Thursday, October 14, 2010

An Insane Bernanke Monetary Tool Gets Flushed Down the Toilet

One of my critiques of Ben Bernanke era at the Federal Reserve is his introduction of new "tools" to manage the money supply. While in an ideal world the money supply would be constant, in the real world of the Federal Reserve that's not going to happen.

Enter the mad scientist Bernanke.

Instead of using the three basics that every Fed chairman before him used, and every Macro 101 student has learned, Bernanke has designed new mad tools.

As a refresher, here are the basic tools that worked, and every other Fed chairman used:

1. the Discount rate

2. the Reserve Requirement


3.  Fed open market operations that controlled the Fed Funds rate.

Thus, the question is why is Bernanke creating new tools that seem to be spinning out of control?

Mad Bernanke has introduced one tool, interest on excess reserves, that has resulted in a TRILLION in excess reserves. No one knows when or how fast this money will enter the system. Bernanke is in the process of a new set of tools that he hopes will deal with the flow of money coming out of this tool. Got that? One tool is so out of control that he is creating new tools, e.g. selling Treasury securities to money market funds, to fix the out of control first tool.

Note to Bernanke: Your new tool to fix the first out of control tool is just as mad. The money market funds that you have designated to deal with the trillion in potential excess reserves have only $900 billion in assets. Got that? You are hoping a group of funds that have only $900 billion in assets are going to help you buy a trillion in Treasury securities. Work that one again with your calculator, Bennie.

But, your problem here is worse than just a subtraction problem., since these funds for certain hold less than 10% of their assets in cold hard cash. They hold it in short term paper, so if they actually started buying any sizable amount of securities you would try to sell them, they are going to be dumping hundreds of billions of other paper on the open market. Bennie this is mad. Do you know how to spell C-R-A-S-H?

But this is a problem for down the road. You have a new problem right now, Bennie. This problem will most assuredly result in a bronco ride for the money supply. The money supply (M2) has been growing in recent weeks by about a 4.8% clip. This is so because you have decided to re-invest proceeds you are receiving from mortgage backed securities you are holding. The proceeds you are receiving  from these MBSs are from people who are refinancing and money you are receiving after foreclosures. Do you see the problem here, Bennie?

The foreclosure market is about to grind to a halt, thanks to a bit of document failure by your banking buddies. Thus, money flow from your MBS proceeds will shrink. In other words, it is a nutty out-of your-control "tool" that just vomited all over you and can just be flushed down the toilet.

Yes, I know you are coming with a new heavy duty QE2 right after the elections, but given what you have done with your "Paying interest rate" tool and your "Reinvest MBS proceeds" tool, you have done nothing but make the monetary structure more unstable and uncertain.

The best I can tell, your coming QE2 will do for the economy what you did for the monetary structure, make it more unstable and uncertain, with  your new "gift" to the economy: the  dagger of hyper-inflation hanging over the economy.

Bennie you are mad.

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