Yellen and the Senate Banking Committee describe a winter economy

The Honorable Dr. Janet Yellen, Chair of the Federal Reserve, testified before the Senate Banking Committee yesterday in a ceremony that her predecessor, Dr. Bernanke, must have come to dread towards the end of his tenure.

Of course, towards the end, Dr. Bernanke’s tenure had been marked by the largest economic downturn in memory for most and he found himself shouldering much of the blame.  Bodies such as the Senate Banking Committee often took the opportunity to grill Bernanke on the latest financial headlines or the direct complaints from their constituents stemming from various financial debacles that had unfolded during his tenure. Be it Lehman Brothers, MF Global, or the troubled housing market, Bernanke could count on questions ranging from the dangerous to the ridiculous from committee members who were, in many cases, further removed from reality than Dr. Bernanke himself.

So it was that Yellen took the hot seat that her predecessor had dreaded yesterday before a new set of faces in order to explain what she sees in her economic crystal ball.

From what could be gathered from the mostly scripted exchange between the parties, there seems to be a range of lingering worries in the minds of policy holders as to the health of the US economy, which recently clocked in at an underwhelming 0.1% annual growth rate in Q1 of 2014. The worries, which are no doubt rooted in recent history, range from the continued drop in labor force participation rates and what many see as a stalled out recovery in the housing market.

The US Q1 GDP number can be summed up in a phrase that Red Green was fond of, “It is winter.” Housing markets invariably slow down over the winter months, which are generally a drag on GDP as households recover from the Q4 holiday spending binge.

Labor market participation, which surfaced as a primary concern during yesterday’s hearing, is a much more complex problem, for deep down it validates the fears of nearly every thinking economist, that the US is following in the footsteps of Japan’s demographic and economic precedent.

The real problem with the US economy was not addressed directly at this hearing, nor is it likely to ever be addressed in such a forum: The extraordinary measures employed by the Fed back in 2008 in an effort to prop up the international banking system have forever altered the mode of transmitting credit into the economy. This has caused a broad based reset of the banking food chain at a time when the US economy could least afford for such a change to occur.

These extraordinary measures will be with us until the US Dollar hits its breaking point, and the inevitable currency reset begins to pick up steam. When this occurs, Dr. Yellen and the Senate Banking Committee are likely to be the last to know.

A Discussion of the Merits of Short Term Interest Rate Management, Part I

4/28/2014 Portland, Oregon – Pop in your mints…

One of our working hypotheses here at The Mint is that short-term interest rate management, the primary tool employed by the Central Banks of the world to implement monetary policy, is necessarily harmful to the economy by providing incentives for achieving what otherwise would be suboptimal economic outcomes. By extension, we believe that these suboptimal outcomes are not simply a lost opportunity or a generator of wasted efforts and resources, but a primary contributor to the imbalances in the environment which today bears the label “climate change.”

Recently, we were invited to present our hypothesis at a Global Macro Roundtable for discussion. Today and over the next several days, we will present a slightly redacted transcript of the roundtable for the consideration of our fellow taxpayers. Names (with the obvious exception of our own) have been changed to protect both the innocent and guilty.

As you will see, the discussion (which we have color coded in order to help follow the cast through the maze of discussion) takes many twists and turns, and in a way reveals how far-reaching the influence of short-term interest rates has become, as well as the broad misunderstanding of the concept of money that persists to this day.

Enjoy!

A Discussion of the Merits of Short Term Interest Rate Management

The hypothesis:

Why Short-Term Interest Rate Management is Harmful to the Economy: The Unseen Funding Dynamic 

While the evidence is clear that centralized planning is a failure, pointing to the reasons why can prove elusive. Recently, a revelation regarding the problem with centralized management of short-term interest rates came upon us. The revelation is the following: Imagine you are a banker who needs to fund a loan. In order to fund this loan, you would presumably need to have the money available with which to fund it. This is simple logic, however, in the real world of banking, the decision of whether or not to fund a loan is completely disconnected from the availability of funds, which is primarily determined by the overnight funding markets which, in turn, are completely reliant upon short-term interest rates.

In a world that followed the rules of financial physics, the short-term interest rates would be completely dependent upon the availability of funds in the system. However, the centralized management of interest rates makes this critical data point, which would otherwise provide a snapshot of the amount of capital in an economic system which is held in liquid form and available for deployment, irrelevant, as the amount of capital available in today’s centrally managed system can be determined on whim.

As such, the ability of the banker to fund the loan is not dependent upon an availability of funds that represents the amount of capital available in the real world, rather, his ability to fund the loan is completely dependent upon the borrower’s ability to pay and the size of the loan in relation to the structure of the bank’s balance sheet.

The three criteria above are important, as any underwriter will tell you, but the invisible fourth criteria, the true availability of the funds for the loan, or funding dynamic, is completely ignored in the following fashion:

When the short-term interest is managed to be low, as is the case currently, any borrower who has the capacity to pay and has a lending need that fits well with a certain bank’s loan mix is extremely likely to get funded, regardless of whether or not the economics system as a whole has the capital available to fund his or her loan. When the short-term interest rate is managed to be high, as it was in the early 1980’s in the US, funding any loan, regardless of the ability to pay and fit within bank’s balance sheet, becomes impossible to fund.

In both cases, both borrower and banker are left completely in the dark as to whether or not there exists the necessary capital stock or productive capacity in the economy for the funds to be deployed in the manner that the borrower envisions, for the short-term interest rate signal has been genetically modified to send a common signal to all participants.

Unfortunately, it is a signal that blinds everyone to the facts of the situation. For many are the hopes, dreams, and ideas of mankind, but it is the funding dynamic which keeps these hopes, dreams, and ideas in harmony with the natural world upon which we all depend.

Right now, we are floating in the clouds, completely disconnected from reality. The landing caused by the next round of high rates, via a natural rebalancing of accounts or further genetic modification of the short-term rates, will be very hard indeed.

The funding dynamic is so delicate that mankind cannot hope to optimize it via genetic modification, for when left alone, it is optimized by definition. Again, by definition, every attempt to modify will bring about sub-optimal results.

As with all complex economic and political systems, dissent is information, and serves to manage the system’s outputs while at the same time increasing the resiliency of the system, making it less susceptible to shocks.

Centralized short-term interest rate management must be abandoned before it is too late, for it is leading the activities of mankind towards a dangerous showdown with the limitations of the natural world.

Discussion

“Contributor A: This brings to mind the Pareto curve reaching a knee limit and catastrophe theory when there is a Quantum state change in the system being considered (the twig will snap, the water will boil as energy (money) is added, etc.). We are expanding the money supply and disregarding that eventually an infinite amount will be needed.

One other point is the Multiplier effect at the Bank who gets $ 1 Million from the fed and uses a low Reserve to make loans greatly exceeding that because the Loans are an asset on their books ; and, as repayments come in multipliers on those. Where does it stop? When the twig snaps and then raging inflation must kick in at an Exponential level with time. Then SNAP!

Contributor B: I have no disagreement with the conclusion, however, the facts leading there need to be adjusted/considered. For example, in the early 80′s, liquidity was not nearly the issue as it was raised in the statement. Not only did my clients acquire funding as required in that period, but I [stupidly] agreed to a mortgage in that period with an interest rate that still gives me nightmares. For the last few years interest rates have been suppressed, but at the same time my middle market clients have complained of there being insufficient liquidity to fund their business loans, meaning that new business ventures were not realised. This has relaxed in the past year or two slightly, but you need to remember one of the issues regarding the vast amount of dollars being held in banks.

When the FED began shipping huge quantities of dollars to friendly banks after the 2008 crash in order to stabilise some very shaky balance sheets, the FED promised to pay interest to the banks on those funds kept in storage with one absolutely unbreakable codicil: under no circumstances could the banks use those funds as part of their asset base in making loans. In other words, none, zero, zip, nada, NONE of those FED funds could be used for loans. Clearly, this move suppressed what would have been an immediately inflationary environment in the US, a highly destructive inflationary environment. But it also left these banks which were otherwise strapped for funds floundering for any money to loan out to their best small business customers. The banks may have stabililsed in the past few years of lean flow of funds, but it is not that much better in the commercial market for small and mid-sized customers.

The Mint: As Contributor A highlights, the entire modern monetary system is extremely fragile and, given its debt base, could quickly disintegrate were a crisis of confidence to emerge or a widespread failure of technology make it inaccessible.

Contributor B (to whom I will defer on funding experiences of the early 80′s) brings up an important point in the form of the “unbreakable codicil” of the FED with regards to funding intended to shore up the Federal Reserve system. While this move made the banks and system technically solvent, the Fed has ignored the fact that the US economy has outgrown the Federal Reserve system, as the economy is starved for money at a time when the Fed’s measurements indicate that quite the opposite is true.

In the 2008 panic, the Federal Reserve deviated significantly from its traditional funding mechanisms to save its system and has altered the normal monetary transmission protocol. I believe that this has created a feedback loop which will result in the Federal Reserve system receding and other mediums of exchange posturing to take its place.

Contributor B: I thoroughly agree that it will be reset, David. However, while you may see market forces and evolved consumer needs driving this reset, I tend to pay attention to the political aggression of states not at all amicable to the interests of the FED and believe the geopolitical transformation we will witness may be the lynchpin upon which the existence of the FED depends. In the long run it will not really matter to the FED whether it is driven by the economic needs of the consumer or the geopolitical ambitions of another nation, but it will matter to the ordinary participants, I suspect. The withering of FED control worn away by alternative exchange mechanisms will provide a much different life at ground level than the sudden repudiation of the USD as the world reserve currency as anticipated (and desired it seems) by the Chinese military (along with a few others who are tired of US economic hegemony). The former is a transformative change more gradual in nature while the latter can be far more sudden in keeping with the rapid shifts in the global market; the former providing the opportunity to adjust more peacefully while the latter is expected to lead to widespread disruptions in service, food, and support delivery at the ground level. Food riots, water riots, just plain riots, and toilet paper riots… sorry, basic staples of urban and 21st century life will be in short supply. I think I’ll find farmland in another country far away.

For ease of transition, I’d vote for alternative exchange mechanisms. Curiously, I saw an article a few weeks ago that noted extreme activity increases in southeast Asia on Bitcoin and the development of alternatives… either opportunity or another front in the attack on the USD. It can be both.
Now, to envision a world without central banks. That takes us back a while in history…

Then again, perhaps this graph {Editor’s Note: Regarding the Longevity of currency reserve status over the past 600 years} tells it all:
http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2012/01/20120103_JPM_reserve.png

… and speaking of market competitors, Googlecoin? it is being touted already.

Contributor C:

“Centralized short-term interest rate management must be abandoned before it is too late, for it is leading the activities of mankind towards a dangerous showdown with the limitations of the natural world.”

I like above statement. 

This game of interest rate putting up and down could create a crisis if somebody implemented at the wrong time. I consider interest rate as a weapon of mass of destruction if we manage it recklessly. Interest rate volatility creates problems for investors, homeowners and other savers. What about instruments linked to interest rates? What will happen if we don’t carefully manage or misuse those instruments? Why do we see higher interest rates in some periods and lower interest rates in some periods? Can’t we find solution to fix interest rates without creating volatility?”

The discussion, which is about to take many an unforeseen turn, continues tomorrow…things are about to get lively (at least lively as far as short-term interest rates discussions go) indeed!

Stay tuned and Trust Jesus.

Stay Fresh!

David Mint

Key Indicators for April 28, 2014

Copper Price per Lb: $3.07
Oil Price per Barrel: $100.93
Corn Price per Bushel: $5.07
10 Yr US Treasury Bond: 2.68%
Bitcoin price in US: $431.71
FED Target Rate: 0.10%
Gold Price Per Ounce: $1,303
MINT Perceived Target Rate*: 0.25%
Unemployment Rate: 6.7%
Inflation Rate (CPI): 0.2%
Dow Jones Industrial Average: 16,361
M1 Monetary Base: $2,721,500,000,000
M2 Monetary Base: $11,353,000,000,000

Basel III Liquidity Ratios

4/18/2014 Portland, Oregon – Pop in your mints…

Up until the financial crisis of 2008 and beyond, most Americans who were not alive during the early 1930′s had grown up in a world where choosing a bank was largely a matter of preference. Once the FDIC insurance program was instituted on January 1, 1934, depositors had little to worry about.
The financial crisis that the world just experienced was a wake up call on many levels. The first alarm rang for many Americans, members of congress included, when the Troubled Asset Relief Program (TARP) was sent on a freight train through the House and Senate under the threat of an imminent global financial meltdown. Meanwhile, in Europe, the European Central Bank and European Union take a series of measures to shore up both their banking system as well as the finances of their member nations.

Giving away trillions of dollars to businesses who made bad decisions, while ultimately the chief function of government, is, paradoxically, politically unpopular. As such, the governments of the world, who found themselves on the hook for losses in the financial system of a nature that many of them could not hope to understand in terms of nature and scope, began to devise a series of rules that would ensure that this sort of thing would never happen again.

So it was that, sometime in 2009, the word Basel, which until that time was a typo on a recipe card, became prevalent in the world of banking.

Basel is a city in Switzerland where the world’s banking regulators chose to meet to put their minds together as to what types of rules were needed so that the financial crisis would never happen again. Today, five years later, the rules that they took so much time to tailor are indeed perfect for a world that existed five years ago. As it stands today, the rules could very well be the cause of the next financial crisis.



The Basel accords and, more specifically, the Basel III Liquidity ratio, which is our focus today, are generally aimed at ensuring that large banks (those with $50 billion USD or more in assets, “too big to fail”, if you will) will always have enough liquid assets to meet the demands made on it each day.
The Basel III liquidity ratio is a simple ratio which places a banks Liquid Assets, meaning cash, Treasuries, and Agencies) over its Stressed Cash Outflows (meaning maximum foreseen withdrawals during a liquidity crisis). The banks must report this ratio at a set time every business day. If the ratio is over 100%, all is well. If not, not, meaning the bank could be forced by regulators to initiate a strategy to unwind its operations.

Serious stuff.

While the numerator of the liquidity ratio is extremely simple to calculate, it is driven by the denominator, which is infinitely more complex. This is where you and I, fellow taxpayer, come in.
Banks will be required to stratify their deposit customers well beyond the simple consumer and business account denominations that have sufficed to some degree until now. They are now required to carefully monitor customers to better understand their daily inflows and outflows from their accounts in order to arrive at a maximum Stressed Cash Outflow number for each category of account.

As a practical matter, the bank will assign each category of customer and account a “run-off” factor, which is expressed as a % of the account’s balance on any given day that may “run” out of the bank. Again, this number is critical for the bank, as it ultimately determines its reinvestment strategy and, by extension, how profitable a deposit customer is.

The good news is that consumer and small business accounts which are FDIC insured are, as of the most recent comment period, assigned a 3% run-off factor. Meaning that for every $100 on deposit, the bank must buy $3 worth of Treasuries as an offset, and it is free to invest the remaining 97% in loans or other more profitable investments.

This means that competition for deposits from consumers and small businesses just got more intense, which should generally be good news for customers. They should expect to see increased savings rates and incentives to hold both more cash and conduct more business at a specific bank, as it will be in the bank’s best interests to retain them and understand their spending habits.

The bad news begins outside of the realm of FDIC insured accounts. For all balances over the FDIC limits for the same customers, the run-off factor, which, all things being equal, has an inverse relationship with a bank’s profitability, jumps to 10%.

For larger Corporate customers, who tend to have operating (daily transaction) and non-operating (reserve) accounts, the run-off factor jumps to 25% on operating accounts and 40% on non-operating accounts. This makes large corporate customers somewhat less attractive.
 
The people that no one will want to bank with, from a run-off factor standpoint, are financial companies (think Insurance companies, small banks, etc.) who are presumed to have a run-off factor of 100%, meaning these companies, under Basel III liquidity rules, must be seen as ready to walk into the bank on any given day and withdraw all of their accounts.

In a way, the 100% run-off factor on financials makes sense, as it requires all large banks to hold Treasuries to backstop the accounts of financial companies. It is a “regulatory” guarantee that these companies will always be liquid.

The way around the 100% run-off factor for financials and other large institutions are accounts with covenants to provide the bank with at least 30 days notice before withdrawal. This type of notice requirement, in theory, gives the bank time to arrange its investments to be able to meet the cash outflow without impacting overall stressed cash outflows.

As one can imagine, Basel III will lead to a number of new banking products in terms of accounts and credit lines. Briefly, this is what consumers and companies can expect to see as January 1, 2015 approaches:

1. A dogfight for small, FDIC insured deposits.

2. Decreased access to business lines of credit, as the Treasuries will be the default reinvestment vehicle for banks as they attempt to sort out their daily Liquidity ratio.

3. Point 2 above means that low-interest rates on Treasuries are likely to be embedded for quite some time.

4. Deposit products which cannot be withdrawn with less than 30 days notice without steep penalties. One idea we have heard is a “perpetual 31 day time deposit,” meaning that the 30 day withdrawal notice requirement is embedded in the covenant, it is like an operating account that the customer has to give 30 days notice, like they would a landlord, to the bank before withdrawing.

As the Affordable Care Act has fundamentally changed the healthcare industry, Basel III will fundamentally change the banking industry. While its aim is to forever stabilize financial markets, its implementation may be the biggest threat that financial markets have seen since late 2008. Beyond that, it places the bedrock of finance firmly on the shoulders of sovereign bonds, which, despite being seen as completely liquid, hold a myriad of unknown risks.

Basel III, coming January 1, 2015. The time to prepare is running out, and the time for action is upon us.

Stay tuned and Trust Jesus.

Stay Fresh!

David Mint

Key Indicators for April 18, 2014

Copper Price per Lb: $3.03
Oil Price per Barrel: $104.30
Corn Price per Bushel: $4.94
10 Yr US Treasury Bond: 2.72%
Bitcoin price in US: $475.00
FED Target Rate: 0.09%
Gold Price Per Ounce: $1,294
MINT Perceived Target Rate*: 0.25%
Unemployment Rate: 6.7%
Inflation Rate (CPI): 0.2%
Dow Jones Industrial Average: 16,409
M1 Monetary Base: $2,704,700,000,000
M2 Monetary Base: $11,330,600,000,000

Bitcoin Stars in a Senate Hearing

11/19/2013 Portland, Oregon - Pop in your mints…

The virtual currency known as the Bitcoin has achieved what has become a badge of honor in the finance industry, it has become the subject of a Senate hearing.

Senate hearings have, in the past, starred noble characters such as MF Global and its lead actor, John Corzine, who still roams free after punting roughly $1.6 Billion USD to another Wall Street leading man, Jamie Dimon, who remains the head of JP Morgan, who added a $13 Billion fine to its list of greatest hits related to its dealings with other entities during what has become known as the Financial Crisis of 2008.

And who can forget the Gorilla, Lehman’s Richard Fuld, who starred in one of the earliest versions of such hearings and gave us the phrase, echoed by insolvent bankers throughout the world, “why us?”

As the Bitcoin has no central authority to speak of, the Senate Committee on Homeland Security and Government Affairs called Jennifer Calvary, head of the Financial Crimes Enforcement Network, Edward Lowery of the Secret Service, and Mythili Raman of the Justice Department to testify on its behalf.

As may be expected by three persons who are cast in the role of antagonist to anything offering anonymity to private citizens, a privilege that the government refuses to recognizes, they expressed concern about “what could happen” and “who may be using” virtual currencies such as Bitcoin.

However, the antagonists did show a measure of empathy for their crypto-foe, the same way viewers feel empathy for characters like John Q or Walter White.  While taking the government line that what people may do with Bitcoins may be bad, the Bitcoins themselves are generally harmless and, in fact, may provide a great benefit to society.

As pageantry that generally accompanies a finance related Senate hearing unfolded, the Bitcoin market went ballistic, touching $900USD before the elevator moves inherent in the Bitcoin/USD (or any other debt based currency) market took hold and thrust it back to $600, it is now climbing past $700 as we write.

While it is interesting for Senators to listen to how various branches of government propose to regulate Bitcoins, it is clear that, while they may have a glimmer of a chance of understanding the technological framework of Bitcoins, they have no clue what it means in the monetary realm, for they do not understand money.

Alas, much of humanity is in the dark as to monetary theory.  It is for this reason that we started The Mint, to explore this deep “mystery” that lies in the wallet of each and every one of us.

Along the way, we have found gems for those who would pause and listen, such as the key to reversing the effects of climate change, and why Bitcoins are the gold standard of digital currencies.

To be sure, Bitcoins have an Achilles heel, but it is not what many people think, want to know what it is and when to get out of Bitcoins?  Someday we will give them away, for now, it will cost you $0.99 USD, or 0.00141 BTC to find out.  Please pick up our hastily written guide to Bitcoins, which, to our knowledge, is the only one that has examined Bitcoins through the lens of monetary theory with clarity and coherence.

All we can say for the moment is that Bitcoin is a buy, you can sort out the details later.

As for the government’s concerns regarding Bitcoin’s inherent anonymity in the monetary realm, we propose the following Quid pro quo.  Rather than the public being obligated to respond to the straw man argument of “If you have nothing to hide, what are you worried about?” what if the public’s retort to the government became a universal, “if you have nothing to fear, what are you worried about?”

Stay tuned and Trust Jesus.

Stay Fresh!

David Mint

Email: davidminteconomics@gmail.com

Key Indicators for November 19, 2013

Copper Price per Lb: $3.16
Oil Price per Barrel:  $93.43

Corn Price per Bushel:  $4.17
10 Yr US Treasury Bond:  2.71%
Mt Gox Bitcoin price in US:  $772.00
FED Target Rate:  0.09% 
Gold Price Per Ounce:  $1,274

MINT Perceived Target Rate*:  0.25%
Unemployment Rate:  7.3%
Inflation Rate (CPI):  0.2%
Dow Jones Industrial Average:  15,967
M1 Monetary Base:  $2,515,000,000,000

M2 Monetary Base:  $10,867,000,000,000

Why What We Use as Money Matters

11/3/2013 Portland, Oregon – Pop in your mints…

Could it be that it is not how, but what we use as money that matters when contemplating the root causes of Climate Change and other global problems? This is the question that is at the root of our Economic and Philosophical Treatise which bears the cryptic name:

Why What We Use as Money Matters: Unpacking the Key to Reversing the Effects of Climate Change is an Economic and Philosophical Treatise

Why What We Use as Money Matters now in print!

Our Monetary Magnum Opus is now available in print at the following embedded links onAmazon.com and Createspace.com.

While there seems to be an endless debate as to what humankind should do in order to reduce our impact on the environment, ironically most of this and indeed countless other political debates result in more action being taken, either to cease and desist an activity or mobilize to clean up and reduce future environmental impacts of certain actions.

However, every action brings about some sort of reaction, often in the form of an “unintended consequence” which serves to negate any good that the carrying out of the well intended initial mandate had managed to accomplish.

Despite Al Gore’s call to action, realistic and manageable solutions to Climate Change remain elusive. As such, where Gore and other Climate crusaders have failed, we have been compelled to step in. You see, there is really a quite simple, certain, and palatable solution to Climate Change that could be implemented today.

The solution lies not in well-known solutions such as recycling, Cap and Trade schemes, development restrictions, technological advances, or taxes and other social engineering methods. In fact, it has absolutely nothing to do with what people do or what they or their governments spend their money on.

It lies in What we use as money circa 2013.

What the world uses as money is not really money, but a highly liquid debt instrument. While the difference is imperceptible to most, the accumulation of mistaken incentives and resulting actions on behalf of humankind which are inherent in the insane debt as currency model are beginning to manifest themselves in nature, and nature itself is beginning to bring itself into balance unilaterally.

Where humankind and the land once lived in a peaceful, mutually beneficial balance with one another, the relationship has become antagonistic and will remain so until the defects in the money supply are remedied.

How, then, can these defects be remedied? Ah, fellow taxpayer, it is for this reason that the above mentioned book contains 400 pages, for while the answer is simple, it will require that humankind let go of some deeply ingrained ideas which a vast majority of us do not even know we hold fast to.

Start letting go by ordering your copy today!

Print editions are currently available at Amazon.com and Createspace.com and Electronic editions are available on Amazon’s Kindle, Barnes & Noble, Google’s Play Store, and a variety of formats via Smashwords.

Thank you for joining us in this quest.

Stay tuned and Trust Jesus!

Stay Fresh!

David Mint

Email: davidminteconomics@gmail.com