Saturday, December 4, 2010

12/4 Weekly Addendum

Here is a re-post of the forecast for a March high using I1:
The Fed balance sheet started exploding in October, 2008 when QE1 was cobbled together.  It was a mish-mash of funding for a plethora of financial institutions and left the Fed with unmarketable securities from Bear-Sterns and a ton of Fannie-Freddie debt.  Since April of this year the Fed balance sheet has actually declined by about 50B to it's current 2.25Trillion as of 11/10/10.  The graphic from Cleveland Fed for the entire Federal Reserve system displays the selling of Agency debt actually exceeding Treasuries purchases.  The real garbage remains unmarketable (blue block).
Since the balance sheet exploded gold has doubled and silver has tripled.

The 3-fold increase in the Fed balance sheet has led to increases in the money supply:

However, as of 11/17 there has been no loan growth:

Until M3 can get positive loan growth will remain stagnant.  This makes the difference between money and credit plain as day. The Fed can create one but cannot create the other.

A study of the multiplier effect by the Fed and published May of this year concluded the following:
Since 2008, the Federal Reserve has supplied an enormous quantity of reserve balances relative to historical levels as a result of a set of nontraditional policy actions. These actions were taken to stabilize short-term funding markets and to provide additional monetary policy stimulus at a time when the federal funds rate was at its effective lower bound. The question arises whether or not this unprecedented rise in reserve balances ought to lead to a sharp rise in money and lending. The results in this paper suggest that the quantity of reserve balances itself is not likely to trigger a rapid increase in lending. To be sure, the low level of interest rates could stimulate demand for loans and lead to increased lending, but the narrow, textbook money multiplier does not appear to be a useful means of assessing the implications of monetary policy for future money growth or bank lending.

My comments on the above synopsis follows.
Since the paper was published the M1 multiplier has increased somewhat but is still far below the 2007-2008 level.  The multiplier has been the "magic" of the Federal Reserve since it's inception.  It has allowed the Fed to entice Americans into debt by keeping the level of interest rates below market levels in order to bring about the implied target of 2-3% inflation rate over the past 50 years.  (Actual inflation has been higher most of the time but nobody complained while their assets were appreciating).   For the multiplier to fail is to eliminate monetary policy as a political tool.  The Fed is  a private institution, paying dividends to it's shareholders out of it's cooked profits.  Washington kow-tows to the Fed only because of this magic.  Without it the Fed is exposed.  The profits have increased with the explosion of it's balance sheet because Agency debt pays a good interest rate.  Even the Maiden Lane and other Bear-Sterns assets pay interest on the whole.  So the Fed has tripled it's supply of assets paying well above Treasury rates and is making money in boatload quantities.  However there is also risk in the "blue" assets and the prospect of Fannie/Freddie defaults going forward (it owns 1.2T of agency debt).  So as part of the egalitarian goal of getting the economy moving again the Fed is selling it's higher risk assets and buy long-dated Treasuries.  It is also selling the Bear-Sterns assets whenever it can find buyers but still owns 96B of it.  In the past the Fed concerned itself exclusively with short-date Treasuries.  It was all that they owned.  By June they will reduce agency debt by 500B give or take and increase long-term Treasuries by 600B.  
Is this a low-risk strategy?  They could be digging themselves a hole they cannot jump out of because it is predicated on the belief rooted firmly in academic circles that the economy will surely recover given a big enough fiat cattleprod and the Fed can start reducing it's balance sheet to counter-balance robust economic growth without killing it.  Selling Treasuries reduces reserves and the money supply.  The economy had better start firing on all cylinders soon because the fiscal disaster is not lost on foreign buyers.  Interest rates are increasing and higher rates will be needed to get funding for deficit spending.  The Fed will buy everything the Treasury can pump out until June.  They are buying at lower than market rates because they have ensured ultra-low rates as part of their policy.  This means that they have been buying at higher than market prices.  If the market (people scared by the spiralling deficits) demand higher rates after that then the Fed will be losing big money and will be unable to sell if the economy does not take off.  A feeble recovery will not be enough for them to avoid the political backlash of selling into a feeble economy, thus choking it off.  This would be enough for Ron Paul to find plenty of allies in a campaign to dismember the Fed.  Only an academic would place the Fed in a fight for survival.  Not having experience in risk/reward market behavior may cost Uncle Ben his job while he's rolling the dice in the biggest fiat game of all time ...


  1. Great post, Steve.

    What's your opinion regarding the effect on the economy if Ron Paul and company succeed in dismantling the Fed?

    IMHO an economy that is founded on debt and inflation is a very sick economy. I say get rid of the Fed. Get rid of debt and inflation. Give us a currency backed by something, so that the currency remains stable over the long term.

  2. pima
    We'll already be deep into the hole by the time it gets to that. Short-term deflationary, depends on what monetary system the politicos employ. Gold would be great but that would imply a massive shift to conservative ideology amongst the populace. That won't happen until the federal checks stop (benefits cut dramatically). Won't happen tomorrow. I just hope Ron Paul lives long enough...

  3. 10Y
    Uncle Ben's Drano effect.

  4. Tnx yesterday closed 3,17¡¡¡i am believe to january this can to go 5% or more,this should collaps stockmarket world.The bonds in europe down strong to jnauary.Stockmarket can to go CRASH to 18 january or in you point day 31 december.two floors in these dates?

  5. The two dates are Dec 21 and Jan 6.