Assessing the Fed under Bernanke by Warren Mosler

Excellent commentary by the best of the best...Warren Mosler. By the way, Mosler is a declared candidate for president in 2012. Here is his campaign website. Please contribute!

>"Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally." Keynes, Chapter 12, The General Theory of Employment, Interest, and Money The Fed has failed, but failed conventionally, and is therefore being praised for what it has done. The Fed has a stated goal of "maximum employment, stable prices, and moderate long term interest rates" (Both the Federal Act 1913 and as amended in 1977). It has not sustained full employment. And up until the recent collapse of aggregate demand, the Fed assumed it had the tools to sustain the demand necessary for full employment. In fact, longer term Federal Reserve economic forecasts have always assumed unemployment would be low and inflation low two years in the future, as those forecasts also assumed 'appropriate monetary policy' would be applied. The Fed has applied all the conventional tools, including aggressive interest rate cuts, aggressive lending to its member banks, and extended aggressive lending to other financial markets. Only after these actions failed to show the desired recovery in aggregate demand did the Fed continue with 'uncoventional' but well known monetary policies. These included expanding the securities member banks could use for collateral, expanding its portfolio by purchasing securities in the marketplace, and lending unsecured to foreign central banks through its swap arrangements. While these measures, and a few others, largely restored 'market functioning' early in 2009, unemployment has continued to increase, while inflation continues to press on the low end of the Fed's tolerance range. Indeed, with rates at 0% and their portfolio seemingly too large for comfort, they consider the risks of deflation much more severe than the risks of an inflation that they have to date been unable to achieve. The Fed has been applauded for staving off what might have been a depression by taking these aggressive conventional actions, and for their further aggressiveness in then going beyond that to do everything they could to reverse a dangerously widening output gap. The alternative was to succeed unconventionally with the proposals I have been putting forth for well over a year. These include: 1. The Fed should have always been lending to its member banks in the fed funds market (unsecured interbank lending) in unlimited quantities at its target fed funds rate. This is unconventional in the US, but not in many other nations that have 'collars' where the Central Bank simply announces a rate at which it will borrow, and a slightly higher rate at which it will lend. Instead of lending unsecured, the Fed demands collateral from its member banks. When the interbank markets ceased to function, the Fed only gradually began to expand the collateral it would accept from its banks. Eventually the list of collateral expanded sufficiently so that Fed lending was, functionally, roughly similar to where it would have been if it were lending unsecured, and market functioning returned. What the Fed and the administration failed to appreciate was that demanding collateral from loans to member banks was redundant. The FDIC was already examining banks continuously to make sure all of their assets were deemed 'legal' and 'appropriate' and properly risk weighted and well capitalized. It is also obligated to take over any bank not in compliance. The FDIC must do this because it insures the bank deposits that potentially fund the entire banking system. Lending to member banks by the Fed in no way changes the asset structure of the banks, and so in no way increases the risk to government as a whole. If anything, unsecured lending by the Fed alleviates risk, as unsecured Fed lending eliminates the possibility of a liquidity crisis. 2. The Fed has assumed and continued to assume lower interest rates add to aggregate demand. There are, however, reasons to believe this is currently not the case. First, in a 2004 Fed paper by Bernanke, Sacks, and Reinhart, the authors state that lower interest rates reduce income to the non government sectors through what they call the 'fiscal channel.' As the Fed cuts rates, the Treasury pays less interest, thereby reducing the income and savings of financial assets of the non government sectors. They add that a tax cut or Federal spending increase can offset this effect. Yet it was never spelled out to Congress that a fiscal adjustment was potentially in order to offset this loss of aggregate demand from interest rate cuts. Second, while lowering the fed funds rate immediately cut interest rates for savers, it was also clear rates for borrowers were coming down far less, if at all. And, in many cases, borrowing rates rose due to credit issues. This resulted in expanded net interest margins for banks, which are now approaching an unheard of 5%. Funds taken away from savers due to lower interest rates reduces aggregate demand, borrowers aren't gaining and may be losing as well, and the additional interest earned by lenders is going to restore lost capital and is not contributing to aggregate demand. So this shift of income from savers to banks (leveraged lenders) is reducing aggregate demand as it reduces personal income and shifts those funds to banks who don't spend any of it. 3. The Fed is perpetuating the myth that its monetary policy will work with a lag to support aggregate demand, when it has no specific channels it can point to, or any empirical evidence that this is the case. This is particularly true of what's called 'quantitative easing.' Recent surveys show market participants and politicians believe the Fed is engaged in 'money printing,' and they expect the size of the Fed's portfolio and the resulting excess reserve positions of the banks to somehow, with an unknown lag, translate into a dramatic 'monetary expansion' and inflation. Therefore, during this severe recession where unemployment has continued to be far higher than desired, market participants and politicians are focused instead on what the Fed's 'exit strategy' might be. The the fear of that presumed event has clearly taken precedence over the current economic and social disaster. A second 'fiscal stimulus' is not even a consideration, unless the economy gets substantially worse. Published papers from the NY Fed, however, clearly show how 'quantitative easing' should not be expected to have any effect on inflation. The reports state that in no case is the banking system reserve constrained when lending, so the quantity of reserves has no effect on lending or the economy. 4. The Fed is perpetuating the myth that the Federal Government has 'run out of money,' to use the words of President Obama. In May, testifying before Congress, when asked where the money the Fed gives the banks comes from, Chairman Bernanke gave the correct answer- the banks have accounts at the Fed much like the rest of us have bank accounts, and the Fed gives them money simply by changing numbers in their bank accounts. What the Chairman explained was there is no such thing as the government 'running out of money.' But the government's personal banker, the Federal Reserve, as decided not publicly correct the misunderstanding that the government is running out of money, and thereby reduced the likelihood of a fiscal response to end the current recession. There are also additional measures the Fed should immediately enact, such banning member banks from using LIBOR in any of their contracts. LIBOR is controlled by a foreign entity and it is counter productive to allow that to continue. In fact, it was the use of LIBOR that prompted the Fed to advance the unlimited dollar swap lines to the world's foreign central banks- a highly risky and questionable maneuver- and there is no reason US banks can't index their rates to the fed funds rate which is under Fed control. There is also no reason I can determine, when the criteria is public purpose, to let banks transact in any secondary markets. As a point of logic, all legal bank assets can be held in portfolio to maturity in the normal course of business, and all funding, both short term and long term can be obtained through insured deposits, supplemented by loans from the Fed on an as needed basis. This would greatly simply the banking model, and go a long way to ease regulatory burdens. Excessive regulatory needs are a major reason for regulatory failures. Banking can be easily restructured in many ways for more compliance with less regulation. There are more, but I believe the point has been made. I conclude by giving the Fed and Chairman Bernanke a grade of A for quickly and aggressively applying conventional actions such as interest rate cuts, numerous programs for accepting additional collateral, enacting swap lines to offset the negative effects of LIBOR dependent domestic interest rates, and creative support of secondary markets. I give them a C- for failure to educate the markets, politicians, and the media on monetary operations. And I give them an F for failure to recognize the currently unconventional actions they could have taken to avoid the liquidity crisis, and for failure inform Congress as to the necessity of sustaining aggregate demand through fiscal adjustments.

Read It Here Last Week, Hear It From the New York Fed This Week

Here is a link to a video interview Steve Leisman of CNBC had with New York Fed President Dudley. This interview aired this morning.

Mr. Dudley addresses several of the issues presented and analyzed on this blog last week, such as the Fed's balance sheet, MBS purchases, and debt "monetization".

Overall a good interview I think. Comments welcome.

China's stimulus ranks the highest!

China's growth should be no surprise. It's stimulus was the biggest of any country.



The U.S. is not on this chart, but at 5% of GDP, roughly, our stimulus was relatively small and that's the kind of economic respose we got...small!

Is the yen done?

Over the weekend voters in Japan sent the LDP packing. This is the nation's first change in government in 55 years. That's pretty much how long the yen has been rising (or at least the last 38 years). Is this secular trend over?

Economists Say No Need for 2nd US Fiscal Stimulus Package...Just cut spending!

"The U.S. economy does not need a second fiscal stimulus package, instead the government should cut spending over the next two years, according to a survey of business economists released on Monday."

Another almost mind-numbing example of how out of paradigm and misinformed mainstream economics has become. They don't understand basic identities.

Any long-time reader of this blog can put this group to shame. Be proud!!

The fallacy of "taxpayer on the hook"...Fed made $14 billion on turmoil loans

This highlights the fallacy of "taxpayer on the hook." The profits on those assets could have been profits to the private sector if the Fed had merely sustained the banks with open-ended, non-collateralized lending. (It didn't have to assume ownership of those assets.) Now the profits go to the Fed or the public sector, but how does that benefit taxpayers? The answer is...it doesn't! Do we all get a check to share in those profits? Does it go to pay down the deficit? If so, that is actually a loss to taxapayers because paying down the deficit reduces the wealth of the private sector by definition!

In actuality, taxpayers have have actually lost out from this!

FT Opinion: This is no time to throw away the crutches

Warren Mosler sent this article over to me just now. A rare moment of clarity and perspective (and non-mainstream opinion) from the Financial Times.

This is no time to throw away the crutches Peter Clarke Published: August 30 2009 19:40 | Last updated: August 30 2009 19:40 Recent news about the world economy has cheered many people after months of unremitting gloom. It is right that we should regain our confidence that the system can recover. Certainly, there will be no lasting recovery without such confidence. But it is dangerous, as well as tempting, to forget how bad things looked only a short time ago. This premature amnesia is not only psychological, burying painful experiences; it also has an ideological dimension, as seen in the US debate over the efficacy of the stimulus package and the bail-out of Wall Street. We are being told simultaneously that these measures have not worked – and that they were not necessary anyway. We are supposed to forget the frightening precipice over which we peered only a few months ago; and we are also asked to believe that what has saved the situation is the spontaneous resilience of the free market. Thus the bogey is “big government”. Like many alarmist narratives, this story feeds on real fears. It is not unreasonable to worry about the size of current budget deficits. The fact that these deficits are partly due to bailing out banks that took unwarranted risks will not strike sympathy among taxpayers. The truth is that the alternative scenario was even worse – a systemic collapse of credit. But this is the bit that is too easily forgotten, innocently or otherwise. The stimulus strategy has an impact on the budget. Indeed, opponents like to blame Keynesian policies for incurring avoidable debts as a deadweight burden, if not on us then on our grandchildren. What lends credence to such criticisms is not only our memory loss about recent events but our failure to benefit from a longer historical perspective. Continue reading here.

Excellent piece. Please pass it around.

Funds Dump Retailer Shares as Money Flows out of Nordstrom Into Goldman

"Investors are dumping shares with the closest links to economic growth. While the government’s bailout of the U.S. financial system spurred record profits at New York-based Goldman Sachs Group Inc., Commerce Department data show salaries for Americans dropped the most in at least five decades during the 12 months through June."

Very sad. A president elected on the promise to help workers, but the sector of the economy most tied to that continues to fail. Real earnings of working people falling, but Wall Street bonuses are back to record levels. This is a total abrogation of a promise made by Obama.

To save yourself you must think like a speculator now because your wages are not likely to rise. It's okay to buy stocks in areas that get support--financials and anything having to do with the export sector (large industrials, technology, etc). It's also okay to buy commodities because there is not likey to be any real attempt to rein in that investment demand.

What really killed the economy?

Was it the bursting of the real estate bubble or the credit crunch or high oil prices? All of the aforementioned have been offered as reasons for the collapse in the global economy and asset prices that started two years ago.

The real reason, however, may have been as simple as the Fed engineering money growth rates to practically zero in early 2007. Money is ike the blood of the economy and the most basic "money" is that which the Fed creates: Federal reserve notes and reserves. These represent the two biggest components of the monetary base (coins are the third). Think of an inverted pyramid, the apex being the monetary base and all other money--bank debt, private credit etc--flowing upward toward the top.

There is no such thing as "monetizing the debt"

This term, "monetizing the debt" has been thrown around a lot recently and it's unfortunate, because it is being used completely in error. When misinformed people talk about monetizing the debt they are claiming that the Fed is buying Treasury securities from the U.S. Treaury--in essence, writing a check to the Treasury because the Treasury is out of money so the Fed is "giving it money" by buying its securities.

That is patent nonsense.

First of all the Treasury can NEVER be out of money as long as the United States government is the issuer of its own, sovereign currency. The Treasury "spends" by merely crediting bank accounts and does not need checks written to it from the Fed in order to spend.

Below are two, very clear explanations from the New York Fed, which is the bank charged with the responsibility of conducting monetary operations.

First statement, on who the Fed conducts business with:

"The Federal Reserve conducts open market operations with primary dealers—government securities dealers who have an established trading relationship with the Federal Reserve..."

So...this explains that the Fed buys securities FROM THE PUBLIC AND NOT THE TREASURY!!

The second statement explains why the Fed conducts monetary operations:

"The purchase or sale of Treasury securities on an outright basis adds or drains reserves available in the banking system. Such transactions are arranged on a routine basis to offset other changes in the Federal Reserves balance sheet in conjunction with efforts to maintain conditions in the market for reserves consistent with the federal funds target rate set by the Federal Open Market Committee (FOMC)."

Thus, the act of buying and selling securities is solely to MAINTAIN AN INTEREST RATE!!!

Financial crisis cripples new affordable housing

A major housing shortage is on the way as the level of construction continues to be frighteningly low. Given population growth and the need to replace housing stock over time, there is just not enough being built. I have been putting up posts on this on a regular basis. This is why I like builders.

If we don't make up for what we will be needing as far as housing stock is concerned, America in a decade or two may look like a very scary place, with millions of homeless and otherwise dilapidated and ramshackle housing conditions.

Read my report on housing and the homebuilders. It will shock you!

My July 24 blog post recommended taking profits on China stocks

Here's my July 24 blog post that explains why I thought it could be a good time to take some profits on China stocks. The Shanghai Index was 3372. It is currently at 2860 or 15% lower.

China had become sensitive about criticism that it was allowing a lending bubble to take place. It put in mild curbs and since then, the market has been trending lower.

I took some profits on China stocks back then, however, I am still long and have been using this pullback to buy shares in companies that I thought had gotten too expensive.

My Special Report on China details a list of over 20 of the highest quality companies that are traded as ADRs on regulated U.S. exchanges.

The report will set you back $39.95, but it is well worth it because besides giving you plenty of good stocks to buy, it has all my rationale and reasons why China is being handed the mantle of economic leadership by the U.S.

Buying into China now is completely different than investing in that country in the past and it's all explained, but only in my report.

Read about the coming China boom!

or buy my China Special Report today!

Mortgage rates may be about to rise...

At the last Fed meeting officials said in a statement that they were prepared to complete their planned purchase of $1.25 trillion of Mortgage Backed Securities. So far the Fed has bought $625 billion and that is what brought mortgage rates down. So with nearly half the allotment yet to go the outlook for mortgage rates had been lower.

Until this news:

"Fed May Not Need to Buy All Authorized MBS, Two Officials Say"

Richmond Fed President Jeffrey Lacker said yesterday in a speech in Danville, Virginia, that he’ll evaluate “whether we need or want the additional stimulus” from buying the full amount. St. Louis Fed President James Bullard, speaking to reporters in Little Rock, Arkansas, said “it might not be necessary.”

What brought on the change of heart? Simple...the Fed has under attack from every direction, so they're extremely sensitive to the "inflation" criticism. And they cannot defend themselves (not that Bullard of Lacker would even know how) because most people believe the, "Fed is fostering inflation," story.

Bottom line: if you're shopping for a mortgate...lock in your rate now!!

Treasury sales will eventually decline

With Fed now paying interest on reserves the sale of Treasuries will eventually decline because public debt sales will not be needed for rate setting anymore.

The Treasury will still need to sell debt, however, because it is precluded from running an overdraft in its account at the Fed, even though operationally there is nothing stopping it from doing so.

Month-to-date (August) public debt sales are running below the same period in July.

Personally, I think the Treasury should stop selling Treasuries altogether because that would finally end one gigantic fallacy--that the gov't needs to sell debt to "fund" the deficit. The gov't spends by crediting bank accounts and the sale of debt has functioned only to sustain an interest rate and/or to meet an artificially imposed constraint on overdrafts.

America ranks WAY down among when it comes to Government debt

Please view the very eye-opening chart from the OECD showing rankings of government gross financial liabilities as a % of GDP. The U.S. ranks far down. Japan is number one by a longshot.



Where are the "debt terrorists" on Japan? Why aren't they screaming about a yen crash. Where is Peter Schiff, Jim Rogers, Pete Peterson, David Walker???

Another awesome piece from Prof Randall Wray at UMKC

This guy is as good as they come. I wish he were at Treasury. Better yet...I wish ALL people understood things the way he does!

Money as a Public Monopoly Share By L. Randall Wray What I want to do in this blog is to argue that the reason both theory and policy get money “wrong” is because economists and policymakers fail to recognize that money is a public monopoly*. Conventional wisdom holds that money is a private invention of some clever Robinson Crusoe who tired of the inconveniencies of bartering fish with a short shelf-life for desired coconuts hoarded by Friday. Self-seeking globules of desire continually reduced transactions costs, guided by an invisible hand that selected the commodity with the best characteristics to function as the most efficient medium of exchange. Self-regulating markets maintained a perpetually maximum state of bliss, producing an equilibrium vector of relative prices for all tradables, including the money commodity that serves as a veiling numeraire. All was fine and dandy until the evil government interfered, first by reaping seigniorage from monopolized coinage, next by printing too much money to chase the too few goods extant, and finally by efficiency-killing regulation of private financial institutions. Especially in the US, misguided laws and regulations simultaneously led to far too many financial intermediaries but far too little financial intermediation. Chairman Volcker delivered the first blow to restore efficiency by throwing the entire Savings and Loan sector into insolvency, and then freeing thrifts to do anything they damn well pleased. Deregulation, which actually dates to the Nixon years and even before, morphed into a self-regulation movement in the 1990s on the unassailable logic that rational self-interest would restrain financial institutions from doing anything foolish. This was all codified in the Basle II agreement that spread Anglo-Saxon anything goes financial practices around the globe. The final nail in the government’s coffin would be to preserve the value of money by tying monetary policy-maker’s hands to inflation targeting, and fiscal policy-maker’s hands to balanced budgets. All of this would lead to the era of the “great moderation”, with financial stability and rising wealth to create the “ownership society” in which all worthy individuals could share in the bounty of self-regulated, small government, capitalism. We know how that story turned out. In all important respects we managed to recreate the exact same conditions of 1929 and history repeated itself with the exact same results. Take John Kenneth Galbraith’s The Great Crash, change the dates and some of the names of the guilty and you’ve got the post mortem for our current calamity. What is the Keynesian-institutionalist alternative? Money is not a commodity or a thing. It is an institution, perhaps the most important institution of the capitalist economy. The money of account is social, the unit in which social obligations are denominated. I won’t go into pre-history, but I trace money to the wergild tradition—that is to say, money came out of the penal system rather than from markets, which is why the words for monetary debts or liabilities are associated with transgressions against individuals and society. To conclude, money predates markets, and so does government. As Karl Polanyi argued, markets never sprang from the minds of higglers and hagglers, but rather were created by government. The monetary system, itself, was invented to mobilize resources to serve what government perceived to be the public purpose. Of course, it is only in a democracy that the public’s purpose and the government’s purpose have much chance of alignment. In any case, the point is that we cannot imagine a separation of the economic from the political—and any attempt to separate money from politics is, itself, political. Adopting a gold standard, or a foreign currency standard (“dollarization”), or a Friedmanian money growth rule, or an inflation target is a political act that serves the interests of some privileged group. There is no “natural” separation of a government from its money. The gold standard was legislated, just as the Federal Reserve Act of 1913 legislated the separation of Treasury and Central Bank functions, and the Balanced Budget Act of 1987 legislated the ex ante matching of federal government spending and revenue over a period determined by the celestial movement of a heavenly object. Ditto the myth of the supposed independence of the modern central bank—this is but a smokescreen to protect policy-makers should they choose to operate monetary policy for the benefit of Wall Street rather than in the public interest (a charge often made and now with good reason). So money was created to give government command over socially created resources. Skip forward ten thousand years to the present. We can think of money as the currency of taxation, with the money of account denominating one’s social liability. Often, it is the tax that monetizes an activity—that puts a money value on it for the purpose of determining the share to render unto Caesar. The sovereign government names what money-denominated thing can be delivered in redemption against one’s social obligation or duty to pay taxes. It can then issue the money thing in its own payments. That government money thing is, like all money things, a liability denominated in the state’s money of account. And like all money things, it must be redeemed, that is, accepted by its issuer. As Hyman Minsky always said, anyone can create money (things), the problem lies in getting them accepted. Only the sovereign can impose tax liabilities to ensure its money things will be accepted. But power is always a continuum and we should not imagine that acceptance of non-sovereign money things is necessarily voluntary. We are admonished to be neither a creditor nor a debtor, but try as we might all of us are always simultaneously both. Maybe that is what makes us Human—or at least Chimpanzees, who apparently keep careful mental records of liabilities, and refuse to cooperate with those who don’t pay off debts—what is called reciprocal altruism: if I help you to beat the stuffing out of Chimp A, you had better repay your debt when Chimp B attacks me. OK I have used up two-thirds of my allotment and you all are wondering what this has to do with regulation of monopolies. The dollar is our state money of account and high powered money (HPM or coins, green paper money, and bank reserves) is our state monopolized currency. Let me make that just a bit broader because US Treasuries (bills and bonds) are just HPM that pays interest (indeed, Treasuries are effectively reserve deposits at the Fed that pay higher interest than regular reserves), so we will include HPM plus Treasuries as the government currency monopoly—and these are delivered in payment of federal taxes, which destroys currency. If government emits more in its payments than it redeems in taxes, currency is accumulated by the nongovernment sector as financial wealth. We need not go into all the reasons (rational, irrational, productive, fetishistic) that one would want to hoard currency, except to note that a lot of the nonsovereign dollar denominated liabilities are made convertible (on demand or under specified circumstances) to currency. Since government is the only issuer of currency, like any monopoly government can set the terms on which it is willing to supply it. If you have something to sell that the government would like to have—an hour of labor, a bomb, a vote—government offers a price that you can accept or refuse. Your power to refuse, however, is not that great. When you are dying of thirst, the monopoly water supplier has substantial pricing power. The government that imposes a head tax can set the price of whatever it is you will sell to government to obtain the means of tax payment so that you can keep your head on your shoulders. Since government is the only source of the currency required to pay taxes, and at least some people do have to pay taxes, government has pricing power. Of course, it usually does not recognize this, believing that it must pay “market determined” prices—whatever that might mean. Just as a water monopolist cannot let the market determine an equilibrium price for water, the money monopolist cannot really let the market determine the conditions on which money is supplied. Rather, the best way to operate a money monopoly is to set the “price” and let the “quantity” float—just like the water monopolist does. My favorite example is a universal employer of last resort program in which the federal government offers to pay a basic wage and benefit package (say $10 per hour plus usual benefits), and then hires all who are ready and willing to work for that compensation. The “price” (labor compensation) is fixed, and the “quantity” (number employed) floats in a countercyclical manner. With ELR, we achieve full employment (as normally defined) with greater stability of wages, and as government spending on the program moves countercyclically, we also get greater stability of income (and thus of consumption and production)—a truly great moderation. I have said anyone can create money (things). I can issue IOUs denominated in the dollar, and perhaps I can make my IOUs acceptable by agreeing to redeem them on demand for US government currency. The conventional fear is that I will issue so much money that it will cause inflation, hence orthodox economists advocate a money growth rate rule. But it is far more likely that if I issue too many IOUs they will be presented for redemption. Soon I run out of currency and am forced to default on my promise, ruining my creditors. That is the nutshell history of most private money (things) creation. But we have always anointed some institutions—called banks—with special public/private partnerships, allowing them to act as intermediaries between the government and the nongovernment. Most importantly, government makes and receives payments through them. Hence, when you receive your Social Security payment it takes the form of a credit to your bank account; you pay taxes through a debit to that account. Banks, in turn, clear accounts with the government and with each other using reserve accounts (currency) at the Fed, which was specifically created in 1913 to ensure such clearing at par. To strengthen that promise, we introduced deposit insurance so that for most purposes, bank money (deposits) functions like government currency. Here’s the rub. Bank money is privately created when a bank buys an asset—which could be your mortgage IOU backed by your home, or a firm’s IOU backed by commercial real estate, or a local government’s IOU backed by prospective tax revenues. But it can also be one of those complex sliced and diced and securitized toxic waste assets you’ve been reading about. A clever and ethically challenged banker will buy completely fictitious “assets” and pay himself huge bonuses for nonexistent profits while making uncollectible “loans” to all of his deadbeat relatives. (I use a male example because I do not know of any female frauds, which is probably why the scales of justice are always held by a woman.) The bank money he creates while running the bank into the ground is as good as the government currency the Treasury creates serving the public interest. And he will happily pay outrageous prices for assets, or lend to his family, friends and fellow frauds so that they can pay outrageous prices, fueling asset price inflation. This generates nice virtuous cycles in the form of bubbles that attract more purchases until the inevitable bust. I won’t go into output price inflation except to note that asset price bubbles can fuel spending on consumption and investment goods, spilling-over into commodities prices, so on some conditions there can be a link between asset and output price inflations. The amazing thing is that the free marketeers want to “free” the private financial institutions to licentious behavior, but advocate reigning-in government on the argument that excessive issue of money is inflationary. Yet we have effectively given banks the power to issue government money (in the form of government insured deposits), and if we do not constrain what they purchase they will fuel speculative bubbles. By removing government regulation and supervision, we invite private banks to use the public monetary system to pursue private interests. Again, we know how that story ends, and it ain’t pretty. Unfortunately, we now have what appears to be a government of Goldman, by Goldman, and for Goldman that is trying to resurrect the financial system as it existed in 2006—a self-regulated, self-rewarding, bubble-seeking, fraud-loving juggernaut. To come to a conclusion: the primary purpose of the monetary monopoly is to mobilize resources for the public purpose. There is no reason why private, for-profit institutions cannot play a role in this endeavor. But there is also no reason to believe that self-regulated private undertakers will pursue the public purpose. Indeed, as institutionalists we probably would go farther and assert that both theory and experience tell us precisely the opposite: the best strategy for a profit-seeking firm with market power never coincides with the best policy from the public interest perspective. And in the case of money, it is even worse because private financial institutions compete with one another in a manner that is financially destabilizing: by increasing leverage, lowering underwriting standards, increasing risk, and driving asset price bubbles. Unlike my ELR example above, private spending and lending will be strongly pro-cyclical. All of that is in addition to the usual arguments about the characteristics of public goods that make it difficult for the profit-seeker to capture external benefits. For this reason, we need to analyze money and banking from the perspective of regulating a monopoly—and not just any monopoly but rather the monopoly of the most important institution of our society. * Much confusion is generated by using the term “money” to indicate a money “thing” used to satisfy one of the functions of money. I will be careful to use the term “money” to refer to the unit of account or money as an institution, and “money thing” to refer to something denominated in the money of account—whether that is currency, a bank deposit, or other money-denominated liability

Link to University of Missouri Kansas City Economics here.

Another perversion of policy tied to the inapplicable, "taxpayer on the hook" belief

FDIC Adopts Weaker Rules to Lure Private Equity to Failed Banks

The FDIC is giving handouts to private equity funds and other private pools of capital on the perverted belief that this somehow takes some non-existent burden off of taxpayers.

Many of the players who are now getting these handouts were some of the same speculators and money operators who targeted these institutions for demise last year. They attacked them with short selling and other forms of manipulation; now the government is handing over the assets to these folks--assets that rightly belong to common shareholders.

As if this were not bad enough, many taxpayers got hosed last year when their own investments in banks stocks--which received no special capital ratio treatment--were wiped out by the government in cases where it had lent a helping hand.

Now they're getting hosed twice!

This constintutes nothing more than a massive wealth transfer to the richest people in the nation, all happening under the most liberal president since Johnson--a president who promised to help workers, but is doing everything to support Wall Street speculators but suppress wages of the working class at the same time.

It's an outrage!

So how big IS the deficit??

There is so much fear mongering over the deficit that I thought I'd take a look and see how big it really is. After all, we've been through the worst economic crisis since the 1930s, so how does the deficit stack up? Not that impressive, is the answer. Take a look for yourself below.



In my opinion, we need an even bigger deficit!

New-Home Sales in U.S. Jumped 9.6% in July, Most in Four Years

All forecast in previous blog posts, here, here, here and here!

Where is Peter Schiff???

Is this blog an exercise in futility?

In light of the comment I just posted I am starting to wonder if I am not wasting an enormous amount of time and energy here and adding to the frustrations of others.

Oh, don't get me wrong...it has been incredibly gratifying to teach so many of you these concepts and watch how you've come to understand the truth in a way that now you have more knowledge and are more savvy than most of the highest economic policymakers in the world. Any of you could run Treasury or the Fed or be the main economic point person in the government and achieve full output and employment and create prosperity the likes of which we haven't seen in generations! However, it is frustrating when I think about the vast tide we are swimming against.

We cannot win. There is simply not enough time, resources and money in the entire world to change the belief system that so pervades our thinking and our policy now. For the moment I am optimistic only because a crisis of monumental proportions has forced us to temporarily suspend this belief system, but at some point when things start looking up, it will come back with a vengence and send us reeling once again.

Peter Schiff may become a U.S. Senator; Ron Paul...who knows? He ran for president and has a huge following.

And that's to say nothing of the David Walkers, Pete Petersons, Heritage Foundations and all the other deficit terrorists and gold standard zealots out there who hold enormous sway and influence over policy and the media.

These people believe that America is profligate, wasteful and off course to such a degree that she needs not only to be "corrected," but corrected in a way that will inflict a painful lesson. In their puritanical minds that is the only way that we will regain our true and proper path.

I feel afraid for my kids.

I just don't know if I can fight the fight anymore. I have spent so much time, for what?

Why can't we get it right?

So many of you have been asking me why we allow all these misinformed beliefs to get in the way of doing the things that would lead to a more prosperous nation.

I feel your frustration.

In an email exchange between Warren Mosler and myself this morning, I think those frustrations are addressed. Please read below.

An email I received from Warren Mosler this morning read: Guys, Indulge me for a moment. Since we agree as a first principle that the government is never operationally constrained on fiscal policy (assuming a freely floating non-convertible exchange rate), and since we agree that bonds are nothing more than a defensive measure by the Fed designed to maintain a set reserve rate, I have the following question: Today, the FT has a front page headline: "US says debt outlook worsening". The article is below. Of course, this is based on the usual gold standard type thinking that afflicts organs of traditional orthodox economic thinking such as the FT. But since Bernanke has already said that it would likely be years before it would be considering raising interest rates, why bother issuing bonds at all? only because existing law requires the tsy to fund itself- it's not allowed to run an overdraft at the fed. Why not call the market's bluff and in effect say, "Okay, you're worried about bond supply overwhelming demand and the impact that this will have on rates, so we just won't issue any this year". If I were in charge I wouldn't issue any tsy secs Since bonds merely act to drain reserves and in any event we plan to keep interest rates low for a long time, why bother issuing the bonds at all? self imposed constraints. and worse, deficit fears as described are very real and can keep a lid on measures to sustain demand, which troubles me a lot more than the bond issuance issues.

Here was my reply:

I once asked Bob McTeer that very same question (or along similar lines) on my radio show and his answer basically was, "It's not possible, politically, to say something like that." (Or do something like that.)

What we in our little group forget is that, above all, this is about politics and in politics if you can't market your ideas you are dead.

Savvy marketers will tell you that it takes enormous time, energy and money to change people's minds. It's far easier to accept the way people are and the things they believe in, and work with that.

People BELIEVE that the gov't is out of money and people BELIEVE that the U.S. has to borrow from the Chinese (and everyone else) and people BELIEVE that their taxes "fund" spending.

Changing those beliefs cannot be done in a month, a year, or even in a full, four-year presidential term or for that matter, two terms.

Trying to change those beliefs--while that would be enormously beneficial to the long-term prosperity of the nation--is not smart politics.

-Mike

Average daily Federal tax receipts rising for two consecutive months now!

Average daily tax receipts are now up two months in a row. These tax receipts are comprised mostly of employee withholding tax, otherwise known as payroll taxes. This is a good sign and might indicate a better than expected reading on the jobs number next week.

U.S. employers see hires in year ahead

Yes, this is why stocks like Monster Worldwide (MWW) had Korn-Ferry (KFY) have been rallying strongly. I ownn MWW from lower levels, but it's no too late to buy.

In many ways this recovery and market rally reminds me of 2003 and the "jobless recovery." The stock market had a great year. It was only in mid-2004 when the data started turning positive and by that time all the gains of that move had occurred and it was time to sell.

If you wait and wait and wait for evidence, you're going to miss the move.

Court Orders Federal Reserve to Disclose Emergency Loan Details

This was the suit filed by Bloomberg LP that sought to force the Fed to disclose who it was lending money to. The Fed has the right under Section 13 article 3 of the Federal Reserve Act to lend in any amount against virtually anything it deems to be satisfactory collateral, but now it must disclose names.

Just as an aside, I had many email conversations with one of the Bloomberg journalists who covered this lawsuit and he admitted that his articles did not explain that the amounts and they types of collateral the Fed accepted were already all available to the public.

Read one of those exchanges here.

Fed MBS Purchases & Balance Sheet

Below is a graph of the current (8/19/09) progress of Fed. MBS purchases and settlements:

So far the NY Fed has made net purchase commitments of over $760B of MBS, while only about $600B of these trades have settled so far. The Fed is creating new reserves to fund these purchases, so the Fed balance sheets stands to increase when these trades settle, unless the Fed is able to reduce other items on the balance sheet by an offsetting amount.

This year the Fed has been able to hold the balance sheet fairly steady at about the $2T level, by reducing certain items while it has purchased over $600B of MBS and over $300B of Treasury and US Agency bonds. Last week the balance sheet expanded by about $45B, the snip below from the H.4.1 report highlights some of the larger transactions:

You can see that Securities Held Outright rose by $76B due mainly to MBS and Treasury purchases. This amount was somewhat offset by reductions in Term Auction Credit and Central Bank Liquidity Swaps.

_

I've numbered 3 line items that I think represent the main options for the Fed to work to reduce if they, for political reasons, desire to keep the balance sheet steady at about the $2T level, while they continue with their current goals of purchasing an additional $800B of securities over the remainder of this year. Even if they are able to reduce all 3 of these special liquidity programs to zero, the balance sheet stands to expand considerably, and the additional new reserves created could put upward pressure on bond prices over this time.

I will be on "Bulls & Bears" on the Fox Business Network this afternoon at 4pm ET

Tune in if you can. That'll be on the Fox Business Network.

European financial institutions have outstanding debt near or exceeding respective countries' GDP

People think the U.S. financial sector is strung out on debt, however, it pales in comparison to Europe. Below are the ratios of European Financial Institutions' international debt (most of that in dollars) as a % of their respective countries' GDP.

Germany 85.4%
France 59.0%
Spain 105.9%
U.S. 35.7%

German banks and financial institutions have debt that is 85% of Germany's GDP. Spain's banks have outstanding debt that is 106% of Spain's GDP. France's banks have debt that is nearly 60% of that countries' GDP. American financial institutions have debt that is only about 36% of U.S. GDP.

If the Fed hadn't come to Europe's rescue with those massive dollar swap lines seen last year and earlier this year, the entire Euro monetary system would have come apart. It may still happen because the Fed has been sharply criticized for those loans, making it questionable whether or not they will do it again if things start coming apart in Europe.

My videos have brought a deluge of reaction from Schiff supporters

Like the old saying, "You can judge a man by the friends he keeps," please have a look at the comments I received from Schiff supporters in the last 36 hours:

Here

and...

here.

Gov't bond issuance in Japan now exceeds U.S.

Recent data from the Bank for International Settlements (BIS) now shows that Japan's domestic government bond market is the largest in the world and the U.S. is second.

Where is the outcry of the "debt terrorists" like Peter Schiff, Jim Rogers and Ron Paul? They should be calling for an imminent collapse in the yen, but they are not. That's because a) they don't understand the monetary system and; b) they support a convenient double standard that says these things only apply to the United States in a negative way.

Total domestic gov't debt issuance:
(Source: BIS, all figures in billions $)



The complete report is available here as a .pdf document.

Meredith Whitney: What planet is she on?

In the interview below Meredith Whitney says consumer credit has already contracted by a "trillion dollars." I guess she was too busy to go look up the data, which shows that total consumer credit outstanding is $2.5 trillion and is down about $80 billion from its peak. (Get data here or see chart below.)

She goes on to say that credit will drop by more than $2 trillion.

I guess that's why she famous and gets the big bucks...truth is cheap and facts are boring.



Total Consumer Credit Outstanding (Source: Federal Reserve)