Ben Bernanke has done gone and went insane

Friday, November 20th, 2009 | Economics | Permalink | No Comments |

Karl Denninger - Open Letter To The Chinese Premier:

Dear Wen Jaibao:

We in America have noted with concern your nations’ expression of alarm at our Federal Reserve’s blatant money-printing, debt monetization, and interference in the free markets, in particular the recent commentary of China’s bank regulator cited here:

“The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation,” he told reporters in Beijing today at the International Finance Forum.

Liu said this has “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

Mr. Liu is correct, of course.  However, yesterday afternoon Ben Bernanke gave you the finger, first in his speech and then later in the Q&A in which he said:

Nov. 16 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke said it’s “not obvious” that asset prices in the U.S. are out of line with underlying values after a 64 percent jump in the Standard & Poor’s 500 Index from its March low.

Donald Kohn, another Fed Governor, erected his middle finger in your direction as well with his comments last night and Yellen added her view this morning in which they also both said “we see no bubble.”  That’s three.

How many more times do you need to be flipped off before you get it: The Fed isn’t going to do what you want, and neither is Obama.  Get over yourself.

On the objective measures the price/earnings multiple of the S&P 500 currently stands at over 130, more than double its previous record and vastly beyond anything achieved even in China’s manipulated and overheated markets.  In short, they’re lying and they don’t care.

Tags: bernanke, the fed

Delicious free lunches for banks

Thursday, November 19th, 2009 | Economics | Permalink | No Comments |

Arnold Kling - Thoughts on the Macro Paradigm:

At this point, I was cornered. I had no choice but to say what I really believe about what the Fed was doing. In spite of all the sophisticated rhetoric about “quantitative easing” and “new tools for monetary policy,” the only way that I can understand what the Fed was doing is to say that the goal was to stimulate bank profits, not the economy. If your goal were to stimulate the economy, you would inject enough reserves to do that and not pay interest on reserves. That might require buying some long-term bonds or mortgage securities, but not the hundreds of billions that the Fed actually bought.

Everything the Fed has been doing over the past fifteen months makes sense if you think of their goal as transferring wealth from taxpayers to banks. If you try to explain it as an attempt to implement an expansionary monetary policy, you won’t even get past my high school students.

Previously - Delicious free lunches for Judge Elihu Smails

Tags: free lunches, the fed

Inflation or deflation? The man with the dollar printing press says “inflation”

Tuesday, October 20th, 2009 | Economics | Permalink | No Comments |

People are debating whether the United States is going to experience inflation or deflation. Ben Bernanke, the chairman of the U.S. Federal Reserve bank, has always intended to fight any hint of deflation with a massive dollar printing campaign. It’s hard to see how he can avoid overshooting attempts to stop deflation and crossing over into inflation.

Bernanke’s plan is a matter of public record since his time as a Federal Reserve governor before taking the reins of the Fed from Alan Greenspan in 2006. This speech is available from the the Federal Reserve archives (my emphasis in bold):

Remarks by Governor Ben S. Bernanke

Before the National Economists Club, Washington, D.C.
November 21, 2002

Deflation: Making Sure “It” Doesn’t Happen Here

As I have mentioned, some observers have concluded that when the central bank’s policy rate falls to zero–its practical minimum–monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The Fed has targeted and maintained an effective zero percent interest rate since December, 2008, forcing itself into a liquidity trap. Continuing from the 2002 speech:

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Gold has risen from $300 in 2002 when Bernanke gave this speech to $1050 today. Gold prices rise when there is public mistrust of government fiscal and monetary policy, and when people expect the money supply to be inflated on a large scale.

Issuing more dollars makes each dollar worth less. It isn’t so much that gold is going up, but that the value of and demand for dollars is falling. This is a difficult idea for most people: we tend to think of prices of things going up and down in dollars. You also have to realize that the price of dollars goes up and down in terms of things - gold, land, stocks, etc. During inflation dollars are worth less so it takes more of them to buy those things. Continuing from the speech:

Each of the policy options I have discussed so far involves the Fed’s acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices.

And in fact the Fed is now engaged in a massive open market purchase of U.S. Treasury and agency debt. Without those purchases the U.S. would be at the mercy of domestic purchasers and foreign governments to buy the $7 trillion in debt we sold in fiscal 2009, which included $1.4 trillion in new debt. All is going according to Ben’s plan. See Federal Reserve has bought 100%+ of 2009 mortgage market. Continuing:

Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers.

Which fits well into the theory that today’s high stock prices are caused - not by fundamentals or earnings, which are in the toilet - but by an excess of dollars floating around and chasing those stocks. See More on the Federal Reserve’s effect on stock markets.

And if you’ve ever wondered why people call him Helicopter Ben:

A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.

Previously - Inflation or deflation? How about hyperinflation

Tags: bernanke, inflation, the fed

“Some days I really wish I could go back to being completely clueless about the economy”

Wednesday, September 30th, 2009 | Economics | Permalink | 3 Comments |

From a financial board I read. “Some days I really wish I could go back to being completely clueless about the economy. Now I know enough to be scared but not enough to actually know what to do.”

I know the feeling.

In speaking to some local bloggers this past year a couple of people said things like, “I can barely read your site anymore. The economic stuff you talk about is too depressing.”

It is depressing. Worse, I’ve been holding back on how bad I think some parts of the economy are going to get.

For instance, I basically think the U.S. banking system is gone. Insolvent. Bankrupt. As in their liabilities greatly exceed their assets if their assets were fairly priced. It only takes a small writedown in assets to destroy a highly-leveraged bank in a fractional reserve system. Even by conservative estimates most banks are wiped out.

In the last few decades the banks made mountains of loans that will never, ever be paid back in full. Every foreclosed property you see is a loan gone bad. As Karl Denninger says, for decades credit expanded much faster than GDP. Do that long enough and you’ll never have any hope of paying back all the money.

The only reason the banking system hasn’t shut off the lights is that the government bailed it out. After they bailed it out they changed the rules so that the banks could mark their assets to fantasy and not be shut down.

The next step was to effectively replace the banks’ lending function. The U.S. government is now the de facto banker in the United States. The banks are just the places with the brick buildings, free toasters, and lollipops for the kids. Any money they lend ultimately comes from the Federal Reserve’s purchase of Treasury notes, Fannie Mae and Freddie Mac debt, and mortgage-backed securities.

If that sounds like paranoid rambling, see yesterday’s post, Federal Reserve has bought 100%+ of 2009 mortgage market. I’d love to be convinced I’m wrong, but I don’t think I am.

Tags: bailouts, banks, mortgage mess, the fed

Fed’s quixotic plan to raise interest rates to the moon once inflation starts

Tuesday, September 29th, 2009 | Economics | Permalink | 2 Comments |

AP - Officials: Fed will need to boost rates quickly:

To prevent inflation from taking off, the Federal Reserve will need to start boosting interest rates quickly and aggressively once the economy is back on firmer footing, Fed officials warned Tuesday.

“I expect that when it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity” to when the Fed was slashing rates to battle the recession and the financial crisis, said Richard Fisher, president of the Federal Reserve Bank of Dallas.

Color me skeptical. What they’re saying is that once the economy begins turning around and inflation begins they’re going to be willing and able to drastically raise interest rates. Consider what that means:

• Businesses that depend on revolving credit lines or short-term financing may be unable to borrow the money they need, forcing them into bankruptcy.
• Homeowners with adjustable rate mortgages will see their rates shoot to the moon, forcing millions of homeowners into foreclosure.
• Students will see their student loan rates skyrocket, keeping many out of college.
• Consumers struggling with credit card debt will see their interest rates rise.

Hiking interest rates is incredibly painful. It takes tremendous political will to do it. It also takes certainty that raising rates won’t kill a nascent recovery.

Too, all of this assumes that inflation can only happen after a recovery starts. That isn’t true at all. We could have stagflation - a stagnant economy combined with high inflation.

Tags: mortgage mess, the fed

Federal Reserve has bought 100%+ of 2009 mortgage market

Monday, September 28th, 2009 | Economics | Permalink | No Comments |

Chris Martenson - Federal Reserve Buys More Than 100% of Mortgages Issued in 2009:

In other words, the Federal Reserve alone bought $722 billion of mortgages and agency debt when only $686 billion in new mortgages were issued. So, through August, the Fed bought more than 100% of the entire supply of mortgages in 2009.

That’s not a free housing market; that’s a market bought, owned, and sustained by the Federal Reserve’s willingness to print up three quarters of a trillion dollars out of thin air.

While the individual mortgages issued in 2009 may or may not be the exact same ones purchased by the Federal Reserve, that’s immaterial. All the mortgage issuers care about is that when they issue a mortgage, a purchaser with money exists somewhere down the line. The chain needs a terminal buyer, and that buyer has become the Federal Reserve.

The impact of these purchases by the Federal Reserve is to both provide liquidity and to drive down the rate of interest for new mortgages. By lowering both the long end of the Treasury curve (which the Fed does by actively buying Treasuries) and providing more than sufficient demand for MBS and agency paper, long-term interest rates come down.

Without the Fed’s activities, it is a rock-solid certainty that mortgage interest rates would be higher than they are, and possibly a LOT higher.

What happens if the Fed can no longer finance the mortgage market? Or America’s government, for that matter, which it is effectively financing by purchasing Treasuries. This is another of the risk factors for a sudden stop, in which the debt-addicted economy or debt-addicted government come crashing to a halt because no one will loan us any more money.

I started worrying about a sudden stop when my wife’s company went out of business in January. It was a 65 year old company with over 400 employees. When the banks wouldn’t renew their revolving loan they went out of business overnight. That’s the sudden stop scenario.

Previously - 80% of mortgages backed by FHA, which is low on funds

Tags: mortgage mess, sudden stop, the fed

Rep. Alan Grayson questions the Fed’s Alvarez before Congress

Monday, September 28th, 2009 | Economics | Permalink | No Comments |

Via Zero Hedge and Matt Tiabbi. Grayson (D-FL) comes off as a slightly-crazed attack dog, but wow does he ever put Alvarez on the hot seat.

Alan Grayson: I would like to know whether it is within the Federal Reserve’s legal authority to try to manipulate the stock market or the futures market.
Federal Reserve GC Scott Alvarez: I don’t believe the Federal Reserve tries to manipulate the stock market…(Yoda: Do or do not, there is no try.)
Alan Grayson: Does the Federal Reserve actually possess all the gold that’s listed on their balance sheet.
Scott Alvarez, doing a classic poker body language tell, and taking his time: Yes…
Alan Grayson: Who actually executes the trades for the Federal Reserve in the markets?
Scott Alvarez: The Federal Reserve Bank of New York, which executes trades through Primary Dealers.
Alan Grayson: Can you name one Primary Dealer?
Scott Alvarez: JP Morgan Chase
Alan Grayson: Do you mind if we have a GAO audit to see if there has been front-running or insider trading by them? Do you mind? Is that ok with you?
Scott Alvarez: I am not sure if I have that authority…

Grayson isn’t the only Congressman tired of the secrecy at the Federal Reserve. Wall Street Journal - Fed Weighs Naming Borrowers:

Continue reading the rest of this post right here ›››

Tags: the fed, youtube

For once, I hope Barney Frank is right

Friday, August 28th, 2009 | Economics | Permalink | No Comments |

Barney Frank Says Ron Paul’s Audit The Fed Bill Will Pass In October.

Tags: the fed

Martenson on the Federal Reserve’s “shell game”

Thursday, August 27th, 2009 | Economics | Permalink | No Comments |

This one is a doozy. I can’t say I understand every bit of what’s going on in this one, but here’s the takeaway. Martenson’s thesis is that the Federal Reserve is monetizing more debt than previously realized, which would lead to inflation faster than previously thought.

The Fed mechanism he proposes is to let foreign central banks swap agency debt for higher-grade U.S. Treasury debt via the Federal Reserve Custody Account. That would serve to shore up everyone’s books while devaluing the dollar by effectively “printing” more dollars (realizing of course that the printing is really a bookkeeping operation).

Many people have said the Fed would have to inflate, but if Martenson is right they’re doing it faster than realized because they’re doing it in a stealthy way that’s escaped attention. This is addition to the non-stealthy way they’ve been inflating the money supply by buying $300 billion in Treasuries this year and reflating the money supply by purchasing over a trillion dollars in bad bank securities and agency debt.

Here are Martenson’s conclusions for what this would mean:

The Federal Reserve has effectively been monetizing far more US government debt than has openly been revealed, by cleverly enabling foreign central banks to swap their agency debt for Treasury debt.  This is not a sign of strength and reveals a pattern of trading temporary relief for future difficulties.

This is very nearly the same path that Zimbabwe took, resulting in the complete abandonment of the Zimbabwe dollar as a unit of currency.  The difference is in the complexity of the game being played, not the substance of the actions themselves.

When the full scope of this program is more widely recognized, ever more pressure will fall upon the dollar, as more and more private investors shun the dollar and all dollar-denominated instruments as stores of value and wealth. This will further burden the efforts of the various central banks around the world as they endeavor to meet the vast borrowing desires of the US government.

One possible result of the abandonment of these efforts is a wholesale flight out of the dollar and into other assets.  To US residents, this will be experienced as rapidly rising import costs and increasing costs for all internationally-traded basic commodities, especially food items.  For the rest of the world, the results will range from discomforting to disastrous, depending on their degree of dollar linkage.

Under these circumstances, “inflation vs. deflation” is not the right frame of reference for understanding the potential impacts.  For example, it would be possible for most of the world to experience falling prices, even as the US experiences rapidly rising prices (and hikes in interest rates) as a consequence of a falling dollar.  Is this inflation or deflation?  Both, or neither?  Instead, we might properly view it as a currency crisis, with prices along for the ride.

If that concerns you, read the whole thing. I’m still trying to get my head around it, but it would explain some oddities in inflows other people have noted. Here’s the Wikipedia definition of monetization:

Monetization is the process of converting or establishing something into legal tender. It usually refers to the printing of banknotes by central banks, but things such as gold, diamonds and emeralds, and art can also be monetized. Even intrinsically worthless items can be made into money, as long as they are difficult to make or acquire. Monetization may also refer to exchanging securities for currency, selling a possession, charging for something that used to be free or making money on goods or services that were previously unprofitable.

And agencies in this case seem to be Fannie Mae and Freddie Mac bonds.

Tags: inflation, the fed

Bernanke in 2007: economy positioned for recovery

Thursday, August 27th, 2009 | Economics, Quotes | Permalink | No Comments |

Hussman’s Weekly:

“Our forecast is for moderate but positive growth going into next year. We think that by the spring, early next year, that as these credit problems resolve and, as we hope, the housing market begins to find a bottom, that the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace.”
– Federal Reserve Chairman Ben Bernanke

On Friday, investors took great cheer in an optimistic statement by Ben Bernanke suggesting good prospects for economic growth ahead. We might be inclined to place a sliver of credibility in Chairman Bernanke’s assessment – if not for the fact that the quote above wasn’t from last week at all, but rather, hails back to November 8, 2007, just before the recent recession began. You might recall that the S&P 500 was pushing 1500 at the time. The implosion of the global credit markets was still just a slight rumble.

Collect the whole set:

• Bernanke in 2005: no housing bubble to go bust
• Greenspan in 2004: fears of speculative bubble in housing prices exaggerated

Tags: the fed

The Fed and asset bubbles, again

Tuesday, August 25th, 2009 | Economics | Permalink | No Comments |

Marginal Revolutions - Identifying and Popping Bubbles: Evidence from Experiments:

The last factor that does seem to make a difference is that bubbles liftoff and reach higher peaks when there’s a lot of cash floating around.  In theory, this shouldn’t matter, fundamental value is fundamental value. If an asset is worth $10 in expected value then it’s worth $10 whether you have $20 in your pocket or $200.  But in practice bubbles are bigger when cash relative to asset value is high.

Note that the latter experiments are consistent with the Fed having a significant role in bubble inflation (a theory I have not pushed).  In other words, rather than identifying and popping bubbles already on the rise, not blowing bubbles in the first place may be easier and more productive.

Tags: the fed

Bloomberg wins FOIA suit against Federal Reserve

Tuesday, August 25th, 2009 | Economics | Permalink | No Comments |

Reuters - Federal Reserve loses suit demanding transparency:

A federal judge on Monday ruled against an effort by the U.S. Federal Reserve to block disclosure of companies that participated in and securities covered by a series of emergency funding programs as the global credit crisis began to intensify.

In a 47-page opinion, Chief District Judge Loretta Preska of the federal court in Manhattan said the central bank failed to show that disclosure would cause borrowers in the Federal Reserve System to suffer “imminent competitive harm,” by stigmatizing them for using Fed lending programs.

“The board essentially speculates on how a borrower might enter a downward spiral of financial instability if its participation in the Federal Reserve lending programs were to be disclosed,” she wrote. “Conjecture, without evidence of imminent harm, simply fails to meet the board’s burden.”

P.S. - Compare that story to this one, about Congress demanding to know salaries in the health insurance industry. Those are private companies. Congress has no business finding out what their employees make. Yet our government gave hundreds of billions of dollars in taxpayer money to banks and doesn’t want us to know which banks got the taxpayer’s money or how much they got. The government wants transparency in private dealings that are none of their business and secrecy in government dealings with enormous public interest.

Tags: the fed

Fed official: “The Fed’s strategy is aimed at promoting a future rise in inflation”

Tuesday, August 25th, 2009 | Economics | Permalink | No Comments |

I’m still trying to understand what this statement means:

Financial markets have not fully understood that the U.S. Federal Reserve’s pledge to keep interest rates exceptionally low for an extended period means they will stay low beyond when officials normally would raise them, a top Fed official said on Friday.

“I don’t think markets have really digested what that means,” St Louis Fed President James Bullard said in an interview.

The Fed’s strategy is aimed at promoting a future rise in inflation, which should provide an immediate boost in activity in anticipation of a future boom, but that hasn’t happened, Bullard said.

Tags: inflation, the fed

More on the Federal Reserve’s effect on stock markets

Monday, August 24th, 2009 | Economics | Permalink | No Comments |

Jesse’s Cafe Americain - Why Is the Fed Creating Excess Reserves in the Banking System and Paying Interest on Them?

The essence of the essay was to point out the enormous increase in bank reserves which the Fed has created through their “New Deal” style banking programs. Because of this, the Fed has created a new function by which it pays interest on banking reserves, which to my knowledge it has never done before.

It is a new function at the Fed, and it does serve a important purpose. The purpose is to place a ‘floor’ under interest rates, in the face of a surfeit of liquidity which the Fed has created, and which shows up in the Adjusted Monetary Base, the Reserve Bank Credit figures, and so forth.

Now, some people have taken issue with my bringing the notion of excess Reserves to your attention for a variety of reasons. Even the mighty NY Fed has written a paper which attempts to defuse the notion that the excess reserves are indicative of anything that might be impeding lending.

Let me be clear about this.

The excess reserves are absolutely indicative of the Fed’s having added substantial amounts of liquidity to the financial system. If the Fed were not paying interest on reserves, this liquidity would crush their target interest rates, since the banks are loath to hold reserves that are not generating some return. This is what they do, generate a return on capital. Capital has a price, even if it is an opportunity cost.

These are all things which have been discussed before, often in the context of consumers! In fact, it is well known among bankers that as the Fed lowers interest rates money flows out of lower paying instruments like bank deposits and money markets, and into higher paying instruments that might be deemed too risky at high rates of riskless return. Such higher paying instruments are known as “stocks” and “corporate bonds.”

Tags: the fed

The stock market rally is being inflated by easy Federal Reserve money

Tuesday, August 11th, 2009 | Economics | Permalink | No Comments |

Any number of blogs I read have been saying that the recent stock market rally is based on nothing but loose money provided by the Federal Reserve to banks and other financial institutions. The stock market P/E ratios are crazy and the price increases are accompanied by tiny volumes. No one in their right mind would buy into this market unless they had lots of money lying around and nothing to do with it.

I’m amazed to see that even Reuters and CNN realize this is a rally built on cheap money provided by the Fed, just as the housing bubble was built on cheap money provided by the Fed.

CNN - Stocks: The latest Fed bubble:

Though liquidity is admittedly a nebulous concept, there’s no question that central bankers around the globe have poured huge amounts of money into the markets to ease the financial crisis. Given free money, investors’ appetite for risk shoots higher and they gobble up stocks.

But surely all the free, cheap money (”quantitative easing” is the central banks’ preferred term) won’t cause inflation, right?

Fed officials have stressed that they will start to unwind their financial support programs at the earliest sign of inflation. Given the cost of cleaning up after the last bubble, Becker writes that “this time, policymakers are unlikely to remain inactive should they suspect the formation of another asset price bubble.”

But it’s clear that bankers are loath to pull back on their support for the financial system before it’s clear the economy has staged a stronger recovery. And the Fed has a long and painful history of ignoring asset price inflation.

“The central bankers have this textbook belief that the only inflation is the kind that appears in consumer price indexes,” said Simons. “They don’t believe what they’re doing could cause an asset price bubble.”

But comparing the bankers with a driver pulled over for speeding for the umpteenth time, Simons said, “At some point, you have to say maybe your speedometer’s broken.”

Yep. See here:

• Bernanke in 2005: no housing bubble to go bust
• Greenspan in 2004: fears of speculative bubble in housing prices exaggerated

Tags: inflation, investing, the fed

Learning economics on the Monopoly board

Thursday, July 2nd, 2009 | Economics | Permalink | No Comments |

And not the usual lessons:

Your argument holds in a monopoly game. But we temporarily got around the basic limit of what can be financed in a monopoly game by adding a second monoply game to the system: we increased the money supply in the bank using money from a second monoply game; we liberalized the building rules so that we could build as much as we wanted to on a property; we issued IOUs to each other to prevent bankruptcies; and among other “Bernanke-like” changes, we added houses and hotel pieces to the original game’s supply.

Our monopoly game went on for two or three more trips past Go, and then there was one gigantic bankruptcy. So your argument holds: in a closed money supply system, there is a basic limit to what can be financed from the bank.

We played this double monopoly game as kids one hot afternoon in San Jose, and we learned some important lessons in economics that apparently the Federal Reserve Bank has yet to learn.

As we added the second game’s money to the original game and liberalized building rules, the first thing we noticed was that the cost of living on the game board went up. (We had inflation.) The cost of living made the final bankruptcy bloodier than ever.

The most interesting thing was that the second bankrutcy— the killer— came quite fast. A couple of trips around the monopoly board, and it was game-over. Unless we wanted to issue more IOUs to each other, the game had reached an end determined by the money supply shortage at the bank. There was not enough money (even with the second game’s supply of money added-in to the money supply) to pay the new rents on the original game board.

Tags: the fed

Great Depression vs. Now: inflation more likely now

Wednesday, June 24th, 2009 | Economics | Permalink | No Comments |

Solid bars are from the Great Depression 9/1929 to 4/1931. Shaded bars are from 10/2007 to 05/2009 (except the green GDP numbers, which are from 10/2007 to 01/2009). Stock market peak was 10/2007.

Source.

We didn’t see crazy inflation during the Great Depression, but with all of the money floating around in 2009 we might see it now. In the current depression the Federal Reserve has gone insane pumping up the money supply.

Tags: inflation, the fed

Former IMF chief calls for higher U.S. inflation

Monday, May 11th, 2009 | Economics | Permalink | No Comments |

Telegraph - Ken Rogoff says Fed needs to set inflation target of 6pc to help ease crisis:

Professor Kenneth Rogoff, former chief economist of the International Monetary Fund, said the threat of debt deflation called for revolutionary measures as an insurance policy. “Excess inflation right now would help ameliorate the problem. For that reason, it would be far better to have 5pc to 6pc inflation for a couple of years than to have 2pc to 3pc deflation,” he told the Central Banking Journal. The Fed has shifted tentatively to an inflation target, but one anchored nearer “stability”.

A number of economists have begun to make similar calls for a radical shift to deliberate monetary debasement, although few have gone as far as suggesting 6pc. Such proposals cause a furious political reaction because they amount to a forced shift in wealth from savers to debtors.

Prof Rogoff – one of the few economists who recognised the gravity of this crisis early on – admits that his policy is fraught with danger because it could lead to an overshoot down the road, “ending up with 200pc inflation”.

Someone described inflation as a negative interest rate on savings. If you don’t spend your paper money it becomes worth less and less every year. It’s a government’s way to force you to spend money when you’d rather not. And of course it’s also government’s way to make it easier for them to repay their debts using debased money. Both ideas appeal to the U.S. government in the position it finds itself. Inflation here we come.

Tags: inflation, the fed

Ron Paul calls for audit of the Federal Reserve - H.R. 1207

Thursday, May 7th, 2009 | Economics | Permalink | No Comments |

From govtrack:

2/26/2009–Introduced.

Federal Reserve Transparency Act of 2009 - Repeals the authority of the Comptroller General to carry out an onsite examination of an open insured bank or bank holding company only if the appropriate federal regulatory agency has consented in writing. (Retains the authority of the Comptroller General to audit a federal agency.)

Directs the Comptroller General to complete, before the end of 2010, an audit of the Board of Governors of the Federal Reserve System and of the federal reserve banks, followed by a detailed report to Congress.

The bill currently has 134 co-sponsors. More information on the Ron Paul Web site.

I’m not sure of the particulars here, but I wouldn’t mind seeing more oversight of the Federal Reserve, which is a very odd beast. Not really part of the government, but couldn’t operate without the government, and exerting immense control over the economy.

Tags: the fed

Inflation is on its way

Wednesday, May 6th, 2009 | Economics | Permalink | No Comments |

Allen H. Meltzer op-ed in the New York Times - Inflation Nation:

Some of my fellow economists, including many at the Fed, say that the big monetary goal is to avoid deflation. They point to the less than 1 percent decline in the consumer price index for the year ending in March as evidence that deflation is a threat. But this statistic is misleading: unstable food and energy prices may lower the price index for a few months, but deflation (or inflation) refers to the sustained rate of change of prices, not the price level. We should look instead at a less volatile price index, the gross domestic product deflator. In this year’s first quarter, it rose 2.9 percent — a sure sign of inflation.

Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.

When will it come? Surely not right away. But sooner or later, we will see the Fed, under pressure from Congress, the administration and business, try to prevent interest rates from increasing. The proponents of lower rates will point to the unemployment numbers and the slow recovery. That’s why the Fed must start to demonstrate the kind of courage and independence it has not recently shown.

Milton Friedman often said that “inflation was always and everywhere a monetary phenomenon.” The members of the Federal Reserve seem to dismiss this theory because they concentrate excessively on the near term and almost never discuss the medium- and long-term consequences of their actions. That’s a big error. They need to think past current political pressures and unemployment rates. For the next few years, they cannot neglect rising inflation.

Tags: inflation, the fed

Eric Janszen gives the economic gloom and doom, take it or leave it

Wednesday, April 8th, 2009 | Economics | Permalink | No Comments |

One of my financial gurus is Eric Janszen of itulip.com. As an introduction and an aid to understanding what’s in the interview below, FIRE is Janszen’s acronym for Finance, Insurance, and Real Estate. His contention is that over the past three decades the American industrial economy has transformed into a FIRE economy, not the “information” economy that most people have been talking about for the past dozen years.

Santa Fe Reporter - Economy on FIRE and in debt:

Can you put today’s economic situation in a historical perspective? Is there any parallel?

More than one-quarter of all homes have negative equity in the US. That’s a bad problem. But there’s a worse problem developing.

I refer to the American housing market as “the big slum.” A slum is where the market value has fallen below the replacement value. It doesn’t make sense to fix anything. You don’t fix it, you just let it go to hell. There’s no way to get your money back.

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It’s not that popular to be negative when things appear to be going well. I get interviewed more by the European and Asian press than the US press. It’s part of the culture, that we don’t really like people who are skeptical, who ask questions like, “How can you grow an economy that requires $5 of debt growth to create $1 of GDP growth?”

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Another thing you’ll see reported all the time is that this is the highest rise in new jobless claims since 1982. The implication is this is like the early 80s recession, except in some ways worse.

What’s not reported is every recession was induced on purpose by the Fed, in order to cool down the economy. This recession was not created by the Fed. The implications of that are lost on a lot of people: They are absolutely not in control.

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I get calls from members of Congress asking me what I think she should do. They don’t really want to hear the answer. I think the ultimate problem is having to write down trillions of dollars of bad debts for their campaign contributors. There’s hardly any other rational explanation.

We lectured the Japanese not to do what we’re doing right now.

Japan started out where we were, in terms of public debt, back in 1992. They were at about 60 percent of gross debt to GDP. Now they’re at 159 percent—a notch above Zimbabwe, just below Jamaica. None of that spending improved their sustainability as an economy. All they did was move the debt from private to public accounts over 20 years through the stimulus programs.

This is what our rocket scientists are planning for us. There can’t be enough output to pay the principal and the interest on all this debt.

Tags: eric janszen, mortgage mess, the fed

WSJ asks 6 economists: Did the Fed cause the housing bubble?

Monday, March 30th, 2009 | Misc | Permalink | 7 Comments |

Five of six answer in the affimative.

Via The Corner, which has a summary of answers if you don’t want to read the WSJ piece. One sample:

“The blame for the current crisis extends well beyond the Fed — to banks, regulators, bond raters, mortgage fraud, the Bush administration’s weak-dollar policy and Lehman bankruptcy decisions, and Congress’s reckless housing policies through Fannie Mae and Freddie Mac and the Community Reinvestment Act.

But the Fed provided the key fuel with its 1% interest rate choice in 2003 and 2004 and “measured” (meaning inadequate) rate hikes in 2004-2006. It ignored inflationary dollar weakness, higher interest rate choices abroad, the Taylor Rule, and the booming performance of the U.S. and global economies.”

Tags: banks, mortgage mess, the fed

Adjusted for inflation, prime interest rates were negative from 2002 to 2005

Friday, March 13th, 2009 | Economics | Permalink | No Comments |

Lots of people, me included, think that the main cause of the real estate bubble and credit bubble were the interest rates set by the Federal Reserve under former Chairman Alan Greenspan. Those interest rates were kept too low for too long. It turns out that the interest rates were so low that once you factored in inflation the interest rates were negative. The Federal Reserve under Greenspan was paying banks to borrow money.

Greenspan recently surfaced to defend his record and distance his decisions from the current mortgage mess and collapse. For his trouble he’s getting attacked further, just as he deserves.

Greenspan lays out his case that the Fed’s easy money policies can’t possibly be to blame for “the U.S. housing bubble that is at the core of today’s financial mess.” It is long-term interest rates that determine “the prices of long-lived assets,” such as housing, he writes. And those rates, which stayed low as a result of a “global savings glut,” are out of the Fed’s control.

Control, yes. Influence, no.

“Why not try raising short rates if long rates are too low?” asks Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. “The recession was over in 2001. Why did he take so long to start to raise the funds rate?”

Greenspan is selective in arguing his case. By any measure, the overnight fed funds rate was too low earlier in the decade. The real funds rate, which is the nominal rate adjusted for inflation, was negative for three years, from October 2002 to October 2005, a longer stretch than in the mid-1970s. And we know how well that turned out.

Now we have additional evidence of the effect of negative real rates. When financial institutions are being paid to borrow, borrow they will.

The history of the mortgage crisis is not going to be kind to Alan Greenspan.

Tags: greenspan, inflation, mortgages, the fed

More reasons I’m worried about banks

Wednesday, March 4th, 2009 | Economics | Permalink | 1 Comment |

I knew it was possible, but I never dreamed the FDIC would actually come out and admit how overwhelmed they are by the current financial crisis.

Bloomberg - FDIC’s Bair Says Insurance Fund Could Be Insolvent This Year

Federal Deposit Insurance Corp. Chairman Sheila Bair said the deposit insurance fund could dry up amid a surge in bank failures, as she responded to an industry outcry against new fees approved by the agency.

“Without these assessments, the deposit insurance fund could become insolvent this year,” Bair wrote in a March 2 letter to the industry. U.S. community banks plan to flood the FDIC with about 5,000 letters in protest of the fees, according to a trade group.

“A large number” of bank failures may occur through 2010 because of “rapidly deteriorating economic conditions,” Bair said in the letter. “Without substantial amounts of additional assessment revenue in the near future, current projections indicate that the fund balance will approach zero or even become negative.”

The FDIC last week approved a one-time “emergency” fee and other assessment increases on the industry to rebuild a fund to repay customers for deposits of as much as $250,000 when a bank fails. The fees, opposed by the industry, may generate $27 billion this year after the fund fell to $18.9 billion in the fourth quarter from $34.6 billion in the previous period, the FDIC said. The fund was drained by 25 bank failures last year.

Smaller banks are outraged over the one-time fee, which could wipe out 50 percent to 100 percent of a bank’s 2009 earnings, Camden Fine, president of the Independent Community Bankers of America, said yesterday in a telephone interview.

She’s telling the American public that their FDIC-insured bank accounts are backed by an agency that may be insolvent this year. Can you say “bank runs”?

Me, I think the FDIC is an eyedropper trying to extinguish a forest fire. They have a few billion dollars in holdings to backstop trillions of dollars in deposits. The only reason the FDIC isn’t completely irrelevant is because the banks are being backstopped by the TARP bailout and separately by the Federal Reserve, which has committed several trillion dollars to guarantee loans.

Want some real banking doom and gloom? There are links from my FDIC and banking file:

Mish: You know the banking system is unsound when…

23. FDIC Chairman Sheila Bair said the FDIC is looking for ways to shore up its depleted deposit fund, including charging higher premiums on riskier brokered deposits.

24. There is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Indymac will eat up roughly $8 billion of that.

25. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.

What cannot be paid back will be defaulted on. If you did not know it before, you do now. The entire US banking system is insolvent.

iTulip: Major US banks worse than Japan’s zombies?

iTulip: What do you make of the extraordinary levels of bank reserves that the Federal Reserve is pumping into the Federal Reserve System, now at more than 600% higher than November 2007 levels?

Dr. B: Think of the commercial banks that take loans from the Federal Reserve banking system as a person and the money that flows through them as the blood in a person’s body. Now think of that person as injured. When he suffers a severe injury and loses blood, the Fed gives him an emergency money transfusion. You can see in your chart below the money transfusions in late 1999 just before the end of the year, due to the Y2K scare — false, as it turns out — and in 2001 after 9/11. Some believe that the withdrawal of reserves in mid 2000 caused the market decline that led to the recession of 2001.

Dr. B: After the injury is operated on and healed and the patient is producing his own money again, the money that was added earlier by the Fed’s transfusion is drained back out. As you can see from your chart above, the transfusions usually take two to six months and typically six months or so after the crisis is over are gradually withdrawn over a period of several months to return total money in the system to pre-crisis levels.”

iTulip: That makes sense. But why has the Fed this time had to continue to transfuse money? Why are the transfusions so huge and why do the transfusions seem to not be working? Is he still bleeding and the money is pouring through the system? If you try to compare previous expansions with this one on the same chart on the same scale, the differences are quite stark.

Dr. B: My theory is, and I admit not everyone will agree with it, is this: the patient is dead.

iTulip: Interesting. That does not bode well for the efficacy of future transfusions.

Dr. B: No it does not. They can keep the intravenous tube hooked up to a pint bottle or a 100 gallon drum of blood but it doesn’t matter if the blood is not circulating through the patient so he can take it in.

I picked a bad year to give up alcohol for Lent.

Tags: banks, fdic, the fed

Alan Reynolds: Fed can’t reduce money supply in time to stop inflation

Monday, February 23rd, 2009 | Economics | Permalink | 3 Comments |

I’ve been noting that the Federal Reserve’s unprecedented increase in the money supply will lead to inflation. Federal Reserve Chairman Ben Bernanke is claiming that just as soon as the economy starts to recover he’ll pull back the money supply Wizard of Oz style and - voila! - no inflation.

Alan Reynolds questions Bernanke’s claims:

If inflation catches the Fed by surprise, are they really “able to quickly reverse the actions,” as Bernanke says? How could they do that?The Fed could certainly raise the interest rates on bank reserves — the fed funds and discount rate — which is how it makes money and credit tighter in normal times. But that rationing device would not prove so effective in times like these, because banks are already sitting on a mountain of untapped reserves. Besides, once expected inflation has begun to rise, the Fed has usually moved rates up in 25-basis steps — increases so small that perceived real interest rates can continue to fall even as nominal rates rise.

To literally reverse the actions that doubled its assets since last September, the Fed would have to sell nearly a trillion dollars worth of IOUs. Unfortunately, they don’t have nearly that many Treasury securities to sell. And even if the Fed were willing sell off all of its Treasury bills and bonds, the remaining backing for Federal Reserve notes would be little better than junk bonds. Meanwhile, private and agency securities acquired since last September must be very hard to sell — or else the Fed would not have felt obliged to buy them.

The Fed’s System Open Market Account at the Federal Reserve Bank of New York holds $39.4 billion in inflation-protected Treasury bonds — more than twice its $18.4 billion stash of short-term Treasury bills. Are they trying to tell us something?

Point 1 is that you shouldn’t believe Bernanke when he claims he can snap his fingers and put the kibosh on the inflationary dragon.

Point 2 is that Reynolds notes something I hadn’t considered.

To assume, as Bernanke does, that inflation cannot possibly accelerate until “the economy begins to rebound and financial markets stabilize” is to assume stagflation is impossible, though 1973-75 and 1979-82 proved otherwise.

I keep saying that we won’t have serious inflation until after the recovery begins, that the recovery can’t begin until we hit bottom, and that we’re a long way from hitting bottom. Sounds pretty pessimistic, doesn’t it? Thing is, just like Bernanke I wasn’t considering the possibility of stagflation (a stagnant economy combined with the inflation of a red-hot economy). If that happens things could be even worse than I imagined. Dangit.

P.S. In another post Reynolds poo poos the jump in producer price inflation I mentioned last Monday.

Tags: bernanke, inflation, stagflation, the fed