This page has been archived and commenting is disabled.
The Fed's Voodoo Economics
From The Daily Capitalist
In its latest outlook, the Fed said:
“Even though the recovery appeared to be continuing and was expected to strengthen gradually over time, most members projected that economic slack would continue to be quite elevated for some time,” according to the report, which doesn’t identify the specific governors or regional-bank presidents making comments.
Officials expected inflation to remain “below rates that would be consistent in the longer run with the Federal Reserve’s dual objectives” of maximum employment and stable prices, the minutes said.
They believe that as long as there is excess industrial capacity, we won't have inflation.
The hot topic running through the halls of the Fed is: When should it dump the $1.1 trillion of mortgage related debt and securities it bought? In a program which tried to suck bad assets out of the banks to create liquidity in the system, the Fed went on a buying spree of these assets which ended in April of this year.
The data reveals that their policy has been a failure because bank credit and money supply are still declining. The result of their policy was to inject the trillion dollars in the pockets of the big banking houses who were more than pleased to dump these "toxic" assets as they were then called.
When they start to sell these assets it will be an attempt to "drain the pond" of the same trillion dollars they put into these banks. Theoretically this could lead to a tightening of the money supply which they view as being too high. The fear is that if they do it too soon, they may raise interest rates, increase the liquidity squeeze, and put a brake on economic recovery. If they do it too late they fear inflation. What's a central bank to do with such a dilemma?
What is interesting is the Fed's lack of understanding of the dynamics of inflation. They take the mostly Keynesian view that because we have idle industrial capacity, the risk of creating inflation right now is very low. In other words, injections of cash into the economy will not have an inflationary impact on prices because, until we are at near full industrial capacity, prices won't rise.
This concept is wrong.
The Fed and the many analysts who talk about inflation confuse the concept of inflation with supply and demand for goods. What they should be looking at is the supply and demand for money and credit.
As an example, it is often thought that high oil prices have an inflationary impact on the economy. The thinking goes that since oil is a factor in the production of about everything, a rise in oil prices will cause a rise in the price of everything. But that never occurs. Assuming that the supply of money in a system is fixed, if I have to spend more money on gasoline it means that I have less money to spend on something else. So while certain prices may go up, the fact that I am spending less on other goods means that there will be less demand for those goods and their prices will fall. These are factors related to the supply and demand for goods.
We have to go back to the general definition of inflation: a situation where all prices increase, not just some. The only way to do that is to increase the money supply. If you had $1,000 and all of a sudden you and everyone else looked in your pocket and saw that you had $2,000, it is certain that all prices would be bid up by this money supply increase. No real wealth was created, we just had more pieces of paper chasing roughly the same amount of goods.
How this really works is that when the Fed increases the money supply (it has a variety of ways to do this), the first to get the new money are prime borrowers of banks and they use the new money to buy the goods they want, increasing demand and prices for these goods. By the time the money has worked its way through the economy, the last guy in line finds that all prices have gone up. It's the lucky guy first in line who benefits the most because he bought goods before prices went up.
So, going back to the excess capacity idea, just because you have low industrial production capacity doesn't mean you can't have inflation. Again the supply and demand for goods (capacity) has nothing to do with inflation (money).
The recession of 1974 is a good example of this. Then we had stagflation: high inflation and low economic activity. This isn't supposed to happen. Here are the charts:
Yet the Fed persists with their faulty theory.
It is difficult to predict the outcome of their sale of these toxic assets. It may or may not cause interest rates to rise depending on what the international situation is with other currencies. If the EU continues to have problems, then the dollar will remain as the world's reserve currency and interest rates will remain subdued as cash stays here. In this situation, the result of mopping up a trillion dollars from the economy will not be significant.
If the international situation is resolved and currencies stabilize at whatever level they achieve, then the sale may increase interest rates. This would be a positive factor. Right now credit is very tight and money supply is low because mostly regional banks are afraid to lend because of all the bad debt on their balance sheets. We need deleveraging to make the economy grow again. The short-term result would be negative, but it would free up the balance sheets of regional banks (as the CRE assets they hold as collateral go under, they would go broke or recapitalize), and this cleansing effect would set the stage for real organic economic growth as liquidity would then improve as surviving banks would be eager to lend.
I don't have a crystal ball here because there are too many variables to make a call. I have my doubts that the Fed can sop up all the excess reserves now held by banks. If that is the case, when banks recover, rising bank liquidity and credit would lead to significant inflation.
Please stay tuned.
»
- advertisements -
US is not isolated entity, what is going on inside US for now is not proper measure of inflation or deflation, its a mess. China is one of the biggest recipient of printed money and just take a look at their actions. They bidding prices up for all assets and buying mines, minerals, companies and whatever you want, they're spending billions every week for such purchases and prices are spiraling up. If you think that wont affect US at some point, that's ok with me. Stock markets are another example of bidding prices up for companies, which are not worth those prices as everybody on this site knows (oh, maybe they are not worth those prices in old $, but in newly printed they probably are).
More argument over inflation or deflation. Until you realise that they are one and the same thing you'll just be groping through the fog, while the 'money managers' fly in the clear above.
Someone once said "Deflation is the midwife to hyperinflation"... Hmm... Who was that..?
Voodoo, after the Latin for bumbling fetishist counterfeiter.
the fed speaks with a forked tounge. the plan has always been to inflate the debt away.
Do you really expect the Fed will ever sell these assets? My take is that they will try to merge GSEs into the Fed and therefore combine the liabilities and the US national exposure to the real estate market will remain in perpetuity...
They will probably do this at the time Italy comes close to blowing up, so there won't be too much protests.
The money was created when they bought that crap at 100 cents on the dollar. The money is locked up on deposit at the Fed gaining interest. The crap assets will never sell for anywhere near what the Fed paid for them. The money is a ticking time bomb with only one way to go. As soon as the bankers feel they can get a better return than the Fed's interest payment, or a US debt/currency crisis starts looking more likely, that money will start coming out and chasing assets. And if the Fed increases interest payments to banks to keep that money on deposit, that will only hasten the debt/currency crisis while adding 5%-20% in interest payments to the money supply each year. Why buy risky treasuries when you can get better return by drinking directly from the tap? Why do either when the Fed is just printing money and debasing it?
IMO, the Fed is not worried about draining liquidity when it sells the MBS portfolio. They are only going to get 5 cents on the dollar anyway. I believe they fear that the eventual audit will show that they bought at mark to myth rates and sold at market rates and have a trillion+ dollar loss. How does Ben explain that one? Especially after when it is all said and done, the market still crashed.
Excellent point.
You do not know who 'they' are, nor do you know what they are referencing.. but somehow your opinion based on 'nothing' is the correct interpretation. Please elaborate.
"Yet the Fed persists with their faulty theory.
It is difficult to predict the outcome of their sale of these toxic assets. It may or may not cause interest rates to rise depending on what the international situation is with other currencies. If the EU continues to have problems, then the dollar will remain as the world's reserve currency and interest rates will remain subdued as cash stays here. In this situation, the result of mopping up a trillion dollars from the economy will not be significant.
If the international situation is resolved and currencies stabilize at whatever level they achieve, then the sale may increase interest rates. This would be a positive factor. Right now credit is very tight and money supply is low because mostly regional banks are afraid to lend because of all the bad debt on their balance sheets. We need deleveraging to make the economy grow again. The short-term result would be negative, but it would free up the balance sheets of regional banks (as the CRE assets they hold as collateral go under, they would go broke or recapitalize), and this cleansing effect would set the stage for real organic economic growth as liquidity would then improve as surviving banks would be eager to lend.
I don't have a crystal ball here because there are too many variables to make a call. I have my doubts that the Fed can sop up all the excess reserves now held by banks. If that is the case, when banks recover, rising bank liquidity and credit would lead to significant inflation."
The short version of the above is:
"I haven't got a clue what is going on, but thought I might as well write a long and padded article anyway"
You compound this total waste of time with grammatical nonsense like
"Yet the Fed persists with their faulty theory"
Oh well.
Ah, the grammar police. I am guilty.
But do you know the future? It's a tricky thing.
Oh well.
You know, given that:
' “Their” is a possessive pronoun like “her” or “our” “They eat their hotdogs with sauerkraut.” ' ( http://www.wsu.edu/~brians/errors/their.html )
I do believe that you used that word correctly.
You have to wonder why people come on here just to make a personal attack.
From what I have seen the article has lead to some informed and ineresting discussion, funny about this being a blog the specific purpose of which is to do that.
But what do we get from you? A mindless and groundless personal attack. Rather than add to the discussion or put forward an opinion the best you could do was to slag the author.
There seems to be an increasing amount of pointless personl attacks on commentors and authors. For the life of me I can't understand people's continual attacks on Leo who makes the effort to put up his analysis and position. You can attack the suposition but why the person?
Econophile-
I may be off your main point a bit...but inflation or deflation vs debt is a very important issue. When most money is credit/debt, the inflation can haircut debtors. So where does debt go from here? If there is general deflation, people default/walk away...if there is inflation, debtors get relative relief. What that does to money supply, I have no idea.
Mutt:
See my comment to Bohica.
I thought only Doctors and Lawyers PRATICED their profession..
Wanna buy a "c"?
:))
More good news:
Fed Assets Reach Record $2.35 Trillion on Mortgage Purchases
The Fed has just enough economists to support a plausibility of purpose. Which one is used depends on the needs at that particular time. One of them is bound to say the right thing to satisfy the immediate need, and better still he actually is sincere in his belief, the perfect stooge.
The key is to follow the money and how its is used. That tells you the Fed's true purpose.
----------
I am convinced the Fed is not concerned at all with the health of the economy or the USD. Nor do they really care about economic theory or the costs of their actions. The Fed has no real way to carry out its mandate of full employment and stable prices, nor does it really care. But, the big catch all of plausible excuses has to be the control of credit. Because there are so many influences on how the economy may respond, you can justify almost any action. The real reason for the movement of rates are dictated by the needs of the banks for profit in the spread. So;
The Fed exits to support big banks.
Thats it, everything else is just window dressing. When you hear Ben present to Congress it is clear who has the power, the Fed. The Fed has these people in their back pocket.
If a senator wanted to he could have crucified Ben during the confirmation period. The data available would prove that the Fed has over stepped its authority in purchasing MBS. But, the senator only cares about funding for his district and subsequent re-election, and without the Fed there is no way to pay for the waste. But his greed will be the downfall of the nation. Let me rephrase, it is the downfall of the nation.
Also, the fiscal irresponsibility by the senators to line their own pockets, essentually makes them willing accomplises to the Fed's directives.
The Fed uses our corrupt political system to their advantage. It really looks like they architected it, or at least molded it over time.
----------
The point I am trying to make is, do not bother with the Fed plausibility of purpose.
There is only one goal.
Increasing Bank profits.
Mark Beck
My God, that was good.
* * * * * (five stars!)
The stock of the Federal Reserve corporation is held by its member financial institutions in proportion to their capital. Follow the money. The Fed operates to advance the interests of those who own it. This is especially easy when the Secretary of the Treasury comes straight from the top tier of Fed shareholders.
If everyone looked in your pocket and saw that you now had $2,000, prices might be bid up, if you chose to spend all that money rather than, say, paying down debt, which seems to be occurring and most probably will continue to occur for some long time. I think we’re just starting the great unwinding.
But as you imply, first that money has to get in your pocket. And that just doesn’t seem to be happening. All that money from the Fed isn’t getting out of the banking system. And the fiscal stimulus is at best treading water.
Re your observations on inflation and capacity utilization in the ’70s and ‘80s, capacity utilization was climbing right along with the CPI and only took a tumble when we were hit with the oil shocks of 1973 and 1979 and the Fed slammed on the brakes by raising the Fed Funds rate. See:
http://research.stlouisfed.org/fred2/series/OILPRICE
http://research.stlouisfed.org/fred2/series/DFF
Putting the two thoughts together, we first have to get that money into consumers’ pockets, then they have to spend it on goods and services rather than paying down debt, and then we have to take up the slack of excess capacity before we’ll see inflation. And in our globalized world, we can’t look only at our own capacity – China and increasingly India are factors as well.
I am convinced we are not in just another run of the mill cyclical recovery from an ordinary recession. We’ve been staving off the consequences of a true financial crisis in the sense of “This Time Is Different,” (Reinhart & Rogoff). The Great Depression is the closest thing to anything the U.S. experience has experienced similar to what we’re going through now. Despite massive federal intervention in the 1930s, it was a deflationary period. In modern times, Japan’s experience since 1989 is probably the closest thing to our current predicament. And even with all their intervention Japan too has been fighting deflation.
I don’t disagree that ultimately inflation is a monetary phenomenon. But we’re on the edge of deflation and we have to get through that, which could be years.
And I'm not an optimist - I don't see any good way out of the fix we're in.
Bend Over Here It Comes Again:
1. In any situation where the central banks has increased the money supply overnight by 100%, ceteris paribus, I guarantee it will result in all prices going up.
2. The purpose of my commentary was to make a simple point. I have written extensively about falling money supply and the credit freeze being a result of banks having too much bad debt on their books and the purpose of excess reserves. Ditto on Keynesian stimulus.
3. No, capacity utilization crashed because of Fed policy. I was there and the price of gas didn't have much to do with it, although that's a popular misconception.
4. Consumers don't need to spend, they need to save. I tried to make the argument for why this excess capacity thing is a myth, but you don't seem to accept that point. If not, explain why demand for more products would cause inflation?
5. I agree that this time is different. What caused the Great Depression was not deflation. What caused it was government intervention that turned a garden variety recession into a major depression. Compare 1920-1921 which had a bigger initial crash, greater initial unemployment yet recovered in less than 18 months. In that case the government did nothing.
6. We will be like Japan if we keep pursuing policies that prevent the economy from correcting itself by getting rid of overvalued assets (real estate) and the debt that banks hold on to thinking that a recovery is around the corner. Extend and pretend, delay and pray, mark to make believe and all that. That's why they are holding on to excess reserves because they are afraid of taking the hit to their capital base. Unless they go under or raise new capital the credit freeze will remain, a situation similar to Japan's zombie banks ('the living dead").
7. Deflation will continue for some time until the debt problem is resolved and banks start lending again.
8. The big question is whether the Fed can drain the pond once that happens. I don't think so. That will result in some serious inflation.
9. You might want to read something other than Keynes.
Thanks for the comment.
Look at what has happened to the St. Louis Fed's MZM - money of zero maturity - over the past 5 months. It is in a catastrophic decline:
http://research.stlouisfed.org/publications/usfd/page5.pdf
It looks like money market fund balances are collapsing as people figure out that they get a much higher (and non taxable) interest rate by paying down debt. Doubtless, it also indicates a resolve to reduce the need for ready transaction balances, implying a resolve to spend less in the future.
Remember that while the Fed has absolute control over the monetary base - the narrowest measure of money - it has very little influence in the intermediate term over the broader aggregates such as MZM. It is the broad aggregates that drive price inflation.
Well done Econophile. Great explanation of high oil prices being deflationary, rare that I read anything like that...
As a note:
In Japan, till early 00's they didn't have inflation as an explicit policy goal, so their Gov't spending priorities were different. That's one if the reasons they got what they got.
As for the money supply being locked up within the banking system - the recent post on modern art auctions comes to mind..
Moreover, in the US, there is a VERY LARGE category of people outside the financial system who benefit if assets such as equities or commodity ETF's go up in value.
Of course, if you are a lower middle class citizen working for a salary, then indeed when gasoline or rent become more expensive, you have less to spend. That indeed creates a risk of deflation. But isn't that exactly why the policy of the Fed is so accomodative?
The economy thus becomes a debt junkie addicted to funny money.
I have a feeling that Bernanke (maybe Yellen & Co., but not Ben Shalom) doesn't really believe in the "slack" argument; it's just a weapon of mass distraction.
Dear Econophile,
I'd like to pursue this but will be out of town today. So just a few quick thoughts.
First, I wonder if we differ primarily on timing. When do you see inflation actually picking up? I think it's a good way off, like years. In the meantime it's trending down.
You're right, double the money supply overnight and prices will go up (assuming people don't use their windfall to pay down debt). But in fact our money supply is dwindling. See:
http://research.stlouisfed.org/fred2/series/M2
http://research.stlouisfed.org/fred2/series/MZM
Of course if BS did resort to using helicopters, we could indeed see an increase in inflation.
I enjoy the exchange.
BTW, I don't read Keynes.
Can you tell me what the Fed will do? Can you tell me what new policies the Obama Administration will adopt? Can you tell me what will happen to the euro? Can you tell me when China's RE bubble will pop? Can you tell me how long it will take for lenders and creditors to clear off bad debt from their balance sheets? Can you tell me if I'll go to Starbucks or Coffee Bean tomorrow morning?
The trouble with predictions is that they are all guesses. There are simply too many moving parts. Some guesses are better than others, true. But mostly those that get the future right are lucky.
So, while I think the deleveraging will take another year, and I think the Fed will have a problem draining the pond, any time frame I give you would be just a guess. The difference between me and the other guys? I know I'm guessing.
The best strategy? Understand that these are the important factors in projecting the future and watch them carefully. Things change.
Thanks for the comment.
I commend you on your post, and consider it a subtly brilliant one.
Although, I don't think the banks will ever recover, not that it is presently important to them.
Great points as usual... and no... the pond cannot be drained even now.
All assets classes are floating on a sea of Fedsquidity amongst other things... and cheap money is the not only the Banksters drug of choice but the drug of neccessity to keep the illusion of 'normalcy' alive.
Make no mistake this experiment will end badly...
I agree, I feel the toothpaste is out of the tube and no amount of monetary policy can change what will eventually happen, which is years of stagnation a la Japan.
I guess the best that we can hope for is that the air is let out of the deflationary balloon slowly (hisssss) rather than all at once (pop!)
The Fed's Voodoo economics requires human blood, chicken won't cut it.
Funny thing is if the bond market continue to rally and mtg rates go down to 4.50 with no point (they are 4.625 now), Fed mtg portfolio will pay down in decent size (they own over 500bb with mtgs rates over 5.7%) and the need to sell goes away - In fact, it is a defacto tightening.
The Fed has been successful to the extent that it has led many into beleiving that there will be inflation. Print all the money you want ( use my toilet paper too) and you will still not get inflation. Money is being destroyed faster than is being created.
I challenge anybody on ZH to buy gold and hold it for 10 years.
No problem. Does Silver count? Already 100% invested in Silver Bullion.
I will take that bet every day of week.
http://www.nowandfutures.com/images/fed_all.png
This trend is not reversing any time soon. Infact, I don't see a single instance of money every being uncreated. You go ahead and keep your paper money. This isn't Japan. Japanese banks did not get their losses monetized like ours did. If we had simply done funky accounting to allow the banks to keep their garbage until they could sell it themeselves, that would have been deflationary. Be we didn't. The Fed paid out like a broken Vegas slot machine to every unlucky loser on Wall Street.
I hereby take that challenge on one condition. You must buy an equivalent (~$1274 * xxx oz. Gold Buffaloes) amount of Federal Reserve Notes to bury someplace safe.
At least 10 years from today you'll have plenty of paper to burn and keep you warm (I suggest you store non-denominated $1s and $5s).... But who knows, maybe this current shitstorm, aka TEOTWAWKI, will quietly blow over.
In view of the destruction of capital by the Oil Spill the selling of assets may become increasing difficult.
As insurance companies liquidate holdings to pay-out claims, who will be the buyers of all these assets?
I assume the insurance companies will need to sell stocks, bonds, other financial assets and real estate. Talk about an "overhang" . On top of this everyone will know of their need to sell and bids held back. So the question the Fed and Insurance companies will come to is "Sell To Who?"
From what I understand, the capacity utilization in Zimbabwe was not at 100%.
Good point... their main industry... agriculture... is below 50% utilization even as Mugabe valiantly continues his assault against it in order to contain domestic hyperinflation.
He should demand the consulting fee he gave Summmers and Rubin back.
ummm..I read something recently that said Zim was doing okay and was debt free, no?...they defaulted on foreign loans by hyperinflating, done.
If Bernanke sees this post it's all over... and on your head... Muttmeister!
Oh, =+1000, I so needed a good laugh today. I love muttmeister and Zerohead.
And speaking of hardmedicine... It's friday evening right?
Time to party like it's 1999! (seems so damn nostalgic now doesn't it? ..:)
The Fed gets to print money at the same rate the level of real wealth in the economy is growing so as to keep price levels constant. It rubs salt into the wound of this theft and breach of trust by claiming it must inflate even more under the rubric of the "targeted rate of inflation". This has been going on so long that everyone thinks this is the Fed is just doing its job. Well, its job, when coupled with an income tax on nominal capital gains and wages is to skim as much as possible off the top.
But this game is entering a new phase: a small but increasing number of the hoi polloi are discovering sites like mises.org on their own and understand what is going on.
Try this informal survey: The next time you interact with a cashier, when it comes time to pay, ask them this question: "May I pay with Federal Reserve Notes?" In my several years of running this informal poll, over 90% will say no, or at best will respond, "do you mean cash?". Of the cashiers who say they will accept FRNs (meaning they have read their money), I will say, "You do know these are really certificates of wealth dilution?" Most of those people will agree with me. It is my impression that the number of cashiers who get this far with me (as a percent) is growing.
If I have a cashier who really appears to know about money, I will pull out a gold coin I carry in my back pocket and ask if I can pay with gold. Nobody has ever said yes. However the very best answer I ever got was from the manager of a frozen yogurt stand in Branson, Missouri. He said that he would love to take it, but he could not make "proper change."
Next time why don't you try paying for your frozen yogurt with silver, Mr. McDuck!
Credit will continue to drop in demand, and the government will continue to print (debase). Of course, it's that ratio that determines the inflation/deflation.
There's tremendous instability. It's like a little old man trying to "walk a ladder" ... works fine when the ladder is 8 feet tall, maybe 20 feet tall (if he's careful), but our ladder is now two thousand feet tall.
It's Bazookanomics. Random. One misstep ... which we will get ...
NOVEMBER INCUMBENT BLOODBATH
MAKE IT HAPPEN!!!!!!!!!!
No one has a universal silver bullet.