Auerback: Amateur Hour at the Federal Reserve

By Marshall Auerback, a portfolio strategist and Roosevelt Institute Fellow

As any student of Economics 101 realises, you can control the price of something, or the quantity, but not both simultaneously. In announcing its decision to purchase an additional $600bn of treasuries last week, the Federal Reserve presumably intended to create additional stimulus to an economy, since tepid growth has failed to make a dent in unemployment. Even Friday’s “good” unemployment numbers, where the US economy added 151,000 jobs, were not enough to reduce the current jobless rate of 9.6%.

So is a new round of “QE2” going to do the trick? It would be interesting to figure out how the Fed came to the magic number of $600 billion. Why not a trillion? Why not $250bn? Why $75bn a month? There’s an element of sticking one’s finger in the air and hoping for the best. The Bernanke Fed is slowly reaching Greenspan-like levels of incompetence.

Let’s go back to first principles: Quantitative easing involves the central bank buying financial assets from the private sector – government bonds and maybe high quality corporate debt. In this particular instance, the Fed has announced it will buy $75bn of treasuries a month. So what the central bank is doing is swapping financial assets with the banks – they sell their financial assets and receive back in return extra reserve balances. So the central bank is buying one type of financial asset (private holdings of bonds, company paper) and exchanging it for another (reserve balances at the central bank). The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns.

Central bank demand for “long maturity” assets held in the private sector reduces interest rates at the longer end of the yield curve. These are traditionally thought of as the investment rates. This might increase aggregate demand given the cost of investment funds are likely to drop. But on the other hand, the low rates reduce the interest-income of savers who will reduce consumption (demand) accordingly.

Essentially, then, you have a supply side response to a problem of aggregate demand. The cost of investment funds might well drop, although that’s not 100 percent clear. Consider the following example: Let’s say the Fed simply targeted the 10 year treasury at 2.25%. The central bank would have a bid at that level and buy all the securities the market didn’t want to buy at that level. They may in fact buy a lot or a very few, and possibly none at all, depending on Treasury issuance, investor demand, and market expectations.

But the FOMC has announced a limit to the Fed purchase program, both in terms of the monthly amounts and the total quantity. How high will 10 year notes trade with the billions free to trade at market levels?

It could be at much higher yields, which presumably defeats the whole purpose of the program. Of course, if the Fed bought every single 10 year treasury, then for sure they could maintain that rate indefinitely; but then they would have to preclude announcing a specific amount that they wished to purchase. Of course, if the Fed did this, people would undoubtedly squawk about “printing money” and “creating inflation” but again, QE does not actually create new net financial assets.

In fact, the Fed has done nothing but TALK about its plans over the past several months, but has yet to initiate the program. There has been no widespread “money printing” or “currency debasement”. The Federal Reserve announced an INTENTION to do something and private portfolio investors took their cue from that. But as any Asian central banker can tell you, private portfolio preference shifts are notoriously fickle, with conflicting motives. The term structure of rates in Japan would imply a comparable intent to make holding yen unattractive, yet 10 year government bonds in Japan yield less than one percent and the yen remains resolutely strong against the dollar.

Is there another method by which the Fed could influence the long term structure of interest rates? Why not just stop issuing 10 year government paper? If the Treasury had announced they were eliminating everything longer than 2 year notes for new issues there would hardly be any screams of “money printing”?

And how low would the 10 year go?

If the objective is to allow the banks to earn their way out of insolvency, then QE2 is also an ineffective means of doing this, since it flattens the yield curve, but still engenders interest rate risk on the part of the banks which persist in “playing the yield curve”, especially via leverage. There is a more effective means of doing promoting bank profitability in a comparatively risk free way, as my colleague, Randy Wray, has noted:

[T]here is nothing wrong with offering longer-maturity CDs to replace overnight reserve deposits held by banks at the Fed. Banks are content to hold deposits at the Fed—safe assets that earn a little interest. They are hoping to play the yield curve to get some positive earnings in order to rebuild capital. If they can issue liabilities at an even lower interest rate so that earnings on deposits at the Fed cover interest and other costs of financing their positions in assets, this strategy might work. That is what they did in the early 1990s, allowing banks that were insolvent to work their way back to profitability. The Fed could even lend to banks at 25 basis points (0.25% interest) so that they could buy the CDs, then pay them, say, 100 or 200 basis points (1% or 2% interest) on their longer maturity CDs. The net interest earned could tide them over until it becomes appropriate for them to resume lending to households and firms.

To be clear, we are not necessarily advocating banks play the yield curve to restore profitability (far better to have a payroll tax cut for that), or that they get such an arbitrage from the Fed, only that it would work with less risk both to the bank and the financial system than what will result from QE. Ultimately, if the objective is to allow banks to restore profitability via traditional lending activities, then there are far more obvious ways to do so. Let’s first recall that BANKS DO NOT LEND THEIR RESERVES, as is always depicted in the economics textbooks via so-called “fractional reserve lending”. The Federal Reserve Bank is a bank, just like Citibank or Wells Fargo. The Treasury has an account at the bank, just as you or I have a checking account at our local bank. Other banks, like BofA and Wells Fargo have accounts at the Fed as well, and they are called reserve accounts (for more see here).

Reserve accounts are not made up of money held in reserve in case a loan goes bad, they are money held at the Federal Reserve for payment settlement. The reserves of money held in case loans go bad are capital. They are not lent out. The way banks actually operate is to seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share. But that’s a function of credit analysis (or the lack of it, as the cycle matures), NOT the bank’s reserve positions.

These loans are made independent of their reserve positions. At the individual bank level, certainly the “price of reserves” will play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the bank’s marginal cost of funds is sufficient, the bank will lend

So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend (for more explanation, see here).

Consequently, the idea that reserve balances are required initially to “finance” bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is ultimately dictated by the presence of creditworthy borrowers, which is a function of FISCAL POLICY. Instead of expending political capital on pointless accounting shuffles and financial guarantees, or programs such as TALF, TARP, Term Auction Credit, or the Commercial Paper Lending Facility, one could simply implement a $2 trillion tax cut (or spend it via the government, or do revenue sharing with the states), thereby generating increased spending power in the economy, providing significantly higher multiplier effects and ultimately shifting the economy back to self-sustaining growth. This would be far more effective than continuing an endless array of silly Fed programs, which do nothing but diminish the central bank’s credibility and have had minimal impact in terms of economic growth.

In many respects, the markets are already implicitly conceding the ineffectiveness of “QE2”. Within hours of the program being announced, there were stories of “QE3”. Instead of having a situation where the markets “buy the rumor, sell on the news”, it appears to have been more a case of buy the rumor and then double up on the news.

We’ve truly hit amateur hour at the Fed. We’re inciting speculation and the Federal Reserve is acting like the kid in his car seat who keeps turning his toy steering wheel as much as it takes to turn the car. Toy cars, however, won’t get you very far if you plan a long journey, and likewise QE2 is a pretty ineffective vehicle if one wishes to engender genuine economic growth. Eventually, investors will realize they’ve been conned (yet again) by the Fed and the end result won’t be pretty.

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  1. attempter

    The most likely explanation is intentional criminality on the part of the Fed. The goal is simply to prop up the banks as long as possible, let them gamble with taxpayer-supplied funny money as long as possible, the whole way using that funny money to buy up more and more actual assets.

    Then, if all goes well, by the time the financial system collapses completely, all the land, all the infrastructure, all the networks, will be legally in the hands of the banksters. (Bankster-driven privatization of public property is another column of the attack.) From there government will literally be nothing but a thug arm of the debt slavery that will then be the basis of “society”.

    This criminal plan is supplemented by the factually disproven but nevertheless zombified trickle-down ideology. The elites simply move forward with the lie that indirect corporatist wealth administration, as in the case of QE as an alleged economic stimulator, can possibly ever work. They stick with it because however much educated people know it’s a lie, trickle-down remains the best ideological justification for what from any other point of view is clearly simple embezzlement.

    (It has the added qualification of actually brainwashing many of its cadres. Although we can’t always tell exactly who the “true believers” are, as opposed to the conscious criminals, there seem to be legions of them. Most people are too morally weak to face their crimes honestly before the tribunal of their conscience. But they still want to commit those crimes, or are too weak to resist conforming to organized crime. That’s where religion or ideology comes to the rescue.

    It’s also useful in order to confirm the commitment of the likes of Obama, who are inclined to support the crimes and are too intellectually deficient to understand their real nature. To such arrogant elitist ignoramuses, something like trickle-down sounds inherently plausible and satisfying. It confirms their whole elitist prejudice. The fact that it’s factually false is an irrelevant detail which is easily ignored. So that’s another kind of true believer.)

    1. jim

      Is the “land and infrustructure” being bought up by the banks?? If that is really the case, that would explain alot for me if they can buy assets with this “increase in reserves” QE money.

      I do belive there is some other scam revolving around buying up the distressed property by the banks, now they have collpased all the prices. However, I can’t figure out if it is the PPIP, or QE, or some other instrument created with the help of the creature from Jekyll Island(FED).

      One other point, I read somewhere that Fannie Mae and Freddie Mac WERE NOT giving the very favorable rates to homebuyers in the “hardist hit markets”. This seems like a scam of some sort. BEcuase the “hardist hit markets” are the markets least likely to fall, and most likely to apprecicate in my opinion.

      1. attempter

        I suppose they prefer not to directly own it, when the longstanding scam of owning it in substance through the mortgages of housedebtors and CRE loans achieves the same level of socioeconomic control while still allowing for the astroturfing of the “American Dream” and “ownership society” propaganda.

        But as we’ve seen the mortgage system is tottering, and they can;t keep the dollar bubble inflated forever. Plus there’s the brute physical fact of resource depletion.

        All this dictates that whoever has lots of funny money should start the final step of using it to “legally” monopolize real assets now.

  2. ds

    Yes all of that is true but the Fed is not in charge of fiscal policy. Proper monetary policy can help to facilitate expansionary fiscal policy and that is precisely what QE is doing. The Fed is buying government bonds right in the range of the average duration of government debt, so the net financial assets from deficit spending are flowing to the non government sector in the form of reserves rather than bonds.

    The Fed cannot directly control speculative behavior. It can certainly kill speculative bubbles with higher rates, but only at dear cost to the real economy. And the same thing would go with fiscal policy as well. If Congress changed course and announced a new round of fiscal stimulus, we would see the same speculators front-running and pushing up asset prices in the same manner as the participants in Keynes’ beauty contest. But I don’t think you would criticize stronger fiscal measures on those grounds.

    QE is likely to prove ineffective, but the alternative is higher interest rates and a steeper yield curve. No one has a compelling reason why higher interest rates would be better for an economy beset with a large output gap.

    1. DownSouth

      ds said: “The Fed cannot directly control speculative behavior. It can certainly kill speculative bubbles with higher rates….”

      You have fallen victim to Milton Friedman and Anna Schwartz’ historical revisionism and the ideology they proselytized that “money (monetary policy) is all that matters.” If we look at the actual events of the Big Bull Market of the 1920s, and not the fictional account put forth by Friedman and Schwartz, what we find is that your assumption above—-that “the Fed…can certainly kill speculative bubbles with higher rates”—-isn’t always so simple.

      In his book Only Yesterday Fredrick Lewis Allen describes in great detail the mechanics that drove the Big Bull Market.

      It began with “an abounding confidence engendered by Coolidge Prosperity.” The first manifestation of Coolidge Prosperity was a nationwide real estate speculative bubble that began in 1920. Though its epicenters were Miami and Manhattan, practically every community in the country got swept away in the frenzy. The speculative bubble in real estate, Allen observes, was fueled by the “abounding confidence engendered by Coolidge Prosperity, which persuaded the four-thousand-dollar-a-year salesman that in some magical way he too might tomorrow be able to buy a fine house and all the good things of earth.”

      The real estate market in Miami was the first to crash in the spring and summer of 1926. Other regional real estate markets after that fell like dominoes. The last to crash was Manhattan.”Here the building boom attained immense proportions,” Allen comments, “coming to its peak of intensity in 1928. New pinnacles shot into the air forty stories, fifty stories, and more; between 1918 and 1930 the amount of space available for office use in large modern buildings in the district was multiplied approximately by ten.”

      And as the real estate bubble imploded, it took many of the nation’s banks with it. “[I]n seven states of the country, between 40 and 50 per cent of the banks which had been in business prior to 1920 had failed before 1929,” Allen observes.

      But the bursting of the real estate bubble did not quell the abiding faith in Coolidge Prosperity, nor the speculative fever of the nation. As Allen goes on to explain:

      Yet the national speculative fever which had turned their eyes and their cash to the Florida Gold Coast in 1925 was not chilled; it was merely checked. Florida house-lots were a bad bet? Very well, then, said a public still enthralled by the radiant possibilities of Coolidge Prosperity: what else was there to bet on? Before long a new wave of popular speculation was accumulating momentum. Not in real-estate this time; in something quite different. The focus of speculative infection shifted from Flagler Street, Miami, to Broad and Wall Streets, New York. The Big Bull Market was getting under way.


      That enormous confidence in Coolidge Prosperity which had lifted the businessman to a new preeminence in American life and had persuaded innumerable men and women to gamble their savings away in Florida real estate had also carried the prices of common stocks far upward since 1924, until they had reached what many hard-headed financiers considered alarming levels. Throughout 1927 speculation had been increasing. The amount of money loaned to brokers to carry margin accounts for traders had risen during the year from $2,818,561,000 to $3,558,355,000-a huge increase. (And as is noted below, by the summer of 1929 it would balloon to $6 billion.)

      And the stock market had come completely disconnected from any underlying economic reality. “While stock prices had been climbing, business activity had been undeniably subsiding,” Allen explains. “There had been such a marked recession during the latter part of 1927 that by February, 1928, the director of the Charity Organization Society in New York reported that unemployment was more serious than at any time since immediately after the war.”

      What on earth was happening? Wasn’t business bad, and credit inflated, and the stock-price level dangerously high? Was the market going crazy? Suppose all these madmen who insisted on buying stocks at advancing prices tried to sell at the same moment! Canny investors, reading of the wild advance in Radio, felt much as did the forecasters of Moody’s Investors Service a few days later: the practical question, they said, was “how long the opportunity to sell at the top will remain.”

      What was actually happening was that a group of powerful speculators with fortunes made in the automobile business and in the grain markets and in the earlier days of the bull market in stocks-men like W. C. Durant and Arthur Cutten and the Fisher Brothers and John J. Raskobwere buying in unparalleled volume. They thought that business was due to come out of its doldrums. They knew that with Ford production delayed, the General Motors Corporation was likely to have a big year. They knew that the Radio Corporation had been consolidating its position and was now ready to make more money than it had ever made before, and that as scientific discovery followed discovery, the future possibilities of the biggest radio company were exciting. Automobiles and radios-these were the two most characteristic products of the decade of confident mass production, the brightest flowers of Coolidge Prosper- ity: they held a ready-made appeal to the speculative imagination. The big bull operators knew, too, that thousands of speculators had been selling stocks short in the expectation of a collapse in the market, would continue to sell short, and could be forced to repurchase if prices were driven relentlessly up. And finally, they knew their American public. It could not resist the appeal of a surging market. It had an altogether normal desire to get rich quick, and it was ready to believe anything about the golden future of American business. If stocks started upward the public would buy, no matter what the forecasters said, no matter how obscure was the business prospect. They were right. The public bought.

      The Fed, growing alarmed, reacted. In February 1928 it raised the rediscount rate from 3-1/2 to 4 percent. It raised the rate again in May to 4-1/2 percent. It raised it again in July to 5 percent.

      But as Allen goes on to explain, “The Federal reserve authorities found themselves in an unhappy predicament.” Wall Street was going ballistic at the same time Main Street was imploding. “Speculation was clearly absorbing more and more of the surplus funds of the country.” High interest rates had no effect on the speculative fever. “Things had now come to such a pass that if they [the Fed] raised the [rediscount] rate still further…[it] ran the risk…of seriously handicapping business by forcing it to pay a high rate for funds.”

      On February 2, 1929, they [the Reserve Board] issued a statement in which they said: “The Federal Reserve Act does not, in the opinion of the Federal Reserve Board, contemplate the use of the resources of the Federal Reserve Banks for the creation or extension of speculative credit. A member bank is not within its reasonable claims for rediscount facilities at its Federal Reserve Bank when it borrows either for the purpose of making speculative loans or for the purpose of maintaining speculative loans.” A little less than a fortnight later the Board wrote to the various Reserve Banks asking them to “prevent as far as possible the diversion of Federal Reserve funds for the purpose of carrying loans based on securities.” Meanwhile the Reserve Banks drastically reduced their holdings of securities purchased in the open market. But no increases in rediscount rates were permitted. Again and again, from February on, the directors of the New York Reserve Bank asked Washington for permission to lift the New York rate, and each time the permission was denied. The Board preferred to rely on their new policy.

      On March 26, 2009 the rate for call money jumped from 12 percent to 15, and then to 17, and finally to 20 percent.

      That afternoon several of the New York banks decided to come to the rescue. Whatever they thought of the new policy of the Federal Reserve Board, they saw a possible panic brewing-and anything, they decided, was better than a panic. The next day Charles E. Mitchell, president of the National City Bank, announced that his bank was pre- pared to lend twenty million dollars on call, of which five million would be available at 15 per cent, five million more at 16 per cent, and so on up to 20 per cent. Mr. Mitchell’s action-which was described by Senator Carter Glass as a slap in the face of the Reserve Board-served to peg the call money rate at 15 per cent and the threatened panic was averted.

      Whereupon stocks not only ceased their precipitous fall, but cheer- fully recovered!

      The lesson was plain: the public simply would not be shaken out of the market by anything short of a major disaster.

      During the next month or two stocks rose and fell uncertainly, sinking dismally for a time in May, and the level of brokers’ loans dipped a little, but no general liquidation took place. Gradually money began to find its way more plentifully into speculative use despite the barriers raised by the Federal Reserve Board. A corporation could easily find plenty of ways to put its surplus cash out on call at 8 or 9 per cent without doing it through a member bank of the Federal Reserve System; corporations were eager to put their funds to such remunerative use, as the increase in loans “for others” showed; and the member banks themselves, realizing this, were showing signs of restiveness. When June came, the advance in prices began once more, almost as if nothing had happened. The Reserve authorities were beaten.

      By the summer of 1929, prices had soared far above the stormy levels of the preceding winter into the blue and cloudless empyrean. All the old markers by which the price of a promising common stock could be measured had long since been passed; if a stock once valued at 100 went to 300, what on earth was to prevent it from sailing on to 400?
      And why not ride with it for 50 or 100 points, with Easy Street at the end of the journey?

      By every rule of logic the situation had now become more perilous than ever. If inflation had been serious in 1927, it was far more serious in 1929, as the total of brokers’ loans climbed toward six billion (it had been only three and a half billion at the end of 1927). If the price level had been extravagant in 1927 it was preposterous now; and in economics, as in physics, there is no gainsaying the ancient principle that the higher they go, the harder they fall. But the speculative memory is short.


      It was all so easy. The gateway to fortune stood wide open.

      1. DownSouth

        Another dynamic I failed to mention is that Allen delineates an entire army of economists and other putative “experts” that assured the nation that all is well with the Big Bull Market. Sitting atop this “prosperity bandwagon” was none other than the president and the secretary of treasury:

        The bull party in Wall Street had been still further encouraged by the remarkable solicitude of President Coolidge and Secretary Mellon, who whenever confidence showed signs of waning came out with opportunely reassuring statements which at once sent prices upward again. In January 1928, the President had actually taken the altogether unprecedented step of publicly stating that he did not consider brokers’ loans too high, thus apparently giving White House sponsorship to the very inflation which was worrying the sober minds of the financial community.

    2. DownSouth

      ds said: “If Congress changed course and announced a new round of fiscal stimulus, we would see the same speculators front-running and pushing up asset prices in the same manner as the participants in Keynes’ beauty contest.”

      That very well may be true. But so what? One of the lessons to be learned from the short history I outlined above is that the only sure way to stymie speculative behavior is to regulate it, to penalize it or make it illegal. And this should be doubly true with any funds that emanate from the government.

      Of course the current Fed policy does just the opposite, doesn’t it? It provides cheap funds specifically to be used for the purpose of speculation.

      1. Siggy

        Have you given thought to just what is the fuel for speculative behaviour?

        You might also want to reflect on the idea that interest rates are a rental rate and they are different from purchasing power.

        During the period leading up to the great crash, anyone could have a margin account and the required equity was 10%. The 30-year mortgage loan was not common and you didn’t have money market funds. It was the banks and investment banks that flooded the market with easy credit. Easy credit becomes money when the borrower spends the loan he was granted. Now there comes a time when the loan must be repaid. This time comes sooner rather than later when it is recognized that the prices can no longer advance and they must come down. Then the margin calls are made and the mope who couldn’t afford to play in the first place is wiped out. Now the decline feeds on itself.

        Your call for a constraint on speculation is appropriate. I suggest high margin or equity positions and allow speculators and entrepreneurs their god given right to go bankrupt. There is no person, firm or government that is too big to fail. Failure can delayed, it can be averted but the current delaying tactics are merely a prelude to an even larger failure.

        The course that has been chosen by the Fed is indeed amateurish and it is creating a bubble of insolvent banks while concurrently allowing the thieves to remain in position.

        Today I note that we are hearing first ballons about a new reserve currency that incorporates gold as a significant component. Will there be a second coming? Quite probably, but not in any form we might like.

        As I see it, there is no politcal will to address the concepts of a fiat currency and fractional reserve banking. The greatest resistance to the reform of fractional reserve banking will come from the banksters and the poltroons who depend on the campaign stipends that the banksters toss around like so much chump change and in the larger scheme of things it is, indeed, chump change.

        1. DownSouth

          • Siggy said: “Have you given thought to just what is the fuel for speculative behaviour?”

          Well hopefully the excerpts from Frederick Lewis Allen above help shed some light on that.

          • Siggy said: “There is no person, firm or government that is too big to fail. Failure can delayed, it can be averted but the current delaying tactics are merely a prelude to an even larger failure.

          “The course that has been chosen by the Fed is indeed amateurish and it is creating a bubble of insolvent banks while concurrently allowing the thieves to remain in position.”

          I wholeheartedly agree.

          But this is why I find your defense of Anna Schwartz and Milton Friedman to be so puzzling.

          Yesterday you said: “The Friedman Schwartz book is more a point of view than a work of revisionism.” You also said: “As to Milton Friedman and Anna Schwartz, there is more value in their little book than all of that presented by Mr. Krugman.”

          Here’s Friedman talking of the Great Depression:

          Prior to October, 1930, there had been no sign of a liquidity crisis, or any loss of confidence in the banks. From this time on, the economy was plagued by recurrent liquidity crises.


          As we have seen, one of the major reasons for establishing the Federal Reserve System was to deal with such a situation. It was given power to create more cash if a widespread demand should arise on the part of the public for currency instead of deposits, and was given the means to make the cash available to banks on the security of the bank’s assets…

          The first need for these powers and hence the first test of their efficacy came in November and December of 1930 as a result of the string of bank closings already described. The Reserve System failed the test miserably. It did little or nothing to provide the banking system with liquidity, apparently regarding the bank closings as calling for no special action. It is worth emphasizing, however, that the System’s failure was a failure of will, not of power. On this occasion, as on the later ones that followed, the System had ample power to provide the banks with the cash their depositors were demanding. Had this been done, the bank closings would have been cut short and the monetary debacle averted.
          –Milton Friedman, Capitalism and Freedom

          Capitalism and Freedom was published in 1962, the year before A Monetary History of the United States. However, the historical rendering and policy prescriptions are almost identical.

          I want to pose two questions to you.

          1) Do you really believe the crises of 1930 were “recurrent liquidity crises” as Friedman asserts? After reading Allen’s account above, with the bank’s portfolios so heavily weighted in real estate and securities loans, loans whose underlying assets were in freefall due to the bubble bursting, do you believe there was the tiniest, remotest possibility that the banks might have had solvency problems, and not just liquidity problems?

          2) When the GFC hit in 2007, how does Bernanke’s assessment of the problem (a liquidity crisis) and the course of action he took (along with Paulson, congress and President Bush with TARP) “to provide the banks with cash,” differ from that recommended by Friedman above regarding the Great Depression?

          • Siggy said: ”Today I note that we are hearing first ballons about a new reserve currency that incorporates gold as a significant component. Will there be a second coming? Quite probably, but not in any form we might like.”

          “As I see it, there is no politcal will to address the concepts of a fiat currency and fractional reserve banking. The greatest resistance to the reform of fractional reserve banking will come from the banksters and the poltroons who depend on the campaign stipends that the banksters toss around like so much chump change and in the larger scheme of things it is, indeed, chump change.”

          Again, given this comment of yours, I am totally baffled by your defense of Milton Friedman. Once more, here’s Friedman:

          It should be noted that despite the great amount of talk by many people in favor of the gold standard, almost no one today literally desires an honest-to-goodness, full gold standard. People who say they want a gold standard are almost invariably talking about the present kind of standard, or the kind of standard that was maintained in the 1930s; a gold standard managed by a central bank or other governmental bureau, which holds a small amount of gold “backing”—-to use that very misleading term—-for fiduciary money…

          My conclusion is that an automatic commodity standard is neither a feasible nor a desirable solution to the problem of establishing monetary arrangements for a free society. It is not desirable because it would involve a large cost in the form of resources used to produce the monetary commodity. It is not feasible because the mythology and beliefs required to make it effective do not exist.

          1. Siggy

            A very long time ago I attended a lunch at the Harris Trust. I had the priviledge of sitting at the same table as Beryl Sprinkel and several Harris loan officers. Milton Friedman was the speaker and I did, in fact get to shake the little fella’s hand.

            Now, I view the writings and speechs of most economists as being a dialogue that is searching for truth. It’s dynamic thing and after all this time I still find Friedman’s ideas interesting but not necessarily relevant to the issues at hand.

            My argument with the current proclamations is that they completely ignore the destructive factor of fractional reserve banking and the absolute fallacy of a fiat, irredeemable currency. On the gold standard idea, a fiat currency issued against a quantity of gold is doable. Lots of people won’t like. 100% required reserves against demand deposits is doable, and even more people will not like that.

            It’s those two things, taken together that create the incentives for easy credit which is the seed bed for chicanery and fraud.

            When Bernanke says he’s going to do $600 billion in Treasury purchases, Auerback has it right, he’s merely doing some bookkeeping. But then look what the bookkeeping gets you to. $6 trillion in new money when new money is not what needs to be accomplished.

            Loans will be demanded when it becomes apparent that there is an unsatisfied demand from which profits can be extracted. This busisness of pushing on string will only destroy the international purchasing power of the dollar. When helicopter Ben inflates the hell out of the money supply he is making you and me and every other citizen substantially poorer. Now here’s the hard part. We really are that poor, we have drunk the kool aid and think that those 401K balances are real.

            What’s worse is that the world has bot the farm right along with us and lo, those of the mercantilist bent now see that all that debt they’re holding is being destroyed in terms of its purchasing and it the purchasing power of that debt that matters.

            Now as to idealogy, I don’t want free markets. I want fair markets. Free markets equal responsible anarchy in my lexicon. Free markets, utter tripe! Milton Friedman, libertarian extraordinaire. You don’t buy the whole argument you extract that which works and some more dialogue that can be cobbled to it and then ypou begin to get to the truth. This Time is Different and Econned get you very close to what you need to pay attention. But even in that, I don’t see the recognition that its the monetary system and the fiat currency that needs to be recreated.

            I still marvel at your ability to marshal a quote and we shall, no doubt, continue to agree to disagree.

          2. DownSouth

            Siggy said: “Now, I view the writings and speechs of most economists as being a dialogue that is searching for truth.”

            Now that’s where you and I totally disagree.

            Put me in Reinhold Niebuhr’s camp when he wrote in Moral Man & Immoral Society:

            Since inequalities of privilege are greater than could possibly be defended rationally, the intelligence of privileged groups is usually applied to the task of inventing specious proofs for the theory that universal values spring from, and that general interests are served by, the special privileges which they hold.


            Whenever the education process is accompanied by a dishonest suppression of facts and truths, relevant to the point at issue, it becomes pure propaganda.

            Kevin Phillips agreed when he wrote in Wealth & Democracy that there are two “aspects of venality”: the more blatant “hard” type, and the more subtle philosophic or “soft” type. “Less obtrusive but at least as important [as hard corruption] has been the corollary corruption of thinking and writing—-the distortions of ideas and value systems to favor wealth and the biases of ‘economic man,’ “Phillips wrote. During periods of heightened political corruption and speculative heydays, “philosophy…has shifted to emphasize markets and Darwinian behavior and to find civic virtue in erstwhile private sins like greed, self-interest, and profligacy.”

            Milton Friedman was a torchbearers in the campaign to propagate the “soft” type of venality. If you study his writings and his philosophy carefully, I think you will find he is pretty much on the same page with Mark Hanna when Hanna said:

            Great wealth was to be gained through monopoly, through using the State for private ends; it was axiomatic therefore that businessmen should run the government and run it for personal profit.

            And I don’t see how you can say that Milton Friedman is “not necessarily relevant to the issues at hand.” Friedman was hands down the most influential economist of the second half of the twentieth century. He was the intellectual father of the rehabilitation of conservatism in the 1970s and his “capitalism and freedom” formulation today stands at the heart of the conservative movement. Where do you think the Republican Party got its ideas? You really don’t think those partisan hacks are smart enough to think this stuff up, do you?

          3. Skippy

            Ha…Leonardo was commissioned not as a seeker of truth…but…as a builder of ramifications, weapons or elitist imagery. Yet is revered as THE popular renaissance man…


      2. ella

        Loved that book. Thanks for posting info on the huge bubble that existed before the Great Depression and was in fact the primary cause. Recently, I read that Charles Ponzi was deeply involved int he Real Estate bubble before the GD. He sold numerous small lots in / near Jacksonville Fl.

        Friedman was a revisionist, and all of his revisionist history was created to support his economic theories. Time to take another look at the causes of the great depression.

        Bubbles are very dangerous to economies…remember the South Seas, tulips?

  3. JKH

    I wouldn’t overestimate the reliance of the banks of the yield curve. It’s largely a myth. The days of the savings and loan rescue are long gone. Banks are much tighter on interest rate risk controls now, and interest rate risk is a far less controversial and simpler risk measure than trying to figure out the credit risk on CDO squared. Also, for every board member out there who has even a remote insight into how the monetary system works, there are probably dozens who fear that rates may go through the roof because of QE, and they’re the same ones who sit on board risk management committees.

    If you have any anecdotal evidence at source to the contrary, that would be interesting.

    Another myth is that banks have bought a lot of treasuries. It’s complete nonsense, as proven by looking at the Fed flow of funds data. Commercial banks have increased their treasury holdings by $ 150 billion over the past 5 years, while the publically held debt has increased by $ 4 trillion. Pension funds and money market funds have increased their holdings measurably more than banks. And dealers only own $ 100 billion.

    1. JKH

      Full disclosure; from today’s Bloomberg:

      Nice timing on my part, but the data I provided presents the longer term pattern before and during the crisis, up until June 30.

      So it appears to be picking up steam since then, although some of the recent purchases are likely front running QE2 and may not be in portfolio by year end.

      The flow of funds report actually shows an increase of $ 61 billion in H1, actually more than Bloomberg reported.

      So now there’s another $ 127 billion.

      In any event:

      Suppose its $ 250 billion for the full year. That’s not immaterial.

      Assume generously an average short funding yield spread of 2 per cent.

      That’s $ 5 billion net accrual a year for an industry that’s earning $ 250 billion plus pre-tax. What’s that – $ 3 or 4 billion after tax incremental for an industry whose capital position is in the area of $ 1 trillion? Not exactly reliance level.

    2. Yves Smith Post author

      I’ve worked with banks for three decades. The fact is that banks are structurally long. There are not enough natural guarantors for them to flatten or net short longer dated risks. Look at how the entire industry tried dumping subprime on customers at the last minute, and only two big players got reasonably flat: Goldman, which started early, and sort of JPM (although not really, it still holds a ton of second mortgages). Even Goldman maintains it was still long risky mortgages, just less so.

      Re duration/funding risk, the Bank of England says maturity mismatches are worse now, not better than they were historically. They have a fair bit of statistical backup, but there is a simple headline: banks are much more dependent on overnight and repo funding (which has turned significantly into overnight funding post crisis, term repo is not as available as it was pre crisis). Deposit funds is of much longer duration.

      1. JKH

        I know something about it myself, and you’re conflating stuff. Banks separate interest rate sensitivity rigorously from liquidity risk analytically, and manage them as separate risks. Banks are structurally short net interest margin risk due to their long duration equity, and core deposit positions on which rates paid hit floors well before central banks hit the zero bound. Interest margin compression on those portfolios has been a substantial risk over the entire period of declining rates. That plus convexity risk in their fixed asset portfolios and customer choices for short term interest sensitivity on mortgages as rates decline. Apart from that, commercial banks make extensive use of the interest rate swap market in managing their structural interest rate exposures – both receiving and paying fixed. Finally trading portfolios in places like Goldman are entirely separate from the management of structural interest rate risk. Like I said, a lot has changed since the savings and loan debacle.

        1. Cedric Regula

          That all rings true from what I can glean from the outside.

          But getting back to simple things, like how to run a central bank, Calc Risk just posted this.

          Essentially the way to make CB decisions is in october you poll the banking system asking them if they need money for anything. The answer comes back “no”. Then in November you announce QE2 for $600B.

          See how simple a job it really is?


          1. JKH


            Give them a break. The poor buggers aren’t in charge of fiscal policy. They’ve brought a knife to a gun fight.

        2. DownSouth


          You know, all that high falutin’ shoptalk and esoteric jargon sure sounds impressive.

          But that dog just don’t hunt.

          The truth is it’s so disconnected from reality that it’s schizoid.

          I’ve been following this saga for several years now, and I know something about the banks’ “risk control” myself.

          What the banks’ “risk control” amounts to is a president and congress in their pocket; a nonstop revolving door between the banks and the regulatory agencies; and a team of well-connected lobbyists.

          And all that stuff you’re talking about? Well I think most of us know how well that worked.

  4. DownSouth

    Marshall Auerback said: “Quantitative easing involves the central bank buying financial assets from the private sector – government bonds and maybe high quality corporate debt.”

    Correct me if I’m wrong, but hasn’t the Fed in the past purchased more than just government bonds and “high quality corporate debt” from the banks? Hasn’t it purchased toxic waste as well, and paid way in excess of market value for this toxic waste? Wasn’t that what Maiden Lane amounted to?

    Isn’t part of what’s driving the public fear is the suspicion that the Fed will engage in this practice again under the aegis of QE2?

    Isn’t also part of what drives the public fear the fact that the Fed operates in complete secrecy, and the public has no idea what the Fed will purchase with the newly announced $600 billion?

    Doesn’t the Fed operate with complete impunity, being accountable to no one?

    What it boils down to is the Fed is telling the public to “trust us.” But what has the Fed ever done in the past to earn the trust of the public? Hasn’t it consistently operated for the sole benefit of the TBTF banks, while concomitantly trying to convince the public that this special interest pandering is “for the public good?”

    Marshall, while I very much appreciate your explanation of what the actual mechanics of QE2 are, I believe the Fed’s problems, and its demonstrated ability and willingness to inflict damage upon the public good, to be far greater than what you put forth here.

    1. jim

      Yep. The $600 billion announced, is really $900 billion. $600 billion for treasuries and $300 billion for other shtuff, the way I heard it briefly mentioned.

    2. Siggy

      $600 billion for Treasury securities is a very big number. The transaction is a money credit in exchange for $600 billion in Treasuries. Now does the bank own those Treasuries outright, or, are they owned on margin. That is: is/was there a loan that funded the purchase of the Treasuries. Most probably the the Treasuries were bot with funds carried in demand deposit accounts. So what happens is that current securities are converted into cash. That cash can now be immediately relent. That amounts to the creation of money. First it’s a loan and then it’s a new demand deposit when the loan is spent.

      Observing a 10% reserve requirement the $600 billion could grow to $6 Trillion. Now what is the banks use that $6 Trillion to buy Treasuries. Why then the government can go hog wild and spend. So, it may be that helicopter Ben thinks he’s doing good, the world market on the other hand is growing increasingly uncomfortable with the idea that the destruction of the purchasing power oif the domestic US economy is something that will kill the golden goose that has been buying all that mercantilist produced stuff.

      Now just when will this all come to an end?

  5. joebhed


    Why is QE the purchase of government securities from the private sector – who, by definition, are holding previously created monies in those securities? I know there are rules, but……..there’s a cliff up ahead if we follow them.

    It is unquestionable that such action, repurchase of existing debt, will further constipate the the top end of the financial food chain, a.k.a. hoarding, while Bernanke and company wish for effective pushing on the capital string.

    To my simplistic way of looking at things, the only real “stimulus” from money-creation MUST end up in the M1 and M2 portions of the money supply where we all live and work.

    The way to achieve that result from any QE-type monetary policy initiative is for the Fed to directly purchase, and to hold, the NEW issuances of government securities issued as required by law to account for the government’s deficits.

    While the quick repeal of that law, and debt-free government issuance of circulating media is the real solution to achieve potential-GDP through increased aggregate demand, the monetary policy options available in these ‘exigent economic circumstances’ should allow the Fed to, again, purchase and hold the new government issues with the knowledge that this money WILL go to pay the bills and wages of suppliers of goods and services to the government, and WILL end up rather immediately in the M1 and M2 where we all live and work.

    Why not?

  6. JKH

    “But on the other hand, the low rates reduce the interest-income of savers who will reduce consumption (demand) accordingly.”

    I’m familiar with that argument, but I wonder about it.

    Most of the treasuries are buried in the portfolios of institutions on which consumers have downstream claims. Many of those claims represent long deferred consumption (e.g. pension funds) and many of the rest represent liquidity transformation within larger portfolios where the income effect is diluted for the ultimate claimant. And of course half are held overseas where the claimants are also long deferred consumers.

    That said, the measure of household held treasuries has been increasing noticeably – it’s up to $ 1 trillion now, which is material. There are lots of conspiracy theories about how this is a plug for more notorious holders, if you’re in to that sort of thing. But I haven’t seen much direct and legitimate investigation into it.

  7. RueTheDay

    Small nit with:

    “But the FOMC has announced a limit to the Fed purchase program, both in terms of the monthly amounts and the total quantity. How high will 10 year notes trade with the billions free to trade at market levels?

    It could be at much higher yields, which presumably defeats the whole purpose of the program.”

    This reasoning makes no sense. Prices are set at the margin. You don’t have to buy ALL of something to increase its price. The increased demand for these Treasury issues due to the Fed bidding for them will increase demand for the bonds in question which will increase their price and thus decrease their yields. If you’re going to beat someone over the head with the “Econ 101” line then at least make sure that you have it right.

    Other than that it’s a decent post. The market expects a QE3 and we’ll almost certainly see it. It’ll be an interesting ride though. The market wants the Fed to start buying up assets other than Treasuries (e.g., resume purchases of MBS, expand purchases of agency debt, start buying corporate bonds, etc.) Bernanke is doing everything possible to avoid that while still finding ways to be expansionary. He’s aware that, given the current political situation in DC, he’s sitting on a powder keg.

  8. marc fleury

    I don’t know… it is easy to throw monikers like “inept and incompetent” when we are sitting comfortably in our chairs and the impact of our words is limited to other bloggers and readers. It is quite another one to sit at the commands of the FED and do things that impact billions of lives because of the inter-connectedness of the system at hand. No one can claim vision on such a system. A little humility is in order.

    Furthermore, on cursory reading, a couple of points jump to my mind and since we are so quick in judging others let me be blunt about those points.

    1/ Bernanke stated clearly that his mechanics for restarting the economy is a trickle down play starting with rising asset prices. They are simply smoking investors out of cash. This is squarely targeted at the velocity of money and not the reserve stock.

    2/ Banks are insolvent largely due to the asset sitting on their balance sheet which are derivatives of the real estate bubble in various stages of decomposition. Again, the FED is targeting the asset side of the balance sheet SANS reserves. Again the pushing on a string theory, no one but the author is claiming that reserves need to increase, that is a strawman argument. The domestic raison d’etre of QE2 is an artificial propping of asset prices. It has been communicated as such. It will impact the banks and consummers alike.

    3/ As usual in most theoretical MMT presentation, there is no mention of the impact of QE on international trade and specifically on FX. Clearly zimbabwe cannot do QE, but the US can. One can find justification for QE2 in RETIRING CHINA DEBT, pure and simple. QE as a way to avoid the foreign debt trap is justification enough without having to look at the domestic agenda. There is no mention of this anywhere above. In fact, if this is the case, as I believe it is, I find the QE solution quite daft.

    4/ Please stop talking about the “money multiplier” as if the fact that banks lend first and seek reserves later was a big deal that only MMT’ers are privy to. There isn’t a MMT presentation without this point being made. One has to look 2 seconds at the modern financial edifice to understand that credit derivatives have moved risk off balance sheets and therefore avoided regulation. IN other words, the real monetary levels were set internationally through CDO/CDS and whether reserves came first or second is completely irrelevant. NONE OF THIS CONSTRAINS THE DERIVATIVES FLOW. A more comprehensive MMT approach would address the fact that monetary levels are completely out of the control of the monetary authorities, not only through the reserve mechanism (no matter how reversed) but also through derivatives. One can argue that the banks have been printing money in QE0 for the past 20 years. It is also a great validation of the MMT framework, it has been applied already :)

    5/ MMT presentations usually have 2 sides to them a/ a description of the way modern money works and b/ a series of prescriptions on how to spend the money thus created out of thin air. Clearly I would believe that in the present situation, we should look at where that money goes. At the present time, we are witnessing a trickle down attempt, that will hot-flow to foreign countries and completely miss main stream america. In other words, instead of wasting time discussing levels of reserves, I would for once like to see the usually more socially combative MMT’ers raise social program points. Doesn’t it disgust anyone that we are throwing 1T at the haves in another attempt at trickle down? You know how many schools, roads, research etc one can buy for $1T???

    Instead we just had to read a rather dull, pointillist, largely missing the big picture and ultimately insulting piece.

    WITH ALL DUE RESPECT I find you are WASTING OUR TIME with an entry like this one and WASTING YOUR TALENTS and the platform offered to you by focusing on personal attacks and focusing on irrelevant details of the program put before us.

    So before we call the authorities in charge “inept and incompetent” I would recommend we collectively sweep in front of our doors and step up the game here a bit. I come here to read and learn.

    nuf said

  9. drfrank

    Rather than the author’s expression of perplexity, and the commentator’s expression of paranoid rage, it would be interesting to have some insight into what the Fed is really up to. In their self interest, the euphoric markets see the Fed’s determination to keep rates low and asset prices from falling, but why would the Fed want to cause banks to increase reserves on deposit for settling interbank liabilities, supposing they know full well that QE2 will not do much to improve economic conditions?

    Why has the Fed consistently responded as if there is a liquidity issue?

    Suppose for a moment that 10% unemployment as reported by the government is accepted as the “new normal” or “structural,” because absent public employment programs there is nothing that can be done unless there is an economic boom. Suppose, also, that there is not much benefit to US exports from a lower dollar, given the small size of our manufacturing sector. Suppose that something worries the Fed more than the pain that QE2 will inflict on the rest of the world which it knows will suffer appreciated currencies, if in fact the Fed cares.

    Recall, we haven’t heard much about “systemic risk” for a while. That does not mean it has gone away. Put on your credit analysts cap and ask yourself if you are comfortable with transactional exposure to counterparties that hold you-don’t-know-how-much in Eurozone sovereign debt and US second mortgages, putback liabilities, unhedged swaps, consumer credit writeoffes, etc., and whose profits (ex reductions in loan loss reserves) are increasingly dependent on successful interday trading, not old fashioned spread lending based on credit underwriting. Spread lending doesn’t look attractive anyway in what is at best a weak recovery and the old loan-to-hold bank model is much less attractive than originate-to-sell.

    As a precautionary measure in the face of a weak and perhaps weakening economic outlook, you might like to see even fatter cash balances on hand for clearing transactions.

    At the peak of the crisis, something close to half the credit granting function in the US was performed via securitization, which lies outside the Fed’s theoretical ability to stimulate or suppress bank lending by targeting reserve levels. To achieve the kind of recovery that is desired will require a rehabilitation of the credit extending functions that lie outside the banking system per se. Does more liquidity do the trick?

    1. marc fleury

      Paranoid? who me?

      I think that what is going on is simply that money creation was a function of securitization and securitization was a function of returns. When returns turn negative, so does securitization. I frankly think we are in the midst of a minsky super-cycle, exacerbated by securitization and international finance. CN has been funding the US financial bubble out of control via imbalances recycled in such interest bearing instruments.

      And again, I don’t know why we run around like there is an ulterior motive. I think the QE2 move can be simple explained with

      1/ rising asset prices domestically (acknowledged)
      2/ debt jubilee internationally (un-acknowledged)

      one need not look any further.

    2. DownSouth


      So let me get this straight. You believe the Fed is providing funds to the banks to enhance their proprietary trading activities? You believe the Fed is trying to bring the shadow banking system back from the dead?

      And you believe bigger prop desks and the rebirth of Wild Wild West finance to be the only ways to “achieve the kind of recovery that is desired”?

  10. Charley


    Would it help the analysis if we considered moving off the gold standard in 1933 as the first instance of QE? And, moving off Bretton Woods as the second instance of QE?

    How does this change the picture?

    Gold is/was an asset that pays/paid an interest rate of zero because it is/was money. If you remove gold from the economy you have now removed the zero interest floor from the economy.

    You can now replace this gold with a negative interest money — inflation. Which does what? Force savings further out the curve, I guess — although I am not qualified to speculate in these terms. But, with money noow carrying a negative interest rate, the preference is to save in the next least risky asset: government bonds.

    But, soon you don’t want savings piled into bonds. So you begin buying bonds to force the interest rate negative. Since you can’t really force the interest rate negative, you push inflation higher than the rate of return on the bond by paying more for the bond and flooding the market with negative interest money in return — effectively outbidding other players.

    Just a thought…QE has been with us for a long time, so there is much to study

    1. Charley

      The question posed by this line of reasoning: what does it take to discourage savers from simply holding government paper? This is just an extension of the previous question: what does it take to keep savers from simply holding money?

      Once the question is posed this way, it becomes clear that the point of the exercise is to force China to use its reserves rather than simply put them in US treasuries…

  11. Ignim Brites

    This argument strengthens the case for eliminating or at least radically reducing the payroll tax. It is unlikely that the lame duck Congress would take up a a trillion dollar stimulus bill. But eliminating the payroll tax (while allowing the Bush tax cuts to expire totally) would put the Reps in a box, for a little while at least. More to the point, it would finally free the Dems from the legacy of Bush. Maybe they don’t want that. May they miss W too.

    1. Charley

      You could also simply nationalize the economy and administrate a recovery — what are the consequences of the action? These guys don’t want to go to the payroll tax cut because it would make it obvious that taxes are part of the problem.

  12. Rdan

    A payroll cut in political terms would probably result in a further outcry over the supposed bankruptcy of the SS Trust fund. Silly, but well financed for thirty years. Be careful what you wish for.

  13. Jim the Skeptic

    In the lunatic asylums they have the inhabitants do crafts. Any benefit from the result of their work is purely coincidental. It’s busy work designed to prevent them from over-thinking their problems.

    The Fed is engaged in busy work. There might be some coincidental benefit but don’t bet on it. Our trading partners assume the Fed is trying to devalue the dollar. Some domestic skeptics amongst us assume the the Fed is just providing additional funding to the banksters. Some domestic skeptics amongst us see the Fed as engaging in ‘trickle down’ in hopes the banksters will take up lending for a living.

    We have a real problem with our economy. THERE ARE NOT ENOUGH DECENT JOBS! Instead of employing our fellow citizens, who were also consumers, we purchased goods from around the world. This seemed almost harmless 30 years ago. Over the intervening decades, consumers have had less and less money to spend. Instead of trying to determine “how many saints will fit on the head of a pin”, we should deal with our problem. The JOBS were here before and now they are gone, WHERE DID THEY GO?

    1. marc fleury

      the narrative was creative destruction, that we would ship low paying jobs abroad and develop highly creative industries in its place. And it worked for a long while. Maybe education and immigration are not enough anymore to fuel the top? I dont know.

      1. Jim the Skeptic

        Sir, the narrative was that corporations would benefit by getting their labor cheaper in foreign lands and part of those savings would be passed through to the consumer.

        The highest paying production jobs were the initial targets for displacement to those foreign lands.

        Re-education was part of the lie given to calm the natives, since job extraction caused some pain from the very beginning.

        It never worked but the problems were MASKED by the Fed’s interventions in the economy. (Lower and lower Feds Fund Rate over the last 30 years.)

  14. marc fleury

    Creative destruction has been a driving force for a couple of centuries. It goes hand in hand with innovation. OECD countries have 5% of their population manning the fields as opposed to 60% for most poor countries. Clearly the historical movement has been one of rising standards of living with wealth spreading first from farm to industrials to services etc. The machine may be sputtering because there is no more wealth created at the top. For lack of education or whatever. Then all the defrauding you refer to can kick in with glasshour effect induced by monetary policies. But the root problem may be deeper: that the ‘creative destruction’ machine is not creating at the top just destroying at the bottom. Again, you need a very educated populace to keep the top line going in high tech for example. We have sent vast amounts of smart young people into finance, an activity that just created the illusion of wealth etc…

    1. Jim the Skeptic

      Sir, we are riding a dead horse. Here is a quote from Judge Jackson.

      “The code of tribal wisdom says that when you discover you are riding a dead horse, the best strategy is to dismount,” Jackson said. But lawyers “often try other strategies with dead horses, including the following: buying a stronger whip; changing riders; saying things like, ‘This is the way we’ve always ridden this horse’; appointing a committee to study the horse; … declaring the horse is better, faster, and cheaper dead; and, finally, harnessing several dead horses together for increased speed.”

      Substitute the Fed where he mentions lawyers.

      The Fed has bought a stronger whip by using more than just the FFR to stimulate the economy.

      Having survived the recessions of the last 60 years they have been using all the old techniques and are shocked that this horse does not ride the same way!

      Isn’t there a committee in the White House dealing with our economic troubles, wouldn’t you like to be a fly on the wall!

      They are now in the process of trying to convince us that this dead horse is getting better.

      I can hardly wait to see several of our dead horses harnessed together!

  15. F. Beard

    Nice post, thanks!

    So what the central bank is doing is swapping financial assets with the banks – they sell their financial assets and receive back in return extra reserve balances. So the central bank is buying one type of financial asset (private holdings of bonds, company paper) and exchanging it for another (reserve balances at the central bank). The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns. Marshal Auerback

    True but what if the Fed starts (continues?) buying crappy bank assets? Wouldn’t that be just a gift to the banks of cash for crap? But even that would not start the banks lending, would it, since who wants to lend into a deflating economy?

    … one could simply implement a $2 trillion tax cut (or spend it via the government, or do revenue sharing with the states), thereby generating increased spending power in the economy, providing significantly higher multiplier effects and ultimately shifting the economy back to self-sustaining growth. Marshal Auerback

    But wouldn’t the deficit hawks scream “You’re increasing the national debt!”?

    Why not cut them off at the knees by issuing and spending debt and interest free legal tender fiat, United States Notes? That would require no new debt. And at the same time, slap corresponding leverage restrictions on the banks to preclude price inflation?

    And why count on indirect methods of getting money to the debtors when a direct bailout of the population would be more effective and is morally justified besides?

    If you wish to defeat the deficit hawks and Austerians, they are vulnerable precisely where they claim to be strong, in the area of principle and morality.

    1. F. Beard

      On second thought, a tax cut is wise. How could the Republicans object to that? But eliminating the Pay Roll as Warren Mosler suggests is the way to go. Not only would it be the most effective cut but it is also the most regressive tax. Let the Republicans dare to oppose cutting it!

  16. Rick Halsen

    “The Bernanke Fed is slowly reaching Greenspan-like levels of incompetence.”


    I’d hate to see what you call fast incompetence.

  17. par4

    Build American Buy American. It was the way we lived until the 1970’s. It made us rich and unions built the largest middle-class ever.

  18. anonymous

    “Instead of expending political capital on pointless accounting shuffles and financial guarantees, or programs such as TALF, TARP, Term Auction Credit, or the Commercial Paper Lending Facility, one could simply implement a $2 trillion tax cut (or spend it via the government, or do revenue sharing with the states) . . . .”

    I think you are missing the political realities here. There will be no tax cuts or spending plan or revenue sharing program any time in the near future. Perhaps if Congress would be able to do something, the Fed wouldn’t have to. But the only thing the Fed can do is QE so why wouldn’t they take a shot?

  19. Paul Repstock

    AHHH…So many Hawks…and not a chicken in sight…
    meanwhile the hungry sharks circle below?????

    There is no merit to being an appologist for the Fed or for China either..Each has their own share of blame.

    But, we keep overlooking the ONE thing that can be profitably done.

    Restore accountability. The evidence and the smoking guns are piled knee deep. Yet all we argue is how best to avoid adding to the Gansters loot.

    Restoring the rule of law in modern society will not cure our hangover, but atleast it means that there will be a tomorrow we can look forward to with less dread.

  20. F. Beard

    Restoring the rule of law in modern society will not cure our hangover, but atleast it means that there will be a tomorrow we can look forward to with less dread. Paul Repstock

    And just who deserves the hangover?

    The savers who may lose their jobs?
    The borrowers who were driven into non-servicable debt by the counterfeiting cartel?
    The banks? (I give you that one.)

    There need be no hangover. Just have the US Treasury bailout the entire population with new debt and interest free legal tender fiat, United States Notes.

    1. Paul Repstock

      I’m not a sadist FB. I think I’m just a realist. There is a price to pay for the complacency by which we have ‘all’ allowed this to happen.

      1. F. Beard

        I think I’m just a realist. There is a price to pay for the complacency by which we have ‘all’ allowed this to happen. Paul Repstock

        I am a realist too; I realize that is just fiat money that is lacking, a lack which could be easily remedied by the US Treasury.

  21. F. Beard

    There is a price to pay for the complacency by which we have ‘all’ allowed this to happen. Paul Repstock

    Nope it is not complacency or even the crooks in the system. It is the fundamentally dishonest and unstable money system we keep trying to make function properly but shall never be able to.

  22. F. Beard

    I would of course consult with leading economists to make sure I wasn’t loco and then:

    1) Set reserve requirements to 100% to put the banks out of the counterfeiting business and to preclude serious price inflation.
    2) Send every American family a huge check of new, debt and interest free legal tender fiat (United States Notes) which was equal in aggregate to the total amount of US consumer debt (M1?) times from two – seven, since that is the Biblical command for restitution.

    After the debt was cleared, I would then implement genuine monetary reform which would include the following:

    1) The abolition of legal tender laws for private debts.
    2) The abolition of fractional reserve lending with the government monopoly money.
    3) The allowance of competitive private currencies that were only good for private debts, not government ones.

    1. Skippy

      Beard, when I was very young maybe 10 or 11. An older relative engaged in a small enterprise, raising rabbits for fur and meat. How could he go wrong prolific multipliers, reasonably cheep to feed and house, hell even the out put can be used to create more input.

      Unfortunately the multiplier effect got out of control with regards to buyers…cough bad equilibrium. It was at this time for some funny reason…that he found greener pastures of endeavor and left his creation behind, although he swore up and down he would come back to resolve any latent issues.

      Many months went by…till the time came that others would have to assume the responsibility of another’s actions.

      My grandfather left the house one morning to do what another would not, and said entrepreneurial apprentice did not resist out of altruisam…no…it was just a case of there was no profit in it any more…no…insentive…eh.

      Shortly after he left I inquired to my grandmother as to where he went, as I usually tagged along to help or learn from the old master. When she informed me of his morning chores, the way he had to start his day, I though to myself why must HE render the solution, why must he go it alone, suffer…shoulder the burden left by another.

      I walked out the door that day and learned one of the greatest lessons of my life and it started with me asking how do I do it correctly…too which he found me a stout stick and instructed me how to hold them from the ears, and where to strike the blow. On this day I helped him carry another’s burden, I shared the pain this senselessness had wrought, help him retain his humanity when dreadful things must be done.

      Skippy…the present system kills a little bit of our humanity, bit by bit, till we become like them…the system masters…copies of copies…like MER’s notes…unless some one[s is ready to stand along side…to retain humanity by sharing the burden…

      PS. for such a kind but tough old cat guts of a man…his eyes conveyed all I need to hear…

      1. F. Beard

        Sad story Skippy, and I understood all of it but this:

        My grandfather left the house one morning to do what another would not, and said entrepreneurial apprentice did not resist out of altruisam…no…it was just a case of there was no profit in it any more…no…insentive…eh. Skippy

        BTW, Rabbits are unclean in the Bible so that problem could have been avoided from the get go. Think the Lord knows what He is talking about? I suppose the Australians learned new respect too.

        Am I becoming like the bankers because I wish to avoid a senseless Depression? If it were only so simple as the wise ants versus the foolish grasshoppers.

        However, the crookedness of the system offers up the solution, justice and restitution.

        Have I understood you?

        1. Skippy

          Securitisation was/is an endeavor to create cheep high volume profit for the top…cough liquidity/cash flow mining/false asset valuations w/ layer after layer of doublespeak clouding jargon, deniability only your god could appreciate…the devil made them do it…I had no part in it…ah. This is the rabbit, someone needs to be the master and show the young how to hold/deliver the blow, to clean up another’s mess. The mess they so far claim to be working on for altruistic reasons, you know saving man kind form collapse. When if fact its their bacon their trying to save, screw everyone else and the future too.

          Skippy…I personally turn my back on anyone that had a part in it, informed or not, I would grant them persona non grata…if they were human and not the rabbits_which in_your book are unclean.

          1. F. Beard

            Ah, I am beginning to parse your lingo. I still don’t get your “Skippy…” though.

            To me, it is not about personalities but the system. The Devil would be quite happy if very many bankers and finance types were ruined yet we did not reform the system.

  23. Matt

    Yes QE2 is a canard, I see it the way Marc Fleury sees it, we have had endless QE with the debt/slave fractional reserve system where now there is 69 Billion in reserves for over 7.8 Trillion in Bank deposits. The fractional reserve is less than 1 percent.
    Today money is created by US banks, DTCC short selling, derivative, securitization and investment vehicle shell games, not by the FRB.
    The only question I have is why is the FRB stepping up to be the bag holder of more Treasuries? Is there a problem with where the last 3 Trillion in US deficit went?

  24. Pixy Dust

    Trying to understand the strategic details of long term yield curves makes my brain hiccup and freeze. That said, thank you for sharing with us a comprehendible, logical explanation even though I have to re-read a few times to grasp.

    One thing I do understand is that more money needs to remain in the hands of working people to help stimulate recovery. Tax cuts for working people is something I think we can all agree on. It had some small measure of success when President Obama and the Democratic Congress provided them shortly after his inauguration. (I speak from personal experience.)

    As a member of a credit union, I share in the profitability of the credit union because it operates at cost and is owned by its’ members – in my case by leaving $5 in savings. Now the costs to operate credit-worthy credit unions has been increased to help fix the insolvency of the banking system (thanks in part to repeal of Glass-Steagall). Not to make this a rehash of “join a credit union”, but there are some distinct rules and regulations, and differences – as well as ownership – that make it a far better model to secure past wealth generation and invest in future wealth creation.

    I haven’t read all of the responses, so my apologies if this is redundant.

    Thank you Yves for posting this article.

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