“The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.
Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.
Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.”
∙ Federal Open Market Committee Statement: December 16, 2008 [federalreserve.gov]
∙ The Fed Cuts Rates To One Percent To Avert “Prolonged” Recession [SocketSite]
“… federal funds rate of 0 to 1/4 percent.”
What does that mean exactly? The rate isn’t zero but it isn’t 1/4 percent either, it’s somewhere in between???
^^perhaps its just a recognition that the Fed may not be able to keep the rate exact. They have had trouble keeping the rate at target lately as it has already gone well below target numerous times.
surprised that this is big news
the effective fed funds rate has been between 0 and 0.25% for the past 2 months now
the interesting part is that the Fed has stated, nearly unequivocally, that we will be ZIRP for awhile, and that they are goign to use their balance sheet on the long end to really push down longer term borrowing rates
I have no idea how they will manage the other side of this coin – makes me very worried about the inflationary ramifications a few years from now
but until then – enjoy your zirp, your liquidity trap and the 5.0% and lower 30 year fixed (assuming that you can get yourself a ‘conforming’ sub 625k mortgage…)
https://www.wellsfargo.com/mortgage/rates/
“but until then – enjoy your zirp, your liquidity trap and the 5.0% and lower 30 year fixed (assuming that you can get yourself a ‘conforming’ sub 625k mortgage…)
https://www.wellsfargo.com/mortgage/rates/“
Be careful with this. I did a large conforming refi a month a go..and the rates are not what are posted for the conforming but between jumbo and conforming and as of yesterday closer to the jumbo rate. The real kicker is once you get in to the product, if you call back as I did this week to see about taking advantage of the lower conforming rate they tell you the loan – any loan over the typical 417k qualifies as a jumbo so you cant get the lower rate. This from Wells.
Can someone explain why a bank couldn’t borrow from the Fed at 0.25% and then immediately invest it in another bank’s 2% CD ? Seems like free money.
Surely I’m missing something here.
milkshake
1.) you aren’t missing much (except that the fed funds rate is an overnight lending rate) – but what you are speaking to is the fact that our taxpayer TARP funds have gone from the Treasury, to the banks, then back to – guess where – the Treasury (think those 2.5% ten year bonds are due to mom and pop buying them???).
2.) The banks are desperate to remain solvent, repairing their balance sheets (zombie banks). So, yes, they would rather put their money to use by making deposits, rather than loans – problem is that they aren’t making 100,000 dollar deposits, or even 250k – so CD deposits won’t work for them (besides, they know that all of the other banks could default on their CDs given all banks know that each one is as bad off as themselves). try 25 billion dollar deposits. Only one good place to put those kind of dollars (zero percent treasuries – yay!). The TARP didn’t get banks to lend. it got them to make deposits. Welcome to your USA liquidity TRAP, courtesy of TARP.
Those banks who can make loans, and do so safely, can find that this environment could be very profitable – problem is, they are too busy preparing for the strom and traiging their wounds. But when the lending starts – watch out.
milkshake
1.) you aren’t missing much (except that the fed funds rate is an overnight lending rate) – but what you are speaking to is the fact that our taxpayer TARP funds have gone from the Treasury, to the banks, then back to – guess where – the Treasury (think those 2.5% ten year bonds are due to mom and pop buying them???).
2.) The banks are desperate to remain solvent, repairing their balance sheets (zombie banks). So, yes, they would rather put their money to use by making deposits, rather than loans – problem is that they aren’t making 100,000 dollar deposits, or even 250k – so CD deposits won’t work for them (besides, they know that all of the other banks could default on their CDs given all banks know that each one is as bad off as themselves). try 25 billion dollar deposits. Only one good place to put those kind of dollars (zero percent treasuries – yay!). The TARP didn’t get banks to lend. it got them to make deposits. Welcome to your USA liquidity TRAP, courtesy of TARP.
Those banks who can make loans, and do so safely, can find that this environment could be very profitable – problem is, they are too busy preparing for the storm and triaging their wounds. But when the lending starts – watch out.
Can someone explain why a bank couldn’t borrow from the Fed at 0.25% and then immediately invest it in another bank’s 2% CD ? Seems like free money.
Counter-party risk. Few banks wants to hold anything other than treasuries. They know that their own balance sheets are full of s&*t and they don’t want to get caught holding the bag of some other bank.
It’s not counter party risk.
For starters, one is an overnight rate and CD’s tend to be long term. What if inflation comes back in Q1 then the fed does an emergency hike to 2.5%. OUCH!!
This is a pretty big announement from the fed that essentially says they are going to print money until asset prices stop going down. amazing stuff.
My prediction stays the same–gold and commodities spike up from here till q1, followed by slowed growth later on in the year as we digest all this crap.
It has everything to do with counter-party risk. That is why banks are hoarding treasuries. That is why spreads on investment grade bonds are blown out. That is why jumbo mortgages are through the roof. If you’re trying to technically analyze why a bank doesn’t specifically buy a CD and how that relates to the overnight lending rate, you’re missing the point. The question is, why isn’t the bank investing in anything? Isn’t that what banks do? Collect deposits (borrow) at X rate and lend at Y rate? Isn’t that “free money”? Answer: yes, but at some level of risk. That risk is currently perceived as very high (i.e. nowhere to hide) hence the liquidity trap.
if counter party risk was still a huge issue…then libor would not be so low and have dropped so dramtically given fed actions.
it’s duration risk-not whether the bank will fold in an environment where banks can’t fail. Even citibank won’t be allowed to fail and it’s book is a POS. that’s not even a small issue these days,
The reason banks don’t like to lend now is because their current asset quality is so poor they like to hold on to cash. until asset quality goes up-i.e. the value of their loans start to go up which means real estate needs to stop going down.
Eventually you could give them so much cash they will start to lend and that’s what they fed appears to be trying to do as well as engineer asset reflation so the huge debt run up borrowed against real estate can be paid for.
Let me get this straight, the Fed is printing money to buy bad assets (mortgages, auto loans, student loans, credit card receivables) from banks so banks can strengthen their balance sheet, which will encourage lending, right?
And all this newly printed money will morph in to inflation, right?
But doesn’t inflation assume two things:
a) Banks will continue to lend indiscriminately to consumers, regardless of credit rating?
b) Consumers will continue to live beyond their means: buying houses they can’t afford, replacing perfectly good cars with new shinier ones, etc?
Even if we increase money supply, we don’t automatically get inflation–inflation requires banks to lend and consumers to consume, right?
But if we do automatically get inflation (because banks and consumers continue to behave foolishly) isn’t this just creating another bubble? Danger, Will Rogers, Danger!
But when the lending starts – watch out.
LOL, the Japanese are still waiting…..
Seriously, though, polip, you’re right, obviously. My contention is that given the debt overhang that looms over the US economy, we will probably be waiting some time as well. Some of this will go away as the USG eats the “merde baguette” of 20 years’ worth of foolishness in the corporate/finacial sectors, but the household debt overhang still remains. And with precious little real savings to draw down (in contrast to the Japanese who started with something like 12% at the beginning of their lost decade, ultimately drawn down to basically zero), the risk of an accident (e.g., funding and currency crisis) is somewhat higher. (For better or worse, the USD is still the reserve currency of the world and the Fed is the world’s central bank for all practical purposes, so we have a little more wiggle room than would otherwise be the case.)
I am expecting a 30% decline in US GDP from trend over the next decade. I’m not sure how much will be outright nominal decline of real GDP (perhaps 10% – just missing one of the common definitions of “depression”) and how much will comprise very low growth well under “trend normal” 2.5-3% over a number of years. The cumulative misallocations of capital since the early 1980s have simply been too great to escape without a severe adjustment process.
LMRiM
1.) The Japanese are still waiting – true, but it is my contention that the waiting is about to end. Join the party (long Japanese equities) before it really gets going (it is just starting).
2.) The culture in the US vs Japan is rather different. Given large amounts of money, the Japanese consumer decided to hoard, in the U.S., old spending habits will die hard. Thus, despite reserve currency status, our country is at much higher risk of a currency crisis/inflationary event (we just had vicious inflationary bubble!) than Japan ever was. Could work to our ‘nominal’ advantage initially. Longer term, could be fatal. I just can’t predict the future on this one at all. The wait will be long and the end may be a nice simple reflation, or a sudden explosive inflation – I don’t know which.
Agree completely though that our debt overhang will make this process seem like watching paint dry – long painful, and only visible if you understand opportunity cost…
We are in a “liquidity trap” — the wet dream every Great Depression “buff”* — in which treasuries trade as cash. This is a great creative accounting opportunity. For instance, interest on the federal debt could be driven down to zero. Maybe even to negative rates, just to mess with the bond traders whose terminals don’t allow negative bids. Hell, it could be an expensive software development make-work program.
Moreover, fiscal policy is redundant, since issuing treasuries becomes the same as issuing cash, which the fed is able to do without limit (Congress, in its wisdom, imposed a debt ceiling on the treasury, but not a ceiling on the size of the Fed’s balance sheet). If the Fed is allowed to sell bonds, then it will also be able to drain without limit. Therefore, I expect to see Fed bonds if there are significant balance sheet “hiccups”. It would also be nice if the fed was able to naked short assets. In fact, the ad hoc “alphabet soup” of Fed lending facilities is reminiscent of the alphabet soup of new deal spending programs, and the real new deal is already underway — for assets.
*If you haven’t read Bernanke’s “Essays on the Great Depression,” then I recommend picking it up. Borders is carrying it — hurry before they liquidate.
🙂
LMRIM,
Would you be willing to share your methodology for the 30% figure?
I think where you and I differ Satchel is a lot of your thinking is based off of the big chart that shows debt to GDP in the US and the UK.
the difference is –I think there is one more chart you should look at which is assets to GDP.
Asset inflation as well as the ability to lend against more types of assets has allowed for the creation of a lot more debt. Do we still have too much debt–yeah. Do we have to deleverge yeah But it is at least mitigated somewhat by some of that debt being borrwed against new types of assets.
Then you have the followign scenario. The fed controls money compltely. It can print as much money as it wants to inflate asset values. if asset values are inflated that debt can’t be paid off.
now the question i have in my mind is how much of the debt created is because of new abilities to lend against types of assets vs asset lent against income
It would be intersting to see two seperate graphs showing one vs the other.
Well I think he got the 30% from what happened in the great depression. The US was a major exporter and when trade failed we tanked. I believe the contraction in the depression last time I looked was 30-40%. he is basically saying what the fed is doing won’t work.
I think it ignores 1) the rise of asset securitization 2) the fed can make asset prices anything it wants by printing money–it didn’t and couldn’t do that before 3) the US is currently the fiat currency and it appears to have reflated before losing that status 4) the ret of the world is inflating as well.
Cooper,
I was hoping for a back of the envelope calculation of some sort, based on assumptions that feed into the calculation. Great Depression redux would be one such heuristic — can you try to assign some numbers to the points that you raised?
I’ve been struggling with this for some time, and don’t have anything satisfactory.
p.s.
I believe that 4) was also true back then, and that 3) is weighing us down, because it means aggregate demand is being siphoned out of the economy to those who print more than we do, and are willing to face greater hardships than we are. 2) is up to debate both in terms of capability and in terms of desire to do so. I’m not yet convinced that 1) is materially relevant for a gross cash flow/deleveraging analysis. I could be wrong.
you’ll have to wait for satchel to end..my gut is what he did is he just took what happened before. debt to gdp in the depression was actually much better than now (lol). so all things being equal the #s would be worse this time round.
FYI: the dollar lost more than 10% in 2 weeks time as opposed to the Euro.
http://www.dailyfx.com/charts/Chart.html?symbol=EUR/USD
It appears currency traders are betting on inflation.
I wonder if we can have both deflation and currency collapse?
A side effect of this would be a big “wage arbitrage” correction, meaning US getting mechanically poorer with lower wages and cheap currency. Maybe this is a global living standard leveling down (for US) and up (China/India) brought by globalization?
FYI: the dollar lost more than 10% in 2 weeks time as opposed to the Euro
it’s due to the fears of quantitative easing. there were some speeches 2 weeks ago when this was suggested as a higher possibility. seems to have jolted the Forex market, although I have no idea why they’re surprised at this.
Ah yes…we are turning japanese…
🙂
We had some of the worst credit excesses in history and people just expect us to inflate our way out of it…dream on
I’m with “Dave” on the Milkshake question – it is completely related to counterparty risk.
CDs are only insured by the FDIC up to specified maximum sums (up to $250,000 – I don’t even know if these limits apply to institutional purchases… but let’s pretend they do).
http://www.fdic.gov/deposit/deposits/certificate/index.html
Any bank that borrowed in the overnight market and moved the proceeds into CDs would be embracing a measure of uninsured default risk that might result in a counterparty’s incapacity to return investment capital.
Consequently, on a risk-adjusted basis, milkshake’s proposal does not make economic sense.
Further, while LIBOR rates have retreated from the October extremes, the Ted Spread still remains at relatively high levels, especially when one considers it on the five-year chart:
http://www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND
We are not out of the credit woods, yet… which is why the political hacks keep screaming about the need to “get credit flowing again.”
It’s flowing – people are just unhappy with its cost.
Tough.
LOL if it were credit riskthen banks would have been doing that for 100 years. overnight borrowing is always less than CD rates. they don’t do it because overnight rates can change on a dime as we have seen. You don’t know what you are talking about.
You’re right. I’m not thinking clearly. Perhaps, it’s the fever from this hellish bug. Thanks for the tailkicking – must be where my brain was.
Robert,
I don’t have a lot of a lot of “hard” data to project an exact figure for GDP “contraction from trend” – more an intuition from looking at (1) level of current account deficit; (2) increase in aggregate debt in the 2000s (approximately 100% increase in aggregate debt versus 20% or so real growth in GDP – iow, $5 in debt for every $1 in real growth); and (3) the structural misalignment of the economy over the past 20 years as a result of the unprecedented aggregate debt buildup.
You know the Austrians would approve of my “intuitive” methods (they hated the “scientism” of the “constructivists” who thought the economy could legitimetly be analyzed through the very imperfect data that we have). 30% is just meant to convey a sense of the size of the adjustment.
It will be interesting to watch – that’s for sure. I know that so many focus on “aggregate demand” (following the Keynesian equation of national income = gdp = spending (aggregate demand), basically). But I like to think in terms of the “quality” and “sustainability” of that demand; in other words, the structure of the real economy in terms of productive capacity and efficiency.
Clearly, had the US economy consisted for a decade of baking ever higher quanitities of mud pies, aggregate demand (and real GDP) would have grown, but would that have made any sense to try to ensure the continued aggregate demand for mud pies when it inevitably collapsed? That’s facetious of course, but not too far off the mark, I’m afraid.
The central question now is what substitutes for the collapse of aggregate demand resulting from the realization that so much of the debt-fueled gdp activity of the US economy was based on illusion (higher prices for assets caused by credit inflation confused producers into believing that societal preference had actually changed). The Austrians take it as a matter of faith that government will not figure it out, and that their activities will impoverish the economy further by substituting political preference for the formerly credit driven priorities (as a result of central bank and fiscal mismanagement).
To (belatedly) respond to one of your points that we talked about on the other thread, I don’t think it is the increase in debt per se that causes the depression. The depression is caused by the prevention of the necessary liquidation of the malinvestments that were occasioned by the credit inflation/bubble. Specifically, the Austrians argue (and I agree, from what I can tell of reading the histories) that the Great Depression was caused by government refusing to liquidate the malinvestment of the 1920s boom. If they are right, we could be in for a very bad period for a long time, because the Fed and USG seem hell bent on trying to stretch out the recognition of losses and necessary adjustment of asset prices.
Specifically, the Austrians argue (and I agree, from what I can tell of reading the histories) that the Great Depression was caused by government refusing to liquidate the malinvestment of the 1920s boom
They argue this, but it is a counterfactual argument. they are wrong IMO. We have no idea what would have happened had people listend to Mellon and liquidated everything. FWIW, I am for the most part an Austrian myself, but I don’t subscribe 100% to any philosophy.
The cause of the Great Depression was the rampant runup in the 1920’s. It is my contention that the Great Depression was unavoidable after that point. much like the south seas and tulip bubbles and the 1873 depression were unavoidable once they ran up to a certain size.
the problem isn’t govt intervention on the down side, it is laissez faire OR govt intervention (or both) on the up side.
If you recall, for the first part of the depression the government DID allow liquidation of many businesses, firms, etc. it was the second part of the depression that saw the steep deflation. (admittedly it was early and there weren’t many businesses to liquidate)
Even Hoover allowed liquidation in his term. People blame him (partly) for the depression due to his tax hikes, but those did not come until 1932 well into the deepest of the depression. Smoot Hawley clearly worsened things in 1930.
later on people blame the New Deal for lengthening the depression, but that didn’t happen until 1933 years and years into the depression. Unemployment was at 25% by that time.
Anyway, it is simplistic at best to blame the Great Depression on just govt interference. It is also simplistic to say that govt interference caused the runup in the 1920’s. The Great Depression was caused by national mania. we have no idea if anything would have made it better or worse. The liquidationist claim is just that: a claim. there is no way to prove or disprove it. thus it is counterfactual argument and nothing else.
unfortunately, we have recently two back to back manias (stock/.com and now housing).
and clearly our govt is going the way of massive intervention. and I’ve stated many times that I strongly oppose the govt intervention as implemented. however, it is also naive at best to think that the free markets would lead to a better outcome.
I’ve talked about the true problem for some time now-CDS markets. the free markets cannot handle the CDS problem. too big.
You and I probably don’t disagree too much on this, ex SF-er. You’re right that any “what if” analysis is conjecture (ahistorical).
I don’t think that any Austrians would argue against the idea that a deep contraction is inevitable following the credit orgy. I just think that most would subscribe to the view that the contraction need not extend for a decade or more (two decades in Japan) if the government were to take its hands off. As you note, we are going full force into the interventionist mode, desperately fearful of what might happen if the USG and Fed left it all alone, and ascribing more weight to the potential downside consequences of inaction versus downside from action (like in stats I guess, the difference between a Type I or Type II error I guess, or maybe I have that exactly backwards :))
I’m coming around more to the conclusion that money should be allowed to be manufactured by anyone, just like bread or computers or any other commodity. The market would sort out all the questions regarding proper supply and rates. It’s very hard to imagine it doing a worse job than Greenspan and Bernanke! I wonder what the exchange rate would be between USG fiat and the “brand name” moneys that would emerge victorious from the Darwinian shakeout of the private money producers? 🙂
Anyway, all this is far afield, and of course the Austrian ideas would never be implemented (government would never relinquish the power). I’m not primarily interested in the economics from a normative point of view (unlike, say, supporters of Keynes or monetarists who actually implement their theories) but rather whether the Austrians provide insights into what is coming and how to position investment-wise.
back to topic:
(quick synopsis: this is very bad).
longer version:
this fed statement is just amazing.
The rate drop means nothing. we’ve been at an Effective Fed Funds Rate near zero for over a month now, so the Fed is just following the FREE MARKET’S lead (like that LMRiM? The Fed is FOLLOWING the free market).
however, the statement itself is a doozy. It basically opens the door for outright monetization of debt (in other words, “printing”). interesting that they pulled this out so early. it must mean things are really really really really bad since they haven’t ever really done this before. nor have they ever had a Fed Funds this low. Lots of historic things going on.
LMRiM: I’m sure you’re unsurprised but still rolling in your grave even though you’re not dead. I know I am.
This fits in with my Ka-POOM philosophy (deflation then inflation). There is no way on earth any entity can inflate us out of deflation without overshooting into significant inflation. I will start watching for the inflation now. any bets on how long until it’s 5-15%??? My guess is 2 years.
LMRiM: it’ll be interesting to see what the Japanese do now. with the promise of “sustained” near ZIRP we may get a reverse carry trade? I’d guess the Japanese will go to zero.
do you think anybody would try negative rates? that seems impossible given computer algorhithms and money markets (calculating negative returns).
unintended consequences indeed!
LMRiM:
agreed. without interventionist policies there seems little doubt that the contractions would last so long. (nearly 20 years now in Japan’s case) the age old question: rip or peel off the adhered bloody bandage?
in a perfect world, we would have predominant laissez faire policies combined with thoughtful rules and regulations which were enforced stridently. this way, you’d have a general framework for a system but room for free markets to work.
sadly, the deregulation we do see quickly deteriorates into major abuses, and the framework we have is neither well thought out nor enforced correctly
the time to act was in 2004-5. the fed could have easily stemmed the housing bubble by changing reserve requirements and by auditing the bank’s books. instead they continued to tinker with the FFR and allowed them to have off balance entities. another simple fix would have been to simply keep Glass Steagall and also to regulate CDS like insurance OR force it on an open market.
transparency is a good thing. it is also evidently difficult to achieve without govt intervention in the modern world. too bad our govt isn’t interested in transparency. (lending facilites anyone?)
(like that LMRiM? The Fed is FOLLOWING the free market).
LOL, ex Sf-er. A free market? With one monopoly supplier of currency, and the unlimited ability to “print” its inventory? And, of course, the whole world hitched to the Fed: 25% of world GDP (US), reserve currency, and just how many countries with currencies tied either explicitly 1-to-1 (e.g., currency board countries like HK), tied to Fed monetary policies in crawling pegs (e.g., China, and Brazil and others til they blew!), “managed” pegs (much of the oil exporters in the Middle East), or “dirty” floats against baskets (Russia until it blew, some of ASEAN, etc.).
The monster that has been created has nothing to do with free markets, that’s for sure! Oh, and let’s not forget the 40%+ of US GDP that represents uneconomic political choices by the Feds and the states/municipalities.
But of course the Fed follows markets in setting Fed Funds. I think I’ve argued that a number of times on SS (and I certainly believe it). It’s just that the markets are anything but free!
I agree that there is no way the Fed will be able to shift smoothly from deflation to managed inflation. It will be a mess. Should be fun to watch!
ROFL.
sometimes it really is just too easy. I was just kidding!
Free markets is an impossible ideal, just like pure communism. I agree with everything you said. we have a worldwide structural problem and the pegs are a big part of it.
this is why I foresee us going more like Argentina compared to Japan. Much of Argentina’s problem was it’s artificial peg to the dollar. they refused to devalue despite massive trade imbalances (against them). the combination of being a debtor and having your currency pegged can be disastrous.
the US is in a somewhat similar situation. We are a debtor. although we do not peg our currency, others peg to us.
our currency has been artificially strengthened for decades which is a partial cause to the trade imbalance. the only way to resolve this is to allow Forex to operate and devalue our currency. but the pegs prevent this. the creditor nations continue to debase with their policies of competitive devaluation.
thus, it is of limited benefit for us to devalue as the peggers devalue with us.
I foresee these pegs breaking this time around. (and an end to Bretton II).
nice link ex-sfer to the blog on the great depression and inflation vs. deflation.
it basically says that the fed can engineer inflation if it wants to–or deflation based on policy responses. whether its smooth or not–who the hell knows or whether it matters.
the fact is–with a fiat currency you can inflate your with a combination of policy choices. right now the fed is saying—pedal to the medal.
also I think folks who so often quote that debt to GDP # and quote stats on debt service to income need to factor in ASSETS to DEBT. If both fall by the same amount, what are the policy implications? the impliations on the economy?
If the fed inflates and debt stays the same…isn’t that something that should be factored in.
Fact is –a lot of the increase in debt –I think- was driven by securitization which drove prices up and thus mean cheaper debt. the cycle stopped recently but you have to factor this in when comparing it to older charts of debt to gDP.