The Monetary Base Finally Moves Posted by: Lance
on Tuesday, September 30, 2008
The Federal Reserve has for a long time eschewed increasing the money supply directly, and instead has manipulated credit to affect the economy and control inflation. This has led to three important things which are in my opinion at the root of this crisis.
Asset price inflation (at least initially) as opposed to broader price inflation.
A massive increase in leverage (debt to magnify returns) throughout the financial system and our economy.
A massive increase in the size of the financial sector relative to the rest of the economy. Since it is built on leverage, financial sector compensation has soared and led to concentration of wealth in financial hands.
The last fascinates me, as a sector which should be a relatively small part of the economy functioning as intermediaries has through leverage achieved profits (a redistribution of wealth from the rest of our citizenry) far from the size their intermediary function can possibly justify. These intermediaries for example accounted for about a third of the market capitalization of the S&P 500 before they crashed and burned. How do the intermediaries deserve a market cap that amounts to around half of those for whom they intermediate?
The answer is increased leverage. I'll address this in more detail later, but the Federal Reserve has finally decided to expand the monetary base, which has consistently grown at a very slow, or non existent rate. From David Merkel:
Check out the very far left side of the graph and look at the vertical takeoff.
David fills us in on the details:
Look at the H.4.1 report. We may have finally hit the panic phase of monetary policy, where the Fed increases the monetary base dramatically. They are pumping the “high-powered” money into loans:
$20 billion for Primary credit
$80 billion for Primary dealer and other broker-dealer credit
$70 billion for Asset-backed commercial paper money market mutual fund liquidity facility
$40 billion for Other credit extensions
$80 billion for Other Federal Reserve assets
-$20 billion netting out other entries
Making it an increase of roughly $270 billion from last week’s average to Wednesday’s daily balance. Astounding.
In general, the increases are not being pumped into the banks, but into specialized programs to add liquidity to the lending markets. Now, I’ve written about this before, but it bears repeating. What happens if the Fed takes losses on lending programs. It reduces the seniorage profits that they pay to the Treasury, which means the Treasury has to tax or borrow that much more. The Fed isn’t magic; it’s a quasi-extension of the US Government in a fiat currency environment. It’s balance sheet is tied to the US Treasury.
Yves Smith at Naked Capitalism is correct. The US is no longer a AAA credit, particularly if you measure in terms of future purchasing power of US dollars. I’ve felt that for years, though, with all of the unfunded future promises that the US Government has made with Medicare, Social Security, etc. The credit of the US Government hinges on foreign creditors (like OPEC and China) to keep it going. What will they offer them? The national parks?
True, all true, but possibly if they are going to provide monetary stimulus this might be a better way than cutting rates, now and in the future.
That comment should be enshrined for time immemorial. Engrave it on the penny. Children should be shown that comment when they reach the age of 12. Webster’s should use it as part of the definition of "asshat."
Actually I don’t think she is qualified, nor is Obama. Nor do you have any idea of who I am voting for, since my vote is still up for grabs.
The theory said Reaganomics and the Laffer Curve were bull-dinky, and could never last.
Hmmm....liberals seemed really impressed with it under Clinton, though they rarely gave Reagan any credit for setting in place the policies which Clinton pursued, tweaked and relabeled his own.
More importantly, the roots of this crisis have little to do with the Laffer curve or Reagan’s policies. They have to do with debt and finance centric federal Reserve and Treasury policies, regulatory idiocy (rather than the amount of regulation per se) perverse government incentives and the fact that things just go wrong in the world, which is a very complex adaptive system that nobody has a great handle on.
Lance, your first three bullet points strike me as elements of market economies, not the results of Fed policies.
We had, for instance, a housing boom. Now we’re having a housing bust.
Even if you correct for the Fannie/Freddie, CRA provocations of bad lending practice, the fact is that the middle and upper ranges of the housing boom moved toward a classic bubble. That’s not what is being bailed out.
If all that is happening is a correction in the housing market, then that’s just part of a market economy. The Fed is in the cart (it’s not even the cart), not the horse.
The subprime mess is hidden beneath the normal market operation, and was a long-term creature of the Congress, via the aforesaid Fannie/Freddie, CRA manipulations, which had no feet in the reality of the market.
In fact, this housing market bust/correction has the hidden advantage of exposing the Fannie/Freddie, CRA distortion.
Working that out of the system is just another reason the Marxist Obama must not be elected.
I’ll have more on what I mean later, but the fed and our government has enabled a situation that led to an explosive growth in financial engineering and credit. Fannie, Freddie, the CRA, etc., are but symptoms and sideshows to a disease that has been metastasizing for some time.
Sure markets blow up, it happens. Potential depressions due to financial meltdowns under central banks are generally enabled by those very same bankers.
I don’t disagree with that, but the financial system is a lot more flexible than the government or the government’s rules, which I believe defined deviancy down in the financial institutions.
What I mean is that firm failures, mergers, buyouts, can reorient the institutions if the government stops forcing them to write bad loans.
Leveraging isn’t the problem if the leveraging is in accordance with good practice (i.e., ability to perform, as opposed to "must make the loan").
Risk is inherent to the system, as calculated risk. So failures happen, as they must. Nothing ventured, nothing gained. Most new businesses fail, for instance. Those are the rules of the road. But those rules of the road were violated by the government and then encouraged by the government.
Most people, moving along meeting credit requirements and paying their mortgages and bills, didn’t see the boondoggle.
This is a housing bubble that has burst, and it reveals a scam that got hidden in the boom, which scam was run, essentially, by the government.
Given the choice between letting the financial institutions eat this at the risk of systemic collapse and letting the government eat it on the full faith and credit of the American people, I’ll take the latter, and hope for the best, because the market must not go down. The American people, in effect, are putting liquidity, through their representatives, into the system, and letting the government eat its own crap.
That makes it possible for people and firms to buy and sell what they need to buy and sell and jams the government up with the rotten deals, which it caused.
It’s not a situation I want to see, but it’s the way it is going to be worked out, for better or worse. I see it as the least bad of the available options, the worst option being a systemic financial collapse that need not happen.
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