Stop Printing Money...

....like the Fed did this summer and you kill inflation.

Wholesale prices plunged a record amount in October.

The Labor Department reported today that wholesale prices dropped by 2.8 percent in October, the biggest one-month decline on records that go back more than 60 years.

The 2.8 percent overall decrease marked the third straight month that wholesale prices have fallen.

Money supply growth, as measured by M2 nsa, was under 2% on an anualized basis this summer, but is now back up over 7%. Take advantage of the inflation pause while it lasts by buying hard assets.

The Changing Operational Face of Monetary Policy

This is big.

The Federal Reserve is now coming out with studies reporting on the impact that the Fed's change in interest policy is having on reserves. If you didn't pay attention to this when I wrote about it, maybe you will now that the Fed is writing on the topic.

Back in early October, I wrote:

Paying interest on required and excess reserve balances changes the entire role of the Fed Funds rate with regard to Fed monetary policy, as long as real rates are below the rate paid by the Fed on excess reserves.

The Fed generally adds monetary reserves to the system through its open market operations, i.e., the buying of Treasury securities. This, in the past, had a downward impact on the Fed Funds rate, as the new money the Fed adds shows up as reserves at various banks. Thus, in the past, the more new reserves, the more the Fed Funds rate dropped, since the Fed Funds rate is a rate set by the loaning and borrowing of the reserves. With the Fed targeting the Fed Funds rate, most recently at 2%, the Fed was in effect frozen, by its own target, from adding more reserves to the system if the Fed Funds rate was already at 2% , since any additional purchases of Treasury securities would push the Fed Funds rate below the targeted 2% rate...

Now, however, with the Fed paying interest on its reserves at a rate near the target Fed Funds rate, the Fed can add any amount of reserves it wants and the Fed Funds rate won't go down, because the Fed is, in effect, simultaneously providing a floor to the Fed Funds rate at the near target rate...

In summary, in the past, a cut in the Fed Funds rate was required to increase Fed open market operations to add reserves. This is no longer the case, now that the Fed will support the Fed Funds rate by paying interest on required and excess reserves AND it is has always been the actual adding of reserves, rather than the cut in rates that has fueled the economic boom times with the new money flowing into the economy.

Now, David Altig, senior vice president and director of research at the Federal Reserve Bank of Atlanta has a blog post linking to an FRBNY Economic Policy Review article written by New York Fed economists Todd Keister, Antoine Martin, and James McAndrews that discusses this topic. Their conclusion coincides with mine:

The key feature of this system is immediately apparent in the exhibit: the equilibrium interest rate no longer depends on the exact quantity of reserve balances supplied. Any quantity that is large enough to fall on the flat portion of the demand curve will implement the target rate…

Altig pulls out the meaty part of their analysis here, and writes:

I haven’t thus far offered explanations for why these changes might be desirable and how they relate to the broader context of monetary policy generally. More on that tomorrow.

The Fed Funds Rate and Why You Read EPJ

One month ago, we posted a note that headlined: Fed Funds Rate Cuts Have Become Irrelevant

In that post we wrote:

A new litmus test has developed to determine how well economists understand the machinations of Federal Reserve operations.

Any analyst now calling for cuts in the Fed Funds rate, or forecasting further cuts in the rate, will fail the test.

Yesterday, the Fed announced that it will begin to pay interest on depository institutions' required and excess reserve balances...

Paying interest on required and excess reserve balances changes the entire role of the Fed Funds rate with regard to Fed monetary policy, as long as real rates are below the rate paid by the Fed on excess reserves...

The Fed generally stays at its target. So under the old rules, if the Fed wanted to add reserves, it would more than likely cut the target Fed Funds rate below 2%, to keep the target in line with its actual operations. Now, however, with the Fed paying interest on its reserves at a rate near the target Fed Funds rate, the Fed can add any amount of reserves it wants and the Fed Funds rate won't go down, because the Fed is, in effect, simultaneously providing a floor to the Fed Funds rate at the near target rate, or at least the target rate for the excess reserves, since a bank will not withdraw reserves when the Fed will pay it for the reserves.

I have seen ZERO reporting on this extremely important fact, until today.

James Hamilton at Econbrowser covers much of the same territory and also expands on it, by examining (with apparently the help of Wrightson ICAP ) the role of an interesting arbitrage of GSE balances at the Fed that other Fed depository institutions can conduct. His ultimate conclusion:

...the target itself has become largely irrelevant as an instrument of monetary policy, and discussions of "will the Fed cut further" and the "zero interest rate lower bound" are off the mark.

Congratulations, to James for figuring out what we did a month ago. It's still a feather in his cap, (You have to be really good to stick with us in real time). Most Fed watchers still don't get what is going on, with the Fed Funds rate.

Money Supply Watch: FEAR Continues

The most recent money supply data has been released today by the Fed.

Although in the last couple of weeks M1nsa showed small declines, this week's M1nsa shows a jump of $77 billion from last week to $1519.6, which to us suggests that there remains a lot of fear in the system and that many choose to keep their funds in the relative safety of M1 components, such as currency and demand deposits. As we have said before, the economy and stock market won't turn positive until this flight to safety stops or slows substantially from its current three-month annualized growth of near 25%.

M2nsa is growing on a three month annualized basis of 7.7%, which is much stronger than what we saw all summer, but still below the double digit growth of early 2008. M2nsa is the best indicator of how much liquidity the Fed is adding to the system. At present, Fed money adding activities would have to be deemed moderate.

Bottom line: Nothing good is going to happen until the fear in the markets subside, which will be indicated by much slower M1nsa growth (perhaps even steady declines), but we are not there yet.

Wall Street Knows A Gift Horse When It Sees One

Today's climb of 889.35 points, or 10.9%, in the Dow Jones Industrial Average to 9065.12, included gains in all 30 of its components.

The catalyst for the move: News that sales of longer-term commercial paper soared 10-fold after the Federal Reserve began buying the corporate paper.

Companies yesterday sold 1,511 issues totaling a record $67.1 billion of the debt due in more than 80 days, compared with a daily average of 340 issues valued at $6.7 billion last week, according to Fed data. The Fed began buying commercial paper from companies yesterday.The central bank probably absorbed about $60 billion of the total, said Adolfo Laurenti, a senior economist at Mesirow Financial Inc, according to Bloomberg.

It's possible the Fed sterilized this buying, but if they didn't money supply is gong to rocket.

The Coming Collapse Of Treasury Security Prices

FT has a solid article this morning on the huge Treasury offerings that will be required because of the "bailouts".

Among the points made:

Before the recent upheavals, the US budget deficit for the fiscal 2009 financial year starting this month was estimated between $400bn and $450bn. Some economists now expect that figure to reach $1,000bn, which would be a record. That will push Treasury debt sales sharply higher...

“It is pretty conservative to say that the cost of the bail-out will be $1,000bn and by the time all the programmes have been tallied, it could be $2,500bn,” says Jamie Jackson, portfolio manager at RiverSource Investments...

This is all going to mean greater frequency of issuance and a return of previously discontinued issues such as the three-year note and possibly the seven. At a minimum, dealers expect the return of the three-year note, which was suspended in May 2007. The sale of 10-year notes is expected to move to a monthly schedule from being sold twice every quarter at present. New sales of 30-year bonds are seen occurring every three months...

From a logistical standpoint, the quarterly sale of debt in November and this week’s sales are a major test for the thinning ranks of primary dealers. These are the banks and securities broker-dealers that participate in Treasury auctions.

From 20 primary dealers at the end of 2007, Bear Stearns, Lehman Brothers and Countrywide have fallen by the wayside this year. The list will shrink to 16 once Merrill Lynch is absorbed by Bank of America.

Fewer dealers at a time when banks are preserving their balance sheets before the end of the year has contributed to an erosion in liquidity for buying and selling current and older Treasury securities. That backdrop could lead to poorly received auction sales, with yields for new notes being awarded at much higher levels, driving up the cost for the Treasury and taxpayers...

Tom di Galoma, head of trading at Jefferies & Co says: “No one has any balance sheet room and supply is a concern for the rest of the quarter.”..

Treasury in recent weeks has been selling securities in a buyers market as the flight to quality has caused enormous demand of Treasury securities. This will all change when the market stabilizes. Not only will there be less demand for Treasury securities, but there is likely to be major liquidation of currently held Treasury positions. A flight from Treasury securities is a very real possibility. This will also have negative ramifications for the dollar.

The only way to stem the collapse of the Treasury market would be for the Fed to step in and become an aggressive buyer of Treasury securities. This would be an exceptionally inflationary move. Bernanke has been running an erratic money supply operation since he has taken over, so it is impossible to guess how inflationary he is willing to get to protect Treasury rates. It is likely to result in a combination of some Fed buying coupled with a climb in rates.

The noose on government money operations is tightening again. For savvy traders, it will be a huge money making opportunity. For the average Joe, plumber or not, it will be a lower standard of living as rates climb, inflation climbs and Treasury borrowing crowds out private sector borrowing.

On The Huge Spike In The Fed's Balance Sheet

Bob Murphy emailed me to ask me my thoughts on the huge spike in the Federal Reserve balance sheet. This is an important enough topic that I will outline my thoughts in this post.

There has been huge coverage in the econ/blog world with regard to this spike--a lot of the commentary being confused or just plain wrong. Anyone, for example, calling the spike a major inflationary injection is way off.

The best coverage I have seen has come from James Hamilton at Econbrowser.

Here's one of the charts that everyone is getting worked up about.

Here's Hamilton's take on what is going on:

...the real action began last month...the Fed expanded its total asset holdings by $600 billion over the last 30 days, with less than a third of this going directly into reserve balances...

Reserves ballooned [immediately after 9-11] to $67 billion, as excess reserves simply piled up in some banks while others remained in need. Last week's spike of $171 billion was 2-1/2 times as big-- the breakdown of interbank lending last week proved more profound than that caused by the physical disruptions in New York in 2001.

Anyone who suggests that last week's ballooning reserve deposits represent inflationary pressure or the Fed monetizing the deficit simply doesn't know what they're talking about. Banks are sitting on the reserves, not withdrawing them as cash. When markets settle down, the Fed can and will absorb those reserves back in with sterilizing sales of Treasury securities, just as it did in 2001 or after the more modest spike in August 2007....

...we see that creating new reserves, as dramatic as it was, was dwarfed in magnitude by some of the other actions the Fed took over the last month...

I gather that the Treasury auctioned off some extra T-bills to the public, in addition to their usual weekly auction, and simply kept the receipts as deposits in an account with the Fed. If that were the end of the story and the Fed kept its total liabilities constant, it would result in a huge (completely infeasible technically) drain on reserve balances and currency in circulation, as banks sought to deliver reserves to the Treasury's account to honor their customers' purchases of the T-bills. So the Fed offset the supplemental Treasury auction with a matching purchase of private assets, such as the PDCF and AMLF, thereby temporarily delivering reserves to banks which the banks in turn could hand over to the Treasury supplementary account. The net result of such dual Treasury/Fed operations is that the newly created "reserves" would just sit there in the Treasury supplementary account doing nothing other than standing as an accounting entry. In other words, the device allowed for a huge expansion of the Fed's balance sheet without causing any change in currency in circulation or reserve deposits.

So there you have it. The flight to quality is resulting in the Treasury being able to raise huge amounts in the T-Bill market. By treasury depositing the proceeds at the Fed, it is the same as the Fed drawing these huge reserves out of the economy. Thus the Fed re-injects the funds by its its purchases through currency swaps, primary dealer credit facility operations and the like. Resulting in a non-event, from a money supply perspective, in spite of the huge increase in assets on the Fed's balance sheet.

The theory then is that when the flight to quality reverses itself, the entire operation will reverse itself. The T-bill owners will demand payment for their T-bills, the Treasury will draw down on its reserves at the Fed to pay off the T-bills, and the Fed will drain money from the system to offset the new money coming into the system from payments to T-bill holders by the Treasury. But, here's the rub, to drain reserves the Fed will have to sell off the securities it has purchased. It may be able to sell off its commercial paper, but who is going to buy the junk mortgage backed securities it has purchased? Thus, this could all turn out very inflationary once the Treasury needs to pull its deposit with the Fed.

Bottom line: Changes in M2 nsa money supply remains the best indicator of how much net-new money the Fed is adding to the system.

Money Supply Watch: Fear Continues To Grow

The money supply numbers (for the week ended Oct. 13) continue to show fear climbing throughout the system.

M1 money supply over the last three months has grown at an astounding 19.5% annualized rate. The week before, growth on a three month annualized basis was 7.6%. Thus the M1 growth rate has more than doubled in a week!

M1 measures currency and demand deposits (checking accounts). The huge growth is clearly a sign that many are moving money from other money holding vehicles, such as money market mutual funds. There will be no recovery until this growth in M1 slows significantly or stops. It is the measure of fear in the system.

The three month M2 money measure is also up, to 6.8% annualized from a revised 3.1% the week before. This is an indicator of Fed money pumping activities. The Fed is, obviously, acting aggressively here, and if this money pumping continues, the recession will be much, much milder than most expect, re-heated inflation will be the big problem.

Martin Feldstein On The Money Supply and Current Crisis

Martin Feldstein, chairman of the Council of Economic Advisers under President Reagan and the George F. Baker Professor of Economics at Harvard University, recently penned a WSJ Op-Ed calling for a program to stop a downward overshooting of house prices and the resulting mortgage defaults. A mortgage-replacement loan program may be the best way to achieve that, he wrote.

Since the latest leg of the downturn in the mortgage market, and now the overall economy, seems to be the result of the fact that the Federal Reserve crashed money supply growth over the summer, I have often wondered what Feldstein's take was on the Fed's activities this summer. I got the chance to ask him. Feldstein was a part of a panel that included Wilbur Ross Jr., Juan Williams and Ron Insana, before 4,000 at the AFP conference.

During the panel discussion, Feldstein stated that the Federal Reserve was doing an excellent job providing liquidity to the system but it wasn't working and that is why further measures, such as his "mortgage-replacement loan program" needed to be implemented.

During the Q & A, I asked him how he could say that the Fed was providing liquidity to the system since M2 growth crashed over the summer from a March peak of 12.5% annualized growth to growth of only 1.5% annualized in September. I further stated to him that, in addition, over the summer the Fed was sterilizing the cash infusions they were making by selling off Treasury securities, thus maintaining a net liquidity neutral stance as part of its various rescue operations.

Feldstein did not answer the question about where he saw liquidity coming from the system over the summer( How could he, since there wasn't any net liquidity added to the system?), but he did address the fact that money growth slowed over the summer. He said it likely occurred because of the problems in the economy (which in his view apparently took time for the Fed to adjust too.) He then said that money supply M2 was back growing at an annualized rate of 4.5%, which was correct. He said that this was about the correct growth rate given current GDP growth. This is a hoot, since money supply in September was at 1.5% annualized, and it then jumped to 2.3%, and now is at 4.5%, the Fed clearly has its foot on the monetary accelerator. I don't believe money supply at 4.5% is anything but a very brief transition point. Within weeks money supply growth could be at double digit rates. Indeed, the money supply numbers due out this Thursday could show M2 growth much higher than 4.5%. Feldstein clearly hasn't figured out that Ben Bernanke's Fed is clueless. When he does, I wonder what his prescription for the economy will be?

SIGNIFICANT DEVELOPMENT: Money Supply Climbing, Again

The fuel that sparks the economy, money supply growth, is climbing again.

As recently as September 15, money supply growth was nosediving.

In September, money supply [M2] growth [three month-annualized] bottomed at 1.5% annualized growth.

In the 3 to 4 weeks since then, money supply has shown sustained growth. This week M2 three month annualized money growth is at 4.1%. Money growth has more than doubled. Though, it is still nowhere near the 12.1% growth in March of this year.

But the change in growth to the upside suggests that Ben Bernanke has opened the floodgates to fill the system with money. This will throw off all the forecasts made by economists who are making projections of a deep and long recession. The recession should be short and brief. The true long term threat is likely to be inflation. That said, Bernanke has run one of the most unpredictable erratic Fed operations ever. IF Bernanke slows printing again, all bets are off and we are back into major recession mode.

Bowyer On Bernanke’s Pretend Rate Cut

The thing about Fed Chairman Ben Bernanke is that he does things in such a complex convoluted manner that few traders realize what he is or isn't up to. Hell, many economists don't realize what he is up to.

At least, Jerry Bowyer gets that today's Fed Funds rate cut is a fake Fed cut:

Today’s rate cut was late and small. Really, the cut was not actually a cut at all. Bernanke had already been pumping enough money into the system to lower the rate at least to 1.5%. What changed today is that it was made official. We didn’t get more money today – we got an announcement of what had already been happening...

But, notice that even Bowyer doesn't discuss the extraordinary power to pump money that Bernanke now has because of the Fed's new ability to pay interest on reserves left at the Fed.

Central Banks Coordinate Emergency Rate Cuts

Following crashing global stock markets, the world’s major central banks including the Federal Reserve, the Bank of England and the European Central Bank announced coordinated interest rate cuts.

In an emergency early morning announcement (7:00 AM ET), the Fed said it cut the Fed funds rate 50 basis points to 1.5 percent. It also cut the discount rate by the same amount.

"The Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates," said the Fed.

This can be seen as a somewhat cosmetic move by the Fed since they have been aggressively pumping money into the system in recent days, anyway. As we have pointed out, the Fed has pushed the funds rate far below the previous Fed target rate of 2%. Indeed, the Fed market activities in recent days has pushed rates even below the new target. From September 19, the Fed Funds rate has traded for the most part significantly below 2%.

Further, as we pointed out yesterday, the Fed's new ability, to pay interest on reserves held by commercial banks at the Fed, dampened the need for rate cuts, as the technical ramifications of the Fed interest rate payments will allow it to add as much reserves as it desires at a given target rate, so long as the target is above the real interest rate for reserves. In comments later yesterday, Bernanke supported this interpretation of the ramifications of the Fed paying interest on reserves held at the Fed.

However, the market not grasping the intricacies of Bernanke's new advanced money printing ways, reacted strongly to the news of a cut in the old fashioned Fed policy tool, the Fed Funds rate. In overnight trading, after the emergency rate cut announcements, the Standard & Poor’s 500 stock index futures climbed by 2%.

Bernanke Confirms Ramifications Of Fed's New Ability To Pay Interest On Bank Reserves

In a speech today before the National Association for Business Economics 50th Annual Meeting in Washington, D.C., Fed Chairman Bernanke confirmed my earlier analysis today of the ramifications of the Fed's new ability to pay interest on bank reserves. From Bernanke's speech today:

The Federal Reserve has also been granted a new authority, the ability to pay interest on bank reserves, which will allow us to expand our lending as needed to support the system while better managing the federal funds rate...

The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding. Recently, however, our liquidity provision had begun to run ahead of our ability to absorb excess reserves held by the banking system, leading the effective funds rate, on many days, to fall below the target set by the Federal Open Market Committee. This problem has largely been addressed by a provision of the legislation the Congress passed last week, which gives the Federal Reserve the authority to pay interest on balances that depository institutions hold in their accounts at the Federal Reserve Banks. The Federal Reserve announced yesterday that it will pay interest on required reserve balances at 10 basis points below the target federal funds rate, and pay interest on excess reserves, initially at 75 basis points below the target. Paying interest on reserves should allow us to better control the federal funds rate, as banks are unlikely to lend overnight balances at a rate lower than they can receive from the Fed; thus, the payment of interest on reserves should set a floor for the funds rate over the day. With this step, our lending facilities may be more easily expanded as necessary.

Bottom line, the ability to pay interest on reserves is a new highly powerful tool for the Fed to use. It will result in the Fed having the ability to increase reserves without necessarily changing the Fed Funds rate. This is not a taser gun, it is a bazooka--and has the potential to be a very inflationary tool.

Fed Funds Rate Cuts Have Become Irrelevant

A new litmus test has developed to determine how well economists understand the machinations of Federal Reserve operations.

Any analyst now calling for cuts in the Fed Funds rate, or forecasting further cuts in the rate, will fail the test.

Yesterday, the Fed announced that it will begin to pay interest on depository institutions' required and excess reserve balances.

The Financial Services Regulatory Relief Act of 2006 originally authorized the Federal Reserve to begin paying interest on balances held by or on behalf of depository institutions beginning October 1, 2011. The recently enacted Emergency Economic Stabilization Act of 2008 (The Paulson 'Bailout' Plan) accelerated the effective date to October 1, 2008.

The interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points.

Paying interest on required and excess reserve balances changes the entire role of the Fed Funds rate with regard to Fed monetary policy, as long as real rates are below the rate paid by the Fed on excess reserves.

The Fed generally adds monetary reserves to the system through its open market operations, i.e., the buying of Treasury securities. This, in the past, had a downward impact on the Fed Funds rate, as the new money the Fed adds shows up as reserves at various banks. Thus, in the past, the more new reserves, the more the Fed Funds rate dropped, since the Fed Funds rate is a rate set by the loaning and borrowing of the reserves. With the Fed targeting the Fed Funds rate, most recently at 2%, the Fed was in effect frozen, by its own target, from adding more reserves to the system if the Fed Funds rate was already at 2% , since any additional purchases of Treasury securities would push the Fed Funds rate below the targeted 2% rate.

Recently, given the crisis environment, the Fed has ignored its own publicly stated Fed Funds rate target and added reserves that pushed the Fed Funds rate below 2%. Last week, the Fed Funds rate traded at 1.56%, 2.03%, 1.15%, 0.67%, 1.10%, respectively from the period September 29 to October 3. This is unusual. The Fed generally stays at its target. So under the old rules, if the Fed wanted to add reserves, it would more than likely cut the target Fed Funds rate below 2%, to keep the target in line with its actual operations. Now, however, with the Fed paying interest on its reserves at a rate near the target Fed Funds rate, the Fed can add any amount of reserves it wants and the Fed Funds rate won't go down, because the Fed is, in effect, simultaneously providing a floor to the Fed Funds rate at the near target rate, or at least the target rate for the excess reserves, since a bank will not withdraw reserves when the Fed will pay it for the reserves.

In summary, in the past, a cut in the Fed Funds rate was required to increase Fed open market operations to add reserves. This is no longer the case, now that the Fed will support the Fed Funds rate by paying interest on required and execess reserves AND it is has always been the actual adding of reserves, rather than the cut in rates that has fueled the economic boom times with the new money flowing into the economy.

Further, because the Fed has put in a spread of 75 basis points between what it will pay on required reserves versus what it will pay on excess reserves, there is increased incentive for banks to put the money to work and get it in the higher paying required reserve column versus the excess reserve column.

The Fed may cut the funds rate in the future for cosmetic reasons to calm the markets, but it is not necessary for the Fed to do so, given that it is now paying interest on reserves at above market rates.

Thus, any analyst calling for a Fed rate cut doesn't understand how the Fed works and the impact the new rule changes will have.

The Fed: We Are Going To Inflate Our Way Out of This Crisis

The Fed has clearly scared itself into an inflation printing mode.

This morning it announced that it will begin to pay interest on depository institutions' required and excess reserve balances. Consistent with this increased scope, the Federal Reserve is also substantially increasing the size of the Term Auction Facility (TAF) auctions, beginning with today’s auction of 84-day funds. In addition, the Fed said it and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets.

The Financial Services Regulatory Relief Act of 2006 originally authorized the Federal Reserve to begin paying interest on balances held by or on behalf of depository institutions beginning October 1, 2011. The recently enacted Emergency Economic Stabilization Act of 2008 (The Paulson 'Bailout' Plan)accelerated the effective date to October 1, 2008.

The interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points. Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points. Paying interest on excess balances should help to establish a lower bound on the federal funds rate

The Fed also announced that the sizes of both 28-day and 84-day Term Auction Facility (TAF) auctions will be boosted to $150 billion each, effective with the 84-day auction to be conducted Monday. These increases will eventually bring the amounts outstanding under the regular TAF program to $600 billion. In addition, the sizes of the two forward TAF auctions to be conducted in November to extend credit over year end have been increased to $150 billion each, so that $900 billion of TAF credit will potentially be outstanding over year end.

Translaton of all this: The Fed can and will print huge quantities of new money.

The Federal Reserve Is About To Engage In The Greatest Money Supply Inflation In Its History

Up until now, the Federal Reserve has been sterilizing its bailout activities by either loaning out or selling Treasury securities that it has had in its portfolio, to match the bailouts activities it has been conducting. In the last 52 weeks, the Feds portfolio of Treasury securities has declined by $303 billion and stands at $476 billion. But, commercial banks and bond dealers, just in the last seven days, borrowed $348.2 billion from the Federal Reserve as of yesterday.

If the Fed attempts to sterilize these borrowings it will be down to $128 billion in its portfolio. If it does sterilize the borrowings, in a day or two with only $128 billion in Treasury securities left, and more borrowing likely, the Fed would be forced to print money, as they would have run out of Treasury securities for further sterilization operations. Either way, it is likely the Fed will start printing money at unheard of rates.

Indeed, they may have already started. According to the latest data, during the week ended September 22, the Fed increased the money supply by nearly $100 billion.

We may be about to experience the greatest inflation the United States has experienced since the Civil War. Gold could break above $1,000 an ounce in record time. You have been warned.

-Robert Wenzel

A Positive From The Crisis: Banks Getting Back To Basics

The current financial crisis is the result of aggressive Fed money printing during the Greenspan era and the early Bernanke era, and the faulty econometric equations designed by "quants".

The quants and their econometric equations will be thrown under the bus. That will not be the fate for Fed Chairman Bernanke. Although it is unclear that Bernanke understands he is exacerbating the crisis by his current slow monetary policy, his slowed monetary policy is producing a needed cleansing of malinvestments caused by the previous money printing. This is the exact prescription that proponents of the Austrian School of economics would recommend. It is unlikely that Bernanke is a closet Austrian, it is more likely that he is clueless.

Thus, the crisis atmosphere will continue as the money growth remains tame. As a bonus, the crisis period is doing wonders for clearing out the bad actors in the banking industry. It is much like a dentist drilling a tooth to remove decay. The pain is no fun, but the result is appreciated. All the decay must be removed before the pain stops. It's likewise for the economy.

Bernanke, of course, will not allow the dentist to complete his work, at some point he will jump out of his chair, spit into the nearby sink, smack the drill out of the dentists hand and start printing money again. At such time, the remnants of decay will remain in his teeth, and it will spread further.

But Bernanke has not yet jumped from his chair and the cleansing period continues, as the WSJ points out in an article about bankers getting back to basics, here.

-Robert Wenzel

Fed Injects $70 Billion to Push Down Federal Funds Rate

Following a surge in the Fed Funds rate, the Fed has added reserves twice today.

In an early market move, the Fed added $20 billion of temporary reserves to the banking system via overnight repurchase agreements. With the Fed funds rate still above target n the 6% area, the Fed added another $50 billion of temporary reserves to the banking system in a second overnight repurchase agreement.

-EPJ Newsdesk

Is No One But Me Watching The Fed?

Markets are crashing and talk across the board is of the various steps the Treasury, the Fed and the SEC are taking, BUT the one step that would reverse things is not occurring, and is not being discussed.

Federal Reserve M2 money supply growth dropped again last week. Three month annualized growth is at 1.5%. In March M2 was growing at an annualized rate of 12.5%.

There will be no end to the crisis anytime soon with the Fed maintaining its near zero growth money stance.

-Robert Wenzel

Unemployment Rate Rises to 6.1%

The unemployment rate rose from 5.7 to 6.1 percent in August, and non- farm payroll employment continued to trend down (-84,000), according to the Labor Department.

In August, employment fell in manufacturing and employment services, while mining and
health care continued to add jobs. Average hourly earnings rose by 7 cents,
or 0.4 percent, over the month.

Over the past 12 months, the number of unemployed persons has increased by 2.2 million and the unemployment rate has risen by 1.4 percentage points, with most of the increase occurring over the past 4 months. Which happens to coincide with the period of Fed slowing of the money supply.

The job losses in August came in every sector, with manufacturing and business services the hardest hit.

In August, the unemployment rates for adult men (5.6 percent), adult women
(5.3 percent), whites (5.4 percent), blacks (10.6 percent), and Hispanics
(8.0 percent) rose, while the jobless rate for teenagers was little changed
at 18.9 percent. The unemployment rate for Asians was 4.4 percent in August,
not seasonally adjusted.

Conclusion: If the Fed continues its tight money policy, the unemployment number is lkely to continue to climb, perhaps to double digit levels.

ALERT: MUST READ Money Growth Plunges To 1.8%

The M2 money supply growth rate continues to plunge.

Data released today by the Fed show the annualized growth rate for the thirteen weeks ending August 25, 2008 for M2 is now at 1.8%. As we have emphasized, this is after early 2008 M2 money supply growth at double digit rates.

If the Fed doesn't reverse engines real fast, the economy will plunge into Depression-like conditions within months, if not weeks.

Extreme caution should be exercised with regard to all long term business decisions. Within six months the economy could look much different. Preserve cash.

Note: For those of you not versed in monetary theory, the Federal Reserve pumps money into the economy through the banking system. There are lots of problems with the Fed dong this, starting with the fact that printing more money causes price inflation. But the Fed almost always is printing money. If the Fed stops printing money, then the entire system previously created by Fed money printing collapses.

This is where we are now. The Fed is barely pumping money into the system. Examine this chart from the St. Louis Federal Reserve, it shows the percentage change in money growth since the start of 2000. How low is the current 1.8% annualized growth compared to growth over the last 7 1/2 years? The Fed chart's growth axis doesn't even go that low! This means there is no new money entering the system to buy houses, cars or for businesses to invest. The seriousness of this fact can not be over-emphasized, if this continues we are headed for a Depression.

On The Road To Depression

In the most recent example of the Fed watching the wrong numbers, directors at the Federal Reserve Banks of Kansas City, Dallas and Chicago sought quarter percentage-point hikes in the discount rate before an Aug. 5 policy meeting to keep inflation at bay, Fed documents released yesterday showed.

Current price inflation is the result of money printing over recent years. It has zero to do with Federal Reserve policy over the last three to six months. It takes a long time, often years, for Fed policy to be reflected in consumer price inflation.

At present, interest rates appear to be ABOVE real rates, since, as we have pointed, out before, money supply growth has slowed to a trickle. Any further hike in rates will simply tighten credit in the economy further and plunge the economy into a Category 5 recession/depression.

Crashing Money Supply Numbers Signal Depression

It is now clear that Ben Bernanke has no clue as to how to control the money supply.

We have been commenting in recent weeks regarding the slowdown in money supply. It has been growing at approximately 2.5% (M2SA) over the last three months on an annualized basis, earlier this year it was growing at double digit rates. This is a dramatic downturn. The numbers out yesterday show no end to the money growth slowdown, in fact, three month annualized growth (M2SA) has dipped further to 2.2.%.

While there is a lot to be said for a no growth money supply that results in a recession to clear the system, the Fed doesn't believe this and neither does Bernanke. They are eternal money pumpers, who consistently want to prop up the economy and never have a recession. Thus, it is truly bizarre that they would allow money growth to collapse. They simply have their eye on the wrong ball. They are watching the Fed Funds rate and believe they are providing huge amounts of liquidity to the system because of the 2.0% Fed Funds target. But the fact that money supply at this target rate is not climbing suggests that the real interest rates must be lower.

Indeed, the actions of M1 suggest this is exactly the case. Since what is climbing is M1. Three month annualized M1SA is growing at 5.8%. And what is exploding is demand deposit money (a part of M1). Three month annualized demand deposits are growing at 9.5%. This suggests there is huge fear in the system, and depositors prefer keeping their money in demand deposits as opposed to M2 components such as saving accounts and retail money market funds, which are displaying no growth. Clearly, this situation tells you that depositors prefer what they perceive is safety over yield.

Only a much lower interest rate would reverse the current situation, or perhaps non-sterilized loans and purchases of bank collateral provided by those using the Term Auction Facility. If this isn't done soon then the economy and stock market will worsen by leaps and bounds, including a major eye opening stock market crash.

Chicago Fed President: The Fed Funds Policy Lever Is Broken

Federal Reserve Bank of Chicago President Charles Evans gets it.

We have been pointing out for some time that despite Fed Funds at 2%, the money supply is not growing to any noticeable degree. Evan is the first Fed official to comment on the current lack of monetary growth despite the low Fed Funds rate. In a speech today in Bloomington, Illinois before the McLean County Chamber of Commerce, Evans said:

Even though I think the current 2 percent funds rate is accommodative, it is not especially stimulative. This is because the financial market turmoil has meant that our funds rate reductions have led to less credit expansion to households and businesses than typically would be the case. Indeed, it has become increasingly clear to me that the fed funds rate alone is neither an adequate nor even an entirely appropriate tool for addressing instability in the financial markets.

Will the Fed stop sterilizing its bailout operations? That will goose the money supply. Stay tuned.

Behind The Great 2008 Commodity Sell- Off

Commodity prices continue to fall.

Gold fell nearly 5 percent in early European trading on Friday. Oil prices have also slipped some more, a session low of under $113 a barrel was hit. Silver suffered the most in the sell-off of precious metals, with prices plummeting to a low of $12.39 an ounce, their weakest since last September.

Platinum and palladium slipped 7 percent and 6 percent respectively. Both have suffered significant losses in recent weeks.

The overall downtrend in the commodity markets in recent months can be seen in the performance of indices such as the Reuters-Jeffries/CRB index, which has fallen almost 18 percent since early July.

Meanwhile, the dollar extended its rally overnight, hitting a nearly 2-year high against the pound and gaining further against the euro.

What's going on?

There are four factors that may be contributing to the sell-off.

The first may be the likelihood that some of the sell-off is simply a normal technical pullback against the major trend. The commodities boom has been a multi-year boom, and thus a pullback was due at any time.

Second, the climb in commodities prices was so dramatic and long lasting that many economic actors, both consumers and producers, have had time to adjust and consider alternatives to paying higher prices and, thus, cutting back on demand.

Third, the possibility exists that some of the sell-off may be the result of hedge fund liquidations. There are continuing rumors that some hedge funds are in trouble, if so, the first things they may try to sell off to meet marginal calls and partner liquidations are various futures positions since the futures offer a very liquid market to sell into.

Fourth, the Federal Reserve over the last three months has dramatically reversed its huge money printing operation. Generally, it takes time for changes in money supply operations to impact the markets, but this change in Fed actions could impact sooner because of the enormity of the change. From double digit growth to growth in the last three months of under 3%.

To the degree that the current sell off is simply a technical pullback, it should be over soon with commodities moving higher, again.

To the degree that it is the result of economic actors adjusting their activities, the drop should soon be over and prices should stabilize at current levels.

To the degree hedge fund liquidations have been behind the decline, then as soon as the liquidations are over (and they could be over very soon), commodity prices will begin to climb again.

To fourth and final factor is most important for the long-term trend in commodities. If the Fed maintains the current low growth rate of money supply, then commodities have much farther to go on the downside as the United States will be in a deep recession--extended far behind the housing crisis.

If the Fed reverses ts low growth operations, and begins printing at double digit rates again, then this will fuel further advancements in commodities prices.

Finally, it should be noted that these factors are not mutually exclusive, and that more than one of these factors could be operating on commodities prices, sometimes in countervailing fashion.

Money Supply Watch: Moving Closer to Recession

After growng at near double digit rates, Fed money supply growth over recent months has slowed dramatically. Three month annualized M2NSA money growth is at 2.8%. If money growth remains this low we will be in a recession in no time.

How Are Interest Rates Going Down, While Money Supply Isn't Expanding?

Money market funds, the short-term cash alternatives, grew to $2.9 trillion in June, up from $2.1 trillion a year ago, according to Crane Data. Further, those funds, in turn, have more than tripled their holdings of Treasuries and other government debt while reducing the share of their portfolios invested in somewhat riskier corporate notes, according to Vikas Bajaj .

Felix Salmon notes:

Money-market funds have gone up by eight hundred billion dollars over the past year? Yikes. To put this in perspective, the total amount of Treasury bills outstanding, according to the most recent schedule of Federal debt, is $1.13 trillion. If the money-market funds are massively overweight Treasury bills, there can't be very many left over for anybody else.

Bernanke is in kind of a Catch-22 here. Because of the fear in the markets, the real short-term rates for safe paper are below the Fed Funds rate. Thus banks do no money borrowing from the Fed to put the money in T-Bills, since it is currently unprofitable. Thus, no money supply growth. At the same time, the lack of money supply growth weakens the economy even further, creating even more fear in the markets and pushing T-Bill rates even lower.

Beware of Headline Analysts

There's a lot of detail to follow when you analyze the economy, and sometimes it's tempting to just offer analysis off of the headline of a story without digging into the details. But you have to dig, always.

Barry Ritholz over at The Big Picture writes:

While the Federal Reserve continues to pump money into the system at an unprecedented rate, less and less of it is finding its way to consumers and commercial borrowers. Instead, its being used to prop up speculators and financial firms.

This is headline analysis. He sees all the headlines re:bailouts and simply assumes that the Fed is pumping money at "unprecedented rate[s]", when in fact the Fed has been sterilizing its bailout activities by using its portfolio of Treasury securities, rather than printing new money. Money supply growth, in fact, over the last three months has been barely detectable. Through August 7, three month M2 annualized money growth has been at a dismal 1.2%. No "unprecedented rate[s]" here

Money Supply Watch

Has Bernanke crashed his helicopter? Money supply growth is virtually non-existent. The three month M2NSA money supply measure is showing an annualized growth rate of only 1.2% through the end of June.

We don't expect this slow money growth to continue, but, if it does, we are headed for a Depression.

Is The Fed In Crash Dive Mode?

Krishna Guha at FT writes this morning that the Fed has moved towards an inflation bias.

If Guha is correct, the Fed may very well crash the economy.

According to Guha, this inflation bias comes in spite of the continuing troubles at Fannie Mae and Freddie Mac, extreme volatility in bank stocks and the recent dip in the price of oil.

He focuses on the June 30 Fed meeting where the minutes of that meeting say:

With increased upside risks to inflation and inflation expectations, membersbelieved that the next change in the stance of policy could well be an increase in the funds rate.

Bernanke is no Alan Greenspan. He will never get away with tightening money now, if he does we could very well have a stock market crash of the October 1929/October 1987 variety, with an accompanying recession.

Is this where Bernanke is going? Who really knows with this guy? I have never before seen a Fed that has gone from double digit money printing to zer growth, but that has just occurred with this Fed.

M2NSA money supply growth has been flat--zero growth--for the months of May and June. If Bernanke thinks he needs to get around to fighting inflation now, then he doesn't even realize what he has been doing for the last two months.

Further, given the failure of IndyMac, the fears of a bank run have escalated, which means that some bank customers from around the country are likely to have pulled their funds from banks and those funds are now in the form of physical currency. Thus, there are likely to be all kinds of distortions in the money supply numbers which make a shift in Fed policy at this time particularly insane.

ALERT: Collapsing Credit

I have previously noted that over the last two months money supply has been collapsing. M2NSA has gone from double digit growth to nearly zero growth .

A review of the credit situation appears worse. According to recent Fed data, for the 13 weeks ended June 25, bank credit (securities and loans) contracted at an annual rate of 7.9%.

There has been a minor blip up since June 25 in both credit growth and M2NSA, but the growth rates remain extremely slow.

If a dramatic turnaround in these numbers doesn't happen within the next few weeks, we are going to have to warn of a possible Great Depression style downturn.

SUPER ALERT: Dramatic Slowdown In Money Supply Growth

After growing at near double digit rates for months, money growth has slowed dramatically. Annualized money growth over the last 3 months is only 5.2%. Over the last two months, there has been zero growth in the M2NSA money measure.

This is something that must be watched carefully. If such a dramatic slowdown continues, a severe recession is inevitable.

We have never seen such a dramatic change in money supply growth from a double digit climb to 5% growth. Does Bernanke have any clue as to what the hell he is doing?

Monetary growth is one thing. A slowdown in money growth is another. To jerk the money supply back and forth is to jerk the economy back and forth. Our guess is that the Fed is using models, in an attempt to sterilize their junk mortgage paper purchases, and that somehow they have miscalculated how much of the Feds portfolio had to be sold off for the sterilizations.

As of April 3, 2007, the Fed held $781 billion in various Treasury securities. By the start of April of this year, the Fed held only $589 billion in Treasury securities. As of July 10 of this year, the Fed held only $479 billion in Treasury securities. In the last three months, alone, the Fed has sold off (or traded for junk paper) $110 billion of its Treasury securities!

In the last year, the Fed has liquidated 39% of its Treasury portfolio and replaced it with mortgage junk. That last $110 billion to go out the window was 18.6% of what they had left. With a Fannie Mae bailout, a Freddie Mac bailout, rumors about Lehman and Merrill Lynch, the Fed will most assuredly be liquidating more Treasury securities to buy more junk. At the rate it is going (This is not a prediction) the Fed could be out of Treasuries by the end of the year, then its sterilization efforts will by necessity have to end and we would get a knee jerk reaction back to huge money printing as the Fed would have spent all the cash, i.e. Treasury securities, in its till.

Keep in mind that Freddie Mac has a loan portfolio of 1.5 trillion dollars and Fannie Mae's is over 700 billion. Together they own or guarantee some 5.2 trillion dollars in loans, or about 40 percent of the total value of home loans in the United States.

Depending on the details of how a Freddie Mac/ Fannie Mae bailout goes, it could certainly result in the Fed liquidating the remainder of its government securities portfolio.

Federal Reserve Maintains Inflationary Stance On Interest Rates

Below is the Federal Reserve announcement stating that they will keep the Federal Funds at a target rate of 2%. At this interest rate level, M2NSA money supply is growing at a rate of around 10%. Thus, by the Fed keeping interest rates steady at this level, the Fed will most assuredly be required to continue to increase the money supply at the 10% growth rate, if not faster. Only Richard Fisher appears to be any kind of an inflation hawk, as he voted against
the current target rate, and wanted a higher rate:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.

The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was
Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

Fed's Yellen Sees Signs of Recovery, But Conditons Not Normal

Always keep an eye out for comments from San Francisco Fed President Janet Yellen. She never rocks the boat and always tows the line. If you want to really know what Bernanke is thinking, Yellen will channel his thoughts.

This morning she spoke at an Asian banking conference in San Francisco and said that:

While there have been glimmers of hope that strains in our markets may be easing, conditions are still not normal...

Translation: The Fed is in no hurry to battle inflation and raise rates aggressively.