Interest rate reality check

There is a lot of talk about when “the Fed” is going to “raise rates.” Rates are actually determined mostly by supply and demand in the money market. Without getting into an academic fracas, I am going to present some graphs representing very strong empirical regularities that suggest interest rates, long or short, are not going up any time soon.

I’ve presented one of these before, the long term chart; here I’ve added the 3-month T-bill. These graphs show the relationship between interest rates and the ratio of the St. Louis monetary base to GDP. Data is to April or first quarter 2014. The ratio of base to GDP is ~0.23 currently.

Here is the trajectory of the base/GDP ratio. Can you spot the taper?

Here is the trajectory of base:

From these empirical regularities I draw the following conclusions:

• Interest rates aren’t going up any time soon. The “taper” is really a reduction in the rate of addition to base, not a reduction of base.
• Nor is inflation taking off any time soon, except for stagflationary cost-push. Negative real interest rates will continue. The labor market has no power; the reserve army of the unemployed (whether they are categorized as such or “not in the labor force”) is growing. There is no wherewithal for a wage-price spiral to get started.

This mirrors the experience of the Thirties. ZIRP in that period lasted until near the end of WWII. It took a war to get the inflation started. Federal debt exploded. But America had relatively less sovereign debt going into that war; we are already at comparable levels.

So people who suggest that the Fed “raise interest rates” are really asking the Fed to reduce the size of the monetary base a huge amount. There is no question the Fed would crash the stock market if they did this, purely because of the “optics,” so it won’t happen. Moreover, if the Fed sent all those bad debts back into the banking system they’d be subject to “stress testing” (heaven forbid they were actually marked to market) that I somehow doubt the Fed does on the stuff they hold. (Comment if you know better than I, please.)

Plutocracy World, the Global Casino, rocks on for years to come. The banking system hangs like an albatross around the neck of the world economy. China seems to be making the same mistakes; it will be interesting to see what they do with all their bad debt.

The great economic task of the first half of the twenty-first century will be to reform the world’s monetary system.

On the moral superiority of blogging hedgies

While I am an avid follower of several financial blogs written by folks who make their money managing money, I at times become impatient with their unrelenting condemnation of the messed up world situation while they are actively trying to arbitrage it.  As Dmitri Orlov has said, the financial types are the ones earliest to understanding of the extent of the rape and pillage of Main Street by Wall Street, and the complicity of Washington—the Fed and the federal government.

I get tired of the attitude of moral superiority, even as I appreciate the information and knowledge flow provided, that just isn’t reliably going to occur in the MSM.  I do hope these people are doing something with their money for charitable causes.  We salarymen can hardly imagine the amounts of money they make.  A young friend who just moved to London took a flat in Notting Hill with another young American working in The City, who casually allowed that he was in the habit of spending 300 pounds a night when he goes out. The stories of financial sector excess are rife, but they sting when it comes close to you.

In sum, these folks are part of the problem, exacerbating the inequalities that are tearing the world apart.  Cassandra recently schooled those peers who let their moral indignation get in the way of making good investment decisions.  Of all the financial bloggers, Barry Ritholtz stands out as having the best follow-through on policy recommendations, informed by legal training and a proudly middle class, up on your merits, background.  Barry’s positioning in the New York and Washington media outlets suggests some higher levels of support.  Yves is good but lets her cynicism get the better of her too often; likes to carp too much.  Kyle Bass keeps forecasting doom for the Japanese but doesn’t seem to recognize that only about 5 percent of Japan’s government debt is owned by foreigners, so the MMT refrain of “print to pay” applies.  Japanese life expectancies have been rising during their supposedly lost two decades, which I’ve never heard Paul Krugman acknowledge.  The Japanese take care of each other as a big family.  Japanese boomers may very well come up with methods of forgiveness to keep the kids on the islands, so long as the boomers can eat and have a roof over their heads.

Make a nonrandom act of kindness today. 

Peace.

The FDIC is in trouble

Via:  The Daily Reckoning   Nothing succeeds like failure in disciplining a financial system, an inconvenient fact that we’ve forgotten in our age of unlimited moral hazard or financial fascism.  The current administration could be called “The Dukes of Moral Hazard…,” with Tim Geithner as their poster boy.

As we all know, the Federal Deposit Insurance Corporation (FDIC) guarantees depositors that they'll get their money back if a bank fails, at least up to a certain amount. To fund its operations, the FDIC collects small fees from the banks that are held in reserve for the purpose of taking over troubled banks and paying off depositors.

Since the Great Depression, a period marked by widespread runs on banks, the FDIC has done a good job of fulfilling its mandate. So how are they doing in this crisis?

In a nutshell, they are in trouble.

The FDIC insures 8,246 institutions, with $13.5 trillion in assets. Not all of them are going bankrupt, of course. Yet as of late July, a disturbing 64 banks had gone belly up this year - the most since 1992 - costing the FDIC $12.5 billion. At the end of Q1, the agency was already asking for emergency funding.

And worse, much worse, is likely yet to come. The following chart shows the total assets on the books of the FDIC's list of 305 troubled banks. The list doesn't include the biggest banks that are considered too big to fail, as they are being separately supported with bailouts. By contrast, if the banks on this list fail, the FDIC is on the hook to have to step in and take them over and, of course, make depositors whole.

Other measures of how serious the losses at banks are becoming can be seen in the chart below, which shows charge-offs and non-current loans at all banks. You can see that the Net Charge-offs remain stubbornly high, with banks charging off almost $40 billion in bad loans in the last two quarters alone. And the number of non-current loans - loans where payments are not being kept up - is soaring.

Together, these measures indicate the potential for more big failures and more big bailouts coming down the pike.

Into the battle against bank insolvency the Fed brings a level of reserves that can best be described as paper-thin. From almost $60 billion last fall, the FDIC's reserves have been drawn down to only about $13 billion today, a 16-year low. A quick look at the FDIC's own data shows us how inadequate those reserves are compared to the deposits they are now insuring.

The chart below says it all:

As you can see, the Federal Deposit Insurance Corporation currently covers each dollar on deposit with a trivial 2/10ths of a penny.

And even that understates the seriousness of the situation: the $4.8 trillion in deposits the FDIC is providing coverage on doesn't include the expansion that now extends insurance coverage from $100,000 to $250,000 for normal bank accounts. That likely brings the exposure of the FDIC closer to $6 trillion. But that's pretty inconsequential at this point: using any reasonable accounting method, the FDIC is already bankrupt and will require hundreds of billions of dollars in government bailouts just to keep the doors open.

So, given the dire shape of its finances, what measures is the FDIC taking, you know, to batten down the hatches and all that?

For starters, they are expanding their mandate by guaranteeing bank loans - $350 billion and counting at this point. And the government has tapped the FDIC to play a pivotal role in guaranteeing the loans issued to buy toxic waste through the government's highly problematic and fraud-prone new Private Public Investment Partnership (PPIP). The FDIC's commitment to the PPIP is and may become limited based on its resources.

It is hard to draw any other conclusion but that hundreds of billions in new funding will be required to keep the FDIC operating. Given the catastrophic consequences of the FDIC failing, starting with a bank run of biblical proportions, there's no question it will get whatever funding it needs. By loading the new loan guarantee responsibilities and the PPIP onto the FDIC's back, the administration will go back to Congress and ask for the next large bailout.

Of course, in the end, all of this falls on the taxpayer, either directly in the form of more taxes or indirectly via the destruction of the dollar's purchasing power. Another bale of straw on the camel's back, and another reason to be concerned about holding paper dollars for the long term.