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Fed & Unintended Consequences.

by ChrisCook Wed Sep 24th, 2008 at 07:59:25 AM EST

In this recent Diary

LQD: Central Banks and Unintended Consequences

I had a quick look at the proposition that current Bank of England policy - based upon conventional thinking about money and inflation - is diametrically wrong and can only lead to the outcome they are aiming to prevent.

More evidence is gathering daily that liquidity is draining out of the system despite what appears to be the valiant efforts of the Fed to maintain it.

A case in point is Norway, and a few others, who have been "bailed out" (honestly!... you couldn't make this up...) by the Fed because they have been running out of dollars to settle inter-bank dollar borrowing.

U.S. Fed Agrees to $30 Billion Swap With Four Central Banks

In fact, on one day last week virtually no Norwegian bank could give a price on NOK/$ at all....


Norway's central bank, or Norges Bank, yesterday supplied $5 billion in one-week dollar currency swaps to ease liquidity in financial markets. The bank also swapped $5 billion to ease dollar shortages last week.

The point is that, as Geoffrey Gardiner pointed out in that LQD there is a big difference between "pro inflationary" printing of dollars "unfunded" by T Bills, and "anti deflationary" printing of dollars to replace the catastrophic destruction of dollars by defaults.

If the Fed continues on this course they can only make a bad situation worse. They have forgotten - if they ever learned - the lessons of deflationary times which is, counter to conventional thinking, that the printing presses must roll to replace the money destroyed.

As I understand it, Gardiner is saying that the Banks are unable to create credit because of a shortage of "high-powered" money.

Now, as Thomas Edison said


"But here is the point: If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good."

That is as true in the age of electronic bills as it was in the age of paper ones. Why should it not be the case that the users of a pool of Treasury credits, which cost nothing to create, actually pay no "inteerst" but instead pay a provision for the use of the Treasury guarantee, and a service charge to the banks who would manage the system?


http://www.eurotrib.com/story/2008/9/20/62018/3086

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It need not - indeed it should not - be the Fed that does this either: I think that the US Treasury should issue the necessary Bills/Credits directly (under Fed management perhaps?) and should do so in return for Equity stakes in the Banks.

As Krugman points out, when Treasuty yields are 0%, Treasuries are as good as cash (actually, a bit worse: less liquid).

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 08:04:59 AM EST
Shades of Japan, again....

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 08:17:17 AM EST
[ Parent ]
Have you read Krugman's The Humbling of the Fed?
But why not purchase stuff other than T-bills? This can be thought of as changing the composition of the Fed's balance sheet, rather than enlarging it; and Ben Bernanke, in happier days, thought that might be an effective policy in a liquidity trap.

...

Nonetheless, I guess the Fed had to try the "Bernanke twist." And it did -- the old Fed balance sheet, in which T-bills were the vast bulk of assets, is no more. But the effects have been disappointing, especially weighed against the risk, which I know is making Fed officials very nervous.

...

So Ben Bernanke came into his current position believing that central banks have the power, all on their own, to fight Japan-type problems. It seems that he was wrong.



A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 08:19:21 AM EST
[ Parent ]
You are being unfair. Japan was a major exporter all along.

USA are in much bigger dung.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Thu Sep 25th, 2008 at 10:27:04 AM EST
[ Parent ]
As I understand it, Gardiner is saying that the Banks are unable to create credit because of a shortage of "high-powered" money.
What is "high-powered money", pray tell?

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 08:17:46 AM EST
I dunno, I only work here.

High Powered Money

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 08:27:32 AM EST
[ Parent ]
... when held by depository institutions allow them to create new account liabilities when they grant new debt.

The idea that the system is short of Federal Reserve Notes sounds like a way of being confused on whether its a liquidity crisis or a solvency crisis. Answer, its a solvency crisis that has been papered over by treating it as a liquidity crisis.

Now, a solvency crisis that stretches out to include depository institutions whose accounts function as credit-money becomes a liquidity crisis because 90%+ of liquidity is credit-money rather than fiat-currency ... but all the bridging loans in the world will not magically make an insolvent financial institution solvent in the face of a recession and a bear market. In those conditions and for a firm that is not solvent, its a bridge to nowhere.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 03:32:48 AM EST
[ Parent ]


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