Commercial Real Estate Finance

In a recent Real Clear Markets article (see here), the author trashes Ben Bernanke.  The article is supposedly about how Bernanke’s term should not be renewed because he employs a hybrid approach (Philips Curve & Monetarist).  Why he thinks Bernanke should be doctrinaire about any given theory, I’ll never know.  He also says Bernanke doesn’t understand how the markets actually work.  It all ends up being a bunch of nonsense to justify a return to the gold standard.

In a classic example of academic knowledge vs. practical experience, the author does not understand how the markets actually work. He writes:

“Put simply, the dollar is the world’s currency. For evidence we need only remind ourselves that 2/3rds of all dollars are overseas. If and when dollar shortages reveal themselves stateside, the shortfall is made up with inflows of dollars from foreign locales.

So when Bernanke says he can contract U.S. bank reserves and lending through interest payments on dollars returned to the Fed, he is not writing truthfully. Just the same, if the Fed increases reserve requirements on banks in order to reduce lending and the money supply, there will similarly be no decrease in dollars lent in the U.S. despite Bernanke’s protests otherwise.

That is so because there exists a large reserve of dollars that the Fed does not control. Specifically, our largest money center banks have outposts around the world. Most notably through the Eurodollar markets, major U.S. banks can easily work around any supposed tightening by the Federal Reserve by accessing dollars from banks the Fed does not regulate. Smaller regional banks can borrow from the larger ones.”

Let’s start with the first misunderstanding. 2/3^rd of all dollars are not overseas. In fact, dollars never actually leave the US. From Marcia “Stigum’s Money Market” by Marcai Stigum, we learn that “The first important point to make about Eurodollars, is that regardless of where they are deposited – London, Singapore, Tokyo, or Brazil – they never leave the United States. (page 211)” Ultimately, all that happens is a transfer between reserve accounts at the Fed. It is part and parcel of how the Fed is the monopoly producer and controller of dollars. Anyone who spent a day trading money products would know that.

Next, the bit about bank lending. Again from Stigum:

“Specifically, because the nation’s largest corporations concentrate their borrowing in big money center banks in New York City, large regional banks and other financial centers, the loans and investments these banks must fund exceed the deposits they receive. Many smaller banks, in contrast, receive more money from local depositors than they can lend locally or choose to invest otherwise. Because large banks have to meet their reserve requirements regardless of what loan demand they face and because excess reserves yield on return to smaller banks, it is natural for large banks to borrow the excess funds held by smaller banks.” (page 45)

So, as a practical matter, the idea that the Fed doesn’t have control, and smaller banks can just borrow from larger ones has no basis in reality. Stigum’s book, by the way, was recommended to me by a guy who actually traded interest rate products for 15 years.

The fact is, the Fed has a great deal of control over the supply of USD. It does not, however, have control over how those dollars are used. That is not the author’s point, however.

It seems to me that if you are going to write that Benanke should not stay on for another term, you should first know what he does and how he does it.

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