Wednesday, December 11, 2013

How the US Dollar Will Fail?

Bernanke made new money but kept most of it in the Fed by paying interest on excess bank reserves.   If you imagine a big black box around both the Federal Government and the Federal Reserve, then to everyone outside this box there is no difference between interest on government debt and interest on excess reserves.   So really excess reserves are like government debt as far as the impact on the economy, inflation, and risk of hyperinflation.

It looks like a Yellen led Fed wants to reduce the interest rate paid on excess reserves.   Interest rates have been rising, so to provide enough incentive for banks to leave money as excess reserves the Fed would have to raise the interest they pay.  Instead they are talking of lowering the interest rate they pay.

Looks to me like a good bet for how things fail is that the Fed does not keep rates on excess reserves competitive, so that money comes flooding out into the real economy. 

Of course, the Japanese Yen failing and then the UK and US following is another good bet.


  1. That's precisely what Scott Sumner an the other Market Monetarists would like to see happen (for the Fed to lower the IOR rate) to help get NGDP back on track.

    Maybe they're right. :D

  2. Agreed - seems to be a calculated, lever-pulling effort to stoke the fires of inflation? Are chance the banks will hoard it themselves as collateral?

  3. The policymakers at the Fed think they are dialing a thermostat up and down, but they're actually playing with a nuclear reactor. A runaway chain reaction can melt the whole thing down. Paraphrase of Jim Rickards, Currency Wars.

  4. Many years ago when Alan Greenspan was at the controls, (my nickname for him is appropriately "Green-Spin"), I likened him to my 12-month old son sitting at his Playschool workbench, turning pretend knobs and drooling all over the place. I think that pretty much sums up the effectiveness of Fed lever pulling.

    1. If Market Monetarists like Scott Sumner are right, then if "lever pulling" amounts to setting interest rates or even adjusting the base money supply, then those efforts (levers) are "lousy" as a communications strategy, and communications is really the best tool the central bank has:

  5. I don't think you understand monetary policy well enough, so far the inflationistas have been wrong for an extended period of time, particularly those owning gold the last 18 months.

    The question should be: what did you misunderstand about monetary policy and inflation?

    1) inflationistas didn't account for the credit overhang - which ensured the new money entering the system would go straight back out through the existing credit channels and keeping the money multiplier low.

    2) if you can consider how much the velocity of money slowed down since the financial crisis, you will realise with some simple arithmetic that the addition to base money via printing (about 9%) vis a vis the contraction in velocity on the rest, gives you a smaller result. Hence, disinflation.

    3) finally, QE is just a credit and debit on the fed's balance sheet - an asset swap if you will - of non-interest bearing cash, for interest bearing bonds... Certainly not helicopters from the sky!

    4) If you are a republican voting American, you must avoid falling into the old hyperinflationist meme, it is so deeply associated with your politics, most people do not realise and stems back to political/philosophical arguments against Lenin and Marx, when the left was much more politically left.

    1. I have a new post up addressing why there will be inflation. See it at:


Looking for polite debate on ideas. Never attack a person. Be nice.