Comments (20)

• steve

  Central planning of the economy is the end result of a central bank.

  Published: August 13, 2007 11:00 AM

• billwald

  Purpose is to help the rich people, not the working class people who were suckered into losing their houses.

  Published: August 13, 2007 11:44 AM

• Ron Brown

  Could the author or someone else elaborate on the last sentence in this article?

  Published: August 13, 2007 11:58 AM

• Paul Marks

  billwald is a leftist - but his is a logical attack (so one can hardly blame him).

  As Bastiat pointed out a more than one and half centuries ago, if rich people benefit from government (via trade restrictions or special subsidies) soon people will start demanding subsidies for lots of other people.

  It may be much more expensive (and, therefore, harmful) to subisidize "the masses" than it is to subsidize a few well connected people - but these well connected people will look bad opposing the subsidizing of the masses if they themselves have had their fingers in the cash register.

  I do not know whether anyone here watched the last Republican debate (the American Broadcasting System one), but Mike Huckabee (a big tax increaser from Arkansas) got lot of clapping and happy noise for saying that all Americans should have the medical care that members of Congress get. 300,000,000 people getting the same level of subsidy as 435 Representatives and 100 Senators? Crazy (and I doubt that he meant it seriously), but it struck a cord in the hall.

  Still back to the topic.

  I have never owned a home in my life, but if I borrowed money to buy a house - why should I not scream "I was suckered" if I know people like billwald are going to back me up. After all, if things go well in such a political campaign I would get to keep my home without paying for it.

  Of course if the money supply is expanded (which it has been) the credit money will go to all sorts of places (malinvestment), lending money to people who should never have been lent money (because they do not earn enough to pay the money back) is just one of the places the fiat credit-money expansion went this time.

  As for the great splurge of spending by central banks last week (and the European Union central bank spent far more than the Fed - over one hundred billion Dollars) - billwald has a point.

  One can say it was done to "save the economy" (or whatever), but the fact remains the money goes to the various institutions of the financial services industry - and most of the people there are rather wealthy.

  Remember F.A. Hayek's attack on the Chicago School view of "increasing the money supply".

  Money is not like a wave of water - hitting everyone fast.

  It is more like "treacle" - it flows slowly and piles in mounds in certain places (and some people get sticky fingers).

  The original article talked of the technical ways the Fed uses to increase the money supply (it seems to be using some method it should not be using). But the truth is that I doubt that many people are interested in what exact method the Fed uses.

  In fact most people just assume it uses dodgy methods.

  Of course it should not be using any method at all - and the Federal Reserve system should not exist anyway.

  Published: August 13, 2007 1:03 PM

• Jim Waddell

  Thanks for actually explaining what the FED did. All the mainstream media articles simply said the FED "injected money into the economic system" or something like that. As if there were a giant pipe and Bernanke were flushing 20s into it. I think most reporters are so clueless that the questions of HOW they inject the money and WHAT they buy do not even occur to them. I haven't seen this information anywhere else.

  Published: August 13, 2007 1:13 PM

• JCR

  Very good article. Thank you. Two questions.
  (1)Where did the author learn that the Fed bought MBS and not Treasuries. Is this information publically available?
  (2) Within 14 days, the Fed will sell back those MBS assets. Is that buy-back price already determined? Is it conceivable that the Fed will take a loss, creating long-term growth of money supply and transferring money to specific people?

  Published: August 13, 2007 2:20 PM

• JCR

  My apologies for my first question because the footnotes should give me the answer. Maybe the author could elaborate a bit on those data though. My second question remains. Thanks again for this quite informative article.

  Published: August 13, 2007 4:08 PM

• jp

  "Could the author or someone else elaborate on the last sentence in this article?"

  If the Fed signals it is willing to buy up significant amounts of MBS, banks and thrifts may be willing to keep on lending irresponsibly knowing that their mistakes will be taken care of in the future.

  "Where did the author learn that the Fed bought MBS and not Treasuries. Is this information publically available?"

  In note 1 of the article I added a link to this data.

  "Is that buy-back price already determined? Is it conceivable that the Fed will take a loss, creating long-term growth of money supply and transferring money to specific people?"

  Those are good questions and I don't know the answer to them. The Fed doesn't give that much data on prices at which repos are closed off at, unfortunately. We don't know the exact type of MBS bought either. But theoretically, if the MBS it bought declined in value substantially over the short period of time for which the Fed owned them it would be sitting on a loss. If the opposite, it could be sitting on a gain.

  Published: August 13, 2007 4:12 PM

• jp

  Also, the party that the Fed borrowed from could default, leaving the Fed holding the bag.

  Published: August 13, 2007 4:30 PM

• Bill Barnett

  The repurchase agreements require the sellerr to buy back at a specified date, paying the purchase price plus a premium that is de facto interest. For more on repos/reverse repos take a look at:
  http://www.newyorkfed.org/aboutthefed/fedpoint/fed04.html

  Published: August 13, 2007 9:01 PM

• jomama

  Also, the party that the Fed borrowed from could default, leaving the Fed holding the bag.

  Since the Fed pays no cost for being wrong, and their reasons for the injection are to keep The System greased, all is well...for them.

  How it all works out when the grease squirts out
  no one knows.

  I expect it'll make almost everyone's slip and
  slide trying to find a way out.

  Published: August 14, 2007 7:24 AM

• Charles

  Good article. A general question though. Does the Fed really care whether it buys good or bad securities? In this case, the intention was only a temporary "injection", so they might care a little, but in general, if they buy securities that end up worthless, do they care? What do they do with the money when, eg, a bond matures anyway?

  Published: August 14, 2007 7:55 AM

• jake

  People that think that we are headed for a deflationary recession like Mike Shedlock and Gary North are probably going to eat their words. They say when the credit crunch comes and consumers can no longer take out loans, the Fed will no longer be able expand the money supply. Steve Saville at safehaven.com disagrees saying that this is based on the incorrect premise that the consumer is the engine of inflation, not the central bank. To quote him:

  "The central bank, not the consumer, has always been and always will be the engine of inflation. There are times, such as the past decade in the US, when a massive build-up of consumer debt is the major contributor to growth in the money supply, but in such cases consumers are simply responding to stimuli provided by the central bank (it is only possible for a credit bubble to form if the central bank does something to facilitate the massive expansion of credit, such as hold interest rates at artificially low levels for lengthy periods). Furthermore, if consumers stopped borrowing more money into existence, or heaven forbid actually began to pay-down their debts, the central bank would still have little difficulty keeping the inflation going.

  Some of the means by which the central bank could keep the inflation going were outlined by Ben Bernanke in the 21st November-2002 speech that made him a household name (in our household, anyway). As far as we were concerned Bernanke was, in the aforementioned speech, just stating the bleeding obvious, but it was very significant that he could publicly discuss one of the current monetary system's major defects -- that the monetary authorities have the power to create an unlimited amount of money and therefore to reduce the purchasing power of the money by any amount they wish -- without causing hardly anyone to question the integrity of the system and without causing the devout deflationists to abandon their dearly-held view.

  Bernanke's November-2002 speech garnered a lot of attention in the financial world, but similar sentiments were expressed just as clearly in a little-known speech by Alan Greenspan in January of 1997. According to Greenspan:

  "When there is confidence in the integrity of government, monetary authorities -- the central bank and the finance ministry -- can issue unlimited claims denominated in their own currencies and can guarantee or stand ready to guarantee the obligations of private issuers as they see fit. This power has profound implications for both good and ill for our economies.

  Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit. They can discount loans and other assets of banks or other private depository institutions, thereby converting potentially illiquid private assets into riskless claims on the government in the form of deposits at the central bank.

  That all of these claims on government are readily accepted reflects the fact that a government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit."

  Note the liberal use of the terms "without limit" and "unlimited" in the above. Note, also, the qualification: "When there is confidence in the integrity of government". Once confidence collapses it becomes counter-productive for the central bank or the government to issue more "claims" (money and money substitutes). When that point is reached you don't get deflation; you get a total collapse and a new monetary system."

  And from another article:

  "No one can predict the future with certainty, but we would be extremely surprised if the uninterrupted inflation of the past 70 years were followed by a period of genuine deflation (a prolonged decline in the total supply of money and credit). One of the reasons this would surprise us is that there IS so much debt in the system. The high debt levels actually make deflation LESS likely, not more likely, because the current monetary system -- the world's greatest-ever Ponzi scheme -- could not survive a bout of genuine deflation. That is, deflation will never be a viable policy option regardless of how bad things get. Instead, the central banks of the world will likely risk destroying their currencies and obliterating the values of their bonds before they will permit deflation to occur.

  The question then becomes: central banks may well WANT to avoid deflation at all cost, but will they be ABLE to avoid it? Will they be able to implement policies that cause the currency to lose its purchasing power in an environment where almost all potential borrowers are 'tapped out'?

  We don't really understand why this is even a question because it's such a basic economic truth that someone with the ability to increase the supply of some 'thing' by an unlimited amount also has the ability to push the price of the thing down by as much as they desire. This is true regardless of whether the thing in question is a dollar or an apple or communications bandwidth. Central banks have the ability to create currency in unlimited amounts so they have the power to reduce the purchasing power of currency under any and all circumstances should they choose to do so."

  What happened last week when central banks started buying up mortgage-backed securities to bail-out the banks and hedge funds may be just the start of new creative ways the Fed is going to increase the money supply, in ways that the deflationists have never even considered.

  Published: August 14, 2007 8:47 AM

• sjp

  If the Fed tries to prevent deflation by printing money would that not destroy confidence in the treasury market, causing bond prices to plummet and interest rates to soar? Why would the Fed want to destroy the value of its own assets?

  Published: August 15, 2007 10:15 AM

• mike

  FINALLY, an explanation of the "liquidity injection"! This should be front-page news.
  Note, if the counterparties default on the repos, you will have a deflationary event because an asset on the Fed's books has disappeared, removing a part of the inverted pyramid on which fractional-reserve banking is based. Also, the markets will be severely shaken, because that will prove that the MBS issue is not just a temporary mark-to-market problem, but a systemic deflationary crisis. (Deflationary in the strict Austrian sense.) Monday should be an interesting day.

  Published: August 15, 2007 1:06 PM

• David C

  According to this article, the Fed loaned out cash that allowed the use of mortgage based securities as collateral.

  http://www.washingtonmonthly.com/archives/individual/2007_08/011861.php

  To me that means the banks kill likely take the cash and forfiet the collateral.

  Published: August 15, 2007 8:35 PM

• Jim Waddell

  jake, to my knowledge Gary North has never predicted price deflation. Quite the opposite. He repeatedly points out that we have only had price-deflation maybe a month or two in the last 50 years. He does expect a recession, but that is not necessarily price-deflationary

  Published: August 15, 2007 9:42 PM

• jake

  Jim you are right, Gary North does not predict price inflation. He does not even predict monetary inflation. So I take back my assertion that he is a deflationist. However the reason I carelessly grouped him with the deflationist's is because he thinks we have price inflation of only 2% and monetary inflation in the last year of only 1.7% based on the adjusted monetary base which he thinks is the best guide to monetary inflation. Both of these are numbers are very questionable IMHO. He says the AMB follows price inflation better over a long time period, but that is based on the CPI, which is itself a significant under reporter of inflation. This does even address the fact that prices tend to decline over time with increased productivity, much more when you consider how cheap foreign made goods have become. In short I think there is a lot more inflation going on than he thinks.

  Published: August 16, 2007 9:39 AM

• jp

  update...
  Fed open market operations in billion $
  Monday, Aug 13
  total (includes mbs, treasury, and agency debt): 2
  mbs: 1.15

  Wednesday, Aug 15
  total: 12
  mbs: 11.528

  Thursday, Aug 16 (1 day repos)
  total: 12
  mbs: 11.528

  Thursday (14 day repos)
  total: 5
  mbs: 4.75

  Published: August 16, 2007 11:24 AM

• Robert in Houston

  Security only matters when you call it in.

  While highly interesting the Fed bought MBS (Freddie & Sallie approved only?), it really is of no consequence. It mostly shows the Fed will support any market it chooses. Not just T-paper. What next? DJIA stocks? Pink sheets? :)

  The Fed will not declare default on any of the MBS repos because all those whith access to it's Discount Window" are considered to big to "fail". They will be foisted upon others. That's the deal.

  Published: August 19, 2007 9:06 AM