Has the Federal Reserve been inflating?

Discussion in 'Economy' started by gonegolfin, Sep 27, 2008.

  1. gonegolfin
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    gonegolfin Member

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    The Federal Reserve updates its statistical releases each Thursday at 4:30pm EST. These reports contain plenty of useful information to help ascertain what our Central Bank is doing with respect to monetary policy as well as the relative health of our banking system. One of the reports I look at weekly is the H.4.1 Factors Affecting Reserve Balances, which gives you a high level view of the balance sheet of the Federal Reserve. You can find the H.4.1 reports here ... FRB: H.4.1 Release--Factors Affecting Reserve Balances, Release Dates. Meanwhile, the various series of statistical releases and historical data can be found here ... Federal Reserve Board of Governors Statistics: Releases and Historical Data.

    I want to briefly focus on the question of whether or not the Fed has been inflating the money supply. No doubt that you have been hearing, since the crisis began, that the Fed is inflating or printing money. The Fed initiated a variety of measures with the intent of aiding financial institutions (not just depository institutions) in the repair of their mangled balanced sheets such that their reserve requirements could be met and they could ultimately effectively lend again. These measures included the typical and well known open market operations, discount window lending (depository institutions), and cuts in the target rate for federal funds. The Fed also created new lending facilities for both depository institutions (TAF) and primary dealers (TSLF, PDCF, 28-day Repo program). The scope and terms of these offerings have changed over the months, most notably the collateral accepted. But it is important to understand that the Fed has mostly been changing the contents of its balance sheet (swapping good debt for bad debt or what you would call taking on credit risk), not increasing reserves in the system. When the Fed did loan out cash (Ex. TAF), it mostly sterilized the liquidity injection by selling treasuries from its portfolio (again, balance sheet manipulation as opposed to an increase in reserves), with the sterilization amount also taking into account the current market federal funds rate in relation to the target rate of interest for federal funds. Thus, the TAF transactions are only inflationary to the extent that funds disbursed by the Fed for collateral exceed the offsetting treasury sales (sterilization) conducted in the Fed permanent open market operations (as well as the treasury securities that are allowed to expire as they mature).

    Just this past week, there have been several financial sites using the "Reserve Bank Credit" number as evidence that the Fed is on a money printing binge. But it is the reserve levels that you must examine. Due to the introduction of the $200 billion Treasury Supplemental Financing Program last week, the Fed took a liability side entry on its balance sheet in the amount of $159.806 billion as of Wednesday 9/24. This reflected the treasury debt that was auctioned to the public with the proceeds being deposited with the Fed (The Fed is acting as the principal in this program and not the Treasury's agent). This is not inflationary because purchases were made by investors (via treasury auction) from existing money stock. This accounting maneuver by the Fed allowed it to strengthen the asset side of its balance sheet (treasuries), which had been depleted during this crisis as the Treasury swapped good debt for bad.

    Total deposits with federal reserve banks that were not reserves totaled $187.138 billion in the last reporting week. Thus, you also had an asset side entry reflecting these additions, which caused the "Reserve Bank credit" number to swell. This prompted folks to claim that the Fed has the printing presses running at full throttle. Yes, the Fed was expanding its balance sheet, but was not creating new money. This $187.138 billion number represents money on deposit for various accounts (most of the amount is for Treasury accounts). The Treasury does not withdraw money from its accounts, as banks can do with their deposits with the Fed (these bank deposits count as reserves and represent potential new dollars in circulation if withdrawn). Therefore, the funds in these accounts do not represent potential money creation. If you decide to use the "Reserve Bank credit" number to arrive at the reserve levels (since this is the easy way), you must subtract the amounts from these accounts. But many folks did not do that and simply read the "Reserve Bank credit" number.

    Once we remove these non-reserve deposits, we arrive at about $1001 billion ($1.001 trillion), which represents the amount of credit in the system. This is radically different than the $1197 billion ($1.197 trillion) number that many in the financial community are reading from the "Reserve Bank credit" line of the recent H.4.1 report. This number should be compared with the $954 billion number of Wednesday (9/17) and $893 billion of (9/10). Note that this number was $894 billion at the beginning of the year. The smaller changes are also confirmed by the increase in the monetary base. The non-seasonal adjusted monetary base on 9/24 was $915 billion, about a $65 billion increase over that of 9/10. So, we did have an increase in the monetary base over the last couple of weeks (about 7%). But the beginning of the year through 9/10 only saw an increase of just over 2%, for the reasons I described earlier.

    If you understood very little or none of the above, you simply need to understand that the Fed has expanded the money supply very little until two weeks ago and still just about 6% in the last two weeks (not the 25% that some have claimed). But it is important to keep looking at the numbers for signs that this is changing. One of these signs will be whether investors consume the treasuries that will be auctioned to fund any legislated bailout (since treasury debt was the stated funding mechanism in the Treasury bailout proposal). If investors do not purchase all of the debt required to fund the bailout, the Fed will have no choice but to engage in quantitative easing (money creation).

    Brian
     
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    Last edited: Sep 28, 2008
  2. dilloduck
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    dilloduck Diamond Member

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    And the reason the Fed has kept interest rates so low for so long is------?
     
  3. gonegolfin
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    gonegolfin Member

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    Why do you think? Why do you think that the Fed increased liquidity injections over the past year and has kept them at these levels in recent months?

    Brian
     
  4. dilloduck
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    dilloduck Diamond Member

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    sorry but your talking to an economic idiot. I have no clue but the cheap money has been flowing for YEARS---apparently to help minorites and the poor to close the financial gap and buy a home. Why ?
     
  5. dilloduck
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    dilloduck Diamond Member

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    How about a teeny hint for those of us with visions of derivatives dancing in our heads ?
     
  6. gonegolfin
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    gonegolfin Member

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    No problem ...

    We have been a debtor for nation for years, racking up a very impressive national debt. Our trade deficits are now legendary (we were once a creditor nation in the 70's). We are selling off our country piece by piece (we need to borrow roughly $3 billion daily to meet our consumption). These burdens weigh on the currency (even the world's reserve currency). Increasing debt crowds out borrowing for legitimate economic growth. As I stated, we have been financing consumption for some time now. This leads to phantom wealth ... wealth that can collapse when an asset bubble is popped.

    The above is not exhaustive (because I am exhausted), but frames the topic. With the above burdens, it takes much more credit to generate a given level of growth. We have had artificially low interest rates for at least 15 years. But they keep getting lower and lower (in aggregate) because it takes cheaper and cheaper credit to sustain the economic growth we have come to expect. Obviously this cannot continue forever. You are beginning to see the cracks in the armor now.

    We completely lost our discipline and fiscal way when we decided we could try to cheat the Gold standard (mostly in the 60's), which led to the closing of the Gold window in 1971 by Nixon. Since then, we have continued to debase our currency and rack up debt. Again, it gets costlier and costlier to generate growth ... until we have the real economic cleansing (this means a substantial reduction in our standard of living) that is required to bring our economic system back into balance. If we do not allow it to happen, it will eventually be forced on us by economic law. Once again, with the proposed bailout package, we are attempting to cheat economic law one more time. The result will be a nastier correction down the road (but maybe not that far down the road).

    So, if you have not guessed by now ... cheap money has always been the prescribed antidote to recession or the cure if we happened to stumble into a recession. Of course, this is not responsible economic and monetary policy. But the politicians only care about the present and the next election. Why not kick the problem down the road a bit (someone else can get blamed)? As was done in 2001 when we should have had a serious recession (though I do not think a depression) to cleanse the excesses (mis-allocation of capital).

    Brian
     
  7. editec
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    editec Mr. Forgot-it-All

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    Brian, for the benefit of those who might be reading this besides myself, I'm posting the following:

    And now, since it is obvious to me that you understand monetary policy FAR better than I do, I would appreciate it if you commented on the following source

    Do you agree that not publishing the M-3 liberates the Fed to bamboozle the public, or do you think that publishing M-3 is, as the Fed suggests largely a waste of time, and that savey investors don't need it?

    You appear to be confident that you can ferret out the M-3 using the technique you posted, or have I misread you post?

    I am frankly and sadly, not well educated enough to know for sure if your post is addressing that issue.

    My personal belief (as a mere consumer) is that the money supply is being inflated much faster than it ought to be (compared to real economic growth I mean), and that, while very little of that fiat money is TRICKLING DOWN to the consuming public(where it would help us to offset rising prices) it is circulating in those lofty heights of super finance between nations and banks and fiancial houses.

    Another question about this credit crises that is ALREADY affecting organizations which nornally sell bonds to get investment money?

    Is this merely a problem of the potential lenders who are as yet unsure who is credit worthy and what interest to charge them for borrowing?

    Or is the problem that the write downs of assets (such as RE based bonds and the derivitives they spawned) actually DEFLATING the money supply (thus making the capital that still exists worth more, but again, nobody is quite sure what to charge for it?)

    Hearing, as I did recently, that the nation of Sweden tried to float some bonds last week, only to discover that the lenders demanded 15% ROI (!!) suggests to me that the lenders are simply scared to death that our government will try to bail us out of this system by hyperinflating the money supply.

    One last question...if you were designing the solution to this problem, what would your approach be?

    Oh, BTW, one more thing I'd to read your thoughts on. It's more theoretical than specific, but it is germane to this issue generally.

    When NiXXon took our national specie off the gold standard?

    Yes, I fully understand that that allowed the FED to inflate our money supply, but do you think he really had any choice?

    After all, isn't limiting our specie (and every other national specie as well) to an amount not larger than the amount of gold (and silver? I don't know) going to create a DEFLATIONARY cycle that has got to be at least as problematic to an economy as INflation coming from fiat dollars?

    In other words, isn't a well run FED -- one which only allows increases in the the M3 equal to the REAL increases in goods and services --- what we really need for a stable currency and economy?

    Or do you think we can devise a viable economic system which assumes DEFLATION , just as easily as we accept an economic system which accepts some normal rate of inflation equal to the REAL increases in goods and services in our economy?
     
    Last edited: Sep 28, 2008
  8. Paulie
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    Paulie Platinum Member

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    Dillo, that's BASICALLY what I've been saying in our recent discussions, only with not quite as much articulation as Brian.

    Brian, what do you think would happen to the so-called "global economy" if we were to do nothing and let the market cleanse? Would other nations have to follow suit as well, or could just the US balance things out by letting this adjust on its own?

    I wonder about it, because 30-40 years ago we could probably do nothing and slide right out of it, but with today's interconnection of economies, how would us doing nothing affect the world as a whole?
     
  9. editec
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    editec Mr. Forgot-it-All

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    Excellent questions, Paul.

    Of course 30-40 years ago this problem could not possible have happened either, since the banking laws prevented such wild speculation by banks.

    I SUSPECT that the reason this problem is going global is because banks the world round have been speculating in bad paper.

    the risk/rewards ratios were good --or at least the lies the rating companies told about them made them seem okay, so I suspect there are banks (including national banks) the world over holding a lot of dubious paper.

    And since most national banks are playing the same deficit spending games that our FED has allowed our nation to do, they ALSO cannot afford a drastic shock to their systems.
     
  10. Paulie
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    Paulie Platinum Member

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    You also can't forget, international central banks are in collusion with ours, and they act accordingly with our bank's policy moves. There seems to be ample indication that other central banks are debasing their own currencies lately to prop the Dollar up, as it doesn't seem likely that all the other currencies would be depreciating as rapidly as they are, and CERTAINLY the Dollar should not have been strengthening as it has been lately.

    There's also the definite probability that some large investment banks have been shorting the metals market to keep those prices artificially low, as one would otherwise have to assume Gold would be MUCH higher right now. It looks bleaker than it did back in the spring when gold was over $1000, but yet it sits at $880 right now in the face of possible economic catastrophe and almost CERTAIN inflation acceleration.
     

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