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BS Detector
245 Comments
Chart of Initial Jobless Claims
Berkshire Hathaway's Stock Slump
Inflation Is Bad for Stocks...
Berkshire Hathaway's Stock Slump
The Reykjavik Scenario (or How Interest Rates Can't Control Monetary Inflation)
"When interest rates rise, lenders are encouraged to lend, and thereby the cash supply is increased and inflation is increased and so the real rates are brought low."
Except, of course, there are fewer borrowers at higher interest rates. Once again you ignore the demand side of the equation. But that's a minor matter, since you're ignoring the market pricing mechanism as well. Lending rates are determined through competition. And of course lenders also factor expected inflation into their interest rates.
And of course, what we're talking about are not rates between banks and borrowers, but rates between the banks and the Fed. This is in a very real sense the cost of money to the banks. Lower the cost of money and the banks have a greater incentive to lend, because the profits are larger. Given time, profits will be squeezed out and new equilibriums will be reached across the lending markets at lower interest rates.
Seriously, this isn't rocket science.
"The exchange rate is not a good indicator of the inflation rate at all."
Who said anything about exchange rates? Do you not know what the Nikkei is?
"The money supply was contracting, was it not?"
Strictly speaking, no, M1 was not contracting at all. Was M2 or M3 contracting? Of course it was. Was it because of interest rate changes? Not at all.
"Yet the interest rates were falling, making Japan less desirable to foreign investors, and so the exchange rates fell off even though the cash contraction was diving into deflation."
Shift your arguments all you want. The highest central bank interest rates persisted more than halfway through the market collapse.
"Where are you getting that info?"
So you really have no clue at all, then. Nikkei is from Yahoo finance, the rates of the BOJ are easy to find.
"I remember when the Nikkei crash was THE big news story, it was also stated that interest rates were already virtually zero and couldn't be lowered anymore."
So your beliefs are based on your obviously fuzzy recollections of something that happened more than 15 years ago. Now I understand completely. Good bye.
The Reykjavik Scenario (or How Interest Rates Can't Control Monetary Inflation)
No, actually, it's not. What's shown is deflation. Once again, with feeling, since the real interest rate equals the nominal interest rate plus inflation, how exactly would the real interest rate and the nominal interest rate be inversely correlated?
"The [Japanese] rates went down to virtual zero WHILE the [Japanese] markets were collapsing."
Naturally, of course, unsurprisingly, you're wrong yet again. Please look at the data. The Nikkei fell more than 60 percent—from a high of 40,000 at the end of 1989 to under 15,000 by 1992. Japan raised the discount rate from 2.5% in the beginning of 1989 to 6% at the end of 1990. Starting in mid 1991, when the market had already lost 40% from its peak, the discount rate was lowered several times over the next 5 years. When the market reached its 8/92 bottom, more than 60% off the peak, the discount rate was still 3.25%. The rate continued to be cut, to 0.5% in 1995 and eventually to 0.1% in 2001 - not at all WHILE the markets were collapsing. Most of the collapse occurred before the discount rate was cut ONCE.
Of course, it's necessary to consider the nature of the savings patterns of the Japanese people vs. the American people, but that's beyond my patience to explain.
Deflation Now; Inflation's Coming
The world's banks have been deleveraging for some time, as they have reassessed their risks and sought to raise their capital levels. This deleveraging is a direct reduction in the monetary base (M3 specifically). The rapid infusions by central banks are meant to stem the drop in M3 by providing the added capital the banks needed to raise.
The trick comes on the other end, when the banks wipe out the excess risk and seek to raise their leverage. That's when inflation becomes an issue. The preferred investments by the central banks are designed to prevent this inflation automatically, as the banks will seek to redeem these shares and their high dividend rates as they return to a more normal operating state.
There are other problems, but the structure of the preferred bank infusions makes clear that the Fed/Treasury are aware of the longer-term implications of what they're doing.
The Reykjavik Scenario (or How Interest Rates Can't Control Monetary Inflation)
"Open Market Operations"
"Open market operations--purchases and sales of U.S. Treasury and federal agency securities--are the Federal Reserve's principal tool for implementing monetary policy. The short-term objective for open market operations is specified by the Federal Open Market Committee (FOMC). This objective can be a desired quantity of reserves or a desired price (the federal funds rate). The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.
"The Federal Reserve's objective for open market operations has varied over the years. During the 1980s, the focus gradually shifted toward attaining a specified level of the federal funds rate, a process that was largely complete by the end of the decade. Beginning in 1994, the FOMC began announcing changes in its policy stance, and in 1995 it began to explicitly state its target level for the federal funds rate. Since February 2000, the statement issued by the FOMC shortly after each of its meetings usually has included the Committee's assessment of the risks to the attainment of its long-run goals of price stability and sustainable economic growth.
"For more information on open market operations, see the article in the Federal Reserve Bulletin (102 KB PDF). [www.federalreserve.gov...]
From that article:
"Open market operations are the Federal Reserve’s principal tool for implementing monetary policy. These purchases and sales of U.S. Treasury and federal agency securities largely determine the federal
funds rate—the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight...
"The market in which the lending of Federal Reserve balances takes place is the federal funds market, and the interest rate at which the loan is made is the federal funds rate. Federal funds lending is not collateralized; therefore, different depository institutions pay different rates for loans depending on their creditworthiness. Depository institutions can arrange transactions directly between themselves, or for large transactions they can use a federal funds broker. Typically, the term ‘‘federal funds rate’’ refers to the rate at which the most creditworthy institutions borrow and lend balances in the brokered market."
Once again, slowly:
(a) the federal funds rate IS the overnight lending rate;
(b) the market determines the ACTUAL federal funds rate;
(c) the Fed declares a TARGET for the federal funds rate;
(d) the FOMC conducts open market operations to attempt to move the effective federal funds rate to the target.
"How do you suppose that any negotiation is possible? Checks and wire transfers must be cleared through the interbank accounts. These accounts will fluctuate daily regardless what any institution does or wants done. Only public activity affects these accounts, and the interest charged and paid is simply declared by the Fed."
Now it sounds like you're confusing the federal funds rate with the discount rate. But clearly, you should go do some reading and then come back.
"Proving causation is impossible. Your point was to dismiss correlation that fails to support your mindset."
Proving causation is impossible? Are you trying to move into philosophy now? If I run over you with my car, is it possible to prove the cause of your injuries? Of course it is.
Now, as for dismissing correlation that fails to support one's mindset, you're the one who is ignoring decades of evidence that belies your assertion. From the last 80 years of data, you pulled out 5% that appears to support your assertion, ignoring the remaining 95%. Even your own cited page states: “the nominal interest rate was declining over the course of the economic decline from 1929 to 1933 but BECAUSE THE RATE OF INFLATION WAS NEGATIVE the real interest rate was much higher than the nominal interest rate [emphasis added]. YOUR OWN SOURCE doesn’t claim an inverse correlation between nominal interest rates and real interest rates.
But let’s get more basic. Do you know the definition of real interest rates? It’s the nominal rate plus inflation. That’s it! So how could there possibly be an inverse correlation?
By the way, here’s that fed chart I mentioned last time: www.newyorkfed.org/cha.../ . On this page (www.ny.frb.org/markets...) that links to it you will find this text: “By trading government securities, the New York Fed affects the federal funds rate, which is the interest rate at which depository institutions lend balances to each other overnight.” Are you still going to insist that you’re right, without citing a single source, when I now have both the main fed and the NY fed websites stating that THE FEDERAL FUNDS RATE IS THE OVERNIGHT LENDING RATE?
“I am telling you that deflation is a symptom of money supply tactics and nothing else.”
What are “money supply tactics”? Deflation occurs when the money supply doesn’t grow fast enough or shrinks, which is what has been happening as the banks deleverage.
“In the 70s, nominal rates soared and real rates went negative.”
In the 1970s, we had wage and price controls and oil shocks, both of which had significant impacts on inflation. High inflation is what caused the real interest rate to become negative.
“Every time nominal rates are adjusted, the real rates move in the opposite direction.”
You’re making a fool of yourself. You should just stop.
“The fed does not create money.”
Of course it does. That money created by the fed is a fraction of M3 does not mean the fed doesn’t create money.
“We are discussing macro economics. Micro principles are not applicable to the macro economy.”
Actually, what I was talking about was the functioning and interconnection of a couple of very specific money markets. Certainly microeconomics. Back to the question: do you have any economics training at all?
The timetable link is there. I’m not surprised you couldn’t find it, however. en.wikipedia.org/wiki/...
“Why should [the fed and Treasury throw money at everything] if cash contraction is not a problem?”
I never said the money supply was not shrinking. I’m saying you have no clue as to the reasons for it.
“The cash contraction is caused by the fact that cutting interest rates discourage lenders from lending, and no amount fed activity will encourage banks to lend again until the Fed hikes rates again.”
You are apparently an ignoramus. You present no evidence to back your assertions, you ignore evidence handed to you that refutes your beliefs, and yet you are steadfast. Why am I wasting my time?
“Again I suggest you look at the experience of Japan.”
I’m just going to give you a quick quote on this:
“The government attempted to offset the stronger yen by drastically easing monetary policy between January 1986 and February 1987. During this period, the Bank of Japan (BOJ) cut the discount rate in half from 5 percent to 2.5 percent. Following the economic stimulus, asset prices in the real estate and stock markets inflated, creating one of the biggest financial bubbles in history. The government responded by tightening monetary policy, raising rates five times, to 6 percent in 1989 and 1990. After these increases, the market collapsed.” [mises.org/story/1099]
Again, doesn’t follow your incredibly incorrect theory.
GE, Goldman Bond Spreads: Unrealistic and Unsustainable
Will Apple Beat 2009 Revenue Consensus?
"While a moderate to deep recession will undoubtedly affect Apple's business, the natural growth rate and penetration in even a flat economic environment will offset the negative effects of a slowdown. Unless we're talking 10-12% unemployment and 5-6% negative GDP growth throughout 2009, the analyst consensus simply makes no sense."
We are NOT in a flat economic environment. We are in an extraordinarily fearful environment. Until the fear is taken care of, I expect consumer spending will be greatly reduced, which will hit all retailers to some degree. It's possible that the last week or two before Christmas will be gangbusters, if markets stabilize, people feel confident in their jobs, and the media stop reporting the worst possible economic news every...single...day. But I'm inclined to think not. I think nearly all consumer-related companies are going to see an unprecedented drop in sales this quarter, which will basically be a dead loss, since Christmas is a once-per-year event.
As an aside about the media: I watched a thestreet.com video with Arthur (yes the curve guy) Laffer, who basically said that the huge amounts of debt that we're adding to the national balance sheet will be a big drag on future economic growth, which needs to be solved by reduced future government spending rather than tax increases, as Obama described in his campaign. He also said that Obama could change into a more Bill Clinton-like economic President, and said he could turn out to be one of our best Presidents. The headline on the story: "Laffer: Obama will tax us to death."
The Reykjavik Scenario (or How Interest Rates Can't Control Monetary Inflation)
Superficial, eh?
I quoted a description of the federal funds rate directly from the Fed's website. Here's the quote again, in case you missed it:
"The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight." (www.federalreserve.gov...)
Read it again. Do you comprehend the words? If you bothered to follow the link and actually read what the FOMC does, you'd learn that what the Fed sets is a TARGET. Look at the table on that page; it's called "INTENDED federal funds rate" (emphasis added). What good would it do for the fed to set the actual rate if it's not at market equilibrium (which it almost never is)? As a point of fact, the recent change in the target federal funds rate had very little effect, as the effective federal funds rate, as tracked by the NY Fed, has been below 1% for some time.
Ahh, found a link that should bring you to your senses. It's a chart from the NY Fed titled "Federal Funds Rate," showing the TARGET rate and the DAILY EFFECTIVE RATE. Since I've already established that the federal funds rate IS the overnight lending rate, you'll see that you're completely wrong here. Not that I expect you to admit it.
"Correlation is factual. Causation is the interpretation of the facts."
Geez. Look causation up in the dictionary. It's really very simple, and has nothing to do with interpretation. Determining causation is often difficult; that was my point.
"What is shown is that as nominal rates fell, real negative rates went through the roof. You can also look at Japan's march into deflation last decade."
Again, you're acting as if the deflationary environment had nothing to with anything, and you're also taking about two of the most extreme negative markets of the last 80 years, where massive systemic failures occurred. What about all of the years in between, where there was no such inverse correlation between nominal and real interest rates?
"As I have said, rate cuts discourage lenders from lending, and thereby shrinks the money supply and causes deflation."
You're making two large errors here. One is completely discounting the demand side of the equation. Second is a complete misunderstanding of how lending works. Lending markets are like any other; the players have the same motives and the same types of decisions to make. If the federal funds rate is lowered because the fed is injecting money into that market, the cost of money to the banks goes down. If this were the end of the story, the banks would lend much more, because their profit margin has increased, enabling them to take on somewhat riskier loans. Because lending is competitive, price competition will reduce rates to a new equilibrium with lower rates and somewhat more lending.
This is really basic micro stuff we're talking about here. Do you have any economics background at all?
"The failure of a single company does not cause system wide panic."
When the history is written, I think the odds are pretty good that the failure of Lehman Brothers will be identified as the catalyst that brought about the worldwide panic.
"Only cash contraction can [cause meltdown of entire market sectors]..."
Really? Have you not been paying attention to the whole CDS story? Cash contraction is not a CAUSE here. It's a result. As the banks have deleveraged, which has been happening over the course of many months but accelerated in the last two months, M3 has been decreasing. This has been happening not because of the fed's interest rates, but because of a realization that the risks that these banks took on were far more dangerous than previously understood, and that they needed to raise their capital to offset potential losses. The fear of those losses reached a tipping point with Lehman's failure, and we started a race for the bottom.
"...and there was no panic or meltdown until the Fed cut rates in September."
Huh. The S&P 500 was at 1560 or so last October. By September 11th it was 1250 (down 20%). It fell 4.7% on the day Lehman went bankrupt. It fell 4.7% two days later, when the government took over AIG. It rose 8.5% over the next two days, when the Fed first cut rates and when Paulson unveiled "The Plan." The market was fairly stable the following week, and then the House killed The Plan. Then all hell started breaking loose. The IMF issued it's worst forecast ever. The Fed and Treasury started throwing money at anything that moved. Foreign governments started nationalizing banks.
You're trying to tell me this was all because the Federal Reserve lowered the target federal funds rate from 5.25% to 4.75%?
Talk about superficial.
"Two weeks after every Fed cut, there is another meltdown of some markets."
There is so little evidence to back this assertion that's it's not worth responding to.
The Reykjavik Scenario (or How Interest Rates Can't Control Monetary Inflation)
Problems at Teck Cominco Bring Trouble for Banks
Lack of Confidence Impacting the Market
The Reykjavik Scenario (or How Interest Rates Can't Control Monetary Inflation)
"The overnight rate is the interbank rate and is simply declared by the Fed."
Again, this IS the federal funds rate: "The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight." (www.federalreserve.gov...)
"There is no market force on this rate."
And again, the Fed sets a TARGET rate, and then uses open market operations to attempt to push the actual rate to the target.
"The federal fund rate is the rate garnered by the fed when it sells securities to get money and has no impact on the interbank rate that the fed simply charges to the local bank's account."
No, not at all - this is completely separate. The Fed buys or sells Treasuries at market rates to increase or decrease the amount of money in the system. The change in the money supply leads to a change in interest rates (the cost of money).
">The real rate cannot move inversely to the nominal rate.<
This notion is proven wrong over and over and over. applet-magic.com/d...&...;
Please explain HOW you think the real rate is inversely impacted by changes in the nominal rate. I don't think there's anything in the link you provided that backs your assertion. What it shows is a dramatic deflationary environment, at a time when national output was slowing at an unprecedented rate, which increased risk aversion in lenders. It does not show any causation between lowering rates and rising real rates.
"Can you backup that statement. I see the rate cut as being the initiator of the meltdown."
Sure. First rate cut: 9/18/07. See this nice wikipedia page for a timeline of events, which includes New Century Financial's April bankruptcy filing, and the beginning of the appearance of the cascade of losses in August.