One of the questions that has arisen from the posts I have put up over the last several months has to do with my statement that the international financial community doesn’t like government deficits and tends to believe that a lack of fiscal discipline will result in an increased monetization of the debt. The feeling that the central bank of such a country cannot, in the longer run, overcome the fiscal imprudence of its national government and act independently of that government has resulted, time and again, in a decline in the value of the currency of the country being examined. The dollar is no exception.
Let’s look at the following information.
Average Yearly Increase in Gross Federal Debt (in billions of dollars)
Nixon/Ford $49.5
Carter $90.2
Reagan $258.6
Bush 41 $359.3
Clinton $232.1
Bush 43 $541.1
Now let’s look at the decline in the value of the dollar from the start of an administration to the end of that administration. I will use the trade weighted index of the United States dollar versus major currencies. The series begins in January 1973. Up until August 1971 the United States had a fixed exchange rate. At that time President Nixon announced that he was allowing the dollar to float in foreign exchange markets and was taking the United States off of the gold standard.
He also announced that “We are all Keynesians now!” meaning that he was going to stimulate the economy with budget deficits (so that he could get re-elected) and to protect against inflation he was freezing wages and prices. He created the Cost of Living Council and the Committee on Interest and Dividends to administer these controls as well as controls on interest rates. As can be seen from the above figures, the Gross Federal Debt increased by an average of almost $50 billion every year during the Nixon/Ford years. This compares with those spendthrifts John Kennedy and Lyndon Johnson who introduced Keynesian economic policies to the United States and who only increased the Gross Federal Debt by an average of less than $10 billion per year.
Change in the value of the dollar (as measured against major foreign currencies).
Nixon/Ford - 1.0 %
Carter - 10.4 %
Reagan - 5.7%
Bush 41 - 1.9 %
Clinton + 16.6%
Bush 41 - 21.6%
Note that the only administration to see a rise in the value of the dollar over the past forty years was the Clinton administration. Note, too, that the only break in the continued increase in the Gross Federal Debt outstanding was during the Clinton administration. As you may recall, the last four years it was in office, the Clinton administration ran budget surpluses.
Also, one can remember the accolades received by Paul Volcker, when he was the Chairman of the Board of Governors of the Federal Reserve System, for bringing inflation under control. Volcker was Chairman from August 1979 until August 1987. Volcker did bring inflation under control and early on this effort was reflected in a rise in the value of the United States dollar. The value of the dollar reached a short term bottom in July 1980 and then, accompanying the decline of inflation in the United States, the dollar rose in value by 55 percent to peak out on March 1985. However, even Volcker could not hold out against the massive deficits that the Reagan administration was piling up and the value of the dollar fell from that peak by 31 percent through the month at Volcker left his position at the Fed. Even someone as strong as Paul Volcker could not fight against the increasing deficits that were being posted by the Reagan administration. The value of the dollar closed lower at the end of the Reagan years than it was at the start.
The only conclusion one can draw from these data is that participants in international financial markets do not like the currency of countries that lack discipline over their fiscal affairs. This, of course, has very strong implications for the Obama administration. With the possibility that the Gross Federal Debt is on a trajectory in which the debt will increase in the $1.0 trillion range per year, at least for the near term, the implications seem clear. There will be continued pressure on the value of the United States dollar in the upcoming years.
The specific argument for this relationship is that increased federal deficits will result in increased monetization of the debt. Increased monetization of the debt will result in an increased rate of inflation. An increased rate of inflation will cause the value of the currency to decline. So, the question being posed by skeptics right now is “where is the inflation?” The time seems more right for deflation rather than inflation.
In the short run it is hard to argue against this logic. The only thing one can fall back on to answer this question is the fact that when budget deficits increase and there is no relief from substantial increases in the debt of the country, participants in international markets tend to sell the currency. What we have seen in the past is that any inflation that results from the massive increase in the debt outstanding can come in many forms that are not all registered in the computed price indices like the Consumer Price Index. Something like the CPI is an estimate, a guess at what is happening to prices. The important thing to remember about massive increases in debt is that they have to go somewhere and where ever they go they will have large consequences. We hope that we can measure these consequences and measure them in a timely manner. However, that does not always happen.
And, where else are we seeing action? India has now joined China and Russia and Brazil in calling for a discussion at the upcoming G-8 conference of the place of the United States dollar in the world’s monetary system. China is tired of continuing to support its currency against the United States dollar. Given the likelihood of a further decline in the value of the dollar, China faces the need to buy more and more dollars and invest in more and more securities from the United States. This, in the longer run, is not in China’s best interest. Nations, other than England and those from the Eurozone, are getting tired of the United States abusing its privilege of having the only reserve currency in the world. Although nothing is going to be done to change the monetary system at this time, this talk is going to get stronger and stronger. And, if the value of the dollar continues to decline in the future, the arguments are going to resonate more and more with others in the world. The basic approach to fiscal policy in the United States over the past 50 years has not been the most productive one in terms of maintaining a sound dollar currency.
Showing posts with label monetize debt. Show all posts
Showing posts with label monetize debt. Show all posts
Sunday, July 5, 2009
Sunday, June 28, 2009
Is Treasury's TARP Debt Already Monetized?--Part Two
My post from Friday June 26 contained the first part of this discussion. Today I would like to continue the discussion and there are two reasons for doing so. The first reason is to understand just what the Federal Reserve has been doing over these last nine months. The second is to understand how likely it might be for the Federal Reserve to “unwind” what it has done over the past nine months and reduce a part of the fear of future inflation. Note, I am not including any discussion of future government deficits and the probability that they will be “monetized.”
There is no doubt in my mind that the Federal Reserve has “printed” a lot of money since early September 2008, most of it before January 2009. The Monetary Base (Non-seasonally adjusted, NSA) rose from $847 billion in August 2008 to $1,712 billion in January 2009, an increase of $865 billion. Between January and May 2009, the Monetary Base only rose $63 billion.
Total Reserves (NSA) in the banking system increased by $817 billion from September 2008 to January 2009, but only increased by $42 billion since January. The most interesting thing is that Excess Reserves (NSA) in the banking system rose by almost $800 billion in the earlier period and increased by $46 billion in the January to May period.
The Federal Reserve put a lot on money into the banking system over the last nine months and the VAST MAJORITY of the funds went into Excess Reserves. The Fed “printed” a lot of money (or, created a lot of deposits at the Fed) but these monies did not find their way into the economy!
These two periods need to be separated in order to get a better picture of what the Fed has done and for some implications about what might occur in the future. My basic argument is that the Fed has put a tremendous amount of money into the world banking system and has ultimately underwritten the Treasury’s TARP program and provided much more money to the banking system than Congress authorized.
The underlying effort has two goals: first, to keep financial markets liquid; and second, to protect against the insolvency of the banking system. The first goal has basically been accomplished. The second is still playing itself out. The crucial thing to understand is that the way the Fed has acted has given the system a chance to get healthy and yet provide a net to catch insolvent banks so as to avoid a precipitous collapse of the banking system.
In the September 2008 to January 2009, the crisis period, the Fed basically ceased using the normal tools of monetary policy: open market operations consisting of outright purchases of government securities and repurchase agreements. In the fall, the Federal Reserve basically picked and choose what parts of the financial markets needed liquidity and created facilities to support these ill-liquid sub-markets. The major ways that it supplied funds or saw funds withdrawn in the September 2008 through January 2009 period and in the January 2009 through May 2009 period.
Change (billions) from Sept/08 to Jan/09: Term Auction Credit $257; Other Loans $166; Commercial Paper LLC $334; Other Fed Reserve Assets $506; for a total of $1,263. The change (billions) from Jan/09 through May 2009: Term Auction Credit (-$124); Other Loans (-$62); Commercial Paper LLC (-$206); Other Fed Reserve Assets (-$411); for a total of minus $803.
The Term Auction Credit Facility (TAF) helped to get reserves to the commercial banks that needed reserves, an effort the Fed believed was more efficient than open market operations. TAF peaked at $300 billion increase on 12/31/08. Other loans include increased borrowings from the Fed’s discount window, a facility for asset-backed commercial paper (which reached a peak increase of $152 billion on 10/8/08), a facility for primary government security dealers (which reached a peak increase of $147 billion on 10/1/08), and a facility for AIG. The commercial paper LLC was a limited liability facility that bought 3-month paper from eligible issuers (which reached its peak of $334 billion on 12/31/08). The increase in Other Fed Reserve assets was primarily Central Bank Liquidity swaps (which reached a peak of $682 billion on 12/17/08).
However, the Fed’s efforts reported here resulted in almost a $1.3 trillion increase in its assets and an $865 billion increase in the Monetary Base. Thus, almost the entire monetization ended up as excess reserves held at Federal Reserve Banks. Bank reserves at Federal Reserve Banks increased steadily throughout the fall, peaking at $856 million on December 31, 2008. Whew! The Federal Reserve had made it through this period of financial market illiquidity which accompanied the entire Thanksgiving/Christmas seasonal need for cash.
What happened in 2009? As mentioned above, the needs of specific market makers retreated, but now the solvency of the banking system came to the fore. In terms of the special facilities, as can be seen from the figures given above, a total of $803 billion was removed during the first five months of the year. Then the Fed began to conduct open market operations again. Throughout this time, securities bought outright by the Fed increased by $712 bullion. This included a program to buy government securities on a regular basis which contributed $177 billion to the Fed’s portfolio. It also added $70 billion of Federal Agency issues. Furthermore, the Fed initiated a very important program in 2009 and bought $465 billion of Mortgage-backed securities.
In essence, Total Federal Reserve Bank credit declined by about $200 billion during the first five months of the year but, as was reported earlier, the monetary base increased by $63 billion and total reserves and excess reserves in the banking system increase by more than $40 billion. In essence, the Fed operated in 2009 to keep the banking system very liquid and replaced the reserves that had been supplied to different parts of the financial markets in 2008 by interjecting funds directly into the banking system. The new twist? Directly helping banks sell their mortgage-backed securities, thereby reducing pressure on the banks to clean up their balance sheets. This was the original purpose of the Treasury’s TARP program.
The banking system faces three problems going forward: existing bad assets; bad assets that will appear over the next 18 months or so; and refinancing needs as the banks may not always be able to roll over existing liabilities.(See my post of June 15, “What Banks Aren’t Telling Us”, http://seekingalpha.com/article/143276-what-aren-t-banks-telling-us, for more on these factors.) The huge amount of excess reserves will help the banks face these problems. In terms of financing needs, the banks have the cash to pay off maturing liabilities without needing to roll the debt over. In terms of bad debts, this is where the TARP program comes in because the Treasury has provided preferred stock to banks with warrants attached. Charge offs can go against existing capital and the preferred stock and warrants can be transformed into new capital owned by the government to keep these banks afloat until something can be done with them.
Some banks have repaid the TARP funds that they had received. Several well-known large banks returned $68.25 billion this month to reduce Federal Government oversight. Still there have been 633 banks that have directly received about $200 billion in TARP funds and a total of 32 banks have now repaid about $70 billion. (On this see “Small Banks Not Shying From TARP” in June 27 Wall Street Journal, http://online.wsj.com/article/SB124606040026463617.html.) So, of the roughly $800 billion that banks are now holding in excess reserves, one could argue that approximately $130 billion of them have been supplied through the Treasury program and are held, mostly, by smaller banks and $670 billion of them has been supplied by the Federal Reserve, the total of the two being the money “printed “ to get us out of the current financial crisis.
The hope is that as the banking system works through its problems, TARP funds will be returned and the mortgage-backed securities will mature or be sold back into the market allowing the balance sheet of the Federal Reserve to contract back to where it was in the summer of 2008. The banking system is apparently holding onto reserves to protect itself and that is why they are really not lending. The idea is that if they don’t need these excess reserves they will return them. This is what the Federal Reserve is planning to happen. Let’s hope that they are correct!
There is no doubt in my mind that the Federal Reserve has “printed” a lot of money since early September 2008, most of it before January 2009. The Monetary Base (Non-seasonally adjusted, NSA) rose from $847 billion in August 2008 to $1,712 billion in January 2009, an increase of $865 billion. Between January and May 2009, the Monetary Base only rose $63 billion.
Total Reserves (NSA) in the banking system increased by $817 billion from September 2008 to January 2009, but only increased by $42 billion since January. The most interesting thing is that Excess Reserves (NSA) in the banking system rose by almost $800 billion in the earlier period and increased by $46 billion in the January to May period.
The Federal Reserve put a lot on money into the banking system over the last nine months and the VAST MAJORITY of the funds went into Excess Reserves. The Fed “printed” a lot of money (or, created a lot of deposits at the Fed) but these monies did not find their way into the economy!
These two periods need to be separated in order to get a better picture of what the Fed has done and for some implications about what might occur in the future. My basic argument is that the Fed has put a tremendous amount of money into the world banking system and has ultimately underwritten the Treasury’s TARP program and provided much more money to the banking system than Congress authorized.
The underlying effort has two goals: first, to keep financial markets liquid; and second, to protect against the insolvency of the banking system. The first goal has basically been accomplished. The second is still playing itself out. The crucial thing to understand is that the way the Fed has acted has given the system a chance to get healthy and yet provide a net to catch insolvent banks so as to avoid a precipitous collapse of the banking system.
In the September 2008 to January 2009, the crisis period, the Fed basically ceased using the normal tools of monetary policy: open market operations consisting of outright purchases of government securities and repurchase agreements. In the fall, the Federal Reserve basically picked and choose what parts of the financial markets needed liquidity and created facilities to support these ill-liquid sub-markets. The major ways that it supplied funds or saw funds withdrawn in the September 2008 through January 2009 period and in the January 2009 through May 2009 period.
Change (billions) from Sept/08 to Jan/09: Term Auction Credit $257; Other Loans $166; Commercial Paper LLC $334; Other Fed Reserve Assets $506; for a total of $1,263. The change (billions) from Jan/09 through May 2009: Term Auction Credit (-$124); Other Loans (-$62); Commercial Paper LLC (-$206); Other Fed Reserve Assets (-$411); for a total of minus $803.
The Term Auction Credit Facility (TAF) helped to get reserves to the commercial banks that needed reserves, an effort the Fed believed was more efficient than open market operations. TAF peaked at $300 billion increase on 12/31/08. Other loans include increased borrowings from the Fed’s discount window, a facility for asset-backed commercial paper (which reached a peak increase of $152 billion on 10/8/08), a facility for primary government security dealers (which reached a peak increase of $147 billion on 10/1/08), and a facility for AIG. The commercial paper LLC was a limited liability facility that bought 3-month paper from eligible issuers (which reached its peak of $334 billion on 12/31/08). The increase in Other Fed Reserve assets was primarily Central Bank Liquidity swaps (which reached a peak of $682 billion on 12/17/08).
However, the Fed’s efforts reported here resulted in almost a $1.3 trillion increase in its assets and an $865 billion increase in the Monetary Base. Thus, almost the entire monetization ended up as excess reserves held at Federal Reserve Banks. Bank reserves at Federal Reserve Banks increased steadily throughout the fall, peaking at $856 million on December 31, 2008. Whew! The Federal Reserve had made it through this period of financial market illiquidity which accompanied the entire Thanksgiving/Christmas seasonal need for cash.
What happened in 2009? As mentioned above, the needs of specific market makers retreated, but now the solvency of the banking system came to the fore. In terms of the special facilities, as can be seen from the figures given above, a total of $803 billion was removed during the first five months of the year. Then the Fed began to conduct open market operations again. Throughout this time, securities bought outright by the Fed increased by $712 bullion. This included a program to buy government securities on a regular basis which contributed $177 billion to the Fed’s portfolio. It also added $70 billion of Federal Agency issues. Furthermore, the Fed initiated a very important program in 2009 and bought $465 billion of Mortgage-backed securities.
In essence, Total Federal Reserve Bank credit declined by about $200 billion during the first five months of the year but, as was reported earlier, the monetary base increased by $63 billion and total reserves and excess reserves in the banking system increase by more than $40 billion. In essence, the Fed operated in 2009 to keep the banking system very liquid and replaced the reserves that had been supplied to different parts of the financial markets in 2008 by interjecting funds directly into the banking system. The new twist? Directly helping banks sell their mortgage-backed securities, thereby reducing pressure on the banks to clean up their balance sheets. This was the original purpose of the Treasury’s TARP program.
The banking system faces three problems going forward: existing bad assets; bad assets that will appear over the next 18 months or so; and refinancing needs as the banks may not always be able to roll over existing liabilities.(See my post of June 15, “What Banks Aren’t Telling Us”, http://seekingalpha.com/article/143276-what-aren-t-banks-telling-us, for more on these factors.) The huge amount of excess reserves will help the banks face these problems. In terms of financing needs, the banks have the cash to pay off maturing liabilities without needing to roll the debt over. In terms of bad debts, this is where the TARP program comes in because the Treasury has provided preferred stock to banks with warrants attached. Charge offs can go against existing capital and the preferred stock and warrants can be transformed into new capital owned by the government to keep these banks afloat until something can be done with them.
Some banks have repaid the TARP funds that they had received. Several well-known large banks returned $68.25 billion this month to reduce Federal Government oversight. Still there have been 633 banks that have directly received about $200 billion in TARP funds and a total of 32 banks have now repaid about $70 billion. (On this see “Small Banks Not Shying From TARP” in June 27 Wall Street Journal, http://online.wsj.com/article/SB124606040026463617.html.) So, of the roughly $800 billion that banks are now holding in excess reserves, one could argue that approximately $130 billion of them have been supplied through the Treasury program and are held, mostly, by smaller banks and $670 billion of them has been supplied by the Federal Reserve, the total of the two being the money “printed “ to get us out of the current financial crisis.
The hope is that as the banking system works through its problems, TARP funds will be returned and the mortgage-backed securities will mature or be sold back into the market allowing the balance sheet of the Federal Reserve to contract back to where it was in the summer of 2008. The banking system is apparently holding onto reserves to protect itself and that is why they are really not lending. The idea is that if they don’t need these excess reserves they will return them. This is what the Federal Reserve is planning to happen. Let’s hope that they are correct!
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