Tuesday, December 23, 2008

On this day, December 23

Most Fed students are aware of the significance of this day. As one of many government Days of Infamy, December 23 ranks at or near the top because on this day in 1913 Woodrow Wilson signed the Federal Reserve Act into law. It's always interesting how quietly this day passes in the MSM. Wikipedia mentions it as worthy of note in their "On this day" page for December 23, but readers in 2008 will not see it listed on Wikipedia's main page. It does list the December 23, 1972 earthquake in Nicaragua that killed over 10,000 people, but the birth of the Fed, which has funded millions of deaths by making war easy to finance, while reducing the value of the dollar to roughly five cents since its inception, is just another event. It reminds me of Bastiat's famous Broken Window Fallacy, in the significance given to "what is seen over what is not seen."

Thursday, December 18, 2008

Where's the trust? (revised)

As reported here, the monetary base, or M0 measure of the money supply, soared to $630 billion as of December 3 -- a 74% increase from September 3, according to a Celent report. It normally takes a central bank a decade to accomplish such a feat.

The rationale for the increase would seem to be the faulty logic of increasing bank reserves to increase lending -- such logic made faulty, in this case, because it's not a lack of reserves that's curtailing lending, it's a lack of trust. In the credit world, no one believes anyone anymore. The Fed realizes this, so on October 9, it began paying interest on bank reserves. Consequently, banks have shifted more of their funds into reserves, rather than lending them out. This is called "sterilizing" the reserves. It's also a free lunch for the banks.

Banks make money by charging interest on loans. With lending activity depressed, interest on loans is depressed, and the solvency of the banking system is threatened. This is one reason the Fed began sterilizing reserves: to supplement the banks' loan interest and keep the banks' cash flow intact. It's as if the Fed changed the nature of the member banks' reserves from demand deposits to savings deposits, with the latter paying interest. Since interest is a lender's profit, the Fed is providing the banks profits without risk.

But there's another reason behind its sterilization policy. The Fed is trying to avoid massive inflation, and to do that it has to avoid the money multiplier of commercial bank lending. At the same time it wants to revive lending activity. But how will it accomplish these conflicting goals?

My guess is, by becoming the world's largest commercial bank.

We need to remember the Fed is considered the lender of last resort. It can create money with the stroke of a pen or the press of a key. It doesn't need borrowers, like the commercial banks do, to create money out of thin air. The market of corporate borrowers will therefore trust the Fed because it can always avoid insolvency. So the question arises: Will the Fed begin lending directly to the market while continuing to sterilize reserves to keep banks solvent? And if so, where will it get the funds to lend? From the pool of bank reserves? From credit it creates? Both?

In effect, the commercial banks, the big ones at least, would be swallowed up by the Fed. You would be borrowing from Bank of America in name only. In truth, the loan would be managed by the Fed.

Even in 2008 this possibility seems too ludicrous to consider, but given the premises the Fed has set up, I don't see what other conclusion follows. I can't see the Fed or any central bank building up reserves to promote 100 percent reserve banking, for example, though that would be cause for celebration. Instead, it looks like the Fed is trying to solve the trust problem at the cost of high inflation, though accomplished in an unorthodox manner. The mighty Fed will do the lending, not the shaky commercial banks. Perhaps this is why the Celent report concludes:
. . . one might be excused for thinking that the frequent comparisons with the Great Depression of 1929 are not the most apt. Perhaps the economic crisis in the Weimar Republic some seven years earlier could provide a better comparison.

Wednesday, December 17, 2008

Orthodoxy

Orwell said, "Orthodoxy means not thinking -- not needing to think. Orthodoxy is unconsciousness." Chris Matthews' comment about Obama comes to mind: Hands off the state. Let it do its thing and hope for the best. If Bernanke's latest rate cut doesn't propel us to prosperity, then he'll come up with something else. Give him time, have patience, don't judge -- at least not where the Thought Police might hear you.

Tuesday, December 16, 2008

Fed cuts rates again but . . .

According to a CNN poll, two out of three respondents think the Fed's rate cuts have not helped the economy, from a total of 32,304 responses to the poll. I realize this doesn't require anything more than attentiveness to the economy and what the Fed has done, but it is a good sign. Now, if only those two-thirds will graduate to the view that the Fed is hurting the economy by manipulating interest rates our descendants might have a bright future.

As mentioned in this blog on October 31, Frank Shostak said if the Fed cut rates to zero it
would underscore the reality that the Fed is incapable of producing wealth from its printing press. It would show that the Fed is completely powerless, except to produce mis-signals that generate malinvestment. The only thing that might temporarily move is the stock market.
The rate cut was not quite to zero. A target rate of zero would be admitting utter futility, so Bernanke and his gang will keep the Fed Funds Rate between 0 - 0.25, which is almost utter futility. That's not zero. Don't anyone say it's zero, because it isn't. Still, Wall Street came through.

Stocks surge after the central bank cuts a key interest rate to the lowest level on record.

Tuesday, December 2, 2008

Go, Iceland!

Thanks to a post this morning on Strike-the-Root, I've learned that Icelanders have roared their disapproval of the country's central bankers and government:
Thousands of Icelanders marked the 90th anniversary of their nation's sovereignty with angry protest Monday, and several hundred stormed the central bank to demand the ouster of bankers they blame for the country's spectacular economic meltdown.
Americans are increasingly aware of the harm fostered by the Fed, but can you see them storming the central bank?

In time, yes. Not the Obama-worshippers. Not the neo-con Republicans. Not the establishment media. Not the tenured academic economists at state universities. But the young libertarians, who are not merely protesting the central bankers, but the institution of central banking itself. The End the Fed movement is growing.

Monday, December 1, 2008

Myths of the Great Depression

Andrew B. Wilson debunks the prevailing views on the Depression in the November 4, 2008 edition of WSJ online.

The five myths he explodes are:

- Herbert Hoover, elected president in 1928, was a doctrinaire, laissez-faire, look-the-other way Republican who clung to the idea that markets were basically self-correcting.

- The stock market crash in October 1929 precipitated the Great Depression.

- Where the market had failed, the government stepped in to protect ordinary people.

- Greed caused the stock market to overshoot and then crash.

And the most disastrous myth of all:

- Enlightened government pulled the nation out of the worst downturn in its history and came to the rescue of capitalism through rigorous regulation and government oversight.