Posted on 04/27/2008 3:01:19 PM PDT by shrinkermd
When the Federal Reserve cuts interest rates for a seventh consecutive time this Wednesday, it will begin to wind down a pernicious campaign that has flooded the market with cheap dollars since last summer. At the same time, the whoosh of air from Europe's deflating credit bubble puts new pressure on the European Central Bank to begin cutting borrowing costs in order to goose growth.
The strategy shifts by central banks will drive a greenback comeback against the overpriced euro, turning back the 15% slide that since August has lifted the euro -- to a record $1.60 last week -- even as the dollar continues to struggle against the undervalued currencies of Asia.
Monetary policy isn't the only catalyst for a healthier dollar. "A lot of what has happened since last summer also is emotional, and that can change on a dime," says James Paulsen, Wells Capital Management's chief investment strategist. Among other drivers: mounting evidence that the credit crisis loosening its grip stateside is still tightening across the Atlantic, and a growing belief that the U.S. economy could bottom and rebound before Europe's.
The rehabilitation, ironically, is driven by a weak dollar, which makes bargains of our exports, fills Manhattan's 65,000 hotel rooms with European tourists, and entices foreign giants from Ikea to Toyota to open factories here to exploit our increasingly cheap labor.
Already, the dollar has begun to strengthen against commodity-driven currencies from the Canadian loonie to the South African rand, and odds are it is close to a bottom against the euro, sterling and most developed-world currencies. On top of that, "negatives about the dollar are more fully discounted compared to the potential positives," says Marc Chandler, Brown Brothers Harriman's currency strategist, who expects the euro to pull back to test the $1.40 threshold this year
(Excerpt) Read more at online.barrons.com ...
In our world of central banking, bank loans require reserves (make one without it and they come and shut you down). When your bank loaned you $1B by writing out a check for $1B which was deposited in the other guy's bank your banks reserves (actual cash balance on hand) decreased by $1B (the FED's clearing house sees to this, now overnight) and the others guy's bank's reserves increased by $1B.
Total bank system reserves did not increase, and so total bank loan volume could not increase. In factional reserve banking aggregate bank loans is the allowed multiple of aggregate reserves. Sure, each new loan is based on the fact that the bank has excess reserves against which to make the new loan. If the bank has a reserve requirement based on deposits of $10B and it has $11.1B in reserves it can loan you $1B leaving it with the required $10.1B in reserves. If it has $10B in reserves it can loan you nothing. The $1B it loans you circulates through the system and creates a total of $10B in bank loans, but this is not "new" in the sense that the banking system did not expand the money supply beyond bounds established by the reserves on hand. It merely reflects that at some moment in time there were excess reserves in the system that meant banks could lend more.
If this were not the case, if banks, independent of the FED, could create their own reserves, the FED would be both superfluous and ineffectual. But instead, through adding or subtracting banking reserves, the FED does control the volume of money in the system.
You are putting words in my mouth AND you need to get your terms clear. By Austrians, I mean not the country of Austria, which is actually a very pleasant place, but rather the Austrian school of economics. Second, as Switzerland shows, it is possible to have very robust economy without hyperinflated monetary growth. Third, we have acheived almost zero economic growth with what even the USG recognizes as a worrisome level of inflation. Fourth, I think we are long past the stage where there "might be" some inflation.
As a matter of fact, we have virtually zero growth (if not negative depending on your view of BLS inflation rates and GDP corrections), and we have inflation roaring along just fine (even using the USG's numbers with corrections that even the most boneheaded Joe six pack knows are wrong - as he finds out when he gasses up his Ford 250 and buys his case of Budweiser).
We have achieved the halcyon days of Jimmy Carter's presidency (which Johnson and Nixon had a large hand in creating BTW, to spread the wealth a bit) of stagflation. You may see that as a wonderful period. Those who view Volker as a national hero would claim otherwise.
I like the job the Fed has been doing ... because if your stocks aren't growing more rapidly than inflation you're in a heap of trouble.
WTF does the FED have to do with whether your stock's are growing faster than inflation. There is only one conclusion, that you are invested in stocks of companies who derive an economic benefit not from productive enterprise, but from speculating on those things that differentially are advantaged by inflation.
BTW - your tag line - what would victory in Iraq look like if it were achieved? I just want to know that you have a clearer strategic vision than apparently the neo-cons [who between themselves never served a day in the military, including Cheney] did when they decided this little military adventure was of such great national advantage that we could abandon any other national goals in order to execute it. This is not a slam against our military, but rather against ignorant and egoistic political leaders who did not understand the seriousness of war and strategy as laid out in the first 4 paragraphs of Sun Tzu for instance.
I do get it.
When your bank loaned you $1B by writing out a check for $1B which was deposited in the other guy's bank your banks reserves (actual cash balance on hand) decreased by $1B
Yes, the bank I borrowed the money from reduced their excess reserves. That's different than cash on hand. The bank I deposited the check in now has extra reserves.
Total bank system reserves did not increase, and so total bank loan volume could not increase.
Total bank reserves do not have to increase for loans to increase. Unless you think that every dollar is loaned and reloaned to the maximum level of the multiplier?
If the bank has a reserve requirement based on deposits of $10B and it has $11.1B in reserves it can loan you $1B leaving it with the required $10.1B in reserves. If it has $10B in reserves it can loan you nothing. The $1B it loans you circulates through the system and creates a total of $10B in bank loans,
See, now you do understand! I'm glad I could help.
but this is not "new" in the sense that the banking system did not expand the money supply beyond bounds established by the reserves on hand.
Who said anything about expanding "beyond bounds established by the reserves on hand"? I borrow money, money supply expands. The Fed didn't have to buy more Treasuries to make it happen.
Now that you see how my borrowing expands the money supply, you should understand how it expands MZM, with no action by the Fed.
Were you born as dumb as a box of rocks or did you get that way listening to your Austrian heroes?
You are dissatisfied with the way the Department of Labor reports CPI? Why don't we hear more about this from the gurus of Wall Street?
You aren't happy if the economy is fine and everyone is prosperous are you?
Actually, the bank records as an asset the IOU of Joe Smith, in the amount of say $10000. And records as a liability the checking account of Joe Smith, $10000 (more than the yesterday). The bank's assets and liabilities have both increased by the same amount. Joe Smith's assets and liabilities have both increased by the same amount. So far, no "cash" (physical banknotes) has entered a particle of it.
Then Joe Smith writes a check to his supplier. This is an IOU of Joe Smith, underwritten by the bank. You can tell because it has the underwriter's routing number at the bottom. It can be pay to bearer or pay to an addressee. Joe Smith now owes in two places at once - the loan and the check - while being owed in one - the bank to him for the checking account. In return he acquires some other asset, presumably, from his supplier.
The supplier used to own some other asset, now he has traded it for a check from Joe Smith drawn on Joe's bank.
Pause. Check not deposited yet. What has happened?
The supplier could have just lent Joe Smith the value of the goods he sold him. Joe could have paid him that way. His loan IOU would be with the supplier instead of with the bank. The bank wouldn't enter the picture at all. There would be one extra contract with possible future value in existence, Joe's IOU. Real assets in existence are of course unchanging, but their *value* may not be unchanged, at all. They have moved in ownership and use, and Joe may have better things to do with them than the supplier. Presumably, urgent enough better things that he offered say 7% interest on his IOU.
If the moved goods are enough more useful in Joe's hands than in the supplier's hands to repay that interest, then net value can readily have been gained by all concerned, without a single new physical item coming into existence. Since all items are themselves just arrangements, and goods are valuable arrangements of scarce items, this should be completely unsurprising. But acres of misconception about the real origins of value mislead people about it.
If Joe is *wrong* about the usefulness of the item to him, compared to what he offered for it, 7% interest per year, then the action may have destroyed value overall. And he will bear the loss, because he owns the asset and all it can do for him, but owes the 7% per year. If Joe is *right* about the usefuless of the item to him, then net value has indeed been created, and he will reap it. If in the middling case he offered the whole extra value of the item to him in interest, then the whole society and he himself and his lender, will all break even. And note well, the debt can be fully repaid.
Now back to the intermediated case. The supplier didn't loan directly to Joe, because the supplier has no knowledge or opinion about the soundness of Joe's plans, and no idea whether Joe can pay 7% interest and will return the principle. The supplier doesn't want to become an expert in such things to sell his item, which he specializes in being good at producing effeciently, not assessing ultimate users of it, etc. So he takes a check instead.
Why does he like taking a check? Is he going to put it in his dresser drawer for a rainy day? No, he likes it because it is denominated in a common unit of account, and drawn on a reputable payer, bank. In the supplier's experience, when bank says somebody can pay, they can. He finds his own bankers readily accept checks drawn on Joe's bank and will pay cash for them, or a bank deposit, at full face value.
So the supplier takes the check to his bank and "deposits" it. This really means he has sold the check to his bank and immediately loaned his bank the proceeds. Let's look at that transaction.
Before it, the supplier owns a check. After it, he owns a bank deposit. His bank, before the transaction, has nothing to do with any of it. After it, it holds the check and owes the supplier a $10000 bank balance.
Now the supplier's bank goes to clearing with Joe's bank. After they net off all their other transactions, they find (compared to what would have happened without this one) that $10000 more has been drawn on Joe's bank than on his supplier's. Joe's bank reduces Joe's checking account by the amount of the check, and owes supplier's bank $10000. Which in practice Joe's bank borrows from anyone in creation at 3%.
Joe owns an asset but has an IOU outstanding against it paying 7% interest. Joe's bank owns his IOU but has borrowed the same value from anyone in creation at 3%. His supplier has a bank balance at supplier's bank. Anyone anywhere has loaned Joe's bank the same amount at lower interest.
First order, it is very likely the supplier. His proceeds are sitting in his money market account, and are relent by his bank into the LIBOR market, where Joe's bank borrowers them.
In fact, the extra bank balance created when Joe and his bank agreed on the loan, can careen around as much as you like but can't be destroyed, until Joe repays the loan or Joe's bank writes it off. It can end on deposit in Joe's bank, or some other one, but it isn't going to disappear. It is, in fact, now part of the money supply.
Yes, a liability was also thereby created, and someone has to fund it. But it would be funded if Joe never drew on the account. It would be funded if his supplier left the proceeds in a money market. It would be funded if after thirty eight intermediate steps it ends up back in Joe's bank as a retiree's CD held by Joe's father in law. Wherever is stays or goes, somebody is going to own it, and if it remains a bank deposit, it is going to be lendable to fund Joe's loan, directly or indirectly.
But maybe someone instead wants physical federal reserve notes. That's fine, their holding those still funds the banking system - even cost less than CDs. The "earning" bank is just the Fed in that case. Holding an FRN is completely indistinguishable from having a checking account deposit of the same amount, with the Fed as your bank.
OK, but what about the question of the soundness of the loan, under the intermediated case? Has it changed? It has not. If Joe's father in law lent him the money at 3% and Joe paid 3% to him and 4% to his favorite charity, the same soundness questions would arise. The bank earns because it is more useful at getting this stuff to happen than Joe's unassisted efforts, let alone his favorite charity. Really, 1% of that 7 is an insurance premium because Joe may fail. And another 2% of it is a running cost of the bank. Leaving it a slender but positive profit for its intermediation.
Is it inevitable that Joe will invest in worthless assets, empty buildings, stupid schemes that all fail, saddling himself and everyone else with real welfare losses? Nope, not at all. He can gain or lose, depends entirely on how sound his bets were. "He should be forbidden to do so because when he fails, he hurts the rest of us, not just himself". That principle will leave no economic freedom of any kind, anywhere. Anything you do economically, that fails, hurts others as well as yourself. You use resources that could have been used better elsewhere.
Suppose Joe instead first scrimps and saves the full value of his purchase from his supplier, out of income. Does this eliminate the risk of loss from his purchase? Not at all. It means the bar his use of the item has to clear is his real time preference in scrimping and saving, instead of the 7% offered by the bank. It means he is invested about a third in his father in law's CD, now held by him, about a third in the bank's stock, and about a third in his speculative venture.
That may or may not be a sounder portfolio. It may or may not have a higher return than being all in his speculative venture. But it can still fail, by exactly the same process as any other entrepenurial command, that resources should cease to be held by party A and purpose A, and should instead shift to party B and purpose B. It can also fail even if its return is positive nominally, if it fails to clear the bar of Joe's own real time preference (then it fails him), or the whole society's (meaning his scrimping and saving didn't even benefit others, since it reduced current incomes too much for anything it gained longer term).
All of the above would be true without any fractional reserve system at all, without any bank regulation at all. In practice, whenever banks are not directly up against their maximum reserves, and even when they are if the Fed is being accomodative about adding extra reserves because they are, the above is the actual process of money creation.
The Fed simply controls the total *demand deposits* - which means *only* checking accounts, not savings or CDs - that all the banks together create for their customers, to a multiple of the size of the Fed's own balance sheet. The Fed itself increases the size or decreases the size of its balance sheet, with just as much freedom as an unregulated version of Joe's bank. In return for its promise to provide FRNs on demand, for any demand deposit, it requires banks to hold a fixed amount of physical FRNs in their vaults or deposits at Fed branch banks.
Notice, this means there was a reserve requirement at the instant of creation of the checking account for Joe, but only a small fraction of its face, meetable by bank vault cash or Fed deposits. But also notice, once the money thereby created transfers to a CD or savings account at the other end of the intermediation chain, there is no reserve requirement against it, at the Fed or in vault cash. The Fed only directly controls M1, not the other money measures.
The limits on the growth of the other money measures is solely the prudence of the banks and the Basel capital standards, which apply to all of their assets and liabilities (though risk weighted in quite generous ways), not just that subset of their liabilities that are customer checking accounts.
Also notice that the public has a free choice between the reserved-against transaction forms, physical notes or checking accounts, and the non-reserved forms, savings and CDs. If the public wants to hold more money as a mere safe form of investment, then its demand for the second sort will rise, while its demand for the first may remain unchanged or fall.
The whole system is *designed* to not be restrictive about such desires. A surge in merely safety seeking, not spending power seeking, desire to hold money, will not meet any reserve requirement "bar" preventing quantity from moving. This is deliberate - it is meant to prevent such panic surges in money demand from changing the exchange *value* of money. (Quantity moves instead).
Now examine recent matters knowing all this. You will see M1 hasn't moved since March of 2005. Since prices have, the real narrow money supply is actually contracting. The Fed started that deliberately to break the real estate bubble and did so - too many Joe's were clearly making clearly bad bets, and being accomodated. The Fed deliberately raised the hurdle any such brainstorm had to clear, to be funded.
In the last 2 years, on the other hand, broader money has increased without narrow money increasing. Why? Because fewer supplier pay-ees are using Joe's loan proceeds to buy more raw material or hire more workers, and more of them are using them to instead run up their safety-seeking balances of CDs and institutional money market accounts etc. Flight to safety demand to *hold* non-transactions bank-money, is not a sign of too-rapid money creation - quite the reverse.
If you see M1 accelerating relative to MZM with prices not (yet) moving, then the Fed is driving up narrow money trying to increase the nominal value of transactions. If you see MZM decelerating and M1 catching it, as prices rise strongly, then the public is trying to get out of dollar balances into real goods. But if you see M1 flat and MZM rising, it means the public is trying to get into dollar balances, and out of riskier assets. Which is deflationary (if money quantity didn't move, money value would rise, aka all prices would fall), not inflationary.
Not only do you know more about running the economy and the Federal Reserve than anyone else alive, you know more about how to prosecute a war than the Joint Chiefs. Is that about it?
There are plenty of anitwar sites for you to post on:
Go here
IOW you have no idea what our strategic goals are, what they ought to be or how we might obtain them.
How does the Fed control how many times Citicorp can borrow from a CD buyer, (or in the Eurodollar market or LIBOR to get savings deposits from other banks) and invest the proceeds in a mortgage agency security at 5.5% or a corporate at 6-7%?
Fractional Fed reserve requirements *only* govern the volume of physical currency plus checkable demand deposits. Also known as M1. They don't restrict the creation of other forms of money, including other bank deposits, one iota.
But Basel II capital requirements do. Not to a multiple of the *Fed's* balance sheet, but to a multiple of the individual *bank's*, *capital*.
the federal reserve will not clear your bank's check for Joe's car against your banks funds based upon Joe's IOU. They will only do so on the basis of actual reserves held on deposit with the federal reserve by deducting the $10,000 from the same. Your bank actually has to have real money on deposit. Even Toddster agreed with that point.
C can sell as many CD's as it can find buyers, up to its capital lending limits You are free to part with your M1 to purchase a CD and C can lend the entirety of your CD to a mortgagee, business, or car loan, should it so choose, with one MAJOR restriction. Total assets (loans outstanding due to the bank) cannot exceed some multple of bank capital (initial investor purchases of stock + bank owned reserves (reserves that the bank owns itself say through previously retained earnings) - accumulated bank losses).
Do you? Why don't you join the army? I'm sure they could use a genius like you after you have spent all of your limited intellectual capital running the economy into the ground advising the Fed.
As a retired Navy 0-6 I doubt the army would take me as a raw recruit. Good suggestion.
BTW, all of the guys who got us into Iraq are now gone. As Thomas Sowell once said, Einstein's vision was not just Einstein's vision. Getting facts right matters.
Furthermore, those who are in favor of conducting a war have the responsibility to define the strategy, not those who oppose it. Me, I am neutral. With the right strategy against terrorism I am for it. What we did not have until Petraeus was any strategy at all. Invading Iraq is not a strategy. It is merely a wanton and purposeless act unless it is a step in achieving an identified goal.
What we know about you is that you are a jingoist, both in finance and in war.
You have provided no evidence that a sound money policy is would "run the economy into the ground."
Clearing means all the banks add up their drafts on each other for the day, and net them out, cancelling all movements from A to B that have an equal and opposite movement from B to A, without using a dime of anything. If all the payments from Citi to Chase where matched by payments from Chase to Citi that day, regardless of who they were for or how many accounts, not a dime would be needed by either and nothing would change hands. Literally all the checks would be cancelled and that would be that.
When instead, Citi checks running in favor of Chase come to $2 million more than the reverse, Citi owes Chase $2 million. But there are lots of other banks and they see first if just handing off Bank of America's obligations to Citi, on to Chase, can cancel any need for any payment. B of A pays Chase. Only the minimum net transfers are actually made, which amounts to saying each bank has to pay only its net to all banks combined at the end of clearing, not to each specific counterparty, let alone for each transaction.
Needless to say, the volume of payments actually needed to settle at the end of clearing are a tiny fraction of the gross volume of checks. Basis points, not even full percent. All the rest net out, and nothing whatever is needed to fund them.
But suppose Citi has $10000 left to pay to Chase, because were are considering the change in things brought on by own extra transaction. It can pay it directly or it can borrow it and transfer the borrowed proceeds. It can even borrow it from Chase itself. As for regulators, they care that each account had the amount in it sufficient to cover each check, and at the end of clearing each bank has to arrange to settle its net position - but it doesn't move any reserves around for each transaction. That would be horribly inefficient.
The usual thing to settle remainders in clearing would be to pledge some securities as collateral for an overnight repurchase agreement, paying the lender a single day's interest at a low money-market rate, and then see if the next day the balance goes the other way. When longer term amounts are needed, the first recourse is term LIBOR, borrowing from other banks for a month or three. Since the payment proceeds ended up somewhere, the amount wanted is going to be available to lend. When an end holder decides to park proceeds in a CD or other broader non-M1 money, one longer term loan can net things back between the banks. The only effect of a deposit being in bank A or bank B is who pays CD and earns LIBOR and who has the reverse. For that matter, if the banks don't like their sides in that, they can just enter a swap and change it around to the other way, without moving the deposits.
As for Fed *reserves*, at the end of each day, each bank has to count up its demand deposits on the one hand, and its vault cash on the other, and it needs a deposit at its Fed branch (its own or a partner bank for the smaller ones, which keep Fed deposits through an intermediary) in the amount, one tenth of the former minus the latter. But if it doesn't have that much, it doesn't mean it can't make the loan. It just means it has to borrow the required balance from another bank with extra - that's Fed Funds. Nobody needs to have prior Fed Funds sitting unused to make a new loan. Banks just need to have their required reserves at the end of the day - required reserves will always be enough to move their net payments in so short a period, the point is they need to restore them by borrowing when they run against that bank, that day.
And if the bank can't arrange to get a Fed Funds overnite loan of reserves up to its required amount, does it have to go back to Joe and say, "I'm sorry, we messed up, we didn't have the money to make you that loan. Sorry, it is cancelled". Um no. If it can't get it from the Fed Funds market it is legally entitled to go to the Fed discount window and get the required reserves directly from the Fed. On any highly rated collateral, pledged as an overnight repurchase agreement, and paying 0.25% more than for Fed Funds. But still way less than it is charging Joe.
The only real clearing requirement, is that the checking account needs to have the funds in it, of the check will be returned "not sufficient funds". But that is a constraint on Joe not drawing more from the checking account than the bank lent him, and not a constraint on the bank lending him this amount or that amount.
Now, in practice, especially for a small bank, it needs to see how it is going to fund the liability side of the loan, to enter into it. It needs a plan in the matter. If it doesn't have depositers, it is going to forced to use the money market, and short term loans from big boy banks can come with strings attached or disappear at unexpected times.
Being forced to the discount window can bring a regulatory inspection to find out what the heck is up, and whether the bank prez is lending recklessly to his brother in law. In case everyone forgot, though, there have been plenty of cases of that which got rather large, and not because the Fed first requires each bank to have gold or FRNs lying around First Podunk's vaults before making a loan.
But a big, sound national bank? It actively manages its liabilities every day, just like any investor manages his assets. So and so many checking deposits, so and so many CDs, so many bonds outstanding, so much in LIBOR term loans, means we will need X amount of repurchase agreements by the close of business, or we will have Y amount to lend there, instead. Investments with smaller negative signs beat ones with larger negative signs, and as far as the bank is concerned, both sides of the balance sheet are actively managed investment portfolios.
So in practice, what happens when a bank nears its capital adequacy limits, is the *mix of assets* it can carry, changes, not that the total assets allowed, are capped. It changes toward lower credit risk assets - or at least, broad categories that the regulators *thought* were lower risk, when they wrote the regs. (One major issue in the present mess is those regulations pretend all loans against real property are safer than loans to corporations).
Once again, the Fed controlling M1 is not controlling the broader money supply, the broader money supply that *is* expanding is *not* the one subject to Fed control, the narrow money measures that *are* subject to Fed control, are *not* expanding, and the fractional reserve mechanism has practically *nothing* to do with *either* the increase in broad money currently going on, or the bank's pulling back on their risks.
Narrow money under Fed control? Flat nominal, down real, cause the Fed deliberately controlling money growth since 2005.
Broad money not subject to Fed control? Up nominally and in real terms, cause an increased public demand to hold non-transaction money balances as a form of safe investment.
Bank risk taking? Down sharply, not because of the first and despite the easier financing available via the second, but instead because they are hitting Basel capital limits, due to loan losses reducing their capital.
Your academic cartoon version of how it is supposed to work isn't tracking what is really happening...
It was you who brought up the topic. So it should be you who lays out alternatives.
It wouldn't. Your ideas of strangling money and credit are not sound money policy.
If banks make $2 trillion in new loans while the public's demand to hold CDs expands by $2 trillion, how much "real money" do the banks need to already hold, to create that $2 trillion?
The answer is "zero".
Does this mean those $2 trillion in new loans will wreck everything and all be lost?
No, it means the net movement of real assets the loans to parties A by CD holder parties B, brought about, will enrich the whole society if and only if the shifted assets in favor of group A, exceeds the value they had before in their prior holder's hands. A will gain if they exceed that value by enough to cover their higher loan interest costs. The bank intermediaries will gain by their spread if the loans stay current. The CD holders will probably be lucky to break even in real terms, but got the safety and liquidity they freely chose as more important to them than return.
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