War in the Winds

When you look at events combining in the model space, the winds of war are starting to blow in earnest.  We have known for a number of months that a military option was going to be played against Iran.  It was only a matter of time and quietly negotiating consent from allies and other interested partners.  Interestingly in achieving that consensus, the players calling for action include quietly a number of GCC countries.  This is to me one of the strongest indicators that the military option is being moved forward is  when Israel and GCC nations are silent partners in calling for military options to be exercised.  However, it is not the only indicator. There are several others, including the inability of OPEC to stabilize oil prices above $75/BBL.

In addition, the financial crisis seems recalcitrant in nature and the EU is threatening to precipitate the second leg down in D2.  G7 nations are facing crushing deficits and shrinking revenues, coupled with persistent high unemployment and decreased consumer spending.  Remember the rhythms between D1 and D2.  War was the final answer for D1 and it looks stronger every day that it is the solution to D2. Below are two more reasons that I will go on record that the military activities will be initiated against Iran between July 11 to August 1st. By who? How? I can’t really say, but as I said the winds of war are starting to blow.  First two months ago, a ship load of bunker buster bombs were shipped to Diego Garcia, remember, now below:

By fleet diplomatic footwork, US Secretary of State Hillary Clinton assembled a sanctions package for submitting to the UN Security Council Tuesday, May 19, which Western diplomats admitted contained few new measures, but gained the reluctant assent of Russia and China, as well as the UK, France and Germany. She achieved this by heavily diluting the original draft. That too will be further revised and watered down in the weeks of haggling ahead before it is approved.
The Obama administration gave ground on severity in order to salvage the last vestige of its sanctions strategy from the disastrous impact of the deal Brazil and Turkey brokered with Iran the day before, whereby half of Iran’s low-enriched uranium would be deposited in Turkey to be swapped for 19.5 percent processed material within a year.

That deal was regarded in Washington as a maneuver to delay the fourth round of sanctions. The secretary of state responded with a package of measures without the teeth for deterring Iran from driving forward toward a nuclear weapon but, as she admitted, it was the best possible in the circumstances.  The measures fall short of a total arms embargo against Tehran, although some additional arms are banned, or blacklisting Iran’s central bank. Iranian ships will be watched for contraband but only boarded in the territorial waters of UN member-states, not on the high seas.States are asked to take appropriate, though not mandatory, measures, exercise vigilance against Iranian bank transactions and “be wary” of dealing with the Revolutionary Guards Corps and the companies it controls.

debkafile http://www.debka.com reported on Tuesday, May 18 in the wake of the Brazilian-brokered deal in Tehran:

The US-led Six-Power bloc, known also as the Vienna Group, was given the sole option of endorsing the deal even though Tehran bluntly declared its intention to continue to enrich uranium up to 20 percent inside the country, in defiance of all previous UN Security Council resolutions. Turkish foreign minister Ahmed Davutoglu said supportively that he saw no need for further sanctions against Iran. As an administration official admitted to debkafile early Tuesday, “the international climate manufactured in Tehran had tossed harsh sanctions against Iran on the rubbish heap because there are no takers.”
The Israeli Prime Minister Benyamin Netanyahu convened his inner cabinet in Jerusalem Tuesday, May 18, to decide how to handle the crisis created by the Brazilian-Turkish-Iranian uranium enrichment accord.

But the fact is that sanctions with real bite had never been more than a will-o’-the wisp in the first place.
For months, President Obama chased the unreachable goal of unanimous UN Security Council approval of sanctions as empowerment for tough, unilateral US and European penalties against Iran. Russia and China had circled around the draft but never climbed aboard. So when Vice President Joe Biden declared in the last week of April that a fourth round of tough sanctions would be in place by the end of the month – or in early May, at latest, he knew they were off the table and hoped only to calm Israel and Iran’s Arab Gulf neighbors and fend off their clamor for tangible action to stop Iran’s nuclear progress.

And US Secretary of State Hillary Clinton was whistling in the dark when she warned the foreign ministers of Brazil and Turkey Thursday night May 13 that they were wasting their time if they hoped their mediation bid would have any practical impact on Tehran’s nuclear aspirations. Both knew that Washington was being relentlessly driven back by Beijing and Moscow on a sanctions draft: US negotiators had more or less agreed on the quiet to draw its teeth by giving up on a total embargo on the sale of sophisticated weapons systems to Iran and energy export restrictions.
The same US official admitted that restrictions on arms sales had been watered down to “very moderate” and provided no real bar to the sale of warplanes and missiles to Iran. The final blow was delivered in Tehran Monday by two non-permanent Security Council members, Brazil and Turkey, dropping out.  In Jerusalem, Prime Minister Benyamin Netanyahu convened his inner cabinet of 7 ministers on the crisis. Both he and defense minister Ehud Barak have come in for extreme criticism in military circles for allowing Israel’s hand to be held by the false prospect of painful sanctions stopping Iran’s development of a nuclear bomb in its tracks.

Barak in particular was accused of misleading the public by his constant assurances that it was up to the United States to deal with a nuclear-armed Iran and the issue was well in hand. Both knew the truth, namely that the Obama administration’s efforts to gather a coalition of world powers for the imposition of effective sanctions had never realistically got off the ground.

debkafile’s military sources report a decision by the Obama administration to boost US military strength in the Mediterranean and Persian [Arabian]Gulf regions in the short-term with an extra air and naval strike forces and 6,000 Marine and sea combatants. Carrier Strike Group 10, headed by the USS Harry S. Truman aircraft carrier, sails out of the US Navy base at Norfolk, Virginia Friday, May 21. On arrival, it will raise the number of US carriers off Iranian shores to two. Up until now, President Barack Obama kept just one aircraft carrier stationed off the coast of Iran, the USS Dwight D. Eisenhower in the Arabian Sea, in pursuit of his policy of diplomatic engagement with Tehran.
For the first time, too, the US force opposite Iran will be joined by a German warship, the frigate FGS Hessen, operating under American command. It is also the first time that Obama, since taking office 14 months ago, is sending military reinforcements to the Persian Gulf. Our military sources have learned that the USS Truman is just the first element of the new buildup of US resources around Iran. It will take place over the next three months, reaching peak level in late July and early August. By then, the Pentagon plans to have at least 4 or 5 US aircraft carriers visible from Iranian shores.
The USS Truman’s accompanying Strike Group includes Carrier Air Wing Three (Battle Axe) – which has 7 squadrons – 4 of F/A-18 Super Hornet and F/A-18 Hornet bomber jets, as well as spy planes and early warning E-2 Hawkeyes that can operate in all weather conditions; the Electronic Attack Squadron 130 for disrupting enemy radar systems; and Squadron 7 of helicopters for anti-submarine combat (In its big naval exercise last week, Iran exhibited the Velayat 89 long-range missile for striking US aircraft carriers and Israel warships from Iranian submarines.)
Another four US warships will be making their way to the region to join the USS Truman and its Strike Group. They are the guided-missile cruiser USS Normandy and guided missile destroyers USS Winston S. Churchill, USS Oscar Austin and USS Ross.

debkafile’s military sources disclose that the 6,000 Marines and sailors aboard the Truman Strike Group come from four months of extensive and thorough training to prepare them for anticipated missions in the Persian Gulf and the Mediterranean.

So keep your attention focused to the Gulf.  Will the storm dissipate or will the winds of war blow harder?  I am opined to support the later as most likely.

The Truth About Economic Recovery..What is the Cost?

If you are awake you will realize that the CONgress was supposed to consider the 2011 budget in April of this year.  The budget proposal was not even presented and as of this writing, no proposal is on the table to be even considered. The reason is the real mess that must be dealt with in the current budget.  This is not however an issue unique to the US.

Each of the G7 are facing challenges unlike any dealt with in the past, including D1.  If you have been following the political process in the UK, each of the parties discussed the need for austerity measures in the UK, but they all understated the problem by at least 75% because of the fear of the public’s reaction to the truth.

The International Monetary Fund printed the Cross Country Fiscal Monitoring Report on May 14 and it contains both the definitive and astonishing analysis of just how bad it is really going to get and in my estimation it contains a lot of happy talk.  For example, it states that the US composite debt will exceed 100% of GDP by 2015.  We were at 90% of GDP this month, so I believe we will exceed 100% by 2011.

Some of the highlights of the report include that while global activity is rebounding faster than projected earlier, the fiscal outlook is not improving commensurately.  In most advanced economies, fiscal developments are still dominated by the need to boost aggregate demand.  The average gross general government debt-to-GDP ratio for advanced economies is projected to rise from almost 91 percent at end-2009 to 110 percent in 2015, bringing the increase from pre-crisis levels to 37 percentage points.  Public debt in advanced economies is also rising as a ratio of household financial wealth, following decades of relative stability.

Government financing needs remain exceptionally high in most advanced economies.  The supply of government securities will also be affected by the eventual unwinding of large positions taken by some central banks.  Since mid-2009, average government debt maturities have shortened.  Yields on government securities in most advanced economies remain relatively low, but spreads have risen sharply in some countries, reflecting concerns about the fiscal outlook.

In the US, fiscal adjustments are required in the 6% of GDP range, which is considered high and very difficult to achieve.  The budget proposal includes a 3-year freeze on non-security discretionary funding, requiring the financial services industry to fully pay back the costs of the TARP, allowing the 2001–03 tax cuts for households earnings more than $250,000 to expire, broadening tax base for corporate and upper-income taxpayers, and eliminating funding for inefficient fossil fuel subsidies. By 2014, the deficit is projected to reach 3.9 percent of GDP.

The enacted health care reform is projected by the CBO to lower federal deficits by US$143 billion by 2019, however many believe the inverse to be true. The administration has created a fiscal commission to identify further savings with the goal of achieving primary balance by FY2015 and achieving long-run fiscal sustainability.

In this context, while a widespread loss of confidence in fiscal solvency remains for now a tail risk, its potential costs are such that the risk should not be ignored. Even in the absence of such a dramatic development, without progress in addressing fiscal sustainability concerns, high levels of public indebtedness could weigh on economic growth for years. This issue of the Monitor presents new evidence on the links between debt and growth: it suggests that based on current projections, if public debt is not lowered to pre-crisis levels, potential growth in advanced economies could decline by over ½ percent annually, a very sizable effect when cumulated over several years.

Even as the global economy improves, fiscal balances in the advanced economies are, on average, worsening. While World Economic Outlook projections for 2010 output growth in the advanced economies have increased by a full percentage point since the last issue of the Monitor, updated projections in Section I of the Monitor show that after discounting for reduced financial sector support operations, both headline and cyclically adjusted (CA) fiscal deficits in these countries will increase in 2010—relative both to the 2009 outturn and to projections made six months ago.

Based on current likely policies, the advanced economies will continue to run sizable primary deficits over the medium term, leading the average general government gross debt ratio—which has already ballooned by close to 20 percent of GDP since the onset of the crisis—to rise by a further 20 percentage points by 2015, reaching about 110 percent of GDP. The outlook is more favorable among emerging economies, where the CA fiscal balance is expected to improve this year relative to last.

Even among these economies, however, the projected improvement in the CA balance this year is barely half that projected in November. Over the medium term, these economies continue to be expected to run primary deficits. As long as the interest rate-growth differential stays favorable for them, debt ratios should stabilize or decline.  However, these economies will still be exposed to interest rate and growth shocks, including as a result of fiscal spillovers from advanced economies. The fiscal outlook is also improving in low-income economies relative to last year but, again, at a slower pace than expected six months ago. These developments are occurring amid heightened market sensitivity to variations in fiscal performance across countries.

Section II shows that many countries will be facing historically high financing requirements this year making them especially susceptible to market pressures. Events in Europe are providing the clearest demonstration of the increased attention being paid by markets to differences in underlying fiscal conditions across countries, as borrowing conditions now vary across euro area members to an extent that would have been unimaginable in the recent past. In this environment, the costs of policy missteps, or of a perception of a lack of preparedness, would be high.  Many countries face large retrenchment needs going forward.

Section III provides updated estimates of the adjustment in the primary CA balance needed to lower gross general government debt below 60 percent of GDP by 2030 in advanced economies: the estimate is high—8¾ percentage points of GDP on average, about ¾ of a percentage point more than in the last issue of the Monitor—but hides important differences across countries, with many of the larger economies confronting above-average adjustment needs. The task is even more difficult than it appears from the headline numbers, as many countries are projected to face increases of 4 to 5 percentage points of GDP in spending for health care and pensions over the next two decades.

The measures needed to address these spending pressures will have to be undertaken in addition to those required to achieve the targeted improvement in the primary balance. The adjustment needed to restore debt to prudent levels (40 percent of GDP) in emerging economies is significantly smaller, at 2½ percentage points of GDP. Here too, however, there are important variations across countries.

To date, few countries have made significant progress in exiting from fiscal stimulus, and where countries have announced deficit reduction targets, details about the measures underlying adjustment are often lacking. Many of those that have made progress were facing acute financing pressures that made delay infeasible. The optimal timing of stimulus withdrawal will vary depending on macroeconomic and fiscal conditions.

Some countries with weaker fiscal credibility are already facing market pressures, and should tighten fiscal policy this year. An early tightening is also needed in countries facing a rapid recovery.  Other countries can wait until 2011. However, all countries should introduce structural measures now to strengthen their medium-term fiscal trends.

So what does this all mean??  We are really screwed.  First, one only has to watch California over the next two or three months to understand how badly we are going to take it in the shorts.  Governments have only two choices in dealing with these facts. Tax more and give much less in services.  For the most part, giving less comes in terms of social support programs, education, and infrastructure.  So be prepared to have Granny move in, buying an SUV to navigate the potholes, and brush up on your home schooling techniques.

Of course this is only true if our governments act appropriately and quickly.  With that be as likely as pigs flying, I would suggest simply learn to live and survive on your own period.  Food, security, and infrastructure is all up to you as an individual.  Now that’s the truth.  Don’t believe me?  Ask the Greeks oh say about September.

Denial Depressions and Hyperinflation

Like D1, we are in denial that we are in a depression.  Like D1, we are being fed happy talk and BS. However D2 has the potential to be even more devastating than D1.  The main reason for me making that assertion is that D2 is hyperinflationary and our global central banks cannot sustain printing their way out of the mess.  If you think that Zimbabwe cannot be a global phenomena, you better look closer at the reality under the spreadsheets.

Unlike today, The Great Depression of the 1930’s was deflationary.  The Consumer Price Index was at 17.3% when it began in 1929.  By 1933 it was down to 12.6%.  In other words, as the depression progressed, the cost of things dropped; what cost $1.00 in 1929 only cost 73 Cents in 1933.

If we adjust 1933 prices to a 2010 equivalent here is how things should be stacking up.

Cost of a new house 1933:  $5,750.00 (equivalent to $93,565.72 in 2010)

Cost to rent a house in 1933:  $18.00 per month (equivalent to $292.00 in 2010)

Brand New Chrysler in 1933:  $445.00 (equivalent to $7241.17 in 2010)

Gallon of gas in 1933:  10 Cents (equivalent to $1.62 in 2010)

Loaf of Bread in 1933:  7 Cents (equivalent of $1.13 in 2010)

1 Lb. Of Hamburger Meat in 1933:  11 Cents (equivalent to $1.79 in 2010)

Can of Campbell’s Vegetable Soup in 1933: 10 Cents (equivalent to $1.62 in 2010)

Dozen Eggs in 1933: 5 Cents (equivalent to 81 Cents today)

As you can readily see if all things were equivalent, we have already had a “silent” 100% inflation since about 2002!

Today’s unemployment rate is fast approaching the worst levels seen since the Great Depression.  The official unemployment rate (U3) released by the Bureau of Labor Statistics is currently at 9.9%.  This is the number often reported by the mainstream media for public consumption but is far removed from reality.

To get closer to the real number we must consult the (U6) figure that is often touted as ‘true unemployment’.  This figure adds into the equation those who fall under the contemporary definition of ‘discouraged worker’ and those who can only find ‘part-time’ work.   That number puts the ‘true unemployment’ rate at 17.2%.  But wait, there’s more!

Today’s definition of a discouraged worker is one who has not found work within the last year.  Prior to 1994, a discouraged worker was defined as one who had not found work within the last month.  That’s a big discrepancy.  If we add those lost souls back into the equation, we come up with a more realistic unemployment rate of right around 22%.  That’s just three clicks shy of the 25% often cited for the worst levels of the Great Depression in 1933. That 25% unemployment figure was reflective of all workers both on and off the farm.

When you combine these facts with the conduct of the world’s major banks and hedge funds the reality should become clear that there is a real coordinated effort to separate the entire world into a small cadre of “rich folks” and a large majority of poor folks (slaves).  Consider this.

U.S. authorities are expanding their probes of past mortgage securities deals, with New York’s attorney general opening an investigation into whether eight banks misled rating agencies, a source familiar with the matter said.  New York Attorney General Andrew Cuomo’s office on Wednesday served subpoenas on four U.S. banks and four European lenders, the source said.

Cuomo is targeting Citigroup, Credit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs Group Inc, Morgan Stanley, UBS and Merrill Lynch, now owned by Bank of America, the source said. The investigation comes as Wall Street and major banks around the world are attracting scrutiny from regulators stemming from transactions that occurred in the run-up to the subprime mortgage meltdown and financial crisis.

The Wall Street Journal on Wednesday reported that U.S. federal prosecutors, working with securities regulators, were conducting a preliminary criminal probe into whether four banks misled investors about their roles in mortgage bond deals. The banks under early-stage criminal scrutiny are JP Morgan Chase, Citigroup, Deutsche Bank and UBS, the newspaper reported on its website, citing a person familiar with the matter. The banks have also received civil subpoenas from the U.S. Securities and Exchanges Commission as part of a sweeping investigation of banks’ selling and trading of mortgage-related deals, the report said.

A spokesman for JPMorgan told the Journal the bank had not been contacted by federal prosecutors and was not aware of any criminal investigation. The other banks either declined comment or were not immediately available. The reports come less than a month after the SEC charged Goldman Sachs with fraud over its marketing of a subprime mortgage product. Federal investigators are also probing Morgan Stanley, The Wall Street Journal reported on Wednesday. The bank’s chief executive, James Gorman, said he had no knowledge of any such investigation.

And so how is our CONgress reacting to these realities? The U.S. Senate voted unanimously to force the Federal Reserve to undergo an audit, for the first time, by Congress’ investigative arm. But the proposed legislation would only allow for a one-time examination by the Government Accountability Office that would focus on the Fed’s rescue of banks during the financial crisis of 2008.

Representative Ron Paul (R-Texas) and others have advocated for regular audits of the Fed, but just such a proposal, presented by David Vitter (R-Louisiana), was defeated on Tuesday by a vote of 62-37. Among those who voted against regular audits were the leaders of both political parties, Harry Reid (D-Nevada) and Mitch McConnell (R-Kentucky).

I think the fact that BOTH party’s leadership voted against these regular audits speaks volumes to support my contention that the congress is no longer a representative legislative body, but is instead bought and paid for by major financial interests in this country and globally.  You must keep in mind the FED is a private corporation.

When the evidence is so strong that the FED and their lack of actions were complicit in the entire series of events, how can such a reluctance of our congress to act be explained? Could it be an army of lobbyists with little suitcases shuttling in and out of every CONgressial office have anything at all to do with it?  Naw!  That’s a crazy rambling of an old fool talking.  Sorry I got carried away I guess.

To quote Keith Johnson in his recent article: “Until the American people snap out of their trance, they will refuse to believe that they are in a depression, recession, panic or crisis.  To them, it will be a loving embrace by a charismatic savior.  Only until they feel the piercing bite of cold air on their necks and the pains of an empty stomach will they finally come around to the realization that the panic is not coming—but that the panic is on!”

Underneath the apparent calm demeanor in the financial community which is really a hubristic disdain for the general public there is panic.  If the sheeple really get a scent of what is happening these jokers will have no safe place to hide.  Just a few more steps and they will have us all in the corral. Just a few more steps.

Where Have All the Flowers (Bailout Money) Gone?

The idea we were sold to fork over nearly $7.6 trillion in taxpayer money was to remove “toxic assets” from the financial system and open up credit to consumers and small to medium size businesses, and we just give this money to the banskters and they take from there.  They are good guys and we can trust them.  Well nearly two years later and things haven’t gotten any better and nobody can get a loan, small and medium size businesses are failing left and right.  Banks are continuing to fail at an alarming rate, nearly 60 banks since the beginning of the year and over 150 banks since the start of the crisis. So where is the bailout money?

In actuality the real estate and the ensuing fraudulent bond fraud was the last straw in the elitist house of cards. The collapse known as the credit crisis will hobble America for years to come unless the system is purged. The Fed over the last year transferred off of bank balance sheets some $1.7 trillion in bonds, CDO’s, known as toxic waste. The Fed won’t tell us who they were purchased from or what was paid for them. It is another secret. The US taxpayer will pay all the losses, as less Fed profits flow to the Treasury. Don’t forget as well that the 3-card Monte game of the Fed lending money to banks at ½% and then receiving those funds back to earn 2% is also a paid for by the public to enrich the bankers.

This last sentence is very important to understand.  Here’s an interesting fact that you may not have seen yet. The M1 money multiplier just slipped below 1. So each $1 increase in reserves (monetary base) results in the money supply increasing by $0.95 (OK, so banks have substantially increased their holding of excess reserves while the M1 money supply hasn’t changed by much).

Since January 2009, the M1 Money Multiplier has crashed further, to .786 in the U.S. as of February 24, 2010:

That means that – for every $1 increase in the monetary base – the money supply only increases by 79 cents. Why is M1 crashing? Because the banks continue to build up their excess reserves, instead of lending out money:

Why are banks building up their excess reserves?

As the Fed notes:

The Federal Reserve Banks pay interest on required reserve balances–balances held at Reserve Banks to satisfy reserve requirements–and on excess balances–balances held in excess of required reserve balances and contractual clearing balances. The New York Fed itself said in a July 2009 staff report that the excess reserves are almost entirely due to Fed policy:

Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in above.  Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. That is a 100 fold increase!!! As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.

Why are banks holding so many excess reserves? What do the data tell us about current economic conditions and about bank lending behavior? Some observers claim that the large increase in excess reserves implies that many of the policies introduced by the Federal Reserve in response to the financial crisis have been ineffective. Rather than promoting the flow of credit to firms and households, it is argued, the data shown indicate that the money lent to banks and other intermediaries by the Federal Reserve since September 2008 is simply sitting idle in banks’ reserve accounts. Edlin and Jaffee (2009), for example, identify the high level of excess reserves as either the “problem” behind the continuing credit crunch or “if not the problem, one heckuva symptom”  Commentators have asked why banks are choosing to hold so many reserves instead of lending them out, and some claim that inducing banks to lend their excess reserves is crucial for resolving the credit crisis.

This view has lead to proposals aimed at discouraging banks from holding excess reserves, such as placing a tax on excess reserves (Sumner, 2009) or setting a cap on the amount of excess reserves each bank is allowed to hold (Dasgupta, 2009). Mankiw (2009) discusses historical concerns about people hoarding money during times of financial stress and mentions proposals that were made to tax money holdings in order to encourage lending. He relates these historical episodes to the current situation by noting that “with banks now holding substantial excess reserves, [this historical] concern about cash hoarding suddenly seems very modern.”

In fact, however, the total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions.

The liquidity facilities introduced by the Federal Reserve in response to the crisis have created a large quantity of reserves. While changes in bank lending behavior may lead to small changes in the level of required reserves, the vast majority of the newly-created reserves will end up being held as excess reserves almost no matter how banks react. In other words, the quantity of excess reserves depicted  reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.

Why is the Fed locking up excess reserves?

As Fed Vice Chairman Donald Kohn said in a speech on April 18, 2009:

We are paying interest on excess reserves, which we can use to help provide a floor for the federal funds rate, as it does for other central banks, even if declines in lending or open market operations are not sufficient to bring reserves down to the desired level.

Kohn said in a speech on January 3, 2010:

Because we can now pay interest on excess reserves, we can raise short-term interest rates even with an extraordinarily large volume of reserves in the banking system. Increasing the rate we offer to banks on deposits at the Federal Reserve will put upward pressure on all short-term interest rates. This is just what we need to stimulate the economy?  Upward pressure on short term interest rates,  yeah, that makes sense huh?

As the Minneapolis Fed’s research consultant, V. V. Chari, wrote this month:

Currently, U.S. banks hold more than $1.1 trillion of reserves with the Federal Reserve System. To restrict excessive flow of reserves back into the economy, the Fed could increase the interest rate it pays on these reserves. Doing so would not only discourage banks from draining their reserve holdings, but would also exert upward pressure on broader market interest rates, since only rates higher than the overnight reserve rate would attract bank funds. In addition, paying interest on reserves is supported by economic theory as a means of reducing monetary inefficiencies, a concept referred to as “the Friedman rule.”

And the conclusion to the above-linked New York Fed article states:

We also discussed the importance of paying interest on reserves when the level of excess reserves is unusually high, as the Federal Reserve began to do in October 2008. Paying interest on reserves allows a central bank to maintain its influence over market interest rates independent of the quantity of reserves created by its liquidity facilities. The central bank can then let the size of these facilities be determined by conditions in the financial sector, while setting its target for the short-term interest rate based on macroeconomic conditions. This ability to separate monetary policy from the quantity of bank reserves is particularly important during the recovery from a financial crisis. If inflationary pressures begin to appear while the liquidity facilities are still in use, the central bank can use its interest-on-reserves policy to raise interest rates without necessarily removing all of the reserves created by the facilities.

As the NY Fed explains in more detail:

The central bank paid interest on reserves to prevent the increase in reserves from driving market interest rates below the level it deemed appropriate given macroeconomic conditions. In such a situation, the absence of a money-multiplier effect should be neither surprising nor troubling.

Is the large quantity of reserves inflationary?

Some observers have expressed concern that the large quantity of reserves will lead to an increase in the inflation rate unless the Federal Reserve acts to remove them quickly once the economy begins to recover. Meltzer (2009), for example, worries that “the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain.” Feldstein (2009) expresses similar concern that “when the economy begins to recover, these reserves can be converted into new loans and faster money growth” that will eventually prove inflationary. Under a traditional operational framework, where the central bank influences interest rates and the level of economic activity by changing the quantity of reserves, this concern would be well justified. Now that the Federal Reserve is paying interest on reserves, however, matters are different.

When the economy begins to recover, firms will have more profitable opportunities to invest, increasing their demands for bank loans. Consequently, banks will be presented with more lending opportunities that are profitable at the current level of interest rates. As banks lend more, new deposits will be created and the general level of economic activity will increase. Left unchecked, this growth in lending and economic activity may generate inflationary pressures. Under a traditional operating framework, where no interest is paid on reserves, the central bank must remove nearly all of the excess reserves from the banking system in order to arrest this process. Only by removing these excess reserves can the central bank limit banks’ willingness to lend to firms and households and cause short-term interest rates to rise.

Paying interest on reserves breaks this link between the quantity of reserves and banks’ willingness to lend. By raising the interest rate paid on reserves, the central bank can increase market interest rates and slow the growth of bank lending and economic activity without changing the quantity of reserves. In other words, paying interest on reserves allows the central bank to follow a path for short-term interest rates that is independent of the level of reserves. By choosing this path appropriately, the central bank can guard against inflationary pressures even if financial conditions lead it to maintain a high level of excess reserves.

This logic applies equally well when financial conditions are normal. A central bank may choose to maintain a high level of reserve balances in normal times because doing so offers some important advantages, particularly regarding the operation of the payments system. For example, when banks hold more reserves they tend to rely less on daylight credit from the central bank for payments purposes. They also tend to send payments earlier in the day, on average, which reduces the likelihood of a significant operational disruption or of gridlock in the payments system. To capture these benefits, a central bank may choose to create a high level of reserves as a part of its normal operations, again using the interest rate it pays on reserves to influence market interest rates.

Because financial conditions are not “normal”, it appears that preventing inflation seems to be the Fed’s overriding purpose in creating conditions ensuring high levels of excess reserves. However, is it?  I would  suggest that the FED is simply taking full and complete control of the monetary policy without permission and with the full support of our CONgress harlots. The Dodd reform bill is a sham and people like Uncle Warren B, who called credit derivatives “weapons of mass destruction”, while holding over $60 billion worth and getting a sweetheart exemption for them in the Dodd bill are..let’s be kind being deceptive with us.

For you and I and all the hard working small and medium size business people in the US who really create the quality jobs.  Well, we just have to load another 16 tons boss.