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Just the Facts Ma’am, Just The Facts

The common misconception that the Fed is adding massive amounts of liquidity to the system continues to run rampant, both in the mainstream financial infomercial media and, disappointingly, in the blogosphere. While the BOE and ECB have made enormous increases in their monetary bases over the past couple of months in response to a frozen credit market and a banking system in crisis in the Europe, the Fed has yet to join the party.

I did a quick calc on the ECB’s adds last week and the net was “only” around €125 billion, not €348 billion ($500 billion). That is still enormous. It all expires on January 4, so it will be interesting to see how much is rolled over. We have to see this in the context that the EU credit markets are frozen, and the banking system, virtually so. The EU also faces unusual year end rollover pressures. So it remains to be seen how much of this credit becomes permanent. It also remains to be seen just how much offsetting “money” has been destroyed in the ongoing chaos.

In contrast, over the past 5 days through 12/24 the Fed has drained a net of $15.7 billion from the system, reducing the System Open Market Account (SOMA) by that amount. This includes whatever the Fed has added via the TAFs. They have fully offset that and then some by redeeming T-bills and reducing outstanding repos. The Fed has now redeemed $35 billion of its T-bill holdings in the SOMA over the past 3 weeks, including the announced $14 billion redemption settling Thursday 12/27. The Fed has stated on the NY Fed website that it intends to continue these transactions as necessary, along with considering reverse repurchase agreements and Treasury bill sales. This is the flip side of their announcements regarding the TAF auctions. Strangely, virtually no one in the media or the blogging world has reported on these developments, which are virtually unheard of terms of the Fed’s standard operating procedures.

Over the past 4 weeks the Fed has drained $8.2 billion from the SOMA. In contrast, at this point last year the Fed had added a net of $4.2 billion to the system over the previous 4 weeks. The annual growth rate of the SOMA as of 12/24/07 was a paltry 1.34%. In contrast, at this point last year the annual growth rate was 3.4%. While I would expect the Fed to push back toward that rate, it is surprising and puzzling that, at a time of year when the Fed is normally aggressively adding reserves, this year it is going in the opposite direction. While the ECB and BOE have made enormous increases in their monetary bases over the past month in response to the crisis in the EU, the Fed has yet to join the party.

Most of the analysis out there assumes that the Fed has been aggressively adding reserves or that it will. The first assumption is false. The second makes a leap of faith that I’m not ready to make until I see the evidence that it is in fact happening.

I can only speculate that the Fed’s tightness may be geared toward restraining the surge in the growth of broad money measures, such as MZM, that began last summer concurrent with the emergence of the crisis in the Asset Backed Commercial Paper market. If that is what the Fed is doing, it could be a deeply flawed strategy.

The rapid growth of MZM and other broad measures is directly correlated with the flight of investor cash out of the ABCP market. The declines in ABCP outstanding match, virtually dollar for dollar, the simultaneous growth of dollars held in Institutional Money Funds and Non-transaction deposits in banks, which are counted in broader measures of money. This is a temporary phenomenon that will end when there’s no more cash to be had from the ABCP market.

Considering that much of what is reflected in the data in the broader M’s is fictitious capital, that is, backed by weak or even worthless credit that is yet to be written off, I believe that the reported data on money supply is grossly overstating the actual totals. This should become clear at some point next year. As the writedowns and writeoffs grow, some institutions, rather than bailing out their money market funds as we have repeatedly seen this year, will choose instead to allow these funds to break the buck, in turn revealing that published money supply figures are wrong. As the values of money market funds adjust to the new reality, so will the data on broad money supply.

Obviously, the Fed can turn on a dime. So far it hasn’t. Rather than spend too much time speculating on why the Fed is acting as it is, I think it’s important not to get caught up in the hysteria based on what is so far, a false premise. For whatever reason, contrary to conventional wisdom, which the Fed has done nothing to dispel, the Fed has not been adding liquidity to the system. The Fed has promoted the idea that it is doing so, and the financial media, in its ever present desire to avoid reporting and analyzing the actual facts, is more than happy to go along with the fantasy. Surprisingly, so are many financial bloggers.

I think it’s important that investors who care to think critically about these things arm themselves with the facts, rather than the hype and superstition that dominate today’s environment.

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  1. DefBear

    Robert, if you have some facts to show how this is true, it would be an interesting thesis.

    Money supply measures are debatable, since the ABCP collapse has distorted them.

    Probably oil and gold prices ultimately will prove to be the only measure and by then there will be no opportunity to be had either way, since they are the opportunity, not the usual measuring stick.

  2. cwd

    I have to assume the real players know what is going on, and I would assume if the FED is to retain any credibility it wants to maintain the desired Fed Funds Rate. It has been doing this by restriciting the growth of the SOMA.
    I would assume the BS they have been putting out is for public consumption to show that they are caring, concerned, and are doing all they can to let the public know they feel the debtor’s pain.
    Restricting the growth of the SOMA would also tell that there is little demand for credit from the gang of 20 that requires the collateral that the Fed has been requiring.
    Of course that could change in a flash with the issue of some kind of secret emergency decree.
    As Bill Gross has said the shadow banking system is collapsing.I don’t know how the Fed can bail them out with out collapsing the dollar.
    Right now, the Fed’s strategy seems to be working. The dollar and the stock markets have strengthened.
    How long they do that is the real proof of the pudding.
    Speaking of that, I think I will some.
    Merry Christmas everyone.

  3. edgar

    So when do we get to see the fire sale of assets? Never, that’s when. Why should the fed pump liquidity when their henchmen at the IBs can do it for them?

  4. Lee Adler

    Robert- No disagreement there. REPORTED money supply and credit data is growing astronomically as I noted in the article. That does not change the facts I reported regarding the Fed not growing the monetary base, which you can find in the Fed’s weekly H4.1 release. All the historical data is listed so that you can compare current balance sheet levels with any past period.
    The line item you will want to review is in Table 2., Consolidated Statement of Condition of All Federal Reserve Ban ks- Securities, repurchase agreements, and loans. I update this figure daily in my Fed report using the figures reported by the NY Fed on its daily OMO, along with the data reported on the Fed website on the TAF auctions. The most recent Fed balance sheet data is through 12/19. I have updated that with figures through 12/24.

    On the other hand, perhaps my speculation that the money supply is overstated is wrong because the fictitious capital component is not as large as I suspect. Some Wall Street firms are estimating that there are still $700 billion in CDO and writeoffs lies ahead. How much of that is backing SIV and other ABCP? If this number is anywhere close to correct, some money market funds are trash and the M’s are way overstated. We should know within a few months if the scenario I laid out above begins to play out or not.

  5. edgar

    The rich rob the poor and the outcome they call recession, as soon as the lying gubbermint BLS numbers say so, that is. Puke.

  6. edgar

    Does this mean they are shutting down the yacht clubs and country clubs? Will Tiger Woods play golf on public courses? Will Hank Paulson resort to cutting his own, er, hair?

  7. Kicker

    Tinfoil hat time…

    The only tool the Federal Reserve has to control the growth of bank credit (money) is regulatory capital. Reserve requirements were pretty much gutted by the introduction of seep accounts in the 90’s.

    I’m wondering if the Federal Reserve is determined to kill off the shadow banking system because it threatens the last lever they have over bank credit.

    But, it may simply be that inflation is still too high for the Fed to “turn on the spigots”. I’m guessing that flooding the system with highly charged dollars wouldn’t sit smartly with inflation-targeting Ben.

  8. Slumlord

    If you actually look at the link from the fed you see that the daily rate is more often than not below the fed funds rate. As the Fed has to influence rates through alterations of money supply in the open market, it would appear that the fed is propping up rates which would be naturally trending down. Decreasing money supply raises rates, it does not decrease them. I think the Fed is trying to prevent a dollar collapse.
    Assuming a 12:1 leverage ratio; the withdrawal of 8 billion dollars means that there is no need for approximately 100 billion dollars worth of credit.

    The economy is shrinking.

  9. edgar

    Does this mean that Halliburton, General Dynamics, Boeing, and Ford are going out of business. Exxon? GS? MER? BSC? FNM? FRE? CFC? B of A? Of course not. Little people get poorer, maggots get richer. War is good for business. Yawn.

  10. lenny

    lee and slumlord…great insights…maybe you reported on this, lee, and i didn’t see… but total commercial outstanding fell by $54.7 billion the week ending dec. 19…with the financial and asset-backed categories falling by like amounts to account for the huge drop… asset-backed could fall to zero…and it’s now at $763.5 billion…

    …could you explain what you think is going on a bit more, slumlord?…is it that the fed is working with treasury to prop long-term treasury security yields up to keep attracting foreign investment?…peter schiff says that if long-term treasuries go up, you know the dollar is in trouble…

    …or is something else?

  11. Lee Adler

    No doubt about it. The Fed has needed to drain reserves in order to keep the Fed Funds rate from falling too far below target. The pressure on rates at the short end seems to be down. The same can no longer be said at the long end, where yields have apparently turned a corner.

    And, yes, I do cover some aspects of the CP situation in the Daily Fed Report in the Professional Edition, and in occasional reports on what I refer to as macro liquidity.

  12. Slumlord

    Hello Lenny,

    I’m not an economist and so you shouldn’t take my word as gospel but this is how I see it.

    Normally there is a continual demand for credit. Banks can lend out money up to their reserve limit(usually 12 times the amount). Once that limit is reached the banks cannot lend any more money. Desperate borrowers could therefore offer to pay more interest in order to access funds. This would circumvent the Feds interest rate policy so what it does is temporarily lend put money into the bank’s reserves through a short term loan allowing them to lend more. This increases the supply of credit and hence credit is offered more cheaply i.e lower interest rates. If the Fed needs to repetitively give short term credit it eventually conducts a permanent injection of money into the system.

    What I think is happening at the moment is that the banks are refusing to lend–for a variety of reasons–and therefore have more than adequate reserves. The banks seem quite happy to lend to each other at below the fed funds rate, the fed therefore attempts to raise the price of money by withdrawing supply and thereby raising the price of money.

    The assumption in modern finance is that the Fed lends to the banks, who then lend to the public at a margin. The problem is that the banks are not lending despite demand: The credit chain is broken.

    I don’t think that the Fed is colluding with Treasury to prop up bonds; rather lower interest rates mean less demand for the dollar, which further weakens it, causing a raise in price of imports: This is inflationary. It is also a tax on foreign owners of U.S dollars making their dollars worth less and disinclining them to keep them further weakening the dollar. Bonds do become worth less to foreign investors though I don’t think this is the Fed’s priority.

    The real question is why are the banks refusing to lend? Most of the commentators are stating that the banks are fearful of lending to individuals with suspect collateral. There maybe some truth to this but I also think that the banks are trying to re-capitalise. This would explain the sudden surge in share issues to sovereign wealth funds. The big banks are trying to raise cash as their balance sheets are probably pretty thin and probably below regulatory requirements. Here’s an interesting link. Ponder it. It’s scary.

  13. Aaron Krowne

    Someone should calculate the dollar-value impact of the Fed’s reserve requirements exemptions (such as the 23As). It would be interesting to see how these stack up against the drains you point out.

    The more I think about all this, the more I think the Fed is actually still terrified of inflation. It is now obvious in even the public, gamed statistics that inflation isn’t going away. Not that it is yet at a 1970s level (at least as far as the Fed is concerned), but the danger is of adding to the monetary base and hence stoking the inflationary fires. I don’t think this Fed wants to do that. They want to somehow “fix” the problem without being responsible for creating a new “Carter era”, hence all the innovative sleight-of-hand (ultimately amounting to very little if anything).

  14. Lee Adler

    Aaron- You know I hate like hell to speculate on what the Fed’s motivations here. 🙂 I am beginning to wonder if they even know. The Fed seems almost incoherent in its pronouncements, which is why I just watch what they do and leave the thinking and pontificating about what the Fed is up to, to all the other pundits.

    I just don’t have a clue as to what they really think. Their behavior is puzzling to say the least, especially given that the ECB and BOE have turned on the firehoses. The BOE led off with huge adds to their monetary base in the Rock rescue, and the ECB followed suite over the past two weeks.

    Does the Fed feel that it needs to be tighter to offset that to some degree, or does it have more to do with the screaming growth of MZM of late? I think that a reader here or over on’s message boards, who had seen the exchange between Uncle Ben, and your man Paul, Ron, said that Benny even said as much. Not sure about that, but maybe one of our sharp eyed readers knows where the transcript of that exchange is hidden.

    But again, it would just be words, and I am of the Watch What I Do, not What I Say School of Fed watchers.

    If the Fed drains tomorrow, I think that the signal that the Fed is quantitatively tightening will be on for sure. For the last 4 years they have always tightened up on the base in the first half of the year.

  15. OOUA

    Lee, Happy Holidays to you. I always appreciate the information you gather and present in your writings.

    In neither attack or defense of the FED. It is my opinion that if it were not for the strangle of the cash and cash equivalents approach the FED has been taking … the dollar would be declining in a much more dramatic fashion. While the repo actions of the FED will likely facilitate expansion of credit in the larger monetary agregates, the real effect so far has just been a postponement of raising interest rates which is justified for asset appreciation and risk pricing, natural forces at work. Sooner or later, real stimulus must be given to John Q. Public or a deflationary wave will set in that is beyond correction. The question is … are we there yet ? It appears not quite as some asset classes are still somewhat healthy. Personally, I believe that we are only seeing a minor set back in a much larger inflationary wave to come. Time will play out the facts.

  16. Cheese

    How are the banks going to operate with growing delinquencies in every portion of their lending portfolios? If you cant lend money, you cant make money, this is the next wave to go our monetary banking system, high unemployment, lost wages, increased delinquencies, foreclosures, repos, bankruptcies, inflation thru the roof but the Feds have $51 million to lend to Mazilo at Countrywide after cashing in $560 million in stocks. They Feds have been hiding the facts only time will tell before they have to come clean with the public.

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