Sunday, July 3, 2011

Denninger Displays Total Confusion on How Federal Reserve Operates

Karl Denninger is out with a vicious attack on Ron Paul that can only be described as proof he doesn't understand Federal Reserve monetary policy AND has a problem with reading comprehension.

Here's Denninger mouthing off:
I have repeatedly and very publicly held that Mr. Paul has no clue what the hell he's talking about when it comes to these matters...To those who have supported Mr. Paul all these years, you've now seen his true colors. Will you be man (or woman) enough to admit that he never actually understood what the hell he was screaming about, nor did he ever have an actual intent of restoring "sound money" to America?

What is his proof? Congressman Paul's calling on the Treasury to halt payments to the Federal Reserve on Treasury securities the Fed owns. I reported on this a week ago:

During an interview with Iowa radio host Jan Mickelson, Ron Paul called for the Treasury to stop making payments on Treasury securities held by the Federal Reserve. Congressman Paul pointed out that the Fed simply prints up new money when they buy Treasury securities, so there is no obligation to payback the Fed. He pointed out that through taxes, Americans are paying the interest on the Treasury securities owned by the Fed and this should also stop. As part of its $2.8 trillion balance sheet, the Federal Reserves holds $1.6 trillion in Treasury securities.

What's Denninger's problem with this? Denninger says it is inflationary. He writes:
So let's think through Mr. Paul's "creative" solution. Destroying the bonds The Fed holds while leaving the "excess reserves" that are on deposit, which The Fed creates with a push of a button to pay for those bonds, is in fact exactly identical to unbacked emission of currency. That is, raw printing of money.
Well not exactly. If banks are holding funds as excess reserves, those funds aren't in the system. They are back at the Fed. As I have been pointing out for more than a  year, these excess reserves are extremely dangerous because, if banks start putting them into the system, they become part of the money supply and it would be difficult for the Fed to soak them up without creating a huge spike in interest rates and other distortions in the economy. But if the Treasury simply defaults on the obligations held by the Fed, this means there is $1.6 trillion less that the Treasury needs to raise in the markets and thus creates huge downward pressure on interest rates and makes it much easier for the Fed to make counter-moves to halt the excess reserves from entering the system. There are many possible ways to do this. The text book way, that any student who has taken a Macroecnomics 101 course should be aware of,  is for the Fed to simply raise the reserve requirement. Raising the reserve requirement would prevent any of the excess reserves from hitting the system.

Denninger just doesn't get Macro 101. Further he has a bit of a comprehension problem when the entire concept of raising the reserve requirement is explained to him. How so?

When Denninger quotes Ron Paul's idea of stopping payments on Treasury securities held by the Fed, he quotes Dean Baker reporting the news. But look here as to what else Baker says in the same post that Denninger links to:
However, at some point the economy will presumably recover and inflation will be a risk. This is why the Fed intends to sell off its bonds in future years. Doing so would reduce the reserves of the banking system, thereby limiting lending and preventing inflation. If the Fed doesn’t have the bonds, however, then it can’t sell them off to soak up reserves.

But as it turns out, there are other mechanisms for restricting lending, most obviously raising the reserve requirements for banks. If banks are forced to keep a larger share of their deposits on reserve (rather than lend them out), it has the same effect as reducing the amount of reserves. To take a simple arithmetic example, if the reserve requirement is 10 percent and banks have $1 trillion in reserves, the system will support the same amount of lending as when the reserve requirement is 20 percent and the banks have $2 trillion in reserves. In principle, the Fed can reach any target for lending limits by raising reserve requirements rather than reducing reserves.
In short, Denninger doesn't understand the very article he links to, which explains how the Federal Reserve has tools, specifically the reserve requirement , to deal with the excess reserves.

If it weren't so crude, I might say about Denninger:

I have repeatedly and very publicly held that Mr. Denninger has no clue what the hell he's talking about when it comes to these matters...To those who have supported Mr. Denninger all these years, you've now seen his true colors. Will you be man (or woman) enough to admit that he never actually understood what the hell he was screaming about, nor did he ever have an actual intent of restoring "sound money" to America?


  1. All anyone of these clueless people need to do is read Rothbard's "The Mystery of Banking" that book was an epiphany for me.

  2. I would add since the dollar is not convertible into the assets held by the Fed, we are essentially just trading paper. Every time the Fed goes into the open market and buys assets it amounts to "raw printing of money".

  3. It is going to be interesting to see what Bernanke does when he realizes that raising the IOER may not be enough to stop an enormous liquidity flood. My take has been all along that in this precarious situation, the only way to save the system (although morally we should hope for failure) is to start raising required reserves. If we look to China, they get this. At least, after pummelling their citizens with raging inflation, they afterwards turn around and pummel the banks who have benefitted with higher reserve requirements.

    Technically, it may be what is necessary to prevent uncontrollable runaway inflation. Too bad the economy may well collapse from the shock of Bernanke throwing switches and pulling levers faster than anyone can blink. I seem to remember the "alphabet soup" that was created after a gazillion whim-induced decisions was taken to "save the system" ....

    Interesting times.

  4. Mr. Denninger is simply another simple mind in a sea of them. As usual, talking about something he knows zero about. Next...

  5. No doubt Denninger has an axe to grind with RP (he doesn't credit RP with starting the Tea Party and he also slams him for silly things, like taking earmarks and he's generally pretty disrespectful of him), but doesn't he have a point?

    Of course raising the reserve requirements would make it more difficult to lend out, but I'm a bit puzzled why no one suggested doing it before, despite numbers of people talking about it for years. That suggests that in and of itself it wouldn't have that much of a meliorating effect on money creation.

    In any case, I am really puzzled why there was so much opposition to Ellen Brown, who said similar sort of things before. I recall she wanted to cancel the bonds and print interest-free money....which she said wouldn't be inflationary because the government would be spending it into projects and programs that would increase long-term productive capacity and raise employment so demand would catch up.

    That is the same bit about "interest-free expenditure" that you have in this proposal.

    I think all this needs much more explanation.

    Anyway, the less one trusts politicians (whether conservative or libertarian or any other), the better.

    There is always more going on there than they let on.

    Thanks for picking up on this story though.
    Denninger was really good on a lot of the corruption stuff and maybe he's just disappointed in RP being a politician instead of a ranting blogger, but I can't say I'm not a bit disappointed. I am.

  6. Seems like this Denninger fellow has a personal vendetta against Ron Paul.

  7. OK. RP's actual statement was made in a CNN interview.

    Dean Baker left out the part about getting rid of the Fed, restoring confidence to the market, and meeting other obligations.

    That is a bit different in tone from the TNR piece...OR Denninger's.

    Denninger is a deflationist and anti-gold.
    So maybe that's what it's all about.

  8. Why exactly are you worried about the monetary base causing hyperinflation if all there is to it is raising reserve requirements? You yourself have claimed the fed will not be able to stop liquidity from flooding the economy. But now suddenly it's easy as pie when Ron Paul says something stupid.

    Hey lets just have the fed buy all our newly issue debt and default on it every time. There are zero consequences that are worth mentioning apparently (didn't see any in your post) so why not do it forever?

  9. @Anonymous 2:24

    You sound as bad as Denninger. Re-read my post. I make clear there is a huge difference increasing reserves when there is downward pressure on interest rates from the Treasury not having to enter the market to refund the $1.6 trillion and when the $1.6 trillion has to be refunded. If you add reserve requiremnet increases ON TIP OF refunding, you blow interest rates over 20%

  10. @Robert Wenzel 2:32 PM

    "But if the Treasury simply defaults on the obligations held by the Fed, this means there is $1.6 trillion less that the Treasury needs to raise in the markets and thus creates huge downward pressure on interest rates and makes it much easier for the Fed to make counter-moves to halt the excess reserves from entering the system."

    Wow, lower deficits, lower interest rates AND it'll be easier to control inflation?! There can't possibly anything else worth mentioning. It's all puppies and rainbows!

    You only gave "positive" consequences and ignore all the negative stuff was my point. There must have been a reason you haven't endorsed this idea yourself before. I'm sure we have all thought about this even before Ron Paul said it in public. There must have been something about the idea that made you decide not to tell the whole world about it. But because it's Ron Paul, you put it aside and he's a genius.

    I won't spell out because I think it's glaringly obvious what's wrong with this plan and I rather not insult your intelligence.


    "Denninger Displays Total Confusion on How Federal Reserve Operates"

    Last time I checked the Federal Reserve almost exclusively operates by buying and selling treasuries, not by adjusting reserve requiements even though it's technically possible. (There are reasons for this I'm sure you know) If anything, Ron Paul is showing his confusion.

  11. @Lila Rajiva : The reason no one who has read two lines of economics want to touch Ellen Brown with a 40-foot pole is that she is an marxist ignoramus of the most explicit kind, tries to peddle economic ideas that are so far beyond nonsense that it is laughable, but most specifically because she is a goddamn GREENBACKER.

    For a complete and utter demolishing of anything she has written, try Gary Norths Specific Answers. If you want my opinion, google "Web of Bullshit".

    I believe Ron Pauls proposals vis-a-vis the Federal Reserve has more to do with the unconstitutionality of the Federal Reserve than what the exact monetary outcome of his proposals would be. For instance, reverting to a completely gold-backed currency would start a debt-deflation of the likes the world has never seen - yet that does not make it less morally right.

  12. I used to go to Karl's website there was a lot of stuff that wasn't bad but a lot that was (the last straw was the dismissal of the collateral murder video from wikileaks as justified)but came to EPJ during the last round of flaming. I have never been back since.

  13. Give Denninger the benefit of the doubt. He's been busy looking for Obama's birth certificate...

  14. HPX -

    I know all about the North-Brown debate and commented extensively about it at Daily Bell.

    My point isn't that she's right.

    But that this position of Paul's isn't so different from her position, which elicited howls of outrage from hard money people.

    If Paul is making a political point about the Federal Reserve, then we should be clear about that.

    Here are some questions that perhaps others who are economically savvier than me could clarify:

    1. How will the market (specifically the bond market) react?

    2. How will foreign debtors regard a default on our obligations (of whatever kind)?

    3. What will happen to smaller banks and to businesses dependent on them in terms of liquidity when reserve requirements rise?

    4. What does this do to the balance sheet of the Fed and what are the repercussions thereof on its member banks?

  15. I think Denninger's opposition to Ron's proposal is interesting considering that Denninger's ideal monetary system is a non-debt backed fiat currency managed by the US treasury. Now I grant that Ron's proposal doesn't create that system. Any future money creation would presumably be in exchange for government debt, the US treasury wouldn't take over printing, and the rest of the banking system would still be printing debt-back currency. But, though it may not be the transition he wants, Denninger could still be more optimistic about the direction Ron's proposal would take us in. It would also do a little to fix that debt chart he's always showing us.

    Though the discussion on the issue of whether the federal reserve can/would sell treasurys or can/would raise reserve requirements to arbitrarily determine the quantity of money is interesting. It just reiterates the importance of Ron's other proposal, legalizing the use of gold and silver as money to compete with (and check the expansion of) federal reserve notes.

  16. Ellen Brown wants the gov't to print it's own money because then they wouldn't need to borrow freshly printed out of thin air money from the Fed. The problem in her mind is that this money from the Fed comes with an interest charge, which increases the debt even more. She's right in the fact that if congress printed it's own money, there would not be interest to pay, but can you imagine congress (and/or the president) in charge of the printing press? Push a button, pay for your favorite program. Holy cow, how long would that last before hyperinflation set in?

  17. Well, if Denninger is advocating non debt backed currency under the control of the US Treasury, how is that different from Ellen Brown either?

    Sheesh. Left, right and libertarian all talking the same book with a different accent. Smoke and mirrors for us peasants is my guess.

  18. I really like Denninger for the most part. The work he's done in regards to the bankers and the mortgage mess has been extraordinary.

    But he's dead wrong on this and several other issues.

    RW, you should email him and propose a blog style debate on the issue.

  19. Denninger's reply to this post:

  20. It's gonna be really fun to watch Karl go insane once the entire world goes back on a Gold standard. Hey Karl, do you really think the world is going to accept a new un-backed fiat currency from the US after 40 years of getting screwed? Sure, a lot of it IS math. And a lot of it IS human emotion. Get a clue.

  21. I think most of the confusion can be cleared up by realizing that Ron Paul is not a consequentialist. Since utilitarianism is in vogue and cost benefit analysis applied to ethical questions is the norm, it's easy to be confused by what Ron Paul says. If you do not make the mistake of projecting this onto him, it's quite understandable why he said what he said.

  22. This scheme proposed by RP and defended by RW seems very simple. If it was so simple and so obvious, I wonder why it has not been done? Have all of our Treasury Secretaries been such fiscal simpletons to have missed such an opportunity? I don't think so. To me, this proposal just seems like one more, albeit less disguised, plan getting a "free lunch" out of a financial system already overburdened with previous attempts to extract a free lunch, and really, there is no such thing as a free lunch. There will be a cost; something of this magnitude cannot be swept under the rug so easily. These costs cannot possibly be hidden no matter the attempts at fiscal slight-of-hand that are being proposed.

  23. Personally, I'd rather see Denninger as Secretary of the Treasury than as a blogger. I don't think he's always right, but he sees through all the BS better than ANYONE else.

    Beyond that, I'd just as soon all of you gave up trying to fix this Rube Goldberg time-bomb. It ain't gonna happen. It can't be fixed, doesn't matter how clever your proposals may seem superficially. The malinvestment from forty-six years of fake money is endemic and epidemic and there's no way to back out of it. It permeates society right down to the core.

    Our recent ersatz POTUS expressed it succinctly: this sucker's going down.

    Only truthful thing he ever said.


  24. I just unfriended Denninger on Facebook. He's been irritating me for a long time on various issue and I decided I couldn't take it anymore.

  25. "Baby Huey" Denninger should have his mouth washed out with soap once a week. I've never known any writer whose analogies all seem to come from rear ends and fecal matter. (come to think of it, Martin Luther did this a lot)

  26. Constitutionally, legislatively, and morally, Ron Paul has no equal. His 22 year voting record speaks for itself.
    Mr. Paul has not survived in politics for 22 years and maintain the ethics and morality he has by being anything other than stellar.
    If You refute the above comment, then I please invite You to listen to him speak about key issues. It is amazing how well he comes across because he doesn’t have to remember lies like other politicians. He understands what is happening in the world and knows how to apply the basic principles of liberty to achieve the real change that America so desperately deserves.
    American to American we are all on the same team. So I present Mr. Ron Paul as my Candidate for 2011 and invite anybody to meaningfully and respectfully debate why he is not the best for American and its people in 2012.
    Ron Paul = A real change, not for special interest, but for America’s Interests!
    Thank You for Your time
    Ron Paul 2012

  27. I really think RP needs to stick to his guns and assert that the only way to fix the Federal deficit is to reduce spending. This proposal of his seems like an attempt to be pragmatic with regards to the debt ceiling problem, believing that Congress will not be cutting its budget any time soon. Now, where I'm confused is that I don't understand how large of an effect an increased reserve rate has in comparison to the Fed's current anti-inflationary tactics (yeah, I laughed a bit at myself for typing that to). The Fed is now paying banks interest for keeping money in their Fed accounts in order to order to prevent an exponential increase in the money supply to go along with the Fed's exponential increase in the monetary base. According to John Williams' Shadow Statistics ( the total money supply actually shrank during 2010, so it seems like the Fed has done a pretty good job of preventing that exponential increase in the money supply. So, I'm wondering, will an increased reserve rate really have that great of an effect on stemming inflation, given the banks' current lending practices? I may be completely off in my understanding of the Fed's current interest-bearing-account for banks policy. Then again, even if I'm not, I suppose that the Fed won't be looking to sell back those Treasury bonds any time soon. They still have plenty of "private" sector assets that they can sell back in order to decrease the monetary base.

  28. As it stands now, the Fed plans to sell off its bond holdings over the next few years. This means that the interest paid on these bonds would go to banks, corporations, pension funds, and individual investors who purchase them from the Fed. In this case, the interest payments would be a burden to the Treasury since the Fed would no longer be collecting (and refunding) the interest.

  29. "But if the Treasury simply defaults on the obligations held by the Fed, this means there is $1.6 trillion less that the Treasury needs to raise in the markets and thus creates huge downward pressure on interest rates and makes it much easier for the Fed to make counter-moves to halt the excess reserves from entering the system"

    Now THAT is an interesting statement. US defaults on its obligations and the price of its debt gets driven up?! Its rating get downgraded as a result and the price goes up as the globe dumps and runs? You need to explain to us how this is going to happen because that some interesting Macro 101 at work.

  30. Interesting thought experiment. The Fed collects the interest on its assets, including Treasurys, and after paying its bills (including IOER), it remits the difference back to Treasury as Interest on Federal Reserve Notes. At current interest rates, the Fed should still have enough income from Agency and MBS payments to cover its bills. So, Treasury would make out a bit better because the Fed would not be taking a cut from the Treasury's interest payments (let's leave the issue of Agencies and MBS being backed by the Treasury off the table). However, when short term interest rates rise, the Fed will go cash flow negative sooner, bringing forward the time at which it simply prints money without increasing its balance sheet in order to pay its bills (which, again, includes payment of interest to encourage reserves to stay at the Fed). This is what Denninger refers to as the "unbacked emission of currency", though it arrives in a context different from what he describes.