Monday, February 2, 2009

Monetary Policy Success - Transfered to Fiscal? Hegemon

The worm may have turned, with the Federal Reserve successfully maintaining an orderly market in the money markets and restoring bank liquidity and credit to the "norm". The Federal Reserve almost tripled the balance sheet to accommodate various failed segments of the money markets and financial structure. The first were the Maiden Lanes " facilities established post Bear St earns force sale to JP Morgan, taking on the "toxic assets" into a LLC on the NY Federal Reserve's balance sheet. Then AIG moved considerable assets onto the Fed balance sheet, and money market funds received support, and in the final quarter a CPFF program to fund various types of commercial paper.

The total expansion of Federal Reserve footing is substantial:

But the size of the footing is being reduced. The commercial paper facility CPFF reduced by almost 90 billion last week and foreign central bank funding lines via large currency swaps also reduced. The is an obvious improvement. If this carried on, and it seems it will, it seems the Federal Reserve has been completely successful in restoring liquidity.

The majority of the Federal Reserve expansion to the crisis has not been in the AIG and dealer fundings, contrary to the press and public perception. Rather it has been in two areas, commercial paper purchases and also foreign swap likes to central bank where the Fed for an agreed unwind level at an agreed time , is credited by a foreign central bank and amount of foreign currency and in return the Fed credits that foreign central bank and amount of dollars. These dollars are then deployed by the foreign central bank in various US dollar denominated support operations in their respective countries.

The size of these swap lines is striking, peeking at 600 billion last quarter and currently at 465 billion. That combined with the CPFF facility totals to over 800 billion of additional Federal Reserve "factors" or bank credit provided.

One can see the improvement in the relationship of Fed Funds versus one month LIBOR in 2 year swaps, correcting to below 20 basis points (.20%) at levels indicating fully functioning and liquid bank credit money markets.
Also one can see that the Maiden Lane LLCs and the AIG funding really are almost a detail item - not really mattering in the larger scheme of things.
The foreign swaps is very interesting as allows illumination of various ideas as to USA hegemon and also importance in the markets. It shows that in a a few weeks the Fed Reserve can produce liquidity almost equal to the total US Treasuries held by China. It also shows that the USA has no need or use for non-dollar items yet other foreign central banks are now completely dependent on the USA maintaining their respective money markets. To the contrary of many popular views the USA is clearly the indisputable hegemon. This capability of the USA Federal Reserve shows the demise of New York is highly overrated and one should perceive this balance sheet as the financial equivalent to the 12 USN carrier task forces. Monstrous off the scale financial and monetary strength which has shown that a total Federal Reserve balance sheet at 2.25 trillion is not peak load.
The scope and raw strength of the USA has been demonstrated and successfully implemented. The Fed though has likely reached the limits of their mandate and while able to maintain money market liquidity, the comparable clout that exists in the USA fiscal balance sheets has to be first realized that it exists, and then implemented transferring much of this monetary presence to the fiscal realm.
Considering the Federal Reserve's balance sheet indicates that there are 2 crisis occurring - one a Bagehot bank crash and the second , via contagion of the bank crash, a classic crash in consumption and rise in savings producing the beginnings of a Fisher Debt Deflation spiral (i.e. a depression).
It seems the fact the popular press and many market and political players confuse these two crisis leads to obfuscation and an incorrect idea as to the USA strength and capacity.


  1. I make a distinction. It's irrefutable the US easily fulfills the definition of a hegemon. However, there is nothing intrinsic to the definition of being a hegemon that ensures it will carry on as such. Historically, I would argue that hegemons are at risk--to themselves and to others.

    At this particular juncture, risk is pretty high to the USA as a hegemon. The world has been operating under such a framework for 60 years. If you and I agree that this crisis is fated to give expression to long-standing pressure in the tectonic plates, then one has to carry some for of insurance against hegemon breakdown.



    The world got caught short $US for a variety of reasons including funding $ assets that depreciated.

    Falling crude prices made $ far harder to get, exacerbating the short squeeze.

    The Fed swap lines are, functionally, nothing more than high risk, unsecured loans to foreign cb's that have bought the world some time to cover their $ needs.

    Warren Mosler