Is the Fed Deflating?

[Mish]

Is the Fed Deflating?

Gary North wrote an article suggesting the Fed is deflating. I received many requests to comment on it, including one from Gary North.

North used Base Money for his claim as M2 and M3 are flawed measures that contain credit transactions. The distinction between printing and credit is paramount. But M2 and M3 are not useless for everything. Deflation must take into account credit, velocity, and even consumer psychology.

[c1ue]

Re: Is the Fed Deflating?

Mish,

Both you and Gary North's analysis is very interesting - thank you for your (and his) work.

I do have a question:

The possibility of there being a discontinuity between Fed actions and financial community behavior has not been discussed.

I am wondering if perhaps Bernanke is trying to inflate out of a possible Great Depression II - as suggested by his historical public work as well as Mishkin's recent paper - but that the financial community is refusing to continue to lend and/or borrowers are refusing to borrow.

Given the present economy, I would much more believe the former.

Could this then result in the behavior we are seeing? I.e. Fed pushing rates down, but various M(x) ratios going the opposite direction.

Given your recent blog about the Fed not truly being able to control the financial community, this would seem to fit.

[dbarberic]

Re: Is the Fed Deflating?

Mish,

Both you and Gary North's analysis is very interesting - thank you for your (and his) work.

I do have a question:

The possibility of there being a discontinuity between Fed actions and financial community behavior has not been discussed.

I am wondering if perhaps Bernanke is trying to inflate out of a possible Great Depression II - as suggested by his historical public work as well as Mishkin's recent paper - but that the financial community is refusing to continue to lend and/or borrowers are refusing to borrow.

Given the present economy, I would much more believe the former.

Could this then result in the behavior we are seeing? I.e. Fed pushing rates down, but various M(x) ratios going the opposite direction.

Given your recent blog about the Fed not truly being able to control the financial community, this would seem to fit.

That is a great observation. While the Fed can encourage borrowing, they can not mandate it. Its like throwing a party and no one shows up.

However, there is more than one tool in the Fed's "box". Remember the document written by the Fed in Dallas. Assets currently unallowed for purchase by the Fed can be changed into assets allowed for purchase.

[Guest]

Re: Is the Fed Deflating?

C1ue, Dbarberic -

Make sure you've not overlooked 5% global growth from your estimations.

80% of that growth is coming from the developing world. They do exist, they are quite robust, and they are growing about 5-6 times faster than the US. And we might note that they are quite well cashed up too.

How do we shoehorn a massive industrialisation in demographic areas 10 times larger than the US in aggregate, into an estimation that the US Fed is fearing or battling 'Global Great Depression II'?

How does it work - do we envision a 'great depression' in the US, while Asia and BRIC nations (plus all correlated secondary nations) continue growing (and demanding raw materials) at 5% - 7% a year? Even in a bad year, the larger SE Asian nations should maintain 5-6% annual growth, no?

Analyses risk remaining too US centric.

[Mish]

Re: Is the Fed Deflating?

C1ue, You are correct. Bernanke simply has to be aware of what's going on. He cannot be that stupid. He is also frightened by it, and proof is in his actions.

Panic speaks louder than words.

As "dbarberic" suggested, the Fed can encourage credit expansion it cannot mandate it. This is all really up to consumers and banks.

Right now we are seeing hesitancy on behalf of both (unwillingness to fund IPOs, turn downs in housing, happenings at Target and Lowes). The latter will force more job cuts.

This is a significant and not widely understood change in psychology.

Unions and strikes are a bear market phenomenon as well. A prolonged strike will further dampen spending in all of the Auto states: Michigan, Ohio, Indiana. But it won't stop there. Car inventories are likely to get enormously disrupted in ways we do not even know yet if the strike lasts long. At the top of my list is a shortage of models people want and a huge glut of stuff no one wants.

Again we are in the very early stages of all of this.

"Lukester" writes "Analysis risk remaining too US centric."

Yes, and no but more no than yes. The US is still the dog and not the tail. I think that will change years on down the road, but it is not the case today. Given that much of the junk produced by China ends up in the US is is foolish to discount the US.

That said, Lukester is correct. The US is a diminishing influence. Every day it becomes less important. But less important does not imply unimportant.

This is a question of timing. We are not there YET. China is also overheating because it refuses to float the RMB and it refuses to sterilize US dollars flowing in. The result in China is actual physical printing of currency as opposed to massive expansions of credit.

So that is a second reason to think China is the savior in all this mess. A third reason is that the carry trade in the YEN will unwind, timing is uncertain, and it is actually quite possible that all of these events happen at once.

Let's see Bernanke handle that. In essence the global imbalances make the matter worse, not better.

Mish

[bart]

Re: Is the Fed Deflating?

Is the Fed Deflating?

Gary North wrote an article suggesting the Fed is deflating. I received many requests to comment on it, including one from Gary North.

North used Base Money for his claim as M2 and M3 are flawed measures that contain credit transactions. The distinction between printing and credit is paramount. But M2 and M3 are not useless for everything. Deflation must take into account credit, velocity, and even consumer psychology.

What is your preferred measure or measures for velocity?

[metalman]

Re: Is the Fed Deflating?

What is your preferred measure or measures for velocity?

had the same question, thanks. lots of arm waving. where's the beef? :eek: uh, sorry... mixed metaphor... but you get the idea.

[bart]

Re: Is the Fed Deflating?

had the same question, thanks. lots of arm waving. where's the beef? :eek: uh, sorry... mixed metaphor... but you get the idea.

I'd actually like to hear flow5's preferred measure too. Hope he checks in.

Velocity is yet another one of those areas that's "fluid" in economics.

[Sapiens]

Re: Is the Fed Deflating?

Kudos to you Mish, and also to Gary North for the excellent analysis.

For those that claim the Fed is printing like mad, I give you a hint to the difference between Currency and credit. See this link here:

http://www.frbsf.org/publications/fe.../keyfacts.html

Scroll down to the bottom to where it says "Quantities of U.S. currency in circulation." You will be quite surprised at the low amount in relation to M3.

Cheers,

-Sapiens

P.S. Gary is right that the Fed is deflating, those in the "know" understand that a lender must from time to time re-price the assets to keep control of the game. Inflation carried into hyper-inflation benefits the debtors and not the creditors, that's why a prudent lender must contract credit once in a while to the detriment of the borrower. Salud!

[Guest]

Re: Is the Fed Deflating?

Sapiens -

I thought the most critical debt was that owed by the US government to foreign entities, not the debt owed by US consumers to US lenders?

You write: << Inflation carried into hyper-inflation benefits the debtors and not the creditors, that's why a prudent lender must contract credit once in a while to the detriment of the borrower. >>

You observe that reining in inflation returns a requisite "control" back to the creditors. So according to this explanation, the US Fed and Senior Banks are regaining control of the massive consumer debt by not allowing it to be inflated away to the advantage of Joe Consumer. Maybe so.

But how would such a monetary contraction aimed at the domestic consumer affect the debt the US Government owes to it's foreign lenders? Surely in that direction the Fed has already passed the point wherein they even had a choice as to whether or not they can avoid inflating it away?

[Sapiens]

Re: Is the Fed Deflating?

Sapiens -

I thought the most critical debt was that owed by the US government to foreign entities, not the debt owed by US consumers to US lenders?

Is not, the US has its debt denominated in its own currency. The consumer cannot print its own currency to wipe off their liabilities.

But how would such a monetary contraction aimed at the domestic consumer affect the debt the US Government owes to it's foreign lenders? Surely in that direction the Fed has already passed the point wherein they even had a choice as to whether or not they can avoid inflating it away?

Not quite. You need to think of it as a circle, every "d0llar" that a foreigner comes into possession has been previously created as someones liability to a US bank (or lender that issues "d0llar" denominated debt), this creates an incredible demand for "d0llars" from the domestic market to service its debt load. The effect on foreign lenders is to make their US sovereign owed debt gain in purchasing power as private debtors scramble to service their debt.

[c1ue]

Re: Is the Fed Deflating?

Lukester,

Sounds like you haven't seen the 'how banks work' Youtube videos.

I can't find the original link though...

[Guest]

Re: Is the Fed Deflating?

Sapiens -

<< The effect on foreign lenders is to make their US sovereign owed debt gain in purchasing power >>

Gain in purchasing power relative to what? Foreign buying of US domestic assets?

I fail to see what foreign holders of US Sovereign Debt are gaining puchase power on, when measured per a basket of international currencies - is this reflected somewhere in the international d0llar index?

Apologies for my lack of finish on this topic, but this theory leaves me sorely perplexed.

[Sapiens]

Re: Is the Fed Deflating?

Apologies for my lack of finish on this topic, but this theory leaves me sorely perplexed.

Lukester,

It is not a theory; it is the consequence of a simple, brilliant, yet insidious concept placed in action. Understanding to heart that simple concept drove William Paterson to seek a charter for the Bank of England back in 1694.

See here:

http://en.wikipedia.org/wiki/William_Paterson_(banker)
In 1694, he founded the Bank of England, described in his pamphlet A Brief Account of the Intended Bank of England, to act as the English government's banker. He proposed a loan of £1.2m to the government; in return the subscribers would be incorporated as The Governor and Company of the Bank of England with banking privileges including the issue of notes. The Royal Charter was granted on July 27, 1694.

Gain in purchasing power relative to what? Foreign buying of US domestic assets?

I fail to see what foreign holders of US Sovereign Debt are gaining puchase power on, when measured per a basket of international currencies - is this reflected somewhere in the international d0llar index?

This point in effect is irrelevant to those that own the system, since all they care is to own and control the wealth creation. Foreign investors are nothing more than competition to them, even among the bankers, it is a shark eat shark world. The only thing that matters is that those that own the Fed continue to own the Fed.

I recommend for you to study and understand the historical facts for the Banking Panic of 1907 and J P Morgan's actions for your own edification.

Cheers,

-Sapiens

[Guest]

Re: Is the Fed Deflating?

Sapiens -

You wrote:

Quote:

Originally Posted by Lukester

Gain in purchasing power relative to what? Foreign buying of US domestic assets?

I fail to see what foreign holders of US Sovereign Debt are gaining puchase power on, when measured per a basket of international currencies - is this reflected somewhere in the international d0llar index?

YOUR REPLY: This point in effect is irrelevant to those that own the system, since all they care is to own and control the wealth creation. Foreign investors are nothing more than competition to them, even among the bankers, it is a shark eat shark world.

__________________

With due respect for much superb commentary of yours Sapiens, I've become a bit exasperated at your cavalierly oblique responses, as I wonder if such response may be leaning unduly upon opacity when pressed.

I've diligently read through your recommendations in the past, but I note whenever you are posed a simple yet sticky question you retreat into this same style of highly opaque comment.

< Foreign investors are nothing more than competition to them (you presumably mean: The Federal Reserve - i.e. how comfortably it regards foreign nation holders of approx. 50% of total US government debt?) >

This is a disingenuously casual reply to the question. Why does the US Government then send an entire hand-wringing delegation of top Treasury and State Department officials to China, hat in hand, to plead their case for uninterrupted lines of credit?

You know every bit as well as I that the purpose of this little flock of US dignitaries travel was to quietly obtain assurances from the Chinese Government that they not cause any "hiccups" in the massive line of credit they've extended to the US Govt.

When you write in this specific context that to Fed bankers "foreign investors are nothing more than competiton" you are putting forward some really remarkably fluffy arguments. I object to being fed fluff, as I've seen this treatment from you before and it's curiously always employed in response to any awkward questions.

Do you not frankly suppose that Paulson does not grasp that China's whims regarding their US treasury holdings can send the US bond market into a rapid watery swirl around the toilet bowl? "Irrelevant" you say. Indeed?