The report from the Federal Reserve Wednesday was positive. The headline in the Wall Street Journal was typical: “Fed More Upbeat, but Keeps Lid on Rates.” In other Federal Reserve news, we hear that the Fed is going to phase out the special facilities set up during the financial crisis.

So, what else is new?

The side that wins the political battles is usually the one that presents the issues in such a way that the “public” responds to this presentation and goes with them rather than with the “other side.”

There is an election coming up next year and the campaigning has already begun. The battle: whether or not the Democrats are going to be able to maintain a large enough majority in Congress to control the action in Washington, D. C. Already, the Democrats are looking back over their shoulders to the 1994 mid-term election and their loss of control of Congress at that time. And they are scared.

Something new this week: the Fed started to see how the financial markets would accept its strategy for reducing the size of its security portfolio. At the close of business on Wednesday December 9, the Federal Reserve showed $180 million on its balance sheet under the line item “Reverse repurchase agreements”. (See here, here, here and here for previous posts in this series.)

The Federal Reserve had warned us that it was going to start “testing” the use of reverse repos as the mechanism for reducing the size of its securities portfolio. It had also informed us that a “test period” would begin last week.

Harold James, the author of The Creation and Destruction of Value: The Globalization Cycle (Harvard University Press: 2009), considers two different concepts of value. The first relates to monetary values and their determination, which depends upon assessments of the future. The second relates to immaterial values which are vital to trust and social cohesion. His book is about the collapse of globalization and how this collapse “becomes a story of changing values in both the usual senses of the term, as monetary and ideal values are shaken.”

Bank Holding Companies

The Flow of Funds accounts from the Federal Reserve System came out on Thursday. This gives us a chance to look at parts of the financial system that we do not get to look at on a more frequent basis.

Spain has just had its debt outlook lowered by Standard and Poor’s. In January, Spain’s debt rating was lowered from AAA to AA+, and now the country's debt outlook has been reduced from “stable” to “negative”. The outlook: Spain is now expected to experience a “more pronounced and persistent deterioration” in its budget and a “more prolonged period of economic weakness,” than it expected at the start of the year. Enough said.

Spain joins Dubai and Greece in the headlines that include the label “sovereign debt.” And, the guess is that this list is going to grow in the upcoming weeks and months.

Last month it seemed as if there was a glimmer of hope for the smaller banks, as lending appeared to be picking up across the board. (See my November 9 post, “A Positive Trend in Small Bank Lending”.)

Well, the glimmer of hope went away in November. However, lending, and profits, at the larger banks seemed to become more robust as we went deeper into the fall.

The United States economy lost only 11, 000 jobs in November and the unemployment rate dropped to 10.0% from 10.2%. Good news!

There is still plenty of work left to do, however.

It is instructive to take a closer look at how people seem to be handling their money. Obviously, people are not spending much, although the Federal Reserve sure cannot be faulted for not trying to jump start consumer and business spending. The monetary base, the sum of all bank reserves and money that can serve as bank reserves has gone from a year-over-year rate of increase of about one percent at the end of 2007, to a 101%, year-over-year, rate of increase at the end of 2008, to a 102%, year-over-year, rate of increase through the third quarter of 2009.

The unwillingness of banks to lend and/or the unwillingness of people to borrow shows up in how fast this base money turns over in the economy. That is, in the velocity of use of this base money. Whereas, velocity was increasing by about 4% through 2007, it declined by 101% in 2008, and was declining at a 104% rate through the third quarter of 2009.

This from the Financial Times on the morning of Friday, November 20, 2009:

Short-term US interest rates turned negative on Thursday as banks frantically stockpiled government securities in order to polish their balance sheets for the end of the year.

Ben Bernanke spoke in New York Monday and, depending upon which paper you read, he basically said one of two things. First, he said that the Fed was interested in a strong dollar and would continue to keep the value of the dollar in mind in deliberations concerning monetary policy.

Chuckle, chuckle.

Over the weekend, I posted a report on the strategy of the Federal Reserve to exit its position of excessive monetary ease. In that report I mentioned that, since August, the total amount of reserves in the banking system had shown a substantial increase.

Looking a little further into the data we find that the Monetary Base, defined as all financial assets that serve as bank reserves or could become bank reserves, rose from an average of $1,649 billion in the two weeks ending August 12, 2009 to an average of $2,001 billion in the two weeks ending November 4. (These data are on a nonseasonally adjusted basis, but the seasonally adjusted data are not significantly different.)

This is the fourth month that I have posted something about the performance of the Federal Reserve with respect to its exit strategy, the strategy it is following to remove the massive amount of reserves it put into the banking system in 2008 and beyond (see here, here and here for previous posts).

On November 11, 2009, the Fed was supplying $2,176 billion in reserve funds to the banking system. (This is from the Federal Reserve release H.4.1, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.) This was down slightly from the $2,233 billion total on October 14, 2009, but up from the $2,055 billion on August 12, 2009.

“It is very important to the United States that we have a strong dollar.”

So said the United States Secretary of the Treasury.

There was an interesting article inside the Wall Street Journal Thursday morning comparing the fortunes of Brazil and Argentina. (See “Argentina Falters as Old Rival Rises”) In the article, a research paper published in Argentina is quoted: “Since the middle of the last century, Argentina’s economy has endured a notable decline relative to the rest of the region, falling into ‘insignificance in the international context.’”

During this time period the government of Argentina followed a very undisciplined approach to economic policy while it kept itself in power and suppressed dissent. In 2001, Argentina declared the largest sovereign debt default in history. Things have not gotten much better since.

Will the Federal Reserve System join the ranks of other government public supported agencies like Fannie Mae (FNM) and Freddie Mac (FRE)?

One could argue that they are on the verge of such ignominy.

Could there be a glimmer of life in bank loans at Small, Domestically Chartered Commercial Banks?

The latest figures released by the Federal Reserve on the Assets and Liabilities of Commercial Banks in the United States gives some indication that this is happening. In the latest four weeks for which we have data, all Loans and Leases at commercial banks declined by $22 billion, but loans and leases at the smaller banks actually rose by $50 billion. And, this rise was across the board.

The central premise of “This Time is Different: Eight Centuries of Financial Folly," (Princeton University Press, 2009) is that people need better time series data for studying the history of financial crises. The authors, Carmen Reinhart and Kenneth Rogoff, believe that researchers, as well as practitioners, who have studied instances of financial crises, have neither a long enough nor a broad enough historical perspective to really understand the commonalities that exist in all cases of financial disruption.

In an attempt to correct this deficiency, Reinhart and Rogoff build a database of relevant information which they believe will contribute to the better understanding of what a country, or the world, experiences before, during, and after a financial crises. They have collected data from sixty-six different countries and their sources go back eight centuries.