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Fed Fairy Tales By Carl Pellegrini Print E-mail
by    Fri, Dec 9, 2005, 02:40 AM

carl_charts_20051211 2.jpg

A fairy is a term for a supposed race of supernatural beings that magically intermeddle in human affairs (1911 Encyclopedia Britannica). A fairy tale is a traditional story written for children which usually involves imaginary creatures and magic (Cambridge International Dictionary). Please forgive me for the references to historical fiction, but the FED doublespeak leaves me no alternative.

First, focus your attention to the top chart. The evidence would suggest the rising demand for funds is the prime mover of short term interest rates; and if anything, the FED remains well behind the curve. There is a tried and true relationship between Short Term Debt growth and the rhythm of the inventory cycle. But something is amiss and it is a BIG miss for the FED. The demand for short term borrowing is accelerating during the down leg of an inventory cycle, largely due to the lack of longer term debt issuance and the decline of depreciation allowances after the recent tax cut expired.

Given that loan demand accelerates when business rebuilds inventories, one could reasonably assume that the demand for short term credit is at a low point relative to the 2H of 2006. The new head of the FED, a.k.a., Helicopter Ben, is well known for his study of the linkage of the credit creation process and nominal economic activity. That being the case, as the U.S. economy enters into 2006, the Balance Sheet condition of the largest intermediary of short term credit, the banking industry, bears review.

The second chart reflects the behavior of banks bidding for funds versus the liquidity position of the asset side of their balance sheet. The Banking industry will make new lows in liquidity before it is “loaned up” as it was coincidentally with the “peak” of the inventory cycle of 1999-2000. The behavior/expectations of businessmen engaged in profit maximizing activities is the real world; the FED is left to telling stories.

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