The Financial Times reports Fed mulls options in tacking liquidity problem. What options?
- The possible steps range from the relatively orthodox – a disproportionately large cut in the discount rate at which the Fed lends directly to banks – to more unorthodox measures.
At issue is whether it would be worth the Fed dusting down some rarely used tools – or improvising new ones – to help it reach beyond the banking system and channel liquidity to where it is needed most.
The article proceeds to describe some of these tools:
- “encourage greater use of the discount window”
- “extending the term of open market operations”
- “lending directly to non-banks against their collateral”
- establish currency swaps with European central banks
- “creatiion of a temporary special liquidity facility that would accept commercial paper at a discount rate”
- the sale of call options on interest rates
Although this point is somewhat obscured by the language of the article, a few of these measures are moving in the direction of monetization of securities. This can be direct monetization, if the Fed simply purchases the securities with newly created money, or indirect, if the Fed loans money into existence, taking the securities as collateral, valued at some fictitious non-market price, likely far in excess of the actual market value of the securities (if indeed they have any).
But don’t worry; like all emergency government measures, they will be strictly temporary. “Mr Berner said the Fed’s main concern would be to ensure it did not end up taking any credit risk and that any unorthodox arrangements were truly temporary.”
What is more likely is that temporary measures only prevent this round of problems from blowing up for long enough until the next round of problems occur. Temporary measures might allow time for alternatives to emerge, but what if the securities really are still worthless on the market a month or two months later? (Jim Sinclair has some interesting thoughts along these lines in this MP3 interview which starts at the 34:00 mark in the file). Once the props are removed from these assets, what is to prevent the fund or banks that own them from becoming insolvent?
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Yes, most of those options are basically monetization of financial “assets” if the bubble cannot, in fact, be reflated. Distressed institutions can keep borrowing money against these illiquid assets, but at some point, you either have to pay back the loan (with interest), or let the Fed have the house, so to speak.
2002 bogus deflation scare? If I recall, the solution to deflation was to cut interest rates… so is the solution to deflation, a fear of falling prices, is to cut prices?
Even if these people are stuck on stupid and therefore committed to using the cringe-inducing phrase “injecting liquidity,” do they ever stop to ask themselves WHY various sectors might “need” this so-called liquidity injection?
John Spiers: “2002 bogus deflation scare? If I recall, the solution to deflation was to cut interest rates… so is the solution to deflation, a fear of falling prices, is to cut prices?”
Deflation is not the fear of falling prices, it is falling prices. The solution to the fear of falling prices is for people to stop fearing them. Falling prices as such does not need a solution, it is the solution.
What I mean by bogus was a) there was no deflation and b) if there was, it’s nothing to be scared of.
Inflation was still in positive territory. The current measure of the CPI understates inflation by 4-5%, so it was more like 6% than the 1% that the Fed was using. I recently read a piece (wish I could remember where) that looked at a measure of the CPI in which home prices had been retained as the housing component rather than owner-equivalent rents (rents replaced home prices a while back, when home prices were showing too much of the effects of inflation). Using a CPI with home prices the number was more like 5% than 1%.
The deflation-phobic central bankers fear deflation, but they are totally confused when it comes to different types of deflation. There is nothing wrong with prices going down. If this results from an increase in the production of goods and services in excess of the growth of money supply, all that this means is that peoples’ real incomes are rising. Nothing to fear about that.
Then there is the “bad” kind of deflation. This is the collapse of an credit inflation. But this deflation is the cure to the diseases. If the market was left to correct, you would see the asset price bubble collapse, housing prices would fall, banks and lenders would fall. All pretty nasty. But this process is actually needed to clean up the mess created by the credit bubble.
I have an unorthodox idea. Why don’t they buy a couple of billion dollars worth of houses. Monetize brick and mortar!
I don’t claim it’s a good idea, just unorthodox.
Looks like the Fed is trying to bail out the hedge funds and similar institutions. I guess in previous bubbles it was mostly banks who held the bad debt, but now they don’t so much.
With all this, there is still one unconventional measure which it appears not even the Fed has the nerve to pull it off: stop increasing the amount of money in circulation.
… at some point, you either have to pay back the loan (with interest), or let the Fed have the house, so to speak.
…
Why don’t they buy a couple of billion dollars worth of houses.
Government involved in real estate? That would be where HUD comes in:
My wors[t] fears of the illegality of the government financial operations were confirmed when the chief of staff to the chairman of the HUD appropriations committee told me in the summer of 2000 that HUD was being run “as a criminal enterprise.” HUD can only be run as a criminal enterprise if the Department of Treasury, the Department of Justice, the NY Fed as depository and a group of contractors like Lockheed, DynCorp, AMS, & JP Morgan Chase run it as a criminal enterprise.
If the lead attorneys and accountants for the US government are running HUD as a criminal enterprise, that means that the US government is being run as a criminal enterprise.
Ghetto housing, crooked contracts, graft, money laundering on a titanic scale – what’s not to like about that?
And keep in mind that the above was written by an honest and well-meaning leftie who was predisposed to finding ways to make government work, not a Rothbardian anarchist.
I’m expecting the price of bread and milk to rise.
Is an “unorthodox” overnight devaluation of the dollar thinkable at all?
Robert Blumen wrote:
Deflation is not the fear of falling prices, it is falling prices. The solution to the fear of falling prices is for people to stop fearing them. Falling prices as such does not need a solution, it is the solution.
Robert,
Don’t get sucked into the monetarist trap. No, deflation is not the fear of falling prices. Deflation is the appreciation of the value of the monetary unit. There is a great difference between the two.
And no, the solution is not an end to fear, but ending what is causing the appreciation of the monetary unit. That could be a reduction in the supply of money, but it could also be actions by government that increase the demand for money.
I would refer you to Mises “The Theory of Money and Credit.”
Holding to a monetarist view of inflation/deflation can lead you to supporting the wrong solutions.
In another thread Eric Lansing posted a number of articles by Frank Shostak that he believed proved that Shostak was not a monetarist. I did not respond in that thread because it was on a different topic. I believe it does apply to this topic so my response is below.
How Does Money Acquire its Value?
http://mises.org/daily/1430
“What the market created—gold-based money—the government had to destroy before leaving us with paper money whose value as a currency depends on the management practices of the central bank.”
The value of money can be changed by the central bank but it is not dependent on the management practices of the central bank. There are many things that change the demand for money and this becomes an even more important consideration when faced with a fiat currency. While Friedman wanted to get rid of the CB he wanted to manage the supply of money with no consideration for the demand for money. Q theory and monetarism go hand-in-hand.
Making Sense of Money Supply Data
http://mises.org/daily/1397
“Now, most analysts use money M2 or M3 in their analysis. Does it matter which definition of money one uses? A correct definition of money is a must if one wants to glean the right information from monetary indicators. Unfortunately, most popular ways of defining money are flawed and provide a misleading account of what money is and where it is located in an economy.”
Attempting to use the Ms to manage money is a direct monetarist technique. A correct definition, if it were even possible, at best gives only one side of the equation.
Does a Falling Money Stock Cause Economic Depression?
http://mises.org/daily/1211
“…note that contrary to popular thinking, depressions are not caused by tight monetary policies, but are rather the result of previous loose monetary policies. On the contrary, a tighter monetary stance arrests the depletion of the pool of real funding and thereby lays the foundations for economic recovery. Furthermore, the tighter stance reveals the damage that was done to the capital structure by previous monetary policies.”
We should not engage in punitive deflation in an attempt to cure the ravages of inflation. Mises recognized that the problems caused by inflation and deflation were not distinct problems. If after an inflation you generate a deflation you only create problems of both inflation and deflation that are played out simultaneously. To cure inflation we must come as close to the real value of the currency and establish that as our new base to cure the inflation. Returning to a previous value that is not too low for the value of money only adds injury to injury.
The Ascension of Bernanke Into the Clouds
http://mises.org/daily/1949
“…the biggest problem with Bernanke’s perspective is that it regards increases in prices rather than the expansion in the money supply as inflation. By focusing on the symptoms rather than causes, there is no way that one can make an economy more healthy and prosperous.”
This was a great article. As I read I thought that perhaps I had found the article that would change my mind about Shostak but after a greate exposition of value theory, I ran headlong into monetarism. The value of money is more than the supply of money.
Under the gold standard the supply of money could be adjusted to account for changes in demand by watching the gold flows either in or out. Today the monetarists look only at the supply of money, a return to Q theory. But the best indicator of the value of money is the price of gold. You know inflation or deflation from the change in the price of gold and should be able to use the supply as a tool to maintain a stable value while allowing prices to adjust to the market.
We should not engage in punitive deflation in an attempt to cure the ravages of inflation. Mises recognized that the problems caused by inflation and deflation were [not delete] distinct problems. If after an inflation you generate a deflation you only create problems of both inflation and deflation that are played out simultaneously. To cure inflation we must come as close to the real value of the currency and establish that as our new base to cure the inflation. Returning to a previous value that is not too low for the value of money only adds injury to injury.
Please note the change to this paragraph. Problems from inflation and deflation are distinct and separate.
Selling calls on interest rates? LOL! “Hey, for $X, you can force us to sell you a short term bond at 5%, which will be a worthless option if — for whatever reason — interest rates happen to be above 5% at expiration. It’s not like we’d stiff you by keeping them above that…”
Hey, as far as taking money out of the economy, they could do worse…
“lending directly to non-banks against their collateral”
You mean I can get a car loan from the guvment? Cool!
“establish currency swaps with European central banks”
Does that mean that the Bush daughters would also have to marry Harry & William?
“creation of a temporary special liquidity facility…”
ATMs with built-in printers?
“the sale of call options on interest rates”
I can see Dana Perino with “goldnpalacedotcom” written on her forehead…
How about scratch-off spaces on the FRNs? “You may have already won a new equity loan!”
If fears of possible deflation were entirely unrealistic in 2001, as Mr. Blumen contends, then why does he state that…
“It was my view at the time that the only for the Fed to avoid a total meltdown of the credit bubble is to monetize assets at prices sufficient to maintain the solvency of the banks and funds that hold them.”
Are we to assume that the ten foot tall Federal Reserve Giants always know precisely how much new reserve-money must be created to prevent an unanticipated panic-driven rise in the demand for money? True, a deflationary meltdown would bring down the financial system and cause great suffering–especially in light of the predictable policy errors that would follow. But I doubt that the bureaucrats who vote to reach political consensus on the open market committee of the Federal Reserve System can begin to anticipate highly complex and uncertain chains of counter-party events, of institutional failure, or of public and institutional responses to such events.
I think the situation is always more uncertain than almost anyone today cares to believe. Deflation–and its attendant calamities–is not inevitable, nor impossible. Frank Shostak’s writing about the role of the pool of real funding in fostering conditions that lead to toppling dominoes is highly relevant to this issue. The uncertainties of today’s situation are entirely a tragic consequence of the nationalization of our money and banking system through the Fed.
Dick F
Deflation is the appreciation of the value of the monetary unit.
Wich is the natural tendency in a free society, I believe ?
Only if advances in productivity outstrip the supply of the monetary unit. I believe that recent writings on the gold standard have questioned whether it is deflationary or not.
Thanks Anthony.
Juan, do not confuse appreciation of the monetary unit with price changes. After the PC was introduced its price began to fall rapidly with the price fall continuing even today. That is not deflation and it is not the appreciation of the monetary unit.
Ok, so the terms inflation and deflation are being used here (correctly) to mean increase and decrease of the money supply ? I’m not sure that’t the case.
I mean, it seems to me that not everybody is using the words in that sense.
Juan,
Yes, you make an excellent point and this is my crusade. If Austrians do not use the terms correctly and if Austrians support Q theory and monetarism rather than value theory as described in “The Theory of Money and Credit,” how can we expect anyone to get monetary policy right, especially the FED? Let’s get back to basics.
The FED, can’t, by definition, get ‘monetary policy’ right, I believe ?
I’m no expert on all the theories about money, but it seems to me that when money is not commodity money, propery rights vanish…and that’s the end of freedom.
So, how would you classify people who advocate commodity money ? What ‘theory’ do they support ?
Commodity money is often called “honest money”, “hard money” or, more specifically, the “gold standard”. Advocates tend to be called goldbugs. This is not a uniform group. Misesians (and I believe most Austrians), obviously, will use Misesian theory.
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