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Sent: Friday, November 08, 2002 11:55 PM
Subject: 11/08 11:44P (BN) BARRON'S: Economic Beat
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">11/08
11:44P (BN) BARRON'S: Economic Beat
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">Story
7626 (I/REA, I/TEL, G/FED, G/USG, P/1115, N/BRN, N/DJN,
N/DJWI...)
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Al's Investments Or Malinvestments?
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> By Gene Epstein
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Libertarian Rep. Ron Paul of Texas, who
happens to know more economics than
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">most
economists, tells the story of an encounter with Alan Greenspan that is
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">filled
with irony.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Paul asked the Fed chairman to sign his
copy of an essay called "Gold and
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">Economic
Freedom," which Greenspan wrote for the July 1966 issue of
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">philosopher
Ayn Rand's periodical, "The Objectivist." Beginning with the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">feisty
words, "An almost hysterical antagonism toward the gold standard . . .
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">unites
statists of all persuasions," the article goes on to express antagonism
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">toward
the Federal Reserve, which in the author's opinion helps foster credit
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">bubbles
via the creation of cheap money. By contrast, argues the 40-year-old
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">enfant
terrible, the far more preferable system of "fully free banking . . .
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">and [a]
fully consistent gold standard" would prevent bubbles from occurring.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> While Greenspan obligingly signed his
name to the radical document, Ron Paul
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">asked,
"Would you like to add a disclaimer?"
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> To which affable Al responded, "No, I
reread this article recently -- and I
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">wouldn't
change a single word." (Paul recalls that this exchange probably
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">occurred
early last year.)
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> So maybe Greenspan should call his
memoirs, "A Subversive in Washington: How
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">I Kept
My Mouth Shut, While Enjoying Every Minute."
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Nary a scintilla of the idea that cheap
money can foster credit bubbles
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">crept
into Wednesday's Federal Open Market Committee announcement that the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">targeted
interest rate on federal funds was being cut by another half
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">percentage
point, to 1.25%. The last time money came that cheap was in
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">February
1955, when the fed-funds rate averaged 1.29%.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> But since prices were weakening in early
1955 and are rising today, the real
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">-- i.e.,
inflation-adjusted -- fed-funds rate is far lower than it was then.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">In
February 1955, the consumer-price index was 0.7% below February 1954, which
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">meant a
real fed-funds rate of nearly 2.0%; while based on the most recent
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">figure,
the CPI is now 1.5% higher than a year ago, which puts real fed funds
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">at
negative 0.25%. (A negative reading of as much as 2.0% on real fed funds
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">was not
uncommon in the inflationary years of the late 1970s.)
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> The FOMC announcement pointed to the
same "heightened geopolitical risks"
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">from
September's statement as a principal reason why the "economy [is]
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">work[ing]
its way through this current soft spot." The only surprise in the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">statement
was the shift to neutral in the usual "balance of risks" between the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">Scylla
of higher inflation vs. the Charybdis of slower economic growth. After
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">many
months of fearing the latter more than the former, the now places even
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">odds on
both, a gesture which put the markets on notice that the economy's
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">soft
spot has to soften up a lot more before another rate cut will be
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">considered.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> To use the popular metaphor, chairman
Greenspan decided to buy an extra
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">"insurance
policy" on the economic expansion, one that will pay even if those
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">heightened
geopolitical risks morph into a geopolitical war with Iraq. (The
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">odds of
war may have been boosted last Tuesday by the Republicans' triumph at
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
polls.) But the author of "Gold and Economic Freedom" must know that what
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">he's
really doing is better described as shooting another dose of uppers into
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
economic corpus, in the hope that the drug will energize the patient
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">without
bringing on the kind of sustained mania that leads to a crash.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> The economic bust will happen sooner or
later, of course, but later looks
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">more
likely than sooner. Despite the easy credit, most of the malinvestment
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">that
built up in the boom of the 'Nineties is probably no longer with us.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">True,
the shakeout in the telecom industry is barely in mid-passage, and
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">cheaper
money can only delay the process by which resources tied up in that
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">sector
can be freed up for more productive use.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> But no recovery from a bust is ever
accompanied by a thorough-enough
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">cleansing
of unsustainable projects from the previous boom. The telecom
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">industry
may be plagued with overcapacity for years. But at least no one is
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">proposing
to reliquify the dot-coms; the Nasdaq is still more than 70% down
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">from its
high; and capital investment by the telecoms has collapsed.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Cheap money is also turbocharging the
housing market. But the commonly cited
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">price
bubble in housing is still more myth than reality, leaving aside the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">question
of bubble conditions in local areas. For one thing, a good part of
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
price rise can be accounted for by the garden-variety factor of rising
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">real
wages and salaries. The tendency to compare today with the late 1970s,
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">when
prices were rising by about as much, just doesn't hold up, mainly because
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">this key
component of income was barely increasing during that period.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Of course, rising home prices are also
explained by low mortgage interest
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">rates.
So let's say the interest rate on 30-year mortgages, currently around
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">6.25%,
jumps two full percentage points, to 8.25%. That would reduce the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">volume
of home sales by about 10%. Compare that, for the likely price effect,
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">with the
50% plunge in sales during early 1980s, which was enough to stop the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">median
price from rising further, but not enough to make it fall.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> And on the supply side, we can hardly
talk of huge unsold inventories. There
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">is
currently a four-months' supply of unsold homes, close to the record low
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">touched
in 1999, and about half as great as in 1979.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes">
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> -- Thursday, the open market trading
desk at the New York Fed initiated the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">new
target of 1.25% on federal funds -- a highly imperfect process, given the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">wide
fluctuations around the targeted rate.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> The fed-funds rate refers to the
interest rate one bank charges another for
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
overnight loan of immediately available money held at the Federal Reserve.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">Aside
from vault cash, federal funds are the only kind of coin-of-the-realm
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">deemed
acceptable as reserves against a bank's checkable deposits. And as the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">textbooks
will tell you, the reserve ratio sets the stage for the featured
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">role
played by the money multiplier in the money-creation drama.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> But that script gets the story all
wrong. There just ain't no money
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">multiplier
-- not now, and almost certainly never ever.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> When I first penned this heresy in this
space on Oct. 21, I left all kinds
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">of wrong
impressions. Am I saying that the money supply never grows, or worse,
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">that the
sine qua non of money growth is not the central bank? Hardly.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">According
to the MM-version of the way things work, the central bank first
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">pumps $1
billion into the banking system through the purchase of $1 billion
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">worth of
Treasury securities. And then, given the current reserve requirement
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">of 10%,
$10 billion worth of money is eventually created; the first bank lends
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">out 90%
of that $10 billion, which ends up in second bank, which lends 90% of
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">that
90%, which ends up in a third bank, and so on.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> But this little fairy-tale puts the
reserve requirement cart before the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">money-creation
horse. The banks are the ones that first create the money,
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">mainly
by issuing lines of credit in the form of checkable deposits to their
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">borrowing
customers. And only then does the Trading Desk underwrite those
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">commitments
by pumping fed funds into the system. The money supply expands as
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
banks' demand for fed funds naturally increases.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> If the central bank did pump that extra
$1 billion of fed funds into a
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">bank's
account, the rules under the lagged reserve system would forbid that
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">bank
from using any part of it as reserves against future deposits. Any
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">deposits
created right now will require reserve balances about a month from
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">now. And
since reserves earn no interest, no bank will squirrel those funds
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">away to
meet future reserve requirements.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> For example, right now the banks must
maintain adequate reserves against
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">deposits
held in the two-week "computation period" ended October 14. This
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">current
"maintenance period" began October 31 and will end November 13. And
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">you can
rest assured the Trading Desk will issue adequate fed funds to cover
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">those
commitments, while trying to keep the overnight borrowing rate at 1
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">1/4%.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> The lagged reserve method makes it
virtually impossible for the money
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">multiplier
to operate. And now comes the killer point: In February 1984, the
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">Federal
Reserve replaced lagged accounting with a version of concurrent
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">accounting,
which was again replaced with lagged accounting July 1998.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Under that system, each maintenance
period would begin just two days after
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
computation period. And early on, at least, the Fed actually tried to make
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">the
money multiplier work. But the experiment failed for a simple reason.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> Banks had their own timetable for making
loans to customers, and a sudden
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">injection
of fed funds was not enough make them change course.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> ---
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> E-mail: gene.epstein@xxxxxxxxxxx
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> ---
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> For Barron's subscription information
call 1-800-BARRONS ext. 685 or inquire
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">online
at http://www.barronsmag.com/reader.html.
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> (END) DOW JONES NEWS<SPAN
style="mso-spacerun: yes">
11-08-02
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt"><SPAN
style="mso-spacerun: yes"> 11:44
PM
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">Additional
Codes ( N/CBK, N/DJPF, N/DJSS, N/DJWB, N/ECO, N/EDC,
N/EMJ,
<FONT face=Arial color=black
size=2><SPAN
style="FONT-SIZE: 10pt; FONT-FAMILY: Arial; mso-bidi-font-size: 12.0pt">N/FIN,
N/STK, M/FIN, M/NND, M/TPX, R/NME, R/US,
J/ECB)
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