Comments on: Correction: Pushing on a String? Credit Marches to its Own Drummer.

By: flow5

flow5 — Fri, 22 Feb 2008 22:08:56 +0000

Krugman: “PUSHING ON A STRING?” this has only applied to the period during the Great Depression where at times excess reserves were greater than required reserves.

If today, there are not enough credit worthy borrowers in the private sector (as in the Great Depression), the Fed can now (unlike during the GD where there was an insufficient volume of government debt), buy an unlimited volume of earning assets. (With the federal debt at over 9.+ trillion, and expanding, and billions of dollars of “eligible paper” available, the term “unlimited” is not an exaggeration in terms of any potential needs of the Fed.)

In the process of buying Treasury Bills etc., new Inter-Bank Demand Deposits (IBDDs) are created. These deposits can be cashed by the banks into Federal Reserve Notes, without limit, on a dollar-to-dollar basis.

On the basis of these newly acquired free reserves, the commercial banks can, and do, create a multiple volume of credit and money. And, through this money, they acquire a concomitant volume of additional earnings assets.

By: Tom F.

Tom F. — Tue, 19 Feb 2008 20:46:36 +0000

For you, David, I would say your mental brilliance is exceeded only by your sense of honesty and humility.

By: Tom F.

Tom F. — Tue, 19 Feb 2008 20:33:09 +0000

With respect to James Dailey’s comments above, I would argue that in the case of the Fed, control of the money supply was willingly ceded to Wall Street in the mid-1990′s. For those greedy crybabies constantly carping and whining for “free, unfettered markets”, you have just witnessed one at work. Now it’s time to pay up.

Now that this country has had the stupidity to throw away its manufacturing pre-eminence, it is no longer in any kind of position to just start counterfeiting paper money hand over fist and get away with it.

By: James Dailey

James Dailey — Tue, 19 Feb 2008 14:22:52 +0000

I would argue that the reason the relationship has broken down in the past 5 years is relatively easy to recognize. The Fed and ECB have lost control of the credit systems and the “shadow banking system” has taken over “control”. The manufacturing of all things leverage/derivatives in the past 5 years dwarfed anything the fed has done. The enormous size of the outstanding interest rate and credit derivatives dwarf the tiny amount of reserve money the Fed controls. The Fed is spitting in the wind as that system is now in free fall/implosion.

Given the massive excesses in these markets, which absolutely dwarf those surrounding the S&L crisis, it is absolutely laughable in my mind that the end result could be as relatively benign as what we’ve seen in the past 6 months. Sure, things have been bad in the credit markets but not to a generational extreme, which is what usually follows generational extremes in greed.

While a temporary reprieve is certainly possible, I would be shocked if there is not MUCH WORSE to come from the credit markets and the banking sector.

All of the fixed income guys I know remain amazingly complacent about the ability of the Fed to address the problems. I’ll repeat here what I keep telling them – watch the dollar. It may prevent the Fed from being as reckless as they probably want to be. Even if they are reckless, then I don’t think it is any assurance that it will be enough to “fix” the shadow banking system, just as it didn’t fix the Telecom/Tech bubble.

By: gj

gj — Tue, 19 Feb 2008 10:29:57 +0000

Thanx for this (& every) update — I read both your & Krugman’s blog — and find each of you, highly principled, consistent & informative.