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Common Cents

Manhattan Money

Ralph Murphy

(11/3) Federal Reserve Chairwoman Janet Yellen speaking at a Washington meeting of the Board of Governors noted the continued health in the economy and wouldn't commit to any change in the federal funds interest rate until December. Interest rates encourage borrowing or saving and are a primary source of manipulating the money supply. The federal funds rate she cited amounts to almost nothing as the system has developed since 2008. The cash provided by the Fed is alternately managed and available from private sector manipulators with new and illegal access to stored government- held deposits.

The Federal Reserve Bank (The Fed) has two primary objectives relevant to the economy's financing. It is chartered with regulating the banks as well as the money supply. Policy options used to be fairly simple as the central bank would buy and sell bonds from institutional investors in open market operations (OMO's) to raise or lower the currency levels. Private investors could also serve as currency brokers for the economy through purchases of direct Fed loans that pay interest at a "discount window" from the Treasury or stored central funds. There was also a Reserve Requirement that froze the funds in private vaults. Interest rates have been near zero since 2008 when the federal funds rate that Ms. Yellen cited was split into a "target rate" - the one she said may change shortly- and an "effective federal funds rate". This is the one that banks report they used in an average of interbank loans as reported by private banks. It's at variance with the target rate and the Fed has to retain control of the money supply as outright grants or Repurchasing Agreements (Repos) have been arranged as well. These require little oversight and often come with no interest for borrowers.

The Federal Open Market Committee doesn't publicly report the Repurchasing Agreements (Repo's) to the conventional press as New York- based "borrowers" now operate out of a System Open Market Account (SOMA) tied to the New York Federal Reserve Bank. The Repo funds are taken from central bank vaults in "a deposit for a defined time period" and made available by the Fed to a very limited group of bankers. There are varied estimates but it could credibly involve fewer than 25 commercial borrowers. These actions are surely illegal as the Fed outflow would require Congressional approval as Treasury issue. That Constitutional mandate was more for payment, but the modern supply of transaction currency ideally would also reflect it. Storage of working capital by the government simply isn't working as the access group of private sector investors use it as their pooled account. It's in the system but the Fed lacks real control.

The mortgage market that helped cause the liquidity shortage with a drawdown in 2008, ushered in other investor concerns with international fallout and repercussions. A one time financial services group called LIBOR or "London Interbank Offered Rates" has made news in recent years for their actions tied to their mortgage division. It provided governing authorities in England and abroad, interest rate portfolios reported as required by member banks, but established a "benchmark" that the banks had to charge or be pursued by respective justice departments. These departments could task them although they were still operating from the private sector. Benchmark rates are generally associated with cartels or price manipulation. Those markets are primarily for primitive, primary markets as commodities. Pooled money could theoretically be viewed as a resource to access. However, flippant regard for the money is not the same as losing the mineral wealth- although the access authorities appear to equate them. Libor has been regulated by NYSE Euronext, Inc. since 2014 when it assumed a controlling interest. Banks still report the interest rates they pay worldwide and the arbitrage or divergences from the benchmark rate are penalized.

The money supply provision mentioned earlier is a central bank dictate but cannot be tied to politics and must be linked to actual earnings in national income changes as reflected by Gross Domestic Product (GDP). For example the labor market is often cited as a reason to alter Fed rates, and while it is important to production, it is but one of the aggregate earnings. Money supply changes affect it, as does all other production in the monitored cycle.

The interest rates to policy issue reflects inflation concerns and there are two types of inflation. One erodes the purchasing power of money and the other maintains it if the money supply and price rises match new supply and demand of GDP. The challenge is to provide the money to meet short term demand. With today’s new technology, they can and should be able to tabulate rates far more often than the seven Federal Reserve meetings held each year. The rates could be tabulated daily or each night with an eye toward symmetry of GDP and new money supply.

The provision of new transaction currency should go back to the discount rate that is interest rate controlled. OMO's still would work but the federal funds rates have to be dropped as do the new Repos due to real criminal theft issues. Reserve Requirements could be used but would be slow to effect loans. The old Fed tools that were employed as the interest rates for borrowing have to be restored. The Repo seems to serve the very few bankers or dealers who have access to the Fed.

Private sector banks are still an effective broker for Fed cash and can fuel new growth based upon expansion of the economy. But, they must be regulated as to competence and integrity based on past and future dealings that relate to the lending targets. Repatriating foreign money would also have an impact on the domestic market, but must be monitored closely as the funds may not reflect "value added" or new production source needs. It is important that authorities determine the value a currency should maintain amid changes in production. They should act with policies that are tied to that alone. Playing politics or trusting the traders has proven costly without oversight or accords that are tied to need.

Ralph Murphy is a former member of the CIA Headquarters Staff in Langley, VA.

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