Fed Watch Thread

[flow5]

Implementing the Federal Reserve's Asset Purchase Program

February 9, 2011 Printer version

Brian P. Sack, Executive Vice President

Remarks at Global Interdependence Center Central Banking Series Event, Federal Reserve Bank of Philadelphia

It is a pleasure to be back in my hometown of Philadelphia and to be invited to speak tonight at this event hosted by the Global Interdependence Center (GIC) and the Federal Reserve Bank of Philadelphia. The GIC has an impressive history of promoting public dialogue about monetary policy and other topics, and it is a privilege to be able to participate in that process. Tonight I will focus my comments on the implementation of the recent monetary policy decisions of the Federal Reserve and the associated implications for its balance sheet. As always, the views I will express are my own and do not represent those of the Federal Open Market Committee (FOMC) or the Federal Reserve System.

Unconventional Policy Decisions
In the second half of 2010, the FOMC made two important policy decisions about the size and composition of the Federal Reserve's balance sheet. In August, it decided to begin reinvesting the principal payments from its holdings of agency debt and mortgage-backed securities into longer-term Treasury securities, thereby keeping the amount of domestic assets held in the System Open Market Account (SOMA) portfolio unchanged at about $2 trillion. In November, the FOMC announced that it intended to expand the SOMA portfolio by purchasing an additional $600 billion of longer-term Treasury securities through the end of the second quarter of 2011, bringing the intended level of domestic securities holdings to $2.6 trillion.

Those decisions were aimed at providing more monetary policy stimulus to the economy. The FOMC saw the additional stimulus as warranted because it viewed the progress toward its mandated objectives of full employment and price stability as disappointingly slow.1 In effect, the Committee was using the size and composition of its balance sheet as a policy instrument, given that it had already employed its traditional means of easing monetary policy—decreasing short-term interest rates—to the fullest extent possible. Federal Reserve Chairman Bernanke has noted that the intention of asset purchases is similar to that associated with changes in short-term interest rates, in that they are meant to affect economic activity by influencing broader financial conditions.2

But while the intention of the recent policy decisions may be similar to traditional monetary policy adjustments, the implementation of them is not. These policy decisions involve what are presumably some of the largest and most rapid portfolio adjustments that have ever taken place by any single financial market participant. To put it in perspective, note that these recent policy decisions involve the Federal Reserve purchasing, over an eight-month period, more Treasury securities than the amount currently held by the entire U.S. commercial banking system.

It is therefore no small task to determine how to implement these purchases in an effective and responsible manner. That task falls to the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York. Let me describe how the Desk has conducted those purchases and some of the issues that we have taken into consideration during the process.

Implementing Treasury Purchase Operations
A good place to start is with the distinction between the roles of the FOMC and the Desk. The FOMC is responsible for making monetary policy decisions, while the Desk is responsible for implementing those policy actions on behalf of the FOMC. Thus, decisions about the broad parameters of any asset purchase program, including the amount of securities to be purchased and the duration of those securities, reside with the FOMC, as those are the parameters that will govern the overall impact on financial conditions and, ultimately, on the economy.

The role of the Desk is to determine how best to carry out the purchase programs within those broad parameters. In doing so, the Desk seeks to meet the policy intentions of the FOMC, while taking into consideration two other objectives. The first objective is to obtain the securities at competitive and appropriate prices for the Federal Reserve, as doing so will ultimately benefit the U.S. taxpayer. The second objective is to minimize any negative effects that the purchases might have on the functioning of financial markets. As I noted in a speech in October 2010, the liquidity and efficiency of the Treasury market provide tremendous benefits to our economy, and the Desk was intent on designing a purchase program that would not diminish those benefits in any meaningful way.3

To achieve these objectives, the Desk relies on a system in which it purchases securities through reverse auctions with a set of established counterparties called the primary dealers.4 The securities that are eligible for each operation and an indication of the total size of the operation are announced in advance.5 Dealers then submit offers to sell those securities, either for their own accounts or on behalf of their customers, over a 45-minute period on the morning of the operation. Those offers are assessed by the Desk based on two criteria: their proximity to market prices at that time, and an internal methodology for comparing the relative value of the securities at the offered prices.6 This process occurs over a proprietary trading system called Fedtrade under the oversight of Desk staff, and the results are typically finalized and published within a few minutes of the close of the operation.

With this infrastructure, the Desk has been able to purchase large volumes of securities in a rapid manner, as required by the policy decisions made by the FOMC. Indeed, over the period since the FOMC's decision to expand the SOMA portfolio, the Desk has purchased about $300 billion of Treasury securities.7 That total includes about $220 billion of purchases out of the intended $600 billion expansion of the portfolio, and another $80 billion of purchases associated with the reinvestment of principal payments on agency debt and mortgage-backed securities.8 In terms of the monthly pace, the purchases so far have been running at about $105 billion per month, consisting of roughly $75 billion in new investments and $30 billion of reinvestments. To meet this pace, the Desk has been operating in the market on nearly every available day.9

The operations to date have gone well. Participation by the dealers has been strong, with an average offer-to-cover ratio of about 3.5, and the accepted offers have been allocated across a number of dealers and a wide range of securities. Given the robust participation in the operations, the Desk has received competitive and appropriate prices for the securities obtained.10

Moreover, our purchases do not appear to be causing significant strains on the liquidity or functioning of the Treasury market. It is unusual for the market to have such a large, persistent, and one-sided participant, and we had to worry about how it would adjust to our presence. However, the available evidence suggests that market liquidity is decent at this time. Measures of liquidity, such as trading volumes, bid-ask spreads, or quote sizes, worsened in December, but that pattern appears to have been driven by year-end effects rather than our presence in the market. These measures have recovered since the year-end, moving back toward the levels observed before the start of the purchases.

In addition, we do not see signs that the market is facing unusual scarcity of particular Treasury securities. To monitor this, we look at the number of issues trading on special in the repo market and at the amount and composition of the securities that the market borrows from our securities lending facility. Both measures have increased some, but we do not see their current levels as indicating notable strains. Moreover, it does not appear that these patterns are more acute in securities for which the SOMA portfolio holds a larger proportion of the supply.

Our success at purchasing such large volumes of securities without causing significant market strains reflects some of the operational decisions that were made in the design of the program. One key issue was determining an appropriate speed for purchasing assets. The pace of purchases under the announced plan reflected a judgment by the Desk that it could purchase as much as $100 billion to $125 billion per month without significantly disrupting the functioning and liquidity of the Treasury market. So far, that appears to be the case, given the evidence just described.11

Another important aspect of the operations is the flexibility in terms of the securities that we purchase. As noted earlier, our selection of the specific offers to accept at a given operation depends on our assessment of their relative attractiveness. This process should support market functioning. In particular, it allows the market to determine which securities it is willing to sell on the most favorable terms for us. If a particular security is scarce in the market, we will presumably not be shown offers at attractive terms, and hence we will not end up removing additional supply of that security.

The flexibility of this procedure can be seen in the patterns of our purchases over time. Earlier in the program, we ended up purchasing a large concentration of off-the-run securities, including bonds that were issued 15 to 25 years ago. Given their age, these bonds are generally less liquid and less valuable to market participants, and hence dealers were willing to sell them to us at cheaper prices relative to other securities. At more recent operations, however, we have received a greater share of offers to sell more recently issued Treasury securities, including on-the-run issues, and our purchases have shifted accordingly. This suggests that older, off-the-run securities may have become harder for dealers to obtain, and that they have increasingly found it appealing to offer more recent issues, which are available in greater supply and are generally more liquid. Our procedure allows this shift to take place, as long as the more recent issues are offered to us on generally favorable terms.

Overall, the Desk has endeavored to implement the FOMC's policy decisions in a manner that ensures competitive and appropriate prices for the securities obtained and that maintains the efficient functioning of financial markets. I believe that we have managed to accomplish these objectives with our operations to date.

Market Developments during the Purchase Programs
Of course, the operational objectives discussed above do not speak to the broader policy objectives of the asset purchase programs. The policy decisions made by the FOMC in August and November were intended to influence financial conditions in a manner that would support the economic recovery and return employment and inflation, over time, to levels consistent with the FOMC's objectives. One way that this might occur is through a portfolio balance channel.12 Under this view, removing duration risk from the market would tend to keep longer-term real interest rates lower than they otherwise would be and would encourage investors to move into other types of assets, thereby making broader financial conditions more accommodative.

These intended effects were apparent in financial markets from mid-August to early November, when investors increasingly anticipated the Federal Reserve's decision to expand its balance sheet. Over that period, longer-term real interest rates declined, breakeven inflation rates moved up toward more normal levels, equity prices rose notably and risk spreads on many credit instruments narrowed. This configuration of asset price movements is the pattern that is typically associated with additional monetary policy easing.

Since early November, one of the notable developments in financial markets has been the sharp increase in longer-term interest rates. At first glance, this change may seem at odds with the portfolio balance channel. However, it is important to understand the factors that led to the increase in interest rates in the current circumstances.

The upward movement in longer-term interest rates in large part reflects the greater optimism among investors about the outlook for economic growth. Investors revised up their baseline forecasts for the economy and reduced the perceived downside risks that they see around that outlook. This shift in the outlook led the market to price in the possibility of earlier increases in short-term interest rates and to scale back the size of asset purchases that they expect from the Federal Reserve. Both of those developments contributed to the significant rise in yields.

In contrast, the rise in yields does not appear to be driven by the concerns expressed by some that the asset purchase program would unleash a considerable rise in U.S. inflation and inflation expectations to levels well above those consistent with the Federal Reserve's mandate. Such an outcome would be detrimental to the economic outlook, leading to downward pressure on risky asset prices and a substantial weakening in the value of the dollar. However, what has taken place in U.S. markets to date does not resemble this outcome. Indeed, over the period since the November FOMC meeting, longer-term inflation expectations have remained at levels consistent with the Federal Reserve's mandate, risky asset prices have advanced and the dollar has held its ground.

Overall, the broad improvement in financial conditions since last summer has been an important and encouraging development. Risky asset prices such as equities have risen at a rapid pace, and credit spreads and measures of credit availability have continued to ease. These changes have been driven to a large extent by the improvement in the economic outlook and, in turn, will help to promote the economic recovery going forward.

The decisions taken in the second half of 2010 affecting the size of the Federal Reserve's portfolio have provided support to that process. To be sure, economic fundamentals will ultimately exert the strongest force on financial conditions, as can be seen by the rise in Treasury yields even as the Federal Reserve expanded its balance sheet. But the Federal Reserve's balance sheet actions have helped to make broader financial conditions more accommodative.

Characteristics of the SOMA Portfolio
The set of asset purchase programs launched by the Federal Reserve, including those initiated at the peak of the financial crisis and the more recent actions, have changed some of the basic characteristics of the SOMA portfolio. I thought it would be useful to review those changes and to discuss their implications for the conduct of monetary policy.

The most obvious effect of the purchase programs has been on the size of the SOMA portfolio. If the intended asset purchases announced in November are completed, the size of the domestic portfolio will reach approximately $2.6 trillion by mid-year—considerably larger than the $1 trillion portfolio that would be in place in the absence of the asset purchase programs.

In addition, the purchase programs have affected the duration of the portfolio. The securities that have been purchased by the Desk since November have had an average duration of about 5.5 years. With those purchases and the adjustments from the earlier purchase programs, the duration of the overall SOMA portfolio has reached about 4.5 years, which is somewhat higher than the typical level of between 2 and 3 years that was observed before the financial crisis.

This combination of its larger size and longer duration results in a greater amount of interest rate risk embedded in the SOMA portfolio.13 Of course, under the view that the asset purchase programs operate through a portfolio balance channel, this is precisely how the programs have an effect on the economy—by transferring risk away from private investors and onto the Fed's books.

The risks to the portfolio arise because the characteristics of the assets that have been purchased differ from those of the liabilities that have been created by those purchases. The assets held in the SOMA portfolio have fixed coupon rates that reflect longer-term interest rates. However, the purchases of those assets create reserves in the banking system, and the Federal Reserve pays interest on those reserves at a short-term interest rate that it controls. The interest paid on reserves can be thought of as the "funding cost" of the portfolio.

Today, because short-term interest rates are low relative to longer-term interest rates, this mismatch produces a very elevated stream of net income. In particular, the SOMA portfolio has a weighted average coupon yield of about 3.5 percent, which, if applied to a $2.6 trillion portfolio, produces about $90 billion of income at an annualized rate.14 In contrast, the annualized funding cost of the portfolio at this time is only around $4 billion. This cost is relatively low because of the near-zero level of the interest rate paid on reserves. In addition, the private sector holds nearly $1 trillion of currency, which are liabilities of the Federal Reserve that bear no interest.15 Thus, the SOMA portfolio should produce a considerable amount of net income over the near term.16

Beyond the near term, though, the income that will be produced by the SOMA portfolio is uncertain. If short-term interest rates were to rise, the funding cost of the portfolio would increase relative to the fairly steady yield earned on the assets held, reducing the amount of net income from the portfolio. In addition, if longer-term yields were to shift higher, the Federal Reserve could realize capital losses if it were to begin selling assets.

However, even if interest rates did move up abruptly and the SOMA portfolio experienced realized losses, it would have no meaningful operational consequences for the Federal Reserve's ability to implement monetary policy. These losses would not impair the FOMC's ability to control short-term interest rates by paying interest on reserves or by draining reserves as needed. Accordingly, the Federal Reserve would continue to operate in the same manner that it otherwise would have in pursuing its economic mandate.

What would be affected by unexpectedly large realized losses on the SOMA portfolio would be our remittances to the Treasury. All Federal Reserve earnings in excess of those needed to cover operating costs, pay dividends and maintain necessary capital levels are remitted to the U.S. Treasury on a weekly basis. Accordingly, any change to the income on the SOMA portfolio directly affects the amount of funds that the Federal Reserve remits to the Treasury. The unusually large amount of portfolio income realized of late has boosted those remittances considerably. If portfolio income were to decline going forward, whether toward more normal levels or toward unusually low levels, the amount of those remittances would adjust lower.17

Ensuring our Ability to Remove Policy Accommodation
While the potential risks around the SOMA portfolio will not hamper the implementation of monetary policy, the size and duration of the portfolio will have to be taken into account when considering the appropriate policy strategy. In that regard, it is worth noting that, even as the Federal Reserve has been expanding its balance sheet, it has not lost any momentum in the preparation of its exit tools.

When the FOMC eventually determines that the time to begin reducing policy accommodation has come, the critical tool will be the ability to pay interest on reserves. As has been discussed on many occasions, paying interest on reserves will allow the FOMC to control the cost of short-term credit even with an enlarged Federal Reserve balance sheet.

In addition, we continue to make considerable progress increasing our capacity to drain reserves if necessary. At this time, more than 500 depository institutions have registered for the term deposit facility. Those firms, in aggregate, hold nearly $600 billion of the reserve balances that are currently in the financial system. We also have added 58 money market funds as counterparties for reverse repurchase agreements, in addition to the 20 primary dealers that are our regular counterparties. Those money funds currently hold more than $1.5 trillion of assets, with a good portion of those assets in the type of short-term repurchase agreements that we would be offering. In short, we have already established considerable capacity to drain reserves with these two tools, and we will continue to advance them in productive directions.

Lastly, the FOMC could also remove policy accommodation by halting the reinvestment of maturing assets or by selling securities that are held in the SOMA portfolio, as noted by Chairman Bernanke at last week's press conference.

Conclusions
My purpose today was to provide information on the manner in which the Desk has conducted the asset purchases that the FOMC has decided to pursue and the associated implications for financial markets and the Federal Reserve's balance sheet.

On the whole, I believe that the recent asset purchases by the Federal Reserve have had helpful effects on financial conditions and have been implemented in a manner that has been flexible enough to avoid any significant negative consequences for the functioning of financial markets. Moreover, while the programs have resulted in significant changes to the characteristics of the SOMA portfolio, those changes will not impede the ability of the Federal Reserve to adjust the degree of policy accommodation when judged appropriate by the FOMC.

__________________________________________

1The phrase "disappointingly slow" was used in the November FOMC statement.
2This point has been noted by Chairman Bernanke on several occasions. For example, see his remarks at the European Central Bank on November 19, 2010.
3See Brian Sack. 2010. "Managing the Federal Reserve's Balance Sheet." Remarks at the 2010 CFA Institute Fixed Income Management Conference, Newport Beach, California, October 4.
4The list of primary dealers.
5This information is included in a monthly purchase schedule published by the Desk.
6The methodology for comparing the relative value of the securities at the offered prices is based on a spline fitted through the prices of Treasury securities.
7These changes are measured since the November schedule published by the Desk, which was the first schedule of operations to come out after the FOMC decision. All data on policy operations are through Friday, February 4, 2011.
8The purchases associated with these two components are combined in the monthly schedule. To arrive at the totals reported in the text, we allocate the purchases so far this month proportionally across the two components.
9The Desk tends to avoid conducting operations on days that coincide with FOMC announcements and on days that are known to have lighter liquidity conditions.
10The Desk has begun publishing additional information from its operations, including information about the prices paid for each security, on a monthly basis. In addition, under the Dodd–Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve will publish additional information about its open market operations, including the individual securities purchased, the transaction prices and the counterparty, with a two—year lag for all transactions subsequent to the legislation.
11Implementing the program over an eight—month period would not be expected to significantly reduce the speed or magnitude of its effects on financial conditions and, ultimately, on the real economy under the view that the program's effects arise from the expected stock of our holdings rather than the flow of our purchases. Under this view, financial conditions react immediately to the announcement of the program, bringing forward its effects on financial conditions. This view provides policymakers with some flexibility regarding the amount of time to implement the total amount of purchases.
12The portfolio balance channel was discussed by Chairman Bernanke in a speech at the Jackson Hole Symposium in August 2010.
13Note that the securities purchased under these programs involve no credit risk, given that they are issued by the Treasury or are guaranteed by government sponsored enterprises. The relevant risk for the SOMA portfolio instead has to do with movements in interest rates at different maturities.
14The weighted average coupon rate is closer to 4 percent. However, to get to the reported income stream on these assets, we have to adjust for the amortization of any premium that we paid at our operations. I am referring to this adjusted measure as the average coupon yield.
15Factors other than currency held also affect the amount of reserves in the financial system, as reported in the Federal Reserve's H.4.1 Statistical Release.
16Indeed, the SOMA portfolio has already produced a large flow of income for the Federal Reserve for these same reasons. Over 2009 and 2010, the SOMA portfolio produced $46 billion and $76 billion of interest income, respectively, while the interest expense on reserve balances was $2 billion and $3 billion, respectively, in those years. Over the preceding 10 years, the average SOMA income was about $30 billion. The excess income in recent years has already been remitted to the Treasury.
17In the most extreme case, the Federal Reserve would have to cease remittances to the Treasury for a time. Of course, one might also want to take into consideration the additional tax revenue to the government that could be generated by the more robust economic recovery supported by the asset purchase programs.

[flow5]

Why the Krugman “I See No Commodities Speculation” Analysis is Flawed

Paul Krugman correctly anticipated that I would be unable to resist taking issue with him again regarding his view that the recent increase in commodities prices are warranted by the fundamentals.

Note that I am not saying in this post that “commodities prices have increased as a result of speculation.” That takes more granular analysis of conditions in various markets; we’ll be looking at some that look suspect in the coming days and weeks.

I intend to accomplish something much simpler in this post: to dispute the logic of Krugman’s overarching argument. He professes to be empirical, but as we will show, he is looking at dangerously incomplete data, so his conclusions rest on what comes close to a garbage in, garbage out analysis. And that’s been a source of frustration given his considerable reputation and reach.

Here is the guts of Krugman’s reasoning, from a recent post, “Signatures of Speculation“:

OK, how can speculation affect this picture? The answer is, it has to work through accumulation of inventories — physical inventories. If high futures prices induce increased storage, this reduces the quantity available to consumers, and it can raise the price. And you can, in fact, argue that something like this has been happening for cotton and copper, where there are apparently large and growing inventories.

I’m taking the liberty of putting in my redraw of an older version of his cartoon; I think it makes the point more clearly:


This is another statement of his argument in a 2008 post:

My problem with the speculative stories is that they all depend on something that holds production — or at least potential production — off the market. The key point is that the spot price equalizes the demand and supply of a commodity; speculation can drive up the futures price, but the spot price will only follow if the higher futures prices somehow reduces the quantity available for final consumers. The usual channel for this is an increase in inventories, as investors hoard the stuff in expectation of a higher price down the road. If this doesn’t happen — if the spot price doesn’t follow the futures price — then futures will presumably come down, as it turns out that buying futures produces losses.

So Krugman’s point is that if the price is higher than the level determined by supply and demand (the dashed line), you’ll see inventories, or more accurately, an increase over “normal” inventories, since the real world is not frictionless and there are various buffer stocks in the production system. And note he is NOT making a strong form claim that the speculators are the ones doing the hoarding (”usual channel” falls short of that); it’s merely that if the price is too high (say as a result of people in the cash markets somehow getting bad signals from all those evil speculators in the futures markets), the result will be opportunistic stockpiling.

That is not where our bone of contention with Krugman over oil in 2008 or our reservations now lie. It’s over statements like this:

But for food, it’s just not happening: stocks are low and falling.

This is simply not knowable, or at least not to the degree of confidence that Krugman has.

One thing I do on a regular basis is analyze information about market size and activity, and over time, it’s taken place in a very wide range of industries (yours truly specializes in oddball deals). Unless you are dealing with markets in which the government demands extensive reporting (like Japan, the data you can get in Japanese is just fantastic) or ones where you have a system of centralized reporting or other tight controls (like pharmaceuticals), it is very difficult even to get decent estimates of market size. So a basic issue is: understand the integrity of data.

Now consider commodities. Inventories can be held LOTS of places: storage facilities by private owners (major refiners such as flour mills), finished product, private speculators (there have been reports for years of base metal stockpiling in China), even the consumer level (during the oil crisis, people kept their auto gas tanks fuller due to the even-odd license plate gas station system). Consider what a monstrous supervisory apparatus around the world would be required to track all or even a substantial portion of where inventories in various commodities could be held.

The logical fallacy for Krugman is the official inventories he is looking at are only a subset of the places where inventory can be accumulated, and in many if not most cases a small enough subset that he cannot reach conclusions of the absence of inventory accumulation. For instance, in our long running discussion about oil prices in 2008, Krugman focused on official inventories. We pointed out that that storage was limited and actually surprisingly impractical. Those figures did not include the Strategic Petroleum Reserve (which was increasing its holdings during the 2008 price rise) nor did it consider that oil can simply be stored in the ground, via reducing well output. Our resident petroleum engineer Glenn Stehle explains:

Glenn Stehle on Reducing Oil Well Production


Now let’s look at one of Krugman’s current concerns, which is food price increases. The blog Clouded Outlook (hat tip Ed Harrison) tells us how the food “inventory” data that Krugman is relying upon is woefully incomplete:

Since Krugman lives in New York, it is perhaps understandable that his knowledge of farming is a little limited. There is no such thing as data on inventory. The USDA produces a time series called grain stocks. This number is not the same as inventory. This stocks number has very limited coverage, focusing mainly on government holdings of grain. The USDA produces these estimates largely by looking at grain reserves in the US and reading reports produced by other governments.

Most countries run strategic grain reserves, and there is some limited data for what governments are holding. However, these reserves are disbursed across many sites across the world. Often there is wastage, theft, and miss-reporting. To put the issue in perspective; does anyone really think that the grain supply numbers coming out of say, Chad are accurate? Undoubtedly, the Chadian authorities are doing their best, but gathering comprehensive data on grain storage is not as easy as New York journalists might think.

In some parts of the world, grain markets are subject to government intervention, and price controls. This increases the incentives for corruption and misreporting. In more than one country, grain reserves have mysteriously disappeared, especially when food prices have suddenly accelerated. We should never forget there are some very powerful incentives at work here.

To make the point more forcefully, does anyone really think they know how much grain the private sector are holding? If private wholesalers are hoarding grain, I doubt very much that are reporting their stocks accurately to government officials. If prices are going through the roof, the incentives to hide grain are very potent.

Just to be clear, I am not saying we know nothing about grain stocks. I am sure the numbers coming out of the US, the EU and Canada are reliable. But strategic grain stock numbers from Russia, Kazakhstan and Ukraine? There I pause for a moment and wonder. Maybe, these numbers might be in the ballpark of the truth, but I would treat them with caution. As for private sector holdings of grain, only the Almighty knows that number.

There are estimates of production, which are partly taken from satellite imaging, and assumptions about yield per hectare. There is an obvious relationship between amounts produced last year and likely stocks this year. It is helpful, but I would feel uncomfortable about relying on those numbers.

Furthermore, when I hear that USDA estimates project a 5 percent decline in production, I am inclined to believe it. Nevertheless, reported harvests have been very good over the last few years. Even a five percent decline still puts the projected 2011 harvest up there in the top five years over the last two decades or so.

Nevertheless, these qualifications shouldn’t detract from the point that we shouldn’t take too seriously any argument suggesting that speculation in food markets is implausible, simply because there is a lack of inventory build-up. It is the sort of argument that city folk make. Country people know better.

The Australian blog MacroBusiness, in a recent post “Paul Krugman is Wrong,” reads the UN Food and Agriculture Office reports differently than Krugman does:

So, what about food prices. According to Krugman:

Not much evidence of hoarding, as far as I can tell. So this is straightforward supply and demand. Demand may be up to some extent because of that emerging-market boom. But if you look at the FAO reports it becomes clear that the key thing for cereals prices is that production is down in advanced countries, largely owing to terrible weather. And yes, it’s likely that climate change has played a role.

Well, this blogger read the FAO reports. And yes, one does show a small drop in wheat production. However, another also says the following (h/t threedogsandakid):

In its 2009 Trade and Development Report, the United Nations Conference on Trade and Development (UNCTAD) contends that the massive inflow of fund money has caused commodity futures markets to fail the “efficient market” hypothesis, as the purchase and sale of commodity futures by swap dealers and index funds is entirely unrelated to market supply and demand fundamentals, but depends rather on the funds’ ability to attract subscribers….

The Groups recognize that unexpected price hikes and volatility are amongst major threats to food security and that their root causes need to be addressed, in particular:

a) The lack of reliable and up-to-date information on crop supply and demand and export availability;
b) Insufficient market transparency at all levels including in relation to futures markets;
c) Growing linkage with outside markets, in particular the impact of “financialization” on futures markets;
d) Unexpected changes triggered by national food security situations;
e) Panic buying and hoarding.

Now while there are markets where the inventory data may be more comprehensive (for instance, where the good are perishable, so the requirement for refrigeration and cold storage limit both distribution and inventory options), this pattern strongly suggests that at a minimum, relying primarily on inventory data is risky.

It therefore behooves analysts and commentators to look at market mechanisms and price movements relative to underlying changes in supply and demand before concluding that speculation isn’t playing a role in commodity price increases. Many of the people making these claims are not newbies; in fact, some are professionals with decades of experience, and most have nothing to gain by using the “s” word; in fact, they would damage their reputations if they cried wolf. That does not mean their opinions should be taken as a matter of faith, but it at least suggests that their arguments deserve a serious hearing.

www.nakedcapitalism.com/2011/02/why-the-krugman-i-see-no-commodities-speculation-analysis-is-flawed.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

Yves Smith

[neohguy]

Thanks for the info Flow.

[maui1]

all the above verbiage is wasted energy.............as the fed does nothing that helps anyone or anything.

the fed actions since the early 1900s has proved over and over again, that it gets in the way of free market growth, creates bubbles, and devalues the dollar.

everyone is talking about one or two mandates, for the fed..........i can see only one direction for the fed........and that is the trash heep, as america has done twice before in our history.

i think it was jefferson, that said "a central bank is more dangerous than any army"

[bimetalaupt]

Feb 10, 2011 13:48:51 GMT -5 @maui1 said:

all the above verbiage is wasted energy.............as the fed does nothing that helps anyone or anything.

the fed actions since the early 1900s has proved over and over again, that it gets in the way of free market growth, creates bubbles, and devalues the dollar.

everyone is talking about one or two mandates, for the fed..........i can see only one direction for the fed........and that is the trash heep, as america has done twice before in our history.

i think it was jefferson, that said "a central bank is more dangerous than any army"

CLOUD COMPUTING IS LIKE THE RESERVE SYSTEM.. DISPERSED WITH NO ONE SINGLE POINT OF ENERGY..MOST OF THE 12 RESERVE BANKS HAVE VERY INDEPENDENT THINKING PRESIDENTS LIKE POOLE AND DUDLEY..

THE FED IS ONLY A MODIFIED CENTRAL BANK AS ALL CENTRAL BANKS ARE OWNED BY THE FEDERAL GOVERNMENT. THE FEDERAL RESERVE SYSTEM IS OWNED BY THE TWELVE RESERVE BANKS THAT ARE AROUND THE TOTAL AMERICA LAND SCAPE. ON ONE IS IN NEW YORK. PAUL WARBURG DID A GREAT JOB OF NOT MAKING IT THE POWER OF WASHINGTON,DC.. IN FACT WASHINGTON DC IS THE HOME OFFICE OF THE FEDERAL RESERVE SYSTEM AND DOES NOT HAVE A RESERVE BANK IN THE SYSTEM.

THE CLOSEST THING WE HAVE TO A CENTRAL BANK IS BANK OF NORTH DAKOTA.. THIS IS THE STATE OF NORTH DAKOTA DBA BANK OF NORTH DAKOTA. IT IS FOR ALL PURPOSES A CENTRAL BANK FOR THE STATE AND HANDLES ALL THE MONEY FOR THE STATE AND SELLS AND BUYS BONDS FOR THE STATE. IT IS ALSO SELF-INSURED.. IT IS NOT A MEMBER OF THE FDIC BUT A VOTING MEMBER- SHAREHOLDER IN THE FED. IT IS ALSO VERY PRO-GROWTH FOR NORTH DAKOTA.. CHECK OUT THE UNEMPLOYMENT NUMBERS...

JUST A THOUGHT. ..OPINION,
Bi Metal Au Pt

Attachments:

[flow5]

Appointments to the FED follow the presidential elections:

"The Chairman of the Board of Governors of the Federal Reserve System is the head of the central banking system of the United States. Known colloquially as "Chairman of the Fed," or in market circles "Fed Chairman" or "Fed Chief". The Chairman is the "active executive officer" (see 12 U.S.C. § 242) of the Board of Governors of the Federal Reserve System.

OverviewAs stipulated the Banking Act of 1935, the President appoints the seven members of the Board of Governors of the Federal Reserve System; they must then be confirmed by the Senate and serve for 14 years. Once appointed, Governors may not be removed from office for their policy views. The chairman and vice-chairman are chosen by the President from among the sitting Governors for four-year terms; these appointments are also subject to Senate confirmation.[1] In practice the chairman is often re-appointed, but cannot serve longer than one 14-year term as governor (or, if appointed to fill a position whose previous occupant had not served out their term, then 14 years plus the time remaining in the previous unexpired term).

By law, the chairman reports twice a year to Congress on the Federal Reserve's monetary policy objectives. He or she also testifies before Congress on numerous other issues and meets periodically with the Secretary of the Treasury.

Currently, the chairman is Ben Bernanke, a South Carolina macroeconomist nominated by George W. Bush and sworn into office on February 1, 2006, for a term lasting until January 31, 2010. He was nominated for a second time by President Obama in 2009. In 2010 he was confirmed by the senate for a second term, ending January 31, 2014. Bernanke succeeded Alan Greenspan, who served for more than 18 years under four U.S. Presidents.

The law applicable to the Chairman and all other members of the Board provides (in part):

No member of the Board of Governors of the Federal Reserve System shall be an officer or director of any bank, banking institution, trust company, or Federal Reserve bank or hold stock in any bank, banking institution, or trust company; and before entering upon his duties as a member of the Board of Governors of the Federal Reserve System he shall certify under oath that he has complied with this requirement, and such certification shall be filed with the secretary of the Board.

See 12 U.S.C. § 244"

[flow5]

POMO'S Tentative outright purchases from FEB 11 - MAR 9

www.newyorkfed.org/markets/tot_operation_schedule.html

[flow5]

FINANCIAL TIMES - MONEY SUPPLY BLOG:
A rate rise by November? Hmmm
February 9, 2011 11:10 pm by Robin Harding.

This chart from Merrill Lynch via Alphaville (which shows how the market has made repeated false starts on when the Fed will raise rates) sent me off to CME Fedwatch to see when markets expect the first rise in Fed Funds.

The answer is that fed fund futures give a 22% chance of a rate hike by August, 41% by September, 54% by November, and 67% by December. I can only disagree: given what I understand of the FOMC’s reaction function, I think these probabilities only fit a scenario in which a large part of the FOMC has got its inflation forecast wrong and, by the autumn, been forced to change it.
Consider the following:

(1) January’s FOMC statement says that it “continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period”.

For rates to go up in August, I think the FOMC would probably have to drop ‘extended period’ in April, or June at the latest, before QE2 was complete. In other words, this is a bet on a large, short-term change in the inflation data.

(2) This is getting a bit long in the tooth and we’ll have an update soon but here are the FOMC’s economic projections from last November.

blogs.ft.com/money-supply/2011/02/09/a-rate-rise-by-november-hmmm/

The central tendency expected 2012 core inflation of 1 to 1.6 per cent and 2013 core inflation of 1.1 to 2 per cent. Surely the only reason the Fed would hurry to raise rates is if it had changed that forecast?

But consider the evidence so far. Actual core PCE inflation for 2010 came in 0.89%, i.e. right at the bottom of the November forecast range, and the December figure hit a record low of 0.7%.

(3) We’ll see when the January minutes come out but comments from Fed officials do not suggest any big forecast changes. All Mr Bernanke has done in recent remarks is note that core inflation may be a better predictor of overall inflation than headline.

To assess underlying trends in inflation, economists also follow several alternative measures of inflation; one such measure is so-called core inflation, which excludes the more volatile food and energy components and therefore can be a better predictor of where overall inflation is headed. Core inflation was only 0.7 percent in 2010, compared with around 2-1/2 percent in 2007, the year before the recession began.

Atlanta Fed president Dennis Lockhart in a speech this week said that:

My current projection shows underlying inflation gradually rising over the next few years, putting us back into a range consistent with the 2 percent target by 2013.

It is indeed true, of course, that some hawkish members of the FOMC focus on higher headline inflation. But for this view to sway the majority I think it would have to be validated by signs of movement in the actual inflation data.

Of course, an early exit by the Fed is always possible if the data justifies it. The point that I’m labouring here is that a forecast of an early exit is a forecast that a good chunk of the FOMC will revise its 2012 and 2013 inflation forecasts.

My guess is that the inflation data will not cause that to happen. Therefore, I reiterate my offer after the December FOMC. I will bet $100 that the Fed does not raise short-term rates by the November 2011 meeting. Any takers?

[flow5]

As we watch history unfold, the events that swirl around us are interrelated in ways we never could have imagined a generation ago. And so it is that events in Tunisia and Egypt can be seen as interconnected stories emerging from a single tableau.

For all of the stories wired in from Cairo of the yearning for freedom in Tahrir Square, the question of Why Now? is rarely addressed. Surely the predations of the state visited upon Arab populations by autocrats and secret police from Morocco to the Gulf are not news -- at least not to the citizenry of those countries. Yet as blogs and bylines and televised reports reach us, their central narrative remains the yearning for freedom and dignity.

But Why Now?

In Tunisia, it was Mohammed Bouazizi, a food vendor in the city of Sidi Bouzid, who, after years of taunting and abuse by the police, immolated himself in rage and frustration, and ignited the storm that subsequently erupted. But it was the price of food that had changed Mohammed Bouazizi's world, for the beatings were a regular feature of his life. And so too in Egypt, it is the price of basic foodstuffs--that consume as much as half of a typical family's income -- rather than the denial of basic rights that marks a material change in peoples lives.

Over the second half of 2010, basic food commodity prices have skyrocketed, especially wheat and sugar. While many have pointed to supply and demand factors -- ranging from growing demand in China to floods in Australia that threaten future wheat supplies -- the fact is that commodity price inflation has not been limited to food.

If there is a simple answer to Why Now, it may be that the answer is less Hosni Mubarak than Ben Bernanke. In normal economic times, broad-based commodity price inflation would increase during periods of strong economic growth. But these are not normal economic times.

In the wake of the economic meltdown of 2008, it has become clear that the recovery of the world economy depends on successful return to growth in the United States. For all of the talk of decoupling Europe from the U.S., in the wake of the global collapse the U.S. Federal Reserve emerged as the de facto central bank of the E.U. And for all the talk of China rising, the collapse of U.S. consumer spending wrecked havoc on China in a matter of months, leading to widespread civil unrest and forcing the Communist regime to spend an amount equal to 20% of its foreign exchange reserves on a stimulus program to weather the storm.

By the middle of last year, Bernanke and the Fed broadened their efforts to push liquidity (read: money) into the system to forestall a recessionary "double-dip" and accelerate domestic job creation. This effort, known by the moniker Quantitative Easing, or QE2, basically entailed printing money and buying long-term Treasury bonds.

The response of the global markets to QE2 was an immediate understanding that the Fed's intention was to push down the value of the dollar to ease trade pressures and stimulate domestic growth, even as the Fed was counting on international investment to continue to fund U.S. deficit spending. In a massive game of chicken with the Chinese -- and others whose national development strategies have been nothing less than dumping cheap goods into the hands of U.S. consumers -- Bernanke was counting on international dependence on the U.S. dollar as the reserve currency to assure adequate continued flow of funds in the U.S., even as the dollar traded down in value.

To date, for all the complaining, from China to the Fox commentariat, Bernanke has thus far succeeded. International holdings of U.S. Treasuries have continued to grow in the face of a weakening dollar, the U.S. stock market has boomed and the economic recovery has been sustained. Even some vocal critics of quantitative easing have softened their views, such as Kansas City Fed President Thomas Hoenig, who recently suggested that the Fed would likely consider extending the program.

But if QE2 has been provoked little adverse reaction domestically, a more concrete impact of QE2 has been felt in Tunisia, Egypt and across the Middle East, where basic food price inflation has skyrocketed.

Despite all the talk about supply and demand factors pushing up food commodity prices, the recent price surge reflects the wave of speculative money flowing into commodities and gold, seeking protection against a declining U.S. dollar. As illustrated in this graph, since the implementation of QE2 in mid-2010, wheat and sugar prices -- those foodstuffs most closely linked to Mohammed Bouazizi's livelihood -- have gone through the roof. While rising commodity prices have minimal impact on domestic U.S. inflation, it has a dramatic impact in less developed countries.

In Iran, fear of food riots made international news in December, as the Ahmadinejad regime sought to cut subsidies for fuel and food as commodity prices rose and further strained the national budget. And in Egypt, subsidy regimes that sought to provide low cost bread, oil, and sugar have provided little protection to the wide swath of the population -- 40% of whom live on less than $2.00 per day -- as the price of food reportedly grew by 30% in the last six months of 2010, and the black market price of flour was 100 times the official subsidized price.

Food prices are not new as an instigating factor in popular uprisings, dating at least back to the American and French revolutions, and the price of bread can bring more people to the streets than the noblest of words. The ultimate indignity and humiliation heaped upon Mohammed Bouazizi was not the beatings that he grew to accept, but rather -- faced with forces beyond his control -- it was his inability to provide for his family, to fulfill that most basic responsibility.

For that humiliation, Hosni Mubarak may fall, like Tunisian President Ben Ali before him. But the story is not just about them. It also about the interconnection of the world in ways that we rarely think about, about how policies in Washington might affect traders in Zurich and, in turn, the life of Mohammed Bouazizi on a street in Sidi Bouzid. As we watch history unfold, and imagine what the next chapter might entail, the interdependence of our world should be neither ignored nor forgotten

www.huffingtonpost.com/david-paul/food-matters-commodity-pr_b_820580.html?ir=Business

[flow5]

More Welfare for Wall Street
QE 2 Sets Off Inflation Alarms
By MIKE WHITNEY

Ever since he launched the second round of his bond-buying program (QE2), Ben Bernanke has been on a roll. The S&P has gained 10 percent and the economic data has improved dramatically. Manufacturing and retail have rebounded, consumer confidence has started to brighten, and personal consumption (PCE) is on the rise. Car sales, hotel occupancy and exports are all up, too. Even the banks seem to be more eager to lend than they were just a few months ago. Only housing is still in the doldrums and the Fed chairman probably has something up his sleeve for that, too.

Perma-bear Marc Faber thinks he's figured out the secret of Bernanke's recent successes. He says, "Never underestimate the power of printing money." Indeed. Only, in this case, an asset swap of US Treasurys for bank reserves works just as well as a printing press. Bernanke simply buys up boatloads of Treasurys from the banks and, "Voila", investors flock to riskier assets like lemmings to a cliff. And, just look at the results. Stocks keep climbing higher and higher, and everyone is happy. Well, almost everyone.

Richmond Fed President Jeffrey Lacker is not happy and he's taken his grousing to the press. Lacker thinks that Bernanke should heed the market's warnings and back off while he still can.

"The distinct improvement in the economic outlook since the program was initiated suggests taking that re-evaluation quite seriously," Lacker said in a speech in Newark, Delaware. "That re-evaluation will be challenging, because inflation is capable of accelerating, even if the level of economic activity has not yet returned to pre-recession trend."

Bernanke has brushed off Lacker's inflation handwringing saying that he has matters under control. But does he? That's not what the bond market is saying. Here's the Wall Street Journal's Mark Gongloff with the rundown:

"The U.S. bond market has begun sending a message that inflation risks are rising and the Federal Reserve may be too slow to act, potentially marking a significant turning point in the economic recovery. In the past week, Treasury-bond yields have jumped to their highest levels since last spring. Yields on 10-year Treasurys surpassed 3.5% and 30-year yields broke through 4.7%, which makes some worry could mean rates will march even higher.

Long-term rates have been gradually moving higher in response to an improving economy and rising commodity prices. But in recent days the increases in yields accelerated, a move many say is due to the worry that the Federal Reserve may be underestimating inflationary pressures in the economy, and may act too slowly to tame them.....

While raising alarm bells about inflation, the bond market is also indicating it sees no signs that the Fed will intervene. Short-term rates, which are most sensitive to Fed moves, have held relatively steady, causing the difference between two-year and 10-year notes to reach its steepest level since February 2010....

The yield on the 30-year Treasury bond ended Friday at 4.732%, its highest since last April. Adding to the almost-panicky feel in the bond market on Friday, traders circulated a chart of 30-year-bond yields showing that the yields had broken out of a 30-year trendline—a sign that the decades-long bull market in Treasurys may be drawing to a close...." ("Bond Market Flashes Inflation Warning", Mark Gongloff, Wall Street Journal)

Investors want some indication from Bernanke that if inflation does takes root, he'll fight back and raise rates. But Bernanke will have none of it. He's focused laser-like on deflation and is determined to stay the course until unemployment drops. (Or so he says)

And he's more confident in QE2 than ever. Just listen to him pat himself on the back in this clip from a speech he gave last week to the National Press Club:

"More recently, however, we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. Notably, we learned last week that households increased their spending in the fourth quarter, in real terms, at an annual rate of more than 4 percent....

A wide range of market indicators supports the view that the Federal Reserve's securities purchases have been effective at easing financial conditions. For example, since August, when we announced our policy of reinvesting maturing securities and signaled we were considering more purchases, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen from low to more normal levels....

The fact that financial markets responded in very similar ways to each of these policy actions lends credence to the view that these actions had the expected effects on markets and are thereby providing significant support to job creation and the economy." (National Press Club address, Fed chairman Ben Bernanke)

While it's a bit premature to boast about a "self-sustaining recovery" when rates are at zero and the Fed has affixed a $1 trillion liquidity pipe to the markets, Bernanke clearly believes in the policy. And, notice how he points to "rising stock prices" as a barometer of success even though he has repeatedly said that the Fed does not deliberately target the stock market. Now we have Bernanke's own words to prove the opposite.

Also, it doesn't take a genius to see that if someone buys tons of Treasurys, the money that was in those Treasurys, will go somewhere else. And, so it has. It's gone into stocks, commodities and emerging markets. But how does that help to increase aggregate demand, lower unemployment, or improve household balance sheets? It doesn't. It just creates more liquidity in the financial markets chasing more paper assets. And that is precisely the problem.

It also increases risk appetite which paves the way for another asset bubble. Is that what Bernanke wants, another economy-crushing meltdown? Here's an excerpt from the Wall Street Journal which shows how Bernanke's low rates and bond buying program are pushing investors into riskier and riskier assets:

"The average junk-bond yield fell below 7% for the first time in more nearly six years, moving within striking distance of its all-time low, as bond buyers are willing to take on more risk in order to boost returns....

Yields under 7% are more commonly associated with investment-grade bonds, but investment-grade bonds currently yield only 4.89% on average, according to J.P. Morgan. That is because market forces are squeezing the premium that high-grade bonds enjoy over Treasurys, and the Federal Reserve is suppressing short-term rates on Treasury securities to spur job growth." ("Yield on 'Junk' Approaching All-Time Low", Wall Street Journal)

So, the Fed's low rates are forcing investors (including many fixed-income retirees) into more dangerous assets in an attempt to get some measly return on their savings. This exposes them to even greater losses when the Fed is forced to raise rates and the market tumbles. Here's more from the article:

"Money continues to pour into junk bonds, with high-yield mutual funds recording $5.4 billion of net inflows since early December, according to Lipper FMI, a unit of Thomson Reuters.

Bank loans, a kindred market to high-yield bonds, have seen even greater inflows, of $6.7 billion, in that time. Similarly elevated flows into emerging markets have caused countries such as Brazil to adopt measures aimed at curbing inflation, which can result from torrents of incoming capital.

The cash influx into junk bonds has driven up prices and caused yields to drop over the past two months, even though yields on underlying Treasurys have risen sharply during that time....

Issuers continue to take advantage of elevated demand and falling yields, with $34 million of new high-yield bonds being sold in January, according to Dealogic. Six of the past 12 months have now recorded more than $30 billion in issuance, a threshold that had only been reached once before 2010. ("Yield on 'Junk' Approaching All-Time Low", Wall Street Journal)

So the big banks are making money hand-over-fist, while the mom-and-pop investors--trying to eek-out some small return on his skimpy retirement savings--are hung out to dry. If that's not class warfare, than what is? (Keep in mind, the banks borrow money from you, the depositor, for roughly 1% (1-yr CD) and then lend it back to you at 18% via your credit card. It's a bigger ripoff than student loans.)

And big finance is not just scarfing up junk bonds either. They're also adding to their trove of garbage adjustable-rate mortgages (ARMs), the notorious MBS that sent the housing market into freefall. Here's a clip from Businessweek:

"Home loans that inflated the U.S. housing bubble...are fueling the fastest gains in the mortgage-bond market....Prices for senior bonds tied to option adjustable-rate mortgages, called "toxic" by a government commission, typically jumped 6 cents to 64 cents on the dollar in the past month, according to Barclays Capital.

Rising values show Federal Reserve efforts to stimulate the economy by purchasing an additional $600 billion of Treasuries and holding interest rates near zero percent are driving investors into ever-riskier securities.....

The market is pricing in defaults on option ARMs of about 75 percent, according to hedge fund Metacapital Management LP in New York. As the worst housing slump since the Great Depression deepened, assumptions reached as high as 90 percent, said Whalen, who's based in Los Angeles."("'Toxic' Mortgages Rally as Resets Accelerate: Credit Markets", Businessweek)

Got that? Investors are loading up on these garbage bonds even though they expect 75% of them will go belly-up. Hey, it's a Bernanke gold rush! Is it any wonder why QE2 does not inspire confidence? It's just more bubblenomics.

And Bernanke's pledge to reduce unemployment is pure hogwash. In fact, the Federal Reserve Bank of San Francisco even admits that the effects of QE on unemployment will be negligible at best. Here's an excerpt from the FRBSF's Economic Letter:

"By 2012, the ... program's incremental contribution is ... 700,000 jobs generated ... by the most recent phase of the program. Increased hiring lowers the unemployment rate by 1.5 percentage points compared with what it would have been absent the Fed's asset purchases... Based on other simulations, providing an equivalent amount of support to real economic activity through conventional monetary policy would have required cutting the federal funds rate approximately 3 percentage points relative to baseline from early 2009 through 2012, an obvious impossibility because of the zero lower bound."

"700,000 jobs" in two years. Big deal. That winnows unemployment down to 8% by 2012. It's a drop in the bucket, but it does show that Bernanke's QE2 has nothing to do with jobs. It's just more welfare for Wall Street.

So, where is all this headed? It's not hard to figure out. For one thing, Bernanke will have to tap on the brakes a lot sooner than he thinks. Economic activity is picking up, the banks have started lending again, oil is rising sharply, and Wall Street speculators are snatching up every crummy bond in sight. Even consumer credit is expanding, which is a miracle given the dismal debt-to-disposable-income ratio that's still way above trend.

Also, inflation expectations are on-the-rise along with food and oil prices. At the same time, the yield on the 30-year Treasury is inching higher because investors doubt that Bernanke will defend the dollar by raising rates. It's a question of credibility.

Does this mean that deflation is no longer a problem?

Not at all. In fact, deflation is the main problem, but QE2 is sending false signals that are adding to the confusion. Unemployment is still very high, the output gap still very wide, and housing is in a historic slump. Consumers are still retrenching, households still deleveraging, and defaults, bankruptcies, and foreclosures are still at record highs. In other words, deflationary pressures are still strong and likely to stay that way through 2011.

On the other hand, things look altogether different in the financials, where a feeding frenzy is underway for everything from junk bonds to toxic ARMs. This hyperactivity is the result of flawed monetary policy, hundreds of billions of dollars are shifting out of risk-free Treasuries into other assets. Naturally, that's driving up stock prices and sparking fear of inflation. But, unfortunately, it's not doing anything for the real economy. The excess liquidity in the financial system is merely chasing paper assets, which is why yields on junk bonds continue to fall.

To fully appreciate the magnitude of the Fed's failure to direct stimulus where it's needed, consider this: Investors are now choosing to buy toxic ARMs (which are set to default at a 75%-clip) rather than plants, equipment, real estate or hard assets. That's a good indication of how weak demand really is, and how inadequate the Fed's attempts to fix the problem have been.

So, what does it all mean?

It means we've reached the limits of monetary policy. The stimulus that's pushing liquidity into the markets, is not being transmitted to the real economy. It's stuck financial La-la land where it can't do any good. The problem is not that Bernanke is dropping money out of helicopters. The problem is that his helicopter never stops circling Wall Street.

The Fed's exalted QE experiment is coming to an end. Bernanke has restored large parts of the Ponzi finance system that collapsed after Lehman, but the real economy is still mired in recession. It looks like Keynes was right after all. Trying to use monetary policy to revive the economy, when households and consumers are still underwater, is like pushing on a string.

Mike Whitney lives in Washington state. He can be reached at [e-mail]

www.counterpunch.org/whitney02102011.html

[flow5]

Leading sugar traders have blamed recent volatility in the price of sugar on "parasitic" speculators in a letter seen by the Financial Times.

Sugar recently rose to its highest price in 30 years.

The World Sugar Committee, which represents big traders, told the ICE Futures US exchange that high-frequency traders "enrich themselves at the expense of traditional market users".

But ICE is said to believe such traders are not the cause of price volatility.

Algorithmic, or high-frequency, traders use computers and advanced mathematics to buy and sell positions in the market, sometimes within seconds, taking advantage of small differences in price to make profits.

The New York-based exchange has said that algorithmic traders help to provide the market with liquidity.

But in a letter seen by the Financial Times, Sean Diffley, chairman of the WSC, said: "Arguably, computer-based traders do not even contribute to the traditional function of the speculator in allowing producers and consumers to transfer price risk, since they do not take price risk home."

Last week, the price of raw sugar for March delivery reached 36.08 cents (22.46 pence) per pound, the highest price since November 1980.

The WSC has asked ICE Futures to put in place rules to help limit price volatility.

The exchange has said it would consider introducing "circuit breaker" technology to offset extreme swings in the price of sugar.

Cyclone Yasi, which recently hit Australia's Queensland coast, undoubtedly had an effect on commodity prices, with some analysts suggesting that up to half of that state's sugar cane crop could be lost.

Australia is one of the top three sugar cane exporters in the world.

Greater regulation

Continue reading the main story Sugar No. 11 (World) Futures US cents/pound
Last Updated at 11 Feb 2011, 06:45 ET
price change %
32.19 +
+0.14 +
+0.44
Commodities are traded on futures markets where a contract is agreed between a producer to sell a commodity to a buyer for a set price, at a certain time.

This allows both parties to plan further into the future and offset the short-term risk of, say, a poor harvest or adverse weather conditions.

But some believe that this form of commodities trading is merely pushing prices higher and penalising the poorest.

Campaign group the World Development Movement (WDM), argues the problem is one of institutions and traders "betting on food".

It believes speculators drive commodity prices higher, making food too expensive for the poorest to buy.

WDM wants to see tighter regulation of futures contracts with limits on the amount that can be paid for commodities.

Warning system

However David Hightower, of forecasting service the Hightower Report, told the Today programme last week that speculators performed an important role in warning the market of limited stocks.

"It's like a doctor with a patient - you want to see how high the temperature is. That whole argument about speculation fuelling prices - I think it's good that we are seeing that and maybe it'll save us from having a real shortage."

The UN's Food and Agriculture Organization (FAO) recently said it did not believe large increases in the price of commodities were caused by speculators on the financial markets, though it did suggest that such speculators could make such price increases worse.

It said price increases "might have been amplified by speculators in organized futures markets. However, limiting or banning speculative trading might do more harm than good".

www.bbc.co.uk/news/business-12402698

[flow5]

Total SOMA Holdings 2,270,600,852.2

Change From Prior Week 28,896,000.0


"On August 10, 2010, the Federal Open Market Committee directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities (agency MBS) in longer-term Treasury securities. The most recent H.4.1 data release indicates that outright holdings of domestic securities in the System Open Market Account (SOMA) totaled $2.054 trillion as of August 4, 2010"

SOMA is NOW UP $217b since the start of the first reinvestment of principal & interest announcement (@ 2,054T)

[flow5]

One could mistake? these #'s for hyperinflation:

DAILY AVG IN MILLIONS
Two weeks ended % CHANGE IN WEEKLY AVERAGES
2/9/2011 1/26/2011..……………………………………….…. 13-wk…26-wk…52-wk

Total reserves………………………………………..……….…….….48.6…..13.1……-1.7
Non-borrowed reserves…………………………………….……..61.0…..21.8.……8.0
Required reserves………………………..……………….……....16.8…..15.5…....11.4
Excess reserves………………………………..…………..…...…50.8….-13.0…..…-2.4
Borrowings from Fed………………………..………..…….-209.1..-128.2..….-82.1
Free reserves…………………………………………………..…….…64.2…...22.3….……7.8


WSJ federal reserve market data pg

[neohguy]

From post #282:
As we watch history unfold, the events that swirl around us are interrelated in ways we never could have imagined a generation ago. And so it is that events in Tunisia and Egypt can be seen as interconnected stories emerging from a single tableau.

For all of the stories wired in from Cairo of the yearning for freedom in Tahrir Square, the question of Why Now? is rarely addressed. Surely the predations of the state visited upon Arab populations by autocrats and secret police from Morocco to the Gulf are not news -- at least not to the citizenry of those countries. Yet as blogs and bylines and televised reports reach us, their central narrative remains the yearning for freedom and dignity.

But Why Now?

In Tunisia, it was Mohammed Bouazizi, a food vendor in the city of Sidi Bouzid, who, after years of taunting and abuse by the police, immolated himself in rage and frustration, and ignited the storm that subsequently erupted. But it was the price of food that had changed Mohammed Bouazizi's world, for the beatings were a regular feature of his life. And so too in Egypt, it is the price of basic foodstuffs--that consume as much as half of a typical family's income -- rather than the denial of basic rights that marks a material change in peoples lives.

Over the second half of 2010, basic food commodity prices have skyrocketed, especially wheat and sugar. While many have pointed to supply and demand factors -- ranging from growing demand in China to floods in Australia that threaten future wheat supplies -- the fact is that commodity price inflation has not been limited to food.

If there is a simple answer to Why Now, it may be that the answer is less Hosni Mubarak than Ben Bernanke. In normal economic times, broad-based commodity price inflation would increase during periods of strong economic growth. But these are not normal economic times.

Bernanke and the rest of the Fed, regardless of what some of them say, have only the interests of WS and WS banks as being important.
I agree with David Stockman. Bernanke's panicked attempt to save WS banks in 2008 was not due to the imminent collapse of the economy. It was because he feared his buddies stock would dive, which to him, is the only economy that matters.

[flow5]

No question about it. The FED has OVERDONE it.

[flow5]

fms.treas.gov/mts/mts0111.pdf

Monthly TREASURY statement.

$49.8b deficit - $7.2b bigger than last year

interest on federal debt securities: $21.1 billion - now 7.6% of all federal budget outlays

INTEREST ON THE FEDERAL DEBT IS THE FIGURE TO WATCH, ESP. IF INTEREST RATES RISE

[flow5]

Cullen Roche Comments (117)
Pragmatic Capitalism (http://pragcap.com) was founded by Cullen

Mr. Adler is working under the false premise that govt bonds "fund" the spending of the USA. This is false. Govt bond sales serve only as a reserve drain that help the Fed hit their overnight target rate. In a modern economy where a govt has monopoly supply of currency in a floating exchange rate system there is no such thing as "funding spending".

This piece might help:

pragcap.com/n-y-fed-ex...

Best,

Lee Adler Comments (33) Cullen- Since I have been sending you my reports for months in an attempt to be helpful I would assume that you know that I read the H41 line by line and report on it on a weekly basis.

Having read the reports, you would know that I do understand that bond sales act as a drain in the week in which the bonds are sold. It's a major premise underlying my market forecasts. You would also know that in the ensuing week, when the Treasury spends the money that it took in during the prior week, that money is deposited in bank accounts, generating economic activity, as well as boosting reserves at the Fed, and boosting money supply.

In the long run, as the Treasury sells more and more debt, and banks choose to hold the reserves, those reserves are built up. Since the Fed began QE2 it has purchased $300 billion of Treasuries. Reserves have increased by $100 billion. The rest has entered the economy and the markets, boosting bank deposits, causing M2 to surge.

Here are the line items from this week's H41 illustrating this.

wallstreetexaminer.com...

The Treasury spent $54.4 billion from its general account at the Fed. It also paid down $25 billion in SFP cash management bills. And the Fed bought approximately $29 billion of Treasuries. As a result bank deposits at the Fed rose by a record $108 billion.

Government bond sales from the week before fund a portion of the government's spending in the following week. Taxes only cover about 65% of government outlays.

I don't understand how you can think that the bond sales only act as a reserve drain. You seem to be ignoring the fact that the government turns right around and spends the money immediately after receiving it. As a result, M2 has been surging since the Fed started QE2.

This chart illustrates.

wallstreetexaminer.com... Feb 11 01:04 AM Reply

Cullen Roche 64218
Your comment implies that you believe the US govt can run out of the money that it alone has a monopoly supply of. The sale of bonds is a political show mandated by Congress. Do you believe an alchemist can run out of gold? The US govt is no different....

Best,

Cullen Feb 11 01:39 AM Reply

Lee Adler Comments (33) The money goes into the PD accounts at the Fed. The PDs are the intermediaries through which the printed money gets to the banks, not the other way around. The money enters the system when the Treasury spends it, or when the PDs buy securities or commodities from other dealers or customers, or makes direct loans, such as margin loans.

Think of it this way. The Fed is the manufacturer. The product is dollars. The PDs are the Fed's manufacturer's reps and wholesale distributors. Everybody that deals with them is either a sub wholesaler, a retailer, or a consumer. There's only one way for the product to get into the system, and that's via the PDs. They get it first and they distribute it in a variety of ways.

There's very little demand for the product, so most of it just sits on the sub wholesalers or retailers shelves where it constantly loses value because the manufacturer is constantly stuffing the channel with more inventory. The product that enters the economy also loses value, again because there's just too much of it. The stuff the for which the product is bartered, in this case stocks and commodities, is consequently worth more and more.

Oversimplification, but that's the best I can do. Feb 10 12:39 PM

Lee Adler Comments (33) Also a key point that I missed when reading your question- the funds aren't "just reserves" that aren't spent. I think that's where your hangup is. Yes, a portion of the money does get locked up as reserves, but much of it does enter the economic stream, either when the Treasury spends it, or the PDs engage in trading or lending. Of the approximately 300 billion in QE 2, actually only a fraction has ended up in reserve deposits at the Fed.

"The Fed’s money printing has boosted reserve deposits by about $98 billion since the inception of QE2 in November. The balance of the printing, or roughly $187 billion since QE2 began, has flowed into the economy via Treasury spending, boosting some economic measures, but has also been responsible for spurring soaring commodity and asset prices, the unintended and unwanted consequences of the Fed’s actions. "

from last weekend's Wall Street Examiner Professional Edition Fed Report. wallstreetexaminer.com.../

Hope that helps! Feb 10 12:48 PM

[vl]

No member of the Board of Governors of the Federal Reserve System shall be an officer or director of any bank, banking institution, trust company, or Federal Reserve bank or hold stock in any bank, banking institution, or trust company; and before entering upon his duties as a member of the Board of Governors of the Federal Reserve System he shall certify under oath that he has complied with this requirement, and such certification shall be filed with the secretary of the Board.



Read more: notmsnmoney.proboards.com/index.cgi?board=moneytalk&action=display&thread=273&page=10#ixzz1DejtlIqN

You need ETHICS to make something like this quote "valid". Look at Hank Paulsen as our Sec of Treasury. Former CEO of Golden Sacks, just sold $500 million in shares of it. Had no business in a government role, as is the case for ALL GS alumni in it now.

When you speak of our Federal Reserve "banking" system, you need to remember that banks held and serviced their own portfolios and did business directly in community to city markets when it was created. Few surviving banks do that now. No member-bank does. All banks are irrelevant to the safeguards put in place when a Federal Reserve System was proposed. Both it and any bank doing business beyond a single state border HAS to go.
I applaud North Dakota, Michigan is contemplating something similar right now but the planning components are GOP-dominated with bankers in attendance. That means it will cost a lot and We the People won't benefit from what gets created.

[flow5]

The January budget figures confirm the big story that not many have heard: federal revenue growth has been outpacing spending for more than a year. The 12-month rolling sum of federal revenues rose 10% over the past 12 months, and it rose at a 10.7% annualized pace in the past six months. Meanwhile, the 12-month sum of spending hasn't budged at all since Oct. '09.

This is not an unpredictable outcome, though many have ignored it. Recoveries typically result in a slowdown in spending (fewer people receive unemployment claims) and a pickup in revenues (more people working, rising corporate profits, rising capital gains realizations). Since the current recovery began, the deficit as a % of GDP has declined from a peak of 10.3% to 8.6%, and the 12-month deficit has declined to $1.28 trillion in January, down from a high of $1.48 trillion last February.

If Congress can hold the line on spending, and if the economy picks up a little speed, we could see the deficit fall to 7-7.5% of GDP by the end of this year. We would still be a in mess of trouble (adding at least another $1 trillion to the national debt as interest rates rise), but we would be making progress. Better fiscal policy from Washington would help improve confidence, which in turn would boost investment and job creation, which would then reinforce the positive developments in receipts and outlays that are already taking place. We are not at all in a hopeless situation.

scottgrannis.blogspot.com/

[flow5]

The top 4 of the world’s largest economies in order are:

EU.......$16,106,896
US.......$14,624,184
China...$5,745,133
Japan...$5,390,897

Maybe the EU influenced prices more than the US? Or, what percentage of the world's money supply (including the unregulated Euro-dollar, Yen-dollar, etc. market), is China's M2? How does PPP figure into trade flows? I.e., put figures into perspective.

[usaone]

Flow

Do you know what the deficit% of GDP average is for the last 30 years?

I cant find that figure.

[flow5]

The calls for a bottom in 2011 for California housing do not coincide with the holistic data we are seeing for the state. When people talk about a housing bottom we take it to mean a nominal price bottom (as in what is the sticker price). This is what many are reporting through various articles on the current real estate market data for the state.

I don’t buy this assertion first because the California foreclosure pipeline is spilling over and also the state budget is an absolute mess. Do we even need to talk about our unemployment situation? There is little reason to believe 2011 will be the absolute bottom in terms of price especially when recent trends are showing prices moving lower now that banks seem to be more realistic about moving over priced inventory. Let us first look at the overall foreclosure data for the state.

www.doctorhousingbubble.com/no-california-housing-bottom-2011-foreclosures-increase-50-percent-reo-foreclosure-increase-in-california/

===============

Black swan? Congress may privatize Freddie & Fannie?

[flow5]

usaone - curiosity never killed the cat -- it had nine lives

gDp can be found on St. Louis's Web site:

research.stlouisfed.org/fred2/

federal deficit can be found on St. Louis's Web site:

research.stlouisfed.org/fred2/categories/5

Customize your own chart:

www.usgovernmentspending.com/federal_deficit_chart.html

[flow5]

2/11/2011
Page Content
Reforms Will Shrink the Government’s Footprint in Housing Finance on a Responsible Timeline, Help Protect Taxpayers

Plan Includes Critical Measures to Help Fix the Fundamental Flaws in the Mortgage Market, Better Target Government’s Support for Affordable Housing

WASHINGTON – Today, the Obama Administration delivered a report to Congress that provides a path forward for reforming America’s housing finance market. The Administration’s plan will wind down Fannie Mae and Freddie Mac and shrink the government's current footprint in housing finance on a responsible timeline. The plan also lays out reforms to continue fixing the fundamental flaws in the mortgage market through stronger consumer protection, increased transparency for investors, improved underwriting standards, and other critical measures. Additionally, it will help provide targeted and transparent support to creditworthy but underserved families that want to own their own home, as well as affordable rental options.

“This is a plan for fundamental reform – to wind down the GSEs, strengthen consumer protection, and preserve access to affordable housing for people who need it,” said Treasury Secretary Tim Geithner. “We are going to start the process of reform now, but we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market.”

“This report provides a strong plan to fix the fundamental flaws in the mortgage market and better target the government’s support for affordable homeownership and rental housing,” said Housing and Urban Development Secretary Shaun Donovan. “We must continue to take the necessary steps to ensure that Americans have access to quality housing they can afford. This involves rebalancing our housing priorities to support a range of affordable options, from promoting much-needed financing for quality, affordable rental homes to ensuring the availability of safe, and sustainable mortgage products for current and future homeowners.”

The Obama Administration's reform plan will:

1. Wind Down Fannie Mae and Freddie Mac and Help Bring Private Capital Back to the Market. In the wake of the financial crisis, private capital retreated from the housing market and has not yet returned, leaving the government to guarantee more than nine out of every 10 new mortgages. That assistance has been essential to stabilizing the housing market. However, the Obama Administration believes that, under normal market conditions, the private sector – subject to stronger oversight and standards for consumer and investor protection – should be the primary source of mortgage credit and bear the burden for losses.

The report recommends using a combination of policy levers to wind down Fannie Mae and Freddie Mac, shrink the government’s footprint in housing finance, and help bring private capital back to the mortgage market. The Obama Administration is committed to proceeding with great care as we work toward the objective of ensuring that government support is withdrawn at a responsible pace that does not undermine the economic recovery.

· Phasing in Increased Pricing at Fannie Mae and Freddie Mac to Make Room for Private Capital, Level the Playing Field. The Administration recommends ending unfair capital advantages that Fannie Mae and Freddie Mac previously enjoyed by requiring them to price their guarantees as though they were held to the same capital standards as private banks or financial institutions. This will help level the playing field for the private sector to take back market share. Although the pace of these increases will depend significantly on market conditions, the Administration recommends bringing Fannie Mae and Freddie Mac to a level even with the private market over the next several years.

· Reducing Conforming Loan Limits. To further reduce Fannie Mae and Freddie Mac’s presence in the market, the Administration recommends that Congress allow the temporary increase in those firms’ conforming loan limits (the maximum size of a loan those firms can guarantee) to reset as scheduled on October 1, 2011 to the levels set in the Housing and Economic Recovery Act (HERA). We will work with Congress on additional changes to conforming limits going forward.

· Phasing in 10 Percent Down Payment Requirement: To help further protect taxpayers, we recommend requiring larger down payments from borrowers. Going forward, we support gradually increasing required down payments so that any mortgage that Fannie Mae and Freddie Mac guarantee eventually has at least a 10 percent down payment.

· Winding Down Fannie Mae and Freddie Mac’s Investment Portfolios: The Administration’s plan calls for continuing to wind down Fannie Mae and Freddie Mac’s investment portfolio at an annual rate of no less than 10 percent per year.

· Returning Federal Housing Administration (FHA) to its Traditional Role. As Fannie Mae and Freddie Mac’s presence in the market shrinks, we will encourage program changes at FHA to ensure that the private sector – not FHA – picks up this new market share. The Administration recommends that Congress allow the present increase in FHA conforming loan limits to expire as scheduled on October 1, 2011, after which it will explore further reductions. The Administration will also put in place a 25 basis point increase in the price of FHA’s annual mortgage insurance premium, as detailed in the President’s 2012 Budget.

Throughout the transition, we remain committed to ensuring that Fannie Mae and Freddie Mac have sufficient capital to perform under any guarantees issued now or in the future and the ability to meet any of their debt obligations. This assurance is essential to continued economic stability.

We recognize the critically important role that Fannie Mae and Freddie Mac and their employees have played in the housing finance market while they have operated in conservatorship. We look forward to continuing to work with them to find ways to develop and implement the longer term reform solutions that the Administration determines together with Congress.

2. Fix the Fundamental Flaws in the Mortgage Market. The Obama Administration is committed to fixing the fundamental flaws in the housing finance chain. That process is already underway as we move to fundamentally transform the mortgage market through the Dodd-Frank Wall Street Reform and Consumer Protection Act’s (Dodd-Frank Act’s) critical reforms. Implementing these key measures, as well as additional reforms outlined in this report, will help to strengthen the long-term health of the mortgage market for borrowers, lenders, and investors.

· Helping Consumers Avoid Unfair Practices and Make Informed Decisions About Mortgages: The Administration will continue to implement the Dodd-Frank Act’s reforms to strengthen anti-predatory lending protections, improve underwriting standards, require lenders to verify a borrowers’ ability to pay, and provide increased mortgage disclosures for consumers.

· Increasing Accountability and Transparency in the Securitization Process: The Administration is currently working on rules to require originators and securitizers to keep greater “skin in the game” and to align incentives across the
securitization chain. Dodd-Frank charged the SEC with setting stricter disclosure requirements so that investors can more easily understand the underlying risks of securities, and establishing an Office of Credit Ratings to more effectively regulate the credit rating agencies.

· Creating a More Stable Mortgage Market: The Administration supports stronger capital standards to help ensure that banks can better withstand future downturns, declines in home prices and other sudden shocks, without jeopardizing the health of the economy. Additionally, the comprehensive reforms undertaken pursuant to the Dodd-Frank Act to constrain excessive risk in the financial system, including strengthened and coordinated oversight through the Financial Stability Oversight Council (FSOC), will help build a healthier and more stable mortgage market for the long term.

· Servicing and Foreclosure Processes: The Administration supports several immediate and near-term reforms to correct problems in mortgage servicing and foreclosure processing to better serve both homeowners and investors. These include putting in place national standards for mortgage servicing; reforming servicing compensation to help ensure servicers have proper incentives to invest the time and effort necessary to work with borrowers to avoid default or foreclosure; requiring that mortgage documents disclose the presence of second liens and define the process for modifying a second lien in the event the first lien becomes delinquent; and considering options for allowing primary mortgage holders to restrict, in certain circumstances, additional debt secured by the same property.

· Forming a New Task Force on Coordinating and Consolidating Existing Housing Finance Agencies: Following on the President’s call in the State of the Union to reform government to build a stronger future, the Administration will create a task force to explore ways in which the Department of Housing and Urban Development, the Department of Agriculture, and the Department of Veterans’ Affairs housing finance programs can be better coordinated, or even consolidated.

3. Better Target the Government's Support for Affordable Housing. The Administration believes that we must continue to help ensure that Americans have access to quality housing they can afford. This does not mean, however, that our goal is for all Americans to become homeowners. Instead, we should make sure opportunities are available for all Americans who have the credit history, financial capacity, and desire to own a home have the opportunity to take that step. At the same time, we should ensure that there are a range of affordable options for the millions of Americans who rent, whether they do so by choice or financial necessity. Moving forward, we must design access and affordability policies that are better targeted and focused on providing support that is financially sustainable for families and communities. The Administration recommends initially focusing our efforts on four primary areas:

· Reforming and Strengthening the FHA: We will continue to ensure that creditworthy borrowers who have incomes up to the median level for their area have access to affordable mortgages, but we will do so in a way that is healthy for FHA’s long-term finances, including considering options such as lowering the maximum loan-to-value ratios for qualifying mortgages and adjusting pricing.

· Rebalancing our Housing policy and Strengthening Support for Affordable Rental Housing: The plan advocates additional support for rental housing through measures that could include expanding the FHA’s capacity to support lending to the multifamily market, with reforms like risk sharing with private lenders and dedicated programs for hard to reach property segments like smaller properties.

· Ensuring that Capital is Available to Credit-worthy Borrowers in All Communities, Including Rural Areas, Economically Distressed Regions, and Low-income Communities: The plan calls for greater transparency by requiring securitizers to disclose information on the credit, geographic, and demographic characteristics of the loans they package into securities. The Administration will explore other measures to make sure that secondary market participants are providing capital to all communities in ways that reflect activity in the private market, consistent with their obligations of safety and soundness.

· Supporting a Dedicated Funding Source for Targeted Access and Affordability Initiatives: The plan calls for a dedicated, budget neutral, financing mechanism to support homeownership and rental housing objectives. The Administration will work with Congress on developing this funding mechanism going forward.

4. Longer-Term Reform Choices. The report also puts forward longer-term reform choices for structuring the government’s future role in the housing market. Each of these options would produce a market where the private sector plays the dominant role in providing mortgage credit and bears the burden for losses, but each also has unique advantages and disadvantages that we must consider carefully.

Deciding the best way forward will require an honest discussion with Congress and other stakeholders about the appropriate role of government over the longer term. The Obama Administration looks forward to working to build consensus, on a bipartisan basis, with a wide range of stakeholders on this issue.

==========

Black swan?

www.treasury.gov/initiatives/Pages/housing.aspx

[flow5]

Ben Bernanke arrived at his office a week ago and came face to face with his worst nightmare.

Staring out at the Federal Reserve chairman from page C1 of the Feb. 3 edition of the Wall Street Journal was a photo of a man and his boxes. The man was John Anton, founder and president of Anton Sports. The boxes contained his inventory of T-shirts. Because the price was right, Anton borrowed $300,000 at 2.45 percent to lay in a year’s supply ¯ 2,500 boxes compared with a more normal 30 ¯ in anticipation of higher cotton prices.

And why not? He has seen the future, and the future is higher prices. When commodity prices are rising faster than the cost of financing inventory, businesses have every incentive to stockpile, even if they don’t expect a pick-up in sales. It’s profit-maximization, pure and simple.

Is this what the Fed had in mind when it floated the idea last year of raising inflation expectations to lower real interest rates to get America spending again? I doubt it. But it’s the natural outgrowth of all its efforts.

Take QE2, for example, the Fed’s second foray into quantitative easing via the purchase of $600 billion of Treasuries from November through June. To the extent that the goal of QE2, as outlined by Bernanke, was to drive down Treasury yields and drive up the prices of other financial assets to make consumers feel wealthier, there is reason for concern.

It wasn’t long ago that double-digit annual increases in home prices made consumers feel wealthier. They borrowed and spent until that wealth evaporated.

The Fed seems to have succeeded, and maybe too well, in thwarting deflationary psychology, thanks to some help from overly easy monetary policy in some developing countries and booming commodity prices.

Which brings us back to Anton. He isn’t hoarding T-shirts because he expects the consumer price index to rise, say, 3 percent next year. He’s hoarding T-shirts because he expects cotton prices, which jumped 137 percent in the past year, to increase further.

“Everyone faces a different expected inflation depending on what he does for a living,” says Neal Soss, chief economist at Credit Suisse in New York. “That’s one of the real weaknesses of the expected inflation/real rate story.”

Don’t tell Fed policy makers. Their models determined that raising inflation expectations would lower the real interest rate, making it less attractive to hold cash and increasing the incentive for consumers to spend. Their models never envisioned a rise in nominal rates.

The yield on the 10-year Treasury note shot up to a 10- month high of 3.74 percent earlier this week from 2.4 percent in October. Most of that increase has been in the real rate, which the Fed now says reflects increased optimism about the economy.

Anton, of course, is an anecdote. Somewhere out there, just waiting for a journalist to knock on his door, is his counterpart, whose experience with prices is confined to those that are falling.

It just so happens Anton illustrates a dominant theme, which is rising global commodity prices, food riots in less developed countries where a large share of income is spent on necessities, and fears that the Fed missed the boat on QE2 (sorry).

Forget the frequent references to “food inflation,” “commodity inflation” or, even worse, “cost inflation.” (Thank goodness there’s no “wage inflation” at the moment!) These are all misnomers. Yes, food prices are rising, as are commodity prices. They aren’t inflationary per se unless the Fed allows those relative price increases to translate into a generalized rise in all prices.

The best way to ensure that happens is to keep interest rates at zero, creating an incentive to borrow at a low rate to finance something that’s appreciating in price.

To date, there’s no sign of a borrowing binge. Commercial and industrial loans, which companies use to finance inventories, have inched up in the last two months after a two-year decline. And the amount of credit-card debt outstanding posted its first increase in December after 27 monthly declines. Still, bank credit, which posted back-to-back increases in July and August, is contracting again, according to Fed data.

At a hearing of the House Budget Committee yesterday, Bernanke reiterated that the Fed has the means and the motive to pare its $2.47 trillion balance sheet and raise the benchmark rate to avert an unwanted increase in inflation “at the appropriate time.”

The last time the Fed was prescient, and preemptive, was 1994, so I wouldn’t count on it. Let’s hope they start down the Road to Normal before they find out we’re all John Antons now.

By Caroline Baum

[bimetalaupt]

Flow5,
In 1973 Cotton was at $1.11 lbs for high plains cotton and Diesel was $0.37/Gal for tax free farm use. Today check out diesel prices and the price of a new Deere Tractor.
The are blaming the farmer for what???

Just a thought,
Bruce.

[usaone]

Thank you Flow.

And the average price for a home in 1973 was $19,700!!

[flow5]

IORs are idle & unused. Remuneration is based the average, aggregate, end-of-day balances, held during a 7 day maintenance period (interest which is paid to the excess balance accounts 15 days later).

IORs aren’t the floor envisioned. The overnight FFR trades below the risk-free overnight remuneration rate - so selling inter-bank funds isn’t as profitable - as holding bank earning assets (as sterile reserves). Thus the BOG’s monetary transmission mechanism is via IORs.

By comparison, if the BOG raised the average reserve ratios on deposit liabilities, the volume of required reserves would increase (which if large enough, could induce bank credit contraction), ceteris paribus.

This process is the same as if the BOG raised the remuneration rate on excess & required reserves, vis a’ vis other competitive instruments and yields. It would also increase the volume of legal reserves, ceteris paribus (which likewise, absorbs the commercial bank's lending capacity).

Thus from that perspective, IORs are the functional equivalent of required reserves.

As of JAN 2011 month-end, the BOG's remuneration rate @ .25% on excess reserves (IBDDs), exceeded the "Daily Treasury Yield Curve" out to one full year. But the maturity distribution covered under the level of the remuneration rate’s umbrella, has been rapidly shifting towards the shorter-end of the yield curve in the last 2 weeks.

One year rates have gone up 20%. Two year rates have gone up 46%. Three year rates have gone up 40%. I.e., long-term monetary flows have bottomed as predicted. And in effect, monetary policy has eased.

Traders will soon be enlightened. If there was a doubt, the liquidity preference curve is a false doctrine. The money supply can never be managed by any attempt to control the cost of credit.

[flow5]

Bruce:
I follow agriculture a little. My old man grew up in Leoti Kansas. One of his friends was the first to ever plant wheat in that area of the state. My college roommate cut wheat in the summer for a big farmer outside of Hutchinson.

We used to shoot the stray cats along the hedge rows - to improve the quail & pheasant populations.

[bimetalaupt]

Flow5,
I got two degrees from Tarleton University in Stephenville,TX.. I did my first with a double in Micro and Chemistry. Well farming is about as high techs as anything these day with market analysis and cost projections.. Wheat or Corn both goes into feeding programs and we get milk out of it. I have just about got the process of converting dairy waste from cheese to butanol figured out with our new BCL027. My goal is Butanol at $0.75./gal production cost.

My old room mate used to do the American Breeder Service AI thing. He could produce about 100 cows from one condom of sperm from a good bull. That is why 0.7% of our population feed the rest 99.3%.. GDP they produce is about 2% ( adjust for inflation). We worked hard for the education. I worked for my professor at the Salmonella testing lab for chickens and Turkey. I used to have a pair of geese that used to eat the crickets. They keep my grape vines bug free and I got a lot of good biomass free!!

We did everything but give up!! Picked pecans, Dug earth worms, over one million test for Salmonella, Feed the Deer Corn and molasses, and cleaned the church.. That is how the farmer makes it these day.. Doing everything..

Just a thought,
Bi Metal Au Pt