Monday, May 28, 2012

Fed to Money Market Funds: Get Your Money Out of Europe

How near the cliff are things in Europe? The Federal Reserve is telling money market funds to pull money out of Europe.

During an interview with WSJ, Philadelphia Fed President Charles Plosser said:
The Fed and regulators have tried to stress to money market funds, for example, to reduce their exposure to European financial institutions.
This warning is in sync with comments made to me by a former senior Treasury official. Clearly, U.S. officials are very concerned about the eurozone blowing up. How concerned? This Keynesian former senior Treasury official asked me in something close to exasperation, "How would the Austrians handle this situation?"

That said, any eurozone crisis is not likely to have significant impact in the U.S. in terms of panic. The Fed will print whatever is needed to prop up and prevent any run on U.S. banks. Plosser said as much:
The swap lines we have with the European Central Bank are one way to support U.S. dollar funding in Europe. I don’t think a flood of liquidity is a huge problem. That would be manageable. The bigger problem is if it dries up for everybody. The Fed still has the tools it used during the crisis. We have the discount window and we have the ability to lend to financial institutions at a penalty rate against good collateral. And we have on the shelf some of the tools we used during the crisis: the Term Auction Facility and longer-term lending through the discount window to help mitigate that. So I think we have the tools at our disposal if they become necessary.
Amazingly, in the interview, Plosser correctly warns that the trillion dollars plus sitting in excess reserves could become a major problem. This is the first time I have heard this from a Fed official:
The inflation risk we have is longer term. The problem is that as the U.S. economy grows we have provided substantial amounts of accommodation. We have $1.5 trillion in excess reserves. Inflation is going to occur when those excess reserves start flowing into the economy. When that begins to happen we’ll have to restrain it somehow. The challenge for the Fed is will we act quickly enough or aggressively enough to prevent that from happening.

It may be a challenge politically when we have to start selling assets, particularly if we have to start selling (mortgage backed securities) to shrink the balance sheet and to prevent those reserves from becoming money.
Note well: The Fed selling assets means the Fed would be pushing up interest rates.

Print this post out and tack it to your computer, this is the most accurate analysis I have ever seen by a Fed official and it describes the exact truth as to when the Fed will start pushing up rates. It's when that money starts flowing out of excess reserves. And Plosser is also correct in indicating that it will be very difficult, for political reasons, for the Fed to push rates up high enough fast enough to battle the price inflation at that time. That's why at some point down the road, we are likely to experience quickly accelerating price inflation and interest rates.


  1. "How would the Austrians handle this situation?"

    It's sad that he asks this question now instead of when it was easier to deal with say, a year ago.

    I wonder if he even understands the situation is one that would have never happened to this degree under free markets, hence Austrians would never have to deal with it in the first place.

    That being said, Ron Paul's plan to have competing currencies only works well on "non-emergency" type situations.

    Things are pretty much screwed it's just a matter of waiting for the outcome Austrians knew was going to come along at some point in time anyway.

    To me the question is this:

    Will the Euro collapse domino over to the U.S. and start us on our crack up boom earlier than otherwise?

  2. Question becomes: which FX trading shop has the cajones/ becomes the conduit to front run the Fed and short the dollar? That becomes a Widowmaker trade if the Fed doesn't step in.

  3. Thank you Robert, I will certainly take note. One argument on the other side is that all this money that has been printed has already been absorbed by the system and is evidenced by current bond yields. Regardless of how you feel about that assumption, what will be the FIRST sign that these excess reserves are beginning to flow into the economy? What will you be looking at?

    1. Sorry if it sounds trivial, but like most Americans, I've never looked at these numbers and just assumed the Federal Reserve knew what they were doing. It was your speech that really opened my eyes and got me curious. Is this a monthly number, quarterly? Where can we find it? Are you also looking at "reserve ratios"?

    2. ???

  4. Hello,

    I want to give you a picture of the actual situation in germany and europe.

    The german chancellor Merkel is absolutely doin´ nothing against the crisis instead of lying to the financial markets. She wants to leave the eurozone, but she will be blackmailed by france and the Pig-States to stay in the eurozone.

    We all know, that the Federal Republic of Germany is not a souvereign country at all. The people in germany don`t know anything about the situation what is goin on in the Pig-States... They believe in inflation ratio of only 2% although food prizes rose 10-15% in the last year. They believe in 2,5% growth of our industry.

    If you ask me, it´s a perfect propaganda machine, even Goebbels couldn´t do it better than the Bundesregierung Merkel. A few minutes ago we got some interestic news:

    - the czech government told their people over tv and radio to sell all their euros. This is not secured but I believe the source.
    - the greek banking system will be immediatly stabilized with a sum of 50bln € from EFSF Monetary Fund (Information: that is illegal!)
    - spanish bank "Bankia" needs 20 bln € more money - the hole banking system is collapsing because bankruns and the escape of everythings what has to do with euro. The same in all Pig-States even France.
    - the FED warned all americans to save their money..

    My uncle lives in Spain and told me, that many people transfered their money to german banks...
    The system is collapsing, the situation is absolutely insane. If you say somethings against the euro, than you are a nazi...
    Mr. Steinbr├╝ck (SPD) - candidate for german chancellor said a couple of day ago: "we must rescue the euro because we lost the war and we did holocaust, we have a historical fault.
    Insane, everythings absolutly insane!

    Some german professors said it before the euro has startet, that it will be a very big mistake. But no one wanted to hear them.
    Nobody in europe knows gold or silver as a save source. They all sold their gold and silver to a metal shop to buy more consumer products. I expect 1-2% of all the people know how they can rescue their wealth, the others are sheeps and will be haircutted.

    1. With Germany and its people in the center of current events, it would be very interesting to get such picture more often than occasionally. Do you have a blog?

    2. There is presently an "information overflow", like a war between bloggers and main stream media propaganda. I am not able to write on a daily basis. I still have to earn my living. But you find a pretty big amount of crash links in German and English language which I collected on . You may go there to find current financial news and financial data.

      Hans Kolpak
      Deutsche ZivilGesellschaft

  5. No! Plosser has raised concern with US reserves number of times over last 18 months. I have listened on all of those occasions.

    1. Please provide citations or links. Thanks.

  6. Wenzel,

    What level do you expect interest rates to rise?

    If the FED sells assets and raises rates, how exactly will Congress deal with the existing $15 trillion in debt and the $1.4 trillion annual deficits?