Has the Fed been successful in its inflation efforts?

Discussion in 'Economy' started by gonegolfin, Oct 29, 2008.

  1. gonegolfin
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    gonegolfin Member

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    I have mentioned several times in past weeks that the monetary base is now increasing. You can consider the monetary base to be the bottom most layer of the money supply (the core). It is the base from which banks lend in our fractional reserve system. The monetary base consists of currency in circulation (which is M0), cash held in bank vaults, and cash on deposit with the Federal Reserve as reserves. The Fed obviously has direct power over the monetary base, but only has indirect influence on fractional reserve lending by the banks (and thus the other monetary aggregates). This is why the Fed can "print"/"create" all of the money it wants (assuming that it has an adequate supply of treasuries in the secondary market to buy) and it will not have an impact on inflation if the banks do not put it to use and instead hoard as reserves. Well, this is the problem that the Fed and Treasury are having with the banks. The Fed has funneled all of this new money to the banks (through both lending programs and bailout/injection programs), but the banks are not lending it out as demanded by the Fed and Treasury. They are sitting on it in anticipation of rough times ahead. See White House to banks: Start lending now - Yahoo! News.

    How will we know that the banks have begun lending? We should look at the broader money aggregates, namely M1 and to some extent M2. M1 is M0 (currency in circulation) plus mostly demand deposits and other checkable deposits. Since reserves are not part of the circulating money supply, they are not included in M1. M1 will begin increasing when the banks begin lending in aggregate their now plentiful reserves ... albeit, these are reserves net loaned from the Fed as non-borrowed bank reserves are nearly -$364 billion as of Wednesday 10/24. In last week's Fed H.3 report, the monetary base (not seasonally adjusted) grew to nearly $1.149 trillion, up nearly 14% in just two weeks (see Note: below). This is up 26% since 9/10, approximately when the Fed began its program of quantitative easing. The following chart from the St. Louis Federal Reserve Bank depicts the dramatic rise in the Adjusted Monetary Base (similar to the monetary base cited above, with seasonality factored in) ... St. Louis Fed: Series: BASE, St. Louis Adjusted Monetary Base. However, M1 has declined a bit in recent weeks ($1.412 trillion on 10/13 vs. $1.532 trillion on 9/29) and is up only about 3% from 9/8 ($1.368 trillion). Year-over-year, M1 has increased only about 3.5% (using the latest 10/13 figures). The banks are obviously not putting this new money to use in creating new loans and expanding the money supply. The Fed and Treasury are getting desperate as they know that the refusal of banks to lend in aggregate will result in more asset deflation and potentially a deflationary spiral.

    How far will the Treasury, Fed, and Executive branch go in encouraging (with force) the banks to lend such that our ever increasing economic problems can be kicked down the road a bit? There are various forms of pressure the Fed can apply to persuade the banks to lend. This could include the Fed/Treasury making an example of a few banks that are not cooperating. This could come in the form of banks being shutout from the bailout funds and/or enhancing rival/competitor banks resulting in takeovers. The Fed could also enact broad measures by draining a specific amount of reserves from the system (while propping up the cooperating banks with targeted funding). These broader measures could be implemented by reversing the quantitative easing program currently being conducted by the Fed. They could also be implemented by the cessation of loan rollovers from the staple Fed lending programs (TAF, TSLF, etc.). This would be yet another example of the Fed/Treasury picking the winners and losers, something that has been a focal point of policy to date.

    If the lenders do begin lending again in aggregate off of this vastly expanded monetary base, I think we will likely see serious inflation (monetary and price inflation) and a massive bubble in something (all other things remaining equal, such as the derivatives time bomb). Such a bubble will make the housing bubble seem like child's play. However, if the current deflationary forces win (and bank lending will be a primary indicator), we can fall into a major deflationary spiral. You simply cannot call it at this point and should prepare for both possibilities. I simply keep looking at the numbers for evidence.

    As for the Fed cutting the target for the federal funds rate today from 1.5% to 1.0%, this is mostly a non-event. All this did was signal to the market that the Fed will continue the injections of liquidity at the present rate for the intermediate term. The federal funds rate has been trading under 1% for the last two weeks (due to the Fed injecting massive amounts of reserves into the system). So, you will not see any additional liquidity in the system due to a target rate cut today (the target was already being implemented). In fact, the fed funds rate has been effectively trading at the floor set by the rate now paid on excess reserves by the Fed. The rate paid on excess reserves is now 35 basis points (down from 75 basis points) under the target rate for federal funds (this was also a signal that a rate cut was coming). Thus, with a 1.0% target for federal funds, the Fed is now paying banks 0.65% interest on excess reserves on deposit with the Fed. Thus, banks are not going to lend money in the federal funds market for less than they can receive by leaving those reserves on deposit with the Fed. This allows the Fed to engage in quantitative easing (injecting new reserves into the system - expanding the monetary base) without driving interest rates to zero. Allowing the overnight lending rate to fall to 0% did not work out well for Japan.

    Note: Bank reserves, averaged throughout last week, increased $20.2 billion to $301.27 billion (this is the number used in the calculation of the monetary base). However, the amount of reserve balances on deposit with the Fed at COB Wednesday 10/22 fell substantially to $220.762 billion (see H.4.1 report). Since the H.3 report calculates the monetary base using an average for reserves, the monetary base number published this week may be a bit inflated when compared to an actual calculation of the monetary base on 10/22.

    Brian
     
  2. Zoomie1980
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    Zoomie1980 Senior Member

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    Not sure the point of the question and reading this technical epistle it took until the smallest paragraph, number four, to finally get to what you were trying to say....

    Deflation is clearly winning out at this point. And that has absolutely nothing to do with fed policy and everything to do with the crash in energy prices. Gasoline and diesel are down 30-45% across the country depending on where you are. Shipping costs are down about the same, and commodities, like corn are also down 30% or more. Food prices have dropped over 10% in two months, that's a huge drop at annual rates.

    So what does it do to the only factor that really matters in the economy....psychology. Will people actually notice everything is not only cheaper but a LOT cheaper now than just a few months ago and start spending again? Banks have money to loan now, if they just will....

    The only measure that in any way comes close to quantifying mass market psychology and thus about the only federal number I pay even a lick of attention to, is the "consumer confidence" index. We'll see what that shows the next time
     
  3. gonegolfin
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    gonegolfin Member

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    Zoomie, I am not surprised that you do not understand the point of the question because you still fail to grasp the role the Central Bank plays in all of this. And the answer to the question began in paragraph one, not four.

    Asset deflation is present, not monetary deflation. If you understood what I wrote, you will understand that the Fed is positioning itself to battle deflation via its new program of quantitative easing (in addition to all of the previous debt swap programs and new equity facilities). But simply increasing the monetary base alone will not work. The banks need to lend this money to create inflation (monetary of course) which will only then result in the expansion of the money supply aggregates. This was the point of my article. This is also where Japan failed as reserves simply piled up as Central Bank deposits and vault deposits. Japan allowed interest rates to go to zero and currency became indistinguishable (and equally swappable) with short term government debt.

    Dead wrong. Energy prices are not the cause. They are the effect.

    Gary North said it well ...
    "Economic boom is created by rising monetary inflation. Economic contraction and/or bust occurs when the rate of monetary expansion slows. The economic boom requires ever-larger percentage increases of the money supply. By merely following the policies of the previous year, the central bank will produce a recession."

    The rate of monetary expansion slowed significantly in the 2005-2007 time period, after a period of extremely loose credit policy (fed funds down to 1%) during the last boom phase. It took that extremely loose credit policy to extricate the economy from contraction at the start of the decade (which came off the heels of loose credit). But now, monetary policy is looser than it was in the last cycle. The hills continue to get tougher to climb (and requires ever-larger increases of the money supply to keep from falling into a deflationary recession). I am afraid that we may be dealing with a mountain now.

    Brian
     
  4. Zoomie1980
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    Zoomie1980 Senior Member

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    I fundamentally disagree with everything you say or think. Monetary policy of any single government, is simply irrelevant. Economy is a PSYCHOLOGICAL phenomena, not a mathematical one. When the masses finally "feel better", when bankers finally "feel better" we will begin to recover, REGARDLESS of what any central bank does or doesn't do. Warren Buffet understands this basic reality and preaches incessantly at his seminars. Pay attention to the "moods" of the market and learn to detect when the "moods" show their first signs of change and you will learn to invest well. I'm no Warren Buffet but I've been very successful following his basic strictures. As such I only care what I perceive to the mood of the market.

    As such we "feel" about as bad as we are going to feel but I have no idea at this point when we are going to start "feeling better". But I'll know it when I know it. And I will profit nicely from it.

    You delude yourself into believing your technical analytics really matter. They do not. Have never, and never will, however interesting a read they may be.

    And it's probably not so much disagreement with your technical explanations, simply disagreement that one needs to know things at that level of detail or should really care. To put it simply, I'll leave it your ilk to try and explain my "mood" in mathematical terms, as for me I am comfortable in simply being able to sense it with reasonable accuracy without having any clue as to the technical details.
     
    Last edited: Oct 31, 2008
  5. gonegolfin
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    gonegolfin Member

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    Well, the above statement is simply ignorant. Time and time again, monetary policy in a Central Bank system has proven to have a significant impact on the creation and destruction of credit, leading to artificial expansions and contractions in the real economy (including booms and busts). Especially when it is radical monetary policy.

    This is where you are confused. What I am presenting is fundamental analysis. I am reading balance sheets and various accounting related statements. The accounting statements of our monetary system. I am not applying technical analytics.

    Brian
     
  6. gonegolfin
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    gonegolfin Member

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    The latest Fed H.4.1 report (through Wednesday 10/29) ... FRB: H.4.1 Release--Factors Affecting Reserve Balances--October 30, 2008 ... shows that reserves on deposit with the Fed increased substantially (to $419.979 billion) from the $220.762 billion last week stated in the "Note:" below. The figure was $265.737 billion two weeks ago. Thus, the temporary decrease last week seems to be due to a point in time calculation and the upward trend in bank reserves resumes.

    Interestingly, while the daily average in last week's report was up to $301.127 billion with the Wednesday (10/22) closing value significantly down ($220.762 billion), this week the daily average value was down to $260.924 billion with the Wednesday (10/29) closing value significantly up ($419.979 billion). It looks as if reserves may have been in a low cycle end of last week to early this week with reserves increasing substantially earlier this week.

    Note that this only addresses reserves on deposit with the Fed and not reserves held in bank vaults (this has not been volatile). But the incentive is always to keep cash in vaults as low as possible since they cannot be lent for interest in the overnight federal funds market and with the recent changes on excess reserves, cannot collect interest now paid by the Fed on excess reserves held on deposit at the Fed. Note that this payment of interest for excess reserves is another disincentive for the banks to lend.

    The next monetary base report is next week (Thursday 11/6). We will see if there has been any inflationary effect on M1.

    Brian

     
  7. editec
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    editec Mr. Forgot-it-All

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    The reason that the FED's plan is not working is because they gave the money to the banks instead of the people who actually needed it to do something productive with it.

    We ought to FEDERALIZE the banking industry entirely, and hang a few of the fucking wall street bankers, too, while we're at it.

    We have to stop sharing the weath with the richest people on earth (who hate this nation and have nothing but contempt for the people in it) and start sharing the wealth with ourselves, DIRECTLY.

    I realize this makes me sound like a right wing nut, but the system we have now is completely insane, totally unfair, and as we have seen repeatedly, only leads to these financial meltdowns when the greed of this banking class is so excessive that they melt down our economic system ever couple decades or so.
     
  8. Toro
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    Toro Diamond Member

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    Well, there sure is no inflation now, with consumer prices and asset prices collapsing.
     
  9. Paulie
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    Paulie Platinum Member

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    Wait until the banks start releasing their reserves. We're looking at potential inflation AND probably another bubble. I suppose a lot of investors love the constant business cycles because they offer huge profit potential every 5-10 years, but it is downright KILLING this country as a whole in the long run.

    My guess on the next bubble is agriculture, infrastructure, or health care. Maybe one, maybe a combination of all three. But those will be my investment sectors as I watch the market in the coming year.

    And Zoomie, you're out of your mind. How do you not understand the impact the Fed has on our economy? They are what make the economy move forward or backward. The psychological effects you speak of are what take place BECAUSE of the policies of the Fed. The Fed acts, the MSM shoves the vague info down our throats, and we react psychologically. That's how it's been now for almost 100 years. You're deluding yourself to think the Fed has no impact on it. How does the most powerful bank, one that creates and extinguishes money and credit in the United States of America, one that all other central banks in the world follow the lead of, not directly impact an economy?

    You ought to do yourself a favor and at least open your mind up to other economic philosophies.
     
    Last edited: Nov 1, 2008
  10. Zoomie1980
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    Zoomie1980 Senior Member

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    Bottom line, NO is DOES NOT. It has been a very long time since either Fed policy or Congressional fiscal and tax policies have had any meaningful, lasting impact on the economy.

    The global economy is largely IMMUNE the machinations of central banks in the modern era. It is a creature all unto itself and largely DEFIES any policy analysis. The rise and fall of oil in the past year had nothing at all to do with US monetary policy. The dollar has continued to trade in similar ranges in relation to the other world's currencies all the while oil has gone from 70 to 150 back to 60.... It did so for reasons completely and totally UNRELATED to Fed policy. Same with the mortgage issue. Private financial firms created the derivatives and lent money out of internal policy to maximize profits, not as a direct result of any Central banking policy. Whatever effects it does have are on amplification or dilution of forces already in play.

    Sailboat rudder on the Titanic is still the best analogy.
     

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