Wednesday, June 10, 2009

borrowing heavily to finance massive stimulus and financial bailouts have raised doubts about their ability to repay their debt

TO BE NOTED: From Alphaville:

Time to pull back liquidity?

Wednesday has so far proved to be another inflation focused day.

Among the latest indicators of tearaway borrowing costs in the near future was a jump in mortgage rates to their highest since last November, a fact that has now begun depressing refinancing activity. The Mortgage Bankers Association’s index of mortgage applications, for example, fell 7.2 per cent w/w in the week ending June 5, marking the third consecutive weekly decline. Meanwhile, as Barcap stated:

The average rate on the 30-year conforming mortgage (as measured by the MBA) jumped 32bp to 5.57%, also the highest since November. Mortgage rates have jumped more than 100bp from the trough of 4.62% at the end of April. The index of purchase applications inched up 1.1%, leaving the four-week moving average up 0.5%.

Then there were policymaker comments: the most hawkish came from Richmond Fed President Jeffrey Lacker urging the Fed not to expand its asset purchases in response to rising bond yields. As Reuters reported:

“Right now, I don’t see a reason to increase it,” Richmond Federal Reserve President Jeffrey Lacker told reporters, referring to the U.S. central bank’s pledge to buy up to $300 billion of longer-term Treasuries by the autumn. “In fact, if anything, if yields are rising because of stronger growth that would cut against the case for increasing purchases,” he said after speaking to the North Carolina Senate Appropriations Committee.

Arthur Laffer, he of the Laffer curve, meanwhile presented the following scary graphic in a WSJ journal article:

Exploding money supply - WSJ

Commenting on the above he wrote:

The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base — which prior to the expansion had comprised 95% of the monetary base — has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!

That currency-in-circulation statistic by the way, was also corroborated by Fed’s own monetary base graphics released on Wednesday and reproduced below:

Fed liabilities - Fed

And if all that wasn’t scary enough on the inflation front, Reuters now reports the US government had to offer a much higher than expected yield on its long-dated bond sales on Wednesday just to attract sales:

NEW YORK, June 10 (Reuters) - The U.S. government on Wednesday paid a much higher-than-expected yield to sell longer-dated notes to attract investors who have grown wary of its burgeoning debt load. The U.S. Treasury added $19 billion to a prior 10-year note issue, originally sold in May, at a high yield of 3.99 percent, the highest since August 2008. The added yield incentive pulled reluctant participants from the sidelines, making this strongest bid 10-year auction since September 2007. This is the first auction of long-dated federal debt since questions over the U.S. government’s credit-worthiness arose in the wake of a credit rating downgrade of Britain by Standard & Poor’s. The United States and Britain are conducting similar policies to revive economic growth, but their tactic of borrowing heavily to finance massive stimulus and financial bailouts have raised doubts about their ability to repay their debt.

Laffer’s conclusion by the way ties with that of Lacker’s: Forget additional Fed asset purchases. What is needed now is the reemergence of an inflation not deflation focused committee that is ready to drain liquidity from the system. As he writes:

Now the Fed can, and I believe should, do what it must to mitigate the inevitable consequences of its unwarranted increase in the monetary base. It should contract the monetary base back to where it otherwise would have been, plus a slight increase geared toward economic expansion. Absent this major contraction in the monetary base, the Fed should increase reserve requirements on member banks to absorb the excess reserves. Given that banks are now paid interest on their reserves and short-term rates are very low, raising reserve requirements should not exact too much of a penalty on the banking system, and the long-term gains of the lessened inflation would many times over warrant whatever short-term costs there might be.

Otherwise, behold; tick-tock the inflation clock.

Related links:
Fed releases new balance-sheet data
- FT Alphaville
Federal Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet
- Fed
Fed Would Be Shut Down If It Were Audited, Expert Says - CNBC


Don the libertarian Democrat Jun 10 20:22
So, let's see, now we have higher interest on some bonds because:
1) The govt wants to sell a lot of bonds, and so they have to offer higher interest rates to attract enough buyers
2) People are seeing or predicting inflation ahead, for whatever reason, and so want a higher rate of interest
3) The money supply, as you've laid out in the graph by Laffer, means that inflation is a mechanistic foregone conclusion, and, until the money supply goes down, the govt will have to pay higher interest on bonds
Anything else? Maybe:
4) Investors are seeking higher interest because they can get

Don the libertarian Democrat Jun 10 22:22
Here's McTeer on that graph, I believe:

"People keep talking and writing about the explosion of the money supply and the coming inflationary tsunami. Let me point out once again that the M1 and M2 measures of the money supply spiked but have since come back down. There is no explosion of the money supply.


The monetary base (currency outstanding plus bank reserves) has exploded, and it's graph is indeed startling-startling that is until you realize that excess bank reserves on deposit at the Fed is the reason. We learned to pay attention to the monetary base because it provided the raw material (reserves) from which the banking system can create new money by lending and investing. Because of the money expansion multiplier, the monetary base has been referred to historically as "high powered money."

I could be wrong on all this, but McTeer's post makes more sense to me. Maybe I'm misreading Laffer's graph.

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