Let's step back into our time machine and travel alllllll the way back to the 2000-2009 decade - the one we just finished. We suffered a massive financial crisis because we, as a country and a world really, had borrowed and lent far too much money based on paper asset prices. The assets in question were homes, and the prices were inflated by a massive ignorance of risk on the part of all parties - borrowers, lenders, insurers, modelers, financial wizards, etc. When we borrowed money based on paper asset prices, we were totally hosed when the prices of those assets declined and we then couldn't afford to pay back our loans.
Now press "live" on your remote, and return your DVR time machine to the present. The solution our fearless leaders at the Federal Reserve have chosen is to run this play again - quantitative easing is designed to inflate asset prices, which in turn will hopefully result in people feeling wealthier, borrowing more, and spending more - it's a "virtuous cycle!!!" Bernanke actually told us this, specifically, in an Op-ed today:
"Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."
Just to recap, the Fed's basic goal (in my opinion) is to force capital into risk assets. The Fed buys treasuries, driving their yields to unappealing levels, until investors are forced to put their money into other asset classes: stocks, corporate bonds, commodities. As that happens, portfolio valuations increase, everyone is supposed to feel good again, and we go out and spend money, which flows through to the rest of the economy. Now get back in the time machine and crank it back just a handful of years. How did that work out last time? Of course it was great while the bubble was inflating - flat screen TVs and newly landscaped yards for everybody! - but reality is always a bitch, and bubbles always burst.
I sympathize with The Pragmatic Capitalist, who seems to be pulling his hair out in frustration over the "solutions," we've enacted so far:
" If this indeed works (pushing up asset prices) then why don’t we just perpetually perform QE? Why don’t we just sustain asset prices “higher than they otherwise would be”? The very idea of this as an economic strategy is frightening in my opinion. If QE actually works then there is no need for fundamentals. Why does anyone get up in the morning and go to work? We can all just go out and open an ETrade account and let Ben pour money into our accounts. Unfortunately, that’s not the way economics works. You would have thought that we’d have learned this after two bubbles in less than ten years, but no. Here we are again."
We are trying to ameliorate the effects of a collapsing asset price bubble by inflating a new asset price bubble. That drug doesn't work. In the words of Huey Lewis, I want a new drug.
-KD
21 comments:
Very well written and very well all too true.
Wow, really interesting in context with Grantham's piece you recently recommended (http://fridayinvegas.blogspot.com/2010/10/grantham-and-gross.html).
It is a bit shocking (and disappointing) to read Bernanke opine such contradictory ideals from Grantham's piece, which indicates debt doesn't equal long term growth and the dangers of manipulating market rates (page 3-5).
Good post man. You haven't forgiven the MMT crowd for classifying QE as a non-event?
Holy cow, they had that wrong. Uncle Ben has started a friggin stampede. Who knows how long this can continue? Hot money is pouring everywhere. Emerging markets, stocks, bonds, gold....
These 'virtuous cycles' have real life consequences.
There's no theory that can distill 6 billion dynamic, interconnected people as it relates to goods and services - into a simple outcome.
Dangerous territory we are pushing into.
I have QE fatigue.
scharfy - it's an ECONOMIC non-event, but buying assets creates asset price inflation - I don't know how people can argue against that.
i was thinking of your "lighter fluid swap" example this morning: the Fed can come to your house and buy all of your stuff at market value - that's an asset swap - they take your stuff and give you cash - but that doesn't mean there's no effect! You now have to take your cash and go out and spend it.
Nice quote from PragCap, and it does raise the question of why high asset prices are considered better than low asset prices--they are better for sellers, but worse for buyers. For the workers who are accumulating money in their 401K's, BB's money drop is bad news because they are going to purchase those "investments" at prices which are "higher than they otherwise would be." If someone made us buy gasoline, or clothes, or food, or houses at artificially inflated prices, there would be hell to pay.
The only people who permanently benefit from goosing the stock and bond markets are the people who are going to cash out--why should the Fed wish to do them any favors?
2007-2020 will be fertile ground for alt-reality fiction 50-100 years from now.
The Fed shouldn't be in the business of incentivizing/de-incentivizing asset classes. That's the role of legislative policy enactments and the tax codes. This is some gonzo shit we're witnessing.
Look all I can say is this is wild to watch but myself and others have covered how no one but big boys have any real touchable money in stocks; if somehow this works I cant see it but I am open to suggestions. 8 months of cant lose is too tempting, I am polishing off the trade cap!
QE2 has gotta be better than the truth.
Does anyone think Bernanke may soon step dowm to "spend more time with his family?"
Blurtman,
um....No.
"In '87, Huey released this, Fore, their most accomplished album. I think their undisputed masterpiece is "Hip to be Square", a song so catchy, most people probably don't listen to the lyrics. But they should, because it's not just about the pleasures of conformity, and the importance of trends, it's also a personal statement about the band itself."
well done, Anon
KD,
great thread over at TPC, what a mess!
Off topic;
dug up an old CD from a band my friends had in college and posted a tune from it tonight. What's better than aspiring scientists rocking out? Hee hee.
KD, you rightfully argue that deposits created from Fed Treasury purchases under QE2 can all of a sudden start getting spent/lent. HOWEVER, you also forget that the Fed has ways of reversing this flow of money into the general economy (capital requirements, asset sales, etc).
dawg - indeed - the policies can be reversed in the future - the Fed can sell the stuff it bought. I said nothing about that.
Also, you are right that debt monetization creates money. But it is interesting to think about how the money is transmitted into society. If the Fed bought every Treasury in existence then the national debt would go away. All Treasury holders would now have cash, but they would be no more wealthy than before. So where did all the printed dollars go? Who did they make richer? The money would have in fact been "created" over several centuries via deficit spending by the federal government. It is the federal government who received the free lunch of dollars to spend without ever "earning" those dollars. They made everyone who has ever received federal dollars slightly richer at the expense of those that did not. In the example, it was merely a wealth transfer over a long period of time, despite the monetization happening at one discrete point in time.
dawg - if you're talking about my lengthy comments over at TPC, that is in reference to asset allocation. Cash, currently, at 0%, really isn't an acceptable asset for a lot of people. So when the Fed converts their longer duration positive yield instruments (which may have already reeked of desperation in terms of needing more return) into zero duration zero yielding cash, IN THE REAL WORLD, people will eventually reallocate that. If they fail to, Bernanke will buy more bonds. and more bonds. until they do.
Right, you're saying that the inflationary effect will mainly come from previous treasury holders putting their cash back to work (despite being no wealthier than before).
What I'd contend is that it depends on whether the money getting put back to work gets concentrated into a specific asset class (such as ag commodities). If it goes into global equities, it's unlikely that it will cause prices to soar since global equities as an asset class is multiples the size of the Treasury market.
What I was also trying to point out to you was that you were correct in your analysis that QE2 "creates" money, but that the way it could potentially create inflation is less well understood by you and many others. Newly created dollars, unless transmitted widely and in very large quantities, may not necessarily create widespread inflation.
Dawg - right. and yet if we just look at the tape we'll see what's actually happening (shit is RIPPING!). and I agree with TPC that it's not sustainable.
And I'd say that it's the speculators doing most of that, thinking they are front running banks who will have cash to put to work shortly. For one, QE2 hasn't really even begun yet. And second, even when it does begin, I highly doubt the banks will be putting their excess reserves into equities or gold because the capital requirements are higher AND because big banks like BofA are facing potential capital hits from putbacks.
Of course, it might not be JUST the speculators. The economy is improving in select areas. S&P 500 and MSCI World earnings are still growing year over year. Certain commodities like wheat are facing supply issues. Etc...
sure - but you need to keep in mind that we are all speculators.
Dawg:
For one, QE2 hasn't really even begun yet. And second, even when it does begin, I highly doubt the banks will be putting their excess reserves into equities or gold because the capital requirements are higher AND because big banks like BofA are facing potential capital hits from putbacks.
The banks very well may decide to put "their" excess cash in gold. Why not ? It can be counted as Tier 1 capital with more substance than any other assets during these uncertain QE2 times.
Also, as I wrote at TPC, commercial banks are not the major holders QE2 targeted paper -- they perhaps hold about 5% of the total. The institutional investors, foreigners and other private parties account for the rest. It is this group behavior, rational or irrational decisions that will influence asset price trajectory during the nearest future.
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