Sunday, September 16, 2007

The Fed: Magical Fairies and Pixie Dust / Hussman

There is almost no better way to start the week to focus on facts and filtering all the spin and hype that is hitting you as soon as you switch on the MSM. One of the best ways to achieve this goal is to read the weekly comment from Hussman. With the Fed decision coming this week this is more important than ever. If you have the guts ( I havn´t...)to view the panel on CNBC please compare this nonsense with what Hussman has to say. On top of this Mish is out with another outstanding post and is asking Is the U.S. printing money like mad? .

Es gibt kaum einen besseren Wochenfang als sich auf die wesentlichen Fakten abseits des ganzen Spin´s und Hype´s zu konzentrieren der einen bei jedweder Form der Berichterstattung durch die gängigen Medien (besonders ausgeprägt bei der Wirtschaftsberichterstattung) begegnet Einer der besten Wege dieses Ziel zu erreichen ist die wöchentliche Dosis von Hussman. Und mit der Fed Entscheidung vor der Brust wird das ganze wichtigen denn je. Wenn Ihr das aushaltet,ich stehe das nicht durch :-), vergleicht die Faktenlage mal mit dem "Expertenpanel" auf CNBC. Zudem möchte ich noch ein weiteres Post von Mish hinweisen indem er auf die immer wieder gestellte Frage
Is the U.S. printing money like mad?

“All you need is faith and trust
and just a little bit of pixie dust”

- Peter Pan

Wall Street continues to hold its breath about the upcoming decision by the Federal Reserve. There's no question that the Fed's decision will have a market impact.

This is not because Federal Reserve operations matter, but because investors believe they matter. The total amount of U.S. bank reserves affected by FOMC operations is less than $45 billion, and only the “excess” portion of that – typically about $2 billion dollars – is what determines the overnight Federal Funds Rate. Meanwhile, the total amount of borrowings through the “discount window” – though higher than in recent years – still amounts to only about $3 billion.

There is no well defined “monetary transmission mechanism” by which these minuscule amounts affect bank lending. Yes, during periods of crisis, the Fed has an important role to play in providing day-to-day liquidity so banks can meet depositor withdrawals. But aside from this short-term variation in the monetary base (which we saw, for example, around the “year 2000” turn), there is not even a slight relationship between bank reserves and total bank lending. Indeed, any remnant of that relationship was wiped out in the early 1990's, when reserve requirements were removed on all bank deposits other than checking accounts.

To believe that the Fed operations matter, you have to believe that a $13 trillion economy is controlled by a few billion dollars of reserves and discount window borrowings, none of which vary materially from year to year.

The notion of a powerful Fed is not knowledge born of analysis, but belief born of repetition. Think about it: how did you learn that the Fed is important? Not that interest rates are important (which is certainly true), but specifically, that the Fed is important. Some investors learn it in college, from the “money multiplier” theory that links bank reserves and bank lending (obsolete since the early 1990's when reserve requirements were largely eliminated). ....

> If you want to read more on this topis i highly recommend What (Really) Happened in 1995? / Aaron Krowne

> Wenn Ihr genaueres über die laxen Resrevevorschriften wissen möchsten kann ich Euch diesen Link What (Really) Happened in 1995? / Aaron Krowne empfehlen.

Correlation doesn't imply causation. We need to ask: what is the mechanism by which Fed actions have these effects? If we're convinced that the Fed matters, we can't stop at belief or argument – we need consider reasonable mechanisms, and then actually test them against data. If investors don't do this, they have nothing but superstition. They quietly equate the black cat, or the ladder, or the broken mirror, or Ben Bernanke with an outcome, without looking for any testable relationships that link cause and effect. ....

The Federal Reserve controls one monetary aggregate – the U.S. monetary base, the vast majority of which represents currency in circulation. In a nutshell, the Fed buys U.S. government debt and creates “base money” in the form of either bank reserves or currency. Of the $552.4 billion in securities purchased by the Fed since 1990, $546.3 billion – about 99% – represents currency in circulation (the pieces of paper in your pocket that have “Federal Reserve Note” printed on top).

Total U.S. bank reserves have grown by only $3.1 billion since 1990, to a total of $44.9 billion. Again, it is the day-to-day trading between banks of this amount (and actually, only of “excess reserves” – typically about $2 billion dollars) that determines the Federal Funds rate.

The Federal Reserve lowered the “discount rate” and opened the “discount window” a few weeks ago. Total borrowings from the Fed have increased from about $360 million in July, to $3.2 billion currently. While some analysts have breathlessly noted that “borrowings from the Fed have soared to the highest level in years,” the total amount of this “fresh liquidity” is about the same as the total assets of the Strategic Growth Fund.
Thanks to Wall Street Follies

In contrast to about $2 billion in excess reserves that is the basis for the Federal Funds Rate, and about $3 billion that is currently being lent at the Discount Rate, the U.S. banking system presently carries about $3.4 trillion in real estate loans, and $6.3 trillion in total loans. Gross domestic product is currently about $13.8 trillion.

While the Fed has purchased a total of $240.7 billion in U.S. government securities since 2000, mostly to create currency, foreign investors have purchased $1,185.8 billion in Treasuries alone. Indeed, foreign purchases have absorbed all of the increase in U.S. Treasury debt over the past year (and then some). It makes a great deal of sense to pay attention to foreign capital flows and the U.S. current account. In contrast, except for the psychological effect on investors, it is ridiculous to believe that Federal Reserve operations matter.

The Fed is, at best, a square-dance caller - the guy who by mutual consent gets to holler out when to swing your partner and when to do-si-do. The Fed provides coordination, but it is a mistake to think it has power. When the barn is on fire and people no longer find it in their best interests to follow along, you can bet they'll dance to their own tune (as we're starting to see in the Eurocurrency market, where LIBOR has significantly diverged from thee Fed Funds rate being "called out"). The Fed can provide a modest amount of liquidity to the banking system, but it can't provide solvency to the mortgage market. It's dangerous to believe that a reduction in the Fed Funds rate or the Discount Rate will materially change credit conditions here.

Still, we'll all be gathered there under Ben's helicopter on Tuesday, hoping for a sprinkling of magical pixie dust.

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