The era of permanent quantitative easing by The Federal Reserve (FED) is approaching. Who will be able to pick up the next wave of wealth dividends?

The Federal Reserve will stop tapering and shift to quantitative easing. This policy shift may happen faster than expected. What does this mean for investors? This article is derived from a piece written by James Lavish, organized, translated, and authored by Odaily. (Background: The boom, the crash, and the escape - the disillusionment history of classical VC in Web3) (Supplementary background: KOLs are all showing their income, while I want to show the blood and tears lessons from my 3 years of VC investing.) The Federal Reserve may stop tapering in the coming months. Last week, a statement from Fed Chairman Powell sparked various speculations in the market. The signal hidden behind this statement is “quantitative tightening (QT) is about to shift to quantitative easing (QE), and the speed will be faster than most people expect.” But is this merely a symbolic gesture from the Federal Reserve, or does it hold extraordinary significance? Most importantly, what exactly is Powell hinting about the current state of the financial system? This article will delve into the Federal Reserve's liquidity strategy, the similarities and differences of the current liquidity crisis compared to 2019, and why the Federal Reserve will initiate a permanent quantitative easing policy (QE). A liquidity crisis is imminent. The reverse repurchase agreement (RRP) tool has failed. RRP was once a massive reservoir of excess liquidity, peaking at around $2.4 trillion in 2022, but it is now essentially empty. As of this week, the RRP only has a few billion dollars left, a reduction of over 99% from its peak. Although the RRP was initially created to help the Federal Reserve manage short-term interest rates, it has become a release valve for excess liquidity in recent years, acting as a shock absorber for the entire financial system. During the COVID-19 pandemic, the Federal Reserve and the Treasury injected trillions of dollars into the financial system, with this cash ultimately stored in the RRP via money market funds. Later, Treasury Secretary Janet Yellen played a clever trick by issuing attractive short-term treasury bills to deplete RRP funds. Money market funds withdrew their cash from the RRP (earning the Fed's RRP rate) to buy higher-yielding treasury bills. This allowed the Treasury to fund the massive government deficit without injecting a large amount of long-term U.S. Treasury bonds into the market. Before the RRP was depleted, this was indeed a brilliant strategy, but it is no longer effective. Bank reserves are at a secondary alert status. Bank reserves have fallen to $2.9 trillion, down $1.3 trillion since peaking in September 2021. Powell has clearly stated that the Federal Reserve will become nervous when bank reserves drop below 10-11% of GDP. The 10% threshold is not arbitrary; it is based on extensive research by the Federal Reserve, surveys of banks, and the actual experiences summarized from the disaster that occurred in September 2019 (to be detailed later). So, what level are we at now? Current bank reserves: $2.96 trillion (as of last week). Current U.S. GDP: $30.486 trillion (Q2 2025). Percentage of reserves to GDP: 9.71%. Current bank reserves have fallen below the Federal Reserve's established minimum level of 10% “adequate reserves” (the level necessary for the financial system to operate smoothly). According to the Federal Reserve, to ensure smooth market operation, reserves should be maintained between $2.8 trillion and $3.4 trillion. However, considering that GDP has reached $30.5 trillion, the ideal scenario would require reserves to exceed $3.05 trillion. Currently, our reserves stand at $2.96 trillion, and in short, we are in danger. Furthermore, with the RRP essentially drained, the Federal Reserve has no buffer left. In January of this year, bank reserves were about $3.4 trillion, RRP around $600 billion, totaling liquidity of about $4 trillion, which means total system liquidity has decreased by over $1 trillion in less than a year. Worse, the Federal Reserve is still conducting quantitative tightening at a scale of $25 billion per month. This time will be worse than in 2019. Some may optimistically think that we also faced a similar situation in 2019 when reserves dropped to $1.5 trillion, but everything turned out fine in the end, and it will be the same this time. However, the truth is that the liquidity crisis we face this time will be worse than in 2019. In 2019, reserves fell to $1.5 trillion, about 7% of GDP (when GDP was approximately $21.4 trillion), the financial system was paralyzed, the repo market surged, and the Federal Reserve panicked and chose to start printing money. Currently, bank reserves are 9.71% of GDP, although they are already below Powell's stated 10% reserve adequacy threshold, they are still higher than in 2019. So, why will the situation be worse? There are three reasons: 1. The absolute size of the financial system has expanded. The banking system is larger, the balance sheets are larger, and the amount of reserves needed to maintain system smooth operation has increased. A 7% reserve in 2019 triggered a crisis; now, reserves at 9.71% of GDP are already showing signs of pressure, and as reserve levels decline, this pressure point may further worsen. 2. We no longer have the RRP buffer. In 2019, RRP was almost non-existent, but in the post-pandemic era, the financial system has become accustomed to this additional liquidity buffer. Now that it has disappeared, the financial system must readjust to operate without it. 3. Regulatory requirements have become stricter. After the 2008 financial crisis and the recent regional banking crisis in 2023, banks face stricter liquidity requirements. They need to hold more high-quality liquid assets (HQLA) to meet regulations such as the liquidity coverage ratio (LCR). Bank reserves are the highest quality liquid assets. As reserves decline, banks are getting closer to their regulatory minimum standards. When they get close, they will start to take defensive actions, such as reducing lending, hoarding liquidity, and raising overnight financing rates (SOFR). The SOFR spread is widening. If the increase in bank reserves and the depletion of RRP are merely a few “stop signals” we encounter on our way to a liquidity crisis, then next we will see the real “flashing red lights” ahead. SOFR (Secured Overnight Financing Rate) is the rate at which financial institutions borrow cash overnight against U.S. Treasury securities as collateral. It has replaced the London Interbank Offered Rate (LIBOR) as the primary benchmark for short-term rates, calculated based on actual transactions in the U.S. Treasury repurchase market (with daily trading volume of about $1 trillion). The effective federal funds rate (EFFR) is the rate at which banks lend their excess reserves to each other overnight. Under normal circumstances, the trading prices of these two rates are very close (within a few basis points); they are both overnight rates, linked to Federal Reserve policy, and reflect short-term financing conditions. Under normal circumstances, they should be almost identical, but when SOFR starts to be significantly higher than EFFR, it sends a warning. This means that secured loans (i.e., loans backed by U.S. Treasury securities) suddenly become more expensive than unsecured loans in the interbank market. Typically, the cost of borrowing against rock-solid collateral like U.S. Treasury securities should be lower, not higher. Therefore, when there is…