Liquidity Crisis?

[danmand]

I love the Money and Banking 101 course here..... reminds me fondly of the 80s when I was taking that class......

OTB

I find it very laudable that someone takes the time to educate as unlikely a group as Terb members.

 

[onthebottom]

I find it very laudable that someone takes the time to educate as unlikely a group as Terb members.

I give credit to Someone, he's taken the professorial approach many times..... not that it seems like it's taking.

OTB

 

[alex52]

For me it's a buying opportunity

 

[Gyaos]

Looks like it hit and bounced based on the Fed action... we'll see how this week treats the market. OTB

Have you noticed how the yen moves in exact tandem with the Dow, recently? The yen weakens when the Dow moves up, it strengthens when the Dow goes down. In fact, these fluctuations are within a day and they are lock in step. Something is up there.

Gyaos.

 

[frasier]

I find it very laudable that someone takes the time to educate as unlikely a group as Terb members.

Hmmm....??? Aren't you part of that group?

 

[frasier]

Here is my advisors opinion on this...

In an effort to restore orderly markets, the Fed surprised markets by announcing a 50 basis point cut in its discount rate on direct loans to banks, recognizing that increased economic uncertainty poses risks for the U.S. economy. The Fed said it is prepared to take further actions to mitigate damage to the economy from the rout in global credit markets. This is the first inter-meeting cut in the discount rate since 2001. “Providing depositories greater assurance about the cost and availability of funding,” the Fed also allowed the provision of term financing to banks for as long as 30 days, renewable by the borrower. This lowers the cost of capital for banks and helps keep credit flowing through the economy at a time when investors have shown a greater reluctance to lend. This action is intended to calm jittery markets, which have sold off sharply since July 19; the one exception to the selloff has been the U.S. Treasury bill and bond markets, which are seen as a safe haven in times of diminishing liquidity and great volatility, boosting the U.S. dollar against most other currencies.

This decision has no impact on the federal funds rate—the Fed’s main economic policy lever—but given the Fed’s statement regarding downside risk to growth and its promise to act as needed to support economic growth, there is widespread speculation that a cut in the fed funds rate is coming.

Markets were particularly jittery this morning as the Nikkei sold off 5.4% last night reflecting the negative impact of the stronger yen on Japanese exports and corporate profitability. The yen has risen sharply with the unwinding of the yen carry trade—the longstanding borrowing in Japanese markets where interest rates are exceptionally low to invest in non-yen assets. In pre-market trading, the S&P futures suggested a weak opening to the stock market until the Fed’s surprise announcement.

“Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward,” the central bank's Federal Open Market Committee said in a statement released in Washington. “The downside risks have increased appreciably.” In the statement, the committee said it is “prepared to act as needed to mitigate the adverse effects on the economy arising from disruptions in financial markets.” The cut reflects alarm at the central bank that more restrictive lending conditions and volatility in financial markets will deepen the housing recession, weaken employment and erode economic growth.

As recently as its Aug. 7 meeting, the FOMC kept rates unchanged and said inflation is still the biggest danger to the economy.

Today, the Fed noted that “although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably.” Since the August 7 meeting, the contagion of the collapse in demand for securities backed by subprime mortgages that has forced at leased 70 lenders out of business has spread beyond the U.S. to equities, commercial paper and non-U.S. government bond markets worldwide, wiping out trillions of dollars in asset value. Hedge funds and others in need of liquidity have been forced to sell more liquid higher-quality assets, markedly reducing their prices as well.

These Fed actions show that Bernanke, like his predecessor, is willing to temporarily ignore his inflation objectives to offset a credit crunch. This is important because, until now, Bernanke seemed to shun the so-called ‘Greenspan put’—the predilection of Alan Greenspan to bail out financial players when markets plunged in a disorderly fashion. Noteworthy is the absence of William Poole’s name in the roster of FRB President’s endorsing the discount rate cut. Poole, the President of the St. Louis Fed, who was giving a speech this morning on international trade issues, has been outspoken in his view that it would take a “calamity” to cause the Fed to ease monetary policy.

The Bottom Line: The Fed will now do whatever it takes to re-establish financial stability. The worst is now over in financial markets.

 

[markvee]

Edit: Since you don’t understand my explanation of money creation, see the following interactive explanation: http://www.federalreserveeducation.org/fed101/policy/money.htm
and
http://www.federalreserveeducation.org/fed101/policy/frtoday_depositCreation.pdf

Thanks for the links someone. The table is from the last link.

Here are some more questions.

1) I’m assuming that the $10,000 that the Fed uses to buy T-Bills from N1 is newly created money. Correct?

2) The Fed ultimately should pay back the $10,000, so the Fed doesn’t get to keep the $10,000. Correct?

3) The Fed (in the form of B1) gets to charge interest for lending the money to N2, say at 5.75% on $9,000. Correct?

4) B2 also gets to charge interest for lending money, say 6.75% on $8,100 to its best customer N4. Correct?

5) Let’s stop things here (and cut out N2 and N3) and say after a year, everybody pays their money back:
N4 pays .0675 x 8,100 = 546.75. Therefore, N4 -546.75
B2 gets 517.50 but must pay B1 .0575 x 9,100 = 517.50. Therefore, B2 546.75-517.50 = +29.25
B1 gets .0575 x 9,100 = 517.50. Therefore, B1 +517.50

So, N4 loses 546.75 and B1 gets 517.50 from this liquidity crisis (in which $10,000 is put into circulation but $10,546.75 must ultimately be paid back), but what did B1 do for its 517.50? Maybe, B1 deserves that 517.50 for doing a great job of controlling the reserves and controlling short term interest rates, but if a great depression happens are there any consequences for B1 (which is unelected and can at best be fired with cause by the President)?

6) Also, suppose N4 can’t pay the 8,100 (Let’s say the 8,100 is for a home instead of a stereo). If the banks run into this problem then no problem, just increase reserves. But whether reserves increase or not, N4 still risks losing his home. So, the banks are covered for making bad loans; the Central Banks ultimately profit; but individuals still risk getting thrown out onto the street. Earlier, I asked why not increase reserves by giving every individual the same amount of money, but you countered that the money wouldn’t get quickly enough to where it is needed. However, in the current system the rich B’s get the reward and the poor N’s take the risk. Correct?

7) Also, if money keeps getting added to the reserves, the N’s lose from dilution of the value of their currency (probably most notable in their purchases of local items such as land to live on and college education) while the B’s still collect interest. Correct?

 

[onthebottom]

My take on this is that after some back and forth through September, by December we will have forgotten all about this issue.

However I do think how these bond securties have been package will come back to haunt us all in a couple of years, if or when the US consumer stops spending.

It is possible that we will look back at this time and say we had fair warning.


bbk

May not take that long....

OTB

 

[someone]

Hi Markvee,

It is great that you’re interested in this stuff and you do ask some good questions. Therefore, I really hope that you don’t’ think I’m rude for not giving you as much detail as your questions deserve, however (1) I’ve had far to much to drink to give you detailed answers and (2) from my prospective, this exchange is starting to seem more like work than recreation .

Thanks for the links someone. The table is from the last link.

Here are some more questions.

1) I’m assuming that the $10,000 that the Fed uses to buy T-Bills from N1 is newly created money. Correct?

Yes

2) The Fed ultimately should pay back the $10,000, so the Fed doesn’t get to keep the $10,000. Correct?

Not really. The fed has bought a T-Bill. A T-bill is a IOU of the U.S. government. Thus, the U.S. government used to owe N1 the amount of the face value of the T-bill and now the U.S. government owes that same amount to the Federal Reserve. If the fed reserve keeps the T-bill until maturity, the U.S. government will pay it the face value of the T-bill and the money supply will then decrease by the amount of the t-bill (which is generally more than the fed paid for it). The fed does now owe B1 (the bank N1 deposited the money in) the amount it paid for the t-bill. However, it is a funny kind of debt. If B1 withdraws its money from the fed, the fed gives it currency by first printing the money. Technically, currency is a debt of the fed. At one time if you took a $5 bill to the bank of Canada they gave you $5 in U.S. dollars (under the Briton Woods system), before that, they gave you $5 in gold. Now, they still owe you $5 but if you take the $5 to the bank of Canada, they just give you another $5 bill (e.g. another IOU). When you get right down to it, the only reason people accept fait money is because they think someone else will accept it. That’s why it is important that the central bank never let the money supply get out of hand. There are plenty of famous horror stories from Germany in the 1920s and South American more recently when things really broke down. At one time in Germany, it was cheaper to use money in wood stoves than to use it to buy fire wood.

3) The Fed (in the form of B1) gets to charge interest for lending the money to N2, say at 5.75% on $9,000. Correct?

But the Fed is not B1? B1 is a private bank, which gets to charge interest.

I think I’m too drunk to follow the rest of your example. It seems that you are getting into the Social credit criticisms of the system (a political party that Preston Manning’s father used to lead). Did you happen to pick up an old social credit pamphlet?

 

[solitaria]

4) If the Fed decides that there is a need for $50B more money in circulation, why doesn't the government just write a cheque for $166 to every US citizen?

It makes more sense to use it to pay off debt. After the US government writes that cheque for $166 to every US citizen, it still has the problem of paying off its debt.

 

[solitaria]

6) Also, suppose N4 can’t pay the 8,100 (Let’s say the 8,100 is for a home instead of a stereo). If the banks run into this problem then no problem, just increase reserves. But whether reserves increase or not, N4 still risks losing his home. So, the banks are covered for making bad loans; the Central Banks ultimately profit; but individuals still risk getting thrown out onto the street. Earlier, I asked why not increase reserves by giving every individual the same amount of money, but you countered that the money wouldn’t get quickly enough to where it is needed. However, in the current system the rich B’s get the reward and the poor N’s take the risk. Correct?

Increasing reserves can't be used to cover bad debts since money has to be backed by goods and services even if they are future goods and services. If you knew the money that you were getting back wasn't nearly as valuable as the money you put in would you save money by giving it to banks or buy goods and services immediately? Therefore the banking system would absolutely crumble if the solution was to cover bad debts by printing money. I would say printing money can only be used to cover bad debt on a very small incremental basis such that inflation is way less than prevailing interest rates and with the hope of growing demand and the production of goods and services so that inflation is minimized.

 

[Papi Chulo]

Interesting Read

http://www.reportonbusiness.com/ser.../?page=rss&id=RTGAM.20070824.wtakingstock0824

 

[solitaria]

So, N4 loses 546.75 and B1 gets 517.50 from this liquidity crisis (in which $10,000 is put into circulation but $10,546.75 must ultimately be paid back), but what did B1 do for its 517.50? Maybe, B1 deserves that 517.50 for doing a great job of controlling the reserves and controlling short term interest rates, but if a great depression happens are there any consequences for B1 (which is unelected and can at best be fired with cause by the President)?

I didn't follow through your whole example because I can't be bothered to think in detail right now but I get the gist of your question. Basically the initial lender should get most of the profit because everyone else is gambling with the initial lender's money (or right to X amount of goods and services). The initial lender is the only institution with anything of value until people who borrow money start producing goods and services and the money (that represents goods and services) starts flowing back up the chain.

 

[alphauniform]

interesting little films on the present debacle.......stay with the first one for background...even though it's a little long.
http://www.brasschecktv.com/page/135.html

 

[FOOTSNIFFER]

Increasing reserves can't be used to cover bad debts since money has to be backed by goods and services even if they are future goods and services. If you knew the money that you were getting back wasn't nearly as valuable as the money you put in would you save money by giving it to banks or buy goods and services immediately? Therefore the banking system would absolutely crumble if the solution was to cover bad debts by printing money. I would say printing money can only be used to cover bad debt on a very small incremental basis such that inflation is way less than prevailing interest rates and with the hope of growing demand and the production of goods and services so that inflation is minimized.

Ultimately they want to try to match real demand for stuff with real supply. but that's tough to do.

 

[someone]

Hi Markvee,

Now that I’m sober, I’ve looked over the rest your post again and I see it is fairly straight forward.

5) Let’s stop things here (and cut out N2 and N3) and say after a year, everybody pays their money back:
N4 pays .0675 x 8,100 = 546.75. Therefore, N4 -546.75
B2 gets 517.50 but must pay B1 .0575 x 9,100 = 517.50. Therefore, B2 546.75-517.50 = +29.25
B1 gets .0575 x 9,100 = 517.50. Therefore, B1 +517.50

So, N4 loses 546.75 and B1 gets 517.50 from this liquidity crisis (in which $10,000 is put into circulation but $10,546.75 must ultimately be paid back), but what did B1 do for its 517.50? Maybe, B1 deserves that 517.50 for doing a great job of controlling the reserves and controlling short term interest rates, but if a great depression happens are there any consequences for B1 (which is unelected and can at best be fired with cause by the President)?

OK, I see your point. You are arguing against the free enterprise system. Those of us in favour of the free enterprise system assume that neither party to a voluntary transaction would engage in the transaction if they were worse off. Thus, N4 cannot be worse off or they never would have accepted the loan. Given the voluntary nation of the exchange, we would say that interest paid represented the minimum benefit N4 got from the loan. Clearly, you disagree with this logic. Personally, I think there is a lot of evidence that socialism does not work but you clearly disagree and I don’t’ want to argue about it as I find that such arguments get nowhere.

Also, you should not that since B1 is currently a private bank, its head can't easly be fired by the president. Thus, I take it that you would like to nationalize the banks. I'm really not interest in getting into that debate.

BTW, I have not idea what dumb responses solitaria has made as I’ve had him on ignore for a long time.

 

[dickydee292004]

I am no expert in economics, captialism, credit, the market, inflation trends etc etc. What I do know is I don't owe anybody a penny in this world which probably 70-99% of the North American population cannot say. What I do know about money is if you dont have any your fucked and if you have money you have everything. From what I can tell its not the americans that have the money. Their only saving grace is their military and federal reserve which allows us to continue to live the way we do. Well my opinion and feeling is that this will not last forever. The irresponsibilities of North Americans are catching up to us and the lifestyle that we are blessed to have will end. Just like when you dont pay your bills you lose what you have, well when countries dont pay their bills they lose what they have. Its great living in a bubble that we do, because we all think that life is so rosey here. One day roses wilt and ours is not too far away. But hey since we all like to buy useless shit that we cant afford, hey keep buying (of course buy it on the credit card cause in all liklihood you cant pay cash for it, why, cause you dont have any). Whatever, my post doesnt make any sense but makes perfect sense for those that have any sense, but we dont have any sense so you all can comment how i dont make any sense. You know, maybe a weekend away buying useless shit imported from China will make me feel better. And what would be great is if i could buy plastic shit that makes noises, ohhh that sounds really nice. Worst case scenario i could always form an army send them across the world to blow shit up and then everyone back home can continue to buy shit they cant afford. Ahhh life is good, good luck to all you suburbanites and your overpriced houses that ohhh you'll be forclosing on when the markets true colors are revealed. And what is that, that we are living a lie.

 

[markvee]

Increasing reserves can't be used to cover bad debts since money has to be backed by goods and services even if they are future goods and services. If you knew the money that you were getting back wasn't nearly as valuable as the money you put in would you save money by giving it to banks or buy goods and services immediately? Therefore the banking system would absolutely crumble if the solution was to cover bad debts by printing money.

But didn’t the subprime mortgage crisis just get covered by creating more money?

I would say printing money can only be used to cover bad debt on a very small incremental basis such that inflation is way less than prevailing interest rates and with the hope of growing demand and the production of goods and services so that inflation is minimized.

 

[markvee]

I didn't follow through your whole example because I can't be bothered to think in detail right now but I get the gist of your question. Basically the initial lender should get most of the profit because everyone else is gambling with the initial lender's money (or right to X amount of goods and services). The initial lender is the only institution with anything of value until people who borrow money start producing goods and services and the money (that represents goods and services) starts flowing back up the chain.

Back in the day when every dollar lent had to be covered by an equal value of gold in the vault, I would agree with you that the initial lender with something of value that was at risk.

However, today the money is created to cover demands on the banks for loans. So money = debt. Also, The banks need keep reserves of only money (to cover 10% of it lends), not reserves of gold, so I think it is the borrower who takes the risk (of losing something of real value such as one's home) and not the bank.

 

[solitaria]

Back in the day when every dollar lent had to be covered by an equal value of gold in the vault, I would agree with you that the initial lender with something of value that was at risk.

However, today the money is created to cover demands on the banks for loans. So money = debt. Also, The money need only keep reserves of money (to cover 10% of it lends), not reserves of gold, so I think it is the borrower who takes the risk (of foreclosure, etc) and not the bank.

I would say it is backed by the obligation of others to pay in the form of goods and services somewhere down the line and however indirectly from the initial lender's standpoint. It doesn't have to be backed by gold (i.e. one example of a good or service) to have real value. Therefore the bank is giving away that value to another entity in the form of a loan.

If you think about it you would only want to have a loan if people could produce goods and services that could match the value of the loan and were forced to do so because of their indebtedness however indirect to the initial lender. Sometimes value is artificially created but society's production must go up to match that value or it just becomes inflation and the value of money goes down. That's not viable long-term as people would lose confidence in the system.