The King's Heart

There is another Bible verse we should remember during this time of troubles:

“The king’s heart is in the hand of the LORD, as the rivers of water: he turneth it whithersoever he will” (Proverbs 21:1).

The king is the sovereign; in our Republic, it is the people who are sovereign. So, to paraphrase Solomon, the people’s heart is in the hand of the Lord to turn it in whatever direction He wishes.

Do we believe that? Do we believe He can actually turn the hearts and minds of the people in the face of the onslaught of monolithic media representations?

Is there anything too difficult for God? Not according to the archangel Gabriel, this time speaking to a frightened teenager by the name of Mary: “For with God nothing shall be impossible” (Luke 1:37).

Pray now or forever hold your peace.

And We Have a Winner

The solution to the toxic asset problem, and the credit crisis, may well be the one propounded by Holman W. Jenkins in his Wall Street Journal column of March 18 2009: “Needed: A Bailout That Doesn’t Look Like One.” The root of the crisis is bad assets (securitized subprime loans) on banks’ balance sheets. Mr. Holman’s column discusses how these assets can be most easily taken care of. It looks so easy that a child could do it. But there’s the rub. It’s too easy. After all, it would constitute the waste of the opportunity this “crisis” affords to Cloverfield government.

(Update March 20th: Larry Kudlow offers an alternative approach to solving the crisis. He may be right that no further action is required than the switch to cash-flow accounting from mark-to-market accounting, together with the normalized yield curve on short- and long-term loans. Who’s to say? Not me.)

What the Fed is Up To

The recently announced Fed action has been characterized as a massive exercise in printing money, in “pumping liquidity“. But such characterizations, once again, are misleading.

Take a Wall Street Journal article from March 19th, 2009, by John Hilsenrath. In “Fed in Bond-Buying Binge to Spur Growth” he wrote,

The Fed had already cut its benchmark interest-rate target to near zero. Unable to go lower, the central bank now is essentially printing money to raise the supply of credit and thus push down the longer-term rates paid by families and companies on mortgages and other key loans. The impact was immediately felt.

First, has the Fed been “printing money”? Let’s look at a few graphs, downloaded from the Fed web site, to determine if that’s the case.

First, the trend line of the amount of assets on the Fed’s balance sheet:


This means that the Fed has done a lot of buying since mid-2008. How has it paid for this? By printing money? Let’s look at the trend line of liabilities over the same period:


Here you can see that the amount of currency in circulating (money printed) is roughly stable, while the amount of deposits at depositary institutions has ballooned. The Fed, thus, bought up all those assets by crediting the accounts of depositary institutions (mainly banks).

What does this do? It enables these depositary institutions to lend. How much they are able to lend is a function of how much they have on account at the Fed. Those Fed deposits, plus their own cash on hand (vault cash), constitute what is known as the money base. The money base was fairly stable through mid-2008, and then went through the roof, from $800-plus billion to over $1.5 trillion in March 2009 (see the table here).

So the money base, and thus the amount available to lend (which, with our fractional reserve banking system, is a multiple of the money base), has nearly doubled.

But the money supply, actual money put into the economy, has not. Here are the figures for the broadest money supply counter (monetary aggregate), M2. In March 2007, M2 stood at $7.111 trillion. In February 2009, it came to $8.275 trillion, an increase of about 16%. Nearly all of that increase has occurred recently: the year-on-year gain (February 2008-February 2009) was 9.8%, the six-month gain was 15.3%, and the three-month gain was 15.2%. Still, the gain is not nearly what one would expect given a near-doubling of the money base.

The conclusion: the Fed hasn’t been printing money, it has been expanding the money base and thus the amount banks can lend. But even in that case, the banks can’t lend what people won’t borrow. Given the none-too-precipitous increase in the money supply, it doesn’t appear that borrowing has increased much even given the enormous increase in potential for lending (look here for confirmation).

It would seem to me that the Fed’s purpose in buying up the more unorthodox assets, which underlies the big increase in assets on its balance sheet, is 1) to stabilize the mortgage market by buying up mortgage-backed assets from Fannie Mae et al., 2) to bring down long-term interest rates by buying up long-term Treasury bills.

Bringing down long-term rates is a new way for the Fed to operate. It apparently is working, or at least has a chance of working. By bringing down long-term rates the Fed hopes to spur investment (see Hilsenrath’s article from March 20th, 2009, “Excess Capacity Keeps Heat on Fed”).

The danger is, of course, that by engaging in all this spending it has provided way too much lending potential to banks which could lead to inflation. Hilsenrath’s “Excess Capacity” article shows just how much the Fed is expanding the money base by doing this. But on the other hand, it can head off the danger of rampant inflation by raising interest rates, as well as by selling off those self-same assets.

So this is an area which bears watching but is not yet cause for alarm. The Obama government’s fiscal policy (not to mention war on capitalism) is where one really needs to watch out.

Responses to the Geithner Plan…

are lukewarm at best. Today’s Wall Street Journal op-ed (“The Geithner Asset Play“) raises the appropriate objections. The goal of the plan, which is to rid banks’ balance sheets of unmarketable assets, really is something that has to be done if credit relations are to be restored. But it seems that Geithner wishes to accomplish this, once again, on the backs of the taxpayer. Why not try something such as was suggested by Larry Kudlow (see my blog here), whereby mark-to-market accounting rules are eased — something which will cost the taxpayer nothing. John Berlau notes that Geithner’s plan mentions nothing about mark-to-market.

Furthermore, Paul Krugman’s running commentary on the plan (“The Conscience of a Liberal“) is well worth perusing, even if sprinkled — liberally — with really funky liberalism.

Dollar Bashing — Overdone?

Sometimes the Wall Street Journal is a little too transparent in its editorial bias. Take the article, “Oil Is Up Because the Dollar Is Down” from page A13 of the May 23rd issue. Granted, this is a signed editorial by David T. King, not someone the Journal staff, but it faithfully reflects the viewpoint of the staff, which is that the European Central Bank is maintaining a strong euro through robust monetary policy, while the Federal Reserve is pursuing a weak dollar through lax policy. In King’s view, this policy is to blame for high gas prices at the pump.
Mr. King points to the dollar-euro parity of 2002, when oil was selling at “about 25” dollars a barrel. He contrasts that with now, when a barrel of oil is running for “about 75 euros a barrel,” a threefold increase, versus “over $120 a barrel” in the US, a fivefold increase. His conclusion: “The sole reason for this enormous difference is the incredible depreciation of the dollar against the euro.” One can’t argue with that. The differential is by definition the result of dollar depreciation. But one can certainly argue with the inferences he draws from this fact.
“If it wasn’t for the falling value of the dollar, the price of gasoline wouldn’t be an issue,” he claims, adding that “It’s to blame for the excessive price of gasoline, and now is pushing dangerously into wholesale price inflation, based on the most recent data published by the Labor Department.”
This statement raised red flags for me, seeing as how I live in a euro-currency country — the Netherlands — and actually fill my car here with gasoline paid for in euros. In fact, I just filled up last Saturday. How much did I pay for a gallon of premium? Well, for a liter I paid €1.66. Convert that over to dollars per gallon, and you have $9.88. Hmmmmmm. Boy I’m glad I’m paying in euros! Otherwise, in dollar terms I’d be paying less than $4.00, or 2 1/2 times less. Which is roughly the ratio I’ve been familiar with ever since I can remember, and I’ve lived in the Netherlands since 1990. So the falling dollar hasn’t helped me a bit as far as filling the tank’s concerned.
This bias against Fed policy does not appear to be borne out by consumer price index data, either. Take this simple graph I made, contrasting US and EU CPI data against the background of the dollar-euro exchange rate (sources: exchange rate: Yahoo Finance, CPI data: International Monetary Fund Data Mapper []):

chart-712570Dollar depreciation was accompanied by US CPI gains between 2002 and 2007, while EU CPI remained stable. But in the last year-plus, EU CPI has jumped along with US CPI, nearly equalling it, even as the dollar has dropped further and the short-term interest-rate differential has widened (maybe I’ll put that in a graph too at some point). So where is the correlation between spiking prices for the US as opposed to the EU? It hasn’t been there, at least since 2007, when the dollar really tanked.

Dollar bashing is all the fashion, but don’t get caught up in it, otherwise poor investment decisions could well follow — that’s my nugget of advice.