What You Need To Know About The Repo Market 1

What is money? This is not as simple a question as it may seem at first glance.
Consider the following example: You find yourself in possession of a piece of paper that has a number written on it.
You bring it to the supermarket and try to use it to pay for food, but the cashier thinks you’re insane and calls security to escort you out.
However, when you bring it to a certain, very specialized, type of merchant, the same piece of paper can be used to immediately obtain a cash loan (the paper is used as collateral). And, at an amount almost equal to the number written on it too!
So the piece of paper cannot be used to buy food, but it can very quickly get you access to cash with which to buy food.
Furthermore, you notice that the number written on the paper is slightly more than what you paid for it. Plus, you were told that if you returned it to the place you bought it from after 3 months, you would receive that amount back in cash.
It’s an almost magical piece of paper!
So, is your piece of magic paper money?
Obviously, it depends on whom you ask. The supermarket cashier does not, and will not, think it is, but the specialized merchant definitely does.
Why is that?
Simple – the merchant has use for the piece of paper, and the supermarket does not.
The magical piece of paper is actually a US Treasury 3 month Bill (T Bill), and the specialized merchant a repo trading desk at a big Wall Street bank.
Repo desks have multiple uses for T Bills, but almost all involve using them as collateral – where they are pledged as security against default when taking loans or trading financial securities.
It is important to note that all tenors of US Treasuries can, and are, used in the repo market as collateral, simply because USTs are considered to be the “risk free” asset.
Consequently, USTs are the bedrock on which repo desks and their counterparties from all over the world secure their transactions with each other.
Furthermore, the market for USTs (by virtue of their “risk free” status, or not) is also one of the most, if not the most, liquid market on the planet.
This means collateral can be immediately liquidated by traders with minimal adverse price movements. (In less liquid markets, assets sold quickly and in bulk will push prices lower, causing sellers to get less than they would otherwise have gotten)
Lastly, and arguably most importantly, USTs are denominated in USD. This means sellers do not have to (overly) worry about the value of their collateral fluctuating wildly due to currency movements.
Additionally, upon liquidation, the seller will, by virtue of the USD being the world’s reserve currency, be able to easily swap their holdings into other currencies or assets.
No other financial asset can provide this combination of flexibility, security, and liquidity, which makes US Treasuries the premiere form of collateral in the global financial system.
As such, their role as an interest bearing instrument takes a back seat to their low price volatility and their ability to be quickly converted into some other asset.
Store of value – check, and medium of exchange – check.
USTs are money.
To be continued…
Do You Want To Make Money Trading?
Learn how to, and more, in our Trading Courses.