The Fed has purchased assets at above-market prices, temporarily expanding the monetary base, but they will suck it all out at exactly the right time to avoid inflation, right? The problem with this story is that it looks at the money as a big blob that somehow supports “the economy” during this tough period. But in truth, the economic crisis and the false asset prices are inseparable. The crisis is about establishing market prices for assets that were mis-priced by credit expansion.
The nature of the unsustainable boom is that relative prices of certain assets – houses, mortgage backed securities, and all of the mystery meat that came out of the Wall Street meat grinder – became artificially high. These price distortion caused resource misallocations: too many mortgage brokers, too many home builders, too many real estate agents, and too many houses. The prices of these assets were unsustainable in the sense that they do not reflect the balance between the scarcity of savings and consumer preferences.
The nature of the crisis is that the prices of these assets stopped moving away from their equilibrium values and began to move toward those values. The price adjustments of factors drive the re-deployment of labor and capital away from their current wasteful uses toward more economic uses. Securities are an indirect method of pricing these factors. For the crisis to finish its work, relative price adjustments and resource re-allocations must take place.
But the purpose of the Fed’s program of asset purchases is to prevent relative price changes from occurring by purchasing assets at above their market value (which in some cases is zero but in other cases may be above that amount). There is no way to support the prices of the assets “temporarily” “until the crisis is over” and then withdraw the money because the nature of the crisis is inseparable from the false prices of the assets. If the injections were to be withdrawn, then the relative price adjustments, and hence the cleansing process, would continue.
As Peter Schiff said in his ASC Lecture, they want to remove the excess credit from the system but keep house prices at a level that they reached only through an excess of credit.
(Mark Thornton and Jeff Tucker have commented on farfetched nature of this scenario.)
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But the Fed says “We can use ‘trim mean’ to fight inflation.”
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/5379285/China-warns-Federal-Reserve-over-printing-money.html
That Telegraph article concluded with this insight:
“This situation is of your own creation. When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them.”
This is what happens when you combine the Bell Curve (of IQ distribution) with Democracy.
So, can we say democracy is ultimately at fault?
More and more I’m thinking that the QE has less to do with the economy and more to do with the Treasury having to issue 5T of debt in 2009. Of the public debt, they have 2.5T of existing debt due in 2009 which they need to roll and are trying for around 2.5T of new debt.
That 5T of debt is about 100B/week. Now you know why the treasury auctions are running 100B/week…
I’d guess that the Fed would consider a failed auction as not good…
Now once the debt is sold, well, it will be next year and there will be that year’s debt to sell, plus whatever is due…
I saw this a long time ago:
imho, the Fed is walking a balancing act between keeping the dollar afloat by raising rates, and keeping the economy going by not raising rates.
And parallel lines never meet — what makes everyone assume these lines are parallel? I keep feeling that somewhere in the future we will all find out that they cross…
Right now, there is a huge glut of unsold homes on the market due to the massive waves of forclosures over the past few years so it makes sense that prices for all other homes to fall as well. This holds true for any asset. If a massive supply of gold for example were to be found then it makes perfect sense that the value of all gold would also fall in value due to its now over abundance. The same is true for the dollar but Keynesians do not see it that way. They feel that the dollar retains its purchasing power no matter how much of it they print and inject into the system. That line of thinking never made sense to me.
Peter Schiff is correct in my opinion. They want to remove the excess credit from the system while trying to simultaniously keep housing prices at the inflated levels they were at during the height of the credit expansion. This is impossible to achieve unless they deflate the currency massively to push up all home prices which would mean more government spending or reduce the supply of homes available on the market all together. Personally, I think the former is the only outcome since reducing the supply of homes available is both costly and wasteful.
I expect what will happen is a change in the required reserve percentage. It will rise, perhaps to 20%. Doing that would prevent banks utilizing the huge reserves they have built up recently. So, it will stop the value of normal dollars from falling.
“So, it will stop the value of normal dollars from falling.”
current,
They WANT the value of dollars to fall.
That way nominal prices go up… real wages go down.. they bypass “stickiness” and also, v.v. importantly they get to use the money FIRST.
A natural solution would be to grant millions of green card. This would support housing prices naturally. The excess of houses would suddenly become a clever prediction rather than a mistake. To be sure, there would be other distorsions (to few hospitals, schools etc) but I’m guessing they’d be smaller.
Current,
I agree that that would be a good idea. But, I doubt that the Fed will. The big reason: Ben Bernanke is a student of the Great Depression. During the Great Depression, one thing the Fed did to try to restore confidence was increase reserve requirements – and it didn’t work and actually made things worse (at least that’s the Friedmanite view). Because of that, I strongly doubt that Ben Bernanke would even consider that option seriously.
Flix – Yes I know all that, you’re right.
Think about it more carefully though. The US state cannot afford a very high inflation rate, such as that of the 70s. They must prevent that in some way.
One possibility is to change the required reserve multiplier. That will prevent the banks from running down their reserves as far as they would have done otherwise. There are other rules they could apply to achieve the same effect.
I don’t believe that the government care that much for the banks. If they do though, they will do something different. They will organize a scheme to swap reserve dollars for government bonds. That will “support” the banks without risking inflation.
Lucas M. Engelhardt we are not in a situation like the Great Depression now. Soon the current recession will be over, followed I expect by a period of low or zero growth. Then price inflation will become the problem.
Current,
The point isn’t whether we are in another Great Depression or not. The point is Bernanke believes that that is the primary danger, and is going to act the way he believes the Fed should have acted during the Great Depression. (As he currently is acting.)
Personally, I don’t think the current recession will be over particularly “soon”. Most importantly, I think that prices will pick up before output does as malinvestments will depress output going into the future for some time. So, Bernanke’s choice will be whether he raises interest rates to fight inflation despite the fact that the economy isn’t recovering very quickly. Since “excessively tight” monetary policy is why he thinks the Depression was so bad and so long, he’ll opt for the high inflation.
Of course, the argument is all about Bernanke’s psychology, and neither of us really have any way to say for sure what he’ll do when the choice arises. I think we can agree that increasing reserve requirements is a sensible solution. I think we just disagree on whether or not we can expect Bernanke to be sensible.
The only way the Fed can remove the excess credit they’ve created is by selling assets, much of which is now garbage. Who’s going to want to buy all those toxic securities? Nobody wanted them in the first place–that’s why the Fed bought them.
Joe O.: “[R]educing the supply of homes available is both costly and wasteful.” I seem to recall reading recently that they’re bulldozing unsold new homes somehwere. I’d have to do some Googling, but I’m pretty sure I’ve read that recently.
Mh the Fed can create money out of thin air, so she should be able to do the reverse.
But then it would more simply to create the money and give it to the bank directly without buying all this crap.
Once the money is created and in the economy (and, more importantly, multiplied), they can’t just ask for it back. And giving money to banks for (literally) nothing would look very questionable.
Bob Kaercher: “The only way the Fed can remove the excess credit they’ve created is by selling assets, much of which is now garbage.”
I know what you’re saying, but there is another way for the FED to contract the money supply. They could increase the legal reserve requirement. Doubling the reserve requirement would cut the money supply in half. I doubt they’d ever do this, but it is a consideration.
It’s important to keep this policy tool in mind is because the FED can also use the reserve requirement to expand the money supply. I’m praying that Bernanke won’t lower the reserve requirement to 5%. I wouldn’t be surprised though, he’s a true monetary crank. I like to call him Ben Ber-Crank-y.
re: reducing the supply of homes
I did a blog post about Bill Gross’ recommendation that the government blow up a million homes. This along with Depression-era programs to destroy agricultural products, are based on a mis-diagnosis of the problem. In Gross’ case, he believes that the problem is the fall in home prices, which can be ameliorated by reducing supply. Of course, he is totally mistaken on this: the fall in home prices is part of the solution, not part of the problem.
However, there are cases, and there was a lengthy article in a recent NY Times Sunday Magazine about this, where homes have been gutted or simply decayed to the point where it would cost more to get the home back in livable condition than it would to scrap it. There’s nothing mysterious about this: any durable good has a finite useful life. The life of a home can be prolonged by good maintenance but at some point, it would wear out, in good times or bad. The housing bust has in some ways contributed to the lack of maintenance of homes because the property titles in many cases have gotten very fuzzy during the foreclosure process.
@ Marius Z
you are right i was thinking to much in shrinking the feds balance sheet.
Reserve requirements cannot be used to decrease the money supply when the banking system is insolvent.
If the Fed were to raise reserve requirements and merely give the banks their required reserves, it would do nothing to decrease the money supply. In fact, it would increase the possibility of future inflation if the RR was ever lowered.
If the banks raised cash by shrinking their balance sheets by selling their bad assets, they would be exposed as insolvent and their reserve ratios would actually fall and become negative, thus requiring the Fed to print money and bail them out.
There is no easy way out of this. The Fed must sell its assets to reduce the money supply.
gjc,
Your post is littered with errors. Ceteris paribus, an increase in the reserve requirement will lead to a contraction of the money supply.
“If the Fed were to raise reserve requirements and merely give the banks their required reserves, it would do nothing to decrease the money supply.”
Why do you presuppose that the FED would raise the reserve requirement and simultaneously give away reserves? This procedure would be self defeating and the FED would never do this to combat inflation. This argument is irrelevant.
“If the banks raised cash by shrinking their balance sheets by selling their bad assets, they would be exposed as insolvent”
Selling assets to raise cash does not mean a bank is insolvent. It only means the bank wishes to change its asset mix. Even in goods times banks sell their loans to organizations like Fannie and Freddie. They do this to change their asset mix from loans to cash (so they can make more loans). Furthermore, how does the reserve ratio become negative if a bank sells assets? A bank that sells IOUs debits the cash account and credits the IOU account. This would increase the bank’s reserve ratio. You should check your accounting.
The FED increased the legal reserve requirement in 1937 to combat inflation. This procedure pulled reserves out of the system and precipitated the recession (inside the depression) of 1938.
http://austrianeconomicsentrepreneurship.wordpress.com/2009/05/31/the-epic-failure-of-the-kauffman-foundation-under-carl-schramms-anti-austrian-fiat-leadership/
Austrian Economics & Entrepreneurship
Leading the Entrepreneurial Renaissance« Welcome to Austrian Economics & EntrepreneurshipThe Epic Failure of the Kauffman Foundation and Entrepreneurial Capitalism under Carl Schramm’s Anti-Austrian, Anti-Entrepreneurial, Anti-Founding Fathers Fiat Leadership
“If ye love wealth greater than liberty, the tranquility of servitude greater than the animating contest for freedom, go home from us in peace. We seek not your counsel, nor your arms. Crouch down and lick the hand that feeds you; and may posterity forget that ye were our countrymen.†–Samuel Adams to Carl Schramm the Statist who Exalts Capitalism and Wealth over Liberty, Jefferson, Hayek, Mises, and the Constitution
While Carl Schramm tries to tell us that our freedom comes from postmodern Capitalism and thus the Federal Reserve, Thomas Jefferson, like the Austrians, tells us the Truth, “The God who gave us life gave us liberty at the same time; the hand of force may destroy, but cannot disjoin them.†–Thomas Jefferson
Judging by the title of a recent Wall Street Journal piece which mocks the great Schumpeter while misappropriating his name, “Schumpeter’s Moment
Capitalism remains the foundation for economic growth and freedom,†it appears that Carl Schramm would like to rewrite Jefferson’s Declaration of Independence as follows: “We hold these truths to be self-evident, that all men are created equal, that they are endowed by Capitalism and the Federal Reserve with certain unalienable Rights, that among these are Life, Liberty, and the pursuit of Happiness.â€
Carl Schramm, in all his well-funded fiat arrogance, dismisses the supreme wisdom of America’s original entrepreneur–Benjamin Franklin:
Freedom is not a gift bestowed upon us by other men, but a right that belongs to us by the laws of God and nature. –Benjamin Franklin
This will be the best security for maintaining our liberties. A nation of well-informed men who have been taught to know and prize the rights which God has given them cannot be enslaved. It is in the religion of ignorance that tyranny begins. –Benjamin Franklin
Men will ultimately be governed by God or by tyrants (Schramm and his Harvard MBAs/legal team). –Benjamin Franklin
Rebellion to tyrants is obedience to God. –Benjamin Franklin
Whoever would overthrow the liberty of a nation must begin by subduing the freeness of speech. –Benjamin Franklin
Only a virtuous people are capable of freedom. As nations become more corrupt and vicious, they have more need of masters. –Benjaimn Franklin
Interestingly enough, the above quotes come from a story at the Mises Institute: http://mises.org/daily/1144
I have looked through all the centrally-controlled Kauffman blogs (growthology/entrepreneurship.org), and it seems none of them link to the Mises institute, for some odd reason. Mises and Hayek warned us about this subversion of truth that would arise from time to time as those with ambitions overshadowing their talents seized control of $2.5-billion-dollar foundations. It is truly dangerous to have a Statist redefine entrepreneurship in the image of the Federal Reserve’s monetary policy, as counterfeiting moeny and creating wealth are opposing endeavors.
If we are to save entrepreneurship, we must oppose Schramm’s billion-dollar-funded statist views, which buy him first-class tickets, honorary degrees and awards (from institutions including UI and Rochester). We must oppose Schramm’s armies of sycophantic Harvard MBA Buzzword bloggers with the more exalted, natural views of Hayek, Mises, and the Founding Fathers who exalt God over Schramm’s Mammon/Capitalism as to worship Capitalism is to worship Mammon and thus the Federal Reserve which creates Mammon from thin air and thus orchestrates the Congressional bailouts for the rich:
“God grant that not only the love of liberty but a thorough knowledge of the rights of man may pervade all the nations of the earth, so that a philosopher may set his foot anywhere on its surface and say: This is my country.†–Benjamin Franklin
First, the population was dumbed down through a politicized and substandard education system based on pop culture, rather then the classics. Americans know more about their favorite TV dramas then the drama in DC that directly affects their lives. They care more for their “right†to choke down a McDonalds burger or a BurgerKing burger than for their constitutional rights. Then they turn around and lecture us about our rights and about our “democracyâ€. Pride blind the foolish.
These past two weeks have been the most breath taking of all. First came the announcement of a planned redesign of the American Byzantine tax system, by the very thieves who used it to bankroll their thefts, loses and swindles of hundreds of billions of dollars. These make our Russian oligarchs look little more then ordinary street thugs, in comparison. Yes, the Americans have beat our own thieves in the shear volumes. Should we congratulate them?
–http://english.pravda.ru/opinion/columnists/107459-0/
Recently I dipped into the writings of Carl Schramm–a supposed cheerleader of entrepreneurship who seems to have wired hundreds of millions to our bloated, failing, student-debt-exalting universties and their BMW-driving administrators (central planners), instead of funding entrepreneurs and innovation (is it any wonder we are living through the greatest fiat bubble ever known to mankind! what is the ROI on all of Schramm’s programs–I imagine it is negative–the univeristy administrators who receive millions will of course tell you it is positive, but look at how much the debt and debauchery is augmenting, and central planners hide all their failing in debt and debauchery)–and I had to laugh at the title, “The Entrepreneurial Imperative: How America’s Economic Miracle Will Reshape the World (and Change Your Life) (Hardcover).†Ha!
America’s “economic miracle†is definitely reshaping the world and changing the lives of millions who are losing their homes, families, jobs, and marriages; as Schramm and all his good Anti-Austrian Statist friends/Harvard MBAs are bailed out by the taxpayers who they just ripped off in the “entrepreneurial†dot-com and housing bubbles, fueld by the Fed’s inflation and deflation. This is not the form of honorable entrepreneurship favored by the Austrians, but, instead, its very antithesis. Again, because Schramm is serving his quest to win the Nobel and receive accolades from his Statsit friends, he must deny and demolish the Jeffersonian wisdom and context, which influenced the true Austrians:
I have sworn upon the altar of God, eternal hostility against every form of tyranny over the mind of man. by Thomas Jefferson
“If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered…I believe that banking institutions are more dangerous to our liberties than standing armies… The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.â€
Then, I picked up Schramm’s somewhat indecipherable GOOD CAPITALISM, BAD CAPITALISM. In the index I looked to see what pages Mises and Hayek were mentioned on, only to find they were completely absent from the book! How one can write a book on capitalism without mentioning two of the most influential and enduring economists is beyond me! Hayek won the Nobel in Economics, and he and Mises founded an entire School of economics! Had Schramm never heard of them? That would be like the Beatles claiming that they had never heard of Elvis! What can drive a man to avert his eyes from the Truth? What can drive a man to dedicate his life to covering up the Austrian’s brilliance with insipid writings of his own and bought-and-paid for billion-dollar bloggers?
Fast forward to today when I came across Schramm’s WSJ article, Schumpeter’s Moment: Capitalism remains the foundation for economic growth and freedom.
Right there the title places the cart in front of the horse, for, as Hayek, Mises, and our Founding Fathers noted, freedom comes from God; but then, Schramm, as a postmodern Statist, is not allowed to mention Hayek, Mises, nor Jefferson while campaigning for the Nobel under the Fed’s strict guidelines.
Who has done more for freedom–Thomas Jefferson or Carl Schramm? Who has done more for economics–Hayek, Kauffman, and Mises or Carl Schrammm and his growthology bloggers who must seek to dsiplace and discredit Hayek and Mises, as when the truth ends, teh worst rise to the top? Who has done more for entrepreneurship–God, Mises, Moses, our Founding Fathers, and the entrepreneurs who are losing their homes and businesses, or Schramm? As a fiat Statist, Schramm’s first duty is to defend and exalt the monetary policy of the Federal Reserve–Mises, Hayek, Jefferson, the economy, univeristy, entrepreneurship, freedom, and entrepreneurs be damned.
A free people [claim] their rights as derived from the laws of nature, and not as the gift of their chief magistrate.-Thomas Jefferson
Yes–our rights come from Nature and Nature’s God, and not from Schramm’s corrupted form of Kapitalism.
–http://austrianeconomicsentrepreneurship.wordpress.com/2009/05/31/the-epic-failure-of-the-kauffman-foundation-under-carl-schramms-anti-austrian-fiat-leadership/
I think GJC’s point was two-fold:
1. If the RR was raised to 20%, say, and the banks couldn’t cover it, the Fed would need to cover the difference. Otherwise the banks would fall over.
2. If the banks tried to sell some of their assets to raise the capital to cover the new reserve requirement, someone (the market?) would have to price those assets, and would reveal what they are really worth (NOT face value). As now, they can legitimately claim no one knows what these assets are worth, and the Fed took them at face value.
They _could_ sell non-toxic assets, but that would leave them with junk, and in a much worse position down the road.
Lucas M. Engelhardt – I don’t really agree with you. I think that output measured by GDP is likely to rise soon.
I think this though will be more a symptom of the weaknesses of GDP as a measure than because of real recovery.
What will happen is that the low interest rates will cause the prices of assets to rise. GDP measures however do not take proper account of asset price inflation. So, this will be seen by many to be a recovery. Real recovery will take longer though.
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