``The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”-Ludwig Von Mises, Human Action
As anticipated, the US Federal Reserve has undertaken drastic measures aimed at alleviating the present circumstances.
As credit markets remain under constant pressure, benchmark yields have continued to rise seemingly irresponsive to the monetary policy actions. Thus the Federal Reserve has opened another novel program called the Term Securities Lending Facility or TSLF.
The TSLF is supposedly a compliment to the existing Term Auction Facility. This allows financial companies to trade directly with the Fed which would lend up to $200 billion and accept a wider degree of collateral including “non-agency AAA/Aaa-rated private-label residential MBS" or papers impacted by the real estate bust.
The facility also allows for a swap lines arrangement with several central banks as European Central Bank (ECB) and the Swiss National Bank (SNB).
To top it all off, the Fed even invoked a Depression era law to facilitate for extending loans to non banks as Bear Sterns via JP Morgan.
Some argue that repos extended as loans against an eligible collateral do not signify as inflationary since they will be reacquired by the Fed and secondly, they are meant to repair the capital base of the debilitated financial institutions and not utilized for normal operations-where once a normalization takes place the added liquidity is withdrawn.
True enough the repos do not expand the Fed’s liability (base money) under the assumption that the collateral has value in it. However, by accepting papers which markets has refrained to put a price into or by putting a bid on an illiquid paper with unknown value or by acting as market maker of last resort exposes the Fed to credit risks. Insufficient collateral means losses for the Fed.
Yet there are some even calling for a greater degree of Fed exposure to the market risks…by directly buying up affected mortgages or outrightly subsidizing losses of the financial institutions, which means greater socialization or nationalization of losses and increased moral hazard. Thus our revised meaning for the acronym of TSLF: Total Socialization of Losses for the Financials
According to Frankfurt School of Finance & Management Honorary Professor Thorsten Polleit in his very instructive article, Inflation is a Policy that Cannot Last (emphasis mine),
``There are basically three strategies the government can pursue to prevent a contraction of the credit and money supply caused by a breakdown of the banking sector.
``The first strategy is to inject peoples' tax money into banks, thereby socializing (part of) the domestic banking industry. Under the second strategy, the government would simply buy banks' risky assets, thereby making available (what is left of) banks' equity capital for new lending.
``However, it does not take much to see that both strategies might be highly unpopular. In particular, to finance capital injections and/or purchases of banks' risky assets, the government would have to take recourse to tax financing — using either current taxpayer money or, in the case in which the government issues bonds, future taxpayer money.
``However, there is the third strategy available to the government, a much more subtle and very powerful way of redistributing peoples' resources through the hands of the state: increasing inflation by making the central bank buy banks' risky assets. In fact, such a strategy amounts to creating inflation via monetizing banks' risky assets.
``That said, surprise inflation can lower the real interest rate burden on outstanding loans only in the short term — at the expense of creditors. However, as long as the money system is based on a relentless increase in bank credit and money supply, it would take ongoing surprise inflation to lower the real debt burden, but such a monetary policy would ultimately lead to hyperinflation.”
All three strategies appear to be at work today.
Another, the program deals with the asset side of the Fed’s balance sheet. The Fed will be changing the composition of its $873 billion in total assets from around $700+billion in treasuries to mortgages, expanding its market and credit risk.
But since the Fed’s balance sheet is materially smaller compared to emerging markets as
``But what if the Fed changes its mind and decides that it needs to expand the amount of support it offers the market? Well, nothing precludes the Fed from following the lead of emerging market central banks and issuing short-term “sterilization bills” to offset the growth of the assets on its balance sheet.
``As around $900b, the fed’s balance sheet is something like 6-7% of US GDP. With $1600b in foreign assets, the PBoC’s external balance sheet alone is more like 50% of
``In a world marked by unprecedented central bank intervention, the Fed’s balance sheet is still kind of small.
``Expanding the Fed’s balance sheet dramatically to offset a massive deleveraging of the private financial system – a deleveraging that has been compared to a bank run in reverse, with the banks withdrawing credit from hedge funds and broker dealers in much the same way that households withdraw credit from the banking sector in a bank run – would be a truly radical step.”
Yet inflation seems to be the preferred policy option for the US FED, as we have been saying all along, since that the
From Martin Wolf the Financial Times, ``There are two ways of adjusting the prices of housing to incomes: allow nominal prices to fall or raise nominal incomes. The former means mass bankruptcy and a huge fiscal bail out; the latter imposes the inflation tax. In extreme circumstances inflation must be attractive. Even if it is not the Fed’s choice, it is what a reasonable outsider might fear, with obvious consequences for all asset prices.”
With the radical thrust towards increasing TSLF all these will eventually be reflected in the fate of the US dollar, as Mises prophetically observed.
Ergo, gold, oil, commodities and other hard assets are likely to serve as insurance from devaluing paper assets.
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