A Graph of Adjusted Monetary Base

[adrock3215]

This is astounding:

And here is a chart that shows the same in percentage terms:

I didn't fully realize the historical precedent being set until I saw these two graphs on the St. Louis Federal Reserve's website.

As it turns out, an article released by econbrowser here states that the Federal Reserve is actually freezing the credit markets through some of its policies. The policy that the Fed has implemented is interest payments to banks on reserve holdings. Of course, the obvious effect of this policy is that banks will stop lending money out in favor of receiving a guaranteed return by keeping their reserves on hold with the Fed. Interest payments on these reserves began on Oct 6, and the interest rate was increased to within 35 basis points of the Fed Funds rate on Oct 22.

A blogger here writes about some of the possible implications of this policy by Bernanke. He posits that the Fed may be doing this in order to cause deflation, which will help troubled banks recapitalize. He harks back to the first graph above, noting that the increase in the monetary base is not yet actually in the economy, because banks are not lending.

Are these intended or unintended deflationary consequences of policy designed to recapitalize the banking system? Considering our system can not afford deflation on a long term basis (due to our ballooning debts and dependence on uptrending tax revenues), I imagine these policies will eventually be revoked. In the end, this new money supply will not be inert as it is now when policies are reset back to normal. It looks like the end game is a future which holds either high Fed Fund rates to mop up this extra supply and some extreme level of inflation.

I'm not sure if it is entirely true, but it is interesting to take a look at some of the data and the new Fed policies during this crisis.

Edited October 27, 2008 by adrock3215

[KendallJ]

Any investing implicaitons for the coming rout?

[adrock3215]

Any investing implicaitons for the coming rout?

Certainly no one on earth has ever seen anything like this, so I can only really say: "I have no idea." But since the Bailout Bill passed, you may want to take a look at owning stock in wooden arrow producers or Virgin Island rum distributors.

Obviously there is going to be high inflation in the future. For the average investor, typical experience says hold stocks during periods of inflation, because companies have the power to increase prices, and also because owning a bond with a 5% coupon is worthless when inflation is (say) 10%. On the other hand, the Treasury also has those TIPS bonds out, which I have never dealt with. But they are adjusted every year for ifnlation in order to give a certain real rate of return.

As a trader, I think that selling short Treasuries will be a very rewarding trade, as bond prices will surely have to drop in order for yields to rise with inflation. The other rewarding trade may be in certain commodities, i.e. wheat, oil, gold.

Edited October 27, 2008 by adrock3215

[Maarten]

What exactly does this graph show? Is it a measure of how much money the fed has in deposits at the moment from commercial banks, or how much money they are lending other banks?

[softwareNerd]

The monetary base is all the cash (with the public and in bank-vaults), plus all the balances that banks hold at the Fed. The bulk of the increase is money that the Feds have lent to various financial institutions on fairly short-term loans.

[gags]

This is pretty remarkable stuff. All that liquidity has been pumped in and the banks continue to refuse to lend because of credit concerns. Sounds like this crisis isn't going away any time soon.

[Greebo]

Do they have a chart like this going back to around 1910?

[adrock3215]

All that liquidity has been pumped in and the banks continue to refuse to lend because of credit concerns.

At least in part, according to this article, banks are not lending because the Federal Reserve has provided a disincentive toward doing so by essentially paying banks interest on their overnight reserves. The point here is that the rate the Fed is paying on these reserves (1.15) is higher than the rate in the Fed Funds market right now, and just below the LIBOR dollar rate. Here is the data on Fed Funds for the last few days:

10/24 0.95

10/23 0.93

10/22 0.81

10/21 0.67

10/20 0.70

(Source: New York Fed website here.)

What's interesting to me is the disconnect. If the Fed Funds/LIBOR rates are so low, then banks are certainly lending to each other (at least on an overnight basis, as the longer-term LIBOR rates are still high). Perhaps the Fed is paying 1.15% interest on reserves to discourage banks from lending in the Fed Funds market at less than the target rate (1.5 right now). But if so much lending is going on, what's with the press saying that no lending is going on?

Edited October 27, 2008 by adrock3215

[gags]

But if so much lending is going on, what's with the press saying that no lending is going on?

I was talking to a couple of commercial lenders the othe day, one from Comerica and the other from JP Morgan Chase. Both said they are lending to existing clients with track records, but they are not even talking to new clients. Those weren't their exact words, but it's a close enough interpretation.