Currencies are not memes that only have value because the governments say they do
Now, take the Fed. It’s just a special bank. Like Bernanke said, commercial banks have deposit accounts at the Fed. When the Fed lends them money, it marks up their accounts with dollars we call reserves. And, just like when the commercial banks lend you money, those reserves are a liability for the Fed. But there’s a crucial part of the process that didn’t make it into 60 Minutes: when the Fed marks up those accounts, it’s also buying assets. It swaps, one for one: reserves for assets.
The Financial Times
17 comments:
You get guys like R. Paul Drake who say:
“M2 was once all the money easily spent in the economy, but it seems dated to me. I can write a check on my Fidelity account and go sell investments to cover it, all in a few minutes at negligible cost. Only 20 years ago, this would have been a far more expensive and much less convenient process. As investments become more liquid and accessible, the measurement of money becomes much more complex.”
“…I find it notable that the increase of M2 appears to have been unaffected by the Great Recession. This is a sharp contrast to the Great Depression, in which it collapsed. Fed supporters consider this a major victory in how the Fed responded to the Financial Crisis. My own estimate is that they are probably right.”
Lawrence J. Kramer had similar delusional thinking with MMMFs, to wit: "People want what the banks are selling"
Kramer posited that MMMF's create new money. They, of course, could, but they, of course, don't. Kramer goes on to explain how they do this - which isn't different from a DFI. But the proof is out of context. The overriding perspective is that MMMF's volumes were declining.
And so it is with R. Paul Drake’s analysis. There is a huge difference between reality and theory. It’s called practice. In practice the volume of demand drafts clearing through non-M1 components is miniscule in comparison.
But you have Seeking Alpha editors and sponsors promoting this obvious bull shit.
@ R. Paul Drake, Contributor : "Ultimately, M2 is created from the monetary base (M0) by lending. Banks are required to retain a reserve fraction, f, of the funds they lend. This ultimately has the potential to increase M2 until it equals M0/(1-f), typically about 10 M0."
By mid-1995 (a deliberate and misguided policy change by Alan Greenspan in order to jump start the economy after the July 1990 –Mar 1991 recession), legal, fractional, reserves (not prudential), ceased to be binding – as increasing levels of vault cash/larger ATM networks, retail deposit sweep programs (c. 1994), fewer applicable deposit classifications (including allocating "low-reserve tranche" and "reservable liabilities exemption amounts" c. 1982) and lower reserve ratios (requirements dropping by 40 percent c. 1990-91), and reserve simplification procedures (c. 2012), combined to remove reserve, and reserve ratio, restrictions.
From:
Richard G Anderson
Vice President
Economic Research
Federal Reserve Bank of St Louis
anderson@stls.frb.org
“But remember that most banks no longer face binding statutory reserve requirements -- increasing amounts of vault cash (including ATM networks) plus retail deposit sweep programs (e.g., my articles on this in our Review) have wiped aside such binding requirements
There is general agreement that, for almost all banks throughout the world, statutory reserve requirements are not binding. Banks need central bank deposits for clearing checks and making other interbank payments, which gives the central bank leverage over money and bond markets.
We certainly are at zero reserve requirements, if that is taken to mean statutory requirements that affect banks' choices of assets or business strategy -- and if we mean by that some aspect of the transmission mechanism for monetary policy.”
M2 masquerading madness. To wit:
It would not have been possible for me to predict the 2 flash crashes in both stocks and bonds if I didn’t know the GOSPEL (that M2 is not - as you say":“The most meaningful measure of the money supply is M2”). You can’t used M2 to predict that.
But “the buying panic on October 15, 2014, which was in every way related to repo fails and collateral difficulties” was due exclusively to Chairman Dr. Janet Yellen’s error.
From: Spencer (@hotmail.com)
Sent: Thu 9/18/14 12:42 PM
To: FRBoard-publicaffairs@... (frboard-publicaffairs...
Dr. Yellen:
Rates-of-change (roc’s) in money flows (our “means-of-payment” money times its transactions rate-of-turnover) approximate roc’s in gDp (proxy for all transactions in Irving Fisher’s “equation of exchange”).
The roc in M*Vt (proxy for real-output), falls 8 percentage points in 2 weeks. This is set up exactly like the 5/6/2010 flash crash (which I predicted 6 months in advance and within 1 day).
The Federal Reserve’s first (and unspoken), mandate is to assuage any Treasury market disequilibria.
Example #1: "The Oct. 15th dis-equilibria was so profound and unique that the Treasury did a joint staff study on it with the
(1) U.S. Department of the Treasury,
(2) Board of Governors of the Federal Reserve System,
(3) Federal Reserve Bank of New York,
(4) U.S. Securities and Exchange Commission, and
(5) the U.S. Commodity Futures Trading Commission.
“Diminishing market depth and a surge in volatility were both on display Oct. 15, when Treasuries experienced the biggest yield fluctuations in a quarter century in the absence of any concrete news. The swings were so unusual that officials from the New York Fed met the next day to try and figure out what actually happened”
www.treasury.gov/...
Then this how I denigrated Nassim Nicholas Taleb’s “Black Swan” theory (unforeseeaable event), 6 months in advance and within one day:
[1] To: anderson@stls.frb.org
Subject: As the economy will shortly change, I wanted to show this to you again – forecast:
Date: Wed, 24 Mar 2010 17:22:50 -0500
Dr. Anderson:
It’s my discovery. Contrary to economic theory and Nobel Laureate Milton Friedman, monetary lags are not “long & variable”. The lags for monetary flows (MVt), i.e., the proxies for (1) real-growth, and for (2) inflation indices, are historically, always, fixed in length.
Assuming no quick countervailing stimulus:
2010
jan….. 0.54…. 0.25 top
feb….. 0.50…. 0.10
mar…. 0.54…. 0.08
apr….. 0.46…. 0.09 top
may…. 0.41…. 0.01 stocks fall
Should see shortly. Stock market makes a double top in Jan & Apr. Then real-output falls from (9) to (1) from Apr to May. Recent history indicates that this will be a marked, short, one month drop, in rate-of-change for real-output (-8). So stocks follow the economy down.
And:
05/03/10 07:30 PM
The markets seasonal inflection points usually turn (pivot) on May 5th (+ or – 1 day).
Salmo Trutto
https://seekingalpha.com/user/7143701/comments#&ticker=bil
The average dollar amount held in bank accounts has gone up, while the propensity to save has gone up (precautionary savings). So the demand for money is up depressing the velocity of money.
We haven't had a valid velocity figure since the Debit and Demand Deposit Turnover release was discontinued in Sept. 1996. Transactions' velocity can accelerate when income velocity decelerates.And the money stock growth continues to be expansive. It must be reduced.
If you subtract commercial bank credit, you can estimate SOMA credit by using a money multiplier (RPDs, bank vs. nonbank purchases).
If the trading desk buys securities from the nonbank public, RPDs, then the Reserve Bank creates new money.
Powell is stupid. In my new time series (Powell discontinued my old one), the rate of change in monetary flows, volume times transactions' velocity (proxy for inflation in American Yale Professor Irving Fisher's truistic "equation of exchange"), continues to rise in the projections for June, July, August, and September. I.e., the long-term rise, the base, is still predicting that inflation will remain high (i.e., the FED's "overshoot" will be extended).
M2 components are largely contractionary. Almost all demand drafts cleared through total checkable deposits.
The $ simultaneously rose because the FED tightened short-term interest rates. It raised the rate on its overnight Reverse Repo facility from 0% to 0.05% and the rate on excess reserves (IOER) from 0.10% to 0.15%.
The FED has already marginally tightened short-term rates. When it raised the remuneration rate, the U.S. $ rallied (June 17th). DXY 90.54 to 92.37.
Economists are oblivious to the fact that banks don't loan out deposits. Deposits are the result of lending. Lending by the banks is inflationary (banks are credit creators). Lending by the nonbanks is noninflationary (nonbanks are credit transmitters).
Because bank-held savings have a zero payments velocity (c. 15 trillion dollars), it necessitates that the FED apply increasing infusions of Reserve Bank credit to generate the same inflation adjusted dollar amounts of R-gDp.
This eventually becomes perverse. The increase in the supply of loan funds (Reserve and commercial bank credit), reduces the real rate of interest. This destroys the bond market. It forces bond holders to reach for yield in order to obtain a positive ROI. Thus bond-holders begin to divert their savings to nonproductive channels. Cheap credit leads to asset price bubbles. But all such speculative orgies “come a cropper”.
Keynesian economists have achieved their objective, that there is no difference between money and liquid assets. I.e., the NBFIs are not in competition with the DFIs. The NBFIs are the DFI's customers. Savings flowing through the NBFIs never leaves the payment's system.
Adding infinite, artificial, and misdirected money products (LSAPs on sovereigns) while remunerating IBDDs (inducing nonbank disintermediation), generates negative real rates of interest; eventually has a negative economic multiplier; stokes asset bubbles or mal-investment (results in an excess of savings over real investment outlets); exacerbates income inequality, produces social unrest, and depreciates the exchange value of the U.S. $.
Salmo Trutta
Greeley's article is RIDDLED with mistakes. In fact it took me several hundred words on my own blog to demolish it all:
https://ralphanomics.blogspot.com/2021/07/nonsensical-article-by-brendan-greeley.html
Open market operations should be divided into 2 separate classes (#1) purchases from & sales to, the DFIs (money creating depository institutions); & (#2) purchases from, & sales to, others than banks (non-banks, or non-bank public):
(#1) Transactions between the Reserve Banks (FRB-NY's "trading desk"), & the banks directly affect the volume of bank reserves without bringing about any change in the money supply.
The “trading desk” “credits the account of the clearing bank used by the primary dealer from whom the security is purchased”. This alteration in the assets of the banks (IBDDs), increases - by exactly the amount the PD’s government securities portfolio was decreased.
(#2) Purchases & sales between the Reserve banks & non-bank investors directly affect BOTH bank reserves & the money supply.
(#2) If the proceeds from the sale of securities, is deposited (credited) to the non-bank public owner’s bank account, excess reserves will increase by less than total reserves are increased, since the expansion in Reserve bank credit, will cause an equal increase, in the banks’ deposit liabilities (i.e., cause an increase in the bank's required reserves - provided that the primary deposits are located within "E-bound" banks, or banks where required reserves aren't satisfied by applied vault cash).
http://tinyurl.com/hsh...
(#2) is just a timing issue.
The E-$'s contraction is the casualty of its world-wide interconnectedness - or contagion. It's demise has largely been ignored by pundits.
His single bank balance sheet analogies are prescience. He should take a look at non-U.S. bank's balance sheets too.
Commercial bank credit creation was a "system" process. No bank, or minority group of banks (from an asset standpoint), could expand credit (& the money stock), significantly faster than the majority group were expanding.
If, for example, the TBTF commercial banks hold 80 percent of total bank assets, an expansion of credit by the smaller commercial banks, & no expansion by TBTF commercial banks, will result, on the average, of a loss in clearing balances equal to, 80 percent of the amount being checked out of the smaller community banks.
Basel 3 will effect the E-$ market more than it effects the gold market. It's geopolitical the countries who depend on $'s to function will be under the heel of the US again.
Salmo Trutta
A common misconception is that E-$’s are U.S. $’s that have somehow contrived to leave this country, whereas in fact: all E-$’s are created abroad. The foreign commercial banks, and foreign branches of U.S. banks, which create this money, operated on the premise that they will always be able to convert E-$’s into U.S. $’s on demand, on a one-to-one, basis.
This exchange equivalence privilege may suggest to the E-$ borrower that there is no meaningful difference between E-$’s and U.S. $’s. But in terms of our national and the international economy this is an illusion (as the Great Recession and Jeffrey Snider have proved). In both an economic and legal sense the E-$ is no more a part of the lawful money supply of the U.S. than is the Canadian $ or any other national currency.
Beginning in 1950 the U.S. incurred the first of a chronic series of net liquidity deficits in its balance-of-payments. These deficits have grown in magnitude and continued uninterrupted ever since 1950 (1957 was the only exception). By the mid-sixties foreign banks had acquired more dollar balances than were required to cover their own international transaction needs - so they started lending their excess U.S. $ balances.
As the number of banks participating in E-$ transactions increased, the E-$ bankers discovered that the E-$’s they created for borrowers often did not result in any diminution of their U.S. $ balances – the system was merely shifting balances within itself. I.e., drafts drawn on E-$ banks increasingly were re-deposited in other E-$ banks. Thus was laid the economic basis for an international un-regulated System of “prudential” reserve banks – the discovery that the amount of actual U.S. $ reserves required to support the E-$ bank’s convertibility commitment need be only a fraction of the volume of E-$ loans made – and E-$ deposits (money) created.
The prudential reserves of the E-$ banks consist of various U.S. $-denominated liquid assets (U.S. Treasury bills, U.S. commercial bank CDs, Repurchase Agreements, etc.) and inter-bank demand deposits or reserves held in U.S. banks. These are liquid balances in the U.S., or any other major currency country. If a bank’s balance is inadequate to meet a specific payment in the E-$ system, it borrows in the London money market at or near the LIBOR rate (the London Inter-bank Offering Rate), a rate substantially below the prime rates of most banks.
By both promulgating excessive money and credit creation (avoiding statutory reserve requirements, etc.), E-$ banks were able to preserve their competitive advantages with lower interest rate loans -- thereby driving E-$ creation to unsupported levels.
The volume of prudential reserves held by each E-D bank presumably is dictated by “prudence” – not by any legal requirement administered by a monetary authority. All prudential reserve banking systems have heretofore “come a cropper” (E-$’s unraveled during the GR necessitating dollar reciprocal currency agreements and $ swap lines ). Money creation by private profit institutions is not self-regulatory- Adam Smith’s “unseen hand” simply does not function in this area. Invariably the systems created too much money, speculation became rampant, inflation distorted and destroyed economic relationships, confidence that the banks could meet their convertibility obligations eroded, “runs” on the banks caused mass banking failures, and entire economies were left in ruin.
The viability of the U.S. and E-$ as international units of account is threatened by our protracted and excessive trade deficits. The volume of $-denominated liquid assets held by foreigners is extremely large. Any significant repatriation of these funds, by reducing the supply of loan-funds, will force interest rates up – thus increasing the federal deficit and the burden of all new debt. These events alone could trigger a downswing in the economy resulting in more unemployment, more unemployment compensation, less tax revenues, and larger federal deficits – truly a vicious cycle.
Exchange rates, and reference-rate mechanisms, seem to fluctuate capriciously and by their magnitude have had serious and debilitating effects on trade and commerce (carry trades, capital flights and currency wars). The present unstable system, the consequence of the free-wheeling speculation that prevails in the foreign exchange markets became all too evident when China devalued the Yuan on August 10, 2015, to buttress its export business, in an exchange-rate intervention move that rippled through global markets (China repatriated some portion of its 3 + trillion of foreign exchange reserves). Note: Ben Bernanke in 2005 refers FX reserves as a "global savings glut”. In total, central banks sold off a net $225 billion in U.S. Treasury debt last year, the most since at least 1978.
Since the mid-thirties central banks have been used by governments to exercise almost every conceivable degree of control over the rates at which their currencies exchange for the currencies of other countries. Controls were not only used to influence aggregate balance of payments but multiple rates were used to achieve specific economic objectives.
The first, and most complex, use of multiple rates was in Nazi Germany (1933-45). The Nazi government fostered the pretense that the mark was worth forty cents (U.S.), but actual international transactions were effected with a multiplicity of marks. It had been estimated that the Nazis at one time were quoting as many as sixty prices on the dollar, and perhaps as many rates were being quoted on other major currencies.
This multiplicity of rates permitted the most elaborate and refined degrees of favoritism or discrimination. One exporter or importer could be favored over another, or denied foreign exchange altogether. The government, through the central bank, literally had, and exercised, the power of economic life or death over specific firms.
All of this was achieved by forcing all exporters to turn over all foreign exchange earnings to the central bank, and importers could only acquire foreign exchange through the central bank. Such enforcement had to be rigorous enough to minimize black market currency exchanges.
Russia also channeled all foreign financing through a single money center bank. It used the Amtorg Trading Corporation to transfer all of its receipts to, and drew all of its drafts on a London Bank. The only concern of the London bank with fluctuating exchange rates was to have a minimum inventory of a depreciating currency.
See today China:
Trade: Trade in goods and services in and out of China can be settled in RMB. Trade finance methods are available in both onshore and offshore markets.
Accounts: RMB accounts can be opened outside of China, primarily in Hong Kong (HK) but also in other jurisdictions. Foreign companies do not need to have a legal entity established in China (or HK) in order to open an offshore RMB account.
Capital Markets: A capital market (bonds, equities, etc.), referred to as the “Dim Sum” market, has developed to permit RMB held offshore to be invested. Channels exist to raise CNH in Hong Kong and use it in the mainland. Hedging products are also available and under development.
Exchange rates: CNH is freely traded in HK, although the exchange rate has so far mostly tracked that of CNY which is controlled by the Chinese government.
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Bankrupt U Bernanke should have let the EU deal with their domestic problems instead of importing them to the U.S. via currency swap agreements.
On 8/9/2007, BNP Paribas closed two ABS funds. This marked the beginning of the credit crisis.
(1) In response, the FRB-NY's "trading desk" subsequently made 2 large liquidity injections, $24b on 8/9/07 and $38b on 8/10/07. Then the U.S. CP market had an old fashioned bank run (like Penn Central in 6/1970). Funding haircuts increased and maturities decreased. Thus Bernanke introduced the CPFF program.
(2) MMMFs held many foreign assets (like Continental Illinois held foreign deposits in 1974) – and they are a principal source of dollar funding for European markets. Note that all but $3b of the first $40b in the initial two TAF auctions went to European and other foreign institutions operating in the U.S.
(3) Currency swap agreements (c. $620b) were the Fed's largest single liquidity program. "The progression of market stresses led the Federal Reserve in December 2007 to establish central bank (CB) dollar swaps: reciprocal currency arrangements with several foreign central banks that were designed to ameliorate dollar funding stresses overseas."
Unfortunately, these agreements reinforced the downward trend in the $'s exchange rate which in turn forced the price of a barrel from $72/barrel to $142/barrel in July 2008. Thus making the FOMC unduly concerned about the U.S. price-level (preventing an countervailing easing).
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Long-term money flows, volume times transactions' velocity, fell for over 3 years from Jan. 2013 until Jan. 2016. That's why China devalued the Yuan twice in August 2015. That's why oil bottomed in Jan. 2016 (as predicted).
There's a difference between money and liquid assets. Remunerating interbank demand deposits destroys money velocity by severing the savings-investment process. Banks do not loan out existing deposits. Nonbanks loan out existing deposits. The FED is acting like the world's Central Bank.
Basel III's LCR, and Sheila Bair's assessment fees on foreign deposits, changed the landscape of FBO regulations. It helped make E-$ borrowing more expensive for U.S. banks (benchmarked reference rates) and other countries past and prospective borrowings in the E-$ market (the surplus country “savings-glut hypothesis” notwithstanding).
All prudential reserve banking systems have heretofore "come a cropper". The E-$ market is following that historical precedent.
When the U.S. sneezes (e.g., unconventional monetary policy), the rest of the world still catches a cold (reflecting mis-aligned currencies and maturity mis-matches and wider credit-spread responses), viz. a synchronized impact, correlated with cross-border movements and adjustments in market volatility, asset prices and capital – channeled / concentrated hot-money flows disrupting the exchange rates between dominant trading partners (the Fed’s reciprocal currency swap lines notwithstanding).
Money flows are not neutral, money flows do change the economic patterns of trade, production and consumption, employment and R-gDp (the denigration of the Phillips Curve notwithstanding). Money flows do not exclusively, as pontificated by Ben Bernanke, act only on nominal quantities in prices, wages, exchange rate, etc. (who blames our declining incomes and the redistribution of wealth to the upper quintiles on technology, robots, globalization, and aging). No, BuB doesn’t know money from mud pie. Money flows are not, as Milton Friedman and Anna Schwartz advocated, punctuated with “long and variable” results (helicopter drops notwithstanding).
The distributed lag effects of money flows (money times velocity), are mathematical impregnable constants (hence exactly as my “market zinger” forecast played out at the end of 2012 via the expiration of the FDIC’s unlimited transaction deposit insurance, or “putting savings back to work”, not QE3’s impact (which ended without a paradoxical “taper tantrum” outcome). Quantitative easing programs, as IBDDs were remunerated, induced non-bank disintermediation and a deceleration in money velocity. This was immediately reflected by the money market’s response after all QE programs ended.
It is not exactly a Cantillon effect on the allocation of long-term fixed capital goods, but more so impacts the consumption of short-term intermediate durable consumer goods.
In May 2013, a monetary policy expectations’ shock wave (changing perception of risk premia in the spot and forward/swap markets precipitating portfolio re-allocations) came on the signal, via jawboning, that the Fed would taper its QE3, LSAP purchases of treasury securities and MBS agency bonds, decried as a “taper tantrum” i.e., temporary “noise” (fiscal budget policy sequestration notwithstanding).
No, the “expectations” charge that there was a “taper tantrum” is false. Money flows, the proxy for real-output), had ex-ante, or previously cemented, the markets’ reaction.
All prudential reserve banking systems have heretofore "come a cropper". Basel III requirements (LCR) and the FDIC's assessments on foreign deposits (thank you Sheila Bair), have made the E-$ more expensive. And all currency pegs have ultimately failed. When the Fed hiked rates in 1994, Mexico found it harder to make payments on their foreign denominated bonds, prompting a run on the peso. China’s capital outflows parallel that history.
When the Fed remunerated IBDDs, it wiped out all of the short-term wholesale non-bank funding (which Bernanke and David Stockman deprecated).
Those who are wont to minimize the ill effects of the federal deficit are prone to compare the size of the deficit with nominal GDP, as if the volume of nominal GDP were independent of the size of the deficit.
Unprecedented large deficits “absorb” a disproportionately large share of nominal GDP.
Present deficits are unprecedented no matter how measured, and the past gives us no reliable guide to the future effects of deficit financing, beneficial or otherwise.
But to appraise the effect of the federal budget deficit on interest rates, it is necessary to compare the deficit, not to the debt to GDP ratio (a contrived figure), but to the volume of current savings, domestic and foreign, made available to the credit markets (including "concealed greenbacking" - debt monetization).
Sweep accounts are a better Vt indicator.
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Updates from the world of seeking alpha...
To quote economist John Gurley, “Money is a veil, but when the veil flutters, real-output sputters.”
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The only thing that worries me at the moment is the really clever people who follow the flows are all singing off the same song sheet and saying mid July for a market turn.
When has that ever happened before ? Is it just an example of the very few who understand the flows are getting better at what they do over time ? Or not ?
Normally there are different views on the timing when the markets turn. They are not normally so specific. Never mind singing off the same song sheet.
Or does it mean there will be a turn but not a very big drop and then the upswing continues?
It's a worry because normally the bigger drops in the markets are surprises and nobody sees them comming. If indeed there is a substantial turn in July/ Aug then kudos to the flow followers. They have indeed mastered their art.
It will be the first time so many are on the same page have been right. Although it could be a warning because it is so unusual that they are wrong.
It's getting very interesting waiting on what actually happens. My take on it is if it does happen in July/ Aug then it ain't going to be that big. If it does drop then another oppertunity to buy the dips.
If it does drop during Jul/Aug then never before Has the flows been mastered so beautifully. By some very clever people Mike and Matt included and who have been at the forefront of this type of analysis.
The hedge fund guys who front run the market where waiting on the non farm payrolls figure. Said the turn wouldn't happen before that.
https://seekingalpha.com/instablog/910351-robert-p-balan/5610725-july-2-2021-skew-index-something-slightly-off-beat-should-pay-attention-to
" Meanwhile, there's not much meaningful market moves so far today, so we expect, probably correctly, that the action begins after the Non Farm Payroll data --- a random piece of information that makes no macro sense. But since the Fed made jobs data linchpin of their disengagement strategy, we have no choice but to participate in this madness. "
Brevity is the soul of wit.
— Polonius (Hamlet)
Polonius never used Twitter.
Polonius Monk used a piano.
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