Nexus of Change

Toward Sustainable Habits and Durable Prosperity

The Difficult Transition to Sustainable Growth

Two hundred years after the beginning of the Industrial Revolution in 1750, the average income of people living in industrialized countries had risen 20 times and the notion of strong continous growth became ingrained in expectations and consumption habits, and a majority of Americans after the second world war were signing long term contracts with their bank to acquire houses they would own. The bigger the house, the better. Natural resources and credit were easily available as long as citizens of affluent nations would make up roughly less than 15% of the globe’s population while the rest of the world remained poor and contributed little to world demand for natural resources.

This introductory article to a blog about evolving habits, new methods of production, and emerging opportunities will focus on explaining the information conveyed by one image, an image that summarizes the initial reaction and the initiatives taken in response to the first symptoms of drastically changing times. Major problems were first signaled by financial markets in the fall of 2007 when we learned that banks had packaged together loans made to people who couldn’t afford a house with perfectly good loans. Loans were packaged together as securitized debt and because bad debt couldn’t be dissociated from good debt anymore, good loans became contaminated by bad loans and financial markets were now unable to crunch data. The risk of an absolute catastrophy was very real and bold measures were necessary.

The following chart titled “Securities, repurchase agreements, and loans” shows the amount of money injected in the economy by the Federal Reserve, acting as the United States central bank. The mechanism behind this operation is simple: The Federal Reserve creates credit out of thin air as an alternative to printing money, for whatever institution from which it buys a bond or for which it makes a loan available.

The chart above displays the money injected in the system through three subsquent waves that will be explained here and that will give an overall picture of our society’s effort to adapt to changing reality. The first wave, from September 2008 to January 2009 was caused the need to reassure markets by providing liquidities to banks marred by questionable assets and that were “too big to fail”. The following picture shows the first wave of funds injections in relation to the overall picture.

The task of reassuring markets with bold energy and accurate rethoric at first, became easier when financial markets started to stabilize during the fall 2008 elections. In early March 2009, after the new President had been talking of implementing policies to “build a foundation for sustainable growth” almost everyday for a month and half, the stock market started a rally that was to last almost two years.

Once financial markets were stabilized, the banking system still had to purge bad loans from their contaminated assets through the long slow process of shaking out bad debt through mortgage foreclosures. The second wave of fund injection depicted on the following chart shows the impact of this process on the banking system with the worst part behind after June 2010.

Credits made by the Federal Reserve to purge bad mortgage loans, as seen in the chart above, were going up and down at the same time delinquencies on real-estate loans were going up and down in the nation. The economy seemed to be recovering from complications created by uncertainties about the amount of credit available; and the amount of funds injected by the Federal Reserve seemed to reflect improving conditions until November 2010. At that point, the Fed suddenly started to issue credit at a regular, very rapid pace. The new amount of credit created in the economy by the Fed since fall 2010 was based on a decision made on November 3rd, the day after the mid-term elections:

“(…) the Committee decided today to expand its holdings of securities. (…) In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.”

The third wave of funds injection seen in the original chart corresponds exactly to the amount and to the pace mentioned during the Federal Open Market Committee meeting of November 3rd. See following chart displaying credit for long term debts purchased by the Fed:

The purchase of long term debt instead of short term t-bills usually bought by the Fed has the additional effect of going against the build up of a risk premium on long term debt, which tends to happen in bad political conditions. Now, the Federal Reserve has created almost all the liquidities it had planned on generating after its Federal Open Market Committee meeting of November 3rd when the economy was considered at risk. The next meeting starts tomorrow and comments and decisions will be released Wednesday, June 22nd. Considering the current political climate, with the legislature being unable to work with the President, will the Fed decide on another round of massive funds injections?

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This entry was posted on June 20, 2011 by in Monetary Policy.


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