Jewish World Review Dec. 10, 1999 /1 Teves, 5760
http://www.jewishworldreview.com -- IN ADVANCE of any possible Y2K-related cash and liquidity threats, Alan Greenspan & Co. are exercising their central bank prerogative to provide the nation with an elastic currency.
Since September the Fed has quietly negotiated a series of repurchase transactions designed to inject a massive volume of bank reserve liquidity into the U.S. financial system. Call it a cash insurance policy to underwrite potential Y2K financial emergencies.
At last count the Fed has injected roughly $46 billion of cash through so-called "tri-party repurchase agreements" arranged with third-party custodial banks. This is over and beyond the Fed's normal repurchase program for their own System Account or for customer purposes.
Typically the Fed buys Treasury securities from primary dealers and pays with newly-minted bank reserves. So the Fed holds the collateral (Treasury bills, notes and bonds, or federal agency securities, sometimes held in a custodial bank for safekeeping), and the banking system has itself a big chunk of new cash.
The new Y2K-linked term repos are short-term loans to the banking system made this autumn, but they are scheduled to expire evenly during the period from early January through early February next winter. When they do expire, the Fed will sell the securities back to primary dealers, who then refund the cash back to the Fed.
In other words, the temporary provision of high-powered Fed liquidity will be withdrawn. This means that the bulge in adjusted monetary base growth (25.1% annual growth since September) and adjusted reserve growth (80.2% at an annual rate since August) will disappear.
That is why this "excess money" is not having an inflationary effect. Actually, gold prices are slumping, while the King Dollar index appreciating. Sophisticated credit market participants understand the temporary nature of this Fed reserve-adding operation.
Chairman Greenspan is making good on his promise to supply the U.S. financial system with a precautionary increase in cash. At various times over the past six months the central banker has stated his intention to add as much as $200 billion to credit markets, if need be.
In addition to the term repo program, the Fed has also been writing a large volume of repo options. These options give dealers the right to obtain even more cash financing, though they must pay 150 basis points (1 1/2%) above the 5 1/2% fed funds rate if they exercise the option rights.
So thus far the Fed has sold repo options totaling $481 billion on top of the $46 billion of term RPs. Think of this as a reinsurance program. Insurance to cover insurance, if you will.
Put another way, Mr. Greenspan is telling us that one cannot be too careful about this millennium event. Probably very little will happen out of the ordinary, but you never know. Half a trillion dollars should cover it; it's a fair piece of change.
On the other hand, none of us living souls have had any prior millennium experience, with or without computers. So one can't be too careful if one is running the world's most important central bank. Which, by the way, is really the planet earth's central bank.
This is Greenspan at his best. He's an economist with a strong sense of history. There'll be no financial catastrophes on his watch. Remember the crash of 1987. Greenspan pumped in a massive volume of new reserves to prevent a repeat of the 1929-1933 Depression experience.
Undoubtedly, he also recalls the panic of 1893, which led to a brutal depression lasting into 1897. As well, the panic of 1907.
In those days there was no elastic currency (the U.S. was formally on the gold standard) and there was no central bank (though the Treasury could have provided reserves if it had its wits about it). In both cases Mr. J. P. Morgan bailed out the U.S. financial system (with help from Mr. John D. Rockefeller, Sr. in 1907).
In 1929 the U.S. had a central bank. Trouble was, its guiding light Benjamin Strong died before the crash. The rest of the crew was clueless. They had discovered the reserve-adding effects of open market operations by the mid-1920s, but they did not have the mental wherewithal to put this lesson to work. So the U.S. and the rest of the world suffered enormously and unnecessarily.
One other point. Gold prices have been weakening of late, and this is something the Fed should be watching closely. $500 billion of cash insurance seems like a lot of money, but should gold keep dropping from here, it would strongly suggest that even more cash will be necessary.
The gold signal can help Greenspan & Co. see whether the global demand for dollars is even greater than the insurance policy supply. Chances are a lot of foreign capital (including Euros) will be seeking a safe haven into U.S. dollars in the weeks ahead.
The Fed must not be stingy in accommodating foreign money inflows. If folks
need dollars, give it to them. The fate of our long wave of prosperity may
hang in the balance. Let's hope Mr. Greenspan keeps those history books wide
JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.
11/23/99: Y2K Money: Inflationary or Not?