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Weekly Federal Reserve balance sheet update

by Mark Dow
July 10, 2009

This post is by Mark Dow

This just hit my inbox, from the research team at Barclays. Since we’ve talked a fair amount of late about the Fed balance sheet, I thought I’d pass it on.

“Weekly Federal Reserve balance sheet update

Usage of the various Federal Reserve liquidity programs continues to erode as outstanding loan amounts mature and are not replaced with new borrowing. The overall size of the central bank’s balance sheet is now 9% smaller than it was at the start of the year.”

16 Comments

  • Posted by FollowTheMoney

    Mark-

    What are your thoughts on far increased oversight and government audit of the Federal Reserve proposed in house bill HR1207?

    There really seems to be a large and growing influence to pass this measure, especially on behalf of the public and also congress/senate seems to be snowballing this audit to get a deep look at various Fed assets/programs.

    I’m not sure now is the time to do it, however it is important we get greater transparency by the Fed.

  • Posted by Indian Investor

    It’s 12% smaller, perhaps. The BS total was $2033b + on July 09 2009, and $ 2298 b+ on January 02 2009. That makes for a 12% reduction in my books.

  • Posted by Indian Investor

    I have a question for Rachel Ziemba. What’s the reasoning for the GCC countries demanding $45-$50 per barrel of oil from the rest of the world piece to balance their budget? And what explains the sudden recent mysterious rise in the price of oil back up to something like $70? In the first of 2008, the wonderful explanation for $146 oil provided by analysts was an increase in oil consumption in China and India. That’s when my first suspicions about the crude pricing mechanism arose.
    If countries like India, Brazil, etc – that produce coffee – were to form a new Organization of Coffee Exporting Countries – to rival the OPEC – people in New York would presumably end up paying $45-$50 for each cup of coffee so that we could ‘balance our budget’.
    Since it costs from $3 to $5 to produce a barrel of crude in Saudi Arabia, the break even price for oil can generously be fixed at something like $7 per barrel at most.Wowee! They’ll need to stop making their women wear black masks and have political debates about Jerusalem with the Jews!Like the Indian Muslims, the Saudis will then drive tuk tuks, sell tea in small shops and try to get at least a basic education to survive.

  • Posted by bsanchez

    But the monetary base is still over 90% larger than a year ago.

    Broader measures have also been growing robustly: M2 is up over 8% year-on-year, relatively high levels by historical standards.

    So despite the collapse in the money multiplier growth in broad measures of money keep growing. An interesting question is what would be happening to these variables in the absence of (1) the monetary expansion and (2) the fiscal stimulus.

  • Posted by Indian Investor

    bsanchez – nice observation. My doubt is about the process and logic for a US economic recovery. I read a forecast that US GDP will stop contracting, and perhaps expand by around 2% starting from Q3 2009 onwards – meaning now onwards. But the same forecast says unemployment will go to 10% and stay there before improving in 2010.There’s a view that the employment level is a lagging indicator of recovery. The latest credit card default rates are around 10% for leading US banks. People are also continuing to have problems with foreclosures and home prices. I’m not clear exactly why there’s a feeling and speculation that a US recovery will begin this quarter.

  • Posted by biofuel

    …the drop doesn’t mean that the Fed has reduced liquidity, it has been replaced by securities held outright…

    http://www.aleablog.com/credit-extended-through-federal-reesrve-liquidity-facilities/

  • Posted by Cedric Regula

    Debtor’s Prison just updated their take on it.

    http://www.debtorsprisonblog.org/

    Basically the contraction is due mainly to the currency swaps unwinding (not really something that indicates much about either the direction of Fed policy, or the behavior of the US banking system). Some of the other short term credit programs have unwound somewhat.

    But going forward, the Fed has a long way to go yet to get to the maximum targets they quoted for MBS, GSE and Treasury purchases.

    So if they proceed with these, there will be a continued lengthening of credit maturities on the Fed’s asset side of the balance sheet. These are the things that will be difficult to dump on the market if the Fed decides it’s time to soak up excess liquidity that was created.

    Mortgage defaults are still expected to rise, for the simple reason that many banks had a self imposed moratorium on foreclosures in order to keep from dumping even more homes on the market. Credit card defaults continue to rise, and commercial real estate is the next shoe expected to drop. Rising unemployment makes all these things worse, of course.

    The Stress Test a scant few weeks ago was based on the worse case forecast of 10% unemployment later this year. “Worse case” is now the case, so it seems we would need a new worse case?

    This all implies the Fed will continue with the MBS and Treasury purchase targets announced so far, not cut back on them. Probably expand on them. Then there is the $1 trillion PPIP Christmas present. Tho I haven’t figured out yet if that one gets applied to the national debt, or the Fed balance sheet, if that makes a difference anymore.

  • Posted by Mark Dow

    Biofuel – No, the drop does take into account all of the securities purchases. The decline in banks’ usage of all of the Fed’s facilities more than offsets the increase in the Fed’s purchase of mortgages and Treasuries.

    The proper concept of the Fed balance sheet–and the one I refer to–comprises all of the Fed’s activities.

  • Posted by Mark Dow

    bsanchez – you are factually right about base money, and the number you cite for M2 sounds about right. I disagree that 8% growth is robust by historical matters, but, frankly, it doesn’t matter a whole lot for the general points I am trying to make.

    Why? Because M2 is not broad enough to capture the collapse in credit to (debt of) the private sector. I cited it because it was handy and illustrates the disconnect between the base money that many are focusing on and the broader monetary measures that correlate better to the things that matter.

    To summarize, the points I have been trying to make in this regard are, I think, straightforward. And I am trying to make them because when one goes below the surface one sees that the facts tend to contradict received wisdom on the subject. The points are:

    1) Despite daily assertions to the contrary, base money stopped expanding in December.

    2) There only correlation between base money and the dollar since the crisis hit in September has been a negative one (the dollar has tended to get stronger as base money expanded, and tended to sell off once base money growth flattened out.

    3) From an economic standpoint, what matters to inflation, activity, and, to some extent, the dollar is broader credit–much broader than base money or M2 can capture. When credit card holders default or have their lines cut, when Six Flags defaults, or when homeowners “modify” their mortgages, this contracts credit to the private sector. This is clearly shrinking (I have seen the estimates but can’t track them down at present). Anyway, this is the very definition of deleveraging.

    4) People seem to be focusing on the money supply, rather than the factors underpinning changes in demand. Of course supply equals demand, by definition, but the point is that demand is the driver much more than supply.

  • Posted by bsanchez

    Mark,

    Thanks. When thinking about these issues it is fun to play around with FRED 2 (http://research.stlouisfed.org/fred2/).

    I have posted a couple of interesting charts in my blog (http://randomspaniard.blogspot.com/) on M2 and US consumer credit. I wonder to what extent what seems like a recent (past four months) stalling in M2 is the result of the deleveraging of the consumer. I think this is related to your third point.

  • Posted by Cedric Regula

    The other thing to remember about M1 and M2, is ever since March we had a lot of money sitting in t-bills, which does get captured by the Ms, but then it went back into equities, and I don’t believe that is in the Ms. So that might be part of the reason why the money multiplier looks flat. The S&P Green Shoots rally added something like 2-3 trillion to stock valuations, so that would be significant. We also had alot go into foreign stocks and bonds, part of the reason for the weakening dollar. That’s not in the Ms either.

  • Posted by Mark Dow

    Bsanchez – Tienes razón. Tiene que ver con el tercer punto.

    Pero hay que tener cuidado con M2: no es amplio lo suficiente para recoger bien los efectos de los cuales indico aqui’. M2 recoge tambien el aumento de liquidez que demanda el sector privado para protegerse, en este caso en forma de depositos. M3 tambien refleja hasta cierto punto el mismo fenomeno, con los flujos que entran los money markets cuando salen de otros mercados.

    Por lo tanto, una expansion de M2 no quiere decir necesariamente que haya vuelto la demanda para sacar credito.

    Ojalá que tuviera mas tiempo para jugar con los datos!

    Y gracias por el link: voy a echar un vistazo a tu blog. Seguro.

    Saludos,
    Mark

  • Posted by Ty

    Mark,

    Given that the fed is doing what it was built to do (offer credit when private sector doesn’t want to), isn’t the most important question “how will the fed sell its assets when private credit creation picks up?”

    Who will buy the assets? Does bernanke have to be a good trader to unload the assets in a timely manner so that we don’t go into a credit creation phase with a very large monetary base? What will losses on some of the crappier assets do to the equity of the fed? What historic events give one confidence that the Fed will decide and be able to shrink at the right time?

    Thanks.

    -Ty

  • Posted by Mark Dow

    Ty – the way I see it, the Fed won’t want to sell assets until risk appetite returns and the money multiplier shows signs of expanding. When risk appetite returns, it will be easier to sell assets. Also, some of the assets will naturally roll off. But these elements are not the main tools. The ability to remunerate reserves gives the Fed a huge tool which allows them to hold a lot of the assets to maturity.

    A much better explaination of what an exit strategy might look like comes from an interview Bill Dudley gave to the Economist magazine last month:

    http://www.economist.com/businessfinance/displayStory.cfm?story_id=13768746

  • Posted by flow5

    The FED’s balance sheet gyrations are not indicative of an easier, or more restrictive, monetary policy. The balance sheets asset expansion is for liquidity funding purposes & isn’t associated with an enlargement of the “money supply”.

    The The “monetary base” is not a base for the expansion of new money & credit. Legal reserves are that base (even when considering reserves are no longer binding).

    No money figure (M1,M2 et al.), standing alone is adequate as a “guide post” to monetary policy.

    Also, there are several errors in the construction of the monetary aggregates:

    (1) M1 increasingly overstates the quantity of the means-of-payment money. This upward bias is the consequence of classifying Savings and Loan and Credit Union Deposits as commercial banks (but not Mutual Savings Bank deposits) as demand deposits, rather than inter-bank demand deposits. M1 thus includes both the Negotiable Order of Withdrawal (NOW) account balances and the thrifts’ balances in the commercial banks – a double counting of our means-of-payment money.

    (2) M2 erroneously includes MMFs in its definition (a sizable #). MMFs are the customer’s of the commercial banks. They are financial intermediaries/transmitters. Monetary savings are never transferred from the commercial banks to the intermediaries (non-banks); rather are monetary savings always transferred through the intermediaries. Whether the public saves or dis-saves, chooses to hold their savings in the commercial banks or to transfer them to intermediary institutions will not, per se, alter the total assets or liabilities of the commercial banks; nor alter the forms of these assets or liabilities.

    (3) It is also inaccurate (for the cataloguer of economic statistics) to exclude the Treasury’s General Fund Account from the assets included in M1 (with the exception of WWII). No one has established any unique price effect of federal outlays, as compared to state and local government outlays, or expenditures by the private sector. Of course, the shifting of funds to and out of the Federal Reserve banks has a dollar for dollar effect on member bank reserves, but that is another problem that can be, and is dealt with through open market operations…the money supply is actually unknown & unknowable.

    What’s transpired is that the “trading desk” has altered the rate-of-change in “member bank” legal reserves, in the last several weeks.

    FOMC policy has gradually “tightened” relative to the normal seasonal flows. And perhaps the “transactions velocity” of money is gradually recovering as well.

    I.e., the FOMC stopped “validating” the current or “asked” price levels, as demonstrated by the recent fall in long-term interest rates, as well as the weak oil & gasoline prices.

  • Posted by bsetser

    mark — funnily enough, i also thought the dudley interview provided the clearest explanation of the fed’s exit strategy that i have seen; my guess is that the fed will end up having to sterilize some of its l-term asset holdings with s-term bills or an interest rate on commercial bank deposits at the fed that pulls in money. but that isn’t the end of the world. EMs sterilize all the time.

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