Gold – the final bubble, page-4150

AverageJoe,

Changing bonds which are considered risk free and paying more or less the same as money placed with the Fed as reserves either does nothing or very little to the balance sheet of the banks.

The exercise was inspired in part by the thinking that by saturating the market with liquidity above what the system wanted some would end by being invested, and, therefore, you are right when saying: It was designed to stimulate the economy by providing cheap funds through the banks to the 'man on the street' to create economic activity.

However, as Mr. Koo observed.

"A recession driven by deleveraging leads to prolonged slump. The key difference between an ordinary recession and one that can produce a lost decade is that in the latter, a large portion of the private sector is actually minimizing debt instead of maximizing profits following the bursting of a nation wide asset price bubble. When a debt financed bubble bursts, asset prices collapse while liabilities remain, leaving millions of private sector balance sheets underwater. In order to regain their financial health and credit
ratings, households and businesses are forced to repair their balance sheets by increasing
savings or paying down debt. This act of deleveraging reduces aggregate demand and
throws the economy into a very special type of recession.

As shown in Exhibits 2 and 3, massive injections of liquidity by both the Federal Reserve in the US and the Bank of England in the UK not only failed to prevent contractions in credit available to the private sector, but also produced only miniscule increases in the
money supply. This is exactly what happened to Japan after the bursting of its bubble in
1990, as shown in Exhibit 4.

Nor is there any reason why bringing back inflation or inflation targeting should work,
because people are paying down debt in response to the fall in asset prices, not consumer
prices. And with the money multiplier negative at the margin, the central bank does not have
the means to produce the money supply growth needed to increase the inflation rate."
The first casualty of this shift to debt minimization is monetary policy, the traditional
remedy for recessions, because people with negative equity are not interested in increasing
borrowing at any interest rate. Nor will there be many willing lenders for those with impaired
balance sheets, especially when the lenders themselves have balance sheet problems.
Moreover, the money supply, which consists mostly of bank deposits, contracts when the
private sector collectively draws down bank deposits to repay debt. Although the central bank
can inject liquidity into the banking system, it will be hard pressed to reverse the shrinkage of
bank deposits when there are no borrowers and the money multiplier is zero or negative at
the margens."

Yes, you are also right when stating that: There isn't any traction with the data driven parameters to warrant Sept rate rise..."

It would be, I bilieve, a big mistage to raise rates.