By Michael Pento | February 16, 2010 | 10:47 AM | 0 CommentsTweet This
Ben Bernanke is making sure the Fed's exit strategy goes as easily as a camel can pass through the eye of a needle. Instead of choosing to just sell assets and unwind the amount of securities it holds, the Fed chairman is seeking to be creative once again-as he was in the buildup of its balance sheet--and increase the amount of interest it pays on excess reserves. He said this in a prepared statement for the House Financial Services Committee that was released on Wednesday, "It is possible that the Federal Reserve could for a time use the interest rate paid on reserves, in combination with targets for reserve quantities, as a guide to its policy stance, while simultaneously monitoring a range of market rates."
But in order to prevent intractable inflation, the Fed must at some point shed most of the $1.43 trillion worth of housing debt it will own by the end of March. The Fed's balance sheet has increased to $2.25 trillion from $925 billion at the start of 2008 and excess reserves in the banking system now total more than $1 trillion.
Commercial bank deposits placed with the Fed that are not required to be held against loans are considered excess reserves. By paying interest on these central bank deposits, the Fed can raise the interest rate on interbank lending because loans to other banks are intrinsically more risky than loans given to Mr. Bernanke. But there are major flaws to this strategy. The Fed pays interest on reserves with yet more deposits held at the central bank. Therefore, paying interest on reserves further increases commercial bank deposits held at the Fed, and those new deposits will accrue interest as well...and so on. As a result, by choosing to not sell assets and drain liquidity from banks, the unwinding of their balance sheet will take many years.
Projections from the St. Louis Fed are that it will take 5-7 years for the Mortgage Backed Securities (MBS) to be paid off and unwound from the Fed's balance sheet. That means Ben Bernanke is betting banks will not make more profitable loans to consumers and enterprises during those years and will instead opt for the lower return garnered from receiving interest on deposits.
Another risk that arises from deciding not to sell assets comes through the process know as sweeping. Banks currently have the ability to sweep money into Money Market Funds and time deposits. Those types of deposits do not have any reserve requirements. That means commercial banks do not need a large amount of excess reserves to create a tremendous amount of loan growth and new money. By concentrating on paying interest on reserves, the Chairman not only ignores the crucial action of dramatically reducing the Fed's balance sheet but also fetters his ability to increase the level of interest rates to a level that would attenuate rampant loan growth. In other words, since paying interest on reserves also increases reserves, there is a limit on how high the Fed can pay on deposits.
Mr. Bernanke also made it completely clear that any such future disposal of assets would come at a snail's pace. In regard to the speed of asset sales he said, "Any such sales would be at a gradual pace, would be clearly communicated to market participants and would entail appropriate consideration of economic conditions,"
The most import factors in keeping inflation and money supply growth quiescent are to remove most of the excess reserves held at the central bank and to raise interest rates to keep the demand for loans in check. And it is the cost of money that is the most import governor for inflation. After all, it was not a massive build up in reserves that caused the housing bubble. It was the exceptionally low interest rates for an extended period of time that caused consumers to dramatically increase their debt load and for banks to substantially boost the availability of credit. By focusing primarily on increasing the interest rate on deposits held at the Fed to keep prices in check, Mr. Bernanke misses the key factors behind money supply growth and inflation.
By Michael Pento | February 12, 2010 | 5:06 PM | 1 CommentTweet This
Today I was interviewed by Yahoo Finance and was asked about the direction of the dollar, the state of our economic recovery and where to invest today. If you want to view the short sound bites they can be found here and here. Have a great weekend!
By Michael Pento | February 11, 2010 | 12:49 PM | 0 CommentsTweet This
A couple of points on yesterday's 10 year Treasury auction. The U.S. sold a record tying $25 billion notes at 3.692%. The bid-to-cover ratio was 2.67 compared with the average 2.76 over the last 10 auctions. Indirect bidders accounted for just 33.2% of the auction from the average 39.3% over the last 10 auctions.
The important take from this new trend which has finally arrived is that interest rates are starting to rise because of our significant increase in debt issuance and the fact that foreign central banks have begun to lower their participation in our Treasury auctions.
Higher interest rates will increase debt service payments on both the public and private sector level and will dramatically slow down economic growth.
The U.S. has benefitted tremendously from having the dollar as the world's reserve currency. It kept interest rates artificially low and boosted the value of U.S. assets. As the process of losing its reserve status unfolds, we will see steadily increasing rates of inflation and taxes. And GDP growth will suffer under the ever increasing debt burden caused by rising rates.
By Michael Pento | February 10, 2010 | 10:51 AM | 0 CommentsTweet This
The trade deficit widened in December 2009 to $40.2 billion from the $36.4 in November as imports increased 8.4%. For all of 2009 the trade gap was $380 billion down from nearly $700 billion in 2008.The figure for December was projected to come in at $35.8
It seems the practice of over consumption and under production is already making a strong rebound from the recessionary influences of last year.
This one reason why I believe the structural and secular weakness in the U.S. dollar remains intact, even though we currently see upward pressure on the greenback vs. the Euro. The government's goal to increase consumer spending has to a certain degree been a success. But the consequences of importing more than we export means we get sell away bits of our country piece by piece. And our currency will face a constant headwind when foreigners decide it is time to repatriate their dollar holdings.
A real fix to our trade imbalance can be found through cutting corporate taxes and removing onerous and anti-competitive regulations. There can be no solution found in depreciating our currency.
By Michael Pento | February 09, 2010 | 3:04 PM | 5 CommentsTweet This
The U.S. dollar is not rising; it is the Euro that is falling. There is a big difference and you and your investments need to understand the difference. The Euro has decreased from about $1.50 to $1.37 in just a matter of a few of weeks. The main reason for the dramatic selloff in the Euro is the debt issues in Portugal, Ireland, Italy, Greece and Spain (PIIGS).
But no matter why the move has occurred, the important point is that the US dollar is not rising because of any intrinsic change in its value. There has been no change in interest rates and there has been no move to reduce the supply of dollars being created. Therefore, any increase in value should only be evidenced by comparing the greenback against another currency that is being viewed as having intrinsic problems of its own. It should not, in the long term gain any significant value if measured against hard assets.
To further illustrate this point let's assume my weight is 170 lbs and say, Chip Hanlon tips the scale at 250 lbs. The difference between the two of us would be 80 lbs. Now if Chip puts on 100 lbs--he is by some accounts actually showing signs of increased girth--and I stay the same, the difference would then be 180 lbs. Likewise, if I lose 100 lbs and Chip's weight is static, the difference remains 180 lbs. But it makes a huge difference to me and my health if I weigh 70 lbs or 170 lbs. The same is true if Chip weighs 250lbs or 350 lbs.
The point is that it's not just the movement in the exchange rate that is important, it is which currency is moving and why. Now to be sure we have witnessed a significant move lower in commodity prices, which should not have occurred if the US dollar was not changing its intrinsic value. But the $150 selloff in gold prices was a reactive move in the reversal of the dollar carry trade and not evidence of a secular change in the direction of the value of the dollar. If investors take a longer term view of the dollar, its bear market fundamentals remain firmly in place against hard assets. However, alternatively flawed fiat currencies may not be the best investment to witness the dollar's decline.
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