The Bank of Canada’s Balance Sheet: Bigger than During the Financial Crisis

During the 2008 financial crisis, the Bank of Canada intervened with an unprecedented 50% expansion of its balance sheet to a total of nearly $80 billion. This was done by creating money and purchasing assets from the big banks in order to add liquidity to the market.

By mid-2010, they had unloaded these emergency acquisitions and their balance sheet returned to pre-crisis levels.

But now, after years of growth, the Bank of Canada’s balance sheet is bigger than ever. The BoC holds nearly $90 billion in assets.

boc july 2013

But the crisis is over, isn’t it? The Bank of Canada is trying to keep the Canadian dollar down and interest rates low. They are acting like the crisis is not over, or like another crisis is waiting to emerge.

Why the Fed Will Not “Taper”

Is the Fed going to “taper”? In other words, will it slow the rate of monetary expansion? When will the Fed do this?

That’s what everyone wants to know. As the central bank for the world’s biggest consumer, the Fed is especially important. Their actions have a major effect on the actions of other central banks. The Bank of Canada’s policy is in many ways a function of the Fed’s.

Canada’s head central banker Poloz will not rock the boat. He fears price deflation. The central bankers in Europe and Britain are explicitly committed to inflation. More and more central banks are joining to cause of money printing, like Japan and Australia, yet the Fed seems to be a bit of a wild card.

That’s because because of Bernanke’s remarks on June 19, where he appeared to raise the Fed’s unemployment target from 6.5% to 7%. He suggested the Fed might slow its bond purchases sooner than previously indicated.

Bernanke went out on a limb and changed the target numbers for unemployment in his speech from what was written in the FOMC report.

St. Louis Fed President James Bullard was critical of Bernanke’s comments, in a wishy-washy bureaucratic sort of way. He tried to tell us that Bernanke didn’t really mean what he said. Bernanke even later came out and confirmed his position is the same as it’s always been: “When the economy gets better, we’ll stop. Someday. Maybe.”

Which sort of goes without saying. Of course the Fed plans to execute its promised “exit plan” when the economy gets better. That’s the whole idea behind extraordinary measures like quadrupling its monetary base since the 2008 crisis with QE 1-3. So what’s the big deal?

Other than Bernanke’s 7% comment, the FOMC has been very clear about what it plans to do. The position in the June 19 press release was unchanged from their March press release. The March release was the same as the January release. Literally the sameword for word.

In these press releases, the FOMC has been explicit. The Federal Reserve will maintain its current policy of QE if the US unemployment rate remains above 6.5% and price inflation remains below 2.5%.

All this debate over whether the Fed will “taper,” and all because no one seems to read what the FOMC says.

A few FOMC members said maybe they should taper later this year. But unemployment is not falling fast enough. Price inflation is not rising fast enough. The Fed’s policy is unlikely to change.

Even if it does change, and they slow the rate of monetary expansion, they will be forced to intervene again. No one mentions that there was tapering after the previous QE’s. Heck, they didn’t just taper in 2012: they actually deflated slightly.

But these little taper episodes don’t last. They simply led to further expansion later. So why not a little bit of tapering after QE3? But that will eventually necessitate QE4. When central banks begin slowing their monetary expansion, the correction will manifest and they will intervene again in desperation.

Despite this reality, economists, investors, and financial reporters are obsessed with rumors and hypotheticals because they do not understand central bank policy.

The spastic reaction of investors was very interesting. Markets fell. Yields shot up quickly as a massive $80 billion was pulled from bond funds in June. Gold briefly fell below $1200. Clearly this illustrates that this economic error cycle is perpetuated entirely by faith in central bank bureaucrats to keep the money pumping. Which is, by the way, exactly what the Austrian business cycle tells us.

You can quite clearly see how the Fed’s expansion is correlated with stock market performance in the last few years. Any time the markets have been worried, the Bernanke Fed has stepped up to deliver QE.

s&p and fed

I don’t think the Fed is communicating any kind of serious change in policy. And regardless of what they say, they are completely trapped by their own policy.

FRED Graph

The Fed cannot pull off a smooth “Exit Plan” with that monster they call a balance sheet without causing a crash far more vicious than 2008.

Is there any way the Federal Reserve could avoid this?

Actually, yes. Their asset sales would have to be offset by the releasing of commercial banks’ excess reserves into the economy. Currently these reserves are massive, corresponding to the Fed’s expansion.

Graph of Excess Reserves of Depository Institutions (DISCONTINUED SERIES)

If the Fed stopped QE entirely and started selling assets, but the banks lent out their excess reserves, you wouldn’t even notice the Fed’s exit. In fact, there would be price inflation. That’s because the fractional reserve process could generate nearly $10 trillion in new money out of those excess reserves.

But this will never happen. This becomes obvious as soon as you ask: “Why would the big banks want to release their excess reserves?”

They are not lending now, so why would they want to lend it when the Fed is selling assets and therefore bringing about a recession? The banks are hoarding their excess reserves now due to extreme uncertainty and impaired balance sheets. They are less likely to lend those funds if the Fed tapers.

But what if the Fed tapers and stops paying interest on excess reserves? Yes, the could do this if they wanted. This is a relatively new policy implemented in 2008. But halting this would have little effect.

The banks earn almost nothing on their deposits at the Fed: close to zero percent. Going from almost-zero to zero will be insufficient motivation to lend, especially when the economy is expected to slowdown. Better to make zero return than risk losing 5% or 10% or more when the economy goes bad.

But what if Bernanke went further? He could charge the banks fees and penalties for having too high a level of reserves. I do not believe he will do this because the banks would not like it. Due to counter-party risk and the danger of short-term creditors doing a bank run on a major institution, it’s least risky for the banks to hold their reserves at the Fed.

Another reason why he and other central banks will not force their big banks to lend: they fear massive inflation would result, and no one wants to deal with that. Bringing it under control would bring about a crippling depression.

An interesting possibility that should be considered is the Fed reducing the rate of QE3 just before Bernanke departs in Feb 2014. They could then safely blame him for any negative effects which follow. If the Fed announces a reduction in QE in September, that would fit with this scenario. However, I do not believe they will do this. Bernanke wants to ride off into the sunset without any additional controversy. He is not even speaking at the Jackson Hole meeting this summer, due to “personal reasons.” He wants to get out his position stealthily rather than in a flurry of disputation. He doesn’t want to push a tapering policy that will reflect badly on him as he leaves his position.

And what’s true of Bernanke is true of all the central bankers — none of them want to look bad in front of their friends. So they will continue to inflate.

CONCLUSION

After the NASDAQ bubble exploded and the US went into recession, Alan Greenspan pumped money into the economy to generate a new boom cycle. Over that time, the economy responded to the resulting misshapen financial markets with the formation of a housing bubble. Greenspan departed and Bernanke began to raise rates. The result was the 2008 crash, during which Bernanke & Friends carried out an unprecedented expansion of the monetary base. Another boom period was generated. The US stock market is again making all-time highs, optimism is much more widespread, and all forecasts and experts seem to agree that the recovery is robust and genuine. This means we are in the economic danger zone.

The Fed’s 100-year pattern of propagating booms and busts will continue either until they crash the economy by selling assets, or a monetary crisis arises that they cannot control.

The Fed may tinker with its money supply here and there, but we are a long way from any “exit plan.” Until then, don’t count on any real tapering for any significant amount of time.

Carney vs. the British Pound

UK citizens are running out of time before Mark Carney takes over their central bank.

Carney got the Bank of England job because he was a friend of bank bailouts and has shown no reluctance when it comes to printing money.

Mike Amey, head of sterling bonds at PIMCO, believe that’s what Carney plans to do when he takes over the BoE. He predicts Carney will devalue the pound by as much as 15%. That’s because Britain is desperate, and central bankers don’t really have any solutions other than “MOAR PRINTING.”

I’m so glad Carney’s going to be gone, not that I expect Stephen Poloz to be any better. But we should feel bad for the citizens of the UK. The pound has already lost significant value in recent years.

— Read more at The Telegraph —

 

Mark Carney - HERE I COME BRITAIN YOU SHOULD SELL YOUR POUNDS BEFORE I GET THERE

Bank of Canada Should Raise Rates to Pop Bubbles, Says Former Carney Advisor

Paul Masson, former advisor to Mark Carney, says the Bank of Canada should raise interest rates and pop the housing and debt bubbles.

He says years of low interest rates have distorted the economy and driven people to take higher risks. The accumulation of debt has left Canadians and their institutions stretched thin, ill-prepared to withstand the impact of another financial crisis.

Mr Passon correctly describes our situation.

The Bank of Canada could raise rates very quickly by selling assets. It will definitely not do this, because it would cause a depression. All talk about “maybe” raising rates “in the future” is just that: talk.

Should the BoC raise rates? Well, the Bank of Canada should be closed down, so really all of its assets should be sold. Central banks exist to empower governments and the elite at the expense of everyone else.

But in the context of having the BoC and Canadian dollars, I am sympathetic to the argument that the BoC shouldn’t really do anything. It would be reasonable to leave the money supply as it is and let the market determine interest rates from there. The BoC shouldn’t be jacking the rates around, whether to raise them or lower them. Let the market set interest rates free of further invention. This would give us a bit more time to prepare for the crash, versus an active contraction of the BoC’s balance sheet. “Laissez-faire.”

— Read more at The Financial Post

Economic Ignoramus Stephen Poloz to Replace Carney as Bank of Canada Governor

So far, we don’t know much about Mr Poloz on a philosophical level.

Based on the little we do know, I think he is a bad choice. He has a PhD in economics, so he likely knows very little about economics.

We also know he has spent most of his life as a bureaucrat. Most of his career has been “public service” (cough cough) at the BoC and Export Development Canada. I’m sure he made lots of friends in the export industry there. Friends who will really appreciate a subsidy in the form of monetary inflation.

Back in late 2008, he wrote a commentary on the financial crisis. In essence, he appeals to animal spirits, like all Keynesians who are baffled by economic law. He blames it on nothing more than a change in psychology following the 9/11 attacks. Everyone had a “live for the moment” attitude, he says, and ultimately this created the housing bubble.

The first sign of failure in economic analysis is a reliance on nonscientific pop-psychology. He completely fails to identify the source of bubbles and account for why business cycles occur. The culpability of central banks is nowhere challenged. He pleads agnostic about the ability of economists to understand the cause of bubbles at all. He does not understand the Austrian theory of the business cycle.

Based on these facts, I can safely conclude he is an Keynesian/inflationist/mercantilist. Sort of like, well, all central bankers. He may prove to be better or worse than Carney. Only time will tell.

Ultimately, it matters only a little who is the head of the Bank of Canada. The system as such is the problem, and not so much the individual people in charge.

— Read more at BoC’s website — 

Bank of Canada — engine of too much debt — warns about too much debt.

The Bank of Canada is warning Canadians about too much debt.

Experience suggests a long period of very low interest rates may be associated with excessive credit creation and undue risk-taking as investors seek higher returns, leading to the underpricing of risk and unsustainable increases in asset prices.

This is a remarkable statement, really — it reveals that the Bank of Canada’s economists either don’t know economics, or they pretend not to know. The issue should not be about how low interest rates “may” be associated with excessive credit and excessive risk. Rather, there is a direct causal relationship here.

Mises wrote:

If there is credit expansion [by the central bank], it must necessarily lower the rate of interest. If the banks are to find borrowers for additional credit, they must lower the rate of interest or lower the credit qualifications of would-be borrowers. Because all those who wanted loans at the previous rate of interest had gotten them, the banks must either offer loans at a lower interest rate or include in the class of businesses to whom loans are granted at the previous rate less-promising businesses, people of lower credit quality.

This is not rocket science. It is not a complex relationship to understand at all — if interest rates rise, there will be fewer risky loans than there would be otherwise; if interest rates falls, there will be more risky loans than there would be otherwise.

But if you have a PhD in economics, like our ex-Goldman central planner at the BoC, Mark Carney, you probably are incapable of understanding this, and would say something inane like, “In light of the high level of indebtedness of Canadian households, some caution in banks’ lending to households is warranted.”

Carney does not realize that lending standards are directly related to the ease with which credit is made available. Talk is cheap. If Carney jacked up interest rates to 10% tomorrow, that would have a dramatic impact on lending standards, much more so than his oracular admonitions about risky lending.

On the other hand, what would happen if Carney decided the economy was too weak, and he cut interest rates down to zero? Then we can rightly expect that more loans would be made to those businesses and individuals would have been previously deemed unworthy of credit. 

A lot of Canadians like to think we breezed through the financial crisis without too much pain and suffering — “our banks didn’t need a bailout,” and that we are leading the way out of economic ruin.

All is not well, however. The mammoth growth of consumer debt in this country, the worst of all OECD countries at about 140% debt-to-asset levels, is a very serious problem . With our housing market still in bubble territory, unemployment relatively low, and implausibly low interest rates, Canadians have been piling on more and more debt.

It’s so bad, even the banks — you know, the ones making all these questionable loans to Canadians mired in debt — are raising concerns. You have to acknowledge this is a bit rich — but don’t worry big Canadian banks — I am sure you can keep making your risky loans and if (when) things turn ugly, someone will bail you out.

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