Fed Watch Thread

[flow5]

Long-term interest rates rose, in part, because IORs induced disintermediation (an outflow of funds from, or a negative cash flow within, the financial intermediaries). I.e., IORs absorb savings.

Monetary savings are impounded within the commercial banking system. I.e., savings held within the monetary system have a velocity of zero and are a leakage in the Keynesian national income concept of savings. I.e., Keynes was a moron.

When the CBs lend or invest, they expand both the volume & velocity of new money & credit. Lending by the CBs is inflationary. However, lending by the non-banks simply activates existing money, & all of these savings originate outside of the intermediary lending institutions. Lending by the non-banks is not inflationary. Such lending serves to match savings with investment.

I.e., rates rose in part, because the supply of loan-funds decreased - just when the demand for loan-funds was increasing. Based on the Z.1 release, the non-banks represented 82% of the lending market before it collapsed during the Great Recession.

I.e., redirect savings to the non-banks, and velocity (consumption & investment), will be activated and rebound, without unnecessarily forcing prices (stagflation), higher (just like the 1966 paradigm). I.e., money flowing to the non-banks (or the shadow banking system), actually never leaves the commercial banking system, as anyone who has ever applied double entry bookkeeping on a national scale would know.

When the rubber meets the road, you have to realize Bernanke (has with QE2), actually acted to shift the economy into reverse.

[flow5]

This message has been deleted.

[flow5]

Last week, bank reserve balances at the Federal Reserve went up by $108 billion. I thought that this increase was significant enough to warrant some notice.

There was really only one “factor” supplying reserve funds this past week. This was a net increase in U. S. Treasury Securities held outright by the Fed of almost $30 billion, which brought the Fed’s holdings of Treasury securities up to $1.167 trillion. The portfolios of Federal Agency securities and Mortgage-backed securities did not change a bit.

Furthermore, Thursday afternoon, February 10, the Federal Reserve announced that it would purchase about $97 billion in U. S. Treasury securities in the upcoming week. This total would include about $17 billion to replace the runoff in the Fed’s holdings of mortgage-backed securities, implying that there would be a “net” increase in securities holdings that would be a part of QE2.

The question we can’t answer is whether or not there will be other operating factors on the Fed’s balance sheet that the Fed needs to deal with.

This past week, the banking week ending February 9, 2011, there were substantial movements in two of the Federal Reserve accounts of the United States Treasury. The first movement was in the Treasury’s General Account and this amounted to a little more than a $55 billion reduction in the account.

This movement seems to be seasonal in nature, but was not offset this year, as it often has been in the past, by offsetting sales of government securities. That is why the decline contributed $55 billion more to bank reserves.

In 2009 there was a seasonal year-end buildup in the Treasury’s General Account which peaked in January 2010 and then dropped off to its spring low in April. This year the General Account built up to a peak again in early January before beginning to drop off.

Year-end tax receipts build up at the Fed which causes the peak to occur in early January. From these accounts the Treasury pays out more than it receives thereby causing bank reserves to increase. The difference is that this year the Fed did not sell Treasury securities to withdraw the reserves from the banking system. That would be counter to QE2 if they did..

The other actor in this play is the Treasury’s Supplemental Financing Account. (For a discussion of this see my post of April 19, 2010 here.) The Treasury’s Supplemental Financing Account reached a total of $200 billion in May 2010 and remained at this level until the banking week ending February 9, 2001. The account dropped by $25 billion which reduced the balance in the account to $175 billion. Reducing this account, like reducing the General Account, puts reserves into the banking system.

The Fed allowed an amount of $80 billion to flow into the banking system in the banking week ending February 9, 2011, all from government checks from the Treasury’s deposit balances at the Federal Reserve. There were roughly $3 billion offsets to this on the balance sheet so that only a net of $77 billion actually ended up in the banking system through this activity.

So, the actions were relatively “clean” this week and they resulted in $108 billion going into bank reserves at the Federal Reserve, roughly $30 from the Fed’s purchase of securities and $77 billion coming from government checks from the Treasury’s deposit balances at the Fed going into the private sector.

To my knowledge the $1,187 billion of reserve balances at the Federal Reserve at the end of business on February 9, 2011 is that largest total this account has ever reached!

The question this raises is this…are the reserves being pumped into the banking system getting into the private sector? Is all this Federal Reserve activity having any impact on the money stock numbers?

I am afraid I cannot give any different answer to this question than I have over the past year. The money stock measures are increasing but the reason for these increases still seems to be that people continue to move balances from other earning assets into assets that they can use to transact with. That is, people, in general, are reducing asset balances that were held for a rainy day or were part of their savings and have moved them into assets that they can use for daily purchases of goods and services.

I continue to think this is not a good sign. It is a sign that people are drawing down savings to have cash on hand to pay for daily needs. It is a sign that many people and businesses do not have sufficient income or cash flow to maintain their transaction balances and so have to bring money in from their savings in order to buy food, housing and so forth.

The good new is that bankruptcies and foreclosures are not increasing as fast as they once were.

The bad news is that they are still increasing at close to record rates.

How does this show up in the monetary statistics. Well, currency holdings by the public were increasing in January at a rate, almost 7%, that was roughly twice the rate of a year ago. These year-over-year increases are not near the heights that were reached in the darkest period of the Great Recession, over 11%, but they are high historically.

Demand deposits are also increasing at a fairly rapid pace. The year-over-year rate of growth of demand deposits was about 14% in the fourth quarter of 2010. In January, this figure reached 20%. The highest it reached during the Great Depression was something over 18%.

Note that the growth of the non-M1 part of the M2 measure of the money stock has increased over the past year, but at a very tepid rate. In the fourth quarter of 2010, the year-over-year rate of growth of this component of the M2 money stock measure was slightly over 2%. In January 2011, the year-over-year rate of increase rose to almost 3%, the highest level it had been in several years.

The reason is that the rate of decline in small time accounts and retail money funds slowed dramatically. In the first quarter of 2009, each of these accounts were falling at a 25% rate. In January 2011, the rate of decline in small time accounts was 21% and the rate of decline in retail money funds was around 13%. So, the non-transactions account part of the money stock measures have not declined…have even picked up…but the accounts associated with savings have experience a decline in their rate of decline.

So where are we? About where we have been for two years or so. The Fed keeps trying to push on the accelerator…and the private sector continues to scramble for survival.

What is amazing is that consumer spending and consumer sentiment seem to be picking up. Again, I can only argue that the American society has split. The wealthier, those that are still employed, still live in their own homes, and still have sufficient cash flows are spending. Those that are not fully employed, that have lost their homes or businesses, and those that must rely on their past accumulations of savings are in pretty poor shape. This is the only way I can explain the statistics I see on a daily basis.
JOHN MASON

[flow5]

Inflation: It's Here
by: Econophile February 16, 2011

In an interesting article in the Wall Street Journal's "Numbers Guy" column, it was pointed out that maybe the government's reporting of price inflation is skewed to favor the government. Shocking. He notes that the government keeps fiddling with its methodology:

According to one rogue economist, John Williams at Shadow Government Statistics, if we still calculated inflation the way we did when Jimmy Carter was president, the official inflation figures would look about as bad as they did when ... Jimmy Carter was president. According to Mr. Williams' calculations, if we counted inflation under the old system the official rate wouldn't be 1.5%. It would be closer to 10%.

I follow Shadowstats for price inflation, though I rarely report it. He uses the same methodologies used by the BLS in 1980 and 1990, depending on which chart you select. According to Mr. Williams:

The SGS Alternative CPI-U measures are attempts at adjusting reported CPI-U inflation for the impact of methodological change of recent decades designed to move the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living.

His latest numbers per the 1980 methodology:


shadowstats.com
Compare this to the latest official chart on CPI-U from the BLS and the GDP Price Index which the Fed follows:

This is an important topic because with an expanding money supply, one would expect to see price inflation, yet the official statistics reveal no substantial price increases. And that begs the question: Why not?

Austrian theory commentators, including me, have been saying: just wait and price inflation will happen. Yet, the official statistics were not revealing significant price increases. Austrians say that money expansion, either through the Fed (money base) or the banks (credit creation supported by the Fed), is inflation and that rising prices are an effect of inflation. This theory makes sense because, if the money supply were stable, then if prices rose in one sector of the economy it has to be because of greater demand for those goods relative to the supply. Accordingly, that would leave consumers with less money to spend on other goods, the prices of which would go down. Thus it is a factor of supply and demand for goods in a stable money supply system and not all prices rise, as it does during a price inflation.

On the other hand, assume that the money supply increases overnight by 20% (assume that magically everyone had 20% more dollars the next morning). There is no new wealth created, just more pieces of paper. If everyone goes to buy stuff in the morning, they would bid for scarce resources and drive up all prices for goods, ultimately by 20%. It's not magic; it's simple math.

True inflation, an increase in the money supply, is occurring. This is no surprise to my readers. Here is the latest data on Austrian Money Supply from Michael Pollaro:

Mr. Pollaro states:

The U.S. money supply aggregates based on the Austrian definition of the money supply, what Austrians call the True Money Supply or TMS, continued their recent surge, in December posting an annualized rate of growth of 38.9% on narrow TMS1 and 24.6% on broad TMS2. That brought the annualized three-month rate of growth on TMS1 and TMS2 to 22.3% and 18.1%, respectively, 8.6 bps and 2.7 bps higher than those posted in the prior month. ...

Turning to our longer-term twelve-month rate of change metrics – more indicative of the underlying trends – and focusing on our preferred TMS2 measure, we find that TMS2 saw another healthy increase, in December growing at an annualized rate of 9.9%. Not only was this a tick up from November’s 9.8%, but we think close enough to 10% to mark December as the 23rd time in the last 24 months that TMS2 posted a twelve-month rate of growth in the double digits. For new readers of the Monetary Watch, the last time TMS2 saw this kind of string was during the run up to the now infamous housing boom turn credit implosion, a time during which TMS2 saw 36 consecutive months of double digit growth.

With QE2 underway there is no reason to doubt that this trend will continue.

That is why the ShadowStats data is intriguing. If we measure price inflation by historical methodologies, the rate would be over 8%. If you study the ShadowStats chart you can see that price inflation took off in 2009 about the same time as did QE1 (QE1 expanded dramatically in March 2009), then backed off with the decline in QE and now is moving up again after the announcement of QE2 in September, 2010. This conclusion could, of course, just be confirmation bias or a logical fallacy on my part (post hoc ergo propter hoc), but it does fit into the general Austrian monetary theory: we would expect to see this occur.

I believe we are just starting to see the beginning of price inflation. The data reveals that the main drivers of the CPI at this point are food and oil, and part of those increases are related to supply and demand issues. We all understand the role of OPEC in oil and how they can let short supply chain issues drive up the price of oil. That is occurring now. The same thing is occurring with food where disruptions in production in a short supply chain world (we are just discovering this issue with regard to food) can drive up food prices worldwide.

Supply and demand issues don't account for all of these price increases, but there is no practical way to measure that versus money supply-driven price inflation. The only way to determine it is to look at money supply itself: if money supply expands, we should see other secondary effects besides price inflation.

We should see a rise in the stock market. Since QE goes directly into the pockets of the Fed's primary dealers (the big banks and financial institutions on Wall Street), those companies do what they do best, which is to invest the new money into financial media. Such as the stock market. Since the supply of stocks hasn't grown, it may be that this new money is chasing the stock market and driving it higher. For a discussion of this, please see this article.

We should see a modest increase in consumer spending. While consumer spending as measured by retail sales has been modest (see this chart), I believe much of such spending is coming from upper income folks as a result of the wealth effect of the stock market boom. It isn't coming from middle America since wage growth has been relatively flat, unemployment is still high, and the spending source from this sector has been from savings.

We should see a rather sluggish overall economy because monetary inflation causes the further destruction of real capital (i.e., savings derived from the actual production or services; not dollars from fiat money expansion). Monetary inflation distorts the business cycle, sends the wrong signals to business people, and they embark on projects that will ultimately amount to bad investments based on paper rather than wealth. Real capital is necessary for new economic expansion. Evidence of this lack of real capital is high unemployment, stagnant-to-modest growth, further liquidation of an oversupply of homes and commercial real estate from the last cycle, flat wage growth, lack of credit, and price inflation. All this is occurring now.

I believe this will drive our economy into stagflation: sluggish economic growth and price inflation.

The last time we had stagflation was in the Jimmy Carter/Arthur Burns era. The difference between monetary inflation now and, say the late 1970s and early 1980s as shown in the ShadowStats chart, is that bank credit isn't expanding significantly now, but it was back then. The main source of monetary growth now is from quantitative easing, a rather poor inflationary tool versus fractional reserve bank credit expansion where you have a 10:1 advantage. The Fed is resorting to QE (direct injections of fiat money into the economy by the Fed) only because nothing else has worked for them. While QE does not have as great an impact as bank credit expansion, it does have some impact. It is not possible to inject $2.2 trillion of new money into the economy and not have an impact. Pollaro's calculation of money supply reveals that is does. Even now we are seeing the Fed's measure of M2 money supply expanding, finally.

Price inflation is here.

seekingalpha.com/article/253100-inflation-it-s-here

[vl]

Hi, Flow 5... what's your take on Cotton? Cotton went to $1.90/pound yesterday. Highest price since the Civil War. The latest shipped items from Levi Strauss (China) look like the old cheaply made stuff originally sold at KMart. They aren't real Levi's and they are not a high grade Cotton. I know that the Aegean Sea level is down 20 feet from excessive cotton field irrigation. Wiped out the fishing industry abutting it. Word is- it isn't profitable to make cotton products and ship them to us any longer. They just end up on the Clearance racks for 2+ cycles.

It would take us FOURTEEN years to reconstruct a clothing industry from the ground up.

[flow5]

Can't help you with cotton prices. But world economic growth is accelerating. So cotton prices will participate?

[flow5]

BARRON's - Randall Forysth

The financial markets expect the Federal Reserve to begin tightening monetary policy later this year. Whether they will be right it depends on what's meant by tightening.

This is not a Clintonesque debate over the likes of "what is 'is'?" The stance of Fed policy no longer can be readily defined.

Traditionally, the Fed set its policy in terms of the federal funds rate, the cost of overnight money. That influenced the entire spectrum of interest rates, which, in turn, affects asset values, the cost and availability of credit, and finally, the real economy.

With the fed funds rate pinned at a nearly irreducible minimum of 0-0.25% since the end of 2008, the central bank literally ran out of basis points in its conventional policy tool. Indeed, models such as the Taylor Rule (which calculates an appropriate fed-funds rate based on economic conditions) implied a negative interest rate -- a practical impossibility.

Pressed against the floor for rates, the Fed went further and expanded its holdings of Treasuries in what's been called "quantitative easing." The first phase, set in March 2009, boosted the central bank's securities holdings by $1.7 trillion. That expanded liquidity for the economy since the Fed figuratively prints money to pay for those Treasury purchases. But much of this first phase of QE wound up replacing the emergency credit extensions made in the crisis of 2008-09. In any case, the beginning of QE coincided with the bottom of the stock market, which since has doubled in value.

The second phase, dubbed QE2, called for the purchase of an additional $600 billion of Treasury securities, starting last November and continuing through mid-year. Thus, QE2 has added incremental liquidity to the financial system, which has lifted asset prices, especially for risky ones such as equities, as well as the prices of commodities. In that, QE2 has met its aims.

Now, however, the markets are indicating the Fed has been all too effective, especially in terms of inflation. Thus, they are predicting the first tightening of policy for late 2011.

The financial futures markets (based on Wednesday's closing prices) are discounting an increase in the fed-funds target to 0.5% by November, which would fit the Fed's stated intention of maintaining "exceptionally low" short-term rates for "an extended period."

The futures market also anticipate a full percentage-point rise in the London interbank offered rate, a key money-market benchmark, from the current 0.3% by mid-2012.

Equally telling, the yield on the two-year Treasury note, the coupon maturity most sensitive to expected changes in Fed policy, is up a hefty half-percentage point, at 0.83%, from its lows last fall.

Minutes of last month's meeting of the Federal Open Market Committee released Wednesday showed the central bank's policy-makers were looking for improved economic growth but saw inflation (by their definition) well-contained. As such, the FOMC voted unanimously to maintain its QE2 securities purchases and maintain its fed-funds rate target at extraordinarily low levels.

The Fed sees improvement in the economy everywhere except where it counts, writes Uwe Parpart, chief Asia strategist at Cantor Fitzgerald. That would mean employment and housing, he adds pointedly, which remain under pressure.

Prices, however, are rising under the influence of expansionary monetary policy. The producer price index jumped 0.8% in January and 0.5% even after nettlesome food and energy prices are excluded.

As David Goldman, former head of credit research at Bank of America and currently senior editor at First Things magazine, also observes, the Fed is getting inflation where it doesn't want it (import prices, up 1.5% in January) and deflation where it doesn't, wages and home prices.

The FOMC, for its part, counters that higher commodity prices are being prevented from feeding into inflation at the retail level by the large degree of "slack" (read unemployment), at least as measured by the Fed's favored gauge, the "core" personal consumption deflator, which excludes food and energy, an increasingly dubious proposition.

As noted here previously ("The Bulls Are "All In,"), real-world, real-time prices of goods sold on the Internet tracked by the Massachusetts Institute of Technology are rising at a 2.5% pace, twice the annual rate of increase in the consumer price index, which includes a large swath of services, notably housing costs. Thursday, the Labor Department said the CPI rose 0.4% in January, 0.2% excluding food and energy. On a year-on-year basis, CPI is up 1.2% and 1% on the core measure.

The FOMC noted the public was beginning to doubt the Fed's ability to withdraw the QE2 liquidity, which could feed inflation expectations. As a result, the panel said it would continue to study exit strategies from its massive monetary accommodation.

Thus, the chances of extending the Fed's QE2 purchases are slim to none when they end at mid-year. Indeed, the Fed may be about to embark upon unwinding its QE2 program, which it could do simply by not replacing principal payments on its holdings of mortgage-backed securities. That would passively pare down its portfolio by a few hundred billion dollars per month.

So, what do these arcane questions of monetary policy mean for investors?

As a practical matter, prices of assets, notably stocks, have risen with the rising tide of Fed-supplied liquidity from its $600 billion of securities purchases. Since Fed Chairman Ben Bernanke first floated the notion of QE2 last Aug. 27, U.S. equities have increased 29% in value, worth some $3.7 trillion, according to Wilshire Associates.

Interest rates also have moved, with the benchmark 10-year Treasury note yield up more than a full percentage point, to around 3.60%. In addition to the previously noted jump in the two-year note yield, the five-year note yield has more than doubled from its lows last fall, to 2.30%.

Rising Treasury yields obviously were no impediment to rising stock prices as long as the Fed has been pumping in liquidity, which suggests it's the "quantitative" part of QE that counts most for the markets. Indeed, Bernanke himself said the Fed was responsible for increase in asset prices ("Bernanke Takes Credit for Stocks' Rally, Disavows Commodities' Rise".)

The question for investors to ponder is what happens when the spigot gets turned off after the end of June and, even more, when the draining begins.

[scaredshirtless]

When the spigot gets turned off?

I'll believe it when I see it.

It could happen - if treasury interest rates get too high and out of control.

A little engineered dislocation in the equity market would drive investors back to bonds probably.

See? Ben has lots of options.

[flow5]

I assume to see high rates of interest & collapsing production.

[flow5]

This message has been deleted.

[flow5]

I wanted to offer some clarification on stories about all the money that the Federal Reserve is supposedly printing. It depends, I guess, on your definition of “money.” And your definition of “printing.”

When people talk about “printing money,” your first thought might be that they’re referring to green pieces of paper with pictures of dead presidents on them. The graph below plots the growth rate for currency in circulation over the last decade. I’ve calculated the growth rate over 2-year rather than 1-year intervals to smooth a little the impact of the abrupt downturn in money growth in 2008. Another reason to use 2-year rates is that when we’re thinking about money growth rates as a potential inflation indicator, both economic theory and the empirical evidence suggest that it’s better to average growth rates over longer intervals.

Currency in circulation has increased by 5.2% per year over the last two years, a bit below the average for the last decade. If you took a very simple-minded monetarist view of inflation (inflation = money growth minus real output growth), and expected (as many observers do) better than 3% real GDP growth for the next two years, you’d conclude that recent money growth rates are consistent with extremely low rates of inflation.

swingtradingdaily.com/2011/02/16/money-and-reserves/


Two year growth rate (quoted at annual percentage rate) of currency in circulation. Data source:
FRED.

But if the Fed didn’t print any money as part of QE2 and earlier asset purchases, how did it pay for the stuff it bought? The answer is that the Fed simply credited the accounts that banks that are members of the Federal Reserve System hold with the Fed. These electronic credits, or reserve balances, are what has exploded since 2008. The blue area in the graph below is the total currency in circulation, whose growth we have just seen has been pretty modest. The maroon area represents reserves.




Currency in circulation (blue) and reserve balances with Federal Reserve Banks (maroon), in billions of dollars





Are reserves the same thing as money? An individual bank is entitled to convert those accounts into currency whenever it likes. Reserves are also used to effect transfers between banks. For example, if a check written by a customer of Bank A is deposited in the account of a customer in Bank B, the check is often cleared by debiting Bank A’s account with the Fed and crediting Bank B’s account. During the day, ownership of the reserves is passing back and forth between banks as a result of a number of different kinds of interbank transactions.

To understand how the receipt of new reserves influences a bank’s behavior, the place to start is to ask whether the bank is willing to hold the reserves overnight. Prior to 2008, a bank could earn no interest on reserves, and could get some extra revenue by investing any excess reserves, for example, by lending the reserves overnight to another bank on the federal funds market. In that system, most banks would be actively monitoring reserve inflows and outflows in order to maximize profits. The overall level of excess reserves at the end of each day was pretty small (a tiny sliver in the above diagram), since nobody wanted to be stuck with idle reserves at the end of the day. When the Fed created new reserves in that system, the result was a series of new interbank transactions that eventually ended in the reserves being withdrawn as currency.

All that changed dramatically in the fall of 2008, because (1) the Fed started paying interest on excess reserves, and (2) banks earned practically no interest on safe overnight loans. In the current system, new reserves that the Fed creates just sit there on banks’ accounts with the Fed. None of these banks have the slightest desire to make cash withdrawals from these accounts, and the Fed has no intention whatever of trying to print the dollar bills associated with these huge balances in deposits with the Fed.

Of course, the situation is not going to stay this way indefinitely. As business conditions pick up, the Fed is going to have to do two things. First, the Fed will have to sell off some of the assets it has acquired with those reserves. The purchaser of the asset will pay the Fed by sending instructions to debit its account with the Fed, causing the reserves to disappear with the same kind of keystroke that brought them into existence in the first place. Second, the Fed will have to raise the interest rate it pays on reserves to give banks an incentive to hold funds on account with the Fed overnight.

Doing this obviously involves some potentially tricky details. The Fed will have to begin this contraction at a time when the unemployment rate is still very high. And the volumes involved and lack of experience with this situation suggest great caution is called for in timing and operational details. Sober observers can and do worry about how well the Fed will be able to pull this off.

But that worry is very different from the popular impression by some that hyperinflation is just around the corner as a necessary consequence of all the money that the Fed has supposedly printed.

JAMES HAMILTON

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

Once upon a time legal (required) reserves were a credit control device. No longer. The member banks are no longer reserve constrained. And neither can you say that excess reserves represent unused bank lending capacity. These interbank funds, held at the district Reserve banks, are invested. They are bank earning assets. They are IORs.

Only that tiny amount of interest that accrues at the remuneration rate, is credited to the banks in 15 days after the reserve maintenance period, and actually adds to the effective money supply.

[flow5]

Velocity of money
by James Hamilton on December 21, 2010


I wanted to follow up on Menzie¡¯s recent observations about what¡¯s been happening to the supply and demand for money.

These discussions are sometimes conducted in terms of the following equation:


MV = PY.

Here M is a measure of the money supply, V its velocity, and nominal GDP is written as the product of the overall price level (P) with real GDP (Y). We have direct measurements on nominal GDP. And once we agree on a definition of the money supply (no trivial matter), we have a number for M. But where do we come up with data on this concept of the velocity of money, V?

The answer is, we don¡¯t have independent measures of the velocity of money. So if people talk about velocity as something they could measure, they¡¯re just referring to the value of V that makes the above equation true. That is, we measure the velocity of money from


V = PY/M.

As alluded to above, different people come up with different answers for how we should measure the money supply. One measure is M1, whose key components include currency held by the public and checkable deposits. Another measure is the monetary base, which is currency held by both banks and the public plus deposits banks hold in their accounts with the Federal Reserve. So we could use M1 as the value for M in the above equation, and call the resulting value for V the ¡°velocity of M1¡å. Or we could put the monetary base in for M, and call the resulting V the ¡°velocity of the monetary base¡±. You get the idea¨C use your favorite M to get your favorite V.

Arnold Kling, for example, proposed that we might use for M the quantity of marbles.

Which perhaps sounds a little silly. Even if there¡¯s no particular relation between the quantity of marbles and the stuff we care about (inflation and real GDP), you could still go ahead and use the equation above to define the velocity of marbles. But what you¡¯d find is that when marbles go up, the marble velocity goes down, and it makes no difference for output or inflation.

OK, so let¡¯s look at the velocity of M1. It turns out to look a lot like you¡¯d expect the velocity of marbles to behave¨C when M1 goes up, the velocity of M1 goes down by an almost exactly offsetting amount. Here¡¯s an update of a graph that I presented a year ago:






Top panel: annual growth rate of M1, 1980:Q1 to 2010:Q3. Bottom panel: annual growth rate of the ratio of M1 to nominal GDP. Horizontal line in each figure is drawn at the historical average for that series.






So maybe we¡¯d be better off using the monetary base as our value for ¡°M¡±? I don¡¯t think so.






Top panel: level of monetary base, 1980:Q1 to 2010:Q3. Bottom panel: velocity of base.






Obviously the interest in an equation like MV = PY comes not from using it as a definition of V for some arbitrary choice of M. Instead there must be some kind of behavioral idea, such as that there is some desired value of M1, or monetary base, or marbles, that people want to hold. Suppose it was the case that to a first approximation, this desired quantity was essentially proportional to nominal GDP. If that were true, we would see the graphs of V above behaving roughly as constants instead of simply tracking the inverse of whatever happens to M.

Now, I think it is true that, in normal times, nominal GDP is one of the most important determinants of the demand for M1 or the monetary base. In the absence of other factors changing these demands, there certainly is a connection between money growth and inflation, and you do find a correlation if you look at much longer horizons than the quarterly changes plotted above.

But conditions at the moment are far from normal. In particular, something quite remarkable has happened to the demand for the monetary base. In the current environment, banks have shown themselves to be indifferent between holding reserves (a risk-free way to earn a modest interest rate from the Fed) and making other uses of overnight funds. For this reason, the demand for reserves, and with it the demand for the monetary base, has ballooned without any corresponding changes in output or inflation.

Some people felt I was making a sophistic distinction in emphasizing that the Fed is creating reserves as opposed to printing money ([1], [2]). But I maintain this is a critical distinction. The demand for reserves has increased by a trillion dollars since 2008. The demand for currency held by the public has not. The supply of reserves could therefore increase a trillion dollars without causing inflation. The quantity of currency held by the public could not.

Now, the time will come when banks do see something better to do with these reserves, at which point the Fed will need to take appropriate measures in response, namely a combination of raising the interest rate paid on reserves and selling off some of the assets the Fed has been accumulating. This is of course a key long-term story that we will all be following with interest.

But someone who insists that inflation (P) must go up just because the monetary base (M) has risen may have lost their marbles.


swingtradingdaily.com/2010/12/21/velocity-of-money/

===========

"when M1 goes up, the velocity of M1 goes down by an almost exactly offsetting amount"

This is absolutely wrong. The transactions velocity does not move in concert with income velocity. Income velocity is a contrived figure.

The turnover of money rarely falls, even in recessions. But the number of transactions does. I.e., the volume of money turning over falls. ---- Source: G.6

[flow5]

FRBNY "THE MONEY SUPPLY":

For decades, the Federal Reserve has published data on the money supply, and for many years the Fed set targets for money supply growth.

In the past two decades, a number of developments have broken down the relationship between money supply growth and the performance of the U.S. economy.

In July 2000, the Federal Reserve announced that it was no longer setting target ranges for money supply growth.
In March 2006, the Board of Governors ceased publishing the M3 monetary aggregate.

The Federal Reserve System and public- and private-sector analysts have long monitored the growth of the money supply because of the effects that money supply growth is believed to have on real economic activity and on the price level. Over time, the Fed has tried to achieve its macroeconomic goals of price stability, sustainable economic growth, and high employment in part by influencing the size of the money supply. In the past few decades, however, the relationship between growth in the money supply and the performance of the U.S. economy has become much weaker, and emphasis on the money supply as a guide to monetary policy has waned.

Money Supply Measures
The Federal Reserve publishes weekly and monthly data on two money supply measures M1 and M2. The money supply data, which the Fed reports at 4:30 p.m. every Thursday, appear in some Friday newspapers, and they are available online as well. The Fed publishes measures of large time deposits on a quarterly basis in the Flow of Funds Accounts statistical release.

The money supply measures reflect the different degrees of liquidity—or spendability—that different types of money have. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.

The chart below shows the relative sizes of the two monetary aggregates. In April 2008, M1 was approximately $1.4 trillion, more than half of which consisted of currency. While as much as two-thirds of U.S. currency in circulation may be held outside the United States, all currency held by the public is included in the money supply because it can be spent on goods and services in the U.S. economy. M2 was approximately $7.7 trillion and largely consisted of savings deposits.

Historical Perspective
The Federal Reserve began reporting monthly data on the level of currency in circulation, demand deposits, and time deposits in the 1940s, and it introduced the aggregates M1, M2, and M3 in 1971. The original money supply measures totaled bank accounts by type of institution. The original M1, for example, consisted of currency plus demand deposits in commercial banks. Over time, however, new bank laws and financial innovations blurred the distinctions between commercial banks and thrift institutions, and the classification scheme for the money supply measures shifted to be based on liquidity and on a distinction between the accounts of retail and wholesale depositors.

The Full Employment and Balanced Growth Act of 1978, known as the Humphrey-Hawkins Act, required the Fed to set one-year target ranges for money supply growth twice a year and to report the targets to Congress. During the heyday of the monetary aggregates, in the early 1980s, analysts paid a great deal of attention to the Fed's weekly money supply reports, and especially to the reports on M1. If, for example, the Fed released a higher-than-expected M1 figure, the markets surmised that the Fed would soon try to curb money supply growth to bring it back to its target, possibly increasing short-term interest rates in the process.

Following the introduction of NOW accounts nationally in 1981, however, the relationship between M1 growth and measures of economic activity, such as Gross Domestic Product, broke down. Depositors moved funds from savings accounts—which are included in M2 but not in M1—into NOW accounts, which are part of M1. As a result, M1 growth exceeded the Fed's target range in 1982, even though the economy experienced its worst recession in decades. The Fed de-emphasized M1 as a guide for monetary policy in late 1982, and it stopped announcing growth ranges for M1 in 1987.

By the early 1990s, the relationship between M2 growth and the performance of the economy also had weakened. Interest rates were at the lowest levels in more than three decades, prompting some savers to move funds out of the savings and time deposits that are part of M2 into stock and bond mutual funds, which are not included in any of the money supply measures. Thus, in July 1993, when the economy had been growing for more than two years, Fed Chairman Alan Greenspan remarked in Congressional testimony that "if the historical relationships between M2 and nominal income had remained intact, the behavior of M2 in recent years would have been consistent with an economy in severe contraction." Chairman Greenspan added, "The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place."

A variety of factors continue to complicate the relationship between money supply growth and U.S. macroeconomic performance. For example, the amount of currency in circulation rose rapidly in late 1999, as fears of Y2K-related problems led people to build up their holdings of the most liquid form of money, and then it showed no increase (even on a seasonally adjusted basis) in the first half of 2000. Also, the size of the M1 aggregate has been held down in recent years by "sweeps"—the practice that banks have adopted of shifting funds out of checking accounts that are subject to reserve requirements into savings accounts that are not subject to reserve requirements.

In 2000, when the Humphrey-Hawkins legislation requiring the Fed to set target ranges for money supply growth expired, the Fed announced that it was no longer setting such targets, because money supply growth does not provide a useful benchmark for the conduct of monetary policy. However, the Fed said, too, that "…the FOMC believes that the behavior of money and credit will continue to have value for gauging economic and financial conditions." Moreover, M2, adjusted for changes in the price level, remains a component of the Index of Leading Economic Indicators, which some market analysts use to forecast economic recessions and recoveries.

In March 2006, the Federal Reserve Board of Governors ceased publication of the M3 monetary aggregate. M3 did not appear to convey any additional information about economic activity that was not already embodied in M2. Consequently, the Board judged that the costs of collecting the data and publishing M3 outweigh the benefits.

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

The DIDMCA gave these non-banks the option of becoming commercial banks - but that didn't change how you should define money. But it did loosen the FED's control over money flows.

The current definitions assume there are numerous degrees of “moneyness”. These definitions confuse liquidity with money (money is the “yardstick” by which the liquidity of all other assets is measured). These definitions also ignore the fact that some liquid assets (time deposits) have a direct one-to-one, system accounting, relationship to the volume of demand deposits (DDs), while others affect only the velocity of DDs. The former requires direct regulation; the latter simply is important data for the Fed to use in regulating the money supply.

Aggregate monetary purchasing power is measured by the monetary metric bank debits (our means-of-payment money X's its transactions rate-of-turnover), not Keynes's final product nominal gDp. The proper calculus uses rates-of-change, not absolutes.

[flow5]

Full Speed Ahead
John M. Mason February 18, 2011

The Federal Reserve’s liquidity machine continues “full speed ahead”!

In the banking week ending February 16, 2011, the Fed injected almost $31 billion in new reserve balances into the banking system.

Over the past two banking weeks the Fed has pushed almost $140 billion in new reserve balances into the banking system.

Since the end of 2010 (the banking week ending December 29, 2010) the Fed has increased reserve balances with Federal Reserve Banks by almost $200 billion!

Thus, reserve balances at the Fed, a proxy for excess reserves in the banking system, have increased by a whopping 20% over the past six weeks.

The Federal Reserve is doing to the banking system what it said it was going to do.

In the fall of 2008 and winter of 2009, Chairman Ben Bernanke tossed as much Spaghetti against the wall as he could toss to see what would stick.

It appears that we are not necessarily in the middle of Quantitative Easing 2 (QE2), but are instead in the middle of Spaghetti Toss 2 (ST2)!

The Fed continued to buy more government securities last week, increasing its portfolio by about $23 billion. This supplied reserve funds to the banking system.

The big increase in bank reserves came, once again, in the U. S. Treasury Supplementary Financing Account. (For more on this account and its use see my post.) This account declined by $25 billion for the second week in a row. When this account increases it “absorbs” funds from the banking system. Therefore, when it declines it releases funds into the banking system.

Thus, over the past two weeks when reserve balances rose by almost $140 billion, $50 billion of the increase came from the Fed adding more Government securities to its portfolio and $50 billion came from the Treasury releasing funds to the banking system from its supplementary financing account.

Since December 29 when reserve balances rose by almost $200 billion the Fed bought almost $140 billion in government securities (about $34 billion going to offset maturing mortgage-backed securities), the Treasury reduced its Supplementary Financing Account by $50 billion AND reduced its General Account by almost $35 billion.

This last movement was the usual seasonal swing from the build up in tax revenues toward the end of a calendar year. It still puts reserves into the banking system.

To put things into perspective: Remember back in August 2008, the total reserves in the banking system were $46 billion and excess reserves were less than $2 billion.

Now, within the span of six weeks the Federal Reserve injected into the banking system four times the amount of total reserves that was held by the whole banking system at that time. The wave that is coming looks like it is a part of a Tsunami!

[Virgil Showlion]

It appears that we are not necessarily in the middle of Quantitative Easing 2 (QE2), but are instead in the middle of Spaghetti Toss 2 (ST2)!

Hear hear.

Now, within the span of six weeks the Federal Reserve injected into the banking system four times the amount of total reserves that was held by the whole banking system at that time. The wave that is coming looks like it is a part of a Tsunami!

Curiously appropriate choice of words, wouldn't you say?

[flow5]

MONTHLY MONEY STOCK MEASURES
Daily Average, in billions % CHANGE

Seasonally adj ann rates

..............................3-mth......6-mth.......12-mth
M1 SA..................15.6.........14.2.........10.3

SMOKIN!

Real money is defined as the rate-of-change in the growth of money vs. the rate-of-change in the growth of inflation. The GAP is growing. Historically, a growing GAP has coincided with rising stocks.

[flow5]

The authority to pay interest on reserves is likely to be an important component of the future operating framework for monetary policy. For example, one approach is for the Federal Reserve to bracket its target for the federal funds rate with the discount rate above and the interest rate on excess reserves below. Under this so-called corridor system, the ability of banks to borrow at the discount rate would tend to limit upward spikes in the federal funds rate, and the ability of banks to earn interest at the excess reserves rate would tend to contain downward movements. Other approaches are also possible. Given the very high level of reserve balances currently in the banking system, the Federal Reserve has ample time to consider the best long-run framework for policy implementation. The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

www.federalreserve.gov/newsevents/testimony/bernanke20100210a.htm#fn9

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

The Financial Services Regulatory Relief Act of 2006 authorized the Federal Reserve banks to pay interest on reserve balances and gave the Board of Governors authority to lower reserve requirements on all transaction deposits (applied to deposits above a certain threshold level) to as low as zero percent, from their previous minimum top marginal requirement ratio of eight percent. These changes are not effective until October 2011.

[flow5]

JOHN MASON:

Since the end of December 2010 (the banking week ending December 29, 2010), the Federal Reserve has injected almost $200 billion in new reserve balances into the banking system. (See my post of December 18 here.)

Since the end of December 2010 (the banking week ending December 29, 2010), cash assets at commercial banks have risen by more than $280 billion.

Since the end of December 2010 (the banking week ending December 29, 2010), cash assets at foreign-related banking institutions in the United States have risen by more than $175 billion.

In addition, trading assets at these foreign-related banking institutions have risen by $33 billion and a catch-all asset account has risen by $12 billion. (This catch-all account includes things like loans to foreign banks, loans to nonbank depository institutions and loans to nonbank financial institutions.)

All together the accounts at these foreign banking organizations have risen by about $220 billion in the last six weeks, about $30 billion more than the total assets of these foreign-related banking institutions have increased. One could argue that the foreign-related banking institutions are doing pretty well by the quantitative easing that the Federal Reserve is conducting. These foreign-related organizations seem to be doing a lot of trading!

During this same time period, the total assets of large domestically chartered commercial banks in the United States have declined slightly. The total assets of small domestically chartered commercial banks rose by about $30 billion.

Also, during this time period, cash assets at the largest 25 domestically chartered banks rose by more than $72 billion and the cash assets at all other domestically chartered banks rose by $38 billion.

Thus, the Fed's QE2 is getting the cash out into the banking system. However, almost two-thirds of the cash seems to be going to foreign-related organizations and not to domestically chartered commercial banks.

Is this what was supposed to have happened?

Over the past 14-week period, cash assets in the banking system have risen by almost $300 billion. Again, over two-thirds of the increase (about $205 billion) came in the cash assets of the foreign-related banking institutions. All of the increase in cash holdings at the largest 25 banks came after December 29, 2010, while cash assets holdings in the rest of the banking system fell in the period before December 29 before rising in the last 6-week period.

One would think that this distribution of cash would not bode well for domestic lending. And, in fact, bank lending was abysmal over the past 6-week period and the last 14-week period.

Since the end of the year, loans and leases at the largest 25 domestically chartered banks in the United States dropped dramatically by about $50 billion, much of this coming in consumer lending although loan amounts were down across the board. Loans and leases held roughly constant in the eight weeks that preceded December 29 at these large banks.

In the rest of the banking system, the declines in the loan portfolio came primarily before the end of the year. After falling by about $60 billion in November and December, loans at these institutions rose slightly in the first six weeks of 2011. Notable decreases came in both residential lending and in commercial real estate loans, each declining by a little more than $20 billion over the last 14-week period.

One interesting thing also appeared in the recent statistics. The securities portfolio of the banking system declined over the latest 14-week period by a little less than $40 billion.

However, there were huge differences in the behavior of the largest banks and the smaller banks.

The largest banks REDUCED their holdings of securities by about $96 billion; $67 billion of the total were in U. S. Treasury and Agency securities.

The rest of the domestically chartered commercial banks INCREASED their holdings of securities by almost $60 billion with a $63 billion increase in their holdings of U. S. Treasury securities.

The larger banks got out of securities as interest rates rose through November, December, and January. The smaller banks increased their securities. Is this bad timing on the part of the smaller banks?

So, here we are with the Federal Reserve pumping reserves into the banking system like crazy. But two-thirds of it is going to foreign-related banking institutions? And commercial bank lending continues to contract? What is wrong with this picture?

I am feeling such a disconnect between Ben Bernanke’s view of the world and what seems to be going on in the world. When Mr. Bernanke speaks, I really wonder what planet he is on…it certainly doesn’t seem to be the one that I am on.

Also, I am getting tired of Mr. Bernanke putting the blame for all his troubles on the backs of others. He began this practice in the early 2000s and it continues on today. He doesn’t accept the fact that some of the mistakes of the past are his. As Stephen Covey has said, if all the blame for the problems one faces is “out there”, that’s the problem.

[lifewasgood]

Good read Flow. Sounds like more fleecing of America to me.

[flow5]

Rates bottomed on 8/31/2010. The monetary transmission mechanism is not QE2, it is via interest rates. Thus the degree of ease or restraint is related to the changing portion of the yield curve covered under the remuneration rate’s umbrella.

The higher rates become, the looser policy becomes (as the portion of the yield curve which is lower than the remuneration rate @.25% continues to shrink). I guess you could call that fractional yield-curve banking.

I.e., QE2 is not a neutral monetary policy. It is an increasingly easier monetary policy. The banks are not reserve constrained. As long as it is profitable for borrowers to borrow, & lenders to lend, money creation is not self-regulating. That's why the Great-recession is called a balance-sheet recession.

[flow5]

February 23, 2011
Mises Daily

What's Behind the Currency War?
by Antony P. Mueller on February 23, 2011

In September 2010, a short time before the international financial summit of the Group of Twenty (G20) took place in South Korea, Brazilian finance minister Guido Mantega declared that the world is experiencing a "currency war" where "devaluing currencies artificially is a global strategy."

By announcing the outbreak of a "currency war," Mantega wanted to draw attention to the problems caused by the ongoing exchange-rate manipulations that governments put in place in order to gain economic advantages. In this sense, "currency war" denotes the conflict among nations that arises from the deliberate manipulation of the exchange rate in order to gain international competitiveness by way of currency devaluation.

Competitive Devaluation
Calling competitive devaluation a "war" may seem like a gross exaggeration. Yet in terms of its potential of destruction, the current global financial conflict may well rank at a level similar to that of a real war.

In a wider historical perspective, the current currency war is the latest conflict in a series of acute crises of the modern international monetary system. In a world of national monetary regimes based on fiat money without physical anchors, domestic monetary instability automatically transforms into exchange-rate instability. As before, the current crisis of the international economic order is mainly the result of monetary fragilities coming from the unsound national monetary systems and reckless domestic monetary and fiscal policies.

The immediate cause of the currency war entering an acute stage is the policy of massive quantitative easing practiced by the US central bank. Whatever the original intention of this policy may have been, the consequences of the Fed's measures include monetary expansion, low interest rates, and a weaker US dollar. With dollar interest rates approaching the "zero bound," the United States is joining Japan in the effort to stimulate a sluggish economy with massive monetary impulses.

Until recently, the currency war was contained as a kind of financial cold war. The conflict entered its hot phase as a result of the expansive monetary policies that were put in place in the wake of the financial-market crisis that began in 2007. In defiance of the fact that the financial crisis itself was the result of the extremely expansive monetary policies in the years before, many central banks have now accelerated monetary expansion in the vain attempt to cure the disease with the same measures that had caused it in the first place.

Easy Money and International Financial Flows
What has emerged in the global financial arena over the past couple of years is the interplay among easy money, low interest rates, international trade imbalances, financial flows, and exchange-rate manipulations. The failure of attempts to cure overindebtedness with more debt, and to stimulate weak economies by giving them interest rates as low as possible, provokes a repetitive pattern of bubble and crash where each phase ends in a higher level of government debt.

A global search for higher yields has been going on not unlike what happened in the late 1960s and 1970s, when the United States inflated and the countries that had linked their exchange rates to the US dollar suffered from imported inflation. Nowadays, the formal dollar-based fixed-exchange-rate system no longer exists. It has been replaced by a system that sometimes is called "Bretton Woods II": a series of countries, particularly in Asia this time, have pegged their exchange rates (albeit without a formal agreement) to the US dollar.

If a country wants to slow down the appreciation of its exchange rate that comes as a consequence of the financial inflows from abroad, it must intervene in the foreign-exchange markets and monetize at least a part of the foreign exchange. This way, the monetary authorities will automatically increase the domestic money stock. Additionally, under this system relatively poor countries feel forced not only to buy the debt issued by the relatively wealthy countries like the United States but also to buy these bonds at their current extremely low yields.

Under current conditions, the monetary expansion gets globalized and invades even those countries that wish to practice restrictive monetary policy. Relatively high levels of the interest rate improve the restrictive currency's attractiveness. Thus, more and more monetary expansion happens on a global scale, which in turn provides the fuel for the next great wave of international financial flows.

The weaker countries, which compete with each other on the basis of low prices, are getting pushed to the side; it was just a matter of time until more and more governments would begin to intervene in the foreign-exchange markets by buying up foreign currencies in order to try to prevent their exchange rates from appreciating too much, too fast.

Yet using the exchange rate as a tool in order to gain economic advantage or avert damage for the domestic economy is inherently at variance with a sound global monetary order, because one country's devaluation automatically implies the revaluation of another country's currency and thus the advantage that one tries to obtain will be achieved by putting a burden on other countries.

Escalation
By recycling the monetary equivalent of the trade surplus into the financial markets around the globe, monetary authorities in surplus countries form a symbiosis with trade-deficit countries in fabricating a worldwide monetary expansion of extreme proportions.

"Once again, the international monetary system is on the brink of a breakdown."
The paradoxical, or rather perverse, features of the current state of affairs were highlighted a short time ago when in January 2011 the monetary authorities of Turkey decided to lower the policy interest rates so as to make the inflow of foreign funds less attractive, despite a booming Turkish economy that shows plenty characteristics of a bubble.

Exchange-rate policies produce the usual spiral of interventionism: the de facto consequences tend to diverge from the original intentions, prompting further rounds of doomed interventions. This interventionist escalation is not only limited to an incessant repetition of the same failed policies, but the errors committed in one policy area also affect other parts of the economy. Thus, it is only a matter of time until errors of monetary policy lead to fiscal fiascos, and exchange-rate interventions lead to trade conflicts.

At first sight, exchange-rate intervention may appear tolerable as the legitimate pursuit of national self-interest. But exchange-rate policies are intrinsically matters that tend to stir transnational controversies. When a country's exchange rate policy collides with the interests of the trading partners, the tit-for-tat of mutual retaliation automatically tends to lead to an escalation of the conflict. Once the process of competitive devaluation has started, a devaluation by one country invites other countries to devaluate their exchange rates as well. As a consequence, the international monetary order will eventually disintegrate, and sooner or later the conflict will go beyond currency issues and affect a wide spectrum of economic and political relations.

Therefore, because of the unsound monetary system, a peaceful international political system also is constantly at risk. Monetary conflicts provoke political confrontations. Besides the immediate costs of exchange-rate conflicts that come from the damage to international trade and investment, and thereby to the international division of labor, harm will also be done to confidence and trust in the international political arena.

The dispute about exchange rates is the consequence of contradictory tensions that are innate to the modern monetary system. In this respect the currency war is an expression of the defects that characterize an unsound and destructive financial system. The outbreak of the currency war is a symptom of a deeply flawed international monetary order.

Brazil
When Brazil's finance minister repeated his warnings in January 2011 and said that "the currency war is turning into a trade war," Mantega sent a signal to the world that the escalation of the trade war had started. Because of the massive inflow of money from abroad, the Brazilian currency had sharply appreciated and the Brazilian economy was losing competitiveness.

In order to reduce the impact on is domestic economy, Brazil had been intervening in the foreign-exchange markets, diminishing the degree of currency appreciation. In doing so, the monetary authorities had to buy foreign currencies, mainly US dollars, in exchange for its domestic money.

The Mises Wiki
By pursuing such a policy over the past couple of years, Brazil has increased its foreign-exchange reserves from around 50 billion to 300 billion US dollars.[1] Yet even despite these foreign-exchange interventions, the Brazilian currency appreciated drastically against the US dollar and other currencies.

By various estimates, Brazilian foreign trade suffers from an exchange-rate overvaluation of around 40 percent. As a consequence, Brazil's current account balance, which was still at surplus in 2007, has plunged into a deficit of 47.5 billion US dollars in 2010.[2] At the same time when an artificial boom is taking place as the result of massive monetary expansion, the Brazilian economy suffers from creeping deindustrialization.[3]

Part of the explosion of Brazil's current-account deficit can be explained by weak demand from its trading partners, which have plunged into a prolonged recession. Yet beyond this circumstance, there has been another causal chain at work: the inflow of funds from abroad that boosts the exchange rate provides the grounds for an exorbitant increase of the country's monetary base.[4]

The combination of ample liquidity at home, weak demand from some trading partners abroad, and a strong exchange-rate appreciation provides the basis for an extreme import expansion that vastly exceeds exports. Unlike a country such as Germany, for example, whose industry is pretty resilient against currency appreciation, Brazil resembles in this respect the countries of the Southern periphery of the eurozone in its incapacity to cope effectively with an overvalued currency.

When, in January 2011, a new government took power in Brazil, the newly-elected president, Dilma Rousseff, declared in her inauguration speech that she will protect Brazil "from unfair competition and from the indiscriminate flow of speculative capital." Guido Mantega, the former and new Brazilian finance minister, did not hesitate to join in when he asserted that the government has an "infinite" number of interventionist tools at its disposal with which to protect national interests. Mantega said that the government is ready to use taxation and trade measures in order to stop the deterioration of Brazil's trade balance.

China
The countries that form the favored group that gets targeted by international financial flows in search of higher yields compete among themselves in order to prevent their currencies from appreciating too much, and as a group these countries compete against China in their efforts to maintain a competitive exchange rate.

China's position forms part of a long causal chain, which includes low interest rates and monetary expansion in the United States, that fuels higher import demand. Given that China drastically devalued its exchange rate as early as in the 1980s, this country was at the forefront of gaining advantage of America's import surge; China grabbed the golden opportunity to turn itself into the major exporter to the United States.

In order to maintain its currency at its undervalued level, the Chinese monetary authorities must buy up the excess of foreign exchange that accumulates from its trade surplus, preferably by buying US treasury notes and bonds. In this way, China became America's main creditor. Over the past decade, China increased its foreign exchange position from a meager $165 billion in 2000 to an amount that was approaching $3 trillion at the end of 2010.

From the 1980s up to the early 1990s, China devalued its currency from less than 2 yuan to the US dollar to an exchange rate of 9 yuan against the US dollar. And despite its huge trade surpluses, China has only slightly revalued the yuan ever since, establishing the current exchange rate at 6.56 yuan per US dollar.

Over the past decade, China has become the major financier of the US budget deficit. Together with other monies flowing in from abroad, the US government was relieved from the need to cut spending. The inflow of foreign capital also allowed the US government to pay lower interest rates for its debt than it would have if only domestic supply of savings were available. Foreign imports put pressure on the price level, and the US central bank could continue monetary expansion without an immediate effect on the price-inflation rate.

If China wants to hold its competitive position through an undervalued currency, the Chinese monetary authorities must continue their policy of intervention in the foreign-exchange markets. As a consequence of buying dollars from its exporters, the domestic money supply in China continues to rise, throwing additional fuel on a domestic boom that is already in full swing.

Even more so than their Brazilian counterparts, China's political-decision makers have failed to exert moderation or restraint when it comes to interventionist measures. As long as China's leadership presumes that it gains from exchange-rate manipulation, its currency interventions will go on.

Global Financial Fragilities
Since the abandonment of the gold standard, the global financial system has been in disarray. All the international monetary arrangements that have been established since then have ended in crisis and finally collapsed. For almost a hundred years now, one interventionist scheme has been established and then soon fallen to pieces.

When the monetary and fiscal decision makers in the United States and Europe discarded all restraints against intervention in the wake of the financial market crisis, socialist and interventionist governments around the globe felt vindicated. They had long been convinced that only through state control could financial stability be obtained. Due to the policies adopted by Western countries in their futile attempt to overcome the financial-market crisis, the leaders of the so-called emerging economies have become even more unscrupulous interventionists.

Political leaders around the globe have shed the little that was left of support for free markets and set the controls for a way back on the road to serfdom.

It is mainly due to ignorance that the modern monetary system gets labeled as a laissez-faire or free market system. In fact not only the basic "commodity" of this scheme, i.e., fiat money, but also its price and quantity are largely determined by political institutions such as central banks.

It is more than absurd when, in the face of crises and conflicts, more government intervention gets called upon: it was state intervention in the first place that laid the groundwork for the trouble to appear.

So-called "speculative" international capital flows already happened decades ago. What has changed since then is the amount of hot money and the speed with which it floats around the world. It would be wrong to describe these financial movements as an expression of free markets. The fact, for instance, that in 2010 daily transactions on the international currency market have reached a volume of four trillion US dollars is the result of unhampered fiat-money expansion and massive state intervention in the foreign-exchange markets.

The increase in the global money supply that has been going on for many years finds its complement in a global asset boom. The inflation of money drives up the price of precious metals, natural resources, and food. Once more, the world experiences a period of fake prosperity not much different from the real-estate bubble, and many other episodes, that led to previous financial crises.

sn117w.snt117.mail.live.com/default.aspx?wa=wsignin1.0

[lifewasgood]

The last paragraph summed it up very well.

[flow5]

Higher oil prices translate into higher trade deficits all of which depresses the exchange value of the dollar, sending all import prices higher - i.e., a reinforcing cycle of stagflation.

& who wants to buy treasuries if you lose a lot of money on dollar conversion?

[flow5]

ZEROHEDGE" The US Treasury completed the latest ponzi shuffling of Treasuries to Primary Dealers (who will shortly send it all back to the Fed, pocketing a few hundred million in bid/ask spreads and commissions in the process), selling $35 billion in 5 Year bonds at a 2.19% high yield, the highest since April 2010. The internals, as has lately been the case, were not pretty.

The bid to cover was 2.69 compared to 2.97 previously and 2.76 LTM average. Directs took down just 7.7%, as it now becomes obvious that the "UK" is no longer gobbling up bonds, and we expect the UK-bond build up as per TIC will stop in a month or two tops.

Indirects also took down less than average, as foreign banks purchased just 34.2% of the auction, compared to 41.5% on average. Which of course means that PDs had to step into save the day: at 58.2%, PDs took down the highest amount since July 2009.

Lastly, the auction prices about 2 bps wide of the when issued. That we could have such a weak auction in a day when risk is surging, is a stunner. Have gold and silver (and the CHF) finally become the widely accepted new risk avoidance products, instead of the USD and the UST? If so, that is a far bigger revolution than anything happening in the Maghreb now.

[neohguy]

This was printed on ZH today. I wish I could find the supporting article:
www.zerohedge.com/article/and-wow-feds-hoenig-says-united-states-has-deeply-undermined-free-market-capitalism
And Wow: Fed's Hoenig Says United States Has "Deeply Undermined Free-Market Capitalism"
* HOENIG SAYS U.S. HAS `DEEPLY' UNDERMINED FREE-MARKET CAPITALISM
* HOENIG WARNS OF ESCALATING SERIES OF CRISES WITH RISING COSTS
* HOENIG: LARGE FINANCIAL FIRMS CAN EXPECT BAILOUTS IN FUTURE
* HOENIG SAYS BIG FINANCIAL FIRMS MUST NOT HOLD ECONOMY `HOSTAGE'
* HOENIG: LARGE FIRMS WERE `GAMING' CAPITAL STANDARDS PRE-CRISIS
* HOENIG:BIG FIRMS `HAVE SIGNIFICANT INCENTIVES' TO INCREASE RISK
* HOENIG: TOO-BIG-TO-FAIL FIRMS POSE `GREATEST RISK' TO ECONOMY
* HOENIG SAYS BIG FINANCIAL FIRMS ENJOY `HUGE' FUNDING ADVANTAGE

And the last one:

* FED'S HOENIG SAYS `HISTORY IS ON MY SIDE'

[bimetalaupt]

Feb 23, 2011 15:20:34 GMT -5 @neohguy said:

This was printed on ZH today. I wish I could find the supporting article:
www.zerohedge.com/article/and-wow-feds-hoenig-says-united-states-has-deeply-undermined-free-market-capitalism
And Wow: Fed's Hoenig Says United States Has "Deeply Undermined Free-Market Capitalism"
* HOENIG SAYS U.S. HAS `DEEPLY' UNDERMINED FREE-MARKET CAPITALISM
* HOENIG WARNS OF ESCALATING SERIES OF CRISES WITH RISING COSTS
* HOENIG: LARGE FINANCIAL FIRMS CAN EXPECT BAILOUTS IN FUTURE
* HOENIG SAYS BIG FINANCIAL FIRMS MUST NOT HOLD ECONOMY `HOSTAGE'
* HOENIG: LARGE FIRMS WERE `GAMING' CAPITAL STANDARDS PRE-CRISIS
* HOENIG:BIG FIRMS `HAVE SIGNIFICANT INCENTIVES' TO INCREASE RISK
* HOENIG: TOO-BIG-TO-FAIL FIRMS POSE `GREATEST RISK' TO ECONOMY
* HOENIG SAYS BIG FINANCIAL FIRMS ENJOY `HUGE' FUNDING ADVANTAGE

And the last one:

* FED'S HOENIG SAYS `HISTORY IS ON MY SIDE'

Yes and the the Federal Reserve Pays him almost two time what they pay Ben B.!! You get what you pay for!!

Hoenig joined the Federal Reserve Bank of Kansas City in 1973 as an economist in the banking supervision area. He was named a vice president in 1981 and senior vice president in 1986.

According to Fed salary figures released for 2010, Hoenig earns $374,400 per year, in the mid-range for the twelve regional bank chairs and considerably more than Fed chair Ben Bernanke ($199,700), whose pay is limited by law.[3]
HOENIG WANT TO PAY SAVERS MORE AND RAISE M2.. HE IS CORRECT AND CORRUGATES
He has served as an instructor of economics at the University of Missouri-Kansas City and lectured on the U.S. banking and regulatory system for the People's Bank of China. Dr. Hoenig is a member of the Board of Trustees of the Ewing Marion Kauffman Foundation and serves on the boards of directors of Midwest Research Institute and Union Station.
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[neohguy]

Thanks Bruce.

[vl]

Currency Wars...

Starting into 4th Quarter 2010, I started seeing a ramp-up in foreign sales and tracked them. It didn't take long to validate that when the US Dollar dropped against other currencies, I saw an increase in sales from that country. From zero to about 30% sales from the likes of Brazil, Chile and Ecuador on such days. Greece, Czech Republic, Russia, Norway, Sweden and France on an opposing dollar drop-off day. Since the start of 2011, those "days" happen more frequently and with greater consistency. Last Saturday (so, Friday's currency rates) were so favorable for foreigners that 85% of my sales were Europe and South America.

[neohguy]

Feb 24, 2011 7:43:10 GMT -5 @vl said:

Currency Wars...

Starting into 4th Quarter 2010, I started seeing a ramp-up in foreign sales and tracked them. It didn't take long to validate that when the US Dollar dropped against other currencies, I saw an increase in sales from that country. From zero to about 30% sales from the likes of Brazil, Chile and Ecuador on such days. Greece, Czech Republic, Russia, Norway, Sweden and France on an opposing dollar drop-off day. Since the start of 2011, those "days" happen more frequently and with greater consistency. Last Saturday (so, Friday's currency rates) were so favorable for foreigners that 85% of my sales were Europe and South America.

Interesting information V_L. Some yahoo on CNBC was creaming his jeans last week because the US had moved 31,000 carloads of iron ore ytd, a 63% increase vs 2010. What he didn't say, or didn't know, was that Canada consistently moves over twice as many cars. Their shipments of ore are down 7.5%. It has nothing to do with the actual economy of either nation. It's all due to currency manipulation.

[flow5]

WSJ - online.wsj.com/article/SB10001424052748704520504576162322026133298.html?mod=googlenews_wsj

Oil prices are rising. Food prices are up. The world economy is gaining momentum. Central banks, still fighting aftereffects of the financial crisis, are keeping interest rates low. Is an outbreak of U.S. inflation around the corner?

Federal Reserve Chairman Ben Bernanke says it isn't. It's hard to sustain inflation with so many people out of work and so many offices, stores and factories empty, he reasons. Plus he sees no big rise in "inflation expectations," the wage and price increases that business executives, consumers, workers and investors anticipate.

"Inflation expectations remain well anchored," Fed officials concluded confidently at their last meeting, minutes show, despite obvious inflationary threats abroad. Translation: Food and energy price increases won't prompt higher wages and prices throughout the U.S., partly because people don't think they will.

The notion is that if we all expect inflation, we'll seek higher wages, prices and rents, and that will produce the inflation we expect. Conversely, no matter what's happening in Libya or grain markets, no matter how much yelping about commodity prices squeezing profit margins, if we all believe the Fed won't permit inflation to take off, it won't. Call it the Tinker Bell school of economics.

This actually was an improvement in economic thinking. Fifty years ago, economists assumed people expected future inflation to match the recent past. Then came a generation of economists arguing that people are smarter than that: Their expectations change when the world does. (If it usually takes you 20 minutes to get to work, and you hear one lane will be closed for construction, you'll leave earlier.)

So central bankers began tracking inflation expectations. It seemed smarter than steering the economy by looking in the rear-view mirror of last month's consumer price index. "The state of inflation expectations," Mr. Bernanke said in a 2007 lecture, "greatly influences actual inflation and thus the central bank's ability to achieve price stability."

Managing inflation expectations became part of a central banker's job—with substantial success. As Goldman Sachs wrote in a recent note, food and oil price spikes in the mid-1980s led to large, persistent increases in economy-wide inflation. Lately, they haven't. "[T]he most likely explanation for this change...is the improved anchoring of inflation expectations since the mid-1980s," Goldman's Sven Jari Stehn wrote.

It sounds comforting, but there are a few rubs.

One is that inflation expectations are easier to define than to measure precisely.

The Federal Reserve Bank of Philadelphia surveys professional forecasters quarterly. They see a spike in inflation this quarter on higher food and energy prices, but over the next decade see 2.3% annual consumer-price-index inflation, a bit below forecasts they have made over the past decade.

Consumers aren't so relaxed, perhaps because they focus more on gasoline and groceries. The University of Michigan/Reuters survey found, on average, that consumers expect prices to rise 3.4% over the next year, faster than they did a year earlier. But the five-to-10-year outlook, which the Fed watches, is stable at about 2.9%.

Alas, there is no reliable inflation-expectation survey of business decision-makers. But in a 1992 survey by Princeton economist Alan Blinder, half the businesses said they "never take economy-wide inflation into account" in setting prices.

An alternative is to look to financial markets. To gauge their expectations, compare yields on Treasury debt that pays interest at a fixed rate, say 3.5% for 10 years, with yields on debt that adjusts so the return rises with the Consumer Price Index. The late economist Milton Friedman liked this measure so much, he proposed that Congress require the Fed to target it. But this gauge can be hard to read, particularly in a financial crisis in which jittery investors flock to the most liquid Treasury securities—conventional ones—and shy away from inflation-protected securities.

At face value, this measure suggested a late-2008 deflation scare that has abated. Inflation expectations now are back at pre-crisis levels, hardly a warning of danger. A more complicated dissection of markets by the Cleveland Fed finds a steady decline in inflation expectations over the past 20 years and now see inflation of just 1.8% over the next decade.

The other rub is that inflation expectations are "anchored"—until they're not. They may change faster than the Fed responds. "The tricky issue is forecasting whether inflation expectations might change," says Joel Prakken of Macroeconomic Advisers, whose model uses inflation expectations to help forecast inflation. "They have been remarkably steady for more than a decade. Presumably this is related to Fed credibility, but it also might be that we've been lucky not to have the big inflation shocks we suffered in the '70s and '80s."

Not so long ago falling inflation expectations at a time of low inflation had the Fed worrying about much-dreaded deflation. That moment has passed. Now, the central bank faces a two-fold challenge: To avoid being stampeded into tightening credit prematurely by the uproar over food and energy prices while also avoiding complacency bred by overreliance on measures of inflation expectations.

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The upward administration in the price of petroleum products in the short-run is deflationary because those products are highly inelastic.

Only price increases generated by demand, irrespective of changes in supply, provide evidence of monetary inflation.

And Feb. Treasury prices are dominated by a demand side factor - a seasonal decline in monetary flows.