Is the Fed deflating ?

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Fantumzone
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Is the Fed deflating ?

Post by Fantumzone » Sat Mar 01, 2008 9:31 am

http://www.lewrockwell.com/north/north608.html
presents the case that the Fed is NOT inflating, that it in fact is deflating

We know that the money shupply M1 has shrunk a wee bit, but I thought this had nothing to do with the fed, that people were just shifting to M2/M3 (which is expanding).
But the poster presents the case that it is the Fed who is deflating.
The Fed controls the money supply by buying/selling govt securities on the open market through FOMC.
Have a look at http://www.federalreserve.gov/releases/h41/
Specifically the "U.S. Treasury" held by the Fed under "Securities held outright"
If the Fed were increasing money supply, then it would buy US treasuries on the open market (and iincreasing the money supply by increasing the bank balances of the sellers).
But, the treasury amount held by the fed has been decreasing for past several months.


Mar 28 2007: 780B
July 25 2007: 790B
Sept 19 2007: 779B
Nov 29 2007: 779B
Dec 20 2007: 769B
Jan 23 2008: 723B
Feb 27 2008: 713B

This is a decrease in "high powered money".
And a decrease in high powered money will cause a 7-8x reduction in M3 over time.

However, I'm not seeing a concomitant reduction in M1/M2 money supply in
http://www.federalreserve.gov/releases/h6/current/

I'm a bit puzzled by that. Anyone know what the heck is going on ???

Some other deflation posts:
http://blogs.wsj.com/economics/2008/02/ ... me-losses/
http://globaleconomicanalysis.blogspot. ... eting.html

(And FINALLY I can post links, woohoo !!)
Last edited by Fantumzone on Sat Mar 01, 2008 10:21 am, edited 1 time in total.

snowman9000
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Post by snowman9000 » Sat Mar 01, 2008 10:11 am

I agree with what Gary North said there. There is another article on LRC by a guy named Mike Whitney, I think it is. You can find the same type of thing at dailyreckoning dot com. Now, these guys all have agendas so you have to evaluate it all yourself.

The contradiction to most is "Why is the Fed lowering rates when they should be fighting inflation? They must be incompetent or worse."

Ayn Rand famously said, when faced with a contradiction, re-check your premises.

EDITED my original post, as follows:

If you assume Ben Bernanke is stupid, that's one thing. But if you assume he and the others in charge are bright and logical, then you have to reconsider the inflation argument. In other words, if he knows what he's doing, then he must be fighting inflation. (first time I said deflation.)

(A lot of stuff edited out here.)
I better stick to what I understand. :oops:

I do believe that the credit collapse is extremely deflationary. I read the North article two weeks ago and my recollection was that it went along with my belief. He doesn't bring it up. My bad. I had the impression that the Fed was inflating to fight the external destruction of money.

So if Gary North is right, then the Fed has decided to quietly fight inflation. I have seen the assessment that the Fed has little power over deflation but they do have a lot of power over inflation. And that they have decided to fight the battle they can win. I didn't really put two and two together until re-reading the North article.

Maybe we could be in for a big dose of deflation.

My prediction has been deflation of paper assets and real estate, inflation of hard assets and consumer prices. I don't know what you call that. :shock:
Last edited by snowman9000 on Sat Mar 01, 2008 10:41 am, edited 1 time in total.

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craigr
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Post by craigr » Sat Mar 01, 2008 10:11 am

A case could be made for either inflation or deflation. That's why I don't try to time the market (even bond markets). The people running the Fed are humans. They can be wrong or unpredictable things could happen. Nobody is infallible, even highly educated economists.

One last thing to consider: When highly educated economists make mistakes they tend to be whoppers.

In the end, diversification is your only winning strategy.

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Post by Fantumzone » Sat Mar 01, 2008 10:19 am

snowman9000 wrote: In other words, if he knows what he's doing, then he must be fighting deflation.

He's all but said that. He does not want to spook the world by saying the word, though, IMO.

It appears that the Fed feels strongly that it can beat inflation when the time comes. It is much less confident about deflation so it is going to throw money at the problem and hope it works. :
Is he throwing money ? It seems he is reducing high powered money by selling off US treasuries :?:

What is LRC ?
Last edited by Fantumzone on Sat Mar 01, 2008 10:20 am, edited 1 time in total.

Rose21
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Post by Rose21 » Sat Mar 01, 2008 10:19 am

"My prediction is deflation of paper assets and real estate, inflation of hard assets and consumer prices. I don't know what you call that."

That phenomenon was the subject of a recent article published by Antal Fekete. I'll see if I can find it.

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Post by snowman9000 » Sat Mar 01, 2008 10:45 am

Fantumzone wrote:
snowman9000 wrote: In other words, if he knows what he's doing, then he must be fighting deflation.

He's all but said that. He does not want to spook the world by saying the word, though, IMO.

It appears that the Fed feels strongly that it can beat inflation when the time comes. It is much less confident about deflation so it is going to throw money at the problem and hope it works. :
Is he throwing money ? It seems he is reducing high powered money by selling off US treasuries :?:

What is LRC ?
I went back and rewrote my post because it didn't make any sense. Maybe it still doesn't. :D Thanks for pointing it out.

LRC is the website host of that article. Go to their home page, click on columnists, and then Mike Whitney, then look at an article about the Fed.

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Post by Rose21 » Sat Mar 01, 2008 11:38 am

I agree with the deflationary premise, but don't see how it is the Fed that is doing the deflating. Everything would indicate a natural contraction of the money supply as financial institutions write off billions at a time, and as the climate of abject distrust spawned by a decade of accounting fraud and lack of transparency continues to put a chill on institutional lending. The response of the Fed, however, appears to be an attempt to counter that contraction by using every device at its disposal. The ultimate outcome of this tension, it seems to me, will depend primarily upon the extent to which the Fed is willing to go.

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Post by snowman9000 » Sat Mar 01, 2008 11:43 am

Rose21 wrote:I agree with the deflationary premise, but don't see how it is the Fed that is doing the deflating. Everything would indicate a natural contraction of the money supply as financial institutions write off billions at a time, and as the climate of abject distrust spawned by a decade of accounting fraud and lack of transparency continues to put a chill on institutional lending. The response of the Fed, however, appears to be an attempt to counter that contraction by using every device at its disposal. The ultimate outcome of this tension, it seems to me, will depend primarily upon the extent to which the Fed is willing to go.
Yes, that is what I was trying to say. Here is another article that just came in. (I can't post links so you will have to modify it)

www dot frontlinethoughts dot com/pdf/mwo022908.pdf

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Post by astroturf » Sat Mar 01, 2008 12:06 pm

The fed is not deflating, it can't. Fed policy can only react to deflation, which is not prevalent except in the housing related sectors. Everywhere else, inflation is spreading and growing.

The fed's priority now is to avoid a recession and find ways to repair the financial institutions (banks) that are practically insolvent. Given that, inflation concerns take the back burner. Ironically a deep recession (not a mere slowdown) will correct inflation. And the fed does have the tool to provoke a recession by rising interest rates thereby getting inflation under control. But that could flatten the yield curve and will hurt the banks. And more important is not politically correct this year to have a deep recession. Wait till next year?

Right now the plan seems to be to make sure the yield curve is steep, and make it steeper. And make foreign investment in the US (from sovereign wealth funds) more attractive. The banks sorely need that type of unlevered capital that the US government is not willing to provide (yet).

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Post by Otto » Sat Mar 01, 2008 1:18 pm

Also note that the Fed is charged with two (2) mandates: 1) maximum employment; and 2) price control (fighting inflation). When you have a period of stagflation - contraction of the economy, along with inflation- they are are stuck with deciding which front to fight on. It seems inflation has become their lesser target.

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Post by timid investor » Sat Mar 01, 2008 1:35 pm

I believe the govt is deflating the money supply , but then again I believe in the easter bunny, global warming and life on earth came from mars . :lol:

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Post by preserve » Sat Mar 01, 2008 1:40 pm

Otto wrote:Also note that the Fed is charged with two (2) mandates: 1) maximum employment; and 3) price control (fighting inflation). When you have a period of stagflation - contraction of the economy, along with inflation- they are are stuck with deciding which front to fight on. It seems inflation has become their lesser target.
That notion is not true. It is one of the worst bits of propaganda created by wall street and their textbook writers. It is almost exactly opposite.

Inflation makes costs unpredictable/unknown for employers and employees. With unpredictable costs, both employers and prospective employees become much more conservative. Ie. Higher unemployment rate. When there is little inflation, both employers and employees begin to feel comfortable and participate in a more liquid marketplace.

The 80's and 90's are a perfect example. After Volker put a hold on inflation, we saw a dramatic drop in unemployment.

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Re: Is the Fed deflating ?

Post by preserve » Sat Mar 01, 2008 1:45 pm

Fantumzone wrote: I'm a bit puzzled by that. Anyone know what the heck is going on ???
No one knows. Thats precisely why finance is interesting.

Personally, I think it is pretty clear institutions (representing their clients) are the ones deflating the credit market. They are the ones that get to choose whether to loan money out or not, not the Fed.

The Fed has very little power, especially when it doesn't back its money with anything tangible.

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Post by Otto » Sat Mar 01, 2008 2:32 pm

preserve wrote:
Otto wrote:Also note that the Fed is charged with two (2) mandates: 1) maximum employment; and 3) price control (fighting inflation). When you have a period of stagflation - contraction of the economy, along with inflation- they are are stuck with deciding which front to fight on. It seems inflation has become their lesser target.
That notion is not true. It is one of the worst bits of propaganda created by wall street and their textbook writers. It is almost exactly opposite.

Inflation makes costs unpredictable/unknown for employers and employees. With unpredictable costs, both employers and prospective employees become much more conservative. Ie. Higher unemployment rate. When there is little inflation, both employers and employees begin to feel comfortable and participate in a more liquid marketplace.

The 80's and 90's are a perfect example. After Volker put a hold on inflation, we saw a dramatic drop in unemployment.
Where's the contradiction? This is the legislation: Federal Reserve's mandate is "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

Here's the choice: To fight inflation, the Fed raises rates - that is not good as we are facing a contraction. To fight contraction, the Fed lowers rates - that's not good as it raises inflation. So, there has to be a choice of which one gets addressed. Right now, their actions exacerbate inflation.

Edit to add: I fully understand your position on fighting inflation and unemployment at the same time. But, a contraction causes unemployment as well - ergo, the dual front of stagflation.

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Post by pjstack » Sat Mar 01, 2008 2:50 pm

I don't find Gary North too credible since I remember his hysterical Y2K web site with worldwide doomsday scenarios, "cascading cross-defaults", and running away to the hills of Arkansas to escape marauding bands of desperate barbarians!
pjstack

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Post by craigr » Sat Mar 01, 2008 3:26 pm

pjstack wrote:I don't find Gary North too credible since I remember his hysterical Y2K web site with worldwide doomsday scenarios, "cascading cross-defaults", and running away to the hills of Arkansas to escape marauding bands of desperate barbarians!
I'm with you. I was a developer at the time of the Y2K madness and remember seeing his site. I just thought to myself how over the top it was. I have written a lot of code in my day and I never remember writing (or seeing) anything remotely like (or could have even caused by error):

Code: Select all

if (date == something_completely_erroneous) then
        intiate_reactor_meltdown_sequence(num_humans_to_kill = untold_millions)
else
        return("All systems normal. Have a nice day!")
Not to say that Y2K date conversions didn't cause some problems (or couldn't have caused more problems if we did nothing), but the idea it was going to destroy the planet was just bizarre.

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Post by Oicuryy » Sat Mar 01, 2008 4:26 pm

Fantumzone wrote:I'm a bit puzzled by that. Anyone know what the heck is going on ???
Don't overlook the new Term Auction Facility. That is $60 billion of high-powered money loaned directly to banks.

IMO, Bernanke is trying to move money around to where it is needed without changing the total money supply. He is selling Treasuries at a time when everyone else is rushing to buy them in a flight to quality. He is loaning money to banks at a time when no one else will. In other words, the Fed is doing what it is supposed to do.

Ron

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Post by lasttoknow » Sat Mar 01, 2008 6:56 pm

Don't believe everything you read. It's the TAF to the rescue. The entire point of the Fed, the reason for it's existence, is to inflate.

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Post by nisiprius » Sat Mar 01, 2008 7:44 pm

timid investor wrote:I believe in the easter bunny
"You think I'm too old to change my mind?"

"You're never too old, Mr. Grudge."

"Well then, I-I believe in Santa Claus. And Columbus."

"How about Cincinatti, Cleveland, and the Easter Bunny?"

"Yeah! them too!"

"And Toledo?"

"I--I--I still ain't made up my mind about Toledo."
--Stan Freberg, "Christmas Dragnet"
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Post by Fantumzone » Sat Mar 01, 2008 7:59 pm

Oicuryy wrote:
Fantumzone wrote:I'm a bit puzzled by that. Anyone know what the heck is going on ???
Don't overlook the new Term Auction Facility. That is $60 billion of high-powered money loaned directly to banks.
Is that the money loaned under the discount window ?

If so, it could explain the loss of treasuries from the Fed.
From
http://blogs.wsj.com/economics/2007/08/ ... ow-action/
It seems the discount window has traditionally been a very small player, but from your link, its seems the fed is loaning out 60B trhrough its discount window now, with 60B being very close to the decline in US treasuries held by the fed.
IMO, Bernanke is trying to move money around to where it is needed without changing the total money supply. He is selling Treasuries at a time when everyone else is rushing to buy them in a flight to quality. He is loaning money to banks at a time when no one else will. In other words, the Fed is doing what it is supposed to do.
That also makes sense. Normally bank A would loan to bank B, but is not doing so now. Now the fed is intevening, and sells securities to bank A ( who has enough funds to buy it), then loans out the funds via its discount window to B

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Post by Oicuryy » Sat Mar 01, 2008 10:00 pm

Fantumzone wrote:Is that the money loaned under the discount window ?
No, the TAF is in addition to the discount window. Interest rates on TAF loans are set by auction, not by the Fed. Also, it doesn't seem to have the stigma that the discount widow has.

Ron

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Post by Fantumzone » Sat Mar 01, 2008 11:02 pm


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Post by Rose21 » Sun Mar 02, 2008 7:58 am

They key is the promise of anonymity. I trust the TAF would carry as much stigma as the discount window if it were known who was going there.

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Post by Fantumzone » Sun Mar 02, 2008 8:42 am

Is it public knowledge who goes to the discount window ?

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Re: Is the Fed deflating ?

Post by drjdpowell » Sun Mar 02, 2008 2:42 pm

Although It's already been said, the reason the Fed has been selling Treasuries is to shift into the new direct lending auction to banks. The European central bank, lacking any "European Treasuries" to invest in, does most of it's lending in this way. I suspect that the Fed wants a more direct way to lend to banks due to the liquidity problems banks have been having.

All told, the Fed is currently neither creating nor withdrawing much money at the moment. This contrasts with the popular view at interest rate drops are "driven" by the Fed running the printing presses at high speed. Actually, most interest rate shifts are driven by market forces and are only smoothed out by short term Fed management. Currently we have a potential recession and severe credit problems, which drives the return of super-safe, super-liquid Treasuries to very low levels.

-- James

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Inflation or deflation

Post by tacitus7 » Sun Mar 02, 2008 3:06 pm

I read the article by Gary North referenced above. I am not sure I understand what he is driving at in that article.

I should read it more carefully, but in general, I think it is easy to make the mistake of speaking in generalities when it comes to the topic of inflation and deflation. Perhaps the fact that we have been conditioned to use indexes like the PPI and CPI has something to do with it.

In my opinion, I think silver and gold will continue to rise in value as we continue borrowing and creating more currency via lower interest rates. Along with these commodities, I think that others may also start taking on a quasi monetary function. Ironically, modern financial technology will actually facilitate the return to a commodity based or commodities based currencies and a move away from fiat currency. It may make more commodities viable options as stores of value and perhaps even mediums of exchange i.e. money.

On the other hand, areas like real estate and housing might undergo a deflation. So some things will go up in value and other sectors will go down, probably where there was a bubble, such as housing, at least in many areas.

With this in mind, I would have to say that I agree with G. North in saying that some sectors will be undergoing a deflation, but I would not go so far as to say that commodities that have traditionally functioned as money (silver and gold) will be suffering a deflationary move. In fact, I think many metals that in the past could not function in a quasi monetary fashion, will now be able to as I hypothesized before.

Finally, if we actually allow more and more of these banks and mortgage companies to simply write off as a loss, billions and billions of loans on their books, the net result should actually be a shrinking of the monetary supply. And this could actually strengthen the dollar. As billions and billions of value simply disappears, those still having money will find that it can buy more. In other words as the prices of goods, for example homes, fall in value, it will be the same as the dollar going up in value.

some thoughts,
Joe E.

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Post by Fantumzone » Tue Mar 04, 2008 10:11 am

From
http://www.federalreserve.gov/releases/ ... 3hist5.txt
It seems the monetary base did not expand in 2007.
In jan 2007 it was about 832B, and now its back to 832B.
Compared to say in 2006 when it went from 810B to 820B
Or in 2005 when it went from 780B to 800B.

Does this not mean monetary deflation ?

EDIT: It seems there is a spike in January. Anyway, even taking jan-jan, the spike was only 10B, when normally it is around 20B.
Alse, the monetary base now seems to be at the same level as nov 2007, implying we do not have inflation.

If we do not have monetary inflation, how the heck is the fed being able to simulatneously reduce the fed funds rate ? Does it not do that by buying treasuries on the open market ? If so, would the monetary base not expand ?

I'm so confused :undecided

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Post by beardsworth » Tue Mar 04, 2008 10:32 am

I'm the first to admit that I get lost in detailed discussions of monetary/fiscal policies, although I keep trying to read and understand.

When I read threads like this one about the effect of Fed actions, I'm always reminded of some of the periodic commentaries from mutual fund manager (and former economics professor) John Hussman. I don't fully understand him, either--especially if he goes off into long equations--but I always find his thoughts, and his coherent writing style, a good read and a potential challenge to conventional wisdom (including my own).

Here's a December 2007 Hussman essay on "Thimbles of Water in a Forest Fire":

http://hussman.net/wmc/wmc071204.htm

And a somewhat famous Hussman essay from the Greenspan years, "Why the Federal Reserve Is Irrelevant":

http://hussman.net/html/fedirrel.htm

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Post by turboLT » Tue Mar 04, 2008 10:47 am

craigr wrote:
pjstack wrote:

Code: Select all

if (date == something_completely_erroneous) then
        intiate_reactor_meltdown_sequence(num_humans_to_kill = untold_millions)
else
        return("All systems normal. Have a nice day!")
That is the funniest thing I have read all morning! /geek

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Post by pjstack » Tue Mar 04, 2008 1:25 pm

It is funny, but "Craigr" wrote it, not me.
pjstack

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Post by Fantumzone » Fri Mar 07, 2008 6:18 pm

The fed prepared to inject 140B into the monetary base:
http://www.reuters.com/article/ousiv/id ... 07?sp=true

Dam, that is a LOT :shock: :shock:
Last edited by Fantumzone on Fri Mar 07, 2008 8:55 pm, edited 1 time in total.

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Post by Oicuryy » Fri Mar 07, 2008 8:31 pm

Fantumzone wrote:The fed prepared to inject 200B into the monetary base:
Inject?? Don't count on it. I still say the Fed is just moving money around. Today they issued $15b of the new repurchase agreements. Then they sold $10b in Treasury bills. I predict they will sell enough Treasuries to offset the $140b in additional loans.

Ron

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Post by Fantumzone » Fri Mar 07, 2008 8:56 pm

Oicuryy wrote: I predict they will sell enough Treasuries to offset the $140b in additional loans.

Ron
Good point. Thats what they did last time when the term auction facility started.

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One possible scenario

Post by tacitus7 » Fri Mar 07, 2008 9:11 pm

Fantumzone wrote:From
http://www.federalreserve.gov/releases/ ... 3hist5.txt
It seems the monetary base did not expand in 2007.
In jan 2007 it was about 832B, and now its back to 832B.
Compared to say in 2006 when it went from 810B to 820B
Or in 2005 when it went from 780B to 800B.

Does this not mean monetary deflation ?

EDIT: It seems there is a spike in January. Anyway, even taking jan-jan, the spike was only 10B, when normally it is around 20B.
Alse, the monetary base now seems to be at the same level as nov 2007, implying we do not have inflation.

If we do not have monetary inflation, how the heck is the fed being able to simulatneously reduce the fed funds rate ? Does it not do that by buying treasuries on the open market ? If so, would the monetary base not expand ?

I'm so confused :undecided
Perhaps malinvestment is destroying money, or monetary value fasted than the Fed can create it through sales of Treasuries or the lowering of the interest rate? As the nominal value of homes and the stock market falls, for example, perhaps the total "money supply" is shrinking despite the Feds best efforts?

Joe E.

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Re: One possible scenario

Post by Fantumzone » Fri Mar 07, 2008 9:32 pm

tacitus7 wrote:
Fantumzone wrote: If we do not have monetary inflation, how the heck is the fed being able to simulatneously reduce the fed funds rate ? Does it not do that by buying treasuries on the open market ? If so, would the monetary base not expand ?

I'm so confused :undecided
Perhaps malinvestment is destroying money, or monetary value fasted than the Fed can create it through sales of Treasuries or the lowering of the interest rate? As the nominal value of homes and the stock market falls, for example, perhaps the total "money supply" is shrinking despite the Feds best efforts?

Joe E.
Yes, but I'm talking about the monetary base here (M0). And there, only the fed can create or destroy money. The money that banks lend to each other, thats fed money.
The M2 money supply (which includes the fake bank money of our accounts), has been merrily increasing.
http://www.federalreserve.gov/releases/h6/current/

Credit IS decreasing. The fed is trying to combat that through its term auction facility. It is taking (fed) money from banks who dont need it (through sale of treasuries), and lending it out to banks who do need it (via the auctions).

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Post by drjdpowell » Fri Mar 07, 2008 9:37 pm

Fantumzone wrote:If we do not have monetary inflation, how the heck is the fed being able to simulatneously reduce the fed funds rate ? Does it not do that by buying treasuries on the open market ? If so, would the monetary base not expand ?
It's a popular misconception that all changes in the interest rate is the result of the Fed making large changes in the money supply. Actually, the Fed seems to act more to "smooth" out interest rate changes that are driven by the market. Potential recessions and credit crises are times when super-safe cash looks real good; supply and demand drives the yield on "cash" down. The Fed has the option of fighting the market by reducing the money supply, or of increasing the money supply to drive interest rates even lower, but it seems to mostly only make small changes, meaning it mostly leaves it up to the market.

-- James

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Post by Fantumzone » Fri Mar 07, 2008 10:00 pm

drjdpowell wrote:
Fantumzone wrote:If we do not have monetary inflation, how the heck is the fed being able to simulatneously reduce the fed funds rate ? Does it not do that by buying treasuries on the open market ? If so, would the monetary base not expand ?
It's a popular misconception that all changes in the interest rate is the result of the Fed making large changes in the money supply. Actually, the Fed seems to act more to "smooth" out interest rate changes that are driven by the market. Potential recessions and credit crises are times when super-safe cash looks real good; supply and demand drives the yield on "cash" down. The Fed has the option of fighting the market by reducing the money supply, or of increasing the money supply to drive interest rates even lower, but it seems to mostly only make small changes, meaning it mostly leaves it up to the market.

-- James
I hear there is a liquidity crunch. That banks are not being able to get money, and thats why the fed started the term auction facility.
This means there is high demand from banks to borrow (high powered) money.
In that case, why would the fed fund rate not go up ?
Even at the TAF, the winning bid rate is about 3%.
http://www.federalreserve.gov/newsevent ... 80226a.htm
That seems contradictory. If these banks could not get money from other banks at the fed rate, would they not bid the rate up in the fed funds market increasing it from the fed rate till money starts flowing ?

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Post by Otto » Fri Mar 07, 2008 10:24 pm

Fantumzone wrote:
drjdpowell wrote:
Fantumzone wrote:If we do not have monetary inflation, how the heck is the fed being able to simulatneously reduce the fed funds rate ? Does it not do that by buying treasuries on the open market ? If so, would the monetary base not expand ?
It's a popular misconception that all changes in the interest rate is the result of the Fed making large changes in the money supply. Actually, the Fed seems to act more to "smooth" out interest rate changes that are driven by the market. Potential recessions and credit crises are times when super-safe cash looks real good; supply and demand drives the yield on "cash" down. The Fed has the option of fighting the market by reducing the money supply, or of increasing the money supply to drive interest rates even lower, but it seems to mostly only make small changes, meaning it mostly leaves it up to the market.

-- James
I hear there is a liquidity crunch. That banks are not being able to get money, and thats why the fed started the term auction facility.
This means there is high demand from banks to borrow (high powered) money.
In that case, why would the fed fund rate not go up ?
Even at the TAF, the winning bid rate is about 3%.
http://www.federalreserve.gov/newsevent ... 80226a.htm
That seems contradictory. If these banks could not get money from other banks at the fed rate, would they not bid the rate up in the fed funds market increasing it from the fed rate till money starts flowing ?
Fantumzone,

You seem to have it backwards. As you said above, credit IS decreasing. Well, that means banks are not lending. The problem is not that banks can't get money, the problem is that the spread is not enough to entice them to lend, given the current market conditions. That's the whole point of lowering the Fund Rate and creating the auction market. Liquidity happens when the banks start lending again. Once that starts to happen, they will bid up the funds rate.

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Fantumzone
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Post by Fantumzone » Fri Mar 07, 2008 11:57 pm

Otto wrote:
You seem to have it backwards. As you said above, credit IS decreasing. Well, that means banks are not lending. The problem is not that banks can't get money, the problem is that the spread is not enough to entice them to lend, given the current market conditions.
That's the whole point of lowering the Fund Rate and creating the auction market. Liquidity happens when the banks start lending again. Once that starts to happen, they will bid up the funds rate.
Are you saying that if the TAF was not there, then the banks would have bid up the fed funds rate to entice other banks to lend high powered money ?
And that the Fed has lowerd the fed funds rate not by injecting money, but by creation of the TAF ?

Or, are you talking about banks lending to the general public ?
And that that has created excess bank reserves of high powered money ?

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Otto
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Post by Otto » Sat Mar 08, 2008 12:31 am

Fantumzone wrote:
Otto wrote:
You seem to have it backwards. As you said above, credit IS decreasing. Well, that means banks are not lending. The problem is not that banks can't get money, the problem is that the spread is not enough to entice them to lend, given the current market conditions.
That's the whole point of lowering the Fund Rate and creating the auction market. Liquidity happens when the banks start lending again. Once that starts to happen, they will bid up the funds rate.
Are you saying that if the TAF was not there, then the banks would have bid up the fed funds rate to entice other banks to lend high powered money ?
And that the Fed has lowerd the fed funds rate not by injecting money, but by creation of the TAF ?

Or, are you talking about banks lending to the general public ?
And that that has created excess bank reserves of high powered money ?
Banks are in the business of lending to the public, not to each other. Given there is ample supply of credit worthy borrowers, a bank will lend everthing in the vault and then some. The problem is they must have the required reserve at the end of the day to meet demand depositor needs and regulatory requirements. So, they borrow overnight from another bank with excess reserves, or if they have weak credit themselves, they borrow directly from the Fed. But, if banks are not lending, then they are not borrowing.

The Fed rate is a target rate set by the Fed and is controlled by the market in the supply and demand for overnight funds. That's the Fed rate money or high powered money you refer to. If the demand for funds is low, the rate is held low. If the demand is high, the rate is pushed up. The Fed can then work at increasing/decreasing the money supply to maintain the target rate at a desired level depending on the supply and demand pressure on the rate.

What would entice a bank to borrow money and take more lending risk? The Fed announces that they will help provide lower borrowing rates.

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Post by Fantumzone » Sat Mar 08, 2008 3:23 am

Yes, I get that, but if banks want to borrow overnight, and are not being able to do so at a 3% rate, would they not offer a higher rate to other banks to borrow ? This implies that in the absence of the fed intervention, the rate would be higher.
So, my conclusion was that the fed must be intervening to keep the rate at 3%. But, I am not seeng any increase in M0, and hence my confusion as to exactly what the fed is doing to keep the fed funds rate low.
controlled by the market in the supply and demand for overnight funds
Am I wrong in assuming that the demand for overnight funds has NOT dropped in the past few months ?

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Post by Otto » Sat Mar 08, 2008 11:27 am

Fantumzone wrote:Yes, I get that, but if banks want to borrow overnight, and are not being able to do so at a 3% rate, would they not offer a higher rate to other banks to borrow ? This implies that in the absence of the fed intervention, the rate would be higher.
So, my conclusion was that the fed must be intervening to keep the rate at 3%. But, I am not seeng any increase in M0, and hence my confusion as to exactly what the fed is doing to keep the fed funds rate low.
controlled by the market in the supply and demand for overnight funds
Am I wrong in assuming that the demand for overnight funds has NOT dropped in the past few months ?
The money base does not have to grow, as just the supply is growing. The base is inclusive of bank reserves held by the Fed. By setting the price of funds, the Fed acts as a market maker, but it also controls the supply to accomplish it goaled price. In this role, they can set a target price and intervene with supply of Fed reserves (part of base) to help maintain the price. Ultimately, they have to create enough spread to entice banks to lend beyond their own deposit requirements, thus pulling more from Fed reserves. Still, none of these actions imply an increase in the money base.

As for some some banks being shut-out of borrowing the reserves they need, I don't know that there is a problem there. They could always borrow directly from the Fed through the discount window, and that rate has been lowered as well.

Edit: Many people often confuse this whole process with the the creation of new money. It's not. This is money already in the system. To create new money requires the creation of a new asset and an offsetting new liability, and that's the process to grow the base.

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Post by drjdpowell » Mon Mar 10, 2008 3:16 pm

Fantumzone wrote:I hear there is a liquidity crunch. That banks are not being able to get money, and thats why the fed started the term auction facility.
This means there is high demand from banks to borrow (high powered) money.
In that case, why would the fed fund rate not go up ?
Even at the TAF, the winning bid rate is about 3%.
http://www.federalreserve.gov/newsevent ... 80226a.htm
That seems contradictory. If these banks could not get money from other banks at the fed rate, would they not bid the rate up in the fed funds market increasing it from the fed rate till money starts flowing ?
I thought it was more of a credit crisis; worries about seemingly safe things defaulting. Subprime and all that. Worries about credit would mean that banks would require a bigger spread between risky lending and safe borrowing. If so, that would drive the Fed Funds rate down if the money supply was constant. Admittedly, I don't really understand the current situation.

-- James

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Post by manifest » Mon Mar 10, 2008 4:53 pm

I think drjdpowell is onto something here. My thinking is that overnight lending is pretty much risk free for the banks. Given the current flight to quality, I'm pretty sure banks are very willing to lend to each other, driving the overnight rate down. The fed is probably propping up the rate by deflating the money supply.

It's a little confusing as to what this actually doing to the price levels because they are clearly going up. My thinking is that the "inflation" that we are seeing right now is coming from oversees because foreigners are losing trust in the dollar driving the demand for US currency down.

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Fantumzone
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Post by Fantumzone » Mon Mar 10, 2008 6:22 pm

manifest wrote:I think drjdpowell is onto something here. My thinking is that overnight lending is pretty much risk free for the banks. Given the current flight to quality, I'm pretty sure banks are very willing to lend to each other, driving the overnight rate down. The fed is probably propping up the rate by deflating the money supply.
.
As far as I know, the current problem is that banks are NOT willing to lend each other. Thats why the fed has created the new term auction facility to directly lend 100B to banks.

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