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Friday, September 26, 2008


inflationary policy response and fed illiquidity

david merkel highlights the new deviation from earlier policy, which highlights both the severity of the ongoing delevering and the inflationary will of the fed.

We may have finally hit the panic phase of monetary policy, where the Fed increases the monetary base dramatically. They are pumping the “high-powered” money into loans:

  • $20 billion for Primary credit
  • $80 billion for Primary dealer and other broker-dealer credit
  • $70 billion for Asset-backed commercial paper money market mutual fund liquidity facility
  • $40 billion for Other credit extensions
  • $80 billion for Other Federal Reserve assets
  • $20 billion netting out other entries

Making it an increase of roughly $270 billion from last week’s average to Wednesday’s daily balance. Astounding.

In general, the increases are not being pumped into the banks, but into specialized programs to add liquidity to the lending markets. Now, I’ve written about this before, but it bears repeating. What happens if the Fed takes losses on lending programs. It reduces the seniorage profits that they pay to the Treasury, which means the Treasury has to tax or borrow that much more. The Fed isn’t magic; it’s a quasi-extension of the US Government in a fiat currency environment. It’s balance sheet is tied to the US Treasury.

Yves Smith at Naked Capitalism is correct. The US is no longer a AAA credit, particularly if you measure in terms of future purchasing power of US dollars.

london banker has noted in response to brad setser's highlighting of the same points:

I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed - only emphasise the urgency.

click banker's link to jim jubak. somewhere down the road, the united states is risking its credit rating. jubak cites concern about the ratings agencies downgrading the united states; but what to worry about is pre-emptive action from the central banks of china, japan, russia and some petrostates.

open foreign bank accounts and place significant savings there before the united states prohibits americans from moving money out of the country.

"The next emergency measure will be that Americans are not allowed to buy foreign currency and transfer money overseas, and the next measure will be not permitting Americans to buy gold and so on and so forth…. It creates even more uncertainty in the market place when you continually change the rules," Faber said.

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from Perrone: hey, GM. why Swiss Francs and not Yen? loved your Andromeda Strain riff, btw. for me, Bernanke is that spectacled lady scientist with epilepsy -- tremendously learned, talented, on the verge of heroic success, but in the end unable to overcome the sinister, debilitating forces within and without.

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From Perrone: Bush is Bailey Boy!

you know, a literary analogy came to me. remember that scene towards the end of "A Good Man is Hard to Find," when a petrified Bailey Boy chirps out, "hush! everybody shut up and let me handle this!" then, "listen! we're in a terrible predicament! nobody realizes what this is," as the gunmen come over to lead him into the woods. that's Bush at the Thursday White House meeting. McCain's his wife, Paulson is grandma. but who's the Misfit? that's the distorted world economy, the undertaker that won't be cheated -- not in the end.

ah, it's no real pleasure in life.

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hi perrone -- you've got it -- i think the important part is to find a way into one of the carry trade funding currencies. yen seems acceptable to me as well, but i would prefer CHF for two subsidiary reasons:

the yen is subject to heavy intervention, japanese exports are a serious matter to the government and the government is further something more than an american "ally" in my view. this is also a country with an outstanding government debt of 170% of GDP.

switzerland, on the other hand, is primary a banking center whose continued economic welfare depends primarily on currency stability. they are backed 40% by gold and remainder by very prudential swiss government bonds.

it's a matter of preference on some level. but i am of the opinion that CHF is safer.

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