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Spanish and
Italian bond yields have now risen back up to the level they were before the
EU Summit. We also learned recently that U.S. job growth remains anemic,
producing just 80k net new jobs in June. The global manufacturing index
dropped to 48.9, for the first time since 2009. And emerging market economies
have seen their growth rates tumble, as the European economy sinks further
into recession.
It isn't much
of a surprise to learn that central banks in China, Britain, Europe and
America have indicated that more money printing is just around the corner.
In fact, we
have recently witnessed the People's Bank of China cut their one-year lending
rate by 31 bps to 6 percent. The European Central Bank cut rates 25 bps, to
.75 percent and dropped their deposit rate to 0 percent. And the Bank of
England restarted their bond purchase program just two months after ending
the previous program, which indicates the central bank will buy another 50
billion pounds of government debt.
This past
Non-farm payroll report in the U.S. virtually guarantees the Fed will take
action to compel commercial banks into expanding loan output within the next
few months. It would be unrealistic to believe Ben Bernanke would watch U.S.
inflation rates fall, the major averages significantly decline, employment
growth stagnate; and do nothing to increase the money supply--especially
while his foreign counterparts are aggressively easing monetary policy and
trying to lower the value of their currencies.
As I
predicted as far back as June of 2010, the Fed will soon follow the strategy
of ceasing to pay interest on excess reserves. Since October 2008, the Fed has been paying interest
(25 bps) on commercial bank deposits held with the central bank. But because
of Bernanke's fears of deflation, he will eventually opt to do whatever it
takes to get the money supply to increase. With rates already at zero percent
and the Fed's balance sheet already at an unprecedented and intractable
level, the next logical step in Bernanke's mind is to remove the impetus on
the part of banks to keep their excess reserves laying fallow at the Fed.
Heck, he may even charge interest on these deposits in order to guarantee
that banks will find a way to get that money out the door.
The move
would be much more politically tenable than to increase the Fed's balance
sheet yet further, most likely because people don't understand the
inflationary impact it would have. Ceasing to pay interest on excess reserves
would allow the Fed to lower the value of the dollar and vastly increase the
amount of loan creation, without the Fed having to create one new dollar.
If commercial
banks stop getting paid to keep their money dormant at the Fed, they will
surely find somebody to make a loan to. They may even start shoving loans out
through the drive-up window with a lollipop. Banks need to make money on
their deposits (liabilities). If banks no longer get paid by the Fed, they
will be forced to take a chance on loans to consumers, at the exact time when
they should be getting rid of their existing debt. But it has already been
made very clear to them that the government stands ready to bail out banks.
So in reality, they don't have to worry very much at all about once again
making loans to people that can't pay them back.
Commercial
banks currently hold $1.42 trillion worth of excess reserves with the central
bank. If that money were to be suddenly released, it could through the
fractional reserve system, have the potential to increase the money supply by
north of $15 trillion! As silly as that sounds, I still hear prominent
economists like Jeremy Siegel call for just such action. If they get their
wish, watch for the gold market to explode higher in price, as the U.S.
dollar sinks into the abyss.
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