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The Consequences of the U.S. Monetary Base Bubble

Thomas McLoed:

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.).

Supply and Demand Have Little Relevance in Commodities Prices

the evidence of inflation is represented by "actual" prices in the marketplace. The "administered" prices of the world's commodities would not be the "asked" prices were they not “validated” by (MVt), i.e., validated by the world's Central Banks ( i.e., as Friedman maintained "inflation is always and everywhere a monetary phenomenon")

Fed Easing: No Free Lunch for Dollar, Oil and Commodities

Wake up. Oil imports are c. 3/8 of the trade deficit. The real culprit is other countries sell higher quality, lower price, goods & services. And lower exchange rates (37% decline since 2/1/2002) have done nothing to correct the problem. And a lower exchange rate will just stoke stagflation.

Big Ben, Please Tell Us You Have a Plan B

As the exchange value of the U.S. dollar falls, inflation rises. Increases in the massive E-dollar market in combination with the current account deficit spells stagflation. Our dollar will continue to decline until it forces a balance of payments on us. At that level the majority of citizens will live in relative poverty.

Ben Bernanke's Tightrope Act

In 1980, Paul Volcker, Past chairman of the Board of Governors of the Federal Reserve System, appeared before the House Domestic Monetary Policy Subcommittee. In response to a question as to why the Fed had supplied an excessive volume of legal reserves to the member banks in the third quarter 1980 (annual rate of increase 13.2%), Volcker's defense was that there are two types of legal reserves: 1) borrowed (reserves obtained by the banks through the Federal Reserve Bank discount windows), and 2) non-borrowed (reserves supplied the banking system consequent to open market purchases). He advised the congressmen to watch the non-borrowed reserves -- "Watch what we do on our own initiative." The Chairman further added --- "Relatively large borrowing (by the banks from the Fed) exerts a lot of restraint."
This is of course, economic nonsense. One dollar of borrowed reserves provides the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. The fact that advances had to be repaid in 15 days was immaterial. A new advance could be obtained, or the borrowing bank replaced by other borrowing banks. The importance of controlling borrowed reserves was indicated by the fact that at times nearly 10% of all legal reserves were borrowed.

Ben Bernanke's Tightrope Act

The last vestige of legal reserve and reserve ratio requirements against the Federal Reserve Note, demand deposit, and inter-bank demand deposit liabilities of the Reserve banks was eliminated in 1968. Today the Federal Reserve Note has no legal reserve requirements, and the capacity of the Fed to create IBDDs has no legal limit. These IBDDs are owned by commercial banks; they are bank legal reserves and can be converted dollar-for-dollar into Federal Reserve Notes. The volume of FRBIBDDs is almost exclusively related to the volume of Reserve Bank credit. When Federal Reserve Banks expand credit, for example by buying U.S. obligations, the balance sheets of the Banks reflect an increase in earning assets and an equal increase in IBDD liabilities, i.e., legal reserves.

Let the Fed buy the entire federal budget this year all the while raising reserve ratios to counter-balance the purchases.

Ben Bernanke's Tightrope Act

Volcker was a joke.

Sell the U.S. Market Before October

but nobody knows why --- It is mathematically impossible to miss a forecast. Nearly every economic crisis was the result of a flawed monetary policy. Oct will be the bottom.