The Consequences of the U.S. Monetary Base Bubble 21 comments
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This is a more serious and depressing article than normal.
With all the talk about money printing and buying back of treasuries, we felt it was time to see how the US Monetary Base is getting on. [For those too lazy to click on the the link, a country's monetary base can loosely be defined and measured as the sum of currency in circulation - depending upon who calcuated the figures it may or may not include 'commodity' moneys (gold, silver, etc) - if you need more, look it up].
We knew that it had got a little exuberant late last year but we have neglected to look at it seriously for a few months.
US Monetary Base 1998 - Present
click to enlarge
Those two little insignificant blips on the left of the graph were the Y2K thingy and 9/11. Which nobody, at the time, felt were insignificant!
Let's get a little more historical perspective.
US Monetary Base 1970 - Present
I think the technical term is: "Dude, a metric bucket load of additional capital has suddenly appeared in our circulation."
We can see no end, or even the beginning of the end, in sight.
If you want to know where the bubble is in world markets, it is to be found in the chart above. Everything else we are seeing in the world right now is merely a symptom of the Fed and/or US Treasury having gone completely mad, or perhaps desperate.
Clearly there is a serious problem. To be honest we are having a lot of trouble comprehending the likely consequences. Can any readers state a reasonable case as to why we are not going to see inflation at levels that will make the 1970s look like child’s play? By this we mean before year-end 2010, crude will be above $200, gold above $2,000 and yields on US 30 Year Treasuries above 8%.
Yield on the US 30yr Treasury 1980 - Present
We get this sinking feeling that yields on the US 30yr are going to also blow up like we have not witnessed in modern history. Goodness knows what other economic effects that will have as well. Again, any reader with a sensible view please add your comment for or against.
After this exercise I can look in the mirror and while things may still look the same, the way I see things has definitely changed.
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This article has 21 comments:
Would you take the Federal Reserve, in sickness and in hell, in good times and in bad... Take the good with the bad... do you think their goal is noble and possible? Can they time the market, manipulate it to make it better for all?
OR should we abolish them? Is enough enough? Does their history of failure mean anything to you?
Lies beget more lies which is why fiat dollars beget serial bubbles and a collapsing exchange rate for the dollar versus any real store of value .......or even against less fake international media of exchange.
This makes, inevitable, an increase in dollar denominated oil (and later other energy forms) prices as well as metal and ore prices. In turn, this will propel a rise in dollar denominated, internationally traded, food and timber prices.
The combination of rising dollar denominated energy, raw material, food and timber prices will lead to inflation in the US, even as the economy stagnates, incomes decline and jobs vaporize.
The consequence of a vast increase in lies must, inevitably ,be a vast increase in material and psychological pain for the American middle class.
A monetary base inflating at maniacal rates will mean(in the not too distant future) a Middle Class compressing at a catastrophic rate.
All lies are eventually exposed; truth prevails.
In this case the truth is misery for the middle class, end of the debased dollar's reign as undisputed global currency and the demise of America as a hyperpower. There is a fearful cost to sustained, enormous, lying.
Hey, what about the news that Walmart is buying Target Stores?
After last week's Fed statement, I commented:
“With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.” While this statement may be true (probably less so than we are led to believe) at the moment, ignore it. It is a “CYA” statement that provides cover for the Fed to continue pumping the economy. This statement or its equivalent will probably be in the Fed’s statement until a month or two before rampant inflation is obvious to everyone.
“The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.” This statement is inconsistent with the prior statement. It is either untrue or a diversion. There is no “smooth transition in markets” possible. While it might be possible that the Fed does actually honor this statement in a strict sense, they will merely shift their pumping to a different vehicle. To stop pumping now would mean a collapse of the mortgage market and the economy that will result in a Great Depression.
It is difficult to discern whether the Fed is merely being duplicitous or just plain wrong in their reading of the economy. After all, they have a pretty good track record for both.
If you believe what is in the statement, then I would get out of the stock market immediately. If not, then it is possible that the financial market fantasy can continue for awhile. Regardless of which you believe, be very careful. For me, I want no part in long positions in traditional stocks or bonds. This Ponzi scheme cannot go on much longer.
Monty Pelerin
High inflation will approach soon. The higher costs of raw materials (due to the weakening of the US dollar purchasing power) have been offset by the mass layoffs of workers and reduction of non-essential expenses. Companies have also been helped tremendously by the zero-interest rate policy by the Fed. It's all evident in most of the earnings releases we've seen so far where bottom line net income has stabilized but top line net revenue growth has been hammered. Margins have been squeezed.
Unfortunately, the US dollar has only one path at the moment....and that's a weakening path. Input prices will continually become more and more expensive as the U.S. purchasing power becomes further eroded. Most companies are already running skeleton crews....and interest rates can't fall below zero. It won't be long before consumer prices have to rise....lest businesses go bankrupt en-masse.
This would have been ok, if America had a stronger production base, as an increase in exports would provide an effective counter-balance. Alas....this is not the case.
On Nov 09 12:08 PM bluesky123 wrote:
> The US equities Super Bubble scares the crap out of me. I have found
> quite a number of US stocks with PEs over 1000. I'm out of US equities
> altogether. This is madness.
NO two ways about it: That is HILARIOUS!!
My good man, this was a brief but brilliant read. And that graphic is FRIGHTENING.
I'm talking "Captain of the Poseidon glances out the window and sees a Mile-High TOWER of Ocean headed his way" FRIGHTENING!!
Good observation at the end of your post about so many participants being more interested in ranting. The fencesitter's remorse that you also detect is often much more than that, it is the sound of people who have gotten massacred because they shorted the market, continue to short the market, and/or are itching to short the market the first chance they get. They've been wrong for months, but they have become married to a doom-and-gloom outlook; a belief that the entire rally has materialized out of thin air; and that it has all been engineered by a government-financier-m... conspiracy.
Don't worry, though. Look around the site and soon enough you'll find articles and comments about riding the rally safely; dividend investing; and others who are working on what you are seeking, namely a way to make money today and tomorrow.
Whether you like it or not, your future....and your children's future are entrusted with only a handful of people on this planet. These people do not know all the facts... they do not know all the answers. They have only one vague precedent that was set almost 80 years ago....and conditions today are very different (more complex, global and integrated) than it was then. And what that precedent tells them is to do opposite of what was done then and hopefully the outcome is opposite of what happened then. And that's really it.
Not once, did our leaders directly address the true underlying problems in the economy: the malaise that has stricken the U.S. manufacturing and production base....the imbalance of global capital and trade flows.....the change in incentives from savings to borrowing....the demographics shift. Their solution to a credit problem was more credit.... like a doctor treating a cocaine addict with more cocaine.... delaying that inevitable crash that all addicts must endure before they can heal.
In general, when a bubble is formed, more often than not, it is sufficiently isolated that I can do something about it.... to reduce exposures to it and sleep well at night. But the current bubble forming is so massive.....so pervasive and so fundamental that I don't believe anyone can be sufficiently protected from it. Even those as far away as China.
And it appears the Fed is willing to blow this bubble to as big as it can possibly grow.... until it stretches the very seams of the economy.... to test how far off equilibrium they can push to before something....someone gives.
The Fed must reverse course NOW. Start raising interest rates. It's not that the economy is overheated......it's the very recovery itself that is overheated. The economy should not be recovering with the fundamental global imbalances still persisting. Raise interest rates to stop the dollar carry trade and encourage savings. Yes...the economy will likely become stagnant or even crash. But perhaps this is the necessary adjustment that must happen in order to correct the imbalances and finally cement the foundations for a true and sustainable recovery.
At the end of the day, we all seek a real sustainable recovery, but we should not do so by cashing in our future. That is not true recovery. All it does is delay the inevitable, and make the problems bigger for us...and for our children.
;-}
On Nov 09 04:18 PM user396040 wrote:
> There are legitimate reasons to be concerned about inflation at some
> point in the future and higher interest rates as well but I am not
> sure this chart is one of them. As I understand it, the monetary
> base is the amount of reserves the banks hold, including amounts
> which banks have on deposit at the Federal Reserve (e.g. Citibank's
> funds held at the Federal Reserve). Because of the extreme financial
> panic, many banks have been extraordinarily conservative in the deployment
> of cash and have decided to deposit funds at the Federal Reserve
> rather than lend them out. This has led to a big increase in the
> "monetary base" but is not, in itself, deflationary because the funds
> deposited at the Federal Reserve are not really available for anyone
> to spend. If and when conditions improve, the banks will withdraw
> these funds and lend them out or use the deposits as a base for leveraging
> more loans and deposits. I think that the issue of how to play this
> whole thing as an investor is a very interesting one. But what concerns
> me about this blog is that many participants seem to be more interested
> in ranting about public policy than figuring out how to make money
> in this admittedly challenging environment. I sense in some of these
> comments a kind of fencesitter's remorse on the part of investors
> who have missed the rally. As economists often say, bygones are
> bygones; the important question (for at least some of us) is how
> do we make money from here.
Same for ability to form a coherent viewpoint
Qui vir odiosus!
On Nov 09 08:22 PM taojaxx wrote:
> Amazing that it would take until the 14th post to read some sensible
> comment on this hastily drafted column. The author of the article
> has obviously no idea what monetary base is (try to pay your grocery
> with gold at the check out register...), let alone what it means
> that banks would keep this much idle excess reserves. Amazing as
> well that it would elicit so many approving comments. I guess that's
> the beauty of the market and the source of its wealth redistributing
> function, from Joe Shmoe's 401 K to Goldman Sachs's Hampton mansion.
>
> ;-}
>
> On Nov 09 04:18 PM user396040 wrote:
Central bankers are legally obligated to accept the dollar as legal tender and our deficit spending policies are based on this fact. Our policy wonks perceive that changes to the global currency system are in the planning stage but don’t think anything will happen in the near future. And their thinking is that they can correct our economic problems before changes do occur therefore responding from a position of strength.
My personnel belief is that our policy wonks are addicted to deficit spending and will not change their policies until they are forced to change.
Once central bankers no longer accept the dollar as legal tender in their country then the American economy will experience the economic dislocations caused by the Federal Reserve’s policies.
In order for the central bankers to act decisively on the dollar and other national currencies used as global currency, they will have to agree to a new global currency system, one that replaces the current system.
We see that Germany, France, China, India, Russia and other central banker’s policy wonks are actively working on a new currency system. The question is will we experience a currency panic before the global economy transitions into the new currency system.
What has mostly been forgotten, even to the point of not being mentioned any more, is the genius of free markets. No collection of Washington bureaucrats can provide the clarity that free markets give us, and the longer we ignore this the worse our situation will deteriorate. The Fed has become a "one trick pony", with the answer to all sticky problems being to print more money. Small dislocations are, therefore, unresolved by free market economics and continue to grow ever larger.
"Anything that can't go on forever won't"--Herbert Stein
It is an indisputable fact that the "monetary base" is not a base for the expansion of new money & credit. Milton Friedman just defaulted to such contrivance.
The basic "expansion coefficient" for the banking system as a whole (the correct source base), is obtained by dividing commercial bank credit, (or the H.8), by the sum of the member bank’s (1) required reserves, plus (2) contractual clearing balances.
Note: the past reductions in required reserve balances have predominantly been accompanied by “offsetting increases” in the member bank’s contractual (required), clearing balances (note: both required reserves and vault cash, can be used for deficits in contractual clearing balances (as long as they are quickly replenished)).
Contractual clearing balances are essentially prudential reserves, e.g., (1) reserves necessary for posting debits and credits resulting from both intra & inter-bank transactions, (2) reserves to meet the public’s demand for currency, or (3) reserves to avoid deficits in the bank’s balance of payments, etc. E.g., prudential reserves are the "source base" for the unregulated Euro-dollar, Yen-dollar, etc. Market (e.g., carry trade). See: "The Euro-Dollar Market: Some First Principles -- Milton Friedman"
In theory, contractual clearing balances function as “reserve requirements against debits to deposits”. They are reserve requirements based both upon the turnover of deposits, as well as upon their volume (See: 1931 Committee on Bank Reserves Proposal (by the Board’s Division of Research and Statistics). This study was declassified in March 1983.
Any changes (use of deposits), will trigger automatic adjustments in a bank’s requirement for either additional (1) contractual clearing balances (required), and or in, (2) supplemental reserves (daylight overdraft credit).
Daylight credit is constrained by (1) “net debit caps” and (2) “interest rate charges on daylight overdrafts (net-debit-caps are the bank’s maximum allowable daylight overdraft positions).
Daylight credit figures (legal reserves), should be incorporated in the banking system’s source base (but the data on daylight credit is unavailable on an up-to-date release). Daylight credit & or overdrafts occur when a member bank operates with a negative legal reserve balances (not the same as borrowed reserves).
& if you didn't understand don't worry, the "source base" is irrelevant. Why? Because the "member banks" are unencumbered in their lending operations (legal reserve requirements are no longer binding, i.e., because of ATM networks, sweep accounts, reserve avoidance, etc.).