Economics Questions

Re: Severely confused on Government Securities and the Federal Reserve

rich — Thu, 25 Dec 2008 05:03:13 GMT

Great stuff...except I don't get most of it:) What does bank A 30M net worth has to do with this example? How did bank A got 870M cash on hand when it bought another 1B worth of paper? Why both banks are in debt to fed 1.10B, shouldn't it be 990M, because they only need to deposit 10M at FED to get 1B? Very good stuff, thank you for providing this info

Re: Severely confused on Government Securities and the Federal Reserve

Christopher Quinn — Mon, 20 Oct 2008 21:08:24 GMT

To start, here is a wonderful video well worth viewing:

'Money, Banking and the Federal Reserve' viewable at www.youtube.com/watch?v=iYZM58dulPE and video.google.com/videoplay?docid=-466210540567002553 .

And, along with a quality dictionary (like Thorndike-Barnhardt), here are easy to understand yet fundamentally sound books well worth acquiring and reading:

Henry Hazlitt's 'Economics in One Lesson';

E. Edward Griffith's 'The Creature from Jekyll Island';

and Dr. Ron Paul's 'The Revolution: A Manifesto'

After that, there are lots of great books that expand upon the topics you expressed interest in available here (as is 'Economics in One Lesson') at the Mises.org site store.

Re: Severely confused on Government Securities and the Federal Reserve

JukkaM — Thu, 24 Jul 2008 23:08:03 GMT

fsk:
It seems like you want a complicated example.

[...]

Does this help?

Does it help!? I've been searching for information like this for years and this is absolutely, by far, the best description of debt monetization and money creation I have ever found.

Thank you!

Re: Severely confused on Government Securities and the Federal Reserve

CrazyDesi — Fri, 06 Jun 2008 05:23:11 GMT

Ya I am aware of the way that the fed raises and lowers rates so that really wasn't a problem.

Re: Severely confused on Government Securities and the Federal Reserve

jpk — Thu, 05 Jun 2008 18:16:01 GMT

Your repurchase agreement example makes sense to me.

I don't know what rates are for private repos, but say that 1 year t-bonds yield 2.2%, another bank might conduct a 1 month repo with Bank B, calculating 2.2%/12 is .18%. The new bank agrees to buy bank B's bonds for $100M and sell it a month later for $100.18. The cost to Bank B for this funding would be $180,000

As you wrote, the Fed will do the repo at 0.17%. The cost of this funding would be $170,000. Of course Bank B will choose to conduct the transaction with the Fed since it is cheaper.

Sigh. I have spent a few years trying to understand the Fed and am only getting more confused!

Re: Severely confused on Government Securities and the Federal Reserve

fsk — Thu, 05 Jun 2008 17:28:31 GMT

I still oversimplified. I assumed that the 1 year Treasury Bond yield was 2.2% and the overnight Fed Funds Rate is 2%.

The Federal Reserve typically buys Treasury debt that is nearly matured. Assume that a 1 year Treasury Bond yields 2.2%, a 6 month Bond yields 2.1% and a 1 week Bond yields 2.0025%.

In my example, all the bonds in the bank's inventory were 1 year bonds. Change the example to have a range of maturities and the transaction makes sense.

Alternatively, the Federal Reserve makes a repurchase agreement. 2%/12 is 0.17%. The Federal Reserve agrees to buy the Treasury debt from the bank for $100M and sell them back a month later for $100M*1.0016=$100.17M. A month from now or a week from now, the Federal Reserve will make another repurchase agreement to further increase the money supply.

Re: Severely confused on Government Securities and the Federal Reserve

jpk — Thu, 05 Jun 2008 17:21:04 GMT

Ok. So Bank B starts out with $1B in Treasury Debt (yielding 2.2%) $1.10B in debt (at the Fed Funds Rate of 2%) $130M cash on hand

After the first stage it ends up with $900M in Treasury Debt (yielding 2.2%) $1.10 in debt (at the Fed Funds Rate of 2%) $100M loan to Bank A (at the Fed Funds Rate of 2%) (an asset) $130M cash on hand.

I still don't understand why Bank B would voluntarily engage in this transaction. It goes from earning 2.2% on $1B and 2% on $1.1B to earning 2.2% on $900M and just 2% on $1.2B (1.1B+100M). It is earning less.

Am I missing something here? Is Bank B being arm twisted into this exchange? Or is the Fed giving some sort of financial incentive not captured in your example? For instance, maybe the Fed overpays for the $100M that it monetizes, thus baiting Bank B into the transaction.

Re: Severely confused on Government Securities and the Federal Reserve

Anonymous Coward — Thu, 05 Jun 2008 16:52:28 GMT

Jon Irenicus:
Right, thanks for the explanation. I wonder if any of the Austrian economists have written on this - maybe Huerta de Soto.

I know some of the laissez faire apologists have discussed the high leverage ratio that banks have been taking on in relation to the Current Crises and how it's a dangerous thing.

Also I recall reading about the government debt being bought up by the banks as part of the 'deal' to join the banking cartel, sort of a guaranteed market for government bonds. IIRC Rothbard talks about it in History of Money and Banking in the US.

Re: Severely confused on Government Securities and the Federal Reserve

fsk — Thu, 05 Jun 2008 16:45:37 GMT

The government only periodically sells Treasury bonds. The Federal Reserve purchases just enough Treasury debt to keep the Fed Funds Rate at its target level.

In the example I gave, Bank B was lending to Bank A at the Fed Funds Rate of 2%, while borrowing from the government (depositor) at 0%. The only 4 parties in my example were Bank A, Bank B, the government, and the Federal Reserve. Bank B's only options were to leave the cash in its vault (earning 0%) or to lend it to Bank A (earning the Fed Funds Rate of 2%).

Suppose Bank B didn't want to lend to Bank A at the Fed Funds Rate. Then, the Fed Funds Rate would start increasing from 2% to 2.1% or more. Then, the Federal Reserve would purchase more Treasury debt, suppose from Bank C, increasing the supply of bank reserves. If the Federal Reserve creates the right amount of reserves, the Fed Funds Rate is equal to the target. The Federal Reserve has (literally) an infinite budget, so it can create just the right amount of reserves to attain the Fed Funds Rate target. When the Federal Reserve buys Treasury debt, it is printing brand new money to fund its purchase.

Re: Severely confused on Government Securities and the Federal Reserve

CrazyDesi — Thu, 05 Jun 2008 16:33:53 GMT

Also I think I get it. The example that you gave before was a little more simpler I think. I just didn't know that the Fed was only buying back 10% of loans before maturity. For some strange reason, I just thought it was more close to 100%.

Re: Severely confused on Government Securities and the Federal Reserve

CrazyDesi — Thu, 05 Jun 2008 16:31:47 GMT

I think all of it is way more complicated than I can understand.

Re: Severely confused on Government Securities and the Federal Reserve

Jon Irenicus — Thu, 05 Jun 2008 16:10:57 GMT

Right, thanks for the explanation. I wonder if any of the Austrian economists have written on this - maybe Huerta de Soto.

-Jon

Re: Severely confused on Government Securities and the Federal Reserve

jpk — Thu, 05 Jun 2008 15:58:52 GMT

That's quite the read, thanks. I liked your point that banks get a guaranteed profit, built into the rules of the monetary system

I was wondering: why would bank B ever lend to Bank A? B can lend Bank A money at 2% but get a far better return of 2.2% by buying treasury bonds.

Re: Severely confused on Government Securities and the Federal Reserve

fsk — Thu, 05 Jun 2008 14:43:42 GMT

I worked at an options trading firm. "Leverage ratio" is one of the concepts used for allocating capital efficiently. For example, a hedge fund can use 7:1 leverage ratios when purchasing equities. For every $1 in capital a hedge fund has, it can borrow $6 more and buy on margin.

It's the same concept as "borrowing on margin" as an individual investor. When institutional investors "buy on margin" they get to use more aggressive leverage ratios. As an individual retail investor, you are limited to 1:1 leverage ratios (50%).

If you invest in a bank stock, you can carefully read their annual statement and see it.

Re: Severely confused on Government Securities and the Federal Reserve

Jon Irenicus — Thu, 05 Jun 2008 14:35:28 GMT

FSK which work are you drawing on? Where can one read up on this? I had no idea about the leverage ratio.

-Jon