The Fed, Banking, Monetary Policy, Dollar & other currencies, Gold/Silver

[DougMacG]

... a panel of federal regulators charged with identifying market risks warned that a sudden rise in interest rates could have a destabilizing effect on financial markets
... interest-rate risk as one of seven major vulnerabilities to financial stability.
...the scenario, which featured a mix of moderate recession, rising consumer prices and rapid increases in short-term interest rates, as might occur if oil prices were to shoot sharply higher.
... The longer the low interest-rate environment persists "the more very low interest-producing assets accumulate on their balance sheets,"
..."At some point the Fed's going to have to raise rates, and the market value of those lower-yielding assets are going to go down."

"At some point the Fed's going to have to raise rates..." 

But why?  If it is a great policy, healthier for job growth than having market rates for interest , why would we ever stop manipulating the market for something as harmless as money?

It's almost as if the architects of the quantitative easing policies, trying to solve a non-monetary problem with monetary flooding, are admitting these policies are unsustainable, and that the longer the wrong policies continue the harder the fall will be.  (Other than the readers of this forum), Who knew?

[Crafty_Dog]

Bitcoin Startups Begin to Attract Real Cash
Venture Investors Pour in Millions, Adding Credibility to Internet Virtual Currency; Regulation Looms as a Concern
By SARAH E. NEEDLEMAN and SPENCER E. ANTE

Bitcoin startups are beginning to raise sizable investment capital even as industry leaders warn that hackers are abusing the Internet virtual currency for profit.
In the past year, fledgling businesses Coinbase Inc., Coinsetter Inc. and CoinLab Inc. have raised millions of dollars collectively from prominent venture-capital firms and angel investors, adding credibility to a digital currency that isn't backed by a central bank.
 
Coinbase founders Brian Armstrong, left, and Fred Ehrsam. 'We are in land-grab mode,' Mr. Ehrsam says.

Bits and Pieces

Mystery still surrounds Bitcoin, but buzz is growing, despite recent wild swings in the currency's value. Here's a rough timeline of the Bitcoin evolution.
s
 
On Wednesday, Bitcoin, which can be used to make payments over the Internet without transaction fees or involving a financial institution, is expected to win its biggest validation to date with a $5 million investment in San Francisco-based Coinbase led by Twitter Inc. investor Union Square Ventures.

That investment would top last month's more than $2 million put into OpenCoin Inc., another virtual currency startup whose backers include venture firm Andreessen Horowitz.

"This is going to be a trigger point," said Union Square managing partner Fred Wilson of the Coinbase investment. "You'll see lot more venture money being poured into this space."

Coinbase operates an online service that allows users to buy Bitcoin, store the virtual currency in a digital wallet and pay merchants for goods or services with it. The company was founded last year by Fred Ehrsam, a 24-year-old former Goldman Sachs GS +0.98% trader, and 30-year-old Brian Armstrong, previously an engineer at short-term rental startup Airbnb.

Bitcoin is attracting attention as a wildly volatile, all-digital currency. How does it work? How are criminals taking advantage of it? How risky an investment is it? In this Bitcoin explainer, WSJ's Jason Bellini has "The Short Answer."

In April, the Coinbase co-founders said the company had about 116,000 members who converted $15 million of real money into Bitcoin, up from $1 million in January. Mr. Ehrsam said its dollar conversions are increasing by about 15% a week, and its user base is growing at a weekly rate of about 12%.

"We are in land-grab mode," said Mr. Ehrsam.

Coinbase profits by charging users a 1% fee to convert dollars to and out of Bitcoin. "We have a pretty clear business model," said Mr. Ehrsam. "It's not like we're eating Ramen every day."

Bitcoin is gaining traction with some small merchants and others who want to reduce costs associated with accepting credit cards, such as content-aggregation site Reddit.com, and OKCupid.com, a dating site owned by IAC/Interactive Inc. IACI +0.20% eBay Inc. EBAY +1.39% Chief Executive John Donahoe last month also said the e-commerce heavyweight is exploring ways to integrate Bitcoin into its PayPal payments network.

Supporters of Bitcoin, which was created in 2009 by a person or group that goes by the name Satoshi Nakamoto, say it offers anonymity and a cheap way to transact business across borders. But critics say Bitcoin faces so many regulatory and technical hurdles it will never mature into a mainstream currency.
Last month, Tokyo-based Mt. Gox Co., the largest online exchange trading Bitcoin, said its services were disabled for approximately four hours by an Internet denial-of-service attack.

"Attackers wait until the price of Bitcoins reaches a certain value, sell, destabilize the exchange, wait for everybody to panic-sell their Bitcoins, wait for the price to drop to a certain amount, then stop the attack and start buying as much as they can," according to the exchange.

Coinbase Nabs $5M in Biggest Funding for Bitcoin Startup

That volatility is one of the concerns about the currency. Bitcoin rose in value from roughly $5 in June 2012 to a high of $266 in April and was down to about $108 on Tuesday, according to Mt. Gox data.

"If I really sat down and thought about writing a financial disclosure statement, I could probably list dozens of risks," said Union Square's Mr. Wilson.

Carol R. Van Cleef, a partner specializing in emerging payments and anti-money-laundering-compliance at Washington, D.C., law firm Patton Boggs LLP, said government financial reporting regulations likely will make it difficult for virtual-currency startups. The Financial Times reported on Monday that the Commodity Futures Trading Commission is discussing whether Bitcoin might fall under its regulatory jurisdiction.

Regulation is "going to force some players out of the market," Ms. Van Cleef said. Others, she added, "will bite the bullet and become compliant. But it will be expensive."
That isn't stopping venture investors. Jeremy Liew, a partner with Lightspeed Venture Partners, which has invested in three virtual currency startups including OpenCoin, said he's "incredibly bullish" because it allows for cost-free micro-transactions—such as buying a single candy bar—that would be too small for other electronic payments.
"The appeal of zero transaction costs is really strong and extremely disruptive for a massive industry, the payments industry," he said.

Chi-Hua Chien, a general partner at venture firm Kleiner Perkins Caufield & Byers who found the Facebook FB -0.41% investment while previously working at Accel Partners, said his firm is actively exploring investments related to Bitcoin and has already looked at more than two dozen such companies.

Mr. Chien estimates almost 100 companies are operating in the Bitcoin domain, including exchanges, payment processors and Bitcoin ATM machine operators. "It is completely crazy that money is not borderless," he said. "This is super-logical."

[Crafty_Dog]

http://www.ftportfolios.com/Commentary/EconomicResearch/2013/5/10/the-bogus-qe-xcuse

[G M]

 

http://www.ftportfolios.com/Commentary/EconomicResearch/2013/5/10/the-bogus-qe-xcuse

I'm curious what the excuse is for the record number of Americans on food stamps and disability, given the amazing economy Wesbury sees.

[Crafty_Dog]

He is addressing claims, such as those made by many of us here, of an impending inflation.

[G M]

He is addressing claims, such as those made by many of us here, of an impending inflation.

What does Wesbury's infomercial say? No negative results from using the magical money machine?

[Crafty_Dog]

Take the six minutes or so and find out for yourself.  It would take me longer than that to write it up 

[Crafty_Dog]

MOBY BEN, OR, THE WASHINGTON SUPER-WHALE: HEDGE FUNDIES, THE FEDERAL RESERVE, AND BERNANKE-HATRED
http://delong.typepad.com/sdj/2013/05/the-washington-super-whale-hedge-fundies-the-federal-reserve-and-bernanke-hatred.html
 
In February 2012, a number of hedge fund traders noted one particular index--CDX IG 9--that seemed to be underpriced. It seemed to be cheaper to buy credit default protection on the 125 companies that made the index by buying the index than by buying protection on the 125 companies one by one. This was an obvious short-term moneymaking opportunity: Buy the index, sell its component short, in short order either the index will rise or the components will fall in value, and then you will be able to quickly close out your position with a large profit.
But February passed, and March passed, and April rolled in, and the gap between the price of CDX IG 9 and what the hedge fund traders thought it should be grew. And their bosses asked them questions, like: "Shouldn't this trade have converged by now?" "Have you missed something?" "How much longer do you want to tie up our risk-bearing capacity here?" "Isn't it time to liquidate--albeit at a loss?"
So the hedge fund traders began asking who their counterparty was. It seemed that they all had the same counterparty. And so they began calling their counterparty "the London Whale". They kept buying. And the London Whale kept selling. And so they had no opportunity to even begin to liquidate their positions and their mark-to-market losses grew, and the risk they had exposed their firms to grew.
So they got annoyed.
And they went public, hoping that they could induce the bosses of the London Whale to force him to unwind his possession, in which case they would profit immensely not just when the value of CDX IG 9 returned to its fundamental but by price pressure as the London Whale had to find people to transact with. And so we had 'London Whale' Rattles Debt Market, and similar stories
The London Whale was Bruno Iksil. He had been losing, and rolling double or nothing, and losing again for months. His boss, Ina Drew, took a look at his positions. They found they had a choice: they could hold the portfolio and thus go all-in, or they could fold. They could hold CDX IG 9 until maturity--make a fortune if a fewer-than-expected number of its 125 companies went bankrupt, and lose J.P. Morgan Chase entirely to bankruptcy if more did. Or they could take their $6 billion loss and go home. They could either take their losses, or sing "Luck, Be a Lady Tonight!" and bet J.P. Morgan Chase on a single crapshoot. After all, what could they do if the bet went wrong and they had to eat losses at maturity? J.P. Morgan Chase couldn't print money. So Drew stood Iksil down, and the hedge fund traders had their happy ending.
 
In late 2008, the Treasury bond went haywire. The interest rate on the Ten Year Nominal Treasury bond fell to 2.1% in the panic--clearly overpriced. In the late 1990s with the debt-to-annual-GDP ratio on the decline the Treasury bond had traded between 5% and 7%. In the 2000s with a weak economy the Treasury bond had traded between 4% and 5%. With the Federal debt exploding even faster than it had around 1990, it seemed to hedge fund traders very clear that the long-term fundamental value of the Ten-Year Treasury bond probably carried an interest rate of 7%, or more--and was at the very least more than 5%. So smart hedge fund traders shorted Treasuries, and waited for the Treasury Bond to return to its fundamental value.
And they ran into the widowmaker.
 
So they scrambled around, wondering: "Why did the interest rate on the Ten-Year Treasury peak at 4%? And why has it gone down since then? And why won't it go back to its 5%-7% fundamental." And they looked around. And they found Ben Bernanke:
 
The Washington Super-Whale.
He had printed-up reserve deposits, and used them to buy Treasury Bonds, and in so doing, they thought, had pushed the price of Treasuries up well beyond their fundamentals. Yet rather than easing off, taking his lumps, and letting the market "clear" he kept buying and buying and buying and buying, leaving the hedge fund traders with larger and larger and larger short positions in Treasuries that had to be carried at a loss. And every year that they carry those positions is a -2% times the size of the long leg negative entry in their cash flow.
Bruno Iksil, they thought, had been pulled up short by his boss Ina Drew's unwillingness to bet the firm and risk bankruptcy. Ben Bernanke, they thought, ought to have been pulled up short by his regard for financial stability--by his promise to keep inflation at its target, for the counterpart to J.P. Morgan Chase's bankruptcy and liquidation would be the national bankruptcy that is another episode of inflation like the 1970s. But Ben Bernanke wasn't pulled up short by the risk of inflation. He had no supervising CEO. And he dominated the Federal Open Market Committee.
But what Bernanke was doing, they thought, was as unprofessional as it would have been for Ina Drew to tell Bruno Iksil: "You turn out to have made a large directional bet that we can sell unhedged protection and profit? Let's see if you are right: let it ride!"
And so they went public with the Washington Super-Whale, as they had gone public with the London Whale. Perhaps somewhere out there was an equivalent of Jamie Dimon who could tell Bernanke that it was time to unwind the Federal Reserve's balance sheet now? Jeremy Stein, perhaps?
From my perspective, of course, the hedge fundies' analogy between the London Whale and the Washington Super-Whale is all wrong--the hedge fundies are thinking partial-equilibrium when they should be thinking general equilibrium. CDX IG 9 has a well-defined fundamental value: the payouts should each of the 125 companies go bankrupt times the chance that they will. What Bruno Iksil does does not affect that fundamental value. He can bet, and drive the price, but he cannot change the fundamental.
But the Washington Super-Whale is different.
In a healthy economy, the Ten-Year Treasury Bond does have a well-defined fundamental. When the economy is healthy enough that pricing power reverts to workers and keeping inflation from rising is job #1 for the Federal Reserve, the level of the Federal Funds rate now and in the future is pinned down by the requirement to hit the inflation target. And the fundamental of the Ten-Year Treasury Bond is then the expected value over the bond's lifetime of the future Federal Funds rate plus the appropriate ex ante duration risk premium.
But when the economy is depressed, like now? When market appetite for short-term cash at a zero interest rate is unlimited, like now? When workers have no pricing power, and so wage inflation is subdued, like now? The Federal Reserve is not J.P. Morgan Chase. It is not a highly-leveraged financial institution that must worry about holding too much duration risk. As Glenn Rudebusch once said:
Our business model here at the Fed is simple: (i) print reserve deposits that cost us 0 (OK. 0.25%/yer), (2) invest them in interest-paying bonds that we then hold to maturity, (3) PROFIT!!
And the more quantitative easing the Fed undertakes and the larger is its balance sheet the larger is the amount of money the Federal Reserve makes on its portfolio, without running any risks--as long as the economy remains depressed.
The Federal Reserve, you see, is unlike J.P. Morgan Chase: the Federal Reserve does print money.
But, the hedge fundies say: "What if the economy recovers and starts to boom? What if inflation shoots up? The Fed could loose $500 billion on its portfolio as it moves to control inflation! Why doesn't that fear that?"
The Fed does not fear that. That is what it is aiming for. The Fed is charged by law with "promot[ing] effectively the goals of maximum employment, stable prices, and moderate long term interest rates". A full-employment economy is not something to be feared but something to be welcomed. And a $500 billion mark-to-market loss on its current portfolio? The Fed has given $500 billion to the Treasury, as a present, over the past decade. It is not a profit-making private bank. It is a central bank charged with "promot[ing] effectively the goals of maximum employment, stable prices, and moderate long term interest rates".
"But," the hedgies say, "George Soros! The Bank of England held the pound sterling away from fundamentals in 1992, and George Soros bet against them and they could not maintain the parity and George Soros took them for $2 billion! Why aren't we doing the same?" Ah. But George Soros took $2 billion from the Bank of England because its political masters told it to stand down: "We will not," they said, "defend the ERM pound parity at the price of bringing on a deep recession and mass unemployment." Who do the hedgies imagine are the Fed's political masters who will tell it to shift and adopt policies that will bring on even massier unemployment? Rand Paul?
There is a reason that the trade of shorting the bonds of a sovereign issuer of a global reserve currency in a depressed economy is called "the widowmaker".

[Crafty_Dog]

Scott Grannis responded to the Moby Ben piece by referencing this post on his blog last year--
see http://scottgrannis.blogspot.com/2012/12/the-fed-leverages-up_17.html for the charts:


Monday, December 17, 2012
The Fed leverages up
Ben Bernanke, head of the world's largest hedge fund (aka The Federal Reserve), last week announced that next year he plans to borrow another $1 trillion dollars—on top of the $1.5 trillion he's borrowed over the past four years—in order to fund the federal government's CY 2013 deficit and give his shareholders (aka taxpayers) a profit to boot. This plan is otherwise known as QE4.

His is a unique business, since he can force the market to lend him money—he simply buys what he wants and pays for it with his "bank reserve checkbook." By the end of next year, the Fed will own $1 trillion more bonds, and the banking system will have $1 trillion more reserves, whether it wants them or not. Bernanke can also dictate the rate at which he borrows money; for the foreseeable future that will be the rate the Fed decides to pay on reserve balances held at the Fed, currently 0.25%. Those who end up with the reserves will have essentially lent the Fed money on the Fed's terms.

To be more specific: Next year, Bernanke plans to make net purchases of $540 billion of longer-term Treasuries, and $480 billion of MBS. He will fund those purchases by issuing $1.02 trillion of newly-minted bank reserves. In effect, the Fed will be swapping reserves (which are functionally equivalent to 3-mo. T-bills, the paragon of risk-free assets, but which currently pay a slightly higher rate of interest) for bonds. Since money and bank reserves are fungible, Bernanke's planned purchases should effectively cover Treasury's deficit next year, which, perhaps not coincidentally, looks to be about $1 trillion.



It's important to note here that when the Fed issues $1 trillion of bank reserves, it is NOT "printing money." That's because bank reserves are not cash and they can't be spent anywhere: like pajamas, they are only for use "in house," since they are always kept at the Fed. Bank reserves do have a unique feature, of course, that other short-term assets don't: they can be used by banks to create new money, and in fact, acquiring more reserves is the only way that banks can increase their lending, because banks need reserves to back their deposits. Since banks now hold $1.6 trillion of reserves, of which only $0.1 trillion is required to back current deposits, banks already have an almost unlimited ability to make new loans and thereby expand the money supply. A year from now they will have an even more unlimited ability to do so.


That banks haven't yet engaged in a massive expansion of lending activity and the money supply is a testament only to the risk-averse nature of bank management and the risk-averse nature of the public, which now holds $6.5 trillion of bank savings deposits (up 64% in the past four years) paying almost nothing. As the above chart shows, in recent years the M2 measure of money supply has grown only slightly faster than its long-term average.

To put it another way: The Fed's massive provision of reserves to the banking system has not resulted in an equally large increase in inflation because the world's demand for money (cash, bank deposits, and cash equivalents like bank reserves and T-bills) has been very strong. Banks, in short, have been content to sit on $1.5 trillion of "excess" reserves because they worry that making more loans and increasing deposits might be a lot riskier.

The rationale for hedge funds is to exploit arbitrage opportunities, buying one thing and selling or borrowing another. Even small differences in prices can become lucrative, thanks to the use of lots of leverage. If done successfully, arbitrage can contribute to market efficiency, which in turn can contribute to the health of an economy. Whether the Fed will accomplish the same thing with QE4, however, is an open question. Will banks lend a lot more next year, even though they have an essentially unlimited capacity to lend today? Will increased bank lending fuel genuine economic growth, or will it just fuel more speculation? No one knows. We are in uncharted waters; what the Fed is doing today has never been done before.

When faced with issues of daunting complexity and with little or no guidance from the past, one can only begin by trying to reduce things to their simplest form. Here's what I think is a simplified description of what the Fed is planning: Next year the Fed will be purchasing a total of $1 trillion of 10-yr Treasuries and current coupon MBS. 10-yr Treasuries currently yield 1.75%, and current coupon MBS about 2.25%, so the Fed will earn roughly 2.0% on its purchases, while paying out 0.25% on the reserves it creates to buy those bonds, for a net spread of 1.75%. By the end of next year, the Fed will be raking in $17.5 billion per year in profits on their $1 trillion swap, and that will make the Fed the envy of all other hedge fund managers.

These profits, of course, are automatically remitted by the Fed to Treasury. Happily for taxpayers, those profits will completely offset Treasury's cost of borrowing, at least for the next several years. Here's the math, also in simplified form: First, let's assume that Treasury is funding its deficit with 7-yr Treasuries (that's a decent approximation, since last year they told us that they were going to lengthen the average maturity of outstanding Treasuries, which at the time was about six years). The yield on 7-yr Treasuries is currently about 1.25%, so Treasury will pay 1.25% on $1 trillion, and receive back from the Fed 1.75%, leaving a profit of about 0.5%, or $5 billion. Bottom line, we will all benefit from next year's deficit financing! (Note that the key to the profit is the Fed's decision to buy lots of MBS, which yield more than Treasuries of similar maturity.)

A real-world hedge fund attempting to do the same thing would run up against the reality of mark-to-market accounting rules. If interest rates on the bonds it buys rise, the mark-to-market losses on the bonds could easily wipe out the interest it's receiving, threaten margin calls and ultimately result in insolvency. For example, a 1 percentage point rise in the yield on 7-yr Treasuries would result in a 6.7% decline in their price, thereby wiping out over 5 years' worth of coupon payments. Mortgage-backed securities could fall in price by even more. A hedge fund would also be exposed to the risk that its borrowing costs could rise, thus narrowing or even eliminating the net interest spread it's earning.

Happily, Bernanke doesn't have to worry about any of this, since he doesn't have to mark his bonds to market, and he can keep his borrowing costs below the current yield on his portfolio for at least the next 2 or 3 years, given the FOMC's recent guidance (i.e., it won't start tightening until the unemployment rate falls to 6.5%, short-term inflation expectations exceed 2.5%, and/or long-term inflation expectations become unanchored). And of course, the Fed can always make the interest payments on its borrowings because its "bank reserve checkbook" is effectively bottomless.

If this all sounds too good to be true, it is. The Fed may not face the risks that a typical hedge fund does, but that doesn't mean the Fed is not taking on a huge amount of risk at taxpayers' and citizens' expense. Although the Fed need never face insolvency, if mark to market losses got really bad, they could lose their credibility and with that the value of the dollar could be seriously at risk. The Fed's losses might become direct obligations of Treasury, or they might be inflicted on taxpayers and citizens via the sinister "inflation tax." The Fed could eventually repay its borrowings with devalued dollars, leaving the rest of us with deflated balance sheets and deflated incomes. Meanwhile, by allowing Treasury to borrow trillions at no cost, the Fed is acting as an obstacle to badly needed deficit reduction.

Although it may seem paradoxical, the biggest risk we all face as a result of the Fed's unprecedented experiment in quantitative easing is the return of confidence and the decline of risk aversion. If there comes a time when banks no longer want to hold trillions of dollars worth of excess bank reserves for whatever reason (e.g., the interest rate the Fed is paying is no longer attractive, or the banks feel comfortable using their reserves to ramp up lending, or the public no longer wants to keep many of trillions of dollars in bank savings deposits), that is when things will get "interesting."

More confidence would mean less demand for cash and cash equivalents, and that in turn would mean that a virtual flood of money could try to exit banks (e.g., as people withdraw their savings deposits, and/or borrow more from their banks). If the public attempted to shift trillions in cash into housing, stocks, gold, or other currencies, the consequences would likely be seen in sharply rising prices and higher inflation. Moreover, higher inflation would almost certainly lead to higher interest rates, which in turn would exacerbate the Fed’s mark to market problem and possibly accelerate the whole process. And of course, higher interest rates will result in significantly higher borrowing costs to Treasury, although this will be mitigated to some extent by Treasury's efforts to extend the average maturity of its borrowings.

The Fed reasons that it could deal with declining risk aversion by selling bonds (i.e., reducing bank reserves), not reinvesting principal, and by raising the rate it pays on bank reserves. But it’s not hard to see how things could get out of control: higher rates on bank reserves would likely accelerate the rise in market yields and the mark to market losses on the Fed’s bond holdings, at the same time as its spread eroded. In the meantime, the more bank reserves the Fed creates, the harder it will be to avoid an unhappy outcome.

It’s ironic that the Fed is trying, with QE4, to accomplish the very thing that could be its own undoing. Trying, that is, to encourage more confidence, more lending, more borrowing, more investment, and higher prices for risk assets.

It’s no wonder that the market remains so risk-averse, since this is hardly a comforting position we're in. For now, that is probably a good thing. But in the wake of the election results and the Fed's latest decision, I am less optimistic today than I have been for several years.

[ccp]

"It’s no wonder that the market remains so risk-averse, since this is hardly a comforting position we're in. For now, that is probably a good thing. But in the wake of the election results and the Fed's latest decision, I am less optimistic today than I have been for several years. "


"less optimistic"  & "for several years".

Wow.

Now if Wesbury starts to show signs of cold feet - it's money under the mattress time. 

[G M]

Wesbury would try to spin a zombie apocalypse into "good news for the plowhorse".