Central Banks providing liquidity

Discussion in 'Coffee Lounge' started by buzzlightyear, 17th Sep, 2008.

  1. buzzlightyear

    buzzlightyear Member

    7th Feb, 2004
    With all central banks around the world, pumping liquidity into the market for banks and other institutions to access over the past few months, does this not have an affect on interest rates, money supply and inflation?
  2. grossreal

    grossreal Member

    14th Aug, 2005
    sydney nsw
    hi buzzlightyear
    simple answer no
    the money pumped into the market as very little to do with the money in the banking market.
    and has alot less to do with the money in the local banking system.
    and it would take alot of posting to explain
    but a local bank ie the home loan lender has to raise capital to lend to you

    now they raise capital via a bundle loan so lots of loans together and the sell that to a investor( or investment group)securities lenders example
    or they raise capital from the rba which is a very different thing and not going to go into that here as it will be a bit long.
    now an overseas bank should be able to capital raise from itself from its overseas parent company bank or account
    but to do so here costs alot of upfront costs and that stops it from being competative at the moment.
    this can, should and probably will change
    but its not the case at the moment.
    if it was the the pumped in money into the world money would make a difference.
    as in effect
    there is a very big disinsentive to a commercial bank to bring in funding from its overseas bank to invest in local currency or bank trading
    hence the reason that unless the loan is
    a over 10mil
    and the fees the bring in the funding are paid by the client.
    the deals just don't work
    as the cost is over local loan rates.
    there are ways around this but they are not for a board.
    but in answer to your question the aust banking system
    aust dollar has very little to do with the yen, us dollar or euro from a borrowers point of view.
    and yes that is a every simlistic view because the quest is alot more coplex then that and there would not be enough room to explain it.
  3. MarkB

    MarkB Member

    15th Jul, 2003
    GR is right.

    Banks, like many other financial institutions, lend long and borrow short.

    What that means is that the money they have lent you (and many other people like you) for mortgages, etc, is for the long term (15, 20, 25 yr mortgages).

    That money is money that have "borrowed" from depositors (the interest paid on deposits is akin to the interest charged on loans). However, depositors typically only part with their money for short periods of time (it may be at call, or in term deposits of varying maturity lengths, eg, 6mths, 1 yr, 3 years, etc).

    Usually there is enough people repaying loans and making deposits, etc, to more than cover the immediate call for cash of those who wish to take their money out.

    What's happening now is that more money is being requested from the system than is being pumped into the system (hence liquidity is an issue).

    While depositors will only part with their money for relatively brief periods of time, Government's (or, more correctly, their central banks) can be more patient.

    So, central banks step in and effectively offer long term debt to banks to cover their short term need for cash.

    Short term loans (from depositors) are being replaced by longer term loans (from central banks).

    No new money is being created, therefore it is not inflationary.
  4. WinstonWolfe

    WinstonWolfe Richard Werner fan

    11th Mar, 2007
    The way many cynics see it Buzz is the recent spate of central bank activity is to keep commerce lubricated (most businesses use constant credit- tax effective) AND stop asset prices from crashing.

    As bad paper is written off (sub prime losses, credit default swaps etc), asset prices would crash if the central banks didn't inject more 'loans from future productivity' to replace the evaporated value of the bad paper.

    The winners are the banks that get a cheap loan from the taxpayer's future work and toil.
    The losers are the taxpayers who as a group end up less able to use future income for replacing infrastructure, research and development, funding public services like police, education, health.

    If the central banks got this switch perfect, then interest rates and money supply shouldn't be effected. But what would have happened is overinflated property prices would have just been artificially propped up, and therefore massive deflation prevented. The downside of this is that eventually the markets won't be able to support asset prices at that level, and they'll come down anyway, but just in a more orderly fashion, hopefully. So in a sense, these loans are inflating asset prices....by not allowing them to deflate.

    Some argue, in central banks propping up asset prices, they are stealing from younger generations. Firstly, it is younger generations' productivity that has to be borrowed from to make the loans to the commercial banks, and secondly, the asset prices are held at a level where many cannot afford to buy them. This has been a big part of the logic of the D&G set, and GHPC. In some respects, they are right.
  5. plusnq

    plusnq Member

    28th Mar, 2007

    Hi WW

    The counter argument is the issue of rapid "wealth" depletion from the BB's and the increased costs in pensions, Medicare etc that would have to be funded. Damned if we do and damned if we don't. I suppose politically and to some extent economically (due to the demographic bulge and possibility of inheritance) it is easier to pragmatic in the short term and keep their fingers crossed for the longer term.


  6. MarkB

    MarkB Member

    15th Jul, 2003
    We all win when central banks step in to protect the system.

    CBs lend money to banks. CBs in turn have the ability to borrow money themselves (government bonds). There is always a market for govt bonds (as you are aware, the interest rate they earn is often quote as the benchmark for pricing investment risk, as govt bonds are risk free). NB - they tend to also sit on a large supply of cash.

    In the event that they dont have enough cash and bonds have to be issued:

    - Issuing bonds today does not mean less government expenditure tommorrow.

    - Issuing bonds today does not affect future taxation reciepts.

    To suggest anything else is a complete misrepresentation of reality.

    Winston, with all due respect to you - you're a smart fellow, I'd never suggest anything else. However, this is not your field of expertise. Be very mindful of buying into the worst of the speculation currently being spread by certain people. It doesn't do anyone any good.
    Last edited: 17th Sep, 2008
  7. WinstonWolfe

    WinstonWolfe Richard Werner fan

    11th Mar, 2007
    You're right Mark, it is not my specialty. But then
    - specialists prefer to keep Joe Schmoe in the dark.
    - specialists didn't see LTCM failing.
    - specialists didn't see sub prime coming
    - specialists didn't see Lehmans exploding

    Is a Brazilian or Argentinian govt bond as risk free as a US bond? If so, why have those countries defaulted on a string of IMF and US private loans over the last 15 years?

    Do you agree with the economist Hyman Minsky calling Russian GKO govt bond issuance policy prior to the ruble crisis a Ponzi Scheme?

    Can you also explain that if government bonds are risk free, why their yield varies? Doesn't that variation itself indicate varying sentiment amongst those who hold or wish to hold bonds?

    What about the currency risk of govt bonds?

    What about the inflation risk of govt bonds?

    How does a central bank limit the risk of bond issuance? - It prints more money, thereby diluting the currency....or it raises more taxes, thereby taking from the taxpayer in the future (the point you seem to be disputng with me)

    What is meant by 'a flight of capital' out of the USA?

    Can you explain the term "moral hazard" in relation to central banks intervening in bank bailouts?
    Last edited: 18th Sep, 2008
  8. MarkB

    MarkB Member

    15th Jul, 2003
    I disagree with that.

    There's alot of information being spread by specialists on this topic.

    Sadly, in this age of digital media it is being drowned out by commentary from a plethora of self-proclaimed experts who seem hell-bent on spreading paranoia (if you need any indication of how dangerous paranoia can be, brush up on the Holocaust).

    Just because millions of people believe it, doesnt make it true.

    No, Winston didn't actually say that, but I want to make a general point over who saw what coming...

    When HIH collapsed in 2001 it left an estimated $5bn hole.

    Did anyone see it coming?


    Was much done about it?

    In truth, no. The warnings fell on deaf ears.

    The following is a true story (no names for obvious reasons).

    At a general insurance conference some months before the collapse, a senior (and well regarded) actuary speaking warns those present (including very senior people from APRA) that their is massive under-provisioning in the sector. Insurance industry people present ask APRA people: "do you know which company he is talking about?" Senior APRA people: "Yes, HIH".

    You can lead a horse to water, but you can't make it drink...

    Long Term Capital Management was the dot-com bust of hedge funds. From Wiki:

    Initially enormously successful with annualized returns of over 40% in its first years, in 1998 it lost $4.6 billion in less than four months and became a prominent example of the risk potential in the hedge fund industry.

    LTCM became especially notorious, not only for the scale of the losses, but also that 2 of it's Directors were Nobel Prize winning economists.

    There is a bit of an explanation on wikipedia as to why it all turned to custard, but it essentially boils down to a combination of (a) not sticking to what they had originally intended to, which in turn was fuelled by (b) greed (and believing they were infallable).

    I'd refute that no-one saw it coming, especially since LTCM claimed to have found the holy grail of investing.

    Obviously there were more than a few who were caught by the razzle-dazzle of it all, but (and I am using another saying here) - if it sounds too good to be true, it probably is (again, no law against stupidity).

    Certainly in NZ (which has had it's own sub-prime crisis with 25+ finance company collapses) there were people who saw it coming and who publicly expressed concerns.

    Still, there is no law against stupidity and despite the warnings some investors kept throwing money at these companies who in turn kept lending it to bad risks.

    I don't believe for a moment that no-one saw sub-prime coming.

    Otoh, I find it very plausible that there were concerns expressed, but that those warnings fell on mostly deaf ears.

    Refer to general comment above about who saw what coming....

    In any event, all anyone can do at any point in time is work off the best information available. That information could have been flawed and, if so, it's hardly the fault of the specialists you deride.

    When I posted before about government bonds being risk free, I could (and probably should have) stated the obvious that not all government bonds are equal - namely because not all government's are equal.

    I thought it would be stating the obvious.

    So now I will state the obvious:

    Bonds from first world stable democratic nations (eg. UK, US, Australia, etc) invariably are seen as safer than those from Brazil, Argentina and countless other LDCs and unstable nations.

    Even within the developed nations, a small country like NZ will arguably have to offer a higher bond rate to attract foreign investors if only to compensate for the perceived risk of a being a small nation.

    I have no comment on that, basically because I am not familiar with the statement.

    Bonds have different yields for a variety of reasons:

    1. Different issuers (governments)
    2. Differnent issue dates
    3. Different expiry dates

    The yield of a bond effectively represents sentiment regarding future interest rates, inflation, and economic conditions, at the time of issuance.

    The US Govt could issue 5 yr bonds today, and 5 yr bonds next week and they would have different yields, simply because even within that week (and less) expectations have altered.

    The longer the term of the bond, then other things being equal, investors expect a greater return (as any normal investor does).
    If you're un-hedged, of course there is that risk.

    The Government issuing the bond is not warranting the exchange rate or inflation rate (below). They warrant the cash flow in whatever currency the bond was issued.

    What about it?

    It's unavoidable.

    The risk free nature refers to the cash flow (yield%) they give you in nominal terms.

    Inflation risk remains.

    For bond traders, inflation (and the changes in interest rates that typically accompanies it) can be either an opportunity or a threat.

    Bonds are paid for by the people who buy them.

    In exchange for the government bond (a guarantee to pay future cash-flows) you give them cash.

    No new money is printed when bonds are issued.

    A "flight of capital" occurs when, over a sustained period of time, more money is taken out of something than is put back in.

    In the context of your particular question, "a flight of capital out of the USA" would occur when investors (both US domestic and international) pull their money out of US investments in favour of investments elsewhere.

    In economics a "moral hazard" is said to occur when a party has possible incentive to act in a manner conrary to how others might want them to act.

    Imagine if an insurance company decided to offer no-fault third-party property damage cover to drivers. All of a sudden alot more drivers would hoon around thinking "well, who cares if I crash into a merc, I'm covered!". That's a moral hazard.

    Taking it back to central banks and how the operate ---

    Essentially, CBs want banks and other instutions to "drive normally" and behave in a commercially prudent manner. CBs do not encourage reckless abandon like that driver I mentioned before (who didnt care if he crashed into a merc because he knew he would be bailed out).

    A basic refresher on how CBs think:

    CBs have three basic rules (in no particular order, save for rule 1):

    1. Protect the system (that is the #1 rule)
    2. Let the imprudent fail
    3. Lend freely, but at a high rate

    CBs will not guarantee any institution (for reasons of moral hazard). Their interest is in protecting the system. Sometimes to protect the system they have to lend to institutions. They tend to let dodgy people fail, but on occasion they will also save them (via loans) only because it is in the best interests of the system. When they do help out institutions it is always in the form of a loan (not a gift).
    Last edited: 18th Sep, 2008
  9. pendo

    pendo Member

    15th Sep, 2007
    Sydney, NSW
    The Latest Report from the Front Line of Wall Street's War
    on America
    by Adam Lass, Senior Editor, WaveStrength Options Weekly

    Yesterday, my fellow editor, Justice Litle, asked where the hell the Plunge Protection Team, or PPT, had gotten to. Today we know the answer: they are up to no good.

    For those of you who don’t believe that Washington and Wall Street manipulate the economy and the market, it’s time to grow up and get real.

    This is not some conspiratorial mumbo jumbo. Heck, several departments within the executive branch are specifically and publicly dedicated to preventing economic and market crashes.

    Other semi-independent entities like the Federal Reserve, Fannie Mae, Freddie Mac and the FDIC were created to insure confidence in various components of the system as a whole.

    The PPT itself has been described numerous times in legitimate media and spoken of in many Wall Street and Washington power player memoirs.

    Beyond that, the evidence for its existence is readily observable. Over the years, students of the market have seen the following trick performed over and over whenever some “line in the sand” has been breached.

    In the midst of a rout, “someone” ignores the six inches of blood on the trading floor and begins to buy massive quantities of S&P 500 futures with the apparent assurance that none of Wall Street’s major players will short this position.

    We are talking billions of dollars here. Thus we presume that it must be a major Wall Street trading house that has been given the nod to act.

    This sudden flood of cash on Wall Street is always followed by a flood of positive press releases from Washington: “We have confidence in the system… we will insure liquidity… might even fork over a rate cut… yadda, yadda, yadda.”

    The following morning, the market turns a bit, and the futures buyer is made good. For the moment, a bottom is set, and Wall Street has a little breathing room in which to try desperately to work something out.

    Does any of this sound familiar? Monday morning, in the face of the worst bankruptcy in history, “someone” began buying up great huge gobs of S&P 500 future contracts.

    Right about then, a parade of premium faces (including President Bush and Senator McCain) went on the air with virtually the exact same speech, assuring us that the country’s fundamentals were sound.

    Then word began to circulate that despite Washington’s initial reticence, it would pony up $50 billion fresh new dollars after all “to lubricate the banking system.”

    Monday night, when even that didn’t work and the market had put in the worst day in recent memory, word began to circulate that the Feds would ignore its own warnings about inflation and cut rates Tuesday, possibly by as much as 50 to 100 basis points.

    Tuesday morning, “someone” ignored common sense and began to buy great gobs of S&P 500 futures again. Lo and behold, the market put in a short-term bottom.

    You can argue the wisdom of this sort of manipulation. In fact, I am about to. But you simply must accept the fact that it happens.

    Now I will tell you exactly why sending more money to Wall Street is a very bad idea.

    This crisis was created in the first place by Washington’s cowardly habits. For the past twenty years, every time Wall Street whined that it had created some kind of trouble for itself, Washington ginned up a trillion dollars to bail them out.

    Sometimes Washington printed shiny new dollars. Sometimes it borrowed them from folks who may not have our best interests at heart, like the Chinese government, Russian oligarchs and the Saudis royal family.

    Either way, the incredible increase in dollars in circulation without genuine growth in GDP is destroying America. Our consumers are broke. Our workers are not working. Our houses are being foreclosed. Our banks are failing. And the Federal institutions that were created to foster stability and protect against genuine emergencies are in shambles.

    Our financial house has been bombed.

    It is burning down.

    And Washington is pouring more gasoline on the fire.

    Another $50 billion and another rate cut may help out Wall Street for a day or so. But in the medium term it will only further make life worse for Americans trying to get by. And in the long term, the stock market will still fail, because it is those very excess dollars that are choking it to death.

    A few weeks ago, I advised readers of this column to purchase put option contracts against Standard & Poors Select Financial SPDR ETF (XLF:AMEX). As I write to you, those puts have gained as much as 105%.

    In time, Washington may be forced to stop flooding the market with dollars. If and when this happens, the rest of Wall Street’s worst players will go bankrupt. Billions more dollars will be lost. In the end, the survivors may even become value buys.

    However, there is no sign of this happening anytime soon. And in the meantime buying puts is the only assured defense against Washington and Wall Street’s continuing malfeasance.

    Sincerely yours,

  10. WinstonWolfe

    WinstonWolfe Richard Werner fan

    11th Mar, 2007
    UF, I don't pull my views out of a hat. They are the views of people a lot smarter, well read, and successful, in many aspects of the free markets. I see a lot of sense in what Ron Paul and Jim Rogers say.

    You seem to be refuting the logic of the Austrian school and supporting derivatives of Keynesian Economics. Rather than wasting our time writing new explanations in support of our differing views, we can keep trading Wiki quotes supporting either.

    The mechanics of U.S. Government debt

    When the expenses of the U.S. Government exceed the revenue collected, it issues new debt to cover the deficit. This debt typically takes the form of new issues of government bonds which are sold on the open market. However, the debt can also be monetized by which the Federal Reserve creates an entry on its books to credit the US Government for an amount equal to the dollar amount of the bonds the Federal Reserve is acquiring. The money created in this process not only includes the new dollars that came into existence just to purchase the bonds, but much more because this new money is now sitting in the form of checkbook money at the Federal Reserve. Under the scheme of Fractional Reserve Banking this new checkbook money is treated as an asset to lend against. Economists estimate the expansion of the money supply as being many times the amount of the initial money created with the exact amount being a function of what percentage of deposits banks must set aside as "reserves".[15][16]
    The ultimate consequence of monetizing U.S. debt is that it expands the money supply which will tend to dilute the value of dollars already in circulation. Thus, expanding the pool of money puts downward pressure on the dollar, downward pressure on short-term interest rates (the banks have more to lend) and upward pressure on inflation. Typically this causes an inflationary boom that ends in a deflationary bust to complete the business cycle. Note that money supply expansion is not the only force at work in inflation or interest rates. United States Dollars are essentially a commodity on the world market and the value of the dollar at any given time is subject to the law of supply and demand. In recent years, the debt has soared and inflation has stayed relatively low in part because China has been willing to accumulate reserves denominated in U.S. Dollars. Currently, China holds over $1 trillion in dollar denominated assets (of which $330 billion are U.S. Treasury notes). In comparison, $1.4 trillion represents M1 or the "tight money supply" of U.S. Dollars which suggests that the value of the U.S. Dollar could change dramatically should China ever choose to divest itself of a large portion of those reserves.

    Arguments for paying down the national debt

    Economists from the Austrian School point out that the United States experienced depreciation of 43% of CPI (from CPI of 51 to 29) from 1800-1912: a period of strong economic growth in U.S. history.[49] [50][51]
    Furthermore, it is not always true that an increase in the money supply leads to an expansion of the economy. For example, consider the failure of Japan's Central Bank to do just that. In an attempt to follow Keynesian economics and spend itself out of a recession, Japan's central bank engaged in ten stimulus programs over the 1990s that totaled over 100 trillion yen.[52] Even enacting this policy Japan has been left with a national debt that is 194% of GDP [6].
    In the absence of debt monetization, when the Government borrows money from the savings of others, it consumes the amount of savings there are to lend. If the government were to borrow less, that money would be freed to work in the private sector and would lower interest rates overall.
    Lastly, raising interest rates is one of the traditional ways that the U.S. Federal Reserve uses to combat inflation (which can be brought on by government debt), but a large national debt figure makes it difficult to do so because it raises the interest paid in servicing that debt.
    Net interest on the U.S. national debt was approximately $240 billion in fiscal years 2007 and 2008. This represented approximately 9.5% of government receipts. Interest was the fourth largest single disbursement category, after defense, Social Security, and Medicare.[53]Paying off the debt would free up these funds for other purposes.

    The Austrian View of Inflation

    The Austrian School has consistently argued that a "traditionalist" approach to inflation yields the most accurate understanding of the causes (and the cure) for inflation. Austrian economists maintain that inflation is always and everywhere simply an increase of the money supply (i.e. units of currency or means of exchange), which in turn leads to a higher nominal price level, as the real value of each monetary unit is eroded, loses purchasing power and thus buys fewer assets and goods and services.
    Given that all major economies currently have a central bank supporting the private banking system, almost all new money is supplied into the economy by way of bank-created credit (or debt). Austrian economists believe that this bank-created credit growth (which forms the bulk of the money supply) sets off and creates volatile business cycles (see Austrian Business Cycle Theory) and maintain that this "wave-like" or "boomerang" effect on economic activity is one of the most damaging effects of monetary inflation.
    According to the Austrian Business Cycle Theory, it is the central bank's policy of ineffectually attempting to control the complex multi-faceted ever-evolving market economy that creates volatile credit cycles or business cycles. By the central bank artificially "stimulating" the economy with artificially low interest rates (thereby creating excessive increases in the money supply), they themselves induce inflation (often focused in asset or commodity markets) and speculative investment, resulting in "false signals" going out to the market place, in turn resulting in clusters of malinvestments, and the artificial lowering of the returns on savings, which eventually causes the malinvestments to be liquidated as they inevitably show their underlying unprofitability and unsustainability.[15]
    Austrian economists therefore regard the state-sponsored central bank as the main cause of inflation, because it is the institution charged with the creation of new currency units, referred to as bank credit. When newly created bank credit is injected into the fractional-reserve banking system, the credit expands, thus enhancing the inflationary effect.[16]

    The Austrian View of Business Cycles

    Austrian economists also have a unique understanding of the phenomenon of business cycles and focus on the amplifying, "wave-like" effects of the credit cycle as the primary cause of most business cycles. Austrian economists assert that inherently damaging and ineffective central bank policies are the predominant cause of most business cycles, as they tend to set "artificial" interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles" and "artificially" low savings.[17]
    According to the Austrian business cycle theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable "monetary boom" during which the "artificially stimulated" borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas which would not attract investment if the money supply remained stable.
    Austrian economists argue that a correction or "credit crunch" – commonly called a "recession" or "bust" – occurs when credit creation cannot be sustained. They claim that the money supply suddenly and sharply contracts when markets finally "clear", causing resources to be reallocated back towards more efficient uses.
  11. MarkB

    MarkB Member

    15th Jul, 2003
    I think you owe me more than a 20 second cut and paste.

    But don't bother, because ultimately it highlights that if you knew anything about economics (which we both know you don't), then you'd realise that the of the couple of dozen or so different economic schools of thought they agree on what they agree on and disagree on what they disagree on. No amount of talking will ever resolve that.

    You think the sky is falling.

    I just think you need to change your undies.

    We agree to disagree and that ends that (and ends my contribution to this thread).
  12. WinstonWolfe

    WinstonWolfe Richard Werner fan

    11th Mar, 2007

    Fine. I'll stick with the Austrian School. And you can own:
    "No new money is being created, therefore it is not inflationary."