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Free the Frozen Fed!

by: David Merkel July 18, 2008    
David Merkel

David Merkel

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I haven’t written about the Fed much recently, largely because little has changed.  The Fed is frozen in its position.  Can’t raise rates because the banking system is on edge (and now the Fed informally cares for the systemic risk created by the investment banks).  Can’t raise rates because labor unemployment is rising.  Can’t lower rates because inflation is moving up.  Can’t lower rates because the dollar will dive.  What a pickle!

This is my monetary aggregates graph over the last year.  Growth of the monetary base is anemic, but that is intentional.  Rather than let the monetary base grow through the purchase of Treasuries, the Fed is using its balance sheet to add liquidity to certain money markets.  When was the last time the Fed did a purchase of Treasuries?  5/3/07.  I think this is the longest period in the Fed’s history without a purchase of Treasuries, and I have written the Fed to ask, but alas, no answer.  For comparison purposes, there is a tool at the NY Fed website that allow you to look at permanent open market operations after August 25, 2005.  How many purchases of Treasuries during the tightening/flat period from 8/25/05 to 5/3/07?  Fifty-nine.  Fifty-nine during a predominantly tightening period, and not one during a loosening period?

I point this out because the Fed is behaving very differently under Bernanke than under any Fed Chair since the Great Depression.  Part of it is the situation in the capital markets.  Leverage got too high among a number of big capital markets players, and the SEC didn’t do diddly.

But under this new arrangement, liquidity goes out to the capital markets through the Fed’s new programs, but not out (at least not directly) to the commercial banking system and the general economy.  The balance sheets of some financial entities get relief, but not much stimulus makes it into the general economy.  What liquidity that is created gets extinguished by the Fed, because they sell/lend Treasuries to fund their lending programs.

Taking a quick spin around the globe, inflation is viewed as a major threat, enough so that the ECB raised its policy rate to 4.25%.   There may not be a lot more rises, but the likely direction of ECB policy is up not down.

China is having inflows of hot money, and much as the central bank keeps raising deposit requirements, it does little good.  Inflation keeps rising.

It’s an inflationary world, and one of the reasons that the US is not feeling it as bad is that we are the world’s reserve currency.  So long as China and OPEC keep buying US debts, the game can go on, but woe betide us if the music stops.

At present, Fed funds futures indicate a Fed that is frozen.  No more moves in 2008.  Using my “pain model” for the Fed (the Fed acts to minimize its political pain), I would concur.  When you don’t know what will work, doing nothing seems like a great plan.

A great plan for now, that is.  My guess is that the Fed can’t be out of step with the rest of the world for too long, and in 2009, they will begin tightening, even if the economy and the banks are weak.

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This article has 8 comments:

  •  
    Jul 18 01:00 PM
    The Fed will need to raise rates, that we know. Timing for this to fix a lot of America's deep economic pain is only partially relevant.

    New leadership in Washington and NYC banking will emerge after it is all over with. There will be a lot of losers but the responsible investor will have the buying opportunity of a lifetime.

    Energy for America is a necessity. To me it is an inevitability that the GCC, China and Russia will eventually de-peg from the dollar, rep-peg with Russia. These are competitors of the USA. Every nation is an opportunist.

    Shipping oil is a lot more cost effective to China and Europe from the Middle East then it is to the America's. Russia is the military monster that can provide the blanket security guarantees in the Eastern Hemisphere in the mid-term. I wish our leadership had not gotten corrupt and destroyed the financial system but it has happened. Now, the law of cause and effect will come into play.

    The possibility of the next world war occurring in the next decade just went up a few notches. I will live in faith however, not in fear. Hope for the best, plan for the worst.

    The best thing American can do now is become energy independent and stop the massive wealth transfer to that part of the globe. But our corrupt leaders make too much profit without thinking through the geopolitical consequences. Be a history student and observe similar cause and effect scenerios of 1908 and 1929. What happened between 6-9 years later is indeed interesting.

    Note Iran, North Korea and Pakistan as useful stool puppet proxies of our competitors that have successfully diverted our attention and while accelerating the wealth transfer. It was brilliant. Awful for the U.S. but brilliant.

    Unfortunately, when Russia, the GCC (give GCC a little slack they tried to further invest in the US but dumb Senators view them as threat) and China create Frankenstein monsters with nukes, well you know the story of Ann Franks Frankenstein. He goes on a rampage at the end and kills some townspeople, the townspeople burn the castle with the monster the inventor in it.
    Reply
  •  
    Jul 18 01:00 PM
    Right on, Dave.

    The question I can't answer right now is why they continue to buy our debt.
    Reply
  •  
    Jul 18 05:00 PM
    I have thought a lot about that too Mark. Perhaps Russia, GCC & China want a legitimate reason to announce to the world why they are depegging from the dollar without facing the wrath of our military.

    Oil will go sky high as they depeg, Wall Mart will not be such a value anymore as we import Chinese goods in other words, more wealth transfer etc.

    We had better be launching the Apollo program of energy next year while we have some time. Unfortunately, this runs a bit contrary to what appears to be government strategy to pay of public debts in energy inflation, sure to balloon with banking bail outs.

    It's the stuff of a good, fictional scary book of conspiricy but unfortunately real. May we live in interesting times! Indeed.
    Reply
  •  
    Jul 19 01:52 AM
    Who cares why they buy it? They're wrong. Take advantage.
    Reply
  •  
    Jul 19 12:35 PM
    I think Big and the author had great posts.The reason the world buys our debt is because we are he most HONEST country in the world BY A LONGSHOT despite what many cynics say.
    Reply
  •  
    Jul 19 01:16 PM
    Truthinvesting, I am really sorry but I have never seen a country with such an amount of crooks in my whole life. The only good thing is that the few who get caught get penalties just short of the one the get in China.
    Reply
  •  
    Jul 19 01:25 PM
    The main problem of the last decade or two is moral corruption mixed with a heavy dose of stupidity. It has proven to be a powerful poison. Domestically, just look at The Speaker of the House. A poster child for finnancial and economic disaster. Remember, she and her ilk will be there in 2009. Put her, Reid in the Senate and a Marxist oriented president together and it is all over.

    The Republican's history has not been much better. McCain has been a part of the problem as much as Nancy and company.

    My faith is in a man on a white horse. Well, one can dream.
    Reply
  •  
    Jul 20 02:41 AM
    It's too bad that the basic principles of economics apply for the United States. You manufacture, service and sell. You work hard and you make a profit. You have a surplus of greenbacks and the trickle down theory applies. Jobs are created and spending increases. Simple. Simple. Simple

    We've given our manufacturing and our basic material supply to other countries, China for example, so they can sell it to us, make the profits, and loan the money back to us. What the #$^$#@?
    This is the most stupid concept in the world. This ranks right up there with the housing crisis and YK2.

    We've given our forefathers' hard work and our heritage to China, Opec, and eventually to Russia. We are so #$#%@ dumb and how did this happen?

    Welfare and entitlement programs. Very, very expensive and hopefully reconsidered in the future.

    Our children aren't getting the education because of lawyers, dumb laws, liberal parents, parents that don't give a damn their children excel in their education and teachers that have their hands tied behind their backs.

    Oil speculators. You shut down the oil, you shut down the country.
    Why can't we have solar, wind, drill our own oil and have energy effecient autos.

    Uncle Ben won't be able to pull to continue to pull rabbits out of his hat forever. Fannie and Freddie will be in free fall soon.

    The US treasury has fewer tax $$$$ as the housing bubble, the mortgage crisis, the bank failures, lost jobs and trillions just evaporate. Pushing paper around just isn't going to be considered profitable much longer.

    Inflation - stagflation - and recession and major recession - and globally I might add. We are competitors - that's always been the way of cultures and economies. Check your history.

    We will be back on the gold standard within 5 years. Period - end of that story.

    Thanks Bil Clinton for Nafda, thanks Al for giving China most favorable trading status. You did the most damage for global warming, you jerk. Take your big corporate jet to China and tell them to stop polluting the world into extinction.

    I say we start really educating our children, stop buying imports, have the government give real incentives for education, manufacturing, oil production and refining, renewable energies, tax revenues - not profits and put us on a flat tax rate. Stop speculating oil and punish those who artificially manipulate markets
    and bring the economy to it's knees.

    Also, bring the troops home. The cost of lives and expense is not worth the fear mongering factor. We've been in this war for 5 years and there's no end in sight. Could be that Bush IS the Anti-Chris from the heartland that Revelations predicted. Does that mean we have another 21 years??? Let's get out now Stop the occupation. Give them a deadline to get their house in order. The muslins in Iraq will be fighting each other long after we leave. It's been going on for more than 1000 years.

    I'm looking forward to the end of the Bush Administration. We need new blood. McCain won't win and there will go the end of the cheap capital gains taxes. Better to sell now. Obama is the new hope even if he doesn't have the experience. He's intelligent enough to figure out how to bring the helm around. It will take time, perseverence, getting most everyone on the same page and taking a lot of deep breaths and prayers.

    I wish all of us hope and thank you for this opportunity to rant.



    Reply
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