Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
UK Coronavirus Infections and Deaths Trend Trajectory - Deviation Against Forecast - 1st Apr 20
Huge Unemployment Is Coming. Will It Push Gold Prices Up? - 1st Apr 20
Gold Powerful 2008 Lessons That Apply Today - 1st Apr 20
US Coronavirus Infections and Deaths Projections Trend Forecast - Video - 1st Apr 20
From Global Virus Acceleration to Global Debt Explosion - 1st Apr 20
UK Supermarkets Coronavirus Panic Buying Before Lock Down - Tesco Empty Shelves - 1st Apr 20
Gold From a Failed Breakout to a Failed Breakdown - 1st Apr 20
P FOR PANDEMIC - 1st Apr 20
The Past Stock Market Week Was More Important Than You May Understand - 31st Mar 20
Coronavirus - No, You Do Not Hear the Fat Lady Warming Up - 31st Mar 20
Life, Religions, Business, Globalization & Information Technology In The Post-Corona Pandemics Age - 31st Mar 20
Three Charts Every Stock Market Trader and Investor Must See - 31st Mar 20
Coronavirus Stocks Bear Market Trend Forecast - Video - 31st Mar 20
Coronavirus Dow Stocks Bear Market Into End April 2020 Trend Forecast - 31st Mar 20
Is it better to have a loan or credit card debt when applying for a mortgage? - 31st Mar 20
US and UK Coronavirus Trend Trajectories vs Bear Market and AI Stocks Sector - 30th Mar 20
Are Gold and Silver Mirroring 1999 to 2011 Again? - 30th Mar 20
Stock Market Next Cycle Low 7th April - 30th Mar 20
United States Coronavirus Infections and Deaths Trend Forecasts Into End April 2020 - 29th Mar 20
Some Positives in a Virus Wracked World - 29th Mar 20
Expert Tips to Save on Your Business’s Office Supply Purchases - 29th Mar 20
An Investment in Life - 29th Mar 20
Sheffield Coronavirus Pandemic Infections and Deaths Forecast - 29th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast - Video - 28th Mar 20
The Great Coronavirus Depression - Things Are Going to Change. Here’s What We Should Do - 28th Mar 20
One of the Biggest Stock Market Short Covering Rallies in History May Be Imminent - 28th Mar 20
The Fed, the Coronavirus and Investing - 28th Mar 20
Women’s Fashion Trends in the UK this 2020 - 28th Mar 20
The Last Minsky Financial Snowflake Has Fallen – What Now? - 28th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20
UK Supermarkets Coronavirus Panic Buying, Empty Tesco Shelves, Stock Piling, Hoarding Preppers - 22nd Mar 20
US Coronavirus Infections and Deaths Going Ballistic as Government Start to Ramp Up Testing - 21st Mar 20
Your Investment Portfolio for the Next Decade—Fix It with the “Anti-Stock” - 21st Mar 20
CORONA HOAX: This Is Almost Completely Contrived and Here’s Proof - 21st Mar 20
Gold-Silver Ratio Tops 100; Silver Headed For Sub-$10 - 21st Mar 20
Coronavirus - Don’t Ask, Don’t Test - 21st Mar 20
Napag and Napag Trading Best Petroleum & Crude Oil Company - 21st Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy - Government PANICs! Sterling Crashes! - 20th Mar 20
UK Critical Care Nurse Cries at Empty SuperMarket Shelves, Coronavirus Panic Buying Stockpiling - 20th Mar 20
Coronavirus Is Not an Emergency. It’s a War - 20th Mar 20
Why You Should Invest in the $5 Gold Coin - 20th Mar 20
Four Key Stock Market Questions To This Coronavirus Crisis Everyone is Asking - 20th Mar 20
Gold to Silver Ratio’s Breakout – Like a Hot Knife Through Butter - 20th Mar 20
The Coronavirus Contraction - Only Cooperation Can Defeat Impending Global Crisis - 20th Mar 20
Is This What Peak Market Fear Looks Like? - 20th Mar 20
Alessandro De Dorides - Business Consultant - 20th Mar 20
Why a Second Depression is Possible but Not Likely - 20th Mar 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

Fed Starting to Unwind Loose Monetary Policy, Could Trigger Secondary Recession

Economics / Money Supply Jan 27, 2010 - 01:21 AM GMT

By: Gary_North

Economics

Diamond Rated - Best Financial Markets Analysis ArticleOfficials at the Federal Reserve System insist that the FED will unwind its more than doubled monetary base. They do not say when. They do not say how. But they insist that they will do this when the economy recovers.

The FED has begun this process. The press has not paid any attention to this, but the evidence is unmistakable. Any time you want to monitor any of this, search Google for "Federal Reserve charts." You can see for yourself.


First, there has been a decline of the adjusted monetary base. This began in early December. This is the major indicator of Federal Reserve policy.

Second, M1 has also fallen in recent weeks.

Third, the M1 multiplier has yet to recover.

This is the indicator that lets us know how commercial banks have responded to FED policy. This graph indicates that most bankers are still in panic mode. They prefer excess reserves at the FED at 0% to 0.25% to loans made to any borrower, including the U.S. government.

Why is the FED deflating? I offer these suggestions.

  1. It is testing the waters to see if unwinding will cause a crisis: a secondary recession.

  2. It is giving itself some wiggle room in case commercial banks begin to lend, which threatens to let M1's expansion force up consumer prices.

  3. It is providing visible confirmation for an announced policy that it cannot follow without creating a true depression.

  4. It has begun to unwind, as promised.

THE ROCK AND THE HARD PLACE

In my previous report, "Bernanke's Doom Loop," I pointed out that the Federal Reserve is trapped by the results of its own expansionary policies in 2008. The FED has more than doubled the monetary base. The big banks always evade regulation and enter into high-risk, high-return ventures, knowing that the FED and the government will bail them out.

If the FED contracts the monetary base to the mid-2008 level, there will be another collapse comparable to the September-October collapse. The FED dares not allow this.

The FED swapped its liquid Treasury assets for the illiquid toxic assets held by the big banks. There is no market for these at face value, which is why it did the swaps in the first place: to restore bank liquidity and solvency at no cost to the banks – no "haircuts," as asset discounting is called. If it sells these assets, it will take a huge loss in its balance sheet. It dares not write down that balance sheet, for the effect would be to withdraw reserves from the banking system: severe monetary deflation.

It has the same problem with its $1.2 trillion in holdings of Fannie Mae and Freddie Mac debt. A sale would force up mortgage rates, i.e., reduce the market price of all Fannie Mae and Freddie Mac debt. Meanwhile, Barney Frank has said that he thinks both outfits must be completely re-designed. Why would the investing public pay anything close to face value?

The FED can sell off liquid assets, but it has few of these remaining. It has begun to do this, however. This is why the adjusted monetary base has contracted since early December.

If the FED continues, it will run out of liquid assets, probably before summer ends. If it simply stabilizes the monetary base, this will trigger round two of the Austrian theory of the business cycle. The Austrian theory says that the central bank can restore the economy by holding short-term rates low, but the result will be bubbles.

So far, the increase in excess reserves held by commercial banks has kept the low federal funds rate from resulting in a doubling of M1, thereby creating hyperinflation. The FED has been given wiggle room by the bankers. But this means that the recovery will be underfunded by local and regional banks. The recession will reappear.

Bernanke is a Keynesian. He is also an academic. He fills his deadly dull speeches with footnotes, in good professorial style. His footnotes do not indicate a late-career interest in the writings of Ludwig von Mises. It is unlikely that he has ever read Chapter XIX of Human Action, on interest rates, or Chapter XX, on how central bank inflation artificially lowers short-term rates, thereby fostering an economic boom that cannot survive the stabilization of money. He does not believe the following:

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system (1949 edition, p. 552).

This is what happened in December 2007. It led to the near-collapse of the big banks in October 2008. The FED then doubled the monetary base. This drove the federal funds rate almost to zero, where it remains.

The FED used credit expansion to save the banks and the newly nationalized housing mortgage market. Now the FED is giving signs of unwinding this enormous expansion. It has been saved from hyperinflation only by commercial bankers, who prefer putting over $1 trillion in excess reserves at the FED, for a paltry 0.25% or less per annum. Mises explained why in 1949: fear.

However conditions may be, it is certain that no manipulations of the banks can provide the economic system with capital goods. What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The boom is built on the sands of banknotes and deposits. It must collapse.

The breakdown appears as soon as the banks become frightened by the accelerated pace of the boom and begin to abstain from further expansion of credit. The boom could continue only as long as the banks were ready to grant freely all those credits which business needed for the execution of its excessive projects, utterly disagreeing with the red state of the supply of factors of production and the valuations of the consumers. These illusory plans, suggested by the falsification of business calculation as brought about by the cheap money policy, can be pushed forward only if new credits can be obtained at gross market rates which are artificially lowered below the height they would reach at an unhampered loan market. It is this margin that gives them the deceptive appearance of profitability. The change in the banks' conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period (p. 559).

If the FED merely stabilizes the monetary base, it will face a recurrence of the recession of 2008–9. The economy needs capital, not fiat money. Banking capital has been misallocated. Its market price was threatened with collapse in the fall of 2008 because it was no longer productive. The past year has not made this capital any less misallocated. The money expansion has merely concealed the extent of the misallocation. It has deferred the day of reckoning.

If the FED continues to unwind, it will soon hit the brick wall of its illiquid portfolio. If it attempts to sell these to the investing public, it will become clear that the FED is technically insolvent. It is allowed to play solvency games, because it is not legally required to adopt mark-to-market accounting. It can legally continue this charade of solvency only while these assets remain on its books.

THE ILLUSION OF RECOVERY

The recovery is based on the low short-term rates that FED monetary inflation has produced. Yet in recent weeks, the FED has begun to deflate. It has withdrawn liquidity from the banking system. Yet the Fed Funds rate and the 90-day T-bill rate have remained close to zero. Treasury rates across the board have not changed much in January. In fact, they have declined slightly. Why?

Investors in fixed-income securities are still willing to settle for a negative real return. Consumer prices were up, December 2008 to December 2009 by 2.7% (CPI). Investors are nevertheless willing to accept six one-hundredths of a percent on 90-day T-bills and three-tenths of a percent on one-year T-notes.

Why should we believe that these investors are fools, while stock market investors are the smartest people on the block? Fixed-income investors have done better than investors in the S&P 500 ever since March 2000. They have received a positive rate of return, just barely, after price inflation. Stock investors have suffered nominal capital losses, plus real losses as a result of price inflation of 12.4%. Their low dividends were offset by fund management fees in no-load funds and major losses of 6% or more in load funds.

The recovery is based on a hope and a prayer: hope that the Federal Reserve has restored permanent solvency to the banking system, and a prayer that the recovery will survive the FED's monetary stabilization. Chapter XX of Mises' Human Action indicates otherwise.

The FED can deflate until such time as it runs out of liquid assets. Then it will stop. It may stop before if the economy begins to reverse course visibly.

The commercial banks may decide to start lending again. If they do, the FED can raise reserve requirements. This will send a signal to the world that monetary inflation is about to make itself felt, as a result of a rise in the M1 multiplier. If the FED does this, it will send a signal to banks: there will be no recovery of bank profits, other than for the big banks. This will lead to a sell-off of regional bank shares. That will further de-capitalize the already de-capitalized banking system. It will mean the return of leverage, as I described in the doom-loop scenario.

Meanwhile, the President and Congress are incapable of doing anything significant to reduce the rate of unemployment. They know what will happen to incumbent Democrats in Congress in November if unemployment is still close to 10%. They are frantic to get the recovery translated into jobs. But the recovery is weak.

When the T-bill rate is stuck at six one-hundredths of a percent, this sends a message: either FED inflation or else the collapse of confidence in the private sector's capital markets: a flight to safety. The FED has not been inflating. It has been deflating. So, the T-bill rate tells us that those whose money is at stake are not convinced that the recovery is real. Local bankers, whose banks fund small businesses, which in turn provide most of the nation's employment, are paralyzed with fear. They are facing a decline in commercial real estate that threatens hundreds of banks – maybe a thousand – with legal insolvency if the accounting profession re-establishes and enforces mark-to-market accounting.

The economy is stalled where it matters most: job creation and business profits. Any profits are still coming mostly from cost-cutting, which means high unemployment.

CONCLUSION

The FED is caught in a trap of its own making. Bernanke cannot figure a way out of it. He promises to unwind, but this is the assurance of the alcoholic that his days of uncontrolled alcoholism are behind him.

There has been a recent period of monetary sobriety. The FED can reverse this at any time. For as long as it lasts, however, the economy will be faced with deflationary pressures. This is healthy, but not for incumbent politicians. They will demand action on the part of the FED to get the economy moving upward again. All the FED can do at that point is inflate. At some point, it will. But, for now, it has adopted a policy of preliminary unwinding.

Let us hope that this continues. But let us be realistic: it won't.

    Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

    http://www.lewrockwell.com

    © 2010 Copyright LewRockwell.com / Gary North- All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

milo Hartmann
27 Jan 10, 16:17
nice

Good read


CrisisMaven
28 Jan 10, 09:45
Onward Keynesian soldiers ...

Right you are Gary, a policy that wasn't right at the beginning is not easy to offeset by tracing ones steps back if one in the meantime had burnt all bridges ... When they are eventually going to raise interest rates they are pushing housing over cliff "for good":


g. Anton
28 Jan 10, 19:40
The End Game

In the "great depression" of the 1930's, the US monetary system remained more or less intact, and the world economy was not a tightly integrated economic entity as it is today. There have been historic instances of monetary system failure, but these have been generally limited to one country or relatively small area of the world. There seems little or no precedent for a large scale failure and collapse of an integrated world monetary system and various world currencies.

So what happens if the worst case result of the current non-sustainable situation as outlined in this article ensues? My guess is that the world would divide itself into a number of relativly independent communistic or socialistic (and very undemocatic) political entities where edicts and vouchers would take the place of money. There will be no need for banks or bankers.

As the Great Poet wrote, "The world will not end with a bang, but with a wimper!".


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules