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« Portfolio Update 19 November 2008 | Main | A New Era by Rob De Graff »

The Federal Reserve was never envisioned to be the lender of last resort!

Bud1 11nov08

In the mailbag this morning is this article by Bud Conrad who is the Chief Economist at Casey Research. It raises interesting questions about the role of the Federal Reserve and its preference for bailouts rather than the protection of the US Dollar.

What’s Up, Doc?
By Bud Conrad
Chief Economist, Casey Research
The Casey Report

Under Bernanke’s direction, the Federal Reserve has completely rewritten its mission. Many articles in the International Speculator and The Casey Report have reported the strange growth in the loans they have made and explained that Bernanke has, for a long time, espoused unconventional actions to avert deflation and to expand the economy. So the charts tell that story, and it is truly amazing.

The Federal Reserve was never envisioned to be lender of last resort to a whole slew of investment banks, money market mutual funds, and commercial paper issuers.

The situation is not easy to sort out, for the simple reason that the extent of their actions is not presented by the Fed via clear and concise data. Instead, the data is complex and hard to analyze, partly because of the piecemeal way the actions were taken, but also probably due to a desire by the Fed to avoid public scrutiny and criticism.

Digging into the details of the Fed’s balance sheet reveals, however, the complete change of composition and direction of the Fed. The most obvious change is that they have doubled the size of their assets and liabilities. A year ago, the Fed’s assets consisted almost entirely of government Treasuries and a little gold.

That is a clean, safe balance sheet.

The only important liability was the currency they issued (our paper dollars). They also had a small reserve of deposits from all the banks. When Greenspan wanted to give the economy a boost by lowering short-term interest rates, he would create some money and buy Treasuries. He could also do the reverse.

Bernanke has turned this upside down. Initially he made focused loans to big banks. But then the loans became bigger than the reserve deposits, leaving the banks in total as net borrowers. The concept of a fractional reserve no longer applies when the reserve is net negative.

To fund yet more loans, Bernanke then sold off half of the Fed’s Treasuries. And he traded Treasuries for toxic waste of poor-quality mortgage-backed securities. And he encumbered half of the remaining Treasuries with “off balance sheet” swaps of about $220 billion. (Does this sound like Enron accounting?) The balance sheet started with $800 billion of mostly reliable assets and now has about $250 billion of unencumbered Treasuries.

The biggest source of funding is from the Treasury. Banks are leaving deposits in the Fed now that the Fed is paying interest.

The important conclusion is that the paper dollars are now issued by a far less soundly structured Fed, an organization that is more interested in bailing out the financial community than defending the dollar.

This chart above compares last year’s assets, which were mostly Treasuries, to this year’s twice-as-large and far more questionable mix:

The other side of the balance sheet shows that the Fed has borrowed and taken in deposits to fund the loans that are as big as the issuance of currency. In effect, the Fed has doubled its footprint and doubled its responsibilities. Mostly under the covers, they added almost $1 trillion new credit to the financial world in about two months.

Bud2 11nov08

There are additional important Fed actions not included in their balance sheet. For example, they invented a Money Market Investor Funding Facility (MMIF) to guarantee up to 90% of $600 billion of loans to that sector. They do this through special-purpose vehicles established by the private sector (PSPVs). The latest Commercial Paper Funding Facility (CPFF) started October 27 and has issued $143 billion so far. These are both in addition to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility initiated September 19. The programs are beyond keeping up with.

Nothing like this has ever been done before by the Federal Reserve. In time, the consequences in terms of confidence in the dollar will be bad.

Bud Conrad is the chief economist of Casey Research, LLC., providing fiercely independent analysis and investment recommendations for subscribers in the U.S., Canada, and over 150 other countries around the world.

Powerful forces are at work in the economy; a global tidal wave of bank failures, credit crises, and sky-high debt. The central banks of the world may not be able to stave off what’s coming -- but you can protect yourself and profit… by catching one of the massive market riptides Casey Research identifies every month in The Casey Report. Don’t miss the lifeboat that can take you to financial safety. Learn more here.

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Reader Comments (19)

real clever ..change the topic just when your buddy de graaf was being rebuttled and outsmarted by the other posters .....deflation he says ..even you say inflation gold prices .biz and you give him his own board to comment? can i have a board too like casey and de graaf so i can comment too? de graaf is the famous james turk isnt he? lol

November 10, 2008 | Unregistered Commenterwil

wil, Why wouldn't James Turk use his own name?

November 10, 2008 | Unregistered CommenterGold Prices

I think Wil is a bit obsessed with Mr. Turk. Well I can assure you, I'm not.

To finalize, I did never say that we are in a monetary deflation at this moment. What I did say, was the possibility that inflation never grounds into the real economy. Furthermore I quoted some economists visions (one corrected)

I hope to rise a debate about the possibilities of monetary deflation, as we are seeing all the initial parameters of Japan's deflationary period passing by. I probably don't have to repeat what has happened lately to identify the obvious.
The only difference with Japan today, is the inflationary policies of the FED are fighting the asset deflation and bankrupcies. So its should not be weird to think about what had/will happen next in contrast with i.e. Japan.

History even points out, that most inflationary periods do not favor for gold. More to the contrary. I can recommend an article from Gary North in 2006. It could change your perspective more realistic.

Gold and deflation.

November 11, 2008 | Unregistered Commenterde Graaf

Hope something happens quick. HRG Is a nickel. That three thousand probably gone. AUY and KGC jan calls look horrible. Yamana seems to be down graded every day along with the price target. Again, what is happening with Yamana internally that is causing all this Bad News. Lower lows every week!!! Much more so than any other gold company. WHY IS YAMANA GETTING SO BEAT UP....BY EVERYONE???????

November 11, 2008 | Unregistered CommenterGAry

I WAS heavily invested in Yamana (TSX venture exchange) and I can tell you there is absolutely nothing wrong with Yamana Gold. The Denver gold summit recently showed that Yamana is one of the premium miners and is going forward with no more takeovers. They said to focus on investor confidence for the future and a stable shareprice.
The argumentation was that takeovers bring along a lot of uncertainty and goodwill that do not contribute to stability. They are focusing on organic growth for stability.

All but good for Yamana. Its really the market outlook that is changing the playing field momentarily. I'm confidently waiting for a second streak of hedgefunds falling over.

Other fact for steel in general;
Just heard news of Corus Steel (Tata Steel India) that they are closing one of its two ovens for 2 quarters minimum. They expect demand to fall at least 30 percent. That has not happened in my lifespan at Corus Netherlands before. Bad thing.

November 11, 2008 | Unregistered Commenterde Graaf

There is plenty of money sitting on the sidelines waiting for some consistency from the Fed. Paulson is the most powerful man in the country and he is trying to figure out what to do next after shooting all that money into his banking buddies. Evermore companies are showing up on the Treasury's doorstep with their hands out looking for their fair share.

As a result, with investors having no direction, many good companies are taking hugh hits with prices at extremely low levels.

Tracking the market everyday is becoming frustrating and nauseating to say the least. Gold is in a quandry too with the price bouncing back and forth like a ping pong ball.

What to do? Any good Crystal Balls for sale?


November 11, 2008 | Unregistered CommenterJohn Ell


Does yamana concern you at all? I was considering taking my loss on AUY and moving the proceeds into AEM and kinross. I have a large loss in yamana. Over 50 percent. However AEM and Kinross seem better postioned in this market and yamana can't seem to get past their earnings miss. THey seem to have plenty of cash and credit..but the stock is performing badly compared to aem and K. Any thoughts...GAry

November 14, 2008 | Unregistered CommenterGAry

As the title of this topic reveals how the FED was never mentioned to be the lender of last resort (but is starting up the printing presses). The true lender of last resort in this world is the International Monetary Fund (IMF) for troubled countries around the world.

There are two significant differences between the institutions;
1. The FED has left the gold standard under Bretton Woods agreements
2. The IMF is still based under Bretton Woods gold standard.

You probably see where I'm going to. The world's inhabitants are feeling the global credit crisis and that shows by the commitments from the IMF capacity to lend.

Per end-July 2008, the IMF has a one-year forward commitment capacity (FCC) of $207 billion (non concessional). An additional $50 billion is at hand for emergency commitments. The gold reserves of IMF; 103.4 million fine ounces.
While quota subscriptions of member countries are its main source of financing, the IMF can activate supplementary borrowing arrangements if it believes that resources might fall short of members' needs. Through the General Arrangements to Borrow (GAB) and the New Arrangements to Borrow (NAB), a number of member countries and institutions stand ready to lend additional funds to the IMF.
GAB arrangement gives additional $26.7 billion from 11 industrial country members (or their Central Banks...) and NAB arrangement provides a $1.5 billion associated arrangement with Saoudi Arabia.
You do the summation (ok ok, approx. $280 billion) and that gives you a total IMF commitment capacity for countries in need for financial support.

The weird thing is that these figures are based on information per end-July of 2008 from the IMF website (with a little searching) but per 10th of july, the same non-concessional commitment amount was a mere US $127 billion...which questions me, how did they fill up the gap so rapidly?
And why do we hear from the IMF chairman Dominique Strauss-Kahn yesterday on BBC, that he needs an additional $100 billion extra fundings within 6 months to support more countries in need for help?
Offcourse this does not mean that the entire commitment capacity is depleted entirely, but it gives reason to believe that when money runs short at its industrial members (the largest which are already in recession; US, Germany, France etc), the only way to supply the IMF would be to unanimously agree to sell the IMF gold reserves.

Thats right, sell gold onto the world markets trough the IMF. Its the last resort if loans become scarser/more expensive, and its the last thing they are willing to do, as its affects the free market principle. It also requires all (or majority if I'm correct) members to vote for this to happen.

What I show you today, backs up the growing possibility of gold being sold in large amounts. The IMF is the third largest goldkeeper in the world.

$500 an oz. Its possible.


November 18, 2008 | Unregistered Commenterde Graaf

a very important fed govt official already stated they are ready with their best weapon against deflation if and when the interest rate has to be set to zero percent --THE PRINTING PRESS--and as that continues to happen more and more the dollar will devaluate setting up the rise of gold and gold stocks ---- the more money they print the higher gold will rise---- why not now? economic standstill for now-once the gears start turning again gold will hit new highs! wait and see.......................

November 18, 2008 | Unregistered Commenterwil

Wil, nice that you finally understand and repeated what I've been saying from the beginning.

But your wrong on one thing. Its not economic standstill, its a downfall (its called a recession). I'll spare you all the elaborate details this time. I recommend you to read some colums and comments of the past months to inform yourself.

November 18, 2008 | Unregistered Commenterde Graaf

What concerns me, Is that Gold didn't start to rally above $500 until 2004. For twenty five years prior it languished between 300 and 450. What happens if we go back to those years between 1981 and 04. THats 23 years. !980 was a great year for gold-since then it did little till 04.

AUY broke below $4.00 today. FRG -1.50....I see know real hope for these Jan calls for Kinross or AUY. Not to mention SLW. Gold could languish for a long time. If commercial real-estate falls next-credit card- UNemployment goes to ten percent-Oil stays between 45-60. Gold seems to be selling off around the World- not being accumulated by governments. What's Gold going to do? For all the positive emails I read on AUY. It still drops daily. Even when Gold is up. Somebody is selling this stock...even at these levels. Maybe it will get back to 12 dollars, were we purchased it, by 2030 when Im 70???

November 18, 2008 | Unregistered CommenterGAry

Gary, ol'fella (just kidding)

You can take some 15 years off that prospect if you ask me. I can wait (but am not willing to) until 2030!!!

But to feel with you for gold; Although you can count me in as a goldbug, I agree with the concern that gold did not rally much in the period you talked about. Its quite scary actually. As if inflation is not a factor for gold over a quarter century...

I dug some deeper for you to see how gold reacts to recessions overall; below a quote from Veronica Brown's article from Reuters -

[quote of quotes]
Turner, the VM Group analyst, noted that during U.S. slowdowns in the early 1990s and 2000s, gold did not go up very much at all. From July 1990 to March 1991 - during the last U.S. recession - gold went from $357 to $362, he said.
"It did go up more in the early part of that period, but that also coincided with the invasion of Kuwait," he said.

From March 2001 to October 2001 - a month after the terrorist attacks in the United States - gold was little changed, trapped in a range between $266 and $278.

"A U.S. recession effectively constricts the supply of dollars onto the international foreign exchange market," said Steve Pearson, the chief currency strategist at Bank of Scotland Treasury Services.
"In that scenario the dollar will be better bid, global liquidity conditions will be that much tighter and gold prices will come lower."
[end quote]

So little hope indeed over nearly 25 years. Then came the 2004 rally upwards passing $500 price barrier. I already explained some time ago how that happened.
Once again; SPDR (GLD) Gold ETF.
Since 2004, this is the real force behind golds rally as it is accessible for everyone (in paper format though) that do not have a giant vault or strong-enough concrete floorbeams to hold the weight of bullion bars. ;)

But Gary, this you should definately read about SPDR Gold ETF;


November 18, 2008 | Unregistered Commenterde Graaf

Thanks for that ...I really don't see the point of holding Gold. My loss will be huge...but I could loose another 50 percent from here. Auy could go to two and Kinross to six...etc. I just don't see were this big gold move will come from anytime soon in this economy. It's kind of like saying the airline rally will last, because the price of oil is down. There load capacity will drop dramatically in 09. Nothing will change. This is so frustrating.

November 18, 2008 | Unregistered CommenterGAry

If I would still be fully invested, I would probably say the same thing. I think it could never be too late to sell, and buy-in lower. But then I don't know your portfolio status.

So, I hope you can make a decent decision, but don't forget that coming out of this global depression will pull all sectors out instantly. Some sectors will rise faster, others even not at all on the levels where they were.

I've studied Aerospace Technology at the University and have passion for the whole industry. But don't you think I ever invest into airlines, even as I know how they operate from the inside. There is no money in that kind of volatile industries, even under normal market conditions. Its pure speculation, for short term traders.
Not my game as a value investor.

Time to make decisions. Outlook is grim. I'm on the sidelines as you know. You should be too Gary.


November 18, 2008 | Unregistered Commenterde Graaf

Little correction for Gary:

I said:
So, I hope you can make a decent decision, but don’t ***forget*** that coming out of this global depression will pull all sectors out instantly. Some sectors will rise faster, others even not at all on the levels where they were.

I meant: but don't *think* that coming...etc.

My bad, corrected.

November 18, 2008 | Unregistered Commenterde Graaf

But when will that come. Maybe a short term rally with Obama in Jan. Then what? Nothing has changed. It will take years for Obama to deal with all these problems. What happens if they let GM go under. Dow will go to 6000 in a nano second. Im down 60 percent on all my gold and silver stocks. The jan calls on Auy and Kinross are virtually worthless. Along with SLW. I will keep my oil and Gas as the down side there is limited in my opinion. Even add to it if there is a severe drop. I will loose huge with my gold and silver. Im tempted to wait till jan for a short term pop..but all hell could break loose before then. WHo knows. Auy could rally from two too three in Jan. Its at four now...I don't know.

November 18, 2008 | Unregistered CommenterGAry

My insights say their will be a true recovery of global markets in about two years to five years from now. But offcourse I can't name a price (index) level as you would understand. No one can predict the future.

But commodities in general will be the first to rally from the renewed growth figures around the world, especially China, Brazil, Dubai, Singapore etc. The emerging countries in total. But this does not reach the price levels that we saw in beginning of 2008. Its gonna take some more time. Jim rogers had a similar thought. He expects the bull in commodities to be longer and stronger lasting some 10 more years. The (leveraged) bubble is empty, and its coming but delayed rally will be gradually stronger. (less volatile ups and downs)

So if you are able to hold the investments until 2018. You'll be fine. But if you want to step in for lower prices(like I intend to do), you should sell and wait on the sidelines for lower entries and grind money for better deals in new upcoming sectors. Not all sectors will come back. Its a new era with new opportunities in alternative energy.

Just forget about the numbers, and try to think rationally and try to form a new investment strategy for the future. My strategy is out of the window already, but as developments improve, I will be ready to absorb new opportunities instantly, from the sidelines.

It keeps my head clear, although I had took a few thousands in losses also. That's part of the game.


November 18, 2008 | Unregistered Commenterde Graaf

On November 18th (post 8. above) I mentioned the IMF could possibly in trouble. Others come to the same conclusion recently;

Although Japan has recently already given their full cooperation in supporting the IMF, they fear the same deflationary situation from which they came out recently. Although estimated IMF help figures amount to $700 billion in 2009. Japans needs to think about their own sake (no pun intended). With 'only' 1 trillion in reserves, the must save some for themselves...if it comes the that point.

On the sidelines, good investing.

November 23, 2008 | Unregistered Commenterde Graaf

Update IMF reporting:
In November 2008 the IMF proposed to sell 400 tons of gold for its funding base...(OTC that is, so no market interference for us bullionboys) :D

Japan and this time America both heading for a significant period of depression. Anyone still in denial should really check up with a doctor.

Its unbelievable what phoney money policies can bring us. I wish they put a stop to Keynesian policies, one way or the other.


February 12, 2009 | Unregistered Commenterde Graaf

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