flow5

Unchartered Economic Waters

"as the Federal Reserve had the option of inflating during the Great Depression, and did not do so"

No, the circumstances surrounding the Great Depression made it impossible for the FED to expand the money supply. The collateral requirements were restrictive, its operations were uncoordinated, the volume of federal debt was insufficient for open market operations, and there weren't enough credit worthy borrowers in the private sector.

These conditions are diametrically opposed to the current conditions.

Three Fatal Flaws with Healthcare Reform

Socialism (price controls), given its nature, has a lot of weaknesses. The bill "rob Peter to pay Paul", will downgrade our health services (companies now pay c. 10% of their revenue towards health care for their employees). We will end up with fewer doctors, working fewer hours, receiving lower wages (because of lower reimbursement for their services).

Today, docs in private practice work 40 hours just to break even. They have to work in excess of 40 hours just to make money.

It's deplorable that health reform doesn't reduce the obvious and correctable costs. I.e., standardize the individual documents required for the backup of billing and coding. Each insurance company has its own forms and requirements. The docs have to remember what to do for each company. And it takes considerable time to fill each one of these forms out.

Why Bernanke Doesn’t Understand Basic Economics of Central Banking

The point is that the FED always accommodates all requests for legal reserves at the policy rate (repo rate). Banks are not "constrained" by the interest rate required to replenish reserves because the policy rate has never been a penalty rate. Only the discount window has a “penalty rate” (.50% discount rate vs. .25% FFR). As Dr. Scott Fullwiler states "There is NO “liquidity effect” associated with changes in the Target Rate".

As long as it is profitable for customers to borrow, & commercial banks to lend, money creation is not self-regulatory. I.e., the money supply can never be managed by any attempt to control the cost of credit.

"There is general agreement that, for almost all banks throughout the world, statutory reserve requirements are not binding" -- Richard Anderson

"Most banks no longer face binding statutory reserve requirements -- increasing amounts of vault cash (including ATM networks) plus retail deposit sweep programs have wiped aside such binding requirements". -- Richard Anderson

"The FOMC targets the federal funds rate, nominally the rate banks charge each other on overnight loans of deposits at the Fed.
In fact, what the NY Open market Desk sets each day is the ONE-DAY REPO-RATE on TREASURIES, that is, the one-day cost-of-carry on government bonds. This is the true policy instrument -- and it affects huge amounts of money (essentially, the one-day return on all government securities), while fed funds transactions daily, in comparison, are a trivial amount" -- Richard Anderson - the guru of guru's on bank reserves and the monetary base - V.P. Economist, St. Louis FED.

“the Fed would have to pull reserves out of the system” No, as I understand interest on reserves, the FED will raise the remuneration rate on excess, & required reserves, to maintain an policy rate “floor”. There won’t be an “exit strategy” because the FED will have to support Treasury Funding operations.

Why Bernanke Doesn’t Understand Basic Economics of Central Banking

Truly inflammatory Auerback . But as you state: banks are unencumbered in their lending operations (except for the venerated, & capricious, 10% bank capital adequacy ratios).

The problem is that the Treasury (for now), seems to be the primary customer/borrower. Lending and borrowing to/from the private sector has collapsed.

All of the FED's technical staff knows legal reserves aren't binding. I wonder if it is just a political statement, aimed at our legislators, because money creation is an abstract concept (where the whole, is not the same as the sum of its parts). Bernanke is very smart, & he understands conventional money & central banking.
======================...
However, the crux of the cause of our monetary mis-mangement, since 1965 (even during Volcker's reign-the brackets were widened not removed), is the assumption that the money supply can be manged through interest rates, specifically the federal funds rate (but now IORs).

Ever since 1965 the operations of the "trading desk" has been dictated by the Federal Funds "Bracket Racket" (interest rates). This has assured the bankers that no matter what lines of credit they extend, they can always honor them, since the FED assures the banks access to more legal reserves, whenever the banks need them to cover their expanding loans - deposits.

We should have learned the falsity of that assumption in the Dec. 1941-Mar. 1951 period. That was what the Treasury-Federal Reserve Accord was all about. The effect of tying open market policy to a federal funds bracket is to supply additional and excessive legal reserves to the banking system, when loan demand increases.

When the member banks operate with no excess reserves of significance, the member banks have to acquire additional reserves, to support the expansion of deposits, resulting from their loan expansion.

If they use the federal funds market, which is typical, the rate is bid up and the "trading desk" responds by putting through buy orders, reserves are increased and soon a multiple volume of money is created on the basis of any given increase in legal reserves.

This is the process by which the FED has financed the rampant real-estate speculation that has characterized the bubble years.
By using the wrong criteria (interest rates, instead of member bank reserves), in formulating, and executing monetary policy, the Federal Reserve has routinely, in the long-run, generated excessive rates of inflation.

What should the FED do? First put all banks on notice that if they need funds for expansion of loans they will individually have to liquidate some of their liquid assets, Treasury bills, etc. And the discount window will only be open for emergency borrowing.

Secondly the Manager of the Open Market Account should be instructed to regulate his operation in terms of the proper volume of legal reserves (at a level where reserves are binding), which the member banks should hold (except for temporary instances, in which support operations for the Treasury are necessary - and the excessive expansion of legal reserves can be removed after the support operations have passed).
======================...
"Where do you think the excess reserves came from?” The source of IORs is not QE, quantitative easing, (the source of IORs within the monetary system, is other bank deposits, directly or indirectly via currency, or the bank's undivided profits accounts).
For IORs to be offsetting, the remuneration rate on excess & required reserves, must be competitive, vis a’ vis other instruments and yields. The member banks have thus shifted their portfolio composition (earning assets), to hold IORs @.25% (rates higher than t-bills and rates which induce dis-intermediation among the non-banks).

This is why the increase in the volume the FED's liabilities (IORs), has been deflationary. The FED has used IORs to offset (how they determine the proper volume of IORs is a mystery to me), its expansion of assets (lending facilities), on its balance sheet.

An increase in the volume of legal reserves (idle excess reserves), is functionally equivalent to an increase in reserve ratios (similar to 1937 when the FOMC doubled reserve requirements on all deposit classifications, driving the economy into a deeper depression).

I.e., raising reserve ratios does not involve QE. In 1990 & 1992, the FED reduced required reserves ratios by > 1/2 in order to stimulate lending and borrowing. So why is the FED pursuing a "tight" monetary policy compared to 1990?

As Dr. Scott Fullwiler states (contrary to Krugman):
"There is NO “liquidity effect” associated with changes in the Target Rate"

With the FED paying interest on excess reserve balances, held at the District Banks, owned by the member banks, the FOMC's policy rate, relative to the volume of legal reserves, has become an independent variable.

Pegging interest rates through IORs will increase the probability of policy errors, as the FED will be able to hold short-term interest rates at the desired level, for longer periods of time, without increasing inflation expectations (long-term rates).

Where Bernanke demonstrates his ignorance is: commercial banks pay for what they already own, interest on their own deposits. I.e., Bernanke doesn’t understand, or demonstrate that he understands, the difference between financial intermediaries, and the commercial banking system.

Inflation Scorecard: CPI and PPI Turn Up

Monetary flows are ex-ante. The rate-of-change in monetary flows (MVt), the proxy for inflation, peaks in March next year. There's not much room for the FED to maneuver (expand the money supply), until Oct 2010. That spells stagflation.

How Are Governments to Finance Themselves?

It's called crowding out. And and increase in inflation expectations will effectively abort the economy.

Review of Keynes: 'The Return of the Master' and 'The Keynes Solution'

"And to the scholar-exegete, Keynes’s lifestyle offers sweet contrast to the dreary portrait of the obscure pedant, the dull economist. No, Keynes was the stuff of literature. For there was Keynes the theorist; but also Keynes the confidant of Virgina Woolf; Keynes the correspondent of Bernard Shaw; Keynes the trustee of the National Gallery; Keynes the husband of Russian ballerina Lydia Lopokova; Keynes the stock market speculator, the insurance executive, the polemic journalist, the social reformer, the avid book collector, and, it must be reckoned, the devotee of Etonian Culture (as it might be called in a sex advertisement; Professor Harry G. Johnson, once remarking on the homosexuality of King’s College, recalled the professor who referred to the chapel there as First Church of Christ, Sodomite)." -- Edward Meadows

It began with the General Theory, John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”

In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to SUBSTITUTE the term FINANCIAL INTERMEDIARY in order to make the statement CORRECT. Perhaps this is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, Reg Q, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, Financial Services Regulatory Relief Act of 2006, Emergency Economic Stabilization Act of 2008, SEC. 128. ACCELERATION OF EFFECTIVE DATE for payment of interest on reserves, etc.

How the Government Creates Money

Credit is the "life-blood of business". We are told to "trade on our equity". But in today's world, we are advised of the "burden of debt".

Debt is an outlet for savings. Savings doesn't affect the total volume of money. Savings is a function of velocity. However savings will exert a depressing effect if not offset by an expansion of "real" debt (not "financial" debt).

For the period encompassing the Great Depression there was no over all debt expansion. Estimates by the Department of Commerce put the net debt figure as of the end of 1939 at $183.2 billion compared with a figure of $190.9 billion as of the end of 1929.

Debt expansion resulting from the commercial and Reserve banks is monetized, resulting in a corresponding increase in the volume of new money issued. I.e., debt must not only be expanded to absorb savings, but new money must be issued (over and above the volume of savings), to keep employment at acceptable levels.

On Releasing Citi from TARP and Banking by Accounting Subterfuge

Your right right about Citigroup:

"A sworn fore of bureaucrats, Mr. Wriston often joked: “Regulators sit by while snails go by like rockets.” He devoted much of his career to diving through loopholes in bank holding-company legislation or wriggling free of interest-rate restrictions. As Mr. Zweig shows, Mr. Wriston presided over an encyclopedic range of innovations-among them negotiable CDs, term loans, syndicated loans, floating-rate notes and currency swaps-that ended forever the moribund bonking of the 1950s and ushered in our razzle-dazzle age of finance. The old prudential banker’s ethic was eclipsed by the hedonistic freedom of the consumer culture. By the 1960s, Mr. Wriston had inverted traditional bankers’ wisdom and proclaimed: “Our job is to help people spend money, not to save it.” --- The “Go-for-Broke Banker” Ron Chernow

Money Supply: Have You Seen M3 Lately?

The decrease in M3 represents a collapse in the non-banks, or an outflow of funds, negative cash flow, or contraction, (e.g., MMMF redemptions), from the financial intermediaries (intermediary between saver & borrower). PIMCO's McCulley called these financial institutions the shadow banking system.

Commercial banks aren't financial intermediaries because they always create new money in the lending process. Commercial banks do not loan out excess reserves nor savings.

The financial intermediaries represented 80% of the lending market in 2007 and before. Unless lending from these non-banks is revived, the economy won't recover. And it is a good bet that this sector of the economy won't recover, and this outcome will eventually send stocks lower.

Eurodollar borrowings are not the same as euro-dollars, as all euro-dollars are created abroad (by foreign banks). Eurodollar borrowings belong to U.S. banks. The E-D market used to be several times larger than the domestic money stock. But we can't count our own money, least the rest of the world's.

Why Are Banks Holding So Many Excess Reserves?

On May 1st 1937 the Board of Governors DOUBLED the required reserve ratios on demand deposits for Central Reserve City banks (26%), Reserve City Banks (20%), & Country Banks (14%). It raised reserve ratios on all time deposits classifications to (6%). That made the percentage of reserves to note and deposit liabilities 68.3% in 1933 rising to 85.4% in 1939, and peaking at 91.1% in 1941.

Note that the continuous increase in weighted arithmetic average of reserve ratios during the 30’s was largely the result of increases in our monetary gold stocks, and increases in its price set by President Roosevelt and Treasury Secretary Morgenthau. Gold was fixed at the dollar price of $20.67 beginning in April 1933 (when the US went off the gold standard) and rose to $35 by year end (and remained there).

I.e., during the Great Depression the FED “tightened” monetary policy and the recession deepened immediately afterwards, in 1937 & 1938. The volume of required reserves more than doubled which significantly reduced the member bank’s legal lending capacity.
======================...

"In December 1990, the required reserve ratio on non-transaction accounts—non-personal time and savings deposits and net Eurocurrency liabilities— was pared from 3 percent to zero, and in April 1992, the 12 percent requirement on transaction deposits was trimmed to 10 percent"

"The elimination of the 3 percent reserve requirement on non-transaction accounts at the end of 1990 reduced the level of required reserve balances roughly $11.5 billion, or about one-third. Overall, this second cut in reserve requirements reduced the required reserve balances of the entire banking system about $8.5 billion. I.e., the volume of required member bank legal reserves fell by > one half.

"some lenders had adopted a more cautious approach to extending credit. This caution was exerting a restraining effect on the cost and availability of credit to some types of borrowers....the cuts in reserve requirements were designed to put banks in a better position to extend credit"
======================...

Now in 2009, presented with another lending crisis, the Reserve Authorities have opted to increase the volume of total reserve balances by a factor of 24, to $1,077,289 (based upon excess reserves). Or the overall reserve-deposit ratio is 7.92%. This compares to 202.3% prior to September 2008.

If the FED argued that it had to reduce the volume of legal reserves in 1990 to incent lending, but now argue that they must operate with over a trillion dollars of excess reserves to accomplish the same goal, then there is a new paradigm.

Why Are Banks Holding So Many Excess Reserves?

The source of IORs within the monetary system is other bank deposits, directly or indirectly via currency, or the bank's undivided profits accounts. IORs are lost to investment, consumption, or to any type of payment (if held in this form). I.e., IORs held within the monetary system have a transactions velocity of zero, and are a leakage in the Keynesian national income concept of savings. IORs exert a contractionary force upon the economy. Such a “cessation of circuit income” has adverse effects on production and employment, and requires large dosages of money to counter-act.

The Confusing Connection Between M2 and Inflation

"Well isn't that what we're looking for? Let's look at it more. A new way to count M1?"

It' not one of the "M's". It's money, the measure of liquidity. It's money actually exchanging hands.

SEE: Member Bank Reserve Requirements -- Analysis of Committee Proposal, February 27, 1938 - declassified March 23, 1983 (too late for any consideration).

In 1931 this committee recommended a radical change in the method of computing reserve requirements, the most important features of which were:

(2) "Requirements against debits to deposits"
(5)"the committee proposed that reserve requirements be based upon the turnover of deposits"

Dr. Richard G. Anderson, V.P. Federal Reserve Bank of St. Louis:

(1) "They "ECB" justify the "reserve" requirement as assuring that banks maintain a PRUDENTIAL LEVEL OF CLEARING DEPOSITS."
(2) "Today, with bank reserves largely driven by bank payments (DEBITS), your views on bank debits and legal reserves sound right."

Dr. Scott T. Fullwiler:

(1) "Without reserve requirements, banks hold non-interest-bearing reserve BALANCES only to SETTLE PAYMENTS such as checks drawn on customer accounts, or Fedwire funds transfers for direct payments to other banks, or the Treasury, or as SETTLEMENT OF NETTED CLEARINGHOUSE TRANSACTIONS"
(2) "In order to avoid the Fed's overdraft charges (discussed in Fullwiler 2003), banks desire to hold sufficient reserve balances to SETTLE their NET PAYMENT COMMITMENTS for the day"

Dr. Leland James Pritchard, PhD, Economics, Chicago 1933, MS, Statistics:

"And to dismiss the concept of Vt (THE TRANSACTIONS VELOCITY OF MONEY, or BANK DEBITS), by saying it is meaningless (that people can only spend their income once) is to ignore the fact that Vt is a function of three factors: (1) the number of transactions; (2) the prices of goods and services; (3) the volume of M...."

I.e., all the DEMAND DRAFTS drawn on these institutions CLEAR THROUGH DDs, except those drawn on MSBs, interbank, and the U.S. government. (G.6 release, debit & deposit turnover, discontinued Sept. 1996). I.e., financial transactions are not random.

Contrary to economic theory (and Milton Friedman), monetary lags are not long and variable. The lags for monetary flows (MVt), i.e. proxies for (1) real-growth, and (2) inflation, are historically, always, fixed (uniform), in length.

Rates-of-change in (MVt) are always measured with the same length of time as the specific economic lag (as its influence approaches its maximum impact (not a date range); as demonstrated by the clustering on a scatter plot diagram).

The BEA uses quarterly accounting periods for real GDP and the deflator. The accounting periods for GDP should correspond to the specific economic lag, not quarterly.

Monetary policy objectives should not be in terms of any particular rate or range of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired roc's in monetary flows (MVt) relative to roc’s in real GDP.

Mathematically, economic prognostications are infallable.

Why Merrill Lynch Is Bullish on 2010: Foreseeing a Burst of the Pessimism Bubble

I was taught in personal finance at KU that Merrill Lynch will lynch you!

As Inflation Ticks Up, Expect Unwinding of Liquidity Programs

The exclusions are the most important prices to watch. When do the food and energy sectors stop being "volatile" and start being "core"?

Anyone who has gone grocery shopping lateley knows that the store's products are being "watered down", i.e., downsized. Produce is being re-packaged and re-priced, into smaller quantities (volumes & numbers). I.e., we have stealth (unreported) inflation.