Here comes the flood of Federal Reserve money. As
this chart neatly shows the Fed has turned on the spigots and let the
So why isn't all of this lending (increase in assets)
dollar to drop, commodities to rise, and raise bond yields?
Fear. The velocity of monetary transactions has collapsed along with
asset prices. The Federal Reserve may be throwing money at the problem, but
the banks refuse to lend out the excess cash created by the Federal
Reserve's activities. A recent Merk
Fund commentary neatly explains the current situation.
Here's an excellent
article describing how the bankers succumbed to
financial engineering wizardry. The high tech equivalent of
turning dross into gold didn't quite work.
the banks are refusing to lend the Fed is going around them and lending
directly to corporations in the form of supporting their commercial paper
operations. As you can see from this chart the drop in yield on GE
(General Electric) 90 day commercial paper is quite impressive. GE evidently has
enough money now because as of December 15th they are no longer offering
90 day paper from their parent corporation!
Since this has not been enough to bring the bankers out from their
hiding places the Fed recently announced the direct purchase of
mortgage backed securities (home loans) from Fannie Mae and Freddie Mac as
well as their bonds as well. This caused an immediate drop in
Who needs to nationalize the banks when the Federal Reserve can do it
On Tuesday December 16 the Federal Reserve cut the Federal Funds
rate to effectively zero. I don't however think
we are in for the same nearly generational malaise the Japanese
suffered through. 'Helicopter' Ben Bernanke, the chairman of
the Federal Reserve is determined to prevent deflation from striking
the American financial system. See the first chart above. If
the current round of monetary stimulation doesn't work the Fed will
keep trying until something works. However I fear the cure may be
worse than the disease. The Federal Reserve will have to drain
the markets of excess liquidity once some semblance of normalcy returns
and they may be too late in their actions.
Like most other assets, Treasury bonds of the plain vanilla and inflation
protected form have been driven to extremes. While US stocks are down
around 40% for the year right now, US high yield bonds and preferred stocks are down
around 35% I mention this 87.5% correlation for two reasons. In this
market everything has fallen with almost perfect correlation. Low risk
strategies designed for low but steady returns failed. The baby, tub, and
the entire kitchen have been thrown out with the bathwater.
As I have mentioned before I'm not bullish on the US consumer. Since
2000, much of our economic growth has come from the US consumer spending
the equity of their appreciating home. Once our economy recovers this ATM machine will no longer be available
to the country as a whole and will inhibit strong GDP growth.
While the market action of the last few
days is encouraging, it is only a thin veneer covering the deep anxieties
felt by the entire world. Don't be surprised when there are more
violent market actions up and down.