Think cheap money was bad? Try the new era of free money instead!
REPLYING to growing concern about the quality of the Federal Reserve System's assets, notes Ed Bugos for Whiskey & Gunpowder, former Federal Reserve Governor Lyle Gramley told reporters last week that "You have to reckon with the fact that one of the Fed's assets is gold certificates.
"They are priced, as I remember, at $42 an ounce, and if we were to price them at market prices, the Fed's leverage would look a lot less than it is now."
Humor me. Let's crunch those numbers.
Those gold certificates have a book value of about $14 billion, if you include special drawing rights and coin holdings ($1.7 billion). Even if you revalued this inventory, it would still total less than $300 billion, or 12% of the Fed's total assets. So far, that's a weak defense against our allegations. And it only goes downhill from there.
Assuming it's still got the goods at all, a lot has changed in just three months. In August, this gold had a market value that represented over 30% of the Fed's assets. Back then, additionally, US Treasury securities still made up half the Federal Reserve's asset base.
Today, however, in a very short space of time, the market value of both of these assets together comprises just 30% of the central bank's total assets. It is fruitless to discuss what makes up the rest of its "portfolio"...because whatever it is, it is of lesser quality – aka higher risk.
His proposal was interesting, however, for other reasons. In case you missed its inference, the idea of a revaluation in gold reserves on the Fed's balance sheet is to boost confidence. It is but a keyboard stroke away, a technical matter. Most analysts already take gold's market value into account anyway.
Still, two outcomes of such a revaluation occurred to me over and above the obvious, I think.
- First, it would align the Fed's interests with Gold Prices – by increasing the price of gold, it would boost the value of its balance sheet, for instance;
- Second, it would inflate gold's perceived importance – an endorsement of sorts, in the eyes of the Fed.
The public and the market would have to reassess their fundamental outlook about the importance of Gold Bullion, too.
On the surface, Gramley's proposal aims at making the Fed look like some kind of Gold Standard bank. But in fact, this kind of thing, especially if it were spun out in reaction to a crisis of confidence, might be so bullish for gold that it sinks the Fed.
If Bernanke were smart, he would want that gold to disappear off the balance sheet without notice. But let's forget about what would be bullish for gold and point out what in fact is the fear of deflation.
You see, in December, the Fed shoveled another couple hundred billion new Washingtons into the banking system, thrown out of its many open windows. (B-r-r-r...!) Its balance sheet expanded to over $2.3 trillion as of December's report, which came out the day after the Fed decided to cut rates to nothing.
My guess is that we've seen nothing yet. You thought "cheap money" was bad? This is the era of FREE money. This stuff really does grow on trees. You don't even need choppers. And already, despite the intensity of the deflation rhetoric, the money supply numbers continue to point the other way – toward the Great Reinflation. Or should we say, the numbers point to strong and rising inflation only "because" of the intensity of the deflation rhetoric!
The latest money supply numbers suggest the alleged credit freeze continues to thaw. After stagnating with little or no growth, stuck at under $1.4 trillion over the past four years (since the Fed began hiking rates in 2004) – and even as the Federal Reserve started cutting rates in 2007 again – the US M1 supply has grown by over $130 billion, or 10%, since August alone. That's when the Fed stopped sterilizing its "liquidity" injections. But this kind of growth in three months is a record. Percentage-wise, too.
Most of that growth, moreover, is occurring in checkable (demand) deposits. The broader M2 supply in the US is growing at almost $100 billion per month, and it is approaching a 9% year-over-year growth rate – its strongest growth since early 2002, midway through the Fed's last reinflation effort (2001-03).
Most of that growth is occurring in money market fund holdings. The definitions of money supply that I put stock in suggest that the banking system is inflating deposits at roughly 5% year over year, but of special significance is that this growth rate is picking up now.
No, it certainly is not as robust as the narrow measures of money or the Fed's balance sheet. But it is not deflation. I promise to keep looking for it, nevertheless. Everyone else says it's already started.