No interest loans

You may have thought the rage of no interest loans was behind us, but we may only be getting started with the biggest no interest loans in the history of the World. I'm referring to the 90 day treasury which has recently been yielding rates of near 0%. The last time treasuries had yields of near 0% and there was a rising stock market was in 1938. That time the the ultra low rate was followed by a 34% decline in the stock market after the Fed tightened the money supply by increasing borrowing costs. Investors willing to accept the 0% and guaranteed return of their capital did extremely well in comparison to their less risk averse counterparts.

The supposed difference to this situation and our current setting is that Fed policymakers prematurely tightened money supply in anticipation of upcoming inflation. Being the student he is of the Great Depression, it is widely believed that Ben Bernanke is too well versed in these mistakes to repeat them in our modern day crisis. What if we are tightening the money supply without knowing it?

Remember, raising interest rates that banks pay to borrow money from the Fed is only one way to reduce the money supply. The money supply can also be reduced by setting levels of capital that banks must maintain in relation to how much they are able to lend. As we trudge through the deleveraging of the American economy, (not only banks) these levels of capital are growing and thus reducing our money supply. These capital levels grow not only through regulatory mandate, but will also grow as a direct result of the heightened levels of asset price volatility we have experienced in the past year. Increased asset volatility will require firms to hold more capital as they are less confident about the future price fluctuations of their assets. It is this new level of volatility that once fully incorporated into internal risk models and rating agency calculations that will be the silent tightening of the money supply.