myavkow: Making Money System

Up to this point this dramatic expansion of the U.S. monetary base has not caused that much inflation because U.S. government borrowing has soaked most of it up and U.S. banks have been hoarding cash and have been building up their reserves.

However, this situation will not last forever. Eventually all this cash will make its way through the food chain and into the hands of U.S. consumers.

But what is even more troubling is the dramatic spike in commodity prices that we have seen in 2010.

Wheat futures have surged 63 percent since the month of June. Wheat has recently been selling well above 7 dollars a bushel on the Chicago Board of Trade.

But wheat is far from alone. In his recent column entitled "An Inflationary Cocktail In The Making", Richard Benson listed many of the other commodities that have seen extraordinary price increases over the past year....

*Agricultural Raw Materials: 24%

*Industrial Inputs Index: 25%

*Metals Price Index: 26%

*Coffee: 45%

*Barley: 32%

*Oranges: 35%

*Beef: 23%

*Pork: 68%

*Salmon: 30%

*Sugar: 24%

*Wool: 20%

*Cotton: 40%

*Palm Oil: 26%

*Hides: 25%

*Rubber: 62%

*Iron Ore: 103%

Now, as those price increases enter the chain of production do you think that there is any chance that they will not cause inflation?

Do you think there is any chance at all that producers and retailers will not pass those costs on to consumers?

It is time to face facts.

Those cost increases are going to filter all the way through the system and your paycheck is soon not going to stretch nearly as far.

Inflation is coming.

Many savvy investors understand what is going on right now. That is one reason why gold and silver are absolutely soaring at the moment.

The price of gold set another record high on Friday for the sixth straight day.

Silver has also experienced extraordinary gains recently, and the U.S. Mint has officially raised their wholesale pricing above spot on American Silver Eagles from $1.50 to $2.00.

Meanwhile, there are even more rumblings that the Fed wants to print lots more money. On Friday, the president of the Federal Reserve Bank of New York, William Dudley, stated that the high unemployment and the low inflation that the United States is experiencing right now are "wholly unacceptable"....

"Further action is likely to be warranted unless the economic outlook evolves in such a way that makes me more confident that we will see better outcomes for both employment and inflation before long."

During his remarks, Dudley even mentioned what the effect of another $500 billion increase in the Fed’s balance sheet would be.

Now keep in mind, this is not just another "Joe" who is making these remarks.

This is the president of the Federal Reserve Bank of New York - the most important of all the regional Fed banks.

In recent weeks it is almost as if you can hear Fed officials salivate as they consider the prospect of flooding the economy with even more money.

Up to this point, very little has worked to stimulate the dying U.S. economy. The Federal Reserve and the Obama administration are getting nervous as the American people become increasingly frustrated about the economic situation.

So will flooding the economy with even more money and causing even more inflation do the trick?

Well, no, but what inflated GDP figures will do is enable Obama and the Fed to say: "Look the economy is growing again!"

But if a flood of paper money causes the value of goods and services produced in the U.S. to go up by 5 percent but the real inflation rate is 10 percent, are we better off or are we worse off?

It doesn't take a genius to figure that one out.

So don't get fooled by "economic growth" numbers. Just because more money is changing hands doesn't mean that the U.S. economy is doing better.

In fact, many American families are going to be financially shredded by the coming inflation tsunami.

Just think about it.

How far will your paycheck go when a half gallon of milk is 10 dollars and a loaf of bread is 5 dollars?

Already, it is incredibly difficult for the average American family of four to get by on $50,000 a year.

So how much money will we need when rampant inflation starts kicking in?

And do you think that your employers will actually give you pay raises to keep up with all of this inflation?

Not in these economic conditions.

In fact, median household incomes are declining from coast to coast all over the United States.

Earlier this year, Ben Bernanke promised Congress that the Federal Reserve would not "print money" to help the U.S. Congress finance the exploding U.S. national debt.

Did any of you believe him at the time?

Did any of you actually believe that the Federal Reserve would act responsibly and would attempt to keep the money supply and inflation under control?

The reality is that the entire Federal Reserve system is predicated on perpetual inflation and a perpetually expanding national debt.

Whatever wealth you and your family have been able to scrape together is going to continue to be whittled away month after month after month by the hidden tax of inflation.

And unfortunately, as discussed above, inflation is about to get a whole lot worse.

So is there any room for optimism? Is there any hope that we will not see horrible inflation in the years ahead? Please feel free to leave a comment with your opinion below....

One of the big problems during the financial crisis was a bank run in the shadow banking system when doubts emerged about the safety of deposits.

In my last column at the Fiscal Times, I talked about an approach to solving the problem that involves having deposits in the shadow system backed (insured) by high quality collateral.

But high quality collateral is not the only option. Another way to do this is through a type of insurance along the lines of what the FDIC does for the traditional banking system, along with restrictions on eligibility for the insurance. In reaction to my column, and in support of the insurance approach, Morgan Ricks of Harvard Law School emails:

I enjoyed your Fiscal Times piece and am glad you're focused on this issue.

I'm a big admirer of Gary and Andrew's work, but I would encourage you to give some more thought to whether collateral requirements for repo are likely to do the trick. Here are a few things to consider:

Many of the short-term liabilities of the shadow banking system were and are uncollateralized (think about Lehman's reliance on unsecured commercial paper -- the default of which caused the Reserve Fund to "break the buck," igniting the run on money market funds; and Citigroup's SIVs, which financed themselves in the unsecured markets).

Money market investors do not want to take possession of collateral and dispose of it. Even if the collateral is high quality, they don't want the interest rate risk. That's not their business. They don't want to deal with the consequences of a counterparty default. This is why, in the crisis, many money market investors stopped rolling even those repos that were fully secured by Treasuries and agencies:

See Chris Cox's testimony on Bear Stearns (here http://www.sec.gov/news/testimony/2008/ts040308cc.htm): "For the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured financing, but short-term secured financing, even when the collateral consisted of agency securities with a market value in excess of the funds to be borrowed"

See also FRBNY's repo task force report (here http://www.newyorkfed.org/prc/report_100517.pdf): “Discussions in the Task Force emphasized repeatedly that many Cash Investors focus primarily if not almost exclusively on counterparty concerns and that they will withdraw secured funding on the same or very similar timeframes as they would withdraw unsecured funding.”

Even if collateral requirements reduce the likelihood of runs, how do we calibrate them -- what is the objective function? Presumably we think maturity transformation (fractional reserve banking) is a good thing -- it increases the supply of loanable funds by pooling otherwise idle cash reserves and deploying them toward productive investments. Risk constraints (such as collateral requirements) necessarily reduce this surplus -- there is a real social cost. How do we appraise the corresponding benefit? That is, how do we estimate the systemic instability associated with any given level of collateral requirements? My argument is that we can't. And by "we" I mean not just the government, but anybody.

My paper argues that we avoid these problems with an insurance regime; that financial firms outside the insurance regime should be disallowed from conducting maturity transformation (i.e., they would have to rely on term funding, not money market funding); and that we should develop functional criteria of eligibility for the insurance regime. (By the way, this is not the same thing as "extending" insurance to shadow banks.)

Anyway, these are things worth thinking about. I think the insurance approach needs more serious consideration than it has received -- it's a little lonely over here ...

Best,

Morgan Ricks

See here for nice summary of this approach and link to the underlying academic paper.

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