the sting, or apparent inequity, out of any plan for limiting FOIs’ use of the FRP. For starters, instead of capping (let alone abolishing) the FRP, it could discourage its use by the less Draconian step of adjusting the FRP rate formula to make the facility less attractive. At the very least, it could quit making its own rate better than corresponding private market lending rates, as it appears to have been doing lately by basing that rate on the SOFR (Secured Overnight Financing Rate). Since the Fed is a uniquely risk-free counterparty, it arguably should make its FRP rate not higher but lower than corresponding private market rates. For example, it might set a rate equal to SOFR minus 10 basis points.

But even if they must pay a (reasonable) price to do so, FOIs aware of the risk of another financial crisis may nonetheless prefer to keep substantial dollar reserves at the Fed than to either lend them on the private market or to invest them in safe but less than perfectly liquid dollar assets. Fortunately, there’s a way for the Fed to overcome this final incentive for FOIs to employ the repo pool, to which I’ll come after I discuss ways to limit the TGA balance.

Taming the TGA

While the Fed alone can take steps to limit use of the FRP, it will need the Treasury’s help to discourage use of the TGA, both because the Treasury has the right to put as much money in the TGA as it likes, and because the Treasury sets the interest return on Treasury Tax and Loan (TT&L) notes, one of its main alternative investments.

The good news, if past experience is any guide, is that the Treasury is likely to cooperate with the Fed, provided that doing so isn’t too costly. The bad news is that the Treasury itself may be powerless to revive the TT&L program, making that avenue for reducing the use of the TGA a dead-end. Under present rules, were the Treasury to open a TT&L note account, it would pay the Treasury just 1.58 percent–the current (November 1) fed funds rate minus 25 basis points. But the Treasury would indirectly “pay” its depository 2.40 percent–the current IOER rate–for the privilege of keeping its money there. In other words, the transfer would leave the Treasury with a net return of minus 82 basis points!

Having the Treasury revise its TT&L rate formula so that TT&L notes themselves pay the IOER rate might seem an obvious solution. But things aren’t so easy. Depository institutions are likely to oppose the plan, as they opposed a similar effort in 1999. And were the Treasury to proceed with the change anyway, some of them might withdraw from the program altogether, leaving it even more concentrated and capacity-constrained than it was on the eve of the financial crises. Consequently, rather than try and revive the TT&L program once again, the Treasury would have every reason to let that sleeping dog lie.

But there’s another solution, and banks don’t have to agree with it. Better still, it has already been successfully tested, thereby winning the Treasury’s approval. Finally, it couldn’t be easier: it consists of simply allowing the Treasury to enter directly into repo agreements with the same primary dealers the Fed itself relies upon for its own domestic repo operations. Because they “cut out the middleman” by dispensing with commercial depositories, Treasury repos would allow it to earn an overnight rate roughly equal to, if not higher than, the IOER rate.

The Treasury first started negotiating overnight repos with depository institutions in March 2006, in a one year pilot the GAO encouraged it to try. As the chart below (from a subsequent, September 2007 GAO report) shows, that program was extremely limited in scope and scale, with the Treasury’s average of $4 billion repos a day comprising but a miniscule share of what was then a $1.8 trillion per day repo-market.

Yet the program was successful, yielding rates considerably above TT&L rates. The rate was in fact very close to the Fed’s own repo rates, and therefore better even than the term investment option (TIO) rate. In its September 2007 report evaluating the program, the GAO found that, had the Treasury been able to repo all save a $2 billion of its surplus cash, it might have earned another $12.6 million in fiscal ’06–no small amount then–while relaxing TT&L and TIO program concentration and capacity constraints. Unsurprisingly, the GAO went on to recommend expanding the Treasury repo program further, to include the full complement of primary dealers, and also to allow the Treasury to repo a broader set of Treasury securities. Finally, the GAO urged the Treasury to consider switching to a triparty repo arrangement which would be both less costly and safer.

In a comment included in the report, the Treasury’s Fiscal Assistant Secretary, Kenneth Carlson, agreed with all of these suggestions. Unfortunately, the Treasury never got around to taking them. Less than a year after the GAO issued its report, the Great Financial Crisis was in full swing. Soon afterward, the Fed began paying interest on bank reserves at rates that for some time exceeded not only repo rates but returns on many Treasury securities. The momentum behind the repo program was lost.

Today, with repo rates well above the IOER rate, Treasury repos could once again offer the Treasury an attractive alternative to the TGA. The Fed has only to encourage Congress to take whatever steps are needed to revive and expand the program, thereby presenting the Treasury with an attractive means for reducing its TGA balance to a modest and stable level.

A Standing Repo Facility Would Help

Only one hitch remains. Even a triparty repo program entails some risk. So, the Treasury might still want to keep a large balance in its TGA account to assure itself access to cash even in the event of another major financial crisis.

But there’s a solution to this problem as well–and it’s the same one that can help overcome FOIs’ reluctance to hold Treasury securities or rely on the private repo-market. That solution consists of a modest refinement to an idea the Fed has already been considering, namely, creating a Standing Repo Facility, or SRF, for short.

As I explained here some months ago, the main purpose of the SRF is to reduce depository institutions demand for excess reserves, by allowing them to convert Treasury securities and other “High Quality Liquid Assets” (as defined by Basel III) into reserves at a moment’s notice, even when private repo-markets are under stress. To avoid undermining the private repo-market, the facility would charge a spread above market repo rates. According to Bill Nelson, because the facility would, at the very least, have to admit all depository institutions as counterparties, “the spread over the target fed funds rate range would have to be relatively wide, probably at least 25 basis points.” Granting large non-bank repo borrowers access to the facility would then tend to keep spikes in market repo rates from exceeding that 25-point spread.

The “modest refinement” I have in mind for the SRF is one that would allow it not just to reduce banks’ demand for reserves, but to help increase the reserve supply. It consists, simply, of including the U.S. Treasury and FOIs, or at least some key foreign central banks, on the list of SRF-eligible counterparties. Doing that would assure them that, so long as they have ample amounts of Treasury securities or other SRF collateral on hand, they need never fear being short of cash, or paying more than a modest premium to acquire it. Because the yield on short-term SRF-eligible dollar-denominated collateral would be close to what the FRP offers, this arrangement would approximate the risk-return profile of that facility without sucking reserves from the banking system.

If allowing FOIs, and important foreign central banks especially, to borrow at the SRF, using good Treasury collateral, serves to limit use of the FRP, the decision should be a no-brainer. After all, as Zoltan Poszar has observed, the alternative of “adding reserves through a standing repo facility or asset purchases while having an uncapped foreign RRP facility sterilizing reserves would be odd.” “Odd” is saying the least. “Futile” is more like it!

Some may object to the idea of allowing the Fed to lend to FOIs, even though the lending involves no risk to the Fed, and would be done only at a spread above the Fed’s rate target upper limit, which is to say, only during periods of extreme credit stringency. But they should keep in mind that the Fed already has the authority to lend to foreign central banks through the “dollar liquidity swap lines” it authorized in May 2010 and made permanent in 2013. The chief difference is that the swap lines allow foreign central banks to borrow dollars against their own currency, while the FRP would allow them to borrow dollars against U.S. Treasury securities. To some extent, the arrangements would be substitutes. But the proposed facility alone would assist the Fed in minimizing the use of the Foreign Repo Pool.

So Would Reinstating the Treasury’s Security Draw Authority

The same might be said of not taking advantage of the SRF to assure the Treasury that it doesn’t need a big-fat TGA balance. Only in this case the “obvious” solution isn’t so obvious, because direct Fed lending to the Treasury happens to be illegal. But here also, experience points to a solution, in the shape of the “security draw authority” Congress granted the Treasury for almost four decades starting in 1942. That authority permitted the Treasury to repo securities with the Fed to meet its short-term cash requirements until it was allowed to expire in 1981.

As Kenneth Garbade informs us, when the security draw authority’s postwar continuation was being debated, then-Fed chair Marriner Eccles explained that having that exception to direct Fed lending to the Treasury helped to prevent Treasury activity from reducing the stock of bank reserves around tax collection dates–precisely the sort of reduction that caused trouble this September. “If,” Eccles said,

the Treasury could not borrow from the Federal Reserve banks by what is, in effect, an overdraft at these tax payment periods, and in this way avoid withdrawals from its war loan accounts to pay off maturing obligations, money conditions would unduly tighten and tend to [destabilize] the money market and the Government securities market.

Eccles added that, were it not for its security draw authority, “the Treasury would feel obliged to carry much larger cash balances.”

Despite its advantages, the security draw authority was never made permanent. Instead, having initially granted it for just two years, the Treasury proceeded to renew it again and again. Finally, in 1981, the authority was allowed to lapse, mainly because new Treasury cash-management options, including the introduction of TT&L note accounts and of special Treasury “Cash Management” bills, made it seem redundant. That the Treasury had taken advantage of the special draw authority in 1977 to borrow from the Fed in anticipation of a debt ceiling constraint also helped to seal the privilege’s fate, prompting then representative Ron Paul of Texas to complain, with reason, that it had “become a device that is used by the Treasury to ignore Congress and the law.” Although, despite complaints like Paul’s, the authority was extended for once more in 1979, that final renewal limited its use to “unusual and exigent circumstances… pursuant to an affirmative vote of not less than five members” of the Federal Reserve Board.

Fear of such “unusual and exigent circumstances” is, of course, one of the reasons why the Treasury might be reluctant to forego a hefty TGA balance even were it able to take advantage of a revived and expanded Treasury repo program to lend most of its surplus funds to private borrowers. Its concern is that, during a major crisis, it might only be able to get cash immediately from the one U.S. lender that can’t fail. Reinstating the Treasury’s special draw authority, or developing a new version of it specifically meant to allow the Treasury to be among the Fed’s SRF counterparties, at least under certain circumstances, would overcome that reluctance. Just as the previous special draw authority imposed a $5 billion borrowing limit, the new one might impose a limit of $100–150 billion, depending on the Treasuries preferred new TGA balance target, the goal being to still allow the Treasury certain access to cash sufficient to cover one week’s expenditures.

Needed Changes: A Recapitulation

Let me now gather together the various steps I’m proposing for substantially reducing use of the TGA and the RTP. These are as follows:

• Congress should (1) revive the Treasury’s direct repo borrowing program, expanded (as per the GAO’s September 2007 recommendations) to allow all primary dealers to take part and also to allow the Treasury to offer any of its securities as collateral, and (2) restore the Treasury’s “security draw authority,” or otherwise have Congress authorize it to borrow directly from the Federal Reserve;
• The Fed should (1) set its FRP rate at 10 basis points below the SOFR rate, (2) establish the Standing Repo Facility that it has already been considering, and (3) allow Foreign Official Entities, and foreign central banks especially, as well as the U.S. Treasury (as authorized by Congress) access to the Standing Repo Facility.

Floor versus Corridor (Again)

Besides allowing the Fed to maintain its floor operating system with a considerably smaller balance sheet, the reforms I’ve recommended would also make it possible for the Fed to slim down considerably further by allowing it to switch from a floor system to a corridor system.

When the Fed first switched to a floor operating system in October 2008, it had no intention of doing so permanently; and as recently as 2018, the Fed claimed that it was still entertaining the possibility of switching to a corridor system. Nevertheless, this January, Jay Powell announced that the Fed had decided to make the Fed’s floor system, with its dependence upon an abundant supply of excess bank reserves, permanent.

Although a number of factors informed the Fed’s decision, one of the more important was the increased importance and volatility of the Fed’s non-reserve liabilities. As Lorie Logan explained in May 2017, that change meant that, to operate a corridor system, the Fed would have to routinely engage in open market operations “that are larger, more variable, or even very different from those used before the crisis.”

This April Logan pursued this same theme, specifically pointing to the behavior of the TGA balance as a factor justifying the Fed’s decision to keep a floor system. “There have been times,” she said, “when the TGA has increased by around $100 billion over the course of a week and there has been a similarly large decline in reserves.” By maintaining its floor system, the Fed could avoid having to compensate for such fluctuations. Instead “a buffer of reserves above the banking system’s demand for reserves” would simply absorb them. Logan went on to declare “that the floor system has proven to be highly effective at controlling the effective federal funds rate and other money market rates, is resilient to significant shifts in market structure, and is efficient to operate.”

Although it’s now painfully obvious that Logan’s assessment of the Fed’s floor system was premature, so long as the TGA balance and FRP remain both large and volatile, Logan’s arguments for retaining that system continue to have weight. But I hope I’ve succeeded in showing that, far from being “given” to the Fed, the size and behavior of the TGA balance and FRP are functions of government policy, and especially of the Fed’s own policies. And Fed officials surely know it. Were they to follow the suggestions offered here, they could rein-in those pesky reserve-absorbing liabilities once and for all. And then the Fed would no longer have any good reason for not switching to a corridor system, and to the truly lean balance sheet that would then be all it needed “to implement monetary policy efficiently and effectively.”

***

I’ve tried to show how, with the Treasury and Congress’s help, the Fed might reduce the demand for its non-reserve liabilities, and thereby add to the stock of bank reserves, while also making a large excess reserve cushion unnecessary. Perhaps I’ve overlooked some details that render my plan incomplete. Or perhaps there’s an even simpler plan that would work at least as well. No matter: my goal is only to convince readers that the objectives I have in mind are both achievable and worth pursuing. If anyone can come up with some better ways to achieve the same ends, believe me, I’ll be the first to embrace them.

Without comment or dissent, the Supreme Court on Tuesday turned down a certiorari petition asking it to review a suit against gunmaker Remington over the Sandy Hook massacre, thus allowing the suit to proceed for now. The current suit, as green-lighted by the Connecticut Supreme Court earlier this year over a dissent from three of its seven justices, claims that Remington violated the broad provisions on deceptive marketing of a state unfair-trade-practices law, the Connecticut Unfair Trade Practices Act (CUTPA). It should be emphasized that the case is still at an early stage and that the Justices will probably be presented with further opportunities to pronounce on its compatibility with the federal law that pre-empts most gun suits, the Protection of Lawful Commerce in Arms Act (PLCAA). For example, some Justices might see PLCAA as pre-empting some but not other claims under the state trade-practices law, and await further factual clarification that could bring the incompatibility into sharper focus.

For now, the Court will not engage with the arguments made in the amicus brief by Cato and others that courts should give PLCAA a fair interpretation to prevent it from being a dead letter. The brief, by David Kopel and others, emphasizes that in some circumstances the workings of private lawsuits can impinge on individual rights guaranteed by the Constitution: exorbitant libel verdicts can menace freedom of speech, and similarly creative stretching of tort and public nuisance law can endanger Second Amendment rights. Just as the Supreme Court acknowledged the first point in New York Times v. Sullivan, so Congress acknowledged the second in enacting PLCAA.

It is noteworthy that both cases arose following litigation campaigns intended to undermine the rights in question. By organizing costly libel suits against defendants that included the New York Times, some Southern partisans of that day hoped to silence or at least discourage voices critical of their local officials. Decades later, advocates of gun control together with allies in government and trial lawyers pursued a litigation campaign intended to force the firearms industry into negotiations by threatening it with bankruptcy through litigation costs, whether it won or lost its cases.

Writes David Kopel: “In both cases, the stakes are the same: whether the Supreme Court will allow the misuse of tort suits to destroy an enumerated right.” And what the Supreme Court is being asked to do in cases like that of Remington, namely give effect to a statute duly enacted by Congress, is less ambitious and far-reaching than what it was asked to do in Sullivan, namely craft entirely new Constitutional law in response to the problem.

Even given strong public emotion about the Newtown massacre, the claims against Remington are likely to fail in the end — assuming the law and the facts matter — since no evidence has been presented that any gun ad influenced either the shooter or his mother, who had two years earlier purchased the rifle he used. But many gun control advocates have been open in arguing that whether the suit wins or loses, it could serve as a vehicle for extensive discovery that would both inflict financial harm on defendant Remington and perhaps also unearth documents from which political and legal hay might be made in future controversies. The menace to rights is still very much a menace, and the reasoning behind the Protection of Lawful Commerce in Arms Act is as important as ever.

“You’ve always had the power to go back to Kansas.”
—the Good Witch of the East, to Dorothy, in The Wizard of Oz.

Equipped with some historical background, we can now consider ways in which the Fed might get the Treasury and Foreign Official Institutions (FOIs) to revive their pre-crisis practice of parking surplus dollars somewhere other than at the Fed. In fact, most of the necessary means are already at hand. Fed officials only need to recognize and take advantage of them. They need, as it were, to click the heels of their ruby slippers together, and repeat three times that, so far as foreign dollar pools and big Treasury balances are concerned, “There’s no place like somewhere else.”

Just how can the Fed get the Treasury and FOIs to take their business elsewhere? Broadly speaking, their options are: capping their Fed deposits, or making those deposits less remunerative, or taking steps to restore the attractiveness of alternative investments that don’t gobble-up bank reserves.

Draining the Foreign Repo Pool

In principle, limiting FOIs’ use of the Foreign Repo Pool (FRP) is very easy, because the Fed is free to set any rules it likes for that facility. Specifically, as Matthew Klein observes in his Barron’s piece, “The New York Fed has the right to ‘manage the overall size of the foreign repo pool’ to ‘maintain orderly market or reserve management conditions’.” The Fed could, therefore, restore the limits it once placed on the pool. It could even scrap the facility altogether, since it operates it as a courtesy to FOIs, and not because the Federal Reserve Act obliges it to do so.

Why shouldn’t the Fed take one of these steps? According to Zoltan Pozsar, it may be reluctant to cap the FRP because other central banks offer similar facilities without capping them. Consequently, he says, the “optics” of the Fed either limiting or discouraging the use of the FRP would be bad. Caps would deprive FOIs of an unlimited and relatively remunerative safe haven for their dollars when private banks come under stress.

These arguments aren’t all that convincing. Optics? Those of the Fed’s recent repo-market tribulations, of its deciding to renew its asset purchases, and of the huge balance sheet it must possess by continuing along its present course, are themselves far from appealing. A “safe haven” for FOI dollars? Should the Fed make it easy, during times of financial stress, for FOIs to yank their money, not just from particular U.S. banks, but from the U.S. banking system as a whole? Isn’t it supposed to protect U.S. commercial banks, not Foreign Official Institutions?

Still, the Fed has reasons to avoid ruffling foreign feathers. So, it’s important for it to be able to take the sting, or apparent inequity, out of any plan for limiting FOIs’ use of the FRP. For starters, instead of capping (let alone abolishing) the FRP, it could discourage its use by the less Draconian step of adjusting the FRP rate formula to make the facility less attractive. At the very least, it could quit making its own rate better than corresponding private market lending rates, as it appears to have been doing lately by basing that rate on the SOFR (Secured Overnight Financing Rate). Since the Fed is a uniquely risk-free counterparty, it arguably should make its FRP rate not higher but lower than corresponding private market rates. For example, it might set a rate equal to SOFR minus 10 basis points.

Even if they must pay a (reasonable) price to do so, FOIs aware of the risk of another financial crisis may nonetheless prefer to keep substantial dollar reserves at the Fed than to either lend them on the private market or invest them in safe but less than perfectly liquid dollar assets. Fortunately, there’s a way for the Fed to overcome this final incentive for FOIs to employ the repo pool, to which I’ll come after I discuss ways to limit the TGA balance.

Taming the TGA

While the Fed alone can take steps to limit use of the FRP, it will need the Treasury’s help to discourage use of the TGA, both because the Treasury has the right to put as much money in the TGA as it likes, and because the Treasury sets the interest return on Treasury Tax and Loan (TT&L) notes, one of its main alternative investments.

The good news, if past experience is any guide, is that the Treasury is likely to cooperate with the Fed, provided that doing so isn’t too costly. The bad news is that the Treasury itself may be powerless to revive the TT&L program, making that avenue for reducing the use of the TGA a dead-end. Under present rules, were the Treasury to open a TT&L note account, it would pay the Treasury just 1.30 percent—the current (November 14) fed funds rate minus 25 basis points. But the Treasury would indirectly “pay” its depository 1.55 percent—the current IOER rate—for the privilege of keeping its money there. In other words, the transfer would leave the Treasury with a net return of minus 25 basis points.

Having the Treasury revise its TT&L rate formula so that TT&L notes themselves pay the IOER rate might seem an obvious solution. But things aren’t so easy. Depository institutions are likely to oppose the plan, as they opposed a similar effort in 1999. And were the Treasury to proceed with the change anyway, some of them might withdraw from the program altogether, leaving it even more concentrated and capacity-constrained than it was on the eve of the financial crises. Consequently, rather than try and revive the TT&L program once again, the Treasury would have every reason to let that sleeping dog lie.

Yet the program was successful, yielding rates considerably above TT&L rates. The rate was in fact very close to the Fed’s own repo rates, and therefore better even than the term investment option (TIO) rate. In its September 2007 report evaluating the program, the GAO found that, had the Treasury been able to repo all save a $2 billion of its surplus cash, it might have earned another $12.6 million in fiscal ’06—no small amount then—while relaxing TT&L and TIO program concentration and capacity constraints. Unsurprisingly, the GAO went on to recommend expanding the Treasury repo program further, to include the full complement of primary dealers, and also to allow the Treasury to repo a broader set of Treasury securities. Finally, the GAO urged the Treasury to consider switching to a triparty repo arrangement which would be both less costly and safer.

In a comment included in the report, the Treasury’s Fiscal Assistant Secretary, Kenneth Carlson, agreed with all of these suggestions. Unfortunately, the Treasury never got around to taking them. Less than a year after the GAO issued its report, the Great Financial Crisis was in full swing. Soon afterward, the Fed began paying interest on bank reserves at rates that for some time exceeded not only repo rates but returns on many Treasury securities. The momentum behind the repo program was lost.

Today, with repo rates well above the IOER rate, Treasury repos could once again offer the Treasury an attractive alternative to the TGA. The Fed has only to encourage Congress to take whatever steps are needed to revive and expand the program, thereby presenting the Treasury with an attractive means for reducing its TGA balance to a modest and stable level.

A Standing Repo Facility Would Help

Only one hitch remains. Even a triparty repo program entails some risk. So, the Treasury might still want to keep a large balance in its TGA account to assure itself access to cash even in the event of another major financial crisis.

But there’s a solution to this problem as well—and it’s the same one that can help overcome FOIs’ reluctance to hold Treasury securities or rely on the private repo-market. That solution consists of a modest refinement to an idea the Fed has already been considering, namely, creating a Standing Repo Facility, or SRF, for short.

As I explained here some months ago, the main purpose of the SRF is to reduce depository institutions demand for excess reserves, by allowing them to convert Treasury securities and other “High Quality Liquid Assets” (as defined by Basel III) into reserves at a moment’s notice, even when private repo-markets are under stress. To avoid undermining the private repo-market, the facility would charge a spread above market repo rates. According to Bill Nelson, because the facility would, at the very least, have to admit all depository institutions as counterparties, “the spread over the target fed funds rate range would have to be relatively wide, probably at least 25 basis points.” Granting large non-bank repo borrowers access to the facility would then tend to keep spikes in market repo rates from exceeding that 25-point spread.

The “modest refinement” I have in mind for the SRF is one that would allow it not just to reduce banks’ demand for reserves, but to help increase the reserve supply. It consists, simply, of including the U.S. Treasury and FOIs, or at least some key foreign central banks, on the list of SRF-eligible counterparties. Doing that would assure them that, so long as they have ample amounts of Treasury securities or other SRF collateral on hand, they need never fear being short of cash, or paying more than a modest premium to acquire it. Because the yield on short-term SRF-eligible dollar-denominated collateral would be close to what the FRP offers, this arrangement would approximate the risk-return profile of that facility without sucking reserves from the banking system.

If allowing FOIs, and important foreign central banks especially, to borrow at the SRF, using good Treasury collateral, serves to limit use of the FRP, the decision should be a no-brainer. After all, as Zoltan Poszar has observed, the alternative of “adding reserves through a standing repo facility or asset purchases while having an uncapped foreign RRP facility sterilizing reserves would be odd.” “Odd” is saying the least. “Futile” is more like it!

Some may object to the idea of allowing the Fed to lend to FOIs, even though the lending involves no risk to the Fed, and would be done only at a spread above the Fed’s rate target upper limit, which is to say, only during periods of extreme credit stringency. But they should keep in mind that the Fed already has the authority to lend to foreign central banks through the “dollar liquidity swap lines” it authorized in May 2010 and made permanent in 2013. The chief difference is that the swap lines allow foreign central banks to borrow dollars against their own currency, while the FRP would allow them to borrow dollars against U.S. Treasury securities. To some extent, the arrangements would be substitutes. But the proposed facility alone would assist the Fed in minimizing the use of the Foreign Repo Pool.

So Would Reinstating the Treasury’s Direct Draw Authority

The same might be said of not taking advantage of the SRF to assure the Treasury that it doesn’t need a big-fat TGA balance. Only in this case the “obvious” solution isn’t so obvious, because direct Fed lending to the Treasury happens to be illegal. But here also, experience points to a solution, in the shape of the “direct draw authority” Congress granted the Treasury for almost four decades starting in 1942. That authority permitted the Treasury to repo securities with the Fed to meet its short-term cash requirements until it was allowed to expire in 1981.

As Kenneth Garbade informs us, when the direct draw authority’s postwar continuation was being debated, then-Fed chair Marriner Eccles explained that having that exception to direct Fed lending to the Treasury helped to prevent Treasury activity from reducing the stock of bank reserves around tax collection dates—precisely the sort of reduction that caused trouble this September. “If,” Eccles said,

the Treasury could not borrow from the Federal Reserve banks by what is, in effect, an overdraft at these tax payment periods, and in this way avoid withdrawals from its war loan accounts to pay off maturing obligations, money conditions would unduly tighten and tend to [destabilize] the money market and the Government securities market.

Eccles added that, were it not for its direct draw authority, “the Treasury would feel obliged to carry much larger cash balances.”

Despite its advantages, the direct draw authority was never made permanent. Instead, having initially granted it for just two years, the Treasury proceeded to renew it again and again. Finally, in 1981, the authority was allowed to lapse, mainly because new Treasury cash-management options, including the introduction of TT&L note accounts and of special Treasury “Cash Management” bills, made it seem redundant. That the Treasury had taken advantage of the direct draw authority in 1977 to borrow from the Fed in anticipation of a debt ceiling constraint also helped to seal the privilege’s fate, prompting then representative Ron Paul of Texas to complain, with reason, that it had “become a device that is used by the Treasury to ignore Congress and the law.” Although, despite complaints like Paul’s, the authority was extended for once more in 1979, that final renewal limited its use to “unusual and exigent circumstances… pursuant to an affirmative vote of not less than five members” of the Federal Reserve Board.

Fear of such “unusual and exigent circumstances” is, of course, one of the reasons why the Treasury might be reluctant to forego a hefty TGA balance even were it able to take advantage of a revived and expanded Treasury repo program to lend most of its surplus funds to private borrowers. Its concern is that, during a major crisis, it might only be able to get cash immediately from the one U.S. lender that can’t fail. Reinstating the Treasury’s direct draw authority, or developing a new version of it specifically meant to allow the Treasury to be among the Fed’s SRF counterparties, at least under certain circumstances, would overcome that reluctance. Just as the previous special draw authority imposed a $5 billion borrowing limit, the new one might impose a limit of $100–150 billion, depending on the Treasuries preferred new TGA balance target, the goal being to still allow the Treasury certain access to cash sufficient to cover one week’s expenditures.

Although it’s now painfully obvious that Logan’s assessment of the Fed’s floor system was premature, so long as the TGA balance and FRP remain both large and volatile, Logan’s arguments for retaining that system continue to have weight. But I hope I’ve succeeded in showing that, far from being “given” to the Fed, the size and behavior of the TGA balance and FRP are functions of government policy, and especially of the Fed’s own policies. And Fed officials surely know it. Were they to follow the suggestions offered here, they could rein-in those pesky reserve-absorbing liabilities once and for all. And then the Fed would no longer have any good reason for not switching to a corridor system, and to the truly lean balance sheet that would then be all it needed “to implement monetary policy efficiently and effectively.”

***

I’ve tried to show how, with the Treasury and Congress’s help, the Fed might reduce the demand for its non-reserve liabilities, and thereby add to the stock of bank reserves, while also making a large excess reserve cushion unnecessary. Perhaps I’ve overlooked some details that render my plan incomplete. Or perhaps there’s an even simpler plan that would work at least as well. No matter: my goal is only to convince readers that the objectives I have in mind are both achievable and worth pursuing. If anyone can come up with some better ways to achieve the same ends, believe me, I’ll be the first to embrace them.

For months, transfixed populations around the world have watched as anti-government, pro-democracy demonstrations continue to convulse Hong Kong. The frequently violent disruptions are producing highly negative economic effects. More than a month ago, data indicated that hotel bookings in Hong Kong were down 40 percent from a year earlier, as both business travelers and tourists sought to avoid being caught up in the turmoil. Demonstrations—and sometimes pitched battles between protesters and police–at Hong Kong’s international airport have produced extensive flight cancellations, and the airport has had to shut down entirely on several occasions.

Thus far, the central government in Beijing has adopted a relatively restrained approach and not trampled on Hong Kong’s legal autonomy. President Xi Jinping’s regime continues to let its appointed chief executive for Hong Kong, Carrie Lam, take the lead in managing the crisis. With Beijing’s approval, Lam even formally withdrew the proposed extradition law. That measure, which would have enabled Beijing to “request” the extradition of Hong Kong dissidents to be tried in mainland courts where even basic due process protections are absent, triggered the initial protests last spring.

Xi’s government apparently believed that such a concession, combined with a low-key approach that relied on Hong Kong police to maintain a modicum of order, would gradually cause the demonstrations to fade away. That scenario did not occur; throughout the summer, the protests actually grew larger and more vocal. Recently, the number of protesters has dropped, but the confrontations with police have become increasingly violent, and arrests on various charges more frequent. Moreover, the demands of the demonstrators are now much more extensive than demanding the withdrawal of the extradition statute. Hong Kong activists are pushing for major democratic reforms, especially making the entire legislature and the chief executive into elected offices, which would dramatically dilute Beijing’s authority and influence.

Signs are growing that Beijing’s patience may be at an end. There certainly appears to be rising pressure on Hong Kong authorities to adopt a much harder line toward protesters. Not only have arrests soared, but police are now using live ammunition and have wounded several protesters. More worrisome, there are indications that a full-scale crackdown, perhaps even using People’s Liberation Army units, could be imminent.

At a November 11 press conference, Carrie Lam bluntly labeled protestors “enemies of the people,” an especially ominous term coming from the appointee of a communist regime. Hong Kong riot police stormed the Chinese University of Hong Kong on November 12 in an attempt to take control. Not only is that campus a logistical hub for the pro-democracy movement, but most internet connections in the city pass through the Hong Kong Internet Exchange housed there. If Xi’s government is contemplating sending in security forces to occupy the city, gaining control of the Exchange would be a crucial prerequisite to control the flow of information. Finally, there are media reports that fleeing mainland students and other residents from the People’s Republic are being evacuated by boat. Since there have been violent attacks on mainlanders in recent weeks, such an exodus might just reflect growing nervousness. But it also could be preparation for a PLA operation in Hong Kong.

One certainly hopes that we are not about to witness a Tiananmen Square-style massacre. But even a less bloody crackdown would have far-reaching consequences and severely damage Beijing’s standing in the world. One key question is how the United States (seemingly preoccupied with the Trump impeachment circus) and its East Asian allies would react to a brutal move by Chinese security forces. At a minimum, there would likely be a push for severe economic sanctions against China, with all the adverse implications for East Asia’s stability and the health of the global economy. The American news media should turn their obsessive gaze away from the impeachment spectacle at least briefly to monitor some nasty crises developing in various locales around the world, including in Hong Kong.

As Turkey’s President Erdogan is coming to Washington DC to visit President Trump in the White House, there are two broad views about Turkey in the U.S. Capital: The more hawkish view, popular in Congress, considers Turkey an authoritarian Islamist regime which unjustly attacked the U.S. allies in Syria, and which must be punished with various U.S. sanctions, and perhaps even be kicked out of NATO. The more dovish view suggests that while Erdogan has indeed been a troubling actor, both at home and in his region, the alliance with Turkey must still be saved.

I believe the dovish view is more correct, but it needs some added nuance.

The dovish view is correct, because treating Turkey as an enemy will only help Erdogan further ally himself with Vladimir Putin, who has been eager to lure Ankara to his side. If Turkey ends up being a Russian ally (and a full dictatorship, just like Russia), the big winner will be neither Turkey, nor America, but Russia.

Also, the dovish view is correct because while Turkey’s recent incursion into Syria is pointless and disastrous, it has come out of an understandable concern with the Kurdistan Worker’s Party, or PKK, Turkey’s main terrorist threat since the early 1980’s. Turkey’s concern with the PKK is wrongly discounted in the West due to an unqualified support here for “the Kurds,” as if there are no nuances between different armed Kurdish groups.

The U.S. would achieve more if it continues working with Turkey, by understanding that the latter has some legitimate concerns while using its own influence for some damage control both in Syria and elsewhere. The ceasefire agreement Vice President Mike Pence brokered in Ankara soon after the Turkish incursion showed that this is possible (and as someone who had called on the U.S. leadership to “mediate between the two sides and broker a peaceful deal,” just four days before, it gave me relief).

But so far, there has been something important missing in the Erdogan-Trump relationship: A serious concern for Turkey’s grim record on human rights, freedom of speech, and rule of law. These are the key principles that no American administration should disregard. So the Turkish-American relationship should go on, but with a focus on urging Erdogan to ease his crushing authoritarianism.

Also, for the long run, American policy makers should not forget that Turkey does not equal Erdogan. He is obviously all too powerful now, but his rule will not last forever. At some point, there will be a post-Erdogan Turkey. And the latter will have a much better chance to restore liberal democracy if, at that point, it is still a part of the Western alliance, and not a minion of Russia and China.

The Jones Act has been a blight upon the United States for nearly 100 years. That the law survives despite its well-documented costs can in large part be ascribed to frequently made claims that it is vital to U.S. national security.

Such claims should be greeted with a skeptical eye.

As I explain in a new paper, decades of evidence suggest any contributions made by the law to national security are vastly overstated. In fact, there is considerable reason to think the Jones Act is a net national security liability.

The facts are these: under the Jones Act’s watch the U.S. maritime sector has suffered grievous setbacks. Numerous shipyards have closed, the domestic fleet’s numbers have dwindled, and the pool of mariners that the military draws upon to crew its sealift fleet has become perilously shallow. Rather than ensuring, as the law states in its purpose, a “merchant marine of the best equipped and most suitable types of vessels” capable of “serv[ing] as a naval or military auxiliary in time of war or national emergency” the Jones Act has produced a depleted, decrepit fleet of limited capabilities.

The Jones Act is complicit in this decline. The law, after all, is rooted in an absurd logic: that to promote both a strong U.S. shipbuilding sector and domestic fleet the latter must be compelled to purchase from the former. The result is the achievement of neither, which is the predictable outcome of linking two protected, uncompetitive sectors together.

U.S. commercial shipyards, oriented towards the captive Jones Act market, lack the scale and specialization that can only be achieved by building for the international shipbuilding market. As a result, the limited number of ships they produce are up to five times more expensive than those built abroad. It is a testament to their technological inferiority and lack of productivity—hallmarks of protected markets—that they do so while offering wages that are lower than those of most leading shipbuilding countries.

Jones Act carriers that operate these wildly expensive ships, meanwhile, are forced to pass their acquisition costs along to consumers in the form of higher shipping rates. This, in turn, means less demand for their services, and thus fewer ships and mariners. Where consumers have a choice, they almost invariably opt for other forms of transportation such as trucks, railroads, and pipelines. Indeed, the 99 ship Jones Act fleet almost exclusively operates where there is low elasticity of demand and little competition, serving the shipping-dependent noncontiguous states and territories and the needs of the world’s largest oil-producing country (tanker ships account for 57 of the fleet’s 99 ships and roughly 80 percent of its deadweight tonnage).

Conceived in protectionist fallacies, the case for maintaining the 1920 Jones Act becomes ever more tortured given its increasingly glaring divorce from modern maritime realities. Among these:

• The sharp rise in cost differences between U.S. and foreign-built ships. Shortly after the Jones Act was passed a U.S.-built ship was typically about 20 percent more expensive than one built abroad. That cost difference can now reach 400 percent.
• The increased specialization of commercial ships. The military places a premium on flexible vessels that can operate in a variety of port environments and carry different types of cargo, while the commercial sector prizes ships geared towards specific tasks that disperse their cargo in modern ports. This makes the ships of the Jones Act fleet less valuable to the military.
• The heavy reliance of U.S.-built Jones Act ships on foreign capital, components, and know-how. Jones Act ships almost invariably use foreign designs and are heavily dependent on foreign sources for critical components such as the engine and propeller. Furthermore, the shipyards themselves are often the subsidiaries of foreign parent corporations. Any notion that the high price of Jones Act ships has produced a U.S. shipbuilding capability free of foreign dependence is entirely illusory.

A new approach is needed.

Rather than maintain the Jones Act status quo with its opaque costs and inequitable burdens that are disproportionately placed upon Alaska, Hawaii, and Puerto Rico, the United States should consider some of the following measures to meet the U.S. military’s need for ships and mariners to transport supplies and equipment:

• The establishment of a civilian Merchant Marine Reserve. The military currently lacks needed certainty around the availability of manpower to crew its sealift vessels in wartime. U.S. merchant mariners, meanwhile, are not provided with the training and benefits commensurate with their role in assuring U.S. national security. A civilian Merchant Marine Reserve could help address this.
• Wage subsidies to the employers of U.S. mariners. To make the employment of U.S. mariners more attractive, the United States could offer wage subsidies to those who employ them in exchange for an agreement that they be released for wartime service with guaranteed employment upon their return.
• Allowing the use of foreign mariners in some circumstances. To ease crew shortages the United States should consider the use of foreign mariners in some circumstances. To help mitigate possible risks measures such as background checks and eligibility restrictions to citizens of certain countries could be implemented.

To learn more please read the paper in its entirety here and visit Cato’s dedicated Jones Act webpage.