Quantitative Easing 2.0

Posted by Ray on July 8, 2010 under Economy, The Federal Reserve | Be the First to Comment

I have written about money velocity at length and what I think will eventually happen and much of my thesis is about to be put to the test. For whatever reason the market seems to think massively shrinking consumer credit is a good thing and that the Federal Reserve will be starting a new QE process very soon, which is the news this afternoon that coincided with the parabolic move late in the day. However, I cannot disagree with this more and believe that any quantitative easing will do nothing to help expand credit or increase the money supply to the public. We have at the very least disinflationary forced if not outright deflation and the Fed is already running negative real interest rates.

If you recall about a year ago there was a paper from a Fed of IMF official, the authors name escapes me, that recommended real interest rates to run at -5% annually. At the time everyone thought the man was nuts and he was/is in my opinion, but the only way to get real rates that low is through loose money policy and quantitative easing. The Fed has maintained, and will continue to maintain a zero interest rate policy forever as far as I can tell, a loose monetary policy and performed the only quantitative easing policy the U.S. has ever seen, $1.5T in agency and U.S. treasury paper. Unfortunately we still have no idea what the long-term impact of these policies will be, but they cannot be good. These policies are causing real rates to go negative and mortgage rates to plummet.

In order to get the target rate to -5% the Fed will need to buy much more paper than it owns now. My guess is another $2-3T in additional paper and, again, we will not know what the impact of this QE program will be to our economy or currency for some time, but it will not be good. I am not sure why the Fed or this President cannot figure out that interest rates really don’t matter and declining credit is actually a good thing. In fact, all of the “bad news” is really long-term good news as far as the consumer is concerned, not the employment or housing data, but consumer credit. This de-leveraging is just what is needed as we were all awash in debt and most people cannot or could not ever repay their debts. I have never seen a government so desperate to reignite indebtedness of the public like we are seeing right now, it makes no sense long-term.

So, the Fed will start QE again, what will this do? Nothing. Will it increase the money supply? Yes, but not the public’s money supply merely the banking sectors balance sheet which is supposedly flush with cash anyhow. Banks are not lending money because they know they will not get repaid, but borrowers simply do not want more debt either, a good thing! We have mortgage rates below 4.6% and there is no demand, it just doesn’t get much better than that right now, although I think mortgage rates go sub 3% soon. Quantitative easing will do nothing to improve that situation and it certainly will not boost the confidence in the USD which is more than likely the goal, remember, the only way to double exports in 5 years is to devalue the dollar, but it will not work.

The point is that all the QE in the world will not put money in your pocket or your employer’s bank account to give you a raise. Essentially, from a monetary point of view the Fed is done as it cannot get money into the system. QE will merely create inflation, but not the kind of inflation Ben wants, Ben wants wage inflation and QE will merely create dollar devaluation which is Weimar Republic type of inflation. The public also does not want more games or trickery from the government and it frightens me to think what could happen if Ben goes down this reckless path. Remember, just because there is not an impact from his current policies today does not mean there will not be negative implications from these idiotic policies a year or 5 years from now.

What Ben will tell Obama is to create a direct QE program, i.e. a Bush style stimulus, a big one. I do not believe this will go over very well nor do I think voters are in any mood to be bribed with their own money this year, but if one is unemployed and offered $2,000 could or would they say no? Probably not. This type of stimulus would create what Ben is looking for, wage inflation and money velocity, but make no mistake it will be a short-term boost only. We have a long time before we are out of this mess and we have much pain ahead of us. We need to suck it up and deal with it. Contrary to popular belief it is not Bush’s fault, it is all politicians fault going back 30 years and the only cure is pain.

We will still look for an easy way out and probably do QE with another stimulus, but make no mistake that will be suicide for our countries long-term financial health and our currency will be in major trouble if we choose that path. I hate to say it, I have friends who are unemployed, but we must take the pain as it will be shorter than looking for the quick fix. We are all credit junkies and we got to kick the habit.

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What year is this?

Posted by Ray on April 23, 2010 under Economy, Main | Read the First Comment

Quotes from The Great Depression: A Diary (click to buy). If I left the dates out you might think I am quoting a modern day book, but I am not. Only a fool thinks history does not repeat itself.

“It is also interesting to note that the effort to create credit by having the Federal Reserve Bank buy U.S. bonds in the open market has failed. Huge reservoirs of credit are available but banks won’t make loans because business is too uncertain. It seems to prove that when business starts moving credit will expand automatically but the artificial creation of credit will not expand business.” November 18, 1933

“The U.S. Treasury will face the task in a few weeks of paying out huge amount for bond interest and maturities. Where will the money come from – greenbacks (printing press)?” November 18, 1933

“Industry continues to boom and the entire public seems to be speculating in the stock market. Almost as bad as 1929. Last Friday was a record day of the year with 9 million shares changing hands. The whole recovery has been so spectacular as to almost be unbelievable. Because so much of it is based on inflation theories I have doubted its permanency. The next few months should tell the story. In the meantime lawyers and professional groups have failed so far to share in the boom.” July 3,1933 – sound familiar? The Depression was just getting going and the boom was because of FDR confiscating the gold and adjusting the price, effectively taking U.S. citizens off of the gold standard, but the U.S. still honored international settlements in gold.

“For the 12th consecutive day stocks have been drifting lower. Congress starts an investigation of short selling.” April 13, 1932

“During the boom years it became popular to buy real estate at inflated prices on a shoestring. This was done by encumbering it with a 1st, 2nd and 3rd mortgage. Second mortgage companies were formed to buy 2nd mortgages at a discount of 10% to 25% per year. It has proven to be a bad investment because at each sheriff sale the 2nd is wiped out. Most of these companies have frozen assets and seem to be heading for bankruptcies.” About June 5, 1931

“Magazines and newspapers are full of articles telling people to buy stocks, real estate, etc. at present bargain prices. They say that times are sure to get better and that many fortunes have been built this way. The trouble is that nobody has money.” July 30, 1931 – He further went on to say in 5/16/32; “This advice was premature. Here a year later prices are 1/3 of what they were in 1931.”

The point of this is that we may very well be in one of the peaks and valleys that were fairly common during the 1930’s. If you look at the economic policies of Hoover, which FDR took over and expanded, they are very similar to what we see the present government doing. As it turns out these policies actually extend the problems because banks cannot purge the troubled loans and assets, sound familiar, which created zombie banks. Eventually banks began to get states to pass laws restricting withdrawals, they did this with life insurance loans as well, and that still did not stop banks from failing. Bad mortgage debt is what caused the banks to fail, sound familiar?

The assets of depositors ended up frozen and shareholders were wiped out when a bank closed, they had double liability back then which means shareholders could lose more than they invest in bank stocks if the bank failed, they would get sued basically. Many of these banks did reopen thanks to Hoover’s Reconstruction Finance Corporation, but the savings accounts or passbooks were frozen. These passbooks were used as currency as people would sell them for pennies on the dollar, in hopes the institution would allow withdrawals at full face value. It is interesting to see how this al played out and what the average person was thinking during those times. I have to tell you, this book is all one needs to read about the Depression. I am sure Ben Bernanke learned a lot about the technical’s of the Depression, but unless he read this book he does not know squat.

The real killer, according to Benjamin, was the Smoot-Hawley Act, which placed high tariffs on imports to prevent dumping. Europe had devalued their currency so the tariff was put in place to make sure people bought American. It did not work and made things worse. Does this sound familiar with the rhetoric coming out of Washington about China’s currency value? The interesting thing is that, just like now, all countries were devaluing their currency in order to remain competitive and export in order to improve their own economies, it failed. When every country is devaluing and trying to export, as Benjamin points out, who is left to buy anything?

I will post more quotes from this book, but I urge everyone to read it. The similarity between the 1930’s and today is amazing to say the least. They tried to create inflation and failed, just like Ben is trying, and they tried the NRA, like the stimulus bill but they made the NRA much more strict and imposed higher pay and shorter hours so they had to hire. The NRA put unions in a position of power and several times Benjamin pointed out that labor troubles would come and they did. The current administration also wants more union jobs and activity, I fear that will fail to as unions strike often and are the primary reason the U.S. is not competitive in manufacturing, among other reasons.

History repeats itself and if we forget that basic rule we will always be doomed to repeat it. People who claim this is nothing like the 1930’s are insane. Sure, it is not as severe, maybe it will be if we relapse, but we are showing many of the same symptoms as were present in 1931, 1932 and 1933. Even the market action is somewhat similar. The one difference I foresee in the future is inflation, which only materialized in the 1930’s through price controls and increasing the price of gold, but overall inflation was very tame in the Depression as there was no money velocity, again, sound familiar?

We are slightly more creative in 2010 so I expect money velocity or a full blown currency crisis in the near future. In 1933 we really could not destroy our currency because of the gold standard, we did float the dollar though, but in today’s world we have nothing backing our money so it could really go to zero. It’s scary if you think about it.

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The Fed lost its appeal!

Posted by Ray on March 19, 2010 under The Federal Reserve | Read the First Comment

Thanks to Bloomberg and Fox we might now find out who borrowed what and what was provided as collateral to the Fed during the crisis we may finally know thanks to a lengthy legal battle. The Fed might continue to fight, but it may not go much further, just show us already as this data is almost 2 years old, I am sure we can handle the truth.

However, you will see that the Fed took some very questionable items as collateral or so we think. Some bankruptcy documents do show that the Fed did take some stocks and other, well, crap for collateral during the height of the financial crisis. What many people do not know is that it is against the rules for the Fed to take credit risk since it is the U.S. governments bank. These documents will either confirm or deny those rumors, but I am betting on the former, if we ever really get to see them.

Could this be the end of the Fed as we know it? I hope so because since the Fed was enacted, in secret in 1913, we have witnessed the dollar lose 97% of its value, a depression in 1920-21, the crash of 1929 leading to the Great Depression (now known to be the Fed’s fault for tightening credit), more boom-bust cycles than any other time in history, the 1970’s (really, need I say more about the 70’s? I think they introduced bell bottoms too, but I cannot prove it), the 1980 near collapse of the U.S. treasury market, the first banking crisis, Long-Term Capital, the dotcom bubble, loose monetary policy for the last 30 years, the housing bubble, the complete meltdown of the financial system, and, for its final act, complicity to destroy the dollar’s value with its current balance sheet.

Really, I cannot think of any reason why we need to reform the Federal Reserve system.

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