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Ben Is No Helicopter

by: Larry MacDonald May 13, 2008    
Larry MacDonald

Larry MacDonald

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Many commentators think the Federal Reserve’s dramatic rate cuts are flooding the world with liquidity and the consequence will be acceleration in inflation and debasement of the U.S. dollar. Bernanke is flying his helicopter over the U.S. dropping off bundles of freshly printed money, to paraphase a common refrain. So buy gold and commodities; sell bonds, such commentators recommend.

But the Federal Reserve is not running the "printing presses" any faster and Bernanke’s helicopter is gathering cobwebs in the hangar. True, the Fed’s efforts to stabilize the financial crisis through the Term Auction Facility (TAF) and the Primary Dealer Credit Facility (PCCF) is expanding liquidity. But as the economists at Northern Trust indicate, the Fed has also sold $230 billion (U.S.) of its U.S. Treasury bond holdings to private-sector banks over the four months to April 23. This has drawn liquidity out the financial system, roughly offsetting or “sterilizing” the expansion in liquidity arising from the TAF and PDCF.

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This article has 4 comments:

  •  
    May 13 11:29 AM
    i assume there is underlying demand for these treasury securities because of the flight to safety that has occurred throughout the system. they are not trying to drain liquidity.

    the fed has pushed real short term interest rates into negative territory, whih is the single most stimulitive policy move they can make. it doesn't take a PhD to understand the underlying problems with such a move:

    1. it underprices risk, which underlies many of the problems we have today.

    2. it puts downward pressure on the dollar, creating pressure on consumers through higher import prices and creating pressure on the foreign investment necessary to fund our never-ending deficits.

    3. it penalizes savings and rewards debtors...exactly the opposite of the behavior the fed should be encouraging.

    4. negative real interest rates effectively force investors into more risky avenues to obtain yield. it is exactly this overreaching for yield that got so many investment banks into trouble.

    we're using the same drug to treat the disease that landed us in the critical ward....the force feeding of underpriced credit to get us to continue our spendthrift ways.

    our own president tells us...."spend those rebate checks, folks....never mind the fact that you're drowning in debt.

    it's laughabe.
    Reply
  •  
    May 13 01:18 PM
    icandoitdon,
    great post,,your explanation and summary of the situation is precise and acurate not like the Larry MacDonald' take on the situation...
    Reply
  •  
    May 13 08:43 PM
    i appreciate the compliment, mark
    Reply
  •  
    May 16 07:07 AM
    Icandoitdon

    I too believe the U.S. economy has long been over-stimulated by the Fed and U.S. government -- as highlighted by the chronic deficit in the trade balance, low savings rates, rising debt, etc. Negative real interest rates, of course, have contributed to all the foregoing. I wonder, though, if they are something to worry about in the midst of a financial crisis. Maybe it would be better to ensure the system is stabilized before re-focusing on what has to be done to end easy money policies.

    As for what the Fed is doing now …. as I understand it, the Fed is actually trying to keep interest rates from falling as much as the market wants. As you say, there has been a flight to the safety of treasuries -- which has bid their yields way down. But the Fed's discount rate has not followed them all the way down. It is keeping its discount rate higher by selling treasuries -- which also drains cash from the financial system. My guess is the Fed wants to avoid an even bigger run on the U.S. dollar and keep inflationary expectations at bay by sterilizing much of the liquidity generated from actions taken to stabilize the financial system.

    Assuming the system stabilizes, the Fed should begin to address its bias toward over-stimulation. The agency is now conducting an internal review of its past “hands-off” policy toward asset bubbles. Hopefully some changes will come of that. One possibility is greater use of regulatory tools. Another, which I have posted on before, is formal or informal inclusion of asset prices in the price target.
    Reply
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