Wednesday, April 22, 2009
Will New Fed "Tools" Avert Hyperinflation?
My sources say no. An excerpt:
Incidentally, the Daily Reckoning doesn't do hyperlinks, so here are some of the things I relied on for the article:
* The CBO analysis of Obama's 10-year budget plan,
* The CBO's forecast in 2001 of $5.6 trillion in surpluses over the next decade,
* Janet Yellen discussing Fed debt as as "exit strategy,"
* Woodward and Hall discussing positive and negative interest on reserves as a way to avoid hyperinflation.
For a different idea, economists Woodward and Hall think the Fed just needs the ability to charge banks for holding reserves....How does this avert the threat of hyperinflation? Simple, according to Woodward and Hall. If banks ever start loaning out too much of their (now massive) excess reserves, and thereby start causing large price inflation, then the Fed can simply raise the interest rate it pays on reserves. Banks would then find it more profitable to lend to the Fed, as it were, rather than lending reserves out to homebuyers and other borrowers in the private sector. Voila! Problem solved.
Obviously these tricks can’t avoid the consequences of Bernanke’s mad money printing spree. At best, they would merely push back the day of reckoning, while ensuring that it grows exponentially (quite literally).
A quick numerical example: Let’s say the Fed wants to drain $100 billion in reserves out of the banking system, in order to cool off rising prices. But it doesn’t want to sell off some of its assets on its balance sheet (like “toxic” mortgage-backed securities), so instead the Fed sells $100 billion worth of the brand new “Fed bonds,” as Yellen hopes.
In the beginning, this will indeed solve the problem. When people in the private sector buy the Fed-issued bonds, they write checks on their banks and ultimately those banks see their reserves go down at the Fed. There is less money held by the public, and so prices don’t rise as quickly.
But what happens when the Fed bonds mature? For example, if the Fed sold a 12-month bond paying 1% interest, then after the year has passed our private sector buyers will hand over the securities and now their checking accounts will be credited with $101 billion. At that point, the economy would be in the same position as before, only worse: there would be an extra billion in newly created reserves (because of interest on the Fed debt).
Incidentally, the Daily Reckoning doesn't do hyperlinks, so here are some of the things I relied on for the article:
* The CBO analysis of Obama's 10-year budget plan,
* The CBO's forecast in 2001 of $5.6 trillion in surpluses over the next decade,
* Janet Yellen discussing Fed debt as as "exit strategy,"
* Woodward and Hall discussing positive and negative interest on reserves as a way to avoid hyperinflation.
Comments:
the fed would have to charge negative interest rates on bonds for this to work, but of course no one buy them (unless they lie).
What will be needed is a recession to destroy the excess capital...
What will be needed is a recession to destroy the excess capital...
I agree with everything you are saying, but do have one question.
If the Fed really wanted to stop bank lending in its tracks, couldn't they just impose a much higher reserve requirement? What if they said banks had to maintain a 100% on demand deposit accounts? Wouldn't that do it?
Not that I believe the Fed would ever entertain such an idea.
If the Fed really wanted to stop bank lending in its tracks, couldn't they just impose a much higher reserve requirement? What if they said banks had to maintain a 100% on demand deposit accounts? Wouldn't that do it?
Not that I believe the Fed would ever entertain such an idea.
Wow. Lots of dynamics at play here:
First of all, would selling Fed bonds, as you claim, even be able to solve the problemn "in the beginning"? If banks start out with a lot of money, then loan it to the fed instead of dumping it on the general economy (as they were planning), they still "feel" wealthy, and still expect to have a lot of money in the futre. Wouldn't this translated into higher prices immediately, since so many people know what's going on?
"Hey, Goldman [Sachs]! How ya doin'? Hey, I'm going to have about $103 billion dollars a year from now because my Fed bonds are going to mature, right? Hey, how about if we set up a deal so that, when they mature, I buy corn from you?"
"Um, hey, boss, should we sell our corn contracts at the current spot? It's pretty high right now. Oh, you've got a buyer for how much in a year? Let's roll them over in that case."
Second, this sounds like it's going to be like every other Fed attempt to drain liquidity: after it "injects the money" by buying bonds, then the maturation of those bonds should equal removing money from the system. But that never actually happens. The Fed just loans the money out again, or hands it over to the Treasury.
So in this case, here's what I see happening: People speculate on when the Fed will pay off all of its bonds. When the first issue comes due, and the banks are all getting ready to go on a buying/spending/loaning bonanza, the Fed says, "Now hold on a minute: Do you guys really want your dollars now? How about if I gave you even MORE interest if you wait another year?"
After a few iterations of that, the only possibilities are:
a) The fed finally pays off the bonds and we get hyperinflation, or
b) The Fed somehow "loses" the bonds, or dumps them on an insolvent underwriter, seriously f'ing bondholders, but accomplishing its goal of reducing the money supply.
Fun times ahead!
First of all, would selling Fed bonds, as you claim, even be able to solve the problemn "in the beginning"? If banks start out with a lot of money, then loan it to the fed instead of dumping it on the general economy (as they were planning), they still "feel" wealthy, and still expect to have a lot of money in the futre. Wouldn't this translated into higher prices immediately, since so many people know what's going on?
"Hey, Goldman [Sachs]! How ya doin'? Hey, I'm going to have about $103 billion dollars a year from now because my Fed bonds are going to mature, right? Hey, how about if we set up a deal so that, when they mature, I buy corn from you?"
"Um, hey, boss, should we sell our corn contracts at the current spot? It's pretty high right now. Oh, you've got a buyer for how much in a year? Let's roll them over in that case."
Second, this sounds like it's going to be like every other Fed attempt to drain liquidity: after it "injects the money" by buying bonds, then the maturation of those bonds should equal removing money from the system. But that never actually happens. The Fed just loans the money out again, or hands it over to the Treasury.
So in this case, here's what I see happening: People speculate on when the Fed will pay off all of its bonds. When the first issue comes due, and the banks are all getting ready to go on a buying/spending/loaning bonanza, the Fed says, "Now hold on a minute: Do you guys really want your dollars now? How about if I gave you even MORE interest if you wait another year?"
After a few iterations of that, the only possibilities are:
a) The fed finally pays off the bonds and we get hyperinflation, or
b) The Fed somehow "loses" the bonds, or dumps them on an insolvent underwriter, seriously f'ing bondholders, but accomplishing its goal of reducing the money supply.
Fun times ahead!
Tom,
Yeah I think you're right, that the Fed could just insist on higher reserve requirements if the excess reserves start getting lent out. I.e. transform excess reserves into required reserves with the stroke of a pen (or whatever).
Silas, right, I didn't spell it out in this particular article, but yeah the Fed could keep rolling it over, but then at some point people have to wonder why they are holding Fed reserves in the first place (if they never get to spend them).
Yeah I think you're right, that the Fed could just insist on higher reserve requirements if the excess reserves start getting lent out. I.e. transform excess reserves into required reserves with the stroke of a pen (or whatever).
Silas, right, I didn't spell it out in this particular article, but yeah the Fed could keep rolling it over, but then at some point people have to wonder why they are holding Fed reserves in the first place (if they never get to spend them).
I forget who said it, but an interviewee on one of the Bloomberg economic podcasts stated that he thought if the Fed went through with the Fed Bond idea they would merely force all member banks to participate. He made it seem like the Fed wouldn't make the bonds available to the general public and that they would enforce participation in an I'm-going-to-make-you-an-offer-you-can't-refuse sort of way. (An unfortunately all too common sentiment these days.)
I'm no expert, but if the Fed required the member banks to role over the bonds at their whim, then this may provide a plausible way for the Fed to stop the diffusion of all this excess liquidity into the real economy.
I'm no expert, but if the Fed required the member banks to role over the bonds at their whim, then this may provide a plausible way for the Fed to stop the diffusion of all this excess liquidity into the real economy.
# posted by 
: April 22, 2009 at 11:32 PM
: April 22, 2009 at 11:32 PM
I am sorry, but I see literally no chance the Fed can undo, in any real way, the policies it has put into place- the mechanism chosen is pretty irrelevant.
A Paul Volcker could only happen once, in my opinion.
A Paul Volcker could only happen once, in my opinion.
# posted by : April 23, 2009 at 10:56 AM
: April 23, 2009 at 10:56 AM
How would selling Fed issued bonds accomplish anything different than selling off the Treasuries that the Fed has in it's reserves? What difference is there between the Fed keeping its Treasuries and selling Fed bonds compared with just selling the Treasuries?
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