Interesting Fed intervention

[gonegolfin]

Indeed it does, but where I'm in slight disagreement is, when you consider from '01 to '03 when the FF rate dropped 6 points down to 1%, the M3 trend upwards wasn't nearly as profound as it is now with a 3 point drop in slightly less than a year.

Simply dropping the "target for the federal funds rate" (not the federal funds rate) does not immediately induce long term inflation. Remember that temporary market operations are used to achieve the target rate. The Fed was also not monetizing debt at this time. A good portion of the inflation created in the last seven years has been by the banks (the explosion in the use of leverage in the credit derivatives market also plays a part in the growth of M3). It took a little time to get that lending rolling. Once the 10 year T-bond yield fell to where it really began to affect mortgage lending, you saw inflation accelerate and build momentum.

I'm sure you can explain that better than I can speculate it, but it appears to me that money supply expansion is greater now more than ever, with no signs of slowing down.

Money supply is now expanding in a different way. There is less lending taking place. But there is much more temporary money creation by the Fed.

There are definite signs that the money supply could contract (I explained this earlier in the thread). This could happen despite the will of the Fed and the other Central Banks. The reasons why this could take place are at the heart of the Bear Stearns crisis (or LTCM for that matter). One thing that is interesting (and at the same time frightening) is that while a hyperinflation is a possibility, so is a massive deflation. This is due to the potentially toxic mixture of central banking, fiat currencies, and complex derivatives.

This said, could you make your case for why we WON'T see hyperinflation?

See above and my earlier post for an explanation as to why we might not see hyperinflation. My most likely outcome is a prolonged period of net no growth (or modest negative growth) with inflation (not hyperinflation). This would include a period of hard recession during this larger period of what some call stagflation. I think it will be painful as a lot of excesses need to be worked from the system. I think that for hyperinflation to happen, we would need to see a lot of nationalization moves by the Fed. For example, the nationalization of ...

- more than one major bank (maybe several)
- Fannie Mae, Freddie Mac, and Sallie Mae (which I think will happen)
- the mortgage market (the Fed rescues the housing market and lending industry by buying a significant number of worthless or near worthless MBSs)

A hyperinflation would require a significant number of Dollars being repatriated to our shores. I think you would need at minimum all of the above for that to happen. Thus far, foreign held US Dollars have helped in that they have been propping up the banks by providing them much needed cash (the result of this is another type of problem), reducing the amount of dollars being held in sovereign wealth funds.

I also think that many exaggerate the usage of the term hyperinflation. Bob Chapman is a prime example as he has stated that we are already in hyperinflation (which is ridiculous).

Brian

 

[gonegolfin]

The below describes some interesting intervention by the Federal Reserve on the short end of the yield curve that I have noticed in the last month ... something I have yet to see anyone write about, either in the Wall Street media nor in the alternative financial media.

I have always monitored the Federal Reserve's open market operations, which are almost always temporary open market operations (TOMOs). But always of great interest are any permanent open market operations (POMOs) undertaken by the Fed since these are operations where the Fed permanently injects more money into the system (increase in the supply of money == inflationary) or removes/extinguishes money from the system (decrease in the supply of money == deflationary). The Fed conducts these operations by either buying securities (usually treasuries, but lately many more agency bonds (Fannie Mae, Freddie Mac, Sallie Mae, etc.) and mortgage backed securities) in the open market or selling treasuries in the open market from their portfolio. The Fed purchasing securities is essentially monetizing debt as debt is purchased (one would argue bad debt as of late) with newly created dollars (why private banks have the power to manipulate our money supply/currency is another topic). This results in an increase of the money supply and is thus inflationary. When the Fed sells treasury securities from its portfolio, it takes in existing dollars from the money supply and as such, those dollars cease to exist (extinguished from the money supply). In theory, the TOMOs will have a neutral effect on the money supply in the end as the borrowing banks must pay back their Fed loans (reverse repurchase agreements) and reclaim their collateral when the loans mature (the loaned money is extinguished). However, the Fed keeps rolling over these loans into new loans. So, the effect thus far has been only an inflationary one. But POMOs are permanent and is the focal point of the discussion here.

These permanent open market operations began on March 7th with the last one being Thursday April 3rd. Now, while the Fed has engaged in many inflationary moves over the past several months (targets for interest rates cut aggressively, TAF, TSLF, more temporary open market operations, extending the discount window to the primary dealers, loans to JP Morgan for the arranged buyout of Bear Stearns), these permanent operations to which I refer are actually deflationary as they are selling T-Bills and T-Bonds from their portfolio.

I wanted to correct/clarify myself on a few points above.

#1 The TSLF is obviously not immediately inflationary. Here, debt swaps are taking place (treasuries for non-treasury accepted collateral). At the present, the Fed is simply taking on credit risk.

#2 TAF transactions are only inflationary to the extent that funds disbursed by the Fed for collateral exceed the offsetting treasury sales conducted in the POMOs I referenced in the original post. The Fed needs to maintain its federal funds target rate (now 2.0&#37. It cannot do this if they auction off $150 billion in funds and fail to sterilize this money injection by selling treasuries (federal funds would dip much lower). Now, with a falling target for the federal funds rate, full sterilization is not required. But thus far, most of the outsanding TAF balance has been sterilized with Fed treasury sales from its portfolio. Of course, this game cannot continue forever ... unless the Fed begins issuing its own liabilities (Ex. sterilization bonds). The Fed's portfolio is down to $510 billion (more POMOs have occurred this month).

The net of all of this is that the Fed has mostly been taking on credit risk thus far. Not much net new money has been created by the TAF ... only enough (while working in conjunction with other monetary policy tools) to ensure that the federal funds rate target is met (which has been moving down for several months). This is partly why M1 is not growing yet. I explained the other reason M1 is not growing earlier in this thread.

Brian

 

[gonegolfin]

I follow Gary North (have for some time) and I really like him. But I think he is wrong here to use M1 as the indicator for consumer price inflation and as evidence that the Fed has an overall policy of actually deflating (as he has been claiming). Regulatory changes made in the early 90's caused M1 to become much less useful as a general monetary indicator. These rule changes allow banks to reduce the amount of reserves required on deposit to the Fed by sweeping money held (for example) in checking deposits to savings accounts (on the books). The difference here is that money held in checking deposits are counted as part of the M1 money supply. But savings accounts are counted as the non-M1 part of the M2 money supply. Thus, due to the shifting of money by the banks, you do not get an accurate representation of the real M1.

That said, I think that practically all of the inflation (monetary) we have experienced in the last seven years (until six to eight months ago) has been due to bank lending and not the Federal Reserve. Of course, the Fed spurred this bank lending by cutting the price of credit. So, they were indirectly responsible.
Brian

Incidentally, Gary North and I have swapped a lot of email in the last week. He had a hard time believing that the Fed was actually selling treasuries from its portfolio. He thought that if they were, it would have a noticeable effect on interest rates. I provided evidence that it did have a noticeable effect on interest rates (just on the very short end of the treasury curve - as explained in the original post of this thread). He wanted proof of the treasury sales and I directed him to the appropriate data on the Federal Reserve site. Incidentally, this explains why the monetary base has been kept in check thus far. North originally believed that the TAF swapped treasuries for accepted collateral (see http://news.goldseek.com/LewRockwell/1210170240.php). I pointed out that it did not, but that there were mostly offsetting treasury sales being conducted by the Fed.

Brian

 

[Toro]

Saw Janet Yellen at the CFA conference in Vancouver this week. She displayed this graph.

Half the Fed's balance sheet is no longer Treasury securities.

 

[Zoomie1980]

You have been reading about the deflationary actions conducted by the Fed on the short end of the yield curve as described in my original post? Where did you see this? I would like to compare takes.



Yes, I see long term inflation as the most likely outcome due to the policy currently being implemented by the Fed. But this outcome is certainly not absolute. The Fed is not in complete control all of this. We have a scary large pile of outstanding derivatives in the world financial markets totaling over $500 trillion. It is certainly possible that despite the best efforts of the Central Banks (to monetize their way out of this mess), they may not be able to stay in front of this problem if an unwinding of enough positions were to occur quickly and we began to see a cluster of cascading defaults. Roughly ten financial institutions hold all of these derivatives. Thus, it is not like this risk is well spread. This is precisely what the Fed was concerned with when it helped orchestrate the sale of Bear Stearns to JP Morgan and backed it with loans.

So, while I see inflation as the most likely outcome. I do chuckle a bit at the sound money advocates (of which I am one) that also feel that inflation is the only possible outcome. They do not understand the massive contraction of the money supply that *could* take place if the event I described above took place. I place my investment bets accordingly with most of my assets in gold, silver, foreign money markets in currencies that will continue to appreciate against the Dollar, and foreign energy/agriculture/mining/utilities/infrastructure equities in currencies that will also continue to appreciate against the Dollar. But I also keep a percentage of my portfolio in US Treasuries to guard/hedge against a systemic meltdown and sudden deflation. Knowing full well that if the inflationary scenario continues to play out, I will do quite well (so well that I do not care so much about my US Treasuries now being worthless). But if the deflation scenario takes place (without hyperinflation first), I will not be obliterated. You can think of it as a well out-of-the money put option being placed on a large long position that you are holding.


Yes.

Brian

Well at least you admit that the Fed has, at best, very limited control over anything. It's been a very long time since Central Banks have had a real grip on economic movement. It always makes me laugh when political candidates claim they can impact economics with policy, presidential or otherwise. Moving marginal rates up or down a few percentage points in income, capital gains, or anything else, giving a few thousand dollars in tax credits for things most people cannot afford to do anyway never has any real impact. "Fiscal policy" is a myth. The global markets drive themselves. No one central bank, even as large as the US can really control anything. All they can do is cause a blip on the curve.

Most of the time Fed just needs to butt out.... They always seem to make things worse than better. All we need is more inflationary momentum with oil at $127 and gold at $910 and $5.50 corn....

 

[gonegolfin]

Saw Janet Yellen at the CFA conference in Vancouver this week. She displayed this graph.

Half the Fed's balance sheet is no longer Treasury securities.

Thanks for posting this Toro. The Fed's SOMA portfolio of treasuries shows $510 billion. This is down from $532 billion last week (and has been declining for months) and roughly $550 billion at the end of April. I think that the discrepancy between what the SOMA portfolio shows and the chart is that the SOMA portfolio seems to count treasuries loaned to the primary dealers via the TSLF (in black on the chart) and the Overnight Securities Lending Facility (shown in red). That is, it is still considers them part of the portfolio since they have been loaned, not sold. The Fed's total portfolio is equivalent to the SOMA portfolio plus the short-term and long-term repo books.

As mentioned earlier, most of the funds lent in the TAF (now $150 bilion) were offset with permanent treasury sales from the SOMA portfolio. Thus the reduction in treasuries held outright on the chart and the corresponding reduction in the SOMA portfolio.

Brian

 

[gonegolfin]

Well at least you admit that the Fed has, at best, very limited control over anything. It's been a very long time since Central Banks have had a real grip on economic movement.

No, this is not what I said. You should reread what I stated taking into account the entire context.

Brian

 

[Zoomie1980]

No, this is not what I said. You should reread what I stated taking into account the entire context.

Brian

Well, then, as with most "insiders", they believe their specialty has much greater control over things than they do. The Fed, no matter what it does, has only a VERY MINOR control over the moves of global economy. "Fiscal policy" is a joke. If they raised marginal tax rates from 35-40% to 90%, or capital gains rates from 15% to 80%, central bank rates for 1% to 10% or 20% now that would have impact. The fact is politicians simply cannot make moves large enough to matter and neither can Central Bank officials. The politicians simply haven't the political balls or backing to do that the officials would all be fired and replaced with less radical officials.

Bottom line, the "technicalities" of the Central Bank are just that, and in the end, have VERY LITTLE impact on the overall economy. they may be important to treasury instrument investors but not to anyone else. The market SPECULATORS control EVERYTHING. When speculators turn sour on oil and gold, they will tank and whala, gas goes DOWN, gold goes DOWN, they start bailing on grain markets too and food prices GO DOWN, or at least stop going up at the tear they are on now....and the Fed will have very little impact on it.

 

[Paulie]

Well, then, as with most "insiders", they believe their specialty has much greater control over things than they do. The Fed, no matter what it does, has only a VERY MINOR control over the moves of global economy. "Fiscal policy" is a joke. If they raised marginal tax rates from 35-40% to 90%, or capital gains rates from 15% to 80%, central bank rates for 1% to 10% or 20% now that would have impact. The fact is politicians simply cannot make moves large enough to matter and neither can Central Bank officials. The politicians simply haven't the political balls or backing to do that the officials would all be fired and replaced with less radical officials.

Bottom line, the "technicalities" of the Central Bank are just that, and in the end, have VERY LITTLE impact on the overall economy. they may be important to treasury instrument investors but not to anyone else. The market SPECULATORS control EVERYTHING. When speculators turn sour on oil and gold, they will tank and whala, gas goes DOWN, gold goes DOWN, they start bailing on grain markets too and food prices GO DOWN, or at least stop going up at the tear they are on now....and the Fed will have very little impact on it.

You have a very narrow view on the entire picture. You say speculators control everything, but you seem to fail to realize who or what is causing the speculation to begin with. Gold and Oil speculation is being fueled by an inflationary policy towards the Dollar. I've posted various charts here which obviously show this to be the case. The Dollar goes down, and commodities go up. It's a given. Speculation is so high on energy and PM's, because investors see no end in sight to the devaluation. Not that it's entirely the Fed, though. There's no end in sight to the occupation in Iraq, there's the threat of continued military action into Iran, which most understand will cause major economic headaches, and the blowback from it will be much worse than Iraq's ever will.

The kicker here, is that Brian is showing us how the Fed may actually be implementing deflationary actions that aren't being noticed by the average investor. And Brian, if I'm wrong about that please feel free to clarify.

 

[Care4all]

Indeed it does, but where I'm in slight disagreement is, when you consider from '01 to '03 when the FF rate dropped 6 points down to 1%, the M3 trend upwards wasn't nearly as profound as it is now with a 3 point drop in slightly less than a year.

I'm sure you can explain that better than I can speculate it, but it appears to me that money supply expansion is greater now more than ever, with no signs of slowing down. More and more economists, TRUSTED ones, have been making a case for hyperinflation. There's also the risk of continued war on into Iran, and no end in sight to the full scale occupation in Iraq. Also, these major banks that have either failed, or are on the verge, are all going to be getting a shot in the arm from the Fed. Look at BOA, profits down 77% (could they be next?). This will no doubt keep the "printing presses" pumping. We're massively in debt in this country, and history shows that the eventual, and inevitable remedy for this has been hyperinflation.

This said, could you make your case for why we WON'T see hyperinflation?

I just heard on a cnn money program that THIS WEEK the Fed printed $3 BILLION dollars a day and gave it to the Banks out there...

$3 billion a day has been dumped in the market for the last 7 days by the Fed.

$21 billion this past week....

 

[Toro]

Bottom line, the "technicalities" of the Central Bank are just that, and in the end, have VERY LITTLE impact on the overall economy. they may be important to treasury instrument investors but not to anyone else. The market SPECULATORS control EVERYTHING. When speculators turn sour on oil and gold, they will tank and whala, gas goes DOWN, gold goes DOWN, they start bailing on grain markets too and food prices GO DOWN, or at least stop going up at the tear they are on now....and the Fed will have very little impact on it.

I disagree with this. I think the Fed has enormous influence on the economy at critical times. The actions in March was a critical time.

Also, interest rate policies that are incorrect also have highly distortionary effects on the economy. We have had not one but two enormous bubbles in asset markets - stocks and housing, and three if you include credit - all within the past decade. The fourth is probably now occurring in commodities. You simply cannot have massive, economy-distorting asset bubbles if you do not have cheap and abundant money, on which the Fed has a tremendous effect.

I have traded portfolios valued in the hundreds of millions, and I can assure you that capital allocation decisions are very much influenced by what the Fed does.

 

[Toro]

I just heard on a cnn money program that THIS WEEK the Fed printed $3 BILLION dollars a day and gave it to the Banks out there...

$3 billion a day has been dumped in the market for the last 7 days by the Fed.

$21 billion this past week....

According to Tony Crescenzi at Miller Tabak, the Fed has pumped $900 billion into the economy. Hence, $127 oil, momentum favorite stocks hitting or approaching all-time highs, etc.

Credit spreads have come in somewhat, but for the most part remain above historical trends. The creation of money to solve a problem generally goes to the asset class that is the hottest, not so much to the asset class that was targeted for resolution.

 

[gonegolfin]

You have a very narrow view on the entire picture. You say speculators control everything, but you seem to fail to realize who or what is causing the speculation to begin with. Gold and Oil speculation is being fueled by an inflationary policy towards the Dollar. I've posted various charts here which obviously show this to be the case. The Dollar goes down, and commodities go up. It's a given. Speculation is so high on energy and PM's, because investors see no end in sight to the devaluation. Not that it's entirely the Fed, though. There's no end in sight to the occupation in Iraq, there's the threat of continued military action into Iran, which most understand will cause major economic headaches, and the blowback from it will be much worse than Iraq's ever will.

The kicker here, is that Brian is showing us how the Fed may actually be implementing deflationary actions that aren't being noticed by the average investor. And Brian, if I'm wrong about that please feel free to clarify.

Close. I am describing deflationary actions that are offsetting (mostly) inflationary ones. Analysts and market watchers are seeing the TAF and TSLF in action, speaking of all the inflationary money that is being pumped into the economy. But they are missing the (mostly) offsetting deflationary actions. The TAF by itself would be inflationary. But that is not the entire story. If the Fed did not offset the new money creation by selling treasuries from its portfolio (sterilizing the monetary injection), the federal funds rate would collapse. The TAF money injections are only inflationary to the extent that the funds disbursed by the Fed for collateral exceed the offsetting treasury sales conducted in the Permanent Open Market Operations (Treasury sales) I have been mentioning.

The TSLF is not at all inflationary at the present time. These are simply debt swaps and are the functional equivalent of the TAF once the monetary injections have been sterilized. If a bank takes the lent treasuries and sells them to raise cash, no new money has been created.

So, the net of all of this is that the Fed has mostly been taking on credit risk thus far. And a lot of it. There has only been a modest amount of inflation with the TAF and none with the TSLF. The Fed has been creating enough new money to manage the federal funds rate at its target level. Of course, if they continue to lower the fed funds target rate, it gives them more maneuvering room to create inflation (lessen the amount of sterilization against the TAF distributions).

Now, the Fed has a limited portfolio. If things begin to get really bad, they will have no other choice but to create new inflation (disburse funds without sterilization). This could come in the form of TAF distributions without offsetting treasury sales or by the Fed simply monetizing other assets in some other liquidity program.

Brian

 

[gonegolfin]

I disagree with this. I think the Fed has enormous influence on the economy at critical times. The actions in March was a critical time.

Also, interest rate policies that are incorrect also have highly distortionary effects on the economy. We have had not one but two enormous bubbles in asset markets - stocks and housing, and three if you include credit - all within the past decade. The fourth is probably now occurring in commodities. You simply cannot have massive, economy-distorting asset bubbles if you do not have cheap and abundant money, on which the Fed has a tremendous effect.

I have traded portfolios valued in the hundreds of millions, and I can assure you that capital allocation decisions are very much influenced by what the Fed does.

Well stated.

Another thing to consider is how the Fed and other Central Banks panicked on the weekend of March 15th and put together a rescue plan in the interest of preventing cascading derivative defaults. There were several high profile players that were counterparty to Bear Stearns in such transactions. The Fed and other Central Banks are very wary of the possibility of such an unwinding that could be catastrophically deflationary.

I think Ludwig Von Mises would have a thing or two to say to Zoomie.

Brian

 

[Zoomie1980]

You have a very narrow view on the entire picture. You say speculators control everything, but you seem to fail to realize who or what is causing the speculation to begin with. Gold and Oil speculation is being fueled by an inflationary policy towards the Dollar. I've posted various charts here which obviously show this to be the case. The Dollar goes down, and commodities go up. It's a given. Speculation is so high on energy and PM's, because investors see no end in sight to the devaluation. Not that it's entirely the Fed, though. There's no end in sight to the occupation in Iraq, there's the threat of continued military action into Iran, which most understand will cause major economic headaches, and the blowback from it will be much worse than Iraq's ever will.

The kicker here, is that Brian is showing us how the Fed may actually be implementing deflationary actions that aren't being noticed by the average investor. And Brian, if I'm wrong about that please feel free to clarify.

There has always been tension in the Middle East. Ever since it became an oil producer. In fact, tensions have been MUCH WORSE in the past than anything we see today. And we had the added threat of a massive Soviet thrust we no longer have today. No speculation is rampant on oil and gold for the same reason it was rampant on housing, internet/tech stocks, etc... When stocks sour, speculators run to something else to make money, right now that';s oil, gold and grain. I simply do not believe the Fed's money policy has very much to do with that at all, never have. The Fed is simply a REACTIONARY body anymore. And they move they normally do so timidly so as to have very negligible long-term impact on much of anything.

A typical limited impact can be seen concerning consumer credit rates. We've a rather historic slashing of the discount rate and other Fed rates. Meanwhile, my prime-tied credit card rate, my variable home equity rate has only dropped a mere 1% saving about $50 a month in minimum payment rates. Wow, $50 a month! My monthly gasoline and food bill more than compensates for that.

And the rebates? No if we each got $6000 or $16000 that might amount to something significant. $600 will buy the average commuter about 2-3 months of gasoline.... What's the tax credit for buying a hybrid again? The cost premium is $3000-$5000 per vehicle? So where is the impact on intended behavior again?

AS you can see, federal fiscal policy is a joke, it's no policy at all.

 

[Toro]

Well stated.
I think Ludwig Von Mises would have a thing or two to say to Zoomie.

Brian

And to Greenspan and Bernanke.

I cracked open Bill Fleckenstein's book on Greenspan tonight. Very unbiased, as you'd imagine [/sarcasm].

 

[Zoomie1980]

I disagree with this. I think the Fed has enormous influence on the economy at critical times. The actions in March was a critical time.

Also, interest rate policies that are incorrect also have highly distortionary effects on the economy. We have had not one but two enormous bubbles in asset markets - stocks and housing, and three if you include credit - all within the past decade. The fourth is probably now occurring in commodities. You simply cannot have massive, economy-distorting asset bubbles if you do not have cheap and abundant money, on which the Fed has a tremendous effect.

I have traded portfolios valued in the hundreds of millions, and I can assure you that capital allocation decisions are very much influenced by what the Fed does.

The earth's topographic contours are actually less abrupt than that of an apple. But if you sitting at the base of of the Himalaya in Nepal, contemplating getting into Tibet, it doesn't appear smooth at all. The Himalaya is the Fed, the global economy is the skin of an apple.

 

[Zoomie1980]

Well stated.

Another thing to consider is how the Fed and other Central Banks panicked on the weekend of March 15th and put together a rescue plan in the interest of preventing cascading derivative defaults. There were several high profile players that were counterparty to Bear Stearns in such transactions. The Fed and other Central Banks are very wary of the possibility of such an unwinding that could be catastrophically deflationary.

I think Ludwig Von Mises would have a thing or two to say to Zoomie.

Brian

Bottom line, Von Mises is obsolete....and represents yesterday's thinking....

 

[Paulie]

Bottom line, Von Mises is obsolete....and represents yesterday's thinking....

What's "today's thinking"? Print your currency into oblivion, bomb countries to keep them using it, and start a new one when it finally collapses? Because that's what's happening, and that's actually not even a new concept.

 

[Toro]

Bottom line, Von Mises is obsolete....and represents yesterday's thinking....

"Yesterday's thinking" is certainly correct when inflation is defined as an excess creation of money as opposed to a flawed index based on the measurement of consumer prices.