Bernanke has the twin problems of monetary inflation coming home in terms of price inflation and a falling dollar combined with a shaky banking structure and economy.

The general point is that he is resorting to new and unusually policy actions that could be considered desperate.

Not necessarily. The lag between increases in the money supply and price inflation can be quite long, 18 months on average. If you add a lag between Fed action and its effect on the money supply, you have to wait a long time to see the effect. And keep in mind that increases in the money supply cause prices to rise with the caveat ALL OTHER THINGS BEING EQUAL. Usually, they’re not. The Fed’s actions will eventually increase the money supply, but it’s hard to say when.

jp: “It also makes his observations such as record high prices in all sorts of commodities, and a falling dollar, hard to explain. If the Fed has not been increasing the money supply, why have we been seeing a collapse in the dollar’s purchasing power?”

The lag between increases in the money supply and prices is about 18 months +-6 months, so the effects you see today are the result of changes to the money supply at least 18 months ago. The recent levelling of the growth in money will see its effect in less than two years.

Here is another one: http://www.newyorkfed.org/markets/pomo/display/index.cfm

It gives the CUSIP numbers for all the bonds the Fed holds in its long term portfolio, or SOMA.

I couldn’t agree with you more on the transparency issue being linked to the dollar’s fall. SOMA data is there for all to see. One knows how much each SOMA instrument worth, and who the issuer is.

With the TAF, we have no idea what the collateral submitted was, nor as you pointed out, who the counterparty was.

By emphasizing TAF and de-emphasizing SOMA, the Fed is a much less transparent organization than before and its liabilities deserve to valued for less.

*****

What kind of collateral is acceptable for the TAF?
The same collateral that is eligible to be pledged by a DI as security for discount window loans is acceptable for the TAF. Advances under the TAF to a Participant will be collateralized by the same pool of collateral as its borrowings from the discount window primary or seasonal credit programs. See Discount Window and PSR Collateral Margins Table at http://www.frbdiscountwindow.org/discountmargins.cfm?hdrID=21&dtlID=83

*****

The discount margins …

http://www.frbdiscountwindow.org/discountmargins.pdf

I’d like a policy of full disclosure … the more secret the TAF is, the less confident people can be of the currency … hence the selloff.

In my view, the immediate effect of a lockdown in the markets where bank assets cannot be known to be valuable is a dollar sell-off because the U.S. is a net seller of dollar debt … if a foreign economic actor cannot know the position of another actor in the U.S. financial system, they have no way of knowing the solidity of their obligations. In that case, the number of settlements drops significantly, and a flight to hard goods begins with any of the remaining financial assets gained by trade. An “inflationary credit deflation” occurs.

Later the process will reverse if the deflation progresses far enough so that purchasing power of the citizenry contracts.

In effect, the markets are forcing the Fed to deflate.

Just to clarify that you mean what I think you mean. The supply/demand and collateral value refers to that of the central bank issued money, right? As for the Fed overcollateralizing – don’t you think we’d need to see what it has actually been accepting at the TAF window to know for sure? To the best of my knowledge this is classified info.

Fundamentalist:
What Jake, JIMB and myself have been pointing out is that money supply has not been increasing, even with the new TAF facility in place. Therefore Professor Thornton’s point about inflation (as in increase of the money supply) doesn’t hold, and the general price level will not increase.

It also makes his observations such as record high prices in all sorts of commodities, and a falling dollar, hard to explain. If the Fed has not been increasing the money supply, why have we been seeing a collapse in the dollar’s purchasing power?

I think Prof Thornton has it right when he says “It appears that they are flooding one area of “liquidity” while draining from another to help achieve their two goals of reflating the financial sector but preventing a complete breakdown of the dollar.”

In essence, Austrian theory can only say that the TAF is bringing about redistibutional effects, changes in relative pricing. ie. draining from one sector to give to another. This hurts the overall economy by artificially sustaining some at the expense of others.

But Austrian theory, as far as I can see, cannot criticize the TAF regarding its effect on the dollar. The overall money supply hasn’t been changed. Therefore Austrian theory cannot say that the currency has been debauched. It has trouble explaining the collapse of the US dollar to record lows against the Euro, for instance.

My implied earlier point was that the change in collateral (from safe government bonds to questionable assets like MBS) could be considered a debauching of the currency. You say the Fed’s assets don’t matter. But if the Fed sold all its gold and substituted this with subprime MBS without actually inflating the money supply, don’t you think this would matter? Especially in the face of a meltdown in housing prices? Switching gold-backing for MBS-backing given what is going on would only be bad for the dollar, in my opinion.

The asset side mattered only when gold was considered money. Once off the gold standard, I don’t think many people would argue that the assets of the Federal Reserve matter, since the whole set up is a fiction, anyway. Nothing backs the US$ except various forms of IOU’s. Does it matter that some IOU’s are backed by mortgages while others are backed by government IOU’s.

The important point is whether or not the money supply has increased. The Fed can’t always increase the money supply at its whim; lenders and borrowers must participate. However, the Fed may be creating a “latent” inflation by pumping so much “liquidity” into banks. When banks and borrowers think the time is right to invest in new production, the built up inventory of “liquidity” will gush into the marketplace, inflation the money supply and drive prices skyward.

In this case, it appears the Fed is heavily over collateralizing their issuance of reserves.

Here are the debt levels for reference.

http://www.federalreserve.gov/releases/z1/Current/z1r-4.pdf

The Fed’s actions the last few months seem to be a simple switch of collateral. It is selling it’s long term bonds while accepting certain questionable securities via TAF. The net change on the financial assets the Fed holds is 0, the net change on circulating currency is 0. (Of course, this could change with the new announcement)

From the above, Austrian theory tells us that since there is no expansion of the money supply, there will be no decline in the purchasing power of money. Yes, the policy creates perturbations in the economy. The money enters the economy via TAF recipients who, flush with cash, push prices up. But at the same time, money is being withdrawn from the government sector as the Fed redeems long term bonds. Cash strapped, government begins to demand money, pushing prices down. The net effect is that the two activities cancel each other out. The overall price level stays the same, though relative prices will change. Does that sound right?

Here is a more extreme version of the actual one above. Imagine a central bank that has issued $1 million in notes and has 1 million ouces of gold in its vault. Like the Fed is doing today, it decides to substitute gold collateral for another asset, say the same sort of questionable assets the TAF is accepting like mortgage backed securities (MBS). The bank stealiy sells all its gold. For each dollar it receives it then loans the dollar out at the going market price of the MBS, receiving those MBS as collateral. In the end, whereas each dollar was backed by gold, now they are backed by MBS.

What does Austrian theory have to say about this scenario? The bank hasn’t increased the money supply, it is still at $1 million. All that has changed is the assets the bank holds. We cannot say any inflation has occurred, yet intuitively it would seem that substituting gold for MBS would be an unwise thing to do. Are there any books or articles you can recommend that deal with the importance of the asset side of a central bank?

TAF is being expanded by 67%.

I really hate to say “…………………………….”

As a positive economist, if the banking system needs to “collapse” I can only analyze why this takes place and offer remedies. I don’t offer ways to help one group versus the others, or keep schemes afloat.

Personally, I’m against schemes.

Mark

In my view, the huge inflation occurred in the past — trillions of it in mortgage credit.

That is the desperate situation the Fed has placed the financial markets in.

Bernanke decided to take desperate measures to bail out the banks.

Why not let banks make their own reserve requirements by offering us higher interest rates on CDs? Cut back on loans? The reserve requirements in place today are almost non-existent and they can’t be met internally?

Where is Paul Volcker when you need him?

The ratio of the funds given in comparison to the collateral is very small (<50% plus potential for margin call) and they accept only excellent collateral.

If they did not do this, banks could get no additional reserves no matter the demand for money (remember money = settlement or cash and everything else is credit). Depositors could not get their funds.

More here:

http://www.federalreserve.gov/monetarypolicy/taf.htm

http://bkmarcus.com/blog/2007/10/failedpunner-joe

Failedpunner Joe
October 22nd, 2007 by bkmarcus

And now a word from Scott Lahti (1, 2):

…I pass along my latest Austrian-”inspired” drive-by, prompted by a caricature of Fed chairman Ben Bernanke’s presumed intention to inject ”liquidity” into the rattled credit markets (attached image), sent to me by my roommate at Hillsdale College (1980-1), a Misesian-Austrian economist…. Only those ignorant of 1970s pop lyrics are assured of being spared the worst.

Bern, Baby, Bern (Fiscal Inferno), or -

Benny and the Debts! *

*You know I didn’t read it in a magazine…**

**And ever since our ”raining”, pennies-from-Heaven monetary carjackers began to sing along to ”Goodbye, Yellow Brick Road”, abandoning (g)old standards in favor of ”payola”, they’ve made the nation’s Brink’s trucks as vulnerable to blowouts as a candle in the wind…***

***At least one band had the better part of hard-money wisdom in singing ”Give me silver, blue and gold”, which is not Bad Company to find yourself in when inflation is rampant – dunno about the ”blue” part, but, hey – ”two out of three ain’t bad”, or, Half a (Meat) Loaf is Better Than None…

But this maybe just short term. There is nothing stopping them from expanding the TAF while also stopping the sale of Treasuries. Thus, they now have monetary jets!

http://www.federalreserve.gov/releases/h41/

Reserves have not expanded hardly at all for the enormity of the credit problems. The fed is NOT expanding money much at all (if the #s are to be believed). The inflation so far, was in the past.

I don’t know how much the Chinese or Arabs have to do with the redeeming process. The Fed is essentially slowing the rate at which it monetizes government debt. It now subsidizes a slightly smaller chunk of the US national debt than before. Some other party must have stepped in to take the Fed’s place (assuming government spending has gone on at the same rate). These new buyers of government debt could have been the characters you mentioned.