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  • Will They, Could They, Should They? [View article]
    "It's cheaper to borrow in the Fed Funds market "

    I will also add, that sometimes other banks won't lend to other banks, so sometimes they have to go to the Fed.

    Another subsidy option is the FHLB, though they don't print the money.
    Oct 7, 2015. 04:34 PM | Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    "As far as I know, no one is borrowing directly from the Fed at the Discount Rate. "

    The Fed has an assortment of facilities. The less they charge for them, the more incentive there is to borrow. I also use the DR as a proxy for Fed accommodation.
    Oct 7, 2015. 09:51 AM | Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    "we already have about the highest inflation we have had since the crisis"

    Fair enough, but I was thinking more in terms of 5% + inflation. Until China, Russia, South America, Europe, or the Middle East turn full on free market (how likely is that?), then there won't be a whole lot of alternatives to the US. As such, demand for dollar denominated assets will remain high. Granted, the demand can weaken a bit from time to time, but the general trend will remain the same for a long time, that is of course, until there is a major policy shift somewhere.

    "Economists tend to believe that growth is trend-stationary;"

    Which is my overall point. We haven't had any major policy shifts back towards free markets. Instead, gov contractionary policies only get more entrenched as each year passes. So, indeed, there is no reason to expect more loan growth, which is why I say, if the Fed instituted negative rates, the money won't flow out into new businesses and new jobs. We have basically outlawed them, like France. The middle tier banks might lower the costs of borrowing for their existing clients, but those clients aren't likely to expand and go on a hiring binge, not with increasing minimum wage laws, Ocare, and the like (really, all gov regs are some form of wage law, if you think about it).

    The banks would be more likely to chase sovereign debt, and thus lower yields.

    "So I never expected loan growth to go to +30%. It has never done that after recessions in the past so no reason to expect that this time."

    Again, because the policy shifts are always towards more contractionary gov policies, not expansionary ones, which is why $1 million is the normal, but the goal should be to break the normal if you want true recovery (recovery not just back to what was, but what was also lost). That's the true measure of exceptional management (like Steve jobs coming back to Apple - the old normal was exploded, and a new, more productive paradigm took over).

    We can apply the same analysis to a country that we can apply to a company. After all, they are both corporate associations, and the laws of nature with regards to productivity are the same for both.

    I don't mean to disparage IT's analysis, he is one of the best around. I am simply relating why I don't see rates, or the economy in general taking off anytime soon, at least, not in the way that would cause the 10 yr to jump back to 5%.

    Instead what we will get, because we haven't totally killed the free market elements of our economy, is just what IT pointed out, a slow return to the norm, but yet with more fits and spits, since we have taken yet another step towards Europe after another Fed engineered stock market crash followed by another gov knee jerk reaction to tax and regulate more in the wake of the disaster it created. This same thing happened in 29 and wasn't really relieved until 1946 when gov spending dropped dramatically. So the same will be true for the present. Until there is a major policy shift, like 1946, there is no reason to expect lending or any economic activity to grow by 30%, and hence low rates and lowish inflation for many years to come.
    Oct 7, 2015. 08:57 AM | 2 Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    "I see this as lending for established businesses, but not for new ones coming online."

    Here is another reason I think the current loan growth is too weak to suggest any more lending would take place if the IOER were eliminated.

    Take a look at these charts. It really speaks to why community banks aren't and won't contribute to a robust recovery.

    We are turning into France and Europe.
    Oct 6, 2015. 05:47 PM | 1 Like Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    I view the DR as a money creation tool. I look at things in terms of the accounting equation - Assets = Liabilities + Owner's Equity, or in very simple terms Assets = Owner's Rights. The Owner's Rights bit is represented by notes. Notes express claims on the assets. Those claims we see via the prism of value. We value the notes to the extent they represent claims on real assets that we can consume to make our lives better. This is the same concept of stock dilution.

    If you consolidated the entire economy of the world, what you would get is a balance sheet of real assets on top (or on the left) and all notes (ownership rights) on the bottom (or right). Fed Res notes (whether paper or electronic) would be part of the notes that represent all ownership rights. To the extent the Fed creates or destroys notes, it impacts the "prices" or "values" we place on assets.

    In a central bank system, all "money" notes flow from the central bank. I picture the banking system as a big pool, with the Fed as the fountain in the center. From it flows all the notes in the banking system. When you have a central bank, you have basically nationalized the banking system. All banks become branches of the central bank. Instead of banks issuing their own notes based on a very price sensitive system, a central bank monopolizes all the notes with the backing of gov force, and dulls price sensitivity. Thus, we wind up with the axiom, "if you have the power to print money, eventually you will."

    This means that a central bank, like the Fed, will have incentives to dilute the notes, and thus diminish the value of the notes. The Fed admits this. It wants to dilute the banking system notes by 2% every year. An accommodative Fed means a low DR. It is encouraging banks to turn up the spigot of the central fountain.

    Here is how it basically works. When a bank pledges collateral at the Fed to take an advance, the Fed debits a loan and credits a DDA for the borrowing bank. So its not that "no one" is borrowing directly from the Fed. The member banks do. When they do, the Fed has essentially issued new notes for already existing assets. This gives them "cash" to use for other things. They can make a loan, buy a security, or even just reduce their demand for deposits, which lowers their cost of funds. QE is basically the same thing. The Fed debits securities (an asset like loans), and credits a DDA. In my analysis, this is a more important event than banks lending amongst themselves. I see the Fed as creating more of a ripple effect as opposed to banks lending to each. After all, the Fed is more of the subsidy than its branches (the banks).

    I guess all that is a long winded way to say, the Fed is the source of the consumption subsidy. Its the old Austrian notion of subsidized credit. It distorts the number of notes and thus the value of ownership claims on assets (just like issuing additional stock). So my focus is on the source, the DR, before the Fed Funds Rate, which is the target of the DR. I see it as a horse before the cart.

    This is why we can look to central banks as one of the major causes of the booms and busts we call "the business cycle". If we learn to watch their swings between subsidy-on and subsidy-off we can better predict the direction of asset prices and interest rates. This is why I focus on the DR before the FF rate.
    Oct 6, 2015. 05:43 PM | 1 Like Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    Here's why I say loan growth is weak (at least in relation to what it would be if we had the kind of recovery where new competitors were coming into the market).

    Community bank loan growth is diminishing, along with the biggest banks. There is consolidation among the larger banks below the largest banks. I see this as lending for established businesses, but not for new ones coming online.

    "Since then, however, the big banks have steadily become a smaller percentage of total U.S. lending with the most recent quarter at 36.91%. Unfortunately, Community Banks are becoming less and less of a player in U.S. bank lending."

    The US is becoming more like Europe, where you have less and less new opportunities, and more and more protection of the businesses that are already in place. The natural tendency for an established business is to eschew risk.

    Now, to the extent you have free markets in your economy (and there are always free markets to some extent, even in communist countries - they are called black markets - its where people get food and medicine), there will always be some growth. IT references this in his upcoming article.

    "Eventually, even without any intervention at all, the business cycle takes over and recessions end."

    The natural state of a free market is to grow. Knowledge builds upon knowledge and the result is standards of living continually grow. The more you stamp out the free market, the more booms and busts you will see, and the more you will see the rich getting richer and the poor getting poorer. Eventually the grow of the economy slows to a crawl and you get Cuba and N Korea. Europe is on their way there, and the US is following close on the heels of Europe.

    Thus, as IT says in his next article.

    "Folks, it’s just not a robust recovery and never has been. "

    So, while there is some growth, its just not enough to be seen in loan growth among all the banking sectors, which would then spur a demand for capital and cause an increase in interest rates.

    Also, keep in mind high interest rates are a sign of a problem, not a sign of a healthy economy. A period of high interest rates because of economic growth would only be temporary (this would be true for inflation as well - assuming the Fed took no actions). A strong economy would eventually attract more capital and thus push rates and inflation back down, just as we seen now for the "safe havens". (Safe relative to all the other possibilities).

    So, if the Fed raises its DR in this environment, it will only shift asset vales, and be a bias towards risk-off, which would mean lower equities and lower interest rates with a flatter yield curve. Again, the solution is for the gov to abandon its contractionary policies of higher spending, higher taxes, and higher regulations. Until that happens it won't be a robust recovery.
    Oct 6, 2015. 08:55 AM | 3 Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    But you can't go back to just normal after you have had a big crash and expect that to create a recovery. Its not just getting the jobs back that you lost, but getting back the jobs that you should have had while you were getting back the jobs you lost. To do that loan demand would need to be double what it has been.

    Its like a company that has a run rate of 1 million in profit a year, and then one year they loose 10 million. Then over the course of the next 10 years they make 100 thousand each year. You don't say they fixed their problem because they finally got back the million they lost.

    What you will see over the next few years is bank consolidation, as the big banks get bigger and small community banks go away. Its typical protectionism (like the French companies above). So existing wealth will get wealthier, but you won't see much new wealth created. Either way, the robust competition for capital won't exist, and thus low rates and low inflation for a very long time.
    Oct 6, 2015. 06:48 AM | Likes Like |Link to Comment
  • The Last 2 Times This Happened, The U.S. Fell Into A Recession [View article]
    Drastic rises in the DR typically lead to the inverted yield curve. Notice how DR increases also tend to precede recessions.

    What is going on here is an accommodative Fed is a consumption binge, just like a war or infrastructure spending or a "stimulus" package. The consumption binge leads to elevated asset prices and higher interest rates. Since those asset prices are not supported by real increases in productivity from technological advancements, the market will cause a correction. It could be from commodity prices or higher consumer prices, but it is typically corrected by the gov itself, either from higher taxes, higher regulations, or the Fed raising the DR to "fight" inflation.

    So, here is how you play it. Look for consumption binge policies, like ZIRP, QE, etc. Buy equities before the policies go into place. Equities will inflate, and then start looking for policies that will end the consumption binge, like a long series of DR increases. Then sell equities, move to bonds (which will have higher yields at that point), wait for asset prices to collapse and yields to fall as people flee to safety. Then sell your bonds, at a gain, take the cash and move to equities, which will have crashed, before the next round of consumption subsidies.

    This pattern has existed in markets for hundreds years, or at least as long as gov has been trying to manage the economy. Its basically wealth transfer, and your job is to have that wealth transferred your way.

    Now, the timing of consumption binges and gov induced recessions is not perfect, but you can learn to judge the general direction. For instance, if we know increases in the DR are reversals of consumption binge policies, then as the Fed increases the DR, we can expect equities to falter and bond yields to decline. Now, add to this that QE is a consumption binge, and that ending QE is a reversal of consumption binge, we can expect the ending of ECB QE in 2016 to add to the risk-off scenario.

    So, in general, maybe we see a recession, maybe not, but we can expect a bias towards risk-off since the Fed is talking about a DR increase and ECB QE is scheduled to end next year. S&P will be trapped in the 1800 to 2000 range, and US 10 yr will trend close to 2% or maybe 1.90 to 2%. Other complications will be increased risk-off from Ocare and Dodd Frank in 2016. These are basically increased taxes. Increased taxes have the same effect as increases in the DR.
    Oct 5, 2015. 01:20 PM | 8 Likes Like |Link to Comment
  • Big miss for jobs numbers [View news story]
    Overall takeaway: Jobs numbers are not of the quantity or the quality to signal a robust recovery that would create the situation where the demand for capital oustrips the supply. As such, rates and inflation will stay low for a very long time.

    Just as a point of reference. The last time the Japanese 10 yr was above 2% was in the late 90s. That's almost 20 yrs ago. So, when we hear the FDIC telling us that rates are about to go up any day, we have to realize they have no basis for saying that.
    Oct 5, 2015. 11:28 AM | 1 Like Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    Speaking of France.
    Oct 5, 2015. 09:49 AM | Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    Funny, I was just talking about this. From Chris Low at FTN.

    "On a related note, the Economist warns excessive regulation stifles progress and innovation. They focus on France, a leader in regulation designed to protect workers from change, and an economy where starting and growing a business is near impossible. Indeed, the youngest company in the CAC 40 was founded in 1967."
    Oct 5, 2015. 08:58 AM | Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    "IT is saying that may be true, but the reserves shift from being excess reserves to required reserves when the loan is made."

    OK. That's fair, but only at a theoretical extreme. That would have to cascade through the whole system, with bank after bank making loans until they were all at their required reserves.

    However, for that to happen, there would have to be copious amounts of loan demand, and more importantly, loan demand from good credits. There is a saying in banking, "Making loans is easy. Collecting is the hard part." Which leads us to this.

    "Now it's time for them to get back to work making loans and taking risks."

    Loan demand is horribly weak. Banks are trying to make loans, but the good credits don't want loans. Right now, all banks are doing is buying loans from other banks. Granted, there is some loan growth, but it is very tepid. So, if the Fed paying IOER, you wouldn't really see any loan growth, what you would see is what we saw in Europe when the ECB went to negative rates on reserves. Sovereign yields took a nose dive. Right now, the Swiss 10 yr is yielding a NEGATIVE 25 bps.

    What we have here is disjointed monetary and fiscal policy (though they are really the same thing). Until gov cuts back on its contractionary policies of higher spending, higher taxes, and higher regulations, the Fed will be like the guy that drives the back of the fire truck when the front of the fire truck is driving over the cliff.

    So, all the Fed can really do right now is affect asset prices for existing assets. It can't do much for creating new assets. It has done all it can do to lower the costs of lending, but the regulatory side has increased the costs of lending beyond what the Fed can do to lower it.

    If the Fed gets rid of IOER, we won't see more appreciable lending, what will probably see is lower US Treas rates. If the Fed raises the DR. Again, we won't see more appreciable lending. What we will probably see is the S&P in the high 1700s or low 1800s.

    Having the Fed grow the economy is like Apple making improved product by just issuing stock while imposing penalties on staff for quality improvements.
    Oct 5, 2015. 08:47 AM | Likes Like |Link to Comment
  • Big miss for jobs numbers [View news story]
    "32 years and the lie is still around. "

    Interesting skepticism about gov numbers. Its good to see.

    Here's another blast from the past. We were supposed to be between 250k and 500k each month.
    Oct 3, 2015. 12:23 PM | Likes Like |Link to Comment
  • Big miss for jobs numbers [View news story]
    In Sept of 1983, NFP was over 1 million in 1 month.
    Oct 2, 2015. 04:31 PM | Likes Like |Link to Comment
  • Will They, Could They, Should They? [View article]
    "remember a deposit is a liability of the bank"

    Yeah, but the liability of the bank is created by a debit to "cash". If the bank uses the Fed, then the loan proceeds check is deposited in another bank. That bank debits their Fed acct, and then credits liabilities (the DDA).

    That bank can choose to just let that cash sit their, even though they are only required to hold 10%. So just making a loan didn't make the reserves disappear.

    I think what you are describing with the Fed, is brand new Fed note creation. The Fed "buys" a bond from a member. The result is an increase in Fed notes. The Fed debits "securities" and credits the bank's overnight acct (DDA). For the bank, its balance sheet mix changes. The DR representing "Securities" is moved to "cash" (in their overnight acct), which means more Fed notes in the system, even if it is not lent out or used to buy more securities.
    Oct 2, 2015. 03:29 PM | Likes Like |Link to Comment