Monday, June 27, 2011

Federal Reserve Money Continues to go Off-Shore

Yesterday in my post I reviewed the consequences of QE2 on the Federal Reserve balance sheet. (

The bottom line: “The ‘net’ increase in securities held outright by the Federal Reserve has been $589 billion, pretty close to the $600 billion ‘net’ increase promised.

Reserve balances at Federal Reserve banks, a proxy for excess reserves in the banking system, have increased by $584 billion to $1,594 billion over this time period. Actual excess reserves in the banking system averaged $1,610 billion for the two-week period ending June 15, 2011.”

Cash assets (excess reserves) at commercial banks in the United States rose by about $800 billion from December 29, 2010 to June 15, 2011 and closed slightly below $1,870 billion on the latter date. 

Basically the Federal Reserve pumped all these reserves into the banking system and there they seemingly sit.  Yet, the amazing thing is that of the almost $800 billion increase in cash assets in American banks, almost 85 percent of the increase, or about $670 billion, ended up on the balance sheets of Foreign-related Institutions in the United States. 

And, what increased on the other side of the balance sheet?

Net deposits due to related foreign offices.  These balances rose by almost $500 billion since the end of last year. 

In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market.  This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit.  This Eurodollar deposit could be lent to foreign banks or investors and this would not change the immediate dollar holdings of the American bank.  This lending and borrowing in Eurodollar deposits could then multiply throughout the world.  And, the American bank might be the ‘foreign-related” institution mentioned above and included in the statistical reports.

Note that the original dollar deposit created by the Fed is still recorded as a deposit at one Federal Reserve bank no matter how much shifting around the borrowing and lending in the Eurodollar market occurs.    

Thus, it appears as if the Federal Reserve pumped one-half a trillion dollars off-shore since the end of 2010!

And, this is going to stimulate spending and getting the economy to grow faster?

Cash assets at the smaller banks remained relatively flat over the last six months…and over the last three months.  Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. 

And, although the largest twenty-five banks in the country increased their cash assets by about $130 billion over the last six months, these banks have been reducing their cash balances (by a little more than $30 billion) over the last three months. 

What have the domestically chartered commercial banks been doing over the last six months?

Basically, the twenty-five largest domestically chartered commercial banks have been modestly increasing their loans to businesses, both in the three-month period and the six-month period.  Commercial and Industrial loans as well as commercial real estate loans have been increasing at the largest banks over the past three-month period. 

However, business loans continue to “tank” at the smaller banking institutions.  For example, Commercial and Industrial loans at the smaller institutions dropped by almost $5.0 billion from March 30 to June 15.  Commercial Real Estate loans took an even bigger hit of almost $35 billion. 

Also, at the smaller banks, residential mortgages continue to decline…by a little over $9.0 billion since March 30 and by almost $35 billion over the last six months. 

The real lending by commercial banks is not taking place in the United States.  The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow. 

It does seem to help produce inflation elsewhere which gets translated back into the United States in the price of imports.

The Fed has not yet gotten bank lending going, it has not yet caused an increase in the money stock measures, and it has not yet stimulated the economy to any degree. 

The Fed may have helped the FDIC close banks in an orderly fashion and it may have helped raise the prices of commodities world-wide. 

For all the efforts exerted in QE2, the results are not very encouraging.

NOTE: As mentioned in my post yesterday, I will not be posting anything for about a week or so.

Sunday, June 26, 2011

Federal Reserve QE2 Watch: Part 8

I usually do the “QE2 Watch” post in the first week of the new month, but in this coming month I will be a little tied up.  I am having hip replacement surgery on June 28 and will be a little preoccupied for a few days.  I will also write a post on the condition of the banking system that I will post tomorrow.  Then I go “on vacation” for a while.

Chairman Bernanke and the Federal Reserve have signaled that QE2 will definitely end on June 30 and they have indicated that QE3 is not in the works…at least at the present time. 

The stated plans for QE2 included the new purchase of $600 billion in Treasury securities and the purchase of a possible $300 billion more in Treasury securities to replace securities maturing in the Fed’s portfolio of Federal Agency issues and the Fed’s portfolio of mortgage-backed securities. 

From Wednesday, September 1, 2010 to Wednesday, June 22, 2011, the Federal Reserve’s holdings of United States Treasury issues have risen by roughly $816 billion.  During this time period, the dollar volume of Federal Agency issues on the Fed’s balance sheet has dropped by $38 billion and the dollar volume of mortgage-backed securities has declined by $189 billion…a combined total of $227 billion. 

The “net” increase in securities held outright by the Federal Reserve has been $589 billion, pretty close to the $600 billion “net” increase promised. 

Reserve balances at Federal Reserve banks, a proxy for excess reserves in the banking system, have increased by $584 billion to $1,594 billion over this time period.  Actual excess reserves in the banking system averaged $1,610 billion for the two-week period ending June 15, 2011.

Almost all the increase in excess reserves can be attributed to the Fed’s purchase of United States Treasury securities. 

Other factors affected reserve balances within this time period but they tended to be minimized over the period as a whole.  For example, in the first quarter of 2011, the United States Treasury Department reduce its “Supplemental Financing Account” at the Fed by $195 billion, a not inconsequential amount of funds.  This reduction added reserves to the banking system.  However, over time, this movement was offset by other factors and hardly had any net effect on the total amount of reserves being supplied to the banking system.

And, what was the total impact of QE2 on the commercial banking system?

All the reserves the Fed crammed into the banking system went into excess reserves!

Yet deposits in the banking system continued to increase. 

Demand deposits in particular rose at a very rapid pace.  From the second quarter of 2010 when demand deposits at commercial banks increased at a 6.3 percent rate year-over-year, these accounts rose by 8.5 percent in the third quarter and 14.3 percent in the fourth quarter.  But this rate of acceleration jumped to 20.4 percent year-over-year in the first quarter of 2011 and in the month of May was showing a rate of increase of almost 27 percent!

What is happening here?

Demand deposits at commercial banks are increasing at a very, very rapid pace, yet commercial banks do not seem to be lending much at all (more on this tomorrow) and everything the Federal Reserve is pushing into the system seems to be going into excess reserves.  What’s going on?

Basically, what’s going on is the same thing that has been going on for the last 18 months or so.  Because of the poor economic climate and because of the excessively low interest rates people and businesses are moving funds out of interest bearing accounts and into transactions accounts.  These latter accounts are where people are locating their “liquidity” these days so as to pay for necessities and other important things to keep on living. 

For example, Institutional money funds are still losing money…perhaps not as fast as they were a year ago, but they are still contracting by more than 5 percent, year-over-year.  Retail money funds are still declining at a rate in excess of 8 percent year-over-year and small time accounts are declining by more than 20 percent, year-over-year. 

All non-M1 money stock money included in the M2 money stock measure has risen only modestly over the past 12 months and most of this has come in the money market deposit account s included in the aggregate category titled savings deposits.

The result is that the M1 money stock measure is increasing rather rapidly at around a 12 percent year-over-year rate in the last three months.  The M2 money stock measure is increasing by less than 5 percent over the same time period.  The rate of growth of the M2 money stock measure has only increased modestly over the last four quarters. 

People are putting their money into accounts from which they can transact.  They are moving their money into these accounts because they need to stay liquid in order to pay for their daily needs. 

The other indicator of this behavior is the rapid increases that have been made in the demand for coin and currency.  In the second quarter of 2010, the currency in circulation was rising by only about 3.5 percent, year-over-year.  This steadily increased through 2010 until it reached a total of over 7.0 percent in the first quarter of 2011.  That is, the coin and currency in circulation more than doubled its growth rate over this time period.  In May 2011, the year-over-year rate of increase in the currency component of the money stock was rising at almost 9.0 percent year-over-year. 

In the slow economic growth climate we are in, people do not increase their holdings of coin and currency in order to generate new spending.  They increase their holdings because they need these funds to buy necessities in the face of unemployment, foreclosure, and bankruptcy!

The information from the financial system is not very encouraging.  The Fed has tried to push all the funds it can into the banking system.  The banking system is not lending it…both because the banking system is still not in that good of a shape…and because people are not in very good financial condition and are not borrowing.  Thus, reserves pile up at commercial banks. 

If QE2 was supposed to get the economy growing faster, it has failed miserably.  If QE2 served other purposes, like allowing the FDIC to close banks in an orderly fashion, then it has succeeded.  If the Fed used the economy as an excuse to explain QE2 while it was assisting the FDIC in its efforts to close banks in an orderly fashion then it was duplicitous.  It might have done this to avoid people getting overly worried about the condition of the banking system.

But, the more I think about this last statement the more I chuckle because I don’t think that the Fed is that good.

Thursday, June 23, 2011

Greece: Please Take More of the Medicine That Has Already Failed to Treat the Disease

With respect to the Greek sovereign debt situation, two statements reported this morning stand out.  First, Simon Tilford, chief economist at the Center for European Reform in London is quoted as saying: “The Greeks have been told to accept more of the medicine that has already failed to treat the disease.”  The consequence of this is that Greece has already entered a “death trap.” (

The other statement deals with how the European banks will deal with some of the cost of a second bailout of Greece: “The trick will be for the private sector to take losses on Greek bonds, without Greece being declared in default.” (

The problem: “If the banks are forced to accept losses, ratings companies likely will declare a default.  Even if the banks act voluntarily, Greece could still be considered in default on some of its debts.” 

For more on this issue you might check the column by Satyajit Das in the Financial Times, “Final arbiter in Greek saga is an untested private body.”  Das is referring to something called the Determinations Committee, a group set up by the International Swaps and Derivatives Association.   This body may be the one that determines whether of not Greece goes into default or not.  (

Marty Feldstein, the Harvard economist, considers the dilemma facing European leaders: “If Greece were the only insolvent European country, it would be best if its default occurred now…But Greece is not alone in its insolvency and a default by Athens could trigger defaults by Portugal, Ireland and possibly Spain. (

Oh, oh!  The “I” word!

So, Greece is insolvent.  Portugal is insolvent.  Ireland is insolvent.  Possibly Spain is insolvent. 

And the European leaders are forcing Greece (and these other countries) to just continue taking more of the same medicine.

But, we can’t have insolvency squared or insolvency cubed?  Or, can we?

And the determination of whether or not a default takes place seems to depend upon a private organization that has never rated any debt before and must, it seems, determine what the definition of “is” is. 

This seems like a scene out of an old Peter Sellers movie!

This is nothing more than a Ponzi scheme being enacted by a bunch of comedic characters.  The Ponzi scheme: borrowing more and more money to pay the interest on the growing body of debt. 

This is the “death trap” mentioned above.

My belief is that the financial markets will be the final arbiter of this picture.  I believe that the “leaders” of Europe are creating a “risk-free” bet that many hedge funds and other investors with lots of money are waiting anxiously to exploit.  Governments seem to have a penchant for creating such “risk-free” bets.  Just ask George Soros.

Marty Feldstein has declared Greece insolvent.  So have a lot of other people. 

The financial markets will take care of this.

An aside about the situation in the United States: the Congressional Budget Office just released new projections for the federal budget.  In the new projections, the interest paid on United States debt will increase from around 2 percent of Gross Domestic Product in 2011 to over 9 percent in the year 2035. And, this is with relatively benign projections on interest rate movements. (

Is this just another rendition of the “death trap”?

Wednesday, June 22, 2011

Another Sign of a Weak Economy: Stock Buy Backs?

Over the past year or so, I have been arguing that the substantial build up in the cash balances of many large United States corporations has been for the purpose of merger and acquisition activity.   And, earlier this year, M&A activity seemed to be proceeding aggressively. (See my post “The Latest Merger Binge and the Economy,”

Now, it seems as if these cash balances may be trending into more stock buy-backs than into the buying of other companies, at least in a relative sense. “US companies are buying back their own stock at the fastest pace since 2007…” (  

Today’s attention on stock buy-backs has been caused by the announcement made yesterday by electronics retailer Best Buy of a proposed $5 billion buyback program. (

Analysts have been wondering what these large corporations were going to do with the huge cash balances on their balance sheets.  These companies were producing profits, they were able to borrow at ridiculously low interest rates, and ample liquidity seemed to be available to them around the world.  Also, there were a lot of other companies or divisions of companies “out there” that were really struggling and seemed to be possible “sitting ducks” for growth hungry large corporations. 

Of course, one of the reasons for the build up of cash in some of these companies was the tax implications associated with bringing monies earned around the world back into the United States.  But, this was not really the major reason.  For example, Microsoft, a cash rich company, did not have to go out and borrow more than $10 billion in the United States, the first time Microsoft has even made use of the bond markets in its history. 

Many economists were hoping that this build up of cash would result in a boom in corporate investment in physical capital, a stimulus to further economic spending and subsequent economic growth.

This physical investment has not yet surfaced. 

My belief has been that this cash build up was for acquisition purposes.  The companies that had the cash were strong and were “on the hunt” for their weaker brothers and sisters hoping to build their economic base by acquiring companies that were not in good positions, had too much debt, and were struggling to make ends meet.  What a way to build markets and enlarge the company’s footprint!

This seemed to be happening…and I believe will continue to go forward.

However, the world economy seems to be stalling.  Perhaps economic growth will not be as robust as originally thought…even three months ago.  Thus, even though the merger binge may continue to some degree, the pickings may not be as lush as once thought. 

And, the stock markets seem to have reached a near term peak.  All the major indices, the Dow, the S&P 500, and the NASDAQ, peaked at the end of April.  Many analysts are saying that with the stagnant economy and the high levels of under-employment, the chances are not very great that the stock market will show much resilience in an upward direction. 

Thus, there is some drop off in the corporate enthusiasm for more and more acquisitions.

So, what does a company with a lot of cash on hand and with dwindling appetite for acquisitions do with all their loot?  Managements with so much cash around and with very little hope that the economy will become more robust, just does not see these excess balances as a good use of resources.

The only viable alternative is to buy back their stock.  They see this as the “best” investment available to them.  And, so they buy back their stock.

Neither one of the latter two uses of the cash really do anything for the economy and the acquisition path could even result in worse economic results…at least in the short run.

Acquisitions, of course, can lead to plant closings, layoffs, and other efforts to combine firms, which increase productivity in the longer run, but does not contribute to capital investment or human employment in the short run.  Obviously, these outcomes are not what the policymakers are looking for.

Stock buy-backs also do not stimulate capital investment or a reduction in unemployment in the short run and may not achieve either of these goals in the longer-run.

Therefore, if the economy is weak and more and more corporations seem to believe that the “best” investment of the cash they have accumulated is to buy back their own stock.  it would seem that this is evidence that more and more corporations are not seeing a very bright economic future ahead of them.  In my mind, this is not very good news. 

Monday, June 20, 2011

Read My Lips! Too Much Debt!

People and businesses leverage when an economy expands over an extended period of time.  The last major period of leveraging in the United States occurred over the past fifty years beginning in the early 1960s.  This was a period of sustained credit inflation that resulted in an 85% decline in the purchasing power of the dollar. 

People and businesses de-leverage when the economy reaches an unsustainable level of debt and that de-leveraging can take a substantial period of time. 

Research by Carmen Reinhart of the Peterson Institute and her husband Vincent Reinhart of the American Enterprise Institute has suggested that “excessive debt could be corrected only by a long period of deleveraging.” (See the article “Running Out of Road” in the June 18, 2011 copy of The Economist, pages 77-78.)

De-leveraging also means, in aggregate, that increases in lending (debt creation) will not become too buoyant during the restructuring of balance sheets. 

Consequently, de-leveraging will tend to reduce the multiplier effect of any fiscal stimulus program and the creation of more debt through fiscal stimulus will only add an additional burden on the economy that is trying to get its balance sheet back under control.

The desperate hope to counter this de-leveraging is to flood the financial markets with liquidity and pray that the printing of money will somehow stop the de-leveraging and make debt acceptable once again. Hence, QE2!

A caveat here: there are a number of large companies that came out of the Great Recession with their balance sheets well in hand.  For example, Microsoft was one of these companies.  Many of these companies have issued debt over the past year or so to build up cash reserves to acquire other companies that have been overleveraged and are not in such good financial shape. This generally represents a separation in the market between large organizations and all others.

Thus, the only way this de-leveraging will be overcome is by reducing the real value of the debt through a period of credit inflation like the one experienced over the past fifty years.  Otherwise, the debt levels are not sustainable.  Efforts to bail out the people, businesses, and governments that have issued too much debt will only postpone the problem.  The debt levels will have to be reduced sometime…now or in the future. 

The debt loads that people, businesses, and governments are carrying seem to be un-sustainable, even with the very, very loose monetary policy.  For example, household liabilities have declined by a little more than $600 billion since the recession began in December 2007, but the total amount of household debt still totals a little more than appeared on the household balance sheets in the second quarter of 2007. 

Household debt at the start of 2011 is almost double the amount of household debt that existed at the start of the year 2000.  This represents a compound rate of increase of more than 8 percent per year.  One could argue that this rate of increase is not sustainable given that over the long haul the real economy grows only slightly more than 3 percent per year.

Total business debt shows roughly the same pattern.  This debt has declined by a little more than $160 billion from the start of the recession to the first quarter of 2011.  However, the current total is around the same level it was in the third quarter of 2008 indicating that in total, businesses have not accomplished a great deal of de-leveraging to this point. 

And, the debt problem is also entangled with the ability of people and businesses to unravel their situations through foreclosure and bankruptcy proceedings.  Foreclosures take time.  If people or businesses are in foreclosure but these foreclosure proceedings take longer and longer to work out, the economic units involved in the proceedings will be more or less relegated to the sidelines in terms of any additional borrowing or spending. 

An instructive article appeared on the front page of the New York Times yesterday. (“Backlog of Cases Gives a Reprieve on Foreclosures,” “In New York State, it would take lenders 62 years at their current pace, the longest time frame in the nation, to repossess the 213,000 houses now in severe default or foreclosure, according to calculations by LPS Applied Analytics, a prominent real estate data firm.
Clearing the pipeline in New Jersey, which like New York handles foreclosures through the courts, would take 49 years. In Florida, Massachusetts and Illinois, it would take a decade.“
And, this problem is not easing.  In May 2011, total foreclosures in the United States totaled 1,736,724.  Six months earlier the total was 1,682,499.  And the number of sales has declined reflecting the back up in the whole foreclosure process. 
Personal bankruptcies are down but are still running near record rates of 1,450,000 to 1,500,000 per year.  In 2010 there were only 56,425 business bankruptcies, down from 60,851 in 2009.  For the first three months of 2011, business bankruptcies are running around a 50,000 annual rate, far above the figures for the rest of the 2000s.
And, this doesn’t even get into the problems connected with the debt of state and local governments. 
Debt loads must be reduced sometime…in one way or another.  People, businesses, and governments are still carrying too much debt.  And, more and more federal government debt does not really help the situation.  A good portion of the debt must be repaid.
This is the drag on the economy.  And, until a lot of this load is worked off…in one way or another…economic growth will remain weak. 
Why hasn’t this gotten the notice it should in all the discussions going on? 
Because almost all of the economic models used to predict economic activity do not contain information on debt levels and leverage.  The reason is that debt levels and leverage levels are quite subjective over time and depend upon what governments are doing and what people believe to be acceptable.  These decisions vary from cycle to cycle and are extremely hard to model.  Furthermore, as the Reinhart’s have argued, there has not been a sufficient amount of data available to adequately study the influence of debt on economic activity.
My conclusion from this information is that the major problem facing the western countries now is that there is too much debt outstanding.
And, when I look at how the system is working off this debt I can only conclude that there is still a long way to go before people, businesses, and government get to levels of debt that are sustainable.  Even QE2 does not seem to be shaking these economic units from their desire to rebalance their balance sheets.  There is just too much debt still in the system and it doesn’t need more.

Friday, June 17, 2011

What is Causing the Worldwide Government Debt Crisis?

Mohamed El-Erian, the Chief Executive Officer of PIMCO, writes this morning that “It is now commonly accepted that Greece’s predicament is due to two inter-related problems: the economy is unable to grow, and the debt burden is enormous. (
Yet, El-Erian states, neither of these issues are being addressed in the discussions going on concerning the resolution of the debt crisis in Greece.
The reasons for this are complicated although they very often boil down to the priority to handle short-run problems immediately and postpone the long-run problems to another day.  Of course, the famous quote of John Maynard Keynes comes to mind: “In the long-run we are all dead!”
A good listing of the complicated entanglement of the politics of the Eurozone is present in the Wall Street Journal article “Europe’s Greek Stress Test” by John Cochrane and Anil Kashyap. ( The authors list four key facts:
First, the Greek government has borrowed more than it can plausibly afford to pay and certainly more than it will choose to pay. It now owes more than one and a half years' economic output.”
“Second, European banks are holding the bag.”
Third, the European Central Bank (ECB) is now involved as well.
Fourth, in the end this is all about Ireland, Portugal, Spain and Italy.”
In other words, by ignoring the basic underlying causes of the problem, the sickness has spread and now envelopes nor only Europe…but the world.
In other words, the old economic paradigm is dead, and the political leaders of the western world have only made things worse by trying to keep the old paradigm alive. 
As a consequence, the options available to these leaders are shrinking and those options that are left are becoming less and less desirable.
And, even if the bailouts continue and postpone the resolution of the crisis until another day, the two basic issues mentioned by El-Erian are not being addressed.  These are the issues pertaining to the reasons for slow economic growth and the reduction of the massive debt levels that are outstanding. 
The solution…increase economic growth and lower debt levels.
The problem…over the past fifty years or so the political leaders of most western nations worked with an economic paradigm that resulted in an increase in debt levels to increase economic growth.  That is, credit inflation, whether in the economy as a whole, or in a particular sector like housing, would buy politicians additional votes by keeping economic growth high and unemployment low. 
“The solution” reverses almost 100 years of the economic and political thought of western intellectuals.  It also contradicts the perception of many voters in western countries. 
Keeping a lid on debt exposure is an old-fashioned idea and one that collides with the modern day concept of what governments should do and of the excesses of the consumer society. 
An emphasis on education and training also is an old-fashioned idea although it was the basis of economic productivity and inventions in the nineteenth and early twentieth centuries in the United States.  And, this particular emphasis is one that collides with the modern-day approach to “certification” and the building up of “self-esteem” where everyone passes or everyone gets A’s.
The current sovereign debt crisis is not going to go away with “doing more of the same.”   Yet, changing the economic paradigm is going to be difficult.  We see this on the streets of Greece…and Spain…and Vancouver…oops, sorry…
The focus is on Greece right now and rightfully so.  But, the lessons need to be learned by others…but this will not make it any easier.  Long-run solutions are never “easy”.
There was an interesting article in the Saturday Wall Street Journal titled, “What Kind of Game is China Playing?” ( The answer is that American leaders need to learn how to play the game of “Go”, an ancient Chinese board game.  The game of “Go”, “emphasizes long-term planning over quick tactical advantage, and games can take hours. In Chinese, its name, wei qi (roughly pronounced "way-chee"), means the "encirclement game."
The economic paradigm of the past fifty years emphasizes “tactical advantage”, the short-run.  Why this approach became so popular was that the political leaders of the western world saw it as the means of gaining their goals…getting elected and then getting re-elected.
What El-Erian and others are arguing for is more emphasis by these political leaders on the “strategic” and not the “tactical.”  The “strategic” aims to achieve “sustainable” results.  The “tactical” way of dealing with a problem always contains the caveat that the other problems will be dealt with when they become the major issue.
Well, the other problems have now become the major issue.
And, this is the lesson for the countries included within the definition of the western world. 
Politicians are going to have to learn how to think “strategically.”  The question is, “Can politicians be allowed to think strategically in a democracy in which winning the next election is the most important thing on their agenda?”
Greece, in my mind, is going to have to restructure its debt in one way or another.  So is Ireland…and so is Portugal…and so in Spain…and so on and so on.  How many more countries will find themselves facing a restructuring of their debt is, of course, unknown. 
It is painful when you find out you have been working with a model that is not correct.  Creating more spending and more debt is not the solution to every problem.  Yet, we have lived by this model for a long time.  And, now the bill seems to be coming due.
To me, this is what is causing the worldwide government debt crisis. 

Tuesday, June 14, 2011

Greece and Dimon and Bernanke

Standard & Poor’s rating services have just given Greece sovereign debt the lowest rating it has.  The Greek leadership is upset.  “We have a very tight fiscal package coming” the leaders say.  Yet the downgrades continue. 

The timing of the reduction in the debt rating, according to some pundits, is not coming at a very good time.

But, these things never happen “at a very good time”.  Building up excessive amounts of debt reduce options ( and they leave you in a state where there is no “good time” to deal with the debt. 

Yet, people and governments, over the past fifty years, acted as if the amount of debt outstanding did not matter to their economy and that any fiscal difficulty a country might find itself in could be overcome by increasing the spending of the government and increasing the amount of government debt.

The amount of debt a government issued did not matter because the economic models the governments used did not include government debt.  Thus, a government could increase debt as much as it wanted and their economic models would be unaffected.

One of the primary reasons that debt, both public and private, was not included in the models was because there was not sufficient historical evidence on the levels of debt outstanding before, during, and after a financial crisis to justify inclusion in the models.  Kenneth Rogoff and Carmen Reinhart have attempted to eliminate this reason with their study of eight centuries of financial data presented in their book, “This Time is Different.”

Another reason why it is hard to study the burden of debt on a country is that the analysis of the risk associated with any given amount of debt is to a large extent psychological.  There seems to be little if any “tight” relationship between when the market determines that the amount of debt being carried by a country is excessive.  There seems to be no unique “trigger” to determine a sovereign debt crisis.

The bottom line is that the role of debt in the precipitation of a debt crisis is very, very complicated and the quantitative tools that exist are just not sufficient to fully capture any one specific situation.

As a consequence, the amount of debt a country carries is a judgment call, but the more debt a country accumulates the more it limits its future options and the more it loses control over the timing of any “crisis” that might occur.    

There seems to be other cases currently in the news pertaining to governmental decisions in areas that are very complicated and cannot be modeled in any satisfactory way. 

This is brought out very clearly is the column by Andrew Ross Sorkin in the New York Times this morning, “Two Views on Bank Rules: Salvation and Job Killers.” (

In this article, Mr. Sorkin re-plays the recent verbal exchange between Jamie Dimon of JPMorgan, Chase, and Ben Bernanke of the Board of Governors of the Federal Reserve System.  Mr. Dimon, among other things, questioned the ability of the Federal Reserve (of regulators) to understand the consequences of their regulatory actions.

Sorkin remarks, “it’s an uncomfortable truth that Mr. Dimon should be taken seriously, at least his suggestion that policy makers can’t predict the full impact of the coming regulation.”

Sorkin reports that when Mr. Bernanke answered Mr. Dimon’s question, he said, “Has anybody done a comprehensive analysis of the impact on credit? I can’t pretend that anybody really has. You know, it’s just too complicated. We don’t really have the quantitative tools to do that.”

Mr. Bernanke’s answer captures something that the economist Friedrich Hayek stated many years ago, that a central organization or one individual body can never possess sufficient information to make decisions that are dependent upon information that is dispersed widely throughout the economy and is relevant for “local” decision making.

With this statement, Mr. Bernanke loses more of the credibility that he had been trying to hang onto over the past eighteen months. 

The economic models that people and governments have been using over the past fifty years are inadequate, at best, and misleading in practice.  They work best when the economy is smoothly growing.  They just do not have sufficient data to handle the very complex situations that happen when things are not going smoothly.

As Hayek taught us, there is just too much relevant information for us to collect, store, and process and even if we could store it all, most of the information pertains to “local” situations that are way beyond our ability to model. 

Hayek also taught us that one of the major roles of the economist is to demonstrate to decision makers how little they really know about what they imagine they can design. 

In this respect, governments need to create the processes though which decisions are made and should not focus on the outcomes.  Outcomes are a result of those things a decision maker thinks he/she can “design” and this applies to bank regulation, unemployment targets, and so forth. 
To me the process of openness and disclosure is still the most important thing that a government can require…of itself…or of the organizations it is regulating.  When the government begins to determine what decisions should be made and what outcomes are to be attained, it begins to exceed its ability to succeed. 

And, as the government fails to attain the outcomes it wants, it asks for more control to gain those outcomes…and then more control…and then more control…

Sunday, June 12, 2011

Business Loans at Commercial Banks Continue to Rise

Commercial and Industrial loans in the banking system continue to rise.  Over the past thirteen week period business loans at all commercial banks in the United States increased by almost $37 billion.  These loans began a slight uptick last November and have been rising modestly since then.

Over the past four weeks, commercial and industrial loans have risen by about $16 billion. 

Up until recently the increase has been solely in the largest twenty-five banks in the country.  These large banks are still making the largest additions to the growth in business loans, but in the latest four-week period there seems to be some life in this kind of lending in the rest of the banking system. 

Of the $37 billion increase in business loans over the past thirteen weeks, $29 billion has come from the largest banks while $3 billion has come in the smaller banks and almost all of this latter increase came in the past four weeks. 

Real estate loans continue to drop although some leveling out in the larger banks seems to have occurred over the past month.  All real estate loans dropped by $65 billion over the last three months although they dropped by only $6 billion over the last month. 

Again, the largest balance sheet movements in the banking system came in cash assets. 

Over the past thirteen weeks, the cash assets in the banking system rose by about $415 billion while the total assets in the banking system rose by almost $500 billion. 

In the last four weeks, the cash assets in the banking system rose by a little less than $160 billion while the total assets in the banking system rose by about the same amount.

QE2 continues fund the banking system. 

There are some really important differences in the rise in cash assets, however, 

Over the past thirteen-week period, the cash assets at the largest twenty-five domestically chartered commercial banks dropped by $42 billion.  At the smaller domestically chartered banks, cash assets fell by $2 billion.

Cash assets at foreign-related financial institutions rose by almost $460 billion during this same time period! 

Over this past thirteen week period it appears as if all the excess reserves the Federal Reserve pumped into the banking system went directly into foreign-related financial institutions and…and…$44 billion of excess reserves already in the banking system found its way from domestically chartered banks into the hands of the foreign-related financial institutions!

Loans and leases at all domestically chartered commercial banks dropped by a small amount during this period of time. 

The summary: business lending seems to be getting stronger in the United States, but it is the only sign of life in the lending area in the domestically chartered commercial banks. 

The funds the Federal Reserve is pumping into the financial system is going directly into foreign-institutions in the United States and is going off-shore. (

So much for monetary policy stimulus!