This is a topic I've been putting off for a while,
because I'm not really an expert on the Fed. In general terms, fine, but not
on the daily nitty gritty. My experience with central bank daily operations
was mostly with the BOJ. Nevertheless, we have to start sometime, so we can
consider this a Version 1 attempt. Nobody else is going to do it but me,
apparently.
The Fed, as a currency manager, is primarily engaged
in one thing -- adjusting the supply of base money. This was not its original
purpose, when it was created in 1913, but one that it adopted as a result of
monopolizing the currency in the 1920s-1930s. At first, the Fed operated
roughly within the confines of the gold standard. However, when this
obligation was lifted in 1971, the Fed became the Fed we know today, the
manager of a floating currency.
The Fed's operations are generally pretty simple:
1) It buys assets, typically government securities,
and issues base money in return. This expands the monetary base.
2) It sells assets, typically government securities,
and takes base money in payment, which is then effectively cancelled. This
contracts the monetary base.
In practice, it can buy or sell any sort of asset.
This includes foreign bonds, stocks, making loans to banks (the same as
"buying a bond from a bank"), etc.
The assets held by the Fed are listed at the Fed's
website.
http://www.federalreserve.gov/pubs/supplement/2008/08/table1_18.htm
However, due to the various complexities introduced
by the Fed's "swap till you drop" activities of late, let's use an
earlier list of assets, such as this one from 2005:
http://www.federalreserve.gov/pubs/supplement/2006/01/table1_18.htm
We see that the Fed had a total of $826 billion in
assets as of September 28, 2005, the leftmost and easiest-to-read column in
the table. Of that, $736 billion was U.S. Treasury securities, and the rest
was bits and pieces.
In the Liabilities column, we find $732 billion of
banknotes, and some other bits and pieces, for a total of $799 billion. The
most interesting among the other bits and pieces are the government's
deposits. The Fed is the government's bank -- where, for example, the
government puts its money when taxes are paid. Depository institutions also
maintain some deposits with the Fed -- these may be the "clearing
balances" used for payments between banks, a form of bank reserves.
Actually, there are $890 billion of Federal Reserve
Notes outstanding, as shown lower down, due to odd accounting of notes held
in Fed depository institutions. I'm not exactly sure what the status is of
these notes held by depository institutions is -- it appears that, although
they are located at the depository banks, they are still owned by the Fed,
ready to be sold to the banks if necessary. This makes sense: if there was a
need for paper money, you would want to have it in the banks, and not in a
vault in Washington DC, from where it would have to be trucked in.
Bank reserves are noted here:
http://www.federalreserve.gov/pubs/supplement/2006/01/table1_12.htm
Most of the reserves held by banks are vault cash,
in other words paper money.
So, we've seen that the Fed holds mostly government
securities, and issues base money, which is mostly paper money with a bit of
bank reserves. That is the monetary system -- at least the supply aspect.
Note that the Fed normally doesn't make loans to banks or anyone else,
although we are in an exceptional period right now as far as that is
concerned.
Another description of the monetary base is here:
http://www.federalreserve.gov/pubs/supplement/2006/01/table1_20.htm
You can see from the tables that the numbers change,
which shows that the Fed's adjustment of base money is continuous. A more
detailed description of the Fed's operations can be seen here:
http://www.federalreserve.gov/pubs/supplement/2006/01/table1_17.htm
Here is an even more detailed look at the Fed's
operations:
http://www.federalreserve.gov/releases/h41/Current/
This has a funny note, with $29 billion of "net
portfolio holdings of Maiden Lane LLC". Maiden Lane is the street that
the New York Fed is located on in Lower Manhat tan. This is apparently a
relatively new entity, as it is an LLC, a corporate structure that did not
exist a few decades ago. I wonder what they are doing? What does "net
portfolio holdings" mean? What are the gross portfolio holdings?
It all comes down to the same thing: the Fed is
adjusting the size of the monetary base. In lay terms, this is "printing
money" (expanding the base), and "unprinting money"
(contracting the base). You will notice that, although the general tendency
is for base money to rise, in the shorter term there are expansions and
contractions. These contractions can be larger and longer-lasting, if the
situation demands it.
Now, we see from this that the Fed is not
"controlling interest rates." It is adjusting the monetary base in
response to an interest-rate target. We'll talk more about that, and how it
works, at some future date.
Probably the point here is that the Fed is not a
mysterious black box. We can lift the hood and see what it is doing. We see
that money -- base money -- is created and dis-created every day. However,
many people get confused here, because looking at what the Fed is doing is
not very helpful, once you understand basically how it works. That's why I
don't actually follow Fed operations that much -- there isn't much value in
it (not to say that there isn't any value at all, just not much). I follow
base money growth rates intermittently. Money aggregates (which are really
credit measures) are not that useful. The important thing is the value of
the currency, which is not found in the Fed's operating statistics.
* *
This is from
CalculatedRisk:
Remember, I think that the rent/price ratio is THE
most important measure of real estate valuation. I wrote about this in past
years:
April 9, 2007: How Far Down for
Housing Values?
March 19, 2006: How to Value Real
Estate
Unfortunately, rent/price ratios are hard to come
by, because they vary with each individual property. Thus, it is nice to have
some sort of standardized rent/price ratio, here offered by the OFHEO and
Case-Schiller. At least, it should be comparable to itself on a historical
basis.
As you can see from this chart, we have a LONG way
down to go before hitting average ratios around 1.0. Rent/price ratios will
probably fall well below the 1995 lows, I think.
* * *
I think Obama is backing off some of his tax hike
threats. He should pump up his tax cut plan, extending his "$50,000 tax
free" plan for seniors to everybody. Here is some recent commentary on the
candidates' tax plans:
http://www.taxpolicycenter.org/UploadedPDF/411749_update_candidates.pdf
* *
Winter is coming, and many people in the colder
states are wondering how they can prepare their residences so that they
consume less fuel in the process of heating. One of the cheapest/highest
return on investment things you can do is to use thermal paint. Not many
people know about this. Thermal paint uses tiny glass spheres, which reflect
infrared heat, much like aluminum foil. Infrared reflectivity for thermal
paint can be as high as 90%. However, it looks like normal paint. In fact,
you can buy just the spheres and add it to normal paint in the designer color
of your choice. Here's a source:
Paint additives online
This costs a whopping $12 for a gallon's worth, and
less in larger quantities. Some people report that using thermal paint
reduced their heating fuel usage by up to 30%! It is especially good if you
have a radiant thermal source, like a wood stove (as opposed to heated air
for example).
Nathan Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United States, Japan, and the Middle
East. About the Book: Gold: The Once and Future Money (Wiley, 2007, ISBN:
978-0-470-04766-8, $27.95) is available at bookstores nationwide, from all
major online booksellers, and direct from the publisher at
www.wileyfinance.com or 800-225-5945. In Canada, call 800-567-4797.
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