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 ...
I keep my dog on a leash. I don't strangle him.
"Oh, that's OK, it just shouldn't have expanded as much in the period 2002 to 2005". Fine, but answer the question. Should the Fed have deliberately reduced nominal money supply by large amounts in the period 2005 to 2008? If so, why? How much? In real terms, how draconian a deflation of narrow money do you advocate as supposely correct, for that specific time period? How much should M1 be forcefully reduced, over the next year? Again, why?
You won't find even Mises defending deliberate deflation, even after a previous unwarranted inflation. There was a big inflation in WW I, for example. He advocated stabilization afterward, but not deflation back to previous levels. You can't cure a past inflation with a current or future deflation - you just cause deflationary losses on top of any misallocations that have already occurred.
Your problem, you see, is that the Fed has already acted as you demand, but it hasn't had the effects you like. Instead of facing this patent fact and examining why, you stick with an ideologically given, pat policy recommendation, and flat ignore what the Fed has actually done. They haven't let M1 increase an inch for over 3 years. And you call them recklessly inflationary.
That's madness. You are driven to it because the alternative is to admit there are major elements of the financial system that are *not* Fed or government controlled, and you are ideologically invested in the proposition that it must all be "da gubmint's" fault.
The reality is, financial cycles are perfectly normal and endogeous, the Fed cannot outlaw them and should not try. It should act countercyclically, and it has this cycle. It was maybe 1% too low in the 2001 recession, worried about a stock market crash, major terrorist attack, and war. It was maybe a year late in raising rates later in the cycle. Both are fine professional performances, not perfect but the right policies, with minor informational lags.
Somehow or other the originating banks need to come up with $2Trillion through direct or derivative deposits.
Sure, a bank issuing a loand based on funds provided thorugh a CD needs to "hold" nothing against a CD in a reserve account. On the other hand they didn't just print a $10,000 CD and give it to me. I had to purchase it transferring to the bank $10,000 from my checking account. Second, the $10,000 actually had to be on deposit with the bank. My bank cannot write a $10,000 check against my CD. They actually have $10,000 in excess reserves which the FED can debit to clear the $10,000 check.
The difference is slight. My bank does not have to hold $1000 in reserves against my $10,000 CD. They can lend the entire amount. The next guys bank who gets the $10,000 as a cash deposit needs to hold $1,000 in reserves in order to loan $9,000 against the $10,000 deposit, so there is a slight difference in the banking system on a deposit held in a checking account and a deposit held in a CD.
Obviously, if you could get everyone to hold money in CDs and none in checking accounts there would be no reserve requirements at all. There would still be capital requirements, however, which are just about as stringent.
As a matter of fact, however, we don't and keep our monthly expenditures in cash, and pay by debiting our demand deposit accounts rather than swapping IOUs back and forth.
Asking for sound money in the face of 15% YOY monetary expansion is hardly demanding a contraction or deflation.
Anybody still think the banking system needs the full value of every payment as a Federal Reserve deposit, to make a payment to each other?
The Fed doesn't control the rate of growth of broader money measures. It does control M1, which isn't moving.
Are you saying the Fed should deliberately *contract* M1, forcing narrow money to go "on special", until broad money growth ceases?
If so, what rate of contraction of the money supply do you think is sufficient to bring that about? Holding it steady for over 3 years straight while prices rise, clearly isn't enough for you. What is?
You only get to direct the M1 variable. If you want to control other things you merely hope will be correlated to your controllable series, fine, but you can only do it by moving the controllable series. So, where do you say M1 should go?
Down 10% a year? That would have given us about the same contraction as the 1929 to 1932 period. Think that is a bright idea, just what you ordered?
Or will you ever admit that the *public*, not the Fed, determines the ratio between savings or CDs they want to hold, and checking or currency they want to hold - not the Fed? Or will you ever admit that the *banks*, not the Fed, determine broader measure money creation, by their lending decisions, quite unconstrained by reserve requirements that only bind M1?
In the last 3 years, MZM has in fact increased by $2 trillion while M1 hasn't changed at all. Since M1 hasn't changed at all, neither have required reserves.
Banks have $2 trillion more on the liability side of their balance sheets from CDs and other money market equivalents. They can carry $2 trillion more on the asset side, therefore. The only "reserve" needed is 4% of risk adjusted "haircuts" of that $2 trillion, in capital, either from retained earnings or from new issues of securities. With a typical asset mix, $40 billion in capital would suffice, which they earn in one quarter, on average.
In practice, they want to carry a larger ratio of capital to assets than they are required to hold by the regulators. Also in practice, they sometimes take losses on bad loans instead of increasing capital via earnings, and they recognize these in a lumpy manner as they overreserve or mark to market when open market prices change their trends. All of which constrain them by prudence, long before they are constrained by any regulatory anything, Basel or Fed.
They are thus acting as free banks, not as the mechanical automatons lending up to legal requirements of your academic cartoons, marching to Fed orders, merely transmitting its current policy actions, etc. Are they still influenced by the Fed? Sure. 5.5% rates on overnight loans are different from 2% rates on overnight loans. An open discount window lending $150 billion on anything at 2% isn't a closed one with penalty rates even on treasury collateral.
But none of those are part of your mechanical fractional reserve, need-to-have-the-money-first, fairy tale. Money supply hasn't increased in the last 3 years because the Fed pushed it along at 15% rates. It increased despite the Fed riding the brake through last summer, and accelerated in a classic liquidity-panic scramblel into low risk savings money (while commercial paper ran off, banks announced $300 billion in loan losses, bank market cap fell $750 billion, etc), since then. Which the Fed has properly met with a full series of cuts, now completed.
And there we get to my claim that instead of asking the Fed or the government to interfer less, you are instead going to be driven to demanding that the government control private economic actors more. Specifically, more draconian bank regulation and greater restrictions on credit transactions. Which is why I said you will be driven, like other Pauleans, to demanding banks give up their economic liberties. And no meaningful liberties will survive this procedure.
Because all the other non-controlled money measures burgeoned and barged for a reason - that they weren't controlled. Control those ones, and new ones will be invented in their place. Money creation in a broad enough sense is endogenous, driven by private entrepenurial decisions, and not by government anything.
The government can *offer* a money form it *hopes* the market will find more attractive or more useful. But the money form the *market* decides actually *is* more useful, is not up to the government. And draconian regulation of credit transactions will not change that.
The favorite Misesean formula is no issue of fiduciary media without prior commodity cover. Taken literally this would forbid even ordinary checks if those are combined with a clearinghouse system. It would certainly forbid credit cards. And anybody who thinks major money center banks operating 24 hours a day in 50 countries, are going to be prevented from ordinary finance by such things, is nuts. You might drive them offshore and change the legalistic forms a bit. That'd be all.
Um, loan a bunch of Joe's $2 trillion and a bunch of Joes' suppliers will magically come into $2 trillion to park in CDs. As long as there is demand to carry money balances as short term investments, banks can create those balances at will, and fund net new loans with them.
Yes, this means bank borrowers can acquire a command over real assets without any prior savings on their part, or anybody else's. Banks can intermediate to the extent one set of people like their debts and consider them fine liquid assets, and other people see real investment opportunities that can cover interest costs.
Entrepenurial profits are possible without any prior savings. They arise the same way all entrepenurial profits, as opposed to mere interest on capital, arise - from more efficient allocation of resources than their prior use. All economic gains are efficiency of substitution gains. Without exception.
I am rooting for our side. Rooting for ourside begins with demanding a leadership that has a clue what it is doing before it sends troops in harms way.
No bank can issue a check against funds it does not have on deposit. Period. End of story. That is how bank runs occur is when folks attempt to withdraw funds that the bank does not actually have. Lending money you turned out not to have is how BSC went bankrupt.
Thanks for the education. I will cherish it.
Yours is not reasoned debate. Offer some answers. If the Fed is too fast and loose with money how tight should they be?
You brought up my tag line. Do you question the wisdom of it? No one wants war. Everyone wants victory.
"No bank can issue a check against funds it does not have on deposit."
Banks don't issue their depositers' checks, their depositers do. The depositer is responsible for sufficient funds being in their account when they draw a check against that account. But the bank can and does change the funds in customer accounts, without writing any checks. When a bank loans money to a customer, it credits that customer's account. The customer can then write a check against that account, and there will be funds in it (duh).
When a bank or anyone else wants to pay someone else, itself - not one of its customers paying them, but the bank paying e.g. an employee or supplier etc - then it pays with funds it already possesses, sure. Not the point.
Banks as a whole, create new money out of thin air whenever they expand their balance sheet, on both the asset and the liability side. When the Fed expands its balance sheet, M1 and narrow money is created out of thin air. And when commercial banks expand their balance sheets, broader money can be and routinely is created out of thin air, without even needing any prior action by the Fed, in proportion.
Money is the debt of a bank. When banks go further into debt, there is more money in existence. Part of the deep confusion here, apparently, is that you don't realize being it debt is not a statement about net worth or about capital. Banks can have an unchanged positive net worth, and have any amount of debt outstanding, greater than their net worth many times over. They simply need assets to match.
Another part of the confusion may be failing to understand that there really is no such thing as a net asset, in pure accounting terms. Equity is a residual liability, is the most one might say, and real property (as opposed to claims against it) is all owned by someone. But every asset is someone's liability - that is an accounting identity. Double entry bookkeeping simply would not work otherwise. Banks are not in the business of first having a net worth, and then lending that net worth and only that net worth out.
"Ah, but money, that at least is a net asset, that you have to already have before anything else." No. It is a liability of the bank known as the Federal Reserve, and indistinguishable from having a checking account there.
"That is how bank runs occur"
Completely wrong. All financial institutions hold assets with different maturities and different liquidity than their liabilities. They might be more or less matched in timing overall under assumed normal conditions, but they can't possibly be under all. They can either not contract to pay back at par, only whatever their assets will fetch, or they can not issue demand debts at all, or they will be subject to runs. More, even in the second case, they will be subject to longer term runs from inability to refinance as liabilities mature.
Runs are not caused by prior lending without cover, they are caused by panics. Runs need not result in any loss, but they can. They are typically triggered by an institution being solvant but illiquid - which means it has more than enough assets to cover all its liabilities (solvant), but it can't turn all those assets into cash instantly, or fast enough to meet a sudden high demand for withdrawals (illiquidity).
Bear did not go bankrupt. It also did not lend money, nor anything else, that it did not have. Bear did become illiquid, when a very large number of its customers wanted to withdraw everything, while Bear held assets sufficient to pay them, but could not sell them all at once to get cash to do so. Bear therefore needed to borrow to cover the withdrawals. It had assets greater in value (by billions, not "barely" or anything like it) than all it needed to borrow. What it required, however, was anyone willing to lend to it, on any pledge of any amount of any assets.
The weekend it failed, there was only one private company willing to lend to Bear on any security - JP Morgan. It was therefore able to drive essentially any bargain it liked. That wasn't particular rational on everyone else's part (all feared they'd be stuck holding some loss after everyone else got clear), but it was the case. As it happens, JPM will make easily $10 billion on it, and none of Bears' creditors lost a dime. Its shareholders weren't so lucky, but running that risk is why they own all the upside when things go well.
Any financial institution, or for that matter any financial asset or ownership of any real asset, even, can be subject to a run. If everyone tried to sell five times as many bushels of corn tomorrow, as exist, you'd have a run. If everyone decided tomorrow that the British Pound was worthless, you'd have a run. If everyone decided tomorrow that any bank you name was going to fail, you'd have a run. It doesn't matter what terms it contracted for or what it did before. There isn't any prior rule that can eliminate the bare possibility of a run. You can ensure against more rational runs, and you can make creditors whole when they happen, to reduce the fear involved for any repetition.
But if there are fifty times the sellers of anything at any conceivable price, as there are willing buyers or holders, there will be no prices (period) and you will not be able to sell it at all, let alone at the same price as the previous day.
This is so simple even a simpleton like you should be able to get it. Banks lend real money. They don't print money and lend it. They lend money on deposit at the bank.
The money on deposit at the bank is the money that their customers deposited at the bank. The bank is not in the business of storing their customers money. They are in the business of lending their customer's money at interest from which they make a return, some of which they pay their depositors and some of which they keep as revenue to pay operating costs, loan losses and profits.
Individual banks don't print money. They really don't. The sytem, through the deposits of loans and fractional reserves multiplies the money that was originally injected into the banking system by the entity that has the right to create money (the FED).
This little think about capital is why you and I cannot just go into the banking business tomorrow.
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