Fed Watch Thread

[scaredshirtless]

Interesting Flow. From Institutional Risk Analytics

us1.institutionalriskanalytics.com/pub/IRAMain.asp

An Excerpt:
The lack of awareness at the top in Washington extends beyond foreign policy to the state of the US economy. As we've noted in recent missives for The IRA Advisory Service, the visible volume of business flowing through the bank consumer channel seems to be receding or maintaining low levels. The commercial channel at most banks we hear from is still running at 1/3 to 1/2 of pre-2008 levels in terms of new originations and demand for credit. This is why when clients ask us about whether we worry more about inflation or deflation, our answer is "both." The chief worry bead remains revenue flowing through banks, housing and the US economy.

The invisible recession in terms of Main Street business volumes is also what drives our caution as to the selective economic "recovery" that is now supposedly underway and how this will or will not affect certain asset classes. The various expedients used by the Obama Administration to paper over remaining problems in the banking sector and wider economy in 2010 may not carry us even part way through 2011.
End excerpt.

Flow of transactions through the bank system sounds like it is running counter to "things getting better".

[flow5]

Scared_Shirtless:

"new originations and demand for credit"

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

Yes, I think if you parsed the composition of commercial bank assets you will find that bank credit hasn't moved much, but that instead, the CBs hold a larger portion in governments, rather than private sector loans & investments. That can't be good. Fiscal policy multipliers have lower employment generating numbers.

I also think that must have been a consideration with QE2, the thinking being that if the Reserve bank got the governments out of the commercial banks, then the CBs would replace the cash they received with new business & consumer loans & investments (i.e., shift the percentage of public to private held assets).

But with Treasury financing at comparable QE2 levels, & no change in the mix, the banks must be avoiding risk, and or, loan demand is slack.

[neohguy]

Biggest banks must be broken up, Hoenig says PDF Print E-mail
Thursday, 24 February 2011 00:00
The systemic risks to the U.S. economy from the biggest U.S. banks are even worse in the wake of Washington efforts to reform the regulatory system, said Thomas Hoenig, the president of the Kansas City Fed, on Wednesday.
“In spite of all that’s been done and debated, the soundness of the largest financial institutions and the systemic risks they continue to pose...is even worse than before the crisis,” Hoenig said in a speech to a finance group in Washington.
Federal regulators must now turn their attention to breaking up the biggest banks, Hoenig said.
Hoenig’s call is likely to fall on deaf ears. The Kansas City Fed president is often a maverick at the central bank. His message is in sharp contrast to the views of Fed Chairman Ben Bernanke, who has said that regulation has made great strides with the Dodd-Frank act. Moreover, the new Congress, led by Republicans, has been seeking to slow implementation of Dodd-Frank.
Hoenig said that the biggest banks should be broken up by expanding the Volcker rule to carve out business lines that are not essential to the basic business of commercial banking.
He argued that these separate parts of most too-big-to-fail firms might add up to a value much larger than each firm in its entirety.
“If action isn’t taken to scale down the biggest banks, we’ll have a bigger crisis in the future,” he said.The top five U.S. banks now have 52% of all banking industry assets, Hoenig said, up from 38% in 1999.
The growth of these banks has hurt the recovery, he said. Normally market forces would steer funds from troubled institutions to strong banks.
But the opposite has occurred coming out of this crisis.
“Too many dollars appear stuck in institutions that must restore capital and work through bad asset problems before they can think of pursuing new lending opportunities,” Hoenig said.
Hoenig said he supported the Dodd-Frank reforms that increase supervision and capital standards for the biggest banks and also the development of a resolution policy. But he said that policymakers would remain under enormous pressure to bail out a big bank to avoid damaging the economy.
Investors and large financial institutions “have little doubt” that these firms will be bailed out again, he said.Separately, Hoenig repeated a call for the Fed to raise interest rates, “sooner rather than later,” citing rising asset prices. He said interest rates needs to rise before the unemployment rate falls to 5%, from a current 9%.

[vl]

All he did, NEOH... is reiterate my last several letters to the POTUS. Never look at the forest without first examining the individual trees. In this case, public housing records are in shambles. Quiet titling may be prudent right now but it's uninsurable and does not have a Statute of Limitations. If in fact (because I can be factual here), somebody appears in 2016 with the deed to the home purchased by somebody else in 2011 as an REO and says PROVE that there was a mortgage on it when [the bank] foreclosed, and they cannot... guess who gets the house back that instant?
Bank of America can't even find its own internally shuffled paper from one shell entity to another. Face it, Chase is a racket, not a bank and it no longer has the type of personnel who can speak without violating statutes and laws associated with past abuse.

Historians know what makes a recovery. Its when someone knows Risk well enough to ascertain when a commonly overlooked segment of asset has enough stability to rely on a valuation validation means and prospective borrowers respect what it is well enough to be beholden to the obligation. They also know that no bank ever led that charge... they only follow and undermine the pacesetter. the bank you deal with, NEOH, likely has a non-banker with strong Risk skills at or influencing the decision-maker.
Here in Michigan, we are growing another toxic failure in First Michigan Bank by letting it absorb all of our community banks. For a fact, we need RELIEF for small banks and a complete divestiture of anything beyond single-state boundaries. We also need more types of credit providers and equal opportunity at the Fed Funds window and BIDDING not STEERING from Wall Street.

All they did was to eliminate people who know this stuff in their sleep, counting on quantity to negate quality's necessity. They were absolutely wrong.

[flow5]

WASHINGTON (MNI) – St. Louis Federal Reserve Bank President James

Bullard said Thursday the Fed’s quantitative easing was “classic” policy easing that caused a normal reaction in financial markets and has seen an improved economic outlook since it was announced.

Bullard also argued that there are difficulties with using global
output gaps to measure inflation pressures, since the results can be contradictory. And while critics say the Fed is exporting inflation, he said instead countries with managed exchange rates are importing U.S. monetary policy.

In a presentation prepared for the Bowling Green Area Chamber of
Commerce Coffee Hour in Kentucky, Bullard said, “Quantitative easing has been an effective tool, even while the policy rate is near zero.”

Prior to announcing the program “monetary policy was ultra-easy,”
he said, and noted that the “Japanese experience with mild deflation and a near-zero nominal interest rate has been poor.”

“The economic outlook has improved since the program was
announced,” Bullard said, referring to the November announcement of the second round of quantitative easing.

In addition, he said, “The financial market effects were entirely
conventional.”

Bullard noted that “The policy change was largely priced into
markets ahead of the November FOMC meeting.” And following the
announcement, “real interest rates declined, inflation expectations
rose, the dollar depreciated, and equity prices rose.

“These are the ‘classic’ financial market effects one might observe
when the Fed eases monetary policy in ordinary times (that is, in an
interest rate targeting environment),” he said.

“Asset purchases can substitute for ordinary (interest rate
targeting) monetary policy,” he said, but added, “The natural debate now is whether to complete the program, or to taper off to a somewhat lower level of asset purchases.”

Weighing in on what he called another “hot topic,” Bullard said
“Critics suggest the Fed is encouraging inflation globally. This despite
the fact that U.S. inflation is relatively low.

“This may imply the Fed is not weighing global conditions
appropriately,” he said. “The Fed is charged with controlling U.S.
inflation, but perhaps global inflation will drive U.S. prices higher or
cause other problems.”

However, Bullard argued, “Inflation is a threat especially for
countries with quasi-fixed exchange rates with the dollar. Many
countries prefer to manage their dollar exchange rate. Those countries are choosing to import U.S. monetary policy to some extent.”

On the debate over whether the Fed should take a global output gap
into account to gauge inflation pressures, Bullard noted the problems
with this measure, since emerging market economies and advanced
economies are moving in different directions.

“The advanced economy gap is negative, but the emerging markets gap is positive. The weighted average of the two is positive. This may
suggest upward, not downward pressure on inflation from this source,”
he said.

He noted “acute” issues in measuring the global output game, and
said “Empirical relationships between gaps and inflation are shaky.”

Bullard also rejected the possibility of the central bank using
commodity standards, and said “Inflation targeting is a better choice in the current environment.”

“Inflation targeting is the appropriate modern alternative to
historical commodity standards,” he said.

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

I think the claim that the normal "re-flating" that occurs when coming out of the recession (by the FED), hasn't been inflationary is wrong. As the exchange value of the dollar declined, PPP (purchasing power parity), adjusted, & the inputs to production have risen.

[flow5]

Thursday, February 24, 2011

by Robert McTeer

When the Federal Reserve was created in 1913, Congress did not give it a monetary policy goal as we understand that term today. The Fed's monetary policy role evolved gradually, and congressional mandates - such as achieving full employment and price stability - came later. Now the question is back at the forefront: What should the Fed be doing?

The Fed Began as a Depository of Bank Reserves. Congress created the Fed in response to financial panics culminating in the Panic of 1907. Those panics spread in part because banks kept their cash reserves with each other rather than in a central location. Withdrawals from Bank A triggered withdrawals from Bank B, then from Bank C, and so on. Withdrawals anywhere would spread through the banking system causing a general contraction of reserves and credit.

Bank reserves were double-counted in that one bank's reserves (assets) were another bank's deposits (liabilities). The reserve base shrank when it was needed the most. A scramble for reserves caused credit contraction and a shrinkage of bank notes (paper money) outstanding. More demand for bank notes dried up the supply. The supply was called inelastic.

The Fed was to fix this problem by centralizing bank reserves - hence the name, Federal Reserve System. The Fed was to bring flexibility to the banks' reserve base and "elasticity" to the currency supply. Simply centralizing the reserves fixed much of the problem; a reserve lending facility did the rest.

The Fed Lends Reserves to Banks. The Fed could lend to the banks by discounting their high-quality bank loans. The Fed's discount window (lending facilities) and its discount rate offered greater flexibility, and hence stability, to the banking system. At first, the discount rate was the Fed's only policy tool. Raising it would discourage bank borrowing from the Fed; reducing it would encourage borrowing.

The difference between borrowing from the Fed and borrowing in the interbank Federal Funds market (where banks borrow other banks' excess reserves) is that borrowing from the Fed creates new reserves for the whole banking system, whereas borrowing in the Fed funds market only reallocates a fixed amount of reserves.

The Fed Buys and Sells Treasury Securities in the Open Market. As Fed lending declined during the 1921 recession, it bought some Treasury securities for income. The broader implications of such open market purchases (and sales) for the banking system was readily apparent. Open market purchases created bank reserves and enabled more credit extension while sales did the opposite. Open market operations became the principal tool of monetary policy.

Legislation authorizing the Fed to change bank reserve requirements, the third tool of monetary policy, came in the mid-1930s, when Congress also formalized the role of the Federal Open Market Committee (FOMC) in open market operations.

The Fed Gets Full-Employment and Zero-Inflation Mandates. The Depression's hardships along with a new (Keynesian) way of thinking increased pressure on the government to become more activist in countering unemployment and inflation. The Full Employment Act of 1946 formally mandated that the Fed pursue full employment and price stability, although specific targets were lacking. The Act also created a Council of Economic Advisers to monitor the economy for the president.

The Humphrey-Hawkins Act of 1978 mandated unemployment under 4 percent within 10 years and an inflation rate of zero. It also mentioned balance in international payments as another goal. The Fed was directed to achieve these goals through its influence over the money supply, although most economists regarded the goals as mutually exclusive.

The FOMC formally adopted a monetarist approach to policy in October 1979. It set annual target ranges for money growth each year. If money growth was slightly higher or lower than the range at year-end, they set the base of the new target at the actual level of the money supply rather than at the midpoint of the previous year's target. Some wits called this "base drift" and accused the FOMC of shooting first then drawing the target around the bullet hole.

Financial innovation gradually eroded the tightness of the relationship between money supply growth and economic activity, making a strict monetarist approach to policy less practical. Limiting money growth allowed market interest rates to reach levels much higher than anticipated in 1980-82, but Fed Chairman Paul Volcker showed great courage in "staying the course" until the high rates broke the back of inflation, albeit at the cost of a severe recession.

During this period, from October 1979 to August 1982, inflation-fighting took top priority while the public wanted interest-rate relief. I recall making many speeches touting the "old time religion," according to which you can't reduce high interest rates by easing monetary policy since the inflation premium would rise. Inflation expectations had to be broken.

As inflation declined in the 1980s and into the 1990s, output and employment growth continued and the combination of falling inflation and a booming economy became particularly striking in the late 1990s. This happy combination enabled the Fed to finesse the troublesome issue of a conflicting "dual" mandate. It cited research suggesting that price stability is the best environment for rapid growth. The incompatibility problem - although becoming less important at the time - was better understood because of the weakening support in the academic community for the Phillips Curve, which had posited an inverse causal relationship between unemployment and inflation. Exchange rate flexibility effectively removed the external sector as a further conflict with domestic objectives.

Conclusion. Over the years, I believe the majority of Open Market Committee members favored a single mandate of price stability - not all, but probably a majority. Making a single mandate formal, however, didn't seem worth the danger that bringing the topic up might open Pandora's box.

I'm surprised, therefore, that proposals for a single inflation mandate would come up now, during this period of low inflation and high unemployment. After all, the Fed's extraordinary efforts to fight the recent recession have not, in fact, increased inflation - not yet anyway. But I guess I should leave the politics to the politicians.

Robert McTeer is a distinguished fellow with the National Center for Policy Analysis.

[flow5]

Monetarism - Brad DeLong

The First Monetarism is Irving Fisher's Monetarism. The ideas of Fisher, his peers, and their pupils make up the first subspecies. It is true that the ideas that we see as necessarily producing the quantity theory of money go back to David Hume, if not before. But the equation-of-exchange and the transformation of the quantity theory of money into a tool for making quantitative analyses and predictions of the price level, inflation, and interest rates was the creation of Irving Fisher.

This first subspecies of Monetarism, however, fell down on the question of understanding business-cycle fluctuations in employment and output. The business cycle analysis of some of the practitioners of this first subspecies of monetarism was subtle and sophisticated. Irving Fisher's (1933) "The Debt-Deflation Theory of Great Depressions" can still be read with profit. But the business cycle theory of this first subspecies of monetarism was by and large not as subtle, and not as sophisticated.

www.j-bradford-delong.net/econ_articles/monetarism.html

[flow5]

% Change from 1 year ago

Growth in CB Assets

H.8 release ALL COMMERCIAL BANKS

Loans/leases in bank credit.....................................1.7
Commercial and industrial loans............................-6.8
Loans to individuals................................................30.9
Real estate loans.....................................................-4.3
Home equity loans...................................................-3.8
U.S. Government securities....................................12.1
Other securities including municipal issues........-11.1

Liabilities
Includes large TDs of $100,000 or more...............-7.2

online.wsj.com/mdc/public/page/2_3022-fedresdata.html

[flow5]

Contractual clearing balances continue to decline. Must be related to declining transaction turnover (declining economic activity?). They averaged $7b prior to the recession and currently total $2.3b.

Clearing Balance Requirement

A clearing balance requirement is an amount that an institution may contract to maintain with a Reserve Bank in addition to a reserve balance requirement, if any. • The minimum clearing balance requirement is $25,000. • A clearing balance requirement is implemented on the first day of a reserve maintenance period. An institution may modify its clearing balance requirement as often as each maintenance period by completing the Clearing Balance Request form.

End of day balances held to satisfy a clearing balance requirement are averaged over a seven or fourteen day maintenance period depending upon the frequency with which an institution reports its FR 2900. • The clearing balances held by an institution generate earnings credits, which may be used to offset the cost of eligible Federal Reserve services. Earning credits are applied to an institution’s monthly billing service charges.

Clearing Balance Band

An institution has some flexibility in meeting their clearing balance requirement. • An institution only needs to hold an average end of day clearing balance for a maintenance period that falls within a range around its established clearing balance requirement. • The range is called the clearing balance band. The top of the band is equal to the clearing balance requirement plus the clearing balance allowance. The bottom of the band is equal to the clearing balance requirement less the clearing balance allowance.

The clearing balance allowance is equal to the greater of $25,000 or 2 percent of the institution’s clearing balance requirement. • For example, an institution with a clearing balance requirement of $25,000 has a clearing 2 balance band ranging from zero to $50,000. If an institution’s maintained clearing balance is within this range, the institution will earn earnings credits on the maintained balance and will not be considered deficient.

If an institution’s maintained clearing balance is less than the bottom of the clearing balance band, the institution is considered deficient in its clearing balance requirement. Likewise, if an institution’s maintained clearing balance is greater than the top of the clearing balance band, the institution is in excess of its clearing balance requirement and it will not earn earnings credits on these excess balances.

[bimetalaupt]

Flow5,
Did you see the j-curve in the interest rates??

30 days has been from 0.08% to 0.13%
Overnight bankers rate has been 0.15% except for one 0.16% for the last two weeks.

Bruce

[flow5]

I attributed the change to the seasonals (temporary).

Contracting balances used by the banks may indicate that the banks are just more efficient at transaction processing.

Remember the 1974 OPEC oil shock? It provides an excellent example of the depressionary effect of price increases generated by supply & not demand (& the U.S's transition from a creditor to world debtor nation).

Only price increases generated by demand, irrespective of changes in supply, provide evidence of inflation. The must be an increase in aggregate demand which can come about only as a consequence of an increase in the volume and/or transactions velocity of money.

The volume of money flows must expand sufficiently to push prices up, irrespective of the volume of financial transactions and the flow of goods & services into the market economy.

Price increases that are "administered", i.e., result from markups by sellers who exercise a greater or lessor degree of monopoly power, are not inflationary.

Higher prices generated by the exercise of monopolistic market powers harm the economy in many ways. Price distorions are created which diminish the prices and demand for competitively priced products, and the resilience fo the economy is diminished. This is just another way of saying the economy ceases to the extent monopolistic practices penetrate the system, to be self-regulatory. The essence of a free (i.e., self-regulatory) capitalistic system is price flexibility, downward as well as upward.

Lacking this flexibility, downswings in the economy are no longer self-correcting. Unemployment causes more unemployment. Bank and other business failures beget more failures. Financial crises in the stock market and especially bank failures, enormously accelerate and deepen the downswing. Since the economy lacks the capacity to rejuvenate itself, government intervention is inevitable. This has been the situation in the era beginning with the Great Depression.

The lesson to be learned here is that inflation is basically a monetary phenomenon. Price increases attributable to the exercise of monoply powers applied to specific commodities, are of temporary duration, create price distortions that foster stagnation and unemployment and generally lower prices if not "validated" by an offsetting expansion of monetary flows. Unfortunately, this "validation" in the present mix of economic frorces seems to give us stagnation and inflation. Economists call it stagflation.

[flow5]

So far beside the elevating and persisting violence taking place in Libya, the green Benjamin is losing momentum and weakening mainly in front of the euro, reaching its lowest level in three weeks versus the Union currency, as it is strongly speculated that the European Central Bank will raise interest rates before the Federal Reserve.

As a result, the euro-dollar pair is inclining faintly on technical movements and a weaker dollar but may most probably start plunging according to the four-hour stochastic oscillator, having the Union currency trading so far around 1.3793 recording a high of 1.3820 and a low of 1.3702, The trading range for today is among the key support at 1.3365 and the key resistance at 1.3715.

Now, the pound-dollar pair is plunging slightly with the royal pound trading so far around 1.6116 recording a high of 1.6253 and a low of 1.6083, knowing that the pair is forecasted to rise to the upside according to the one-hour momentum indicators.The trading range for today is among the key support at 1.5965 and the key resistance at 1.6300.

As for the dollar-yen pair, it is narrow trading so far but expected to rise to the upside according to several time charts momentum indicators with the low-yielding yen trading around 81.75 recording a high of 82.52 and a low of 81.60.The trading range for today is among the key support at 81.05 and the key resistance at 84.25.

[flow5]

JOHN MASON

The Federal Reserve injected $73 billion more reserve balances into the banking system in the banking week ending February 23, 2011.

The Federal Reserve has injected $272 billion into the banking system since the end of last year, since December 29, 2010.

Reserve balances at Federal Reserve Banks totaled $1.290 billion at the close of business on February 23, 2011.

Excess reserves for the banking system averaged almost $1.220 billion for the two weeks ending February 23, 2011.

QE2 rolls on

And commercial banks still seem to prefer holding onto the cash rather than lending the money out. And, it seems as if a large percentage of the funds being pumped into the banking system are now going to foreign-related financial institutions.

The major mover of bank reserves is still the Fed’s purchase of US Treasury securities. The Fed added $23 billion more Treasury securities to its portfolio last week. Holdings of Treasury securities are up almost $200 billion since December 29, 2010.

The Treasury still continues to move money around. In the past week it reduced balances it holds in its General Account at the Fed by almost $32 billion. (This action puts reserves into the banking system.)

Since December 29, 2010, the Treasury has reduced it’s balances in the General Account by about $66 billion.

Last week the Treasury also reduced the amount of funds it holds in its Supplementary Financing Account by another $25 billion. The Treasury reduced these balances by $75 billion since December 29. As the Treasury spends out of these accounts it puts reserves into the banking system. (More on the Treasury’s Supplementary Financing Account.)

As the Treasury has moved funds around since the end of last year it has put more than $140 billion into the banking system that has ended up as reserve balances.

There are three conclusions I have drawn from the financial statistics I have seen:

First, the Fed is scared silly that the smaller banks in the United States (all banks other than the largest 25) will experience a massive series of failures before the FDIC can close a sufficient number of them in an orderly fashion;

Second, the largest 25 banks in the country are having a feast on the low borrowing costs that the Fed is maintaining (the FDIC reported that 95% of all bank profits in the fourth quarter of 2010 went to the largest banks in the United States);

Third, given the mobility of capital in the world today, the Federal Reserve has become the central bank of the world and is supplying funds for potential bubbles in commodities and natural resources globally.

My question: Is conclusion one above sufficient justification for the resulting consequences of the Fed’s policy as observed in conclusions two and three?

[flow5]

KRUGMAN:

February 25, 2011, 9:02 am Good Inflation, Bad Inflation
And another economistic piece: FTAlphaville reports that some people believe that surging commodity prices might be good for Japan, because they will make deflation go away.

OK, this is a failure to understand the principle.

Why does deflation have a depressing effect on the economy? Two reasons. First, it reduces money incomes while debt stays the same, so it worsens balance sheet problems, reducing spending. Second, expectations of future deflation mean that any borrowing now will have to be repaid out of smaller wages (if the borrower is a household) or smaller profits (if the borrower is a firm.) So expected future deflation also reduces spending.

So, does a rise in food and energy prices do anything to alleviate these problems? No. In fact, it makes them worse, by reducing purchasing power. So while the commodity surge may temporarily lead to rising headline prices in Japan, the underlying deflation problem won’t be affected at all.

In a way, this is another illustration of the need to differentiate among inflation measures. It’s not exactly the same as the usual case for focusing on core inflation, but it’s related. And once again, the point is that looking at “the” inflation rate is a bad guide for policy.

[flow5]

DAVE ALTIG

George Melloan is unhappy with U.S. monetary policy, and he repeats what has become by some a criticism of Federal Reserve policy:

"In accounts of the political unrest sweeping through the Middle East, one factor, inflation, deserves more attention…

"Probably few of the protesters in the streets connect their economic travail to Washington. But central bankers do. They complain, most recently at last week's G-20 meeting in Paris, that the U.S. is exporting inflation…

"About the only one failing to acknowledge a problem seems to be the man most responsible, Federal Reserve Chairman Ben Bernanke. In a recent question-and-answer session at the National Press Club in Washington, the chairman said it was 'unfair' to accuse the Fed of exporting inflation. Other nations, he said, have the same tools the Fed has for controlling inflation.

"Well, not quite."

I would simply repeat my argument from our previous macroblog post, but I don't really have to. Mr. Melloan makes the point for me [with my emphasis added in italics]:

"Consider, for example, that much of world trade, particularly in basic commodities like food grains and oil, is denominated in U.S. dollars. When the Fed floods the world with dollars, the dollar price of commodities goes up, and this affects market prices generally, particularly in poor countries that are heavily import-dependent. Export-dependent nations like China try to maintain exchange-rate stability by inflating their own currencies to buy up dollars."

If the United States unwisely floods the world with dollars, driving down the international value of the dollar, countries with flexible exchange rates would see the value of their currencies rise—making food grains and oils denominated in dollars more affordable, not less. The only way inflation gets exported to these other countries is if they attempt to maintain the values of their currencies below the levels that markets would otherwise take them. That inflation is purely homegrown.

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

PPP has to adjust at the same speed as the relative exchange rate. And hot money flows generate added (and competitive), world-wide purchasing power. Maybe these commodities were bought with dollars (or foreign exchange reserves), & not their respective currencies. I don't think Altig is right.

[flow5]

ZEROHEDGE

There are two key datapoints to present in this week's Fed balance sheet update: the surge in excess reserves, and the comparative Treasury holdings between the Fed and other foreign countries. But first the basics: the total Fed balance sheet hit a new all time record of $2.5 trillion.

The increase was primarily driven by a $23 billion increase in Treasury holdings as of the week ended February 23 (so add another $5 billion for yesterday's POMO) to $1.214 trillion. With rates surging,

QE Lite has been put on hibernation and there were no mortgage buybacks by the Fed in the past week: total MBS were $958 billion and Agency debt was also unchanged at $144 billion.

The higher rates go, the less the QE Lite mandate of monetization meaning that the Fed will be continuously behind schedule in its combined QE2 expectation to buy up to $900 billion by the end of June.

Yet most notably, as we touched upon yesterday, the Fed's reserves with banks surged by $73 billion in the past week, as more capital was reallocated from the unwinding SFP program. As noted previously, we expect the total bank reserves held with the Fed to jump from the current record $1.29 trillion to at least $1.7 trillion by June.

And the old faithful chart comparing Fed holdings with those of formerly major foreign holders. The Fed now surpasses China in its Treasury holdings by 37%!

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

Parsing the put & take on the FED's balance sheet is laughable. FED credit no longer grows pari passu with required reserves.

[flow5]

Lacker: My sense core inflation has bottomed out - FEB 8 comment

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

A day late & a dollar short. My excel spread sheet said JAN in July 2010.

[bimetalaupt]

Feb 25, 2011 13:07:18 GMT -5 flow5 said:

JOHN MASON

The Federal Reserve injected $73 billion more reserve balances into the banking system in the banking week ending February 23, 2011.

The Federal Reserve has injected $272 billion into the banking system since the end of last year, since December 29, 2010.

Reserve balances at Federal Reserve Banks totaled $1.290 billion at the close of business on February 23, 2011.

Excess reserves for the banking system averaged almost $1.220 billion for the two weeks ending February 23, 2011.

QE2 rolls on

And commercial banks still seem to prefer holding onto the cash rather than lending the money out. And, it seems as if a large percentage of the funds being pumped into the banking system are now going to foreign-related financial institutions.

The major mover of bank reserves is still the Fed’s purchase of US Treasury securities. The Fed added $23 billion more Treasury securities to its portfolio last week. Holdings of Treasury securities are up almost $200 billion since December 29, 2010.

The Treasury still continues to move money around. In the past week it reduced balances it holds in its General Account at the Fed by almost $32 billion. (This action puts reserves into the banking system.)

Since December 29, 2010, the Treasury has reduced it’s balances in the General Account by about $66 billion.

Last week the Treasury also reduced the amount of funds it holds in its Supplementary Financing Account by another $25 billion. The Treasury reduced these balances by $75 billion since December 29. As the Treasury spends out of these accounts it puts reserves into the banking system. (More on the Treasury’s Supplementary Financing Account.)

As the Treasury has moved funds around since the end of last year it has put more than $140 billion into the banking system that has ended up as reserve balances.

There are three conclusions I have drawn from the financial statistics I have seen:

First, the Fed is scared silly that the smaller banks in the United States (all banks other than the largest 25) will experience a massive series of failures before the FDIC can close a sufficient number of them in an orderly fashion;

Second, the largest 25 banks in the country are having a feast on the low borrowing costs that the Fed is maintaining (the FDIC reported that 95% of all bank profits in the fourth quarter of 2010 went to the largest banks in the United States);

Third, given the mobility of capital in the world today, the Federal Reserve has become the central bank of the world and is supplying funds for potential bubbles in commodities and natural resources globally.

My question: Is conclusion one above sufficient justification for the resulting consequences of the Fed’s policy as observed in conclusions two and three?

NO, That is the total number but not the injection.. Do the math .. soma increased but m2 (8870-8853) or $17 billion total from 1/1/2011 tested by M2...
Soma has been increasing at about 15 to 20 bill per week.. This has not reach M2..

Also 50 billion he was talking about was roll-over money and injection of new money.

Home > Markets > Open Market Operations
System Open Market Account Holdings


The System Open Market Account (SOMA), managed by the Federal Reserve Bank of New York, contains dollar-denominated assets acquired via open market operations. These securities serve three purposes:

* Collateral for U.S. currency in circulation and other reserve factors that show up as liabilities on the Federal Reserve System's balance sheet
* A tool for the Fed’s management of reserve balances
* A store of liquidity in the event an emergency need for liquidity arises


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Securities Holdings as of February 23, 2011
($ thousands)


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Summary

T-Bills

T-Notes & T-Bonds

TIPS

Agencies
Security Type ....................................... Total Par Value

US Treasury Bills (T -Bills) ........................ 18,422,636.7

US Treasury Notes and Bonds (Notes/Bonds) .........1,134,743,398.8

Treasury Inflation-Protected Securities (TIPS)1......53,862,614.6

Federal Agency Securities2............................. 144,119,000.0

Mortgage-Backed Securities3 (Settled Holdings)...............958,201,341.8

Total SOMA Holdings ......................................2,309,348,991.9

Change From Prior week.....................................22,569,550.8

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Unofficial Problem Bank list increases to 960 Institutions
by CalculatedRisk on 2/26/2011 08:51:00 AM

Note: this is an unofficial list of Problem Banks compiled only from public sources.

Here is the unofficial problem bank list for Feb 25, 2011.

As anticipated, the FDIC released its enforcement actions for January 2011, which contributed to many changes for the Unofficial Problem Bank List. This week, there are three removals and 12 additions leaving the Unofficial Problem Bank List at 960 institutions.

The net changes added $8.9 billion in assets, which is the largest weekly asset increase since June 18, 2010 when $19 billion was added. The average net weekly change has been about seven additions and $1.7 billion in assets. However, the aggregate assets on the list declined this week by $4.7 billion to $413.8 billion from $418.9 billion as 2010q3 financials were replaced by year-end figures. Positively, the change in financials caused a $13.6 billion decline in assets.

After the monthly release of actions by the FDIC, it would not be unusual for the Unofficial Problem Bank List to trend down until the middle of next month as closings tend to outpace new order issuance during this part of the month. Until next week, try to have a safe & sound banking week.

CR Note: The FDIC released the Q4 Quarterly Banking Profile this week. The FDIC reported 884 official "problem" institutions at the end of 2010 (the highest since 1992) with $390 billion in assets. There are a total 6,529 commercial banks and 1,128 savings institutions, so about 11.5% are on the "problem" list. Assets of all institutions are $13.1 trillion, so problem institutions have just under 3% of total assets.

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IORs are the FUNCTIONAL EQUIVALENT of required reserves, not short term T-bills. T-bills are settled upon maturity, or are liquidated at a discount. IORs sport a "floating", overnight, remuneration rate (currently consonant with the 1 year "Daily Treasury Yield Curve Rate").

I.e., the policy rate "floats" (like an adjustable rate mortgage), via a series of either, cascading, or stair-stepping, interest rate pegs. I.e., as with ARMs, a "note is periodically adjusted based on a variety of indices".

Similarly, "Among the most common indices (for ARMs), are the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR)." - Wikipedia

The remuneration rate is a monetary policy "tool", it is the Central Bank's target rate's "floor" (a hypothetical policy otherwise known as the "Friedman rule").

I.e., IORs are not just an asset swap. IORs are assets defined by economists to be outside-of-the properties normally assigned to the money aggregates. I.e., IORs are a credit control device. IORs absorb bank deposits (offsetting the expansion of the FED's balance sheet on the asset side, e.g., QE2), as well as impound consumer & corporate savings, and induce dis-intermediation among the non-banks. IORs increase the cost of loan-funds (mortgage rates), ceteris paribus. IORs increase the capitalization rate on company earnings.

IORs are bank earning assets. IORs are investments. IORs are riskless, guaranteed, & are a hedge against higher interest rates (i.e., promise even higher, & safer returns as the economy expands).

IORs eliminate the motivation of the banks to lend within the short-end segment of the yield curve. IORs are the bank’s primary liquidity reserves (clearing balances) - despite the day-light credit backstop, borrowing FED funds, etc. (i.e., both FED-WIRE & contractual clearing balances have declined conterminously).

As Dr. Richard Anderson (V.P. St Louis FED), states: "Remember that "excess reserves" is an accounting concept, not a physical item. The physical item (asset) is deposits at Fed Res Banks. These deposits may be used to satisfy statutory reserve requirements; any "excess" deposits are labeled as "excess reserves." This terminology dates from the 1920s, and I find it obsolete."

Those who point to the "monetary base" which is not now, nor has ever been, a base for the expansion of new money & credit, are the: "could have, would have, should have" dinosaurs.

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"When the effects of financial intermediaries and credit spreads are taken into account, the welfare optimality implied by the Friedman Rule can instead be achieved by eliminating the interest rate differential between the policy nominal interest rate and the interest rate paid on reserves by assuring that the rates are identical at all times." - Friedman Rule

www.cnb.cz/miranda2/export/sites/www.cnb.cz/en/research/seminars_workshops/2010/2010_09-27_Woodford.pdf

"The Central-Bank Balance Sheet as an Instrument of
Monetary Policy" -- April 11, 2010

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ARMs Index:

Rates for some common indexes used for Adjustable Rate Mortgages (1996-2006)All adjustable rate mortgages have an adjusting interest rate tied to an index.[1]

In Western Europe, the index may be the ECB Refi rate (where the mortgage is called a tracker mortgage), TIBOR or Euro Interbank Offered Rate (EURIBOR).

Six common indices in the United States are:

11th District Cost of Funds Index (COFI)
London Interbank Offered Rate (LIBOR)
12-month Treasury Average Index (MTA)
Constant Maturity Treasury (CMT)
National Average Contract Mortgage Rate
Bank Bill Swap Rate (BBSW)

In some countries, banks may publish a prime lending rate which is used as the index. The index may be applied in one of three ways: directly, on a rate plus margin basis, or based on index movement.

A directly applied index means that the interest rate changes exactly with the index. In other words, the interest rate on the note exactly equals the index. Of the above indices, only the contract rate index is applied directly.[1]

To apply an index on a rate plus margin basis means that the interest rate will equal the underlying index plus a margin. The margin is specified in the note and remains fixed over the life of the loan.[1] For example, a mortgage interest rate may be specified in the note as being LIBOR plus 2%, 2% being the margin and LIBOR being the index.

The final way to apply an index is on a movement basis. In this scheme, the mortgage is originated at an agreed upon rate, then adjusted based on the movement of the index.[1] Unlike direct or index plus margin, the initial rate is not explicitly tied to any index; the adjustments are tied to an index.

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

It's probably not happenstance that the 12 month Treasury Average Index is the approximate level of the BOG's remuneration rate @.25%.

1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr
0.12 0.13 0.16 0.27 0.72 1.22 2.16 2.84 3.42 4.26 4.51

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MONEY ILLUSION:
One could write an entire book discussing all the assertions in economics textbooks that are not true. I seem to recall that Coase complained that economics textbooks kept using lighthouses as an example of goods that can only be supplied by the government, even after it was shown that private organizations had supplied lighthouses.

I don’t know whether textbooks claim that supply shocks help explain the high inflation of the 1970s, but at a minimum they leave that impression. In fact, the high inflation of the 1970s was caused by monetary policy. As the following data suggests, NGDP rose extremely rapidly during the 1970s and early 1980s. Because RGDP rose at pretty much the same (3%) rate it rises in any other decade, fast rising NGDP is both a necessary and sufficient condition for the Great Inflation. The only question is what caused such rapid growth in NGDP, or M*V.

1970.. 5.5
1971.. 8.5
1972..9.9
1973.. 11.7
1974.. 8.5
1975.. 9.2
1976.. 11.4
1977.. 11.3
1978.. 13.0
1979.. 11.7
1980.. 8.8
1981.. 12.1
1982.. 4.0

To the extent that oil shocks have any effect on NGDP, it is probably contractionary. That’s why NGDP growth slowed in 1974 and 1980. Thus the energy price shocks contributed almost nothing to the Great Inflation, although they help explain why inflation was higher in some years than others, as oil shocks tend to temporarily depress RGDP growth.

Marcus Nunes sent me a quotation from a 1997 paper by Bernanke, Gertler and Watson:

Macroeconomic shocks such as oil price increases induce a systematic (endogenous) response of monetary policy. We develop a VAR-based technique for decomposing the total economic effects of a given exogenous shock into the portion attributable directly to the shock and the part arising from the policy response to the shock. Although the standard errors are large, in our application, we find that a substantial part of the recessionary impact of an oil price shock results from the endogenous tightening of monetary policy rather than from the increase in oil prices per se.

Bernanke got to put this theory in action in late 2008, when the Fed tightened monetary policy in response to the high oil prices of mid-2008. In this case monetary policy was much tighter than in 1974 or 1980. In those earlier cases, NGDP growth slowed a bit, but RGDP slowed much more, producing “stagflation” in both years. In contrast, in late 2008 monetary policy was so tight that we ended up with a disinflationary recession in 2009.

I was looking at the GDP deflator data and noticed an interesting pattern. During my entire life (I was born in 1955) the GDP deflator rose by 1% or less only twice. Any guesses? Hint, they were the two years when many right wing economists predicted skyrocketing inflation as a result of the Fed’s supposedly ”easy money” policy of late 2008. The period right after they doubled the monetary base in just a few weeks. That’s right, only 2009 and 2010 saw a GDP inflation rate of 1% or less.

The implication of the Bernanke, et al, study is that the Fed shouldn’t overreact to supply shocks, or else they might trigger a recession. Let’s see how they respond to the current surge in oil prices. The earlier indications are that nothing has been learned:

One of the Federal Reserve‘s leading hawks warned Wednesday of the risks of maintaining easy monetary policy in the face of rising commodity prices

PS. Some people think that Jimmy Carter had “bad luck” because of the 1979 revolution in Iran. Look at NGDP growth in the years before the revolution—a period when oil prices were stable.

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

"The only question is what caused such rapid growth in NGDP, or M*V"

? M*Vt = ngDp.

"the Fed shouldn’t overreact to supply shocks, or else they might trigger a recession"

? very little chance of overreacting to changes in prices related to changes in the supply because aggregate monetary purchasing power is always measured with the exact same length (and that length exceeds the vast majority of all "shocks").

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GARY NORTH:

www.lewrockwell.com/north/north951.html

Maybe you have heard about rising food prices. It is happening all over the world. We hear of Third World rural populations that are trapped by rising food prices.

Why are food prices rising? Simple: because urban people in formerly Third World nations are getting richer. India and China are the obvious examples. As these economies are freed from the regulations that once burdened them, the growing urban middle class bids up the price of food. People with money in their pockets like to eat more and better food. In the bidding war between rural people with little capital and therefore low incomes vs. urban residents with more capital and higher incomes, rural people lose.

The price of food is rising not just in U.S. dollar terms, but in terms of all currencies. This is not a U.S. phenomenon only. This is international.

When we compare the rise in the price of oil since 1999, the rise in the prices of commodities in general (including gold and silver), and the price of food, food remains a bargain. Two charts are here.

COLLAPSE IN 2008

The recession in 2008 drove down the oil price from $147 to $33 in the final five months. This was a collapse. The price of food fell, too, though not to this extent. Silver and gold fell – silver far more sharply than gold. This indicates the degree to which commodities are tied to the worldwide business cycle. Commodity prices fell because the international economy fell.

Commodities are not the initiating force in price inflation; monetary policy is. The prices of raw materials rose in the first decade of the 21st century because central bank policies around the world were expansionary. When the recession hit in 2008, the prices of commodities fell, but not until several months into the recession. (Gold and silver fell in March, before the others fell.)

There is an ancient error, stretching back to Adam Smith, which says that retail prices rise because of cost-plus inflation. Prices for raw materials rise, forcing up retail prices. This was refuted by Carl Menger, the original Austrian School economist, in 1871. He showed that production costs rise in response to bids by entrepreneurs, who in turn expect rising demand for the output of their enterprises. The prices of economic inputs rise in response to expectations.

When, in the second half of 2008, entrepreneurs and speculators finally recognized the extent of the recession, they stopped bidding for as many raw materials. So, the prices of these production goods fell.

It is true that monetary policy affects the business cycle. It is true that QE2 is inflationary. But let us not mistake cause and effect. The increase in commodity prices all over the world ever since early 2009 is the result of simultaneous central bank policies. The Federal Reserve System and other large central banks began inflating in late 2008 to reverse the banking panic by large depositors, not small depositors, who were covered by FDIC rules.

The policies of late 2008 have not produced mass inflation, because commercial bankers have increased their banks' excess reserves at the FED and other central banks. They are not lending all of the money that they are legally entitled to lend.

QE2 has nothing to do with much of anything. Yet.

QE2 AND PRICES

First, QE2 did not get rolling until early in 2011. For most of 2010, the Federal Reserve System was deflating. This is seen in the chart of the adjusted monetary base.

Second, commodity prices rose in 2009 and 2010.

Third, the cause of this increase was the prior monetary policies of central banks, late 2008 to early 2010.

Fourth, the increase in the adjusted monetary base in 2011 indicates that the "exit strategy" of 2010 has ended. Bernanke keeps talking about being ready to adopt an exit strategy when the time is ripe. This is a smoke screen. The FED actually began to adopt a policy that can best be described as an exit strategy in March 2010. It has made a fast exit from the exit strategy in 2011.

That commodity prices could continue to rise in expectation of a QE2-generated recovery later this year is quite possible. It depends on what entrepreneurs expect commercial bankers to do. Will bankers lend? If so, the M1 supply will rise, and so will the M1 multiplier. That will force up prices. But QE2 may fail to persuade commercial bankers to lend. Then the FED will be pushing on a string.

My point is this: you should pay no attention to anyone who tells you that the rise in food prices has been the result of recent Federal Reserve policies. Commodity prices rose in 2010 despite a policy of monetary deflation by the FED. This is rarely discussed by financial commentators.

I think the upward move of commodities will continue until China goes into recession. China's central bank is raising interest rates. As far as we are told, monetary policy remains expansionist. But rising rates for commercial banks will have the effect of making commercial loans unprofitable for some entrepreneurs. They will cease hiring workers. They will cease buying commodities. This is what the Austrian theory of the business cycle teaches. In order to avoid price inflation, the central bank changes course and lets interest rates rise. This ends the boom.

At the margin, Western consumers are not the source of the rise in food prices. The West is rich. It allocates relatively little of its monthly expenditures to food. When Western incomes increase, the bulk of the money does not go to increased consumption of rice, wheat, and corn. This is not the case in the Third World. When people move from the country to work in urban settings, they increase their purchases of food. Their mark of wealth is their ability to buy more food. They bid against each other. They bid against rural residents.

The rising price of oil and food indicates a growing economy worldwide, just as falling prices in the second half of 2008 indicated a contracting economy.

Oil is extremely volatile because of the inability of buyers to store large quantities in reserve. This is not true of foodstuffs. The food is kept in grain elevators. The price of food is less volatile than energy prices, because entrepreneurs who hold grain in reserve can sell into this increased demand. This increases the supply of food available to retail food producers.

DOLLARS AND FOREIGN CURRENCIES

One of the marks of an ill-informed analyst is the absence of any discussion of foreign central bank policies in relation to Federal Reserve policies. Let me explain.

Food in foreign countries is priced in the domestic currency units of those countries. What the Federal Reserve does is not directly relevant to the economies of those countries.

When the FED increases the monetary base by purchasing Treasury debt, this reduces the interest rate of short-term bills, but it can – and did – increase the mid-term rates. This was not what Federal Reserve economists would have imagined. You can see what happened in February.

Higher rates of limited magnitude have little effect on foreign central banks. They buy U.S. Treasury debt for other considerations than a few hundredths of a percentage point in interest. They buy for reasons of mercantilism: subsidizing their export sectors.

The average resident in a foreign nation bids for food, as for all other scarce resources. But he bids in terms of his nation's currency unit. This has nothing directly to do with the Federal Reserve and QE2. The bidding process raises the price of food. Americans must bid more dollars to buy food. But this demand is in terms of consumers' output, not dollars. Japanese residents bid with yen. Americans bid with U.S. dollars. Chinese residents bid with yuan. But to buy yen, dollars, or yuan, residents must sell their output. They are buying food with their output. This is the fundamental fact of all pricing.

The FED inflates the monetary base. This may or may not lead to increased M1 and a higher M1 money multiplier. At some point, Americans will get their hands on some of this new money. They will bid for goods and services. But they will not bid very much extra for increased food. If Richard Simmons had his way, Americans would bid more for a new Richard Simmons DVD on how to lose weight by this or that technique. They would bid more for fresh fruits and veggies and less for snack foods that most people enjoy eating. Snack foods are more about packaging and taste than about the cost of grains to produce them.

So, what matters most for the price of food in a foreign country is the domestic monetary policy and economic output in that country.

If the central bank of some Asian country tries to keep its currency from rising in relation to the U.S. dollar by inflating the domestic currency, this will affect the price of food there. The increased monetary expansion will fuel the boom phase of the boom-bust cycle. This will goose the economy by lowering nominal interest rates. But this effect would not take place if the central bank did not tamper with the money supply or the interest rate on short-term government bonds.

To blame Bernanke and the FED for the rising cost of food is based on a misunderstanding of the currency markets. It blames a cause which is not in fact the primary cause. The primary cause is rising output – increased bids – in Third World countries that are experiencing economic growth. To the extent that this rising output is based on long-term innovation and capital investment, this is positive. To the extent that it is based on fractional reserve banking and central bank purchases of debt, it is not positive. Rather, it is creating a boom that will turn into a bust, just as it did in the second half of 2008.

DESPERATE CENTRAL BANKERS

Central banks inflate to keep government debt markets solvent. That is their official task. It has been ever since the Bank of England was created in 1694.

Central banks inflate also to keep large commercial banks solvent in a financial panic. That has been their unofficial task for at least a century.


They began doing this as a depression hedge in the early 1930s. John Maynard Keynes announced his last career flip-flop in 1936, with the publication of The General Theory of Employment, Interest, and Money. Here, he set forth his recommended cure for the Great Depression: government spending. This could be done through taxes, borrowing, and monetary inflation. He preferred the second, but he was not limited to it, nor have his disciples been limited. Keynes baptized policies that Western governments had already adopted. He invented a new terminology to cover his tracks. He was merely promoting the crackpot monetary theories of Major Douglas and Silvio Gesell, as he admitted (pp. 353-58).

Bringing Keynesian policies up to date, the unprecedented increases in the monetary base of the Federal Reserve, the Bank of England, and the European Central Bank, beginning in late 2008, were the cause of the reversal of the collapse of the financial markets. This reversed the recession. This led to a recovery of commodity prices after 2008. These effects had impact on the eating habits of Chinese and Indian consumers. China and India are part of the international economy. But the effect on food prices was indirect. They rose because demand for Asian exports recovered. The people involved in the export trade were able to bid up the price of food.

There is talk about food being a bubble sector. Given what happened in the second half of 2008, this is a legitimate conclusion: the bubble popped. If the central banks continue to inflate, and the West's economy avoids another major recession, then food prices will continue to increase. Poor people are becoming less poor, and as they become richer, they will eat more. They will also move from bicycles to motor bikes. Motor bikes consume gasoline.

Commodities rise in price when there is increased demand for them as factors of production. There will be increases in technology in these sectors, but the rate of speed at which Indians and the Chinese are getting richer is greater than increases in production of raw materials. This is a bubble in the sense of central bank policies promoting a boom economy through inflated currencies. But the general upward move of commodity prices, as distinguished from consumer goods prices, will likely continue over the next two decades.

There will be a bust at some point, perhaps in the next few years, and maybe before. Central bankers in China and India will separately decide to put on the monetary brakes in order to avoid mass price inflation. There will be recessions in both nations. This will once again force down the price of food. But this will be a buying opportunity. The long-run trend is up, because the long-run trend of Asian productivity is up.

Bernanke is responsible for persuading all of the FOMC members except Hoenig to vote for the expansion of the monetary base. To the extent that this delays the day of reckoning, when capital is finally priced apart from monetary inflation, the FED is responsible for the bubble in food prices. But this increase has been going on for a decade. This is not recent. It has nothing to do with QE2. Yet.

CONCLUSION

The rise in food prices is a mark of deliverance out of poverty for hundreds of millions of Asians. The fact that they are saddled with imitations of the Bank of England, just as residents of the West are, is unfortunate. It will be even more unfortunate when the era of central banking and the welfare state reaches its apogee and collapses.

The universal bankruptcy of the national welfare states will provide a great opportunity for free market economists to say, "We told you so," and perhaps gain their followers a market for the reconstruction of the political order from the bottom up.

There will be a price to pay. The rising price of food in the boom phase of the great transformation is likely. When poor people get richer, they spend money more on food, but less time producing it. The bubble in food prices is indeed a bubble, because Asian central banks are inflating. But in the long run, food prices and oil prices will rise because newly middle-class people prefer to buy food and fuel with their increased output.

The supreme mark of a more productive economy is the increase in the price of land, meaning the raw materials that land produces. Capitalism is reducing poverty today on a scale never before seen. So, food and fuel prices will rise until new technologies are implemented that allow raw materials suppliers to keep pace with the move from the Asian countryside to the cities. Such innovations will not keep pace for the next 20 years.

Be thankful that you are not some middle-aged peasant trapped in the pre-capitalist economy of some Asian village. For him, this vast increase of urban wealth will be no picnic.

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

"Freeze-frame" monetary mechanics didn't prevent inflationary supply-side "shocks". Even if only price increases generated by demand, irrespective of CHANGES IN SUPPLY, provide evidence of MONETARY inflation, the standard of living of the vast majority of the world's population has declined almost overnight.

Consider that Investors discount (company earnings), i.e., nominal gDp (up to 9 months in advance), by purchasing equities. It is equally probably that the buyers of commodity ETFs do exactly the same thing (which does increase aggregate demand). Whether prices are "sustainable" depends upon whether the "administered" price increases are evenutally (in succeeding years), "validated" by the FED's subsequent policies.

[usaone]

Post #358

Great article!! Right on the money.

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Also consider the wacky world of economic theory: that the latest M2 money velocity turned over only 1.693 times in the 4th quarter of 2010, or that M1 money velocity turned over only 8.2 times in the 4th qtr (all the St. Louis Fed's velocity figures are still declining).

It is obvious that income velocity (a contrived figure), is declining while the money actually exchanging hands (the transactions velocity of money) is increasing. Milton Friedman didn't deserve the Nobel Prize.

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MarketWatch

WASHINGTON (MarketWatch) — Economists, analysts and strategists disagree more than usual about how much damage higher oil prices will inflict on U.S. economic growth this year.

Some say it’ll barely be a bump in the road, while others are setting their hair on fire about the looming disaster.

Is $100 oil here to stay? Oppenheimer analyst Fadel Gheit talks to News Hub about the outlook for energy prices with unrest growing across the Middle East.

So far, the level crude oil prices and the amount of oil being held off the market are not enough to unhinge the global economic recovery. But we are still in the early innings of the Great Arab Awakening, and we shouldn’t presume to know what course it will take.

No one enjoys paying $3.25 a gallon or more for gasoline (unless you own an oil well), but so far, gas prices at these levels aren’t forcing Americans to cut back too much on their spending on other things. It’s a drag on the economy, but it’s not killing us.

Plus, we’ve seen this before: Gas at $3 doesn’t have quite the same sting as it did in 2005, when we first saw those prices at the pump. Once you’ve paid more than $4 for a gallon, $3.25 maybe doesn’t seem like the end of the world.

Or maybe it does. Economist David Rosenberg of Gluskin Sheff said that “we are getting closer to the point where the surge in oil prices could tip the global economy back into recession.” The deeply bearish Rosenberg said the trigger point is around $120 a barrel, according to a note he emailed to clients Thursday.

The price of crude oil is climbing fast.

Incidentally, the futures prices for Brent crude hit $119.79 a barrel on Thursday. Read our coverage of futures markets, including oil.

On the calmer side of the spectrum, we’ve got economist Sven Jari Stehn of Goldman Sachs, who wrote in a note that there’s “only a modest hit to growth” so far. Even with oil expected to average about $120 a barrel late in 2012, Goldman economists expect robust GDP growth in the U.S. economy of around 3.4% this year and 3.8% next year.

The Goldman economist said a sustained 10% spike in oil prices could be expected to reduce GDP by about 0.2% over one year and 0.4% over two years, mostly by reducing consumer spending, and to lesser extent, business investment.

James Hamilton, economics professor at the University of California at San Diego, comes to a similar conclusion. On his Econbrowser blog, Hamilton concluded that a 20% increase in oil prices could be expected to shave about 0.5% from U.S. GDP. He thinks there’s a tipping point at around $130 a barrel. Read Hamilton’s post on Libya, oil prices and the economy.

The uncertainty among analysts is reflected in volatility in all of the financial markets. U.S. and global stock markets are down, and safe-haven investments are up. Investors are scrambling to protect their wealth now, or positioning themselves for the inevitable correction. Oil prices are responding not only to actual disruptions in supply, but also to potential shut-ins, according to traders.

As the antigovernment protests spread from Tunisia and Egypt to Bahrain and Libya, global oil prices have risen about 15% to $100 in U.S. markets and $120 for Brent crude traded in London. During the spike in the summer of 2008, by comparison, oil prices topped $145 a barrel briefly.

Libya is a significant oil producer, accounting for about 2% of global output. Because global demand is growing rapidly, shutting off all Libyan supply for a prolonged period could send prices sharply higher. Saudi Arabia has promised to make up for any lost supply, but hasn’t increased its production yet. Some doubt that it could do so for an extended period, even if it wanted to.

Even if we lost all Libyan oil, it wouldn’t compare with the biggest oil shocks of the postwar era. UC’s Hamilton figures that the Suez Crisis in 1956 was the biggest oil shock, cutting 10% of global supply. The first Gulf War in 1990 reduced supply by an estimated 9%. The OPEC embargo and the Iranian Revolution in the 1970s and the Iran-Iraq War of 1980 each reduced supply by about 6% to 7%. Each of those supply disruptions was followed by a recession, either in America or in Europe. Read Hamilton’s paper on historical oil shocks.

The Middle East now accounts for 29% of global supply — including 12% from Saudi Arabia, nearly 9% from the Gulf states and about 5% from Iran, according to data from the U.S. Energy Information Agency. See more on global energy supplies from the EIA.

A 2% hit to supply probably isn’t enough to tip the global economy into recession, especially with emerging markets growing with so much momentum. However, an extended 10% hit almost certainly would lead to recession.

Much depends on how long the supply disruptions last, and how widespread they become. The only thing that’s certain is that the Arabs are no longer willing to quietly endure despotic rulers and their vastly unequal societies.

If the mainstream estimates are right, the supply reductions would have to get much worse before they’d threaten a global recession. But even at these levels, higher oil prices are hurting consumers, not only in the United States and Europe but especially in developing countries.

That’s the dangerous dynamic to watch: Higher prices fueling popular unrest, which in turn disrupts supplies of not only oil but other commodities as well, leading to even more dissent. The kind of uncertainty we’re living under now could be the new normal.

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Bank Requirements Containing Inflation, Mantega Tells Folha
By Andre Soliani - Feb 27,

Business ExchangeBuzz up!DiggPrint Email .Brazil Finance Minister Guido Mantega said higher reserve and capital requirements are “more effective” at containing inflation than interest rate increases, Folha de S.Paulo reported, citing an interview.

Mantega is “in favor” of higher interest rates when there is an “inflation problem,” the Sao Paulo-based newspaper quoted the minster as saying. Consumer prices are under control and economic expansion has slowed, as expected by the government, Mantega told Folha.

Brazil’s government is withdrawing all economic stimulus adopted during the global credit crunch to boost economic growth and interest rates charged by the national development bank will increase, Mantega said.

The central bank, which resumed interest rate increases last month, increased capital and reserve requirements in December to slow credit growth and help rein in consumer prices.

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www.newyorkfed.org/newsevents/speeches/2011/dud110228.html

DUDLEY's Speech - room for optimism:

Debt service has been pushed lower by a combination of debt repayment, refinancing at lower interest rates and debt write-offs (Chart 8). Financial institutions have strengthened their balance sheets by retaining earnings and by issuing equity. For many larger institutions, a release of loan loss reserves has been important in supporting earnings

In particular, the temporary reduction in payroll taxes is providing substantial support to real disposable income and consumption. This could have a particularly strong impact on growth during the first part of the year.

growth abroad—especially among emerging market economies—has been strong and this has led to an increase in the demand for U.S.-made goods and services.

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DUDLEY:

there are several reasons why we need to be careful about inflation even in an environment of ample spare capacity. First, commodity prices have been rising rapidly (Chart 19). This has already increased headline inflation relative to core inflation, and the commodity price changes that have already taken place will almost certainly continue to push the headline rate on year-over-year basis higher over the next few months. Second, some of this pressure could feed into core inflation. Third, medium-term inflation expectations have recently risen back to levels consistent with our dual mandate objectives (Chart 20). If medium-term inflation expectations were to move significantly higher from here on a sustained basis, that would pose a risk to inflation and, thus, would have important implications for monetary policy.

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

The FED should target the long-term price level (to avoid supply-side shocks - not NgDp - to maximize real-output).