Good article - finally, someone gets it. I'm going to cut and paste the part that's relevant to my line of thought, but the whole article is worth reading - although most of it is repetitive of things I've been reading for years - here is the part that makes me say "finally":
>>I think we all suffer from trying to analyze the highly complex
contemporary financial world through concepts that were developed back
when the banking system was basically the credit system, and bank
deposit expansion was the key component of money supply growth.
Things have changed profoundly. I have no problem with the concept of
"high powered" money when Federal Reserve open-market operations
(security purchases) create new bank reserves. Traditionally, these
reserves would then hold the potential to be "multiplied" through bank
lending, subject to reserve requirements (i.e. fractional reserve banking),
capital ratios, and bankers’ self-imposed liquidity concerns. This
multiplication process is very powerful, hence the terminology
"high-powered money." Importantly, however, this concept of "high
powered" money specifically revolves around the multiplication of bank
deposits. For example, when the Fed purchases $1 billion worth of bonds
from a bank, the Federal Reserve creates a new liability by journaling $1
billion of reserves to the bank’s account at the Fed (i.e. the expansion of
Fed credit through the ballooning of its balance sheet – creating an
additional $1 billion liability by crediting the account Reserves Owed to
Bank, while increasing its assets $1 billion by debiting Securities
Holdings). For the bank, its assets remain unchanged, although bond
holdings are reduced (credited) by $1 billion, and Cash Reserves Held at
the Fed are increased (debited) $1 billion. Here, it is worth noting that
banking system (financial sector) assets remain unchanged until
additional loans are made. With $1 billion of new reserves, the bank now
has the capacity (with a reserve requirement of 10%) to increase lending
(create new deposits) by $900 million. The proceeds from the initial loan
would then eventually make its way to be deposited in another bank,
where it could be lent to the tune of $810 million (90% of $900 million),
that would be at some point deposited at the next bank, and so on and so
on. When the banking system was responsible for the vast majority of
lending, hence money and credit creation, the issue of "high-powered"
money was a significant aspect of monetary expansion. That Was Then,
This Is Now.
Today, the money and capital markets have come to dominate the money
and credit creation process, with non-bank financial intermediaries at the
heart of the U.S. Credit Bubble. Bank lending to business, the mainstay of
credit growth in years past, plays today a very backseat role to the hot
game in town: financing the asset markets. In so many ways, this just
changes the whole analysis. No longer does "multiplication" work only to
create additional bank deposits but, importantly, the entire process is
opened up for an explosion of money and credit generally. Specifically, an
historic monetary expansion ("multiplication") has created money market
fund deposits in excess of $2 trillion. Here, of course, the
government-sponsored enterprises and Wall Street firms have come to
play a momentous role. As such, it should be recognized that a massive
money market fund complex has moved resolutely to the epicenter of this
credit creation process, becoming what I refer to as "The Fountainhead."
Importantly, this type of monetary inflation involving the expansion of
(nonbank) financial sector liabilities is not subject to reserve
requirements; thus "deposits" can be lent in full, repeatedly, and
instantaneously (especially to asset markets), creating what I refer to as
the "Infinite Multiplier Effect" that leaves the old process of bank
lending "high powered money" in the dust. And with the unparalleled
financial and political might of the GSEs, monetary processes have
developed directing credit to an incredibly vast real estate market. This
confluence of factors has created the equivalent of Nuclear Credit
Fission.
So, in my analysis, during a period of general credit expansion, money
market fund deposits basically operate as "Hot Money." They can be
borrowed and immediately lent, where they can then be deposited and lent
again and again. As such, it should be recognized that GSE balance sheet
expansion financed by money market deposits (either directly by GSE
short-term borrowings or indirectly through leveraged players borrowing
in the money market to finance the purchase of GSE bonds) holds great
potential for providing powerful monetary and financial market effects.
The most conspicuous consequence is the uncontrolled expansion of
money fund deposits and the closely related unlimited availability of
credit. If fact, GSE purchases are not at all dissimilar to the Federal
Reserve creating "Hot Money" through its balance sheet expansion.
GSE balance sheet expansions, and mortgage refinancing booms in
particular, are extremely powerful financial market liquidity operations
that, in truth, make Fed open market operations over the past few years
look like "small potatoes." Not only do they allow homeowners to capture
additional liquidity (buying power to sustain the consumption boom or the
acquisition of financial assets) through the monetization of real estate
inflation, there is also the acutely potent systemic "reliquefication"
effect. <<
Over on the Book Nook thread, when I explained this to J. Fred Quinnelly, his comment was "we've discovered perpetual motion." The idea that the Fed is controlling the money supply is very outmoded. I agree with the author of this article - it's uncontrolled.
My question is - is that a bad thing? Isn't it controlled by the free market? Don't we believe in the free market?
I've been reading publications by the Federal Reserve - they will send them to you for free - maybe not you since you aren't a US citizen but maybe they do it for anyone. They are quite forthcoming about it - they only control a small part of the money supply. Money market funds are not completely unregulated, that's not what I meant - but the Fed has nothing to do with them.
I would like to point out, however, that the massive growth in money market funds since September, 2000, is inversely correlated to the stock market. Americans make a lot of money, and we have to put it somewhere.
The negative savings data is troubling - but I don't entirely trust it - the data is an artifact of GDP calculations - income minus expenditures equals savings. They add up all the known income in the country. They add up all the known expenditures in the country. They subtract the expenditure number from the income number, and what's left is the savings number.
But take a look at it closely - from Larry Lindsey, White House Advisor:
>>The private sector spent $700
billion more than it earned after-tax. Now that is 7% of GDP. We have
never been there before. We are making up that 7% essentially from two
sources. The public sector ran a 3% of GDP, roughly, surplus. And we
took in 4% of GDP by borrowing from abroad. But in terms of being
overextended, we have never been that overextended before. There is a
lot of confusion between the health of the government’s books and the
health of America’s books – they are not the same thing. The public
sector ran a healthy surplus…taking a record share from the private
sector. The private sector is running a record deficit.<<
Let's see, Larry - the government took in more money than it needed and the taxpayer is running a deficit - is it possible that there is a connection there? Duh? |
