Ben Bernanke was at Jacksonville University this past Friday discussing the Federal Reserve with college students.  It’s actually a very good discussion.  He goes through the banking crisis step by step and provides a very clear explanation of the Fed’s role during the crisis.  He confirms most of what I have been repeating for weeks now.

Most importantly, however, he explains what the Fed is doing going forward.  He makes several critical points:

  • He explains that the Fed “is not printing money”.  They are merely swapping treasuries for deposits (sound familiar?).  As he mentioned in his op-ed the other day there is no reason to believe this operation is inflationary.  It alters the duration of debt outstanding and nothing more.  QE IS NOT INFLATIONARY.
  • He says the price increases in commodities (caused entirely by speculators and not fundamental changes) are not a concern because the slack in the economy will make it difficult to pass these costs along to consumers (sound familiar?).   Unfortunately, I think the Chairman is overlooking the fact that corporations will be less likely to hire as they see their margins squeezed.  This is a significant issue the Chairman appears to be glaring over.  It should not surprise any of us that he is viewing this environment as an academic and not as a business owner.  Just one more piece of evidence showing he is unqualified for this position.
  • The Chairman proves that he absolutely does not understand how the US monetary system functions when he says that the US is analogous to Japan in that we have high government debts.  He claims that Japan funds their debt internally clearly implying a solvency constraint.  He goes on to explain that the US budget deficit creates risks for the country despite previously explaining that high inflation is not a problem. Clearly, the Chairman believes the government balance sheet is no different than a household balance sheet.  No wonder he has had this crisis wrong since before it started.

Updated: For those who don’t have the time to listen to the interview here is the important directly from the Fed Chief himself (courtesy of reader LVG):

“What the purchases do… is… if you think of the Fed’s balance sheet, when we buy securities, on the asset side of the balance sheet, we get the Treasury securities, or in the previous episode, mortgage-backed securities. On the liability side of the balance sheet, to balance that, we create reserves in the banking system. Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed. Now the question is what happens the economy starts to grow quickly and it’s time to pull back the monetary policy accommodation. There are several tools that we have”


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Neil Wilson

    Of course Japan funds internally. It is an exporting nation and the US is an importing nation. How can Japan possibly fund Yen debt externally with the current account balance it has? In aggregate only the Japanese have Yen!

    The Basic accounting identity shows that if the external sector is accumulating currency then it will ‘fund’ the deficit in that currency.

    Once again it is using psychological anchoring to deliver a plausible line. Is he also a proponent of bloodletting to stabilise the humours?

  • Jo

    What are you talking about – a regime’s balance sheet is no different from a household one.

  • HAB

    TPC – I am somewhat of a newbie when it comes to understanding monetary policy. One thing that would help me is an overview graphic that shows the basic relationships and “moving parts”. Is there some graphic out there that illustrates what you’ve been saying? In other words, shows the Fed and Treasury operations which do and do not create money, and their interactions. I think something like this would help lots of folks better understand Fed and Treasury operations, and the points you’ve been making (e.g., the nature of the QE asset swap, where new money comes from, deficit funding, etc.).

  • Kid Dynamite

    ok, let’s have this discussion AGAIN.

    you can’t just keep repeating the intellectual claim that “QE is not inflationary” – TPC. In Bernanke’s world, and your Land of Economic Theory – you’re right – QE is not inflationary in isolation. UNLESS, of course, the cash that is received by those who sell treasuries to the Fed is put to work. WHICH IT IS! THEN it’s inflationary – asset price inflation.

    In other words, if the Fed buys treasuries from you, replacing your treasuries with cash – that does not create asset price inflation (except maybe in treasuries)… and you’re no wealthier – we all agree on that. However, when you then turn around and do something with the cash you were just “saddled” with – zero yielding, burdensome cash, you inflate another asset. That’s exactly what has happened.

    It’s great how you’ve constantly explained the non-money-printing point – but that doesn’t mean it’s not inflationary.

  • Scott J.


    Check out Billy Blog’s post”Deficit Spending 101-Part 1″ here:

    And then go on to the “Deficit Spending 101-Part 2″ (you can find the link at the top of the page on the right) and “Part 3″:

    Parts one and three have some interesting graphs showing the consolidated gov’t: Treasury and Central Bank.


  • gf
  • Scott J.

    @ Kid Dynamite:

    The Fed purchases the Treasury securities (asset side of its balance sheet) by “paying” the banks’ accounts at the Fed w/ a corresponding amount of reserves (liabilities side of its balance sheet), not cash. The banks don’t need the reserves to lend, so if they do miraculously begin lending it will not be on account of the Fed pumping them w/ more liquidity, but because the economy is healing and they have found more creditworthy borrowers. In which case, if there is inflation it will correspond to the actual healing in the overall economy. There’s no question QE2 is creating inflationary expectations and speculation, but that’s not the same as inflation. Inflation is a general, sustainable rise in all prices over time. What we have now is a distortion in the commodity markets that is not sustainable because of massive private sector debt, no wage growth, and no housing recovery. So long as we’re in a “balance sheet recession,” the commodity prices will eventually collapse (perhaps too strong a word) due to lack of final demand.

    Cullen, please correct me if I’m wrong here.


  • Scott J.


    From what I can tell, Denninger doesn’t fully understand monetary operations, so his hyperventilating is not warranted. But he is correct that QE2 is ineffective and actually harmful (IMO).

  • Captain America

    You’re being a bit loose in your language and so is Cullen. Nothing “funds” Japan’s spending. Not even their domestic savers. The fact that they run a current account surplus just means the accounting gives the appearance of being internally funded and makes people think the Chinese fund America. Neither is actually true.

  • Captain America


  • Captain America

    Adding new money to the same supply of goods and services is inflationary. If there is no fundamental change in the goods and services outstanding then there is no reasonable reason for asset prices to change. This is the point TPC is making. Since there is no “net new money” being added to the system it’s clear that the commodity price changes are purely psychological and not fundamentally driven. Therefore, they won’t get passed along to consumers because the consumer’s won’t see their wages rise. Therefore, commodity prices should correct from this Fed induced rise.

  • FDO15


    First of all, it’s hilarious to see Ben Bernanke making all the same comments you were making two months ago. Kudos to you for being ahead of the gang.

    Unfortunately, the only inflation we’re seeing is in the form of USD borrowing to jack up commodity prices. This is pure speculation.

    We have to get back to our roots people. Debt and equity markets exist to help entrepreneurs and business people create businesses and tools, and services that will make mankind better. They do not exist to be traded, “swapped” and played around with. The equity market is not here to make America rich. It is here to help America innovate and become more productive.

    Mr. Bernanke clearly doesn’t understand this basic premise.

  • FDO15

    TPC – can you delete my other comment? Sorry for the misplacement.


    First of all, it’s hilarious to see Ben Bernanke making all the same comments you were making two months ago. Kudos to you for being ahead of the gang.

    Unfortunately, the only inflation we’re seeing is in the form of USD borrowing to jack up commodity prices. This is pure speculation.

    We have to get back to our roots people. Debt and equity markets exist to help entrepreneurs and business people create businesses and tools, and services that will make mankind better. They do not exist to be traded, “swapped” and played around with. The equity market is not here to make America rich. It is here to help America innovate and become more productive.

    Mr. Bernanke clearly doesn’t understand this basic premise.

  • Kid Dynamite


    I don’t understand your first two sentences – they seem to conflict:

    “Adding new money to the same supply of goods and services is inflationary. If there is no fundamental change in the goods and services outstanding then there is no reasonable reason for asset prices to change.”

    I very much agree with your first sentence, but not your second sentence. If there is more money chasing the same pile of goods and services, the price goes up. that’s how it works, and that’s the result of QE. there are less assets out there to buy, and more cash with which to buy them.

    if the Federal Reserve came to you and paid you market value for all of your possessions, your net worth wouldn’t change. But guess what – that would still be inflationary, as you’d now have to go out and buy a car… a house… furniture.

    demand is inflationary, supply is deflationary. The Fed’s operations are DEMAND. plain and simple. They also remove supply.

  • FDO15

    The scary thing is that QE has no reason to scare people about the stability of the currency, but we appear to be talking ourselves into that position. The entire country and world is convinced that we are trashing the dollar.

    Can this become a self fulfilling prophecy?

  • Old Timer

    Two comments:

    1. BB appears to feel that private debt levels (as a percentage of GNP) are irrelevant to the overall economy. His exclusively academic view is that if the FRB creates reserves – they (the private sector) will borrow and spend those reserves thus restoring the growth rate of the economy to a vigorous level. He appears to feel that lenders expectation of repayment of new loans and the private sector’s inability to pay current debt, never mind new debt, has any impact on the current economy.

    2. His view that the Great Depression was nearly exclusively caused by the collapse of the banking system because the FRB did not behave as a lender of last resort. The collapse of the banking system clearly exacerbated the Great Depression – but the underlying problem (the root cause) was unsustainable levels of (improperly collateralized) debt (an asset bubble). That was the underlying cause of the Great Depression as it is of the Great Recession.

  • Kid Dynamite

    Scott –
    it’s got nothing to do with lending at all. I’m not talking about lending. I’m talking about asset prices.

    more cash chasing fewer assets. it’s inflationary. and yes – there positively IS more cash post QE than there was before QE. There isn’t more wealth, but there is more cash.

    Cullen, as a money manager, should understand this easily. He has his clients’ money invested in a portfolio of “stuff.” if that “stuff” is no longer available for purchase (perhaps, because the Fed buys it from him), then he goes and invests his clients’ money in OTHER stuff. The supply of other stuff hasn’t changed, but the demand for it has changed – Cullen now needs to buy it – which is inflationary.

  • mad_dom

    People that think that companies won’t be able to pass along higher prices, are not living in the real world. Look up Kraft, General Mills, Sara Lee, UPS, the Post Office, Safeway, Kroger, Cablevision, Anheuser-Busch, McDonalds, Novartis, and many many more. Just do a search and you’ll find tons of articles about companies raising prices. Here’s a few links. They range from parking meters raising prices to the NFL and MLB teams raising prices. But don’t worry, your social security increase in benefits will take care of it. LOL.

  • Angry MBA

    Of course Japan funds internally. It is an exporting nation and the US is an importing nation. How can Japan possibly fund Yen debt externally with the current account balance it has? In aggregate only the Japanese have Yen!

    The Basic accounting identity shows that if the external sector is accumulating currency then it will ‘fund’ the deficit in that currency.

    The MMT crowd disputes the orthodox macroeconomic theory that the current account has to balance, i.e. that trade deficits have to be funded with FDI or asset sales. They believe that because trade deficits are funded with money created by the central bank of the importing nation that no corresponding funds are needed to offset the export of cash, treasuries, etc. (No, I don’t agree with the MMT argument, but that is why they argue to the contrary.)

  • Kid Dynamite

    Are you guys aware of the TrimTabs model for the equity markets? It’s based on how and when “cash on the sidelines” actually changes. As we all know, the common mans’ understanding of “Cash on the sidelines” is a fallacy – when one fund spends cash, they buy stocks from someone else who raises cash – net cash doesn’t change.

    on the other hand, there are two things that DO change cash on the sidelines – issuance, and buybacks. New issues are bearish because they “consume” cash, and buybacks are bearish because they “increase” cash.

    QE is just like a buyback. It increases cash, even if it doesn’t increase wealth (you give up something, and you get cash). So, sure – you can call it an “asset swap” if you want, but that doesn’t mean it’s not inflationary – cash, under ZIRP, is an asset that offers no return. So it flows to other assets in search of return. That’s the entire point of Bernanke’s Ponzi scheme. I agree with you all that it has no REAL economic effect, no LASTING effect, no effect on banks’ ability to make loans – but if you don’t think it drives asset prices higher, well, you’re living on a different planet. Demand drives prices higher. QE = demand.

  • Captain America

    You need to watch the interview again. Mr. Bernanke says it point blank – we are not adding new money. Your entire starting point is off base. No new money gets added because of QE. The demand was always there. If you own a 2 year treasury note you are holding a federal reserve note. You can sell that at any point and go out and buy whatever you want. These are highly liquid notes. If you take physical hold of the bond notes they are just as liquid as the federal reserve notes in your pocket. The 10 and 30 year are no different. We are making a trivial distinction between debt and cash. They are both liabilities of the Federal government. The Fed hasn’t changed the amount of cash in the system. All they did was change the duration of it.

    Inflation is more money chasing the same amount of goods and services. There is not more money. Well, except for the guys borrowing to buy commodities, but that’s just financial inflation and speculation. It’s got nothing to do with the real world and supply and demand.

  • Old Timer

    If BB wants to raise inflation levels he merely needs to convince the U. S. Treasury to issue fewer bonds to drain the money out of the economy created with their magic button.

    That is the magic process that places huge amounts of money into the real economy.

    This is exactly what was going on during the last inflationary period that then led to inflationary expectations.

    Gee…do ya think it might happen again?

  • Captain America

    You’re misunderstanding the entire operation. The banks get interest bearing reserves that are at the Federal Reserve swapped for their 10 year notes or whatever. All they did was change the duration.

  • FDO15

    Treasury issues bonds by Congressional mandate. The Fed can’t just walk over to Treasury and say: hey guys, let’s stop issuing bonds tomorrow.

  • FDO15

    And I should add. The reduction in bonds would require a simultaneous reduction in government spending which would not be inflationary at all. It would be deflationary in this environment.

  • Angry MBA

    Since there is no “net new money” being added to the system it’s clear that the commodity price changes are purely psychological and not fundamentally driven.

    In practice, there is new money being created, in the spread that is produced through the process of lowering the interest rate.

    When the Fed engages in QE, it swaps new cash in exchange for old treasuries. In anticipation of the QE bond auction/ buyback, holders of treasuries (read: banks) will buy up treasuries in advance of the auction. Later, the Fed will offer those banks cash in exchange for their treasuries.

    The QE process will give those bond sellers (those banks that bought up treasuries in advance of the auction) more cash than they originally paid for the bonds. So cash is being added to the system when QE is implemented.

    The corresponding increase in cash, based upon that spread, is a tiny proportion of the total amount of QE, as the net change is in the difference, not the total amount. (In other words, the amount of money being created is a mere fraction of the alleged size of the QE program.) But cash is being created through this process, it is not just an even swap.

    In a Keynesian model, this isn’t necessarily inflationary at this time, because of the output gap. The main component of inflation is (typically) wage growth, which is not an issue when unemployment is at 9+%.

    Commodity prices won’t be passed on to customers over the long run because speculators can only influence spot prices for so long. When the futures trade starts moving away from hedgers and toward traders, as it has lately, then price volatility is a given. Increased margin requirements on futures contracts, at least for certain classes of buyers (read: pure speculators) would be the easiest way to put a pin into the bubble, but good luck getting the CFTC to ever do anything to reduce trading volumes.

  • Captain America

    Rising asset prices is not inflation. Was $150 oil inflationary? Or did we collapse into a deflationary hole right after that? You keep saying there is more money, but your comments don’t agree with what Bernanke says in the video. He specifically states that there is not more money.

    The Fed buys back bonds all the time. It’s not like this is the first time a central bank has ever performed an open market operation. The banks get reserves. They don’t get a gold coin. They get a federal reserve note. It’s the same thing they already had except the duration has been changed!!!!

  • Captain America

    Two things here:

    1) There is new demand for debt because of the interest rate change. That is true. But this does not add new money. It might make other assets more attractive, but it doesn’t necessarily mean there is more money.

    2) The Fed is paying market price for the bonds. We’re not seeing a huge change in bond prices ahead of the buybacks. The change in prices (and new money) is trivial at best. Again, I think Cullen is a bit loose with his language, but this is a swap for simplicities sake.

  • Captain America

    Anyone worried about commodity price inflation needs to read PK’s latest.

    “I get a fair number of comments to the effect that worries about deflation are all wrong, look at commodity prices. I’ve tried in the past to explain why we should focus on sluggish, sticky prices, not volatile prices like commodities — hence core inflation. But let me add another point: arguably the stickiest, sluggishiest prices are those of labor. So why not focus on wages?

    There are, in practice, some problems with doing this, involving composition effects, overtime, etc.. But still, if you want another indicator of the big slide in underlying inflation, look at average hourly wages”:

  • Captain America

    Our wages are going down and we’re exporting our standard of living to China because they’re eating our lunch on the production front while we just keep fiddling around with ways to prop up markets.


  • Captain America
  • jt26

    Let’s try a global or conspiracy theory angle to this discussion.

    The crux of disagreements/misunderstandings on all these TPC QE/money threads revolves around whether lending or money velocity actually increases somewhere:

    (a) global picture: global sum of central bank reserves are not increasing proportionally; in this case it is inflationary (I’m thinking of all the countries pegged/soft-pegged to the USD).

    (b) conspiracy: does anyone think there are any funny conduits or accounting tricks being used or leakage, whereby Fed/BOJ/BoE open market purchases are NOT simply credits to reserves, but are actually resulting in real global leakage? I.e. those reserves are encumbered by liabilities, but are “off balance sheet”, resulting in money creation or increase in velocity somewhere globally?

  • Angry MBA

    But this does not add new money.

    If a bank that bought a bond yielding 3% later sells that same bond for 2%, then the bank ends up with more cash in its coffers after the sale.

    That is simply the operation by which QE works, except the spread isn’t nearly as high as the 100 basis points in the above example. You need to get beyond the narrow accounting identity that MMT fixates on, and deal with the real world of how the process is conducted.

    The accounting identity at the Fed level is irrelevant. The issue is how much money is circulating among participants in the economy, aside from the Fed. There is no dispute that the amount of money in the banking system increases as a result of QE.

    The question is not whether there is more money in the system — there clearly is — but of what the banks that participate in these auctions do with this additional money. If they just sit on it and don’t lend it (more excess reserves), then it goes nowhere and does next to nothing. If that money gets lent out, then there is a multiplier effect.

    The Fed has claimed that the lending problem is one of borrowers not wanting to borrow. If the Fed sincerely believes that, then the Fed should be arguing that QE is unnecessary because it will simply be parked in excess reserves. Their actions betray their words — obviously, they must think that lending is driven by a lack of supply, rather than by a lack of demand.

  • jt26

    BTW I made this comment on another TPC thread (sorry for repeating), but John Taylor says that it doesn’t matter whether QE-N creates inflation or not … if it does, it’s just like the Fed 70’s policy mistake … we’ll get stagflation … if it doesn’t, we get a mild depression. Netiher is good for stocks or the economy, hence the rush into commodities/PMs.

  • jt26

    PS the rush into commodities/PMs is only good in one of the cases, so better factor that 50% into your return expectations!

  • Captain America

    Well yeah, when you say it like that it sounds significant, but what’s the reality? They’re buying mostly 1% paper:

    “The five-year note carries an interest rate of 1.17% per year. The Federal Reserve is thus changing the supply of assets by taking onto its own balance sheet… wait for it… wait for it… duration risk that the market is currently willing to pay $7 billion a year to avoid.

    To take $7 billion a year of duration risk off of the private sector’s books in a global economy that still has more than $60 trillion of financial assets is a change in “credit conditions” equivalent to what would be achieved in normal times by a coordinated one basis point reduction in short-term interest rates by the world’s central bankers.”

    Your arguments are always so semantic. So what. They’re adding a few billion $ to the money supply. Are we really going to argue about the inflationary impact of a few billion dollars in a $15 trillion economy?

  • Angry MBA

    Your arguments are always so semantic.

    There’s nothing semantic about it. What you describe glibly as an “asset swap” with no resulting change is actually $7 billion of cash being injected into the banking system.

    On the one hand, $7 billion isn’t that much in the scheme of things. (It certainly isn’t inflationary, given the output gap and liquidity trap.)

    But it obviously isn’t zero, either, which is what the MMT pundits would claim. The MMT argument is clearly wrong — last time I checked, $7 billion was about seven billion more dollars than zero. As is the case with the money monopoly argument, these core assertions of MMT are easily disproven.

  • Captain America

    So let me get this right – you’re arguing that a 0.004% change in the money supply is not semantic? I agree, Cullen is being loose in calling this just an asset swap, but for practical purposes that is entirely right. You claim victory over 0.0004% and claim that it “disproves” MMT?

    You’re a joke and an ass MBA. That is the only thing your comments here prove.

  • Angry MBA

    That’s hilarious. I’ve just proven you wrong, so because you’ve backed into a corner, you go for the ad hominem.

    You basically just admitted that MMT is wrong; your pet theory was torpedoed within just a few posts. The transaction doesn’t net to zero, as you’ve been trying to claim, which cuts to the core of your alleged argument. Must suck to be you.

  • Captain America

    as for MMT and you having “disproven” it – how come every time you argue with Cullen about MMT he shuts you down? Yeah, I saw your argument about how MMT is like communism. I’ve also seen your claims about how the private sector give the money value. It’s all semantics. That’s all you ever do here. You argue stupid little pointless points to try to make yourself feel smarter than you really are. Well, news flash kiddo – you’re not. You’re just another pompous ass on a chat board.

  • Albardon

    I do not believe you can say that QE is inflationary, or not inflationary, in isolation. It all depends as many of you say in monetary demand. If it increases, chances are there will be inflation as the money created by the swap against Treasuries starts to circulate in the real economy. Even under these circumstances, inflation would only occur if corporations recover pricing power. Under current conditions of high idle capacity, that is at least doubtful. Obviously, assets subject to temporary or permanent supply restrictions, such as certain commodities and premium real estate, might go up in price.

  • Captain America

    Really MBA? Do you round two decimal places like everyone else in the world? 0.004% is trivial. You can argue about whether that makes it a pure swap or not, but for sake of the argument it is ridiculous to say that 0.0004% is anything important. You are so arrogant it’s obnoxious. This argument is beyond stupid. But then again, what argument with you isn’t beyond stupid?

  • plsherid

    Does inflation really have to be defined by it’s cause? If driven by speculators or fundamental reasons, isn’t the net result the same albeit with a potential for sharper reversion at the end of the cycle?
    The argument that the slack will prevent rising prices from being passed on is ridiculous- you going to stop eating and filling up your car? No -and it’s therefore an effective tax on the consumer erasing Bernanke’s theory that he can create a wealth effect via a rising stock market.
    We’re all Doooooomed- as Faber would say.

  • FDO15

    From an operational perspective it is just an asset swap. And the fact that there is some leakage is really insignificant in this example. This has nothing to do with MMT anyway so I don’t even know why you two are arguing about it. Bernanke would agree with you. The impact of this is less than trivial on the inflation front. As Captain said, TPC is too loose with the term “asset swap”, but he’s trying to dumb this down so we can all understand it.

  • FDO15

    I liked Peter Boockvar’s comments on QE:

    “There used to be a time though when asset prices reflected the underlying fundamentals rather than having manipulated asset prices impact economic activity. The former was historically a much healthier foundation for growth rather than the latter.”

  • Albardon

    Apologies. Compelled to reply to Plsherid as he says my statement that the slack will prevent rising prices from being passed on is “ridiculous”. Very strong word. The example given by Plsherid “would you stop eating and filling up your car” is misleading. Both food and gas might go up in price, yes, because of supply restrictions, nothing to do with QE. Failure of the Russian crop and doubts about the U.S. crop are causing a worldwide increase in food prices. Oil, on the other hand, is known to have supply limitations, either real or due to OPEC production quotas. Its price goes up every time China’s GDP surprises on the positive like last week, again nothing to do with QE. However, my statement holds true on most consumer goods, in which it is virtually impossible today to increase prices, due to weak consumer demand and overplentiful production capacity. In fact, that is the main reason to be afraid of deflation. Were it not for the increases in commodity prices, that is where the economy would be. Looking at it from another viewpoint, Asiatic demand of basic raw materials is the main reason why the developed world is not yet in deflation. Again, nothing to do with QE.

  • Kid Dynamite

    Was $150 oil inflationary? Huh? Is that a trick question? Of course it was. it’s the very definition of inflation.

    Captain – step out of the theoretical world and into the real world. I tried to explain this 10 weeks ago here in a similar thread. People need return on their assets. When the Fed takes away their positive yield instruments and replaces them with zero yield instruments (even though both instruments are federal reserve notes, per your description) – they now need to find new yield. This is EXACTLY Bernanke’s goal – and it’s also exactly what’s happening.

    Poor retirees who can’t live on ZIRP savings accounts or 2% ten years NEED to try to increase their wealth. When the Fed takes away their yield, they chase other asset classes. that’s what happens in the real world.

  • gf


    8 months ago I would have taken that point of view without even thinking about it. Makes me worry how many other misconceptions I might have.

  • Kid Dynamite

    Captain – try thinking like a money manager instead of an economic theorist and you’ll get it. That’s also why I expect Cullen to get it – because he’s a money manager (As far as I know)

    now, you can argue that people act irrationally with their investment decisions, and don’t follow theoretical economic models – but so what – this is what people do in the real world.

    If Cullen’s portfolio of investments was no longer available to him because the Fed bought it from him and left him with zero duration Federal Reserve Notes – aka CASH – yielding zero, you can try to argue that this wouldn’t make him go out and buy other assets, but you’d be wrong. In the real world, his clients will say “we don’t need you to manage our money by keeping it in zero yielding assets (Cash), you’re fired.” so, instead, he buys other stuff:
    Stocks, maybe gold, maybe junk bonds – even though he may not like their theoretical value/risk-reward – because he has no choice – the Fed has taken his choice away. Maybe he buys 30 year treasuries. And then, the Fed decides to buy 30 year treasuries until they get to the point where Cullen just has to sell them because THEIR risk-reward sucks, and Cullen’s capital is forced elsewhere.

    the irony, of course, is that the Fed’s actions just make the other assets LESS appealing on a value basis – MORE bubbly – but more appealing on a RELATIVE VALUE basis! How many times have you heard people say that stocks are cheap relative to bonds? Of course they are – I completely agree with that statement – but that doesn’t mean stocks are cheap. And this is why I think the whole experiment is guaranteed to end in tears – I very much agree with TPC on that.

    A lot of this has to do with the fact that cash, with ZIRP, is, in some sense, a liability – offering no return.

  • Kid Dynamite

    But anyway, Captain, maybe the key difference in our outlook is your statement “rising asset prices is not inflation.”

    Call it whatever you want – but rising asset prices (I call that Asset Price Inflation – it sure is inflation to me – as the price of assets goes up, I can afford less of them, regardless of if they are apples, houses, cars, computers, stocks, gold bars, or Treasury Bonds) is the goal of QE – and it’s what’s happening (although maybe not yet in the areas YOU typically think of looking for inflation). it’s what is almost guaranteed to happen when you introduce a new exogenous ASSET BUYER – which the Fed is.

  • j

    My food bill and sundries bill is $3000 higher than last year, it’s not really inflationary to me I’m just not spending on other things to accomadate the rise in commadaties.

    Living in Canada I have seen house prices reach pre 08′ levels and Canadians take on more debt giving them the most debt in the G20 146% of income.

    But now I am seeing a very sharp sell off, house prices have not gone down yet, but the drop in sales in my area as been -40% average in the last 3 months.

    A friend of mine as 50 furniture stores across Canada with sales very good all year and opening more stores all year. Oct sales down 10%, now Oct for furniture is one of the busiest months of the year, 10% is massive.

    Either China is slowing or Commadaties are slowing our spending. You can see the same in Oz retail sales were off .20% last month big miss.

  • Captain America

    Sorry TPC. I am just so tired of him arguing these stupid little semantic points just so he can make himself feel smart. As you showed, he’s wrong anyway so whatever. Have a good weekend and sorry again.

  • Captain America

    That’s the whole point TPC is trying to make. See, commodity prices can and should rise if there is in fact more money chasing fewer goods. But that’s not the case. This is just a case of speculators leveraging up and buying commodities based on a misconception. There is also a certain level of price increase due to the fear and psychology that this is inflationary – which it isnt.

    If the money supply were in fact increasing then the price rise would be justified. But this will not get passed along because there is no increase in the money supply. Consumers will not accept $100 oil when their wages are falling. That’s just a fact of life.

    This might cause assets to move in the short-term, but in the long-term QE is unlikely to do much if anything.

  • Captain America

    That’s a great example of how this all is working in real life. Bernanke is squeezing us all and he doesn’t even know it. We can only hope this new “wealth effect” from higher stock prices actually trickles down.

  • Captain America

    That’s his problem. He thinks this is all a banking crisis, but it’s not. It’s a household crisis.

  • j

    EXACTLY! C.A. You can talk MMT theory and it is important to understand absolutly, but what is going on on the ground now is showing up through these commadatie prices.

    Furniture stores in the USA are now closing down again, margins are coming in either very low, but mostly losses again in the furniture industry. That 50 store chain in Canada, is a like 300 store chain in the states when you take into account the size of can to usa econ, 10% drop in one month wow!, thats a quick steep drop in one month. How about Canada’s Oct PMI expected 69 came in at 54!!!

  • j

    now normally one months data can be here nor there, but the size of these drops are big ,and the $3000 increase in my everyday living bills, fast food, groceries newspapers etc, only, not energy, not gas for car..and that is an increase for 1 person I kid you not…come on Ben B your helping the economy, what a joke.

    On top of that i’m a saver, so i’m getting hit twice by a man who does not even live in my country!!, this all as far reaching effects what he is doing

  • AndyC

    When we are all lying frozen in heaps starved to death you guys will still be going………..QE is not Inflationary!!!!

    If you are still breathing

    Oh wait, I almost forgot…………Its a free lunch!

    Still good

  • AndyC


    How is the inflationistas inflation trade looking vs your deflation trade?

    They are still wrong and you are still right I assume?

  • Kid Dynamite

    Captain –

    but there ARE fewer goods – that is exactly my point. The Fed bought some of the pool of goods. those are no longer available for purchase (Treasury bills/notes/bonds).. SO, the existing pool of capital must chase a smaller pool of available goods. That results in higher prices for those goods.

  • j

    Commodities being high does nothing for inflation there is not enough money circulating in the real economy to pay these prices, there is not much cap-ex spending, no loans for new business or expansions, no IPO’s, etc

    Spending with high commodities prices:
    High net worth’s – No much change
    Middle income – Spend less in other area’s to accommodate
    Lower income – absolutely screwed

    What’s inflationary about that?

  • Huckleberry

    I read this site frequently. Today I have been moved to add my own two (or four) cents.

    Thought Experiment: think from 30,000′ up and 100 year out for two minutes.

    As far as your “real life” is concerned, contemporary Capitalists (pragmatic or otherwise) increasingly resemble Middle Age Catholic Theologians arguing about angels and pinheads. To posterity they will look even more ridiculous. No one outside the finance temple understands what they are talking about. Inside the temple they accuse each other of not understanding what they are talking about. And yet they presume that, if allowed to do what they will, all will prosper. Anyone who questions this is a Communist, a Fascist, or an Ignoramus.

    Far as I can tell, that 9/15 very obviously shook the faith to its foundation for all the world to see is something very few want to consider seriously. The nastiness of the rhetoric (which is rather mild on this site, truth be told, and thanks to TPC) hints at a profound state of denial. Some would rather paper over the cracks per Bernanke (or not, depending on their book), others blame a strawman Great Satan of their own creation & ownership (“government” – which has bailed them out, propped them up, and today through expanded police power keeps them cozy inside the walls of their castles) while I suspect many also try to figure out how to short disaster and opt out of the whole sorry business.

    Everything under discussion is premised with an Either/Or view of reality and human nature, a simplistic view which misunderstands each. To wit: We are either Good or Evil. Rational or Irrational. Enlightened and self-interested or not. Bernanke either understands what he is about or “absolutely does not.” It is profit or loss, upside or downside, genius or foolishness. In my experience, this view does not get you far once you step put into your front yard, or out of company in which everyone is paid to behave this way.

    This Either/Or is also premised with a disastrously short view of time.

    Capitalism is unsustainable. Period.

    You might be dead and gone when this becomes obvious, but “our posterity,” whom our founders explicitly recognized in their political calculations, will suffer diminished blessing of liberty because of it.

    Until resource scarcity is priced with even a tiny degree of accuracy, finance capitalism fails to work properly, even under its own self-justifying view. Growth for growth’s sake, as Cactus Ed Abbey once remarked, is the ideology of the cancer cell. A social contract – especially one as voracious as our modern day industrial political-economy requires the biosphere, not the other way around. All the great Social Contractors, from Aristotle to Thomas Hobbes and Adam Smith, understood this. Their supposed heirs (Freidman, Greenspan, et al) do not. Or pretend not. Or want the unwashed to believe not. It all adds up the same thing: a great narrowing of base with a concomitant expansion of overstory.

    Ecology, like gravity, will have its way – even if finance capitalists want to believe (and enrich themselves) by pretending otherwise. Rather than basing our political-economy on a view that denies this, Why not try to incorporate actual physical laws such as, say, thermodynamics into our world view? They will continue to rule us whether we acknowledge, or are even aware, of them or not.

    The key as I see it is to maintain and expand the great individual opportunities (those damn Blessings of Liberty again) that a free, fair and balanced market economy provides while figuring a way to avoid the inexorable reality or resource scarcity.

    And, as a pramatic exercise: when faced with a nasty bout of Either/Or, resist the urge to take sides and inject a nice round of Both/Neither? This might prove more profitable.

    Now for LSU-Alabama!

  • SS

    TPC says we’re in a disinflation with a higher risk of deflation than hyperinflation. Is he right, who knows? But are you trying to change his argument and be an ass? Yes.

  • LVG

    There aren’t fewer goods. There are the exact same number of goods. All the Fed did was change the interest rate on the notes.

  • This little piggy

    Two things:
    1) Any chance the Fed is introducing QE into a strengthening economy in an attempt to establish at least a psychological belief that monetary policy can be used to successfully combat any recession/crisis? People widely believe QE1 to have vastly improved the economy from the depths of recession, and now QE2 might be seen as pushing the ball over the goal line?

    2) What is the real world difference between deficit spending by the Treasury (which we agree is inflationary) and the Fed buying almost all of the Treasury debt issued in the next 8 months? Isn’t the perception of that lack of distinction what is causing the inflation concerns?

  • Lance Paddock

    @Kid Dynamite,

    I apologize in advance for the length of this response.

    I am going to agree with you on asset inflation, but with lots of caveats.

    1. Yes, if zero yielding liabilities are swapped with income bearing liabilities it can lead to asset prices rising. I say can, because it is not a given, nor is it likely to be long lasting.

    2. Since it is not likely to be long lasting, it runs a real risk of a deflationary outcome. To the extent that leverage is applied the eventual decline in prices can lead to a contraction in total credit and thus deflation. Throw in the decrease in net income to the private economy and the overall result “over time” is more likely to be deflationary than inflationary. If the initial increase is a net addition of leverage it can lead to some inflationary pressures, but if it represents lending not done on other assets, investments or for consumption it doesn’t even do that.

    3. If QE leads to commodity inflation the above still holds true, but it is not inflationary overall if no net new money is added to the economy by the government (leaving aside an increase in private credit creation [velocity] through banks “broadly defined.”) Here the monetary function of the total quantity of money and its velocity still holds true. While commodities may increase in price (or less likely in our present environment, Real Estate) other prices absent such an increase will go down.

    4. There is no reason to believe velocity will rise. In fact, just the opposite as Hussman demonstrates here: Notice the data shows that increases in reserves results in lower velocity! This should not be surprising, since mathematically it almost surely must be so. An increase in reserves results in a reduction in velocity, since perceived (and I use that word precisely because they may or may not be) opportunities for productive lending and investment are not changed significantly by the asset swap, yet there are more reserves. Thus almost by definition velocity (in terms of reserves) must go down.

    5. So why do we see commodities (and possibly other assets) rising? Your analysis of the effect of the cash is not correct. Since this is done through primary dealers who are necessarily (at least in our system) leveraged, the swap makes them no more, or less, likely to use the cash to purchase other assets than they were when it was a t-bill or note. What we are seeing is speculation (much of which is misguided) and also an effect on non primary dealers. If interest rates are driven lower (or it is believed they will be, the record of QE actually doing so is not very convincing) we see (as Hussman also points out) commodity hoarding. Commodities yield nothing as well, in fact, they cost to hold. As such, one would expect that at the margin, people who were considering commodities find the opportunity cost of holding safer income producing assets is lessened. Since commodities are a relatively small market (and in the futures market highly leveraged against those same low yielding securities) small changes in people’s willingness to purchase them can have enormous consequences. Throw in the usual herding, momentum and trend followers (and I am not criticizing any of those approaches, I have hefty allocations to managed futures for clients) and you end up with a volatile market where commodities can temporarily explode. Thinking about marginal changes in demand when it comes to commodities is extremely important.

    6. This effect can also drive stocks higher, but not always as anyone who has bought into “don’t fight the Fed” in either of the last two cyclical bears can attest.

    Given all that, what is being done here is incredibly irresponsible as you rightly note. If it results in asset inflation (but not general inflation) the chances of bubbles and crashes are dramatically increased. The resulting falls in other prices (or just not rising fast enough to offset pressures on margins and incomes relative to debt) can result in massive declines in those assets and destruction of credit which funded those purchases. The outcome of that however is an increase in deflationary pressures, not general inflation. That is the reason I do disagree with TPC that it is a non-event, even though his general argument I believe is spot on.

    Does that mean we cannot have inflation? No, if for reasons that an extensive analysis of the economy and debt situation has missed our economy improves a good bit, private credit growth (velocity) increases, etc. The resulting releveraging of our system (especially with the large increases in default free government liabilities which can be so easily levered) could easily lead to inflation. In fact, I expect we will have that situation eventually.

    If for reasons that I cannot figure out (which does not mean it could not occur) that releveraging were to occur absent strong growth in productive output, we could have stagflation. Been there, done that. Finally we could see a direct printing of money (or its electronic equivalent.) None of that has anything to do with Quantitative Easing.

    None of this by the way implies any necessary agreement with Modern Monetary Theory for those who are having trouble taking that step. My own views are heterodox, but heavily influenced by the Austrians. The facts and data however support analyzing QE in this manner whatever school of economics one wishes to feel most appropriate in general.

  • http://none GLH

    I listened to Mr Bernanke’s comments and there are two things I don’t understand:
    – Since the Fed chairman explains QE as basically an asset swap with no cash being added to the system, the same way that TPC and others have explained it, why do people keep disputing it? What did TPC say, that it is big to do about nothing?
    – Also, from what Mr. Bernanke said isn’t it reasonable to assume that the only reason for QEII is to do what has been suggested here and that is to further bail out the banks?

  • George H

    Based on what were said here, equity prices should not even go up. But they did and have gone up significantly.

    So given your insides, why have equity prices gone up? Is it psychological? Is it a simple asset rotation (from bond to equity)?

  • AndyC

    TPC has went on and on about how the “inflationistas” (his words) have been ALL WRONG and how the inflation trade has been a BIG LOSER in spite of the fact that every asset class from equities to commodities to precious metals to emerging markets have been steadily rising….and will ramp ever higher due to this NON INFLATIONARY QE…surprisingly enough

    I have not changes his argument synchophant….and you can kiss mine by the way.

    When do we see something “disinflate?”

  • Gary_UK

    I am really trying to get my head around this, and I am not stupid, believe me!

    But when TPC says…
    ‘They are merely swapping treasuries for deposits’

    So, they are buying Treasuries yes, but where does the $600billion of cash to do that actually come from? Surely it is just created out of thin air, either by the Treasury or the Fed?
    If I can grasp where the money comes from, I will be a happy man!

  • Lance Paddock

    You have it right, both the treasuries and the reserves are created out of thin air. They take one created asset and replace it with another.

  • Lance Paddock

    Check that. Writing too quick while watching a football game. The ability to back the treasury is created out of thin air, which is also true of the reserves. Each is just a liability which has been issued. The ability to back that obligation is dependent on their ability to pay us out of thin air.

  • GYSC

    Whoa! I am dizzy.

  • James

    TPC you seem to think Ben Bernanke doesn’t ‘know’ these things. I am sure he knows them. He is just lying and pretending.

  • j

    The banks have to have the tresuries for the Fed to buy in the 1st place though and as they are such liquid assets, 1. why would’nt the bank sell them when they wanted/needed cash 2. after the 1st round of QE why would the banks have yet more tresuires left.

    I am confused with how the bank have some many treasuries if they are all so short of cash or were so sort of cash.

    any help on this one anybody?

  • SS

    God damn this is a good thread!!

  • SS

    Gee Andy, what’s deflating? How about your house – only the most expensive thing we all own!!!!

  • W Mitty

    This site might be helpful. Being a newbie as you are, I’m still studying it.

  • Kid Dynamite

    No, LVG – there is not the same number of goods – because a chunk of some goods (Treasuries) is now no longer available for purchase – it’s sitting on the Fed’s balance sheet.

    T = 0: “Market” owns $X Treasuries and $Y “other stuff”
    T = 1: “Market” owns $X-$600B Treasuries, $Y “Other stuff” and has $600B in cash. They spend the $600B buying stuff: other stuff, and Treasuries.

    the “market” is no wealthier” – it’s an “asset swap” in that sense, but the market did receive cash, and does have a smaller target pool of goods to purchase for reinvestment. Which of course is exactly why prices go up

  • JD

    I must admit that I dont really understand all the financial mechanisms associated with QE.
    But I can deduce that only one of these scenarios is possible in the next 3-6 months :
    A)- the general price of all goods will rise significantly to align with the increase in commodities, raw materials, food, oil, etc (ie. significant inflation)
    B)- the price of commodities, raw materials, food, oil, etc will drop significantly to align with actual demand (ie. a significant market correction)
    Is this the right way of interpreting what happens next ?

  • John

    I generally find this to be a very good site which contains some very useful information but I’m with you Mad-Dom and I didn’t even have to use the links you provided. All I had to do is look at my checkbook. The worst part is that if these commodity prices come back down does anyone really believe KFT,GIS,BUD,UPS or anyone else is going to lower their prices to where they were before all this QE nonsence? If they do believe it, I sure hope they don’t spend to much time looking for that 39 cent stamp to mail that first class letter assuming oil drops back to $50. And somehow I doubt that Wal Mart selling what was formerly 39 oz of coffee as a 33.9 oz product is going back to the 39oz container, and no that 4 pound bag of potatoes is not going back to a five pound bag, like it was, anytime soon. The really sad part is that many of the people I know living on Soc Sec are getting crushed on both ends. The pathetic returns from their savings (if they have any left) and the price rises (excuse me deflation) on their everyday purchases. But I guess not to worry, they can still get that cheap, piece of junk, Chinese toaster for ten bucks.
    When I read these guys talking about deflation and how prices can’t be passed on I sometimes get the feeling I must be living in the Twilight Zone………….Then again maybe it’s them living in the Twilight Zone!

  • Lance Paddock


  • Lance Paddock

    For one thing, the treasury has been issuing vast amounts of treasuries. 600 billion isn’t really that many.

  • Lance Paddock

    You can argue that we are about to experience inflation, but whether inflation or deflation is occurring some prices are rising, and some prices are falling. Listing a bunch of specific things going up in price is not an argument for inflation, it is an argument that you don’t even know what you are talking about.

  • Kid Dynamite

    Hi Lance – good points. But I take issue with this statement:

    “the swap makes them no more, or less, likely to use the cash to purchase other assets than they were when it was a t-bill or note.”

    that’s econo-theory-speak and simply does not describe the real world. I ran a trading book at a large commercial/investment bank. I can tell you how it is in the real world – in the real world, when your yield or expected return is taken off your books, you have to find return elsewhere. You don’t get paid to say “but but but but Boss – this is frickin’ CRAZY! all this sh1t is overpriced – it’s a greater fool theory.” In fact, this is one of the reasons I quit (fall 2007) – I simply couldn’t beat it, except to go along with the Ponzi scheme. I have never been good a the Greater Fool Trade. If only I was, I’d be a much richer man. For another example of this, just look at TPC! He thinks this whole thing is a crock of sh1t (I agree) – he thinks it’s destined to end in a spectacular firestorm, and yet he’s still long for his clients! He HAS to be! That’s his job! (side note: this gets back to the old anecdote: if you return 5% when the market returns 30%, you’re fired. But if you return -25% when the market returns -50%, people aren’t calling you up thanking you, telling you how great you are, and sending you more money to manage)

    Anyway – again, back to the money manager analogy: you’re a money manager too, right? I’m sure you own some low risk assets (maybe US Treasuries) for your clients. Imagine if a law was passed that prevented you from owning them – that’s the same effect as QE – you get your money back, and the Fed makes the asset impossible to own (by driving the price up, yield down, to unappetizing levels).

    Familiarize yourself with TrimTabs – talk to Charles Biderman – their model, as I described in another comment here, explains how cash on the sideline ACTUALLY changes. If you own a Treasury bond that matures, that’s asset-price-bullish – you get back cash that you then have to find a home for. QE has the same effect.

  • j


    If you go back to when the financial crisis hit the banks had a liquidity problem and had to be bailed out. So from that bailout have the banks been buying treasuries, with their excess cash. The banks would have to have excess cash to buy treasuries and why would they sell them for a non interest bearing asset like cash, if they did’nt need the cash.

    I get the Fed buying the treasuries to get cash to the banks, but I don’t get why the banks have all these treasuries to sell, unless the Treasury is giving the banks the treasuries, then the banks sell them for cash, but that is plain wrong I know. Trying figure why/how the banks have so much in treasuries

  • AJ

    I’ve been trying to wrap my head around this QE business and am getting a headache. I get the asset swap bit, but here’s my dilemma:

    The Govt. is expected to issue about $900B in treasuries over the next 8 months. MMT says this simply mops up the excess cash slopping around so that the Fed can control the Fed Funds rate. Now if the Fed conjures up $900B and buys a bunch of treasuries, isn’t the excess slop still in the system? Isn’t that saying there’s $900B looking to find a home someplace?


  • LVG

    This has nothing to do with MMT. TPC is not just making this up based on some theory he believes in. Just listen to the Bernanke interview. He explains EXACTLY how QE works and how it is not inflationary AT ALL:

    “What the purchases do… is… if you think of the Fed’s balance sheet, when we buy securities, on the asset side of the balance sheet, we get the Treasury securities, or in the previous episode, mortgage-backed securities. On the liability side of the balance sheet, to balance that, we create reserves in the banking system. Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed. Now the question is what happens the economy starts to grow quickly and it’s time to pull back the monetary policy accommodation. There are several tools that we have”

    That’s it people. Not only is TPC exactly right about all of this, but the Chairman of the Fed is TELLING YOU EXPLICITLY that he’s right. THIS IS NOT MONEY PRINTING. IT IS NOT INFLATION!!!!!

  • George H

    What is MMT?

  • j

    @ George H….oh my god absolutly HILARIOUS!!!!..i am cryin laughing at that last comment

  • AJ

    Thanks, LVG. Just watched the interview again, and it seems to me that the no inflation scenario is based on the Fed either coercing or bribing banks through attractive interest rates on reserves to keep the excess cash from flowing out. If they succeed in doing that, and it seems that over the past year only $90-100B has squished out based on data listed in this week’s Barrons, then you’re right. QE accomplishes absolutely nothing, and I just don’t see why the market is so excited.

  • j

    sorry you maybe serious, I was thinking your joking trying to get another 100 comments going again.

    Modern Montery theory (MMT)

  • Dewy67

    BB says it’s not inflationary.
    TPC says it’s not inflationary.

    I thought BB said the purpose of QE2 was to generate increased inflation from it’s current rate to 2%+ in compliance with the FED’s mandate!

    Equities, Commodities, Gold markets inflate and $$ deflates.

    So which is it? Just asking.

  • George H

    Sounds like it was worth every penny.

  • roger erickson

    George H,
    here are perhaps the three most widely referenced MMT blogs

    “Jo” re: “a regime’s balance sheet is no different from a household one”

    Currency issuers manage real-goods budgets, … and issue nominal, fiat currency purely as internal bookkeeping.
    (they cannot run out of bookkeeping numbers;
    can create as many as their population needs in order to denominate desired real transactions)

    Currency users manage currency budgets, … as an accurate proxy for their local real goods budgets.
    (they can, indeed run out; not allowed to create the state’s currency)


    (most economic confusion stems from a nation forgetting to balance it’s real goods budget, and getting caught up in trying to balance it’s nominal currency budget at the expense of it’s real-goods budgets; that’s how bankers end up trying to stabilize currency value by letting, e.g., unemployment float; the inverse of how fiat currency is meant to work; whole purpose is to manage national capabilities [e.g., full employment], SUPPOSEDLY by letting both currency supply & Fx rates float; …. this was all worked out pretty well in 1933; too bad they just didn’t go further & quit pretending to sell T-bonds as a requirement for creating fiat currency; no T-bond = no national debt, only national currency supply)

  • Michael Murphy

    Obama Fires Bernanke – YouTube cartoon in two parts

    Part 1 –

    Part 2 –

  • http://none GLH

    Thank you Lance Paddock for answering what I have wondering about. If I read your comment correctly, you are saying that all of the increases in asset prices due to QEII are the result of speculation and not anything the Fed is doing. Correct?

  • Downwithmorons

    This is all wrong. And I have to say you are not helping people by writing such gibberish. You do understand that when the Fed puts assets on its books, that the counter to that is money which appears out of thin air right? So the fed buys assets such as treasuries, mbs, etc (I’m guessing purchases in stocks as well, they are saying they are purchasing risk assets now) and gives the people they are buying these things from cash. You think the cash just disappears? Or do you think the cash goes right back into the fed? No obviously it doesn’t. It is obviously being used to buy risk assets here and abroad. The part that you don’t seem to understand is that the money comes off the fed balance sheet (aka printed).

    Wow, this kind of stuff really scares me. When people try to say the fed isn’t printing money when it is so freaken obvious.

    The fed is trying to get rid of debt through the debasement of the US dollar, I seriously hope you understand that. If you don’t you have some serious issues. This whole game is to increase asset prices by debasing the dollar.

    That is the bottom line. The banks are still insolvent (FASB needs to throw mark to market back on, what a bunch of political wimps), then we will see where banks really are. Even with the purchase of “toxic assets” by the fed, these banks are still insolvent.

  • sil

    great video TPC. I love the way Ben answered to the question about factoring in side effect (ie effect on other countries such as emerging markets)…in essence : “we do not care”

    i do not remember who US official said : “dollar is our currency and your problem” talking to the rest of the world after bretton woods breakout

  • AndyC

    I doubt if deflating home prices are helping anyone on a cost of living basis.

    Give them a chance, when they finally destroy the dollar even home prices will rise!

    77 on the DXY and heading headlong for the all time lows.

    They will inflate!

  • AndyC

    I think I got it

    Rolex watches, polo ponies, Maseratis…….Deflate

    Everything else………..Inflate

    but as long as the Rolex the ponies and the Maseratis outpace everything else we are still deflating….glad to hear it, I was getting worried.



  • Angry MBA

    I saw your argument about how MMT is like communism.

    You clearly misunderstood it (no surprise there, given the quality of your posts here).

    To anyone with basic literacy skills, it should be clear that I wasn’t upholding that MMT was an example of communism. Rather, I was pointing to an example of a sovereign state (in that case, the USSR) that was obviously unable to use its alleged monopoly power over its currency as a tool for setting the currency’s value.

    The “monopoly” argument is a poor one, because it’s blatantly false. A government cannot maintain a monopoly over the means of exchange if the market doesn’t consent to it. Every dysfunctional or corrupt system that tries to use its authority to create an arbitrary value for its money will be faced with black markets, a much lower street exchange rate, and an inability to fund import purchases. The power to tax will not, by itself, motivate the public to produce the goods that comprise the output of the economy.

    Some of you keep hanging your hat on an unorthodox theory that few qualified people accept, when the present situation is easily explained with the theory of the liquidity trap. You keep trying to kick down a door in order to open it, when the door is already unlocked. Why you’d want to reinvent the wheel when it isn’t necessary, I have no idea, but the fact that it would drive you to pretend that $7 billion into zero should give you pause.

  • Angry MBA

    rising asset prices (I call that Asset Price Inflation – it sure is inflation to me – as the price of assets goes up, I can afford less of them, regardless of if they are apples, houses, cars, computers, stocks, gold bars, or Treasury Bonds) is the goal of QE

    It appears to me that the primary goal of QE is to spur corporate lending and borrowing. It’s a supply-side driven policy — the Fed wishes to reduce the cost of capital in order to motivate companies and to float more bonds and incur more bank debt, which will be used to fund expansion and employment. The money that is being injected (I agree, it isn’t merely an asset swap, but not much money is being added) is secondary to the objective of controlling the middle to top end of the interest rate curve.

  • Angry MBA

    It appears to me that the primary goal of QE

    To clarify, I had meant to say that business borrowing is the primary objective of this particular round of QE. The previous round was intended to back stop the banking system, which was quite a different goal.

  • Cowpoke

    That’s a sweet visual tool. Thanks for sharing.

  • TPC

    Watch the video again and listen to his comments. He explains this so that even a “moron” can understand. The monetary base is not new money in the system. You clearly don’t understand what you’re talking about.

  • TPC

    This is not inflationary.

  • TPC


    The # of financial assets has not changed. All that’s occurred is that the Fed has swapped 0.1% int bearing paper with 1.2% int bearing paper. It’s just a change in duration. The argument, as Goldman Sachs recently argued is likely all about valuations. There is very little (if any) fundamental impact here, but there is a valuation change and portfolio rebalancing due to the lower rates. How much? That depends on a lot of different factors, but if the fundies don’t improve to catch up with the expectations (which is not an unreasonable bet) then we’ll see a sharp correction at some point in the next few months.

  • TPC

    1) Could be!

    2) Yes, people are misinterpreting this as a helicopter drop. That’s nonsense.

  • TPC


    Did you watch the video? There is no net new money being added. You don’t get sustained inflation without sustained rise in incomes and money in circulation. It’s really that simple. Therefore, we’ll continue to see very low inflation prints. And if your house continues to fall and unemployment remains high we’ll see pressure on the rate of inflation even if commodities continue to rise.

  • Downwithmorons

    Considering I have an MBA from a top 5 school, and a BS in finance (also from a top school) I imagine I might have a slight idea of what I am talking about. I worked for the largest German bank (larger than any of the US banks), and I don’t have to work for the rest of my life (at age 42).

    If you actually believe the crap Bernanke is selling I got some unobtainium I am willing to part with for a mere 1.5 billion an oz.


  • TPC

    Try to be civil.

    The Fed is not adding net new money here. Bernanke, despite all his flaws, is actually right this time. There is very little reason to be concerned about inflation. The expansion of the monetary base is not inherently inflationary. It might cause future inflation to rise (when borrowing expands), but for now that doesn’t look like a huge concern. The only inflation occurring here is the leveraging of financial assets by PMs and that is mostly unsupported by fundamentals and so is likely to be short lived.

    Ben actually gets a lot right here.

  • Angry MBA

    The Fed is removing at least 9B in int income. 7-9=-2. Explain how that is inflationary?

    I never claimed that it was inflationary. But it is incorrect to argue that no money is being added injected into the economy. (It isn’t a fluke that it is called “quantitative easing”.)

    As noted, the bond sellers make a spread between what they initially paid for the bonds, and the higher price (lower yield) at which they sell them back to the Fed when the Fed engages in its open market operations. (In practice, we know that they will buy bonds in anticipation of the Fed action, in order to make that spread.)

    That bond buyback will add about $7 billion to the cash reserves of the various banks that participated in the QE process. For the private sector, this action does not net to zero.

    Your focus on the Fed’s balance sheet misses the point. Let’s get to the bottom line — the Fed is using this process to reduce interest rates, in order to motivate more business borrowing. The relevant questions are:

    (a) Can the Fed can control or at least influence the interest rate curve
    (b) If (a) is true, whether moving the interest rate curve will accomplish anything.

    Whether or not it is an asset swap for the Fed doesn’t frankly matter. (Companies swap cash for assets whenever they buy raw materials, for example, but those “asset swaps” aren’t meaningless, despite the fact that their balance sheets have not increased as a result of those acquisitions.) QE is a means to an end; it isn’t about the increase in the money supply, per se, as it is about the cost of capital that may change as a result of that easing.

    The asset swap comments are a bit of a strawman for those of us who aren’t inflationistas. While I can appreciate that you have to deal with Austrians who believe in such classical interpretations of quantity theory, a lot of us don’t and aren’t even trying to debate that.

  • Downwithmorons

    My apologies. I did not mean to make things personal. I try to keep an open mind about what is happening in this fast paced financial world of ours. I guess working for a European bank does change your view on the world.

    I still disagree with you, but I will take back the part “retard”.

  • Anonymouse

    Imagine for a moment, a future in which Fed buys all the Tsys that exist (e.g. in QE33 per Zulauf), then former Tsy-owners (e.g. retirees) may be forced to invest in other income-yielding assets, e.g. corporate bonds, stocks etc. In this sense, Fed is encouraging risk taking.

  • TPC

    Disagreement is good. Thanks for the comment.

  • Angry MBA

    A lot of people think this is inflationary – that the Fed is adding net new financial assets.

    The sellers of the bonds will end up pocketing about $7 billion more than they paid for the bonds. Those open market operations do add cash to the economy when bond sellers take a profit; the operation does not net to zero, which is where the “easing” part of this comes from. (Incidentally, this view of money is quite different from that of MMT, so it isn’t just a matter of semantics to point this out.)

    However –

    -This round of QE is ultimately about reducing interest rates and setting inflation expectations. The money supply increase is a means to an end.

    -The Fed will later destroy money as the economy rebounds and begins raising rates. So this is not a permanent condition.

    -The amount involved is about $7 billion (per Brad Delong), not $600 billion. A $600 billion operation doesn’t yield much in the way of additional cash, although the amount isn’t zero.

    -A net increase in $7 billion doesn’t mean much for inflation when the overall money supply exceeds $8 trillion and US GDP is around $14 trillion

    -The lack of resulting inflation can be easily explained by the output gap and liquidity trap (although some explanation may need to be offered for rising commodities prices and whatever stagflation risks may result from those)

    Again, the asset swap argument doesn’t help. Take a company such as Starbucks, which takes cash and swaps it for coffee beans; as SBUX pays cash for beans, its net worth does not change directly as a result. However, since Starbucks is in the business of turning coffee beans into retail sales, this operation does become meaningful because those bean purchases will ultimately help to drive future earnings (or losses).

    The end game of QE is not the Fed balance sheet, but in the markets response to the added capital and lower cost of funds. A lot of us aren’t worried about the Fed balance sheet.

  • George H

    Agree with your points that it is a swap and three is no printing money. It is not inflationary except that BB is delusional (while hoping to inflate, recognized and stated publicly it is not so) to make people dream and believe they are richer and can now spend again.

    I was curious why equity prices have gone up. Is it psychological? Is it a simple asset rotation (from bond to equity)?

    Would appreciate anyone share their thoughts.

  • George H

    Sorry. Got your 3). Thanks.

  • Steven

    Of course consumer (or at least US consumers) will accept $100 oil – they have no choice. They might use less of these stuffs (so total monthly bills might still be the same if they forgo that fishing trip, visiting friends etc) or they would have to cut back from elsewhere (e.g. forgo that next 50 HDTV upgrade).

    MMT make perfect sense in a close economy. In an open economy, MMT ignore serious consequences that MMT theory brings (other than inflationary, which MMT accepts). For example, MMT assumes that the dollar either belongs to the private sector or the USGov. Central bank accounts at the Fed is neither private sector or government. Debiting private sectors account via taxation is fine, but debiting the People’s Bank account isn’t.

    Also, for the China not funding US talks, just for a bit of exercise here:
    Say China now holds 90% of all dollar in issue (which she would if current trend continues) and say that total is amount of dollar is 10Trillion. Now, the federal government needs 2Trillion. MMT crowd says as long as the interest is higher than Fed reserve interest rate, the banks will jump in as it is free money. Now, the People’s bank (which is not part of US private sector) says, oh, we will only fund it if you pay 10%.

    The US government has 3 choices – pay the rate, default or monetised the debt (i.e. print more of these stuff). The people bank holding 90% of these stuffs will say, hang on a minute, are you going to dilute our holding? Then we go to the forth option – the 3 letter world that starts with w.

  • Kid Dynamite

    You and others continue to repeat the mantra that the number of financial assets has not changed. I just figured out that this is because you’re treating “Cash” as an asset – is that right? There’s a problem with that – again, in the real world under ZIRP, cash is just a drag on your portfolio. It’s unappealing. In fact, Bernanke is TRYING to make other financial assets unappealing as well (ie, T-notes) – and force capital elsewhere. Investors NEED return. Cash is unacceptable to many of them – yet the Fed just FORCED them to take it by buying their interest bearing assets from them! (yes, I know the Fed didn’t FORCE them, but the Fed manipulates the rates until investors have to sell the treasuries because the yields are so low). Now investors need to reallocate that cash. Of course, the target pool of non-cash assets that they can now buy IS SMALLER! Right? do we agree on that? If the Fed buys $600B of Treasuries, or anything else, there is $600B less of stuff for people to buy. The pool of available assets has been changed.

    The Fed manipulates the “appeal” of different financial assets. Usually, they just manipulate cash (overnight rates) – but they’ve already made that as unappealing as possible. Now, they’re making OTHER assets unappealing as well – Treasuries – and forcing capital into alternative destinations.

    see my reply about to LVG:

    “T = 0: “Market” owns $X Treasuries and $Y “other stuff”
    T = 1: “Market” owns $X-$600B Treasuries, $Y “Other stuff” and has $600B in cash. They spend the $600B buying stuff: other stuff, and Treasuries.

    the “market” is no wealthier” – it’s an “asset swap” in that sense, but the market did receive cash, and does have a smaller target pool of goods to purchase for reinvestment. Which of course is exactly why prices go up”

    the question is, what happens at T =2 ? You want to say that the Market doesn’t spend the $600B – that they just hold it in reserves at the Fed or something. In the real world, that is simply incorrect. It’s not what happens, because people don’t want to hold cash – so they have to spend it – again, on a smaller target pool of assets. So asset prices rise – just like we all learned in Econ 101.

  • Kid Dynamite

    ps – again, I completely agree with your conclusion that if fundamentals don’t improve then we’ll face a harsh reality.

    BB seems to think that fundamentals might improve because when you feel rich because the price of silver has skyrocketed, you’ll go out and spend some of your profits. He wants us to somehow jump-start ourselves based on our good feelings about the inflated asset prices created. The more you think about this “wealth effect as natural stimulus” logic, the more it will make your head spin, as it’s obvious to me that not everyone can reap this “wealth benefit” by taking profits, or prices just plummet again.

    I think that the real, lasting benefit of QE is that it allowed corporations to issue large quantities of new debt at very low rates. Lower cost of capital probably has to have some sort of positive economic effect.

  • Kid Dynamite

    TPC wrote:
    “They’re swapping 900B in 1.2% int paper for 0.25% paper. That’s a pvt sector loss of 9.2B. That actually has a deflationary impact.”

    Yes, TPC – that would have deflationary impact if you assumed that the proceeds of this swap are simply stored in excess reserves at the Fed earning nothing (or 25bps). In reality, this won’t happen (so I claim, at least)

    Or maybe it will happen – and then I’ll agree with everything you’ve been saying in this entire thread. Just because reserves increased after the last round of QE doesn’t mean they will increase this time – you and I discussed portfolio implications previously. It is obvious to me that one cannot make the assumption that proceeds will not be reinvested. At some point, they MUST be. I’d guess that Bernanke will keep buying Treasuries (maybe even other assets too! I hope not) until the proceeds ARE reinvested.

    I guess this comment really sums it up – it depends on what happens to the proceeds that the Fed “Spends.” I’m adamant that they (the proceeds) get spent again by the recipients. I THINK that you are saying that’s not the case, or maybe that it’s not guaranteed to be the case. It’s certainly not guaranteed, but I think it’s what happens.

    good thread. hasta la pasta.

  • TPC

    You’re making the old cash on the sidelines argument. That money moves from one market into another. That is not correct. There are just as many bonds outstanding today as there were before QE. All that was changed was the int rate. Money does not move into assets. It moves through them.

    If your bonds get bought by the Fed then you’ve just swapped a 1.2% int bond for a 0.1% note. The Fed gets your 1.2% bond and there you are with exactly the same amount of assets as before. What you decide to do with those assets is up to you. Do you run out and buy stocks at the asking price and drive up prices? Do you buy at the bid and wait for someone to sell? Who knows? But one thing is guaranteed, if you’re running out and buying Apple at $350 tomorrow (even though the funamentals haven’t changed) then you’re making a very bad decision.

    The main point here is that the fundamentals are unlikely to change dramatically due to QE so most of the move in equities thus far is psychological. Can it stick and turn into sustained recovery and fundamental growth? Perhaps, but past instances of QE prove otherwise.

  • Kid Dynamite

    TPC – you are simply incorrect about cash on the sideline here. I’ve explained it multiple times in this very thread (see my comments about the TrimTabs model)

    before QE, there are a certain number of bonds outstanding. After QE, there are the same number of bonds outstanding, but that’s semantics – the number of bonds in the general population (NON FED) is decreased. This is factual, and THESE are the bonds that “the market” can buy. They can’t buy the Fed’s bonds! The amount of cash in the general population”market” is INCREASED. This is also factual.

    On the other hand, when Mutual Fund A takes their Billion bucks of cash and buys stocks, NOTHING changes – THAT is the cash on the sidelines argument – it’s very much NOT what’s happening here. THere are two things that change cash: issuance (decreases it) and buybacks (increase it). QE is like a buyback, as are maturing bonds.

  • Kid Dynamite

    Well this is another real key, TPC. I haven’t chased this bubble because, for now, I can afford not to. But not everyone can afford not to! Investors living off their portfolio income are being virtually FORCED to take risks. Irrational? maybe. I’d call it DESPERATE – it’s BBernanke’s sick goal. What’s Grandma to do? She thought she could earn 5% risk free. Now it’s more like 1.5%.

  • TPC

    I used to think the same thing you do.

    There are the same number of federal reserve notes in circulation. Think of cash as debt (which it is). All the Fed has done is changed the duration of these notes. In this case, they are giving the banks 0.25% int bearing notes and taking their 1.2% notes off their hands. What is the real change in fed notes outstanding? NADA! Just listen to Bernanke above. He says this SPECIFICALLY:

    “Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed.”

    There are not more financial assets in the system. This is not a helicopter drop. So, what you decide to do with those financial assets is your decision, but the fact is, when you sell your 0.25% paper and buy stocks someone else is buying your note and selling their stock. If the fundamentals of the stock you’re buying do not improve in the future then you’ll have wished that you held onto that 0.25% paper.

    *I edited this. It was all messed up.

  • TPC

    If people want to chase performance then that’s their decision. The stock market is not here to make us all rich. It is not here to provide some income. It exists to help corporations and human beings innovate, create and produce. QE does not innovate, create or produce anything. Therein lies the inherent flaw.

  • Kid Dynamite

    and again, herein lies the difference between theory and reality. In theory the market is about capital allocation, innovation, etc. in REALITY, it’s about wealth expansion, compounding, and enhancement of portfolio values and net worth. Combine that with the minimal financial IQ of most americans, and you see exactly why we got in so much trouble and why the Administration was unable to let Capitalism work when the crisis hit: the realities were not something our system could absorb

  • Chris

    Been following your posts…very interesting points. I don’t disagree with TPC on his point that this isn’t necessarily inflationary (provided reserves remain held at the FED), but agree with you that Ben is on a mission to convince people to spend and borrow. To do this he is manipulating the treasury curve…there will be no reward for holding 10-Y and under treasuries so you best find something else to do with your money. I don’t find it all the crazy that speculators/foreigners are buying commodities and foreign stocks…just re-balance the portfolio from the low yield treasuries. Wall street is going to use all this cheap money to build one hell of a bubble…commodities seem like an easy target. Finite Supply, no regulation, weak shorts…it will be like shooting fish in a barrel.

    “This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. 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.”

  • Oroboros

    Soon after his appointment as US Secretary of the Treasury
    in 1971, John Connolly told a delegation of Europeans who
    were concerned about the decline of the exchange rate of
    the dollar: “The dollar is our currency but your problem.”

  • Kid Dynamite

    TPC –
    if I sell my 1.25% note to you, you’ll take your cash and give it to me, and i’ll take my note and give it to you. Obviously, nothing changes in aggregate.

    If i sell my 1.25% note to the Fed, they CREATE reserves for me, and then I withdraw them, and go buy NFLX and PCLN with them, of course. (no, but seriously – that’s precisely the point – the reserves don’t sit there! a lot of them did the first time, which is why BB is reloading.)

    Of course, if/when reserves get withdrawn, there is absolutely, positively, more cash in existence. Please tell me that we agree on this.

    Bernanke is pretending in that quote explanation that proceeds just sit there as reserves, while he’s doing EVERYTHING HE CAN to make that NOT the case. As i’ve been repeating this entire thread, Bernanke’s goal is to make it so that cash has to be reinvested – by taking away positive yielding assets from balance sheets.

    Anonymouse summed it up with the boundary example in a comment below:

    “Imagine for a moment, a future in which Fed buys all the Tsys that exist (e.g. in QE33 per Zulauf), then former Tsy-owners (e.g. retirees) may be forced to invest in other income-yielding assets, e.g. corporate bonds, stocks etc. In this sense, Fed is encouraging risk taking.”

    again, this is all I’m saying. You can argue until you’re blue in the face that it’s speculation or that there’s no fundamental change – but there’s a mechanical change – a physical change. You have nothing else to own, so you have to own RISK. (in reality, at least. because 0% cash doesn’t pay the bills)

  • Chris

    Nope…this crisis is a direct result of FRAUD.

    A fair and free market always clears…at some price investors will come in to buy assets. Households in the US may be too far in debt, but for every debtor there is a creditor and the creditors have no interest in real estate and negative cash flow businesses (significant chunk of US GDP). Why, because why would you buy a house with no chain of title, MBS backed by nothing, or companies that require ever increasing liquidity to show phantom accounting profit (control fraud banks).

    Ben is attempting to blow a bubble because there are two ways out of the crisis. The first path is extend, pretend, and pray for growth. Growth would allow us to paper over the losses from the fraud. The second path is the way of pain…take a microscope to the bank books, recognize losses (default), claw back bonuses on fraudulent loans/MBS, and put the leaders of banks who did NINJA and liar loans in jail. Mr. Mozilo belongs in a cell next to Mr. Madoff. Every MBS that fails basic documentation should be put back to the banks…if that sinks BAC, WFC, JPM, and C so be it. Clean out the system so we can grow capital off a solid base…all be a much lower one from here.

  • Kid Dynamite

    come on man. Stop. are you now trying to make the case that after JPMorgan sells treasuries to the Fed, JPMorgan doesn’t have more money that they can spend (IF THEY SO DESIRE)? That’s false. Your quoting of banking mechanics is confusing you to death and misleading your readers.

  • TPC

    Kid, I am not confused and not trying to be difficult. What I am saying is fact. Let’s look at what happened.

    JPM has $100B in 1.2% 5 year notes. If they want to they can go out and sell those notes and buy stocks then they’ll swap the notes with another bank and buy stocks. What changed? Nothing except ownership and MAYBE price.

    Now, let’s say JPM sells those $100B in 1.2% 5 year notes to the Fed and gets $100B in 0.25% reserves. What changed? Just duration. If they want to go buy stocks then they can, but they’ll sell their reserves to another bank and then own the stocks. What changed? Nothing except ownership and MAYBE price.

    Got it?

  • Chris

    You are just making the assumption that the US govt will spend more now that we have established that the FED can buy treasuries at will. I think this is spot on…republican house means lots of tax cuts and military spending in our future (TPC agrees this is inflationary). Obama will likely cave provided they fund enough food stamps that the serfs don’t riot and make him go down in history like Hoover.

    Removing the check on the US Govt from issuing excessive debt is like giving a child a loaded gun. Its irresponsible and Bernanke knows this. I believe he is doing this because his models show we need growth to cover the hole in MBS. He is however opening himself up to a commodity/stock bubble in his quest to convince people to spend/invest to create said growth. The Euro perspective and finance back ground should be very helpful in the next couple of years. You understand wall street traders don’t give a crap what happens in the long run…bubbles are very profitable especially when you get bonuses when you win and its others that take the loss when you lose.

  • Chris

    Exactly, all other assets rise as investors rebalance away from low yield treasuries. TPC hits this in #3.

    Its not really psychological though. There is no point in holding a bond yielding 0%, its all downside from there. Hold dollars if you think we are going to deflate…that way your money is liquid and ready for opportunities.

  • Chris

    Kid dynamite…you are so close, but you need to go one step further.

    The market currently isn’t about building capital…its about traders/managers skimming their next quarters bonus. Greed is good, bubbles are fun.

    When you are trading other people’s money, capital preservation is irrelevant. Take the average hedge fund 2 and 20. If we can create a bubble over 1-3 years we get 20% of the gains, when it becomes unsustainable you just create a bear fund. Original fund goes broke you lose nothing, in fact you get 20% from the bear fund.

    Only fools invest money with wall street…make your own invest calls and stop feeding the animals.

  • George H

    Thanks buddy.

  • Kid Dynamite

    TPC wrote:

    “Now, let’s say JPM sells those $100B in 1.2% 5 year notes to the Fed and gets $100B in 0.25% reserves. What changed? Just duration.”

    I’ve explained this at least 5 times in this thread already. Here’s what changed:

    there are now $100B less in assets that JPM (and everyone else) can buy with it’s newly created reserves. “The Market” has the same net worth – JPM has traded notes for cash (reserves) – but there is more cash and fewer assets (YET NO MORE VALUE! notes have been exchanged for cash) in the “market” after this operation.

    seriously – think about boundary scenarios – what happens of the Fed buys ALL the Treasuries? every time someone asks that, there is usually an asinine reply like “the Fed isn’t allowed to buy all the treasuries.” no kidding – that’s not the point. When the Fed buys STUFF – regardless of if that STUFF is stocks, bonds, silver, coffee beans or pork bellies, they decrease the amount of STUFF available for everyone else to buy. At the same time, by buying STUFF, the Fed is giving the sellers cash. WEALTH doesn’t change – cash replaces STUFF (i think this is what you mean when you say that there are no financial assets created or destroyed). So the more treasuries the Fed buys, the less STUFF there is for everyone else to buy – yet they still have the same “net worth” and more cash to spend.

    but again, in the real world, with ZIRP, cash gets spent/invested. when it does, it’s a simple supply/demand that creates asset price inflation. (you got diverted last time we discussed this about 11 weeks ago and started talking about how price is an artifact and a trade is based on the will of the buyers and sellers etc etc… yes – of course – but the will of the buyers has been bastardized by Mr. Bernanke when he saddled them with 0% cash – you don’t like that fact because it’s irrational, yet it’s REAL!). More cash chasing fewer STUFF –> higher prices.

    Let me try one last analogy. You have 50 readers who go to ToysRUs to buy holiday presents for their kids. 25 of them buy Tickle Me Elmo and 25 of them buy Barbie Dolls – these are all of the toys in existence. There are no more anywhere. Everyone is all ready to give their kid a present, but then Ben Bernanke comes in and buys 12 Elmos and 13 Barbie Dolls. He pays market price for them, and now 25 of your readers are holding cash instead of presents for their kids.

    What happens next? the guys who sold their Elmos and Barbies instead go out and spend the money on ice cream, or balloons, or cake – so their kids don’t cry when the don’t get Elmo or Barbie. Back to Econ 101: these items were in equilibrium before, and now they have exogenous demand (a byproduct of Bernanke’s Elmo/Barbie intervention), so the prices go up.

    Asset Price Inflation. Q.E.D.

    is it possible that some of the parents tell their kids “Sorry, Charlie, but I told Ben Bernanke SOLD TO YOU, SUCKA, and sold your present at a really good price, and I couldn’t bear to pay more than fair value for Ice Cream or cake, but we have cash, and eventually all this stuff will correct in price and I’ll buy you something then.” Yes – that’s possible – but in the real world, it’s not happening, just like investors aren’t holding 0% cash right now – they’re spending it on risk assets.

    I’ve enjoyed this discussion. Have a good night.

  • Angry MBA

    That’s a pvt sector loss of 9.2B.

    With QE, the banks sell treasuries back to the Fed, exchanging future bond payments for current cash. The amount of cash received by those banks is based upon a lower yield, i.e. the Fed buys the bonds for more than the banks previously paid for them.

    That increase in cash to the banks is what makes “quantitative easing” what it is. The banks end up with more money than they started with.

    Part of the MMT problem is that it causes you to ignore timing — you ignore that increase in cash because it is presumably lower than the future interest payments. But the point of QE is to pay out that cash **now**, with the presumption that it will be relent and otherwise converted into other, riskier assets, i.e. what Kid Dynamite here is talking about.

    But more to the point, the real end game of QE2 is to alter the shape of the interest rate curve so that it pushes down the rates on those things that are commonly floated on 5-10 year spreads, such as corporate debt and mortgages.

    QE2 isn’t ultimately about the addition to the money supply, but about the reduced cost of capital. If you want to understand Bernanke’s end game, then you need to consider his goal of increasing the investment component of GDP, i.e. the “I” in C+I+G+(X-M). If you want to praise and/or critique him, then I would consider the efficacy of that policy, whether pro or con.

    QE1 was a different ball game; that was clearly about shoring up bank reserves and balance sheets, not so much about a consumer-oriented stimulus. QE2 is meant to be stimulative, with the consumer benefiting only indirectly. Like it or not, all easing is not created equal.

  • TPC

    They have more cash than they did before? I am simply flabbergasted at the level of misconception here (and you guys are very smart!). If you are right then I guess Ben Bernanke is wrong (but he’s not):

    “Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed.”

    There’s no debate here. There is not “more cash” in the system. End of discussion.

  • Angry MBA

    They have more cash than they did before?

    Those parties that sell their bonds in exchange for the Fed’s cash do end up with more cash, yes. They convert their bonds today, which would have provided payments in the future, into cash that they receive in the present.

    You can’t keep ignoring both the timing aspect and the types of parties that receive the cash. The Fed wants to give money now to parties that are (or at least may be) inclined to lend it out. (Money multiplier, etc.) The Fed’s reduction in its own borrowing costs is besides the point.

    But again, the far larger goal is to increase the volume of borrowing and corporate bond sales. Whereas QE1 was about shoving cash into bank coffers, QE2 is about making money cheaper so that the Fortune 500 float bonds, and use the cheap money to fuel investment and employment.

  • Kid Dynamite

    TPC – I think you’re being dishonest here. When Bernanke says they aren’t printing cash and there is no more cash in the system and that proceeds of QE are just sitting at the Fed as excess reserves, he’s talking about what happened with QE1. As we’ve discussed multiple times, this is exactly what BB is trying to CHANGE by punishing the banks with even MORE cash. Cash is punishment right now. No one wants it. Cash has no cashflow. The more cash BB saddles the Market with, the more likely they are to use it to buy other positive yield assets.

    so what Bernanke means is “cash in circulation is not changing IF these proceeds just sit at the Fed in excess reserves, which is what happened after the FIRST QE.” At the same time he’s saying that, deliberately trying to confuse the common folk who don’t get it, he’s doing everything he can to force excess reserves into the system.

    Of course, if instead of holding the proceeds the banks turn around and SPEND them, then Bernanke is flat out wrong. And for goodness sakes – this is NOT the cash on the sideline argument. stop it. You are way too smart to not get this point.

  • Kid Dynamite

    Tpc –

    if you really believe this claim you made:

    “What is cash KD? It is a debt of the Federal govt. It is an asset of yours. Really no different than a 5 year tsy note except not as liquid. The only difference between a 4 week tsy note (effectively “cash”) and a 5 year bond is the interest rate it pays. ”

    then we have nothing more to discuss. It’s not right, no matter how many times you repeat it. A 5 year note is not the same as cash. (you forgot the FIVE YEAR part of the 5 year note). Just because it’s liquid and guaranteed doesn’t mean it’s cash. However, one goal of the Fed’s QE is to make the 5 year note as unappealing to hold as cash. After that, they’ll try to make the 10 year note as unappealing to hold as cash. Until eventually you’re forced to hold risk assets (which you buy with your cash, of course).

    I think you’ve really gotten too engrossed in your Theory and have forgotten what you/we do in the real world. But even in Theory cash and 5 year notes aren’t the same. You continue to abuse the Cash on the Sidelines argument because you arbitrarily declare cash and bonds to be equivalent. They are not.

    I think what’s really bothering you is that you think people are acting irrationally. This is why the elmo/barbie example is so important – it helps you understand that yield/return chasing isn’t as crazy as you think – it’s natural. People NEED return. When Bernanke sticks them with cash, they get zero return. So they have to remedy that situation.

  • Kid Dynamite

    TPC – if you own a bond, and that bond matures, does cash in the market increase?

    hint: the answer is YES. you have more cash than you did before. Positively.

    t = 0: you have no cash – you have a bond
    t = 1: you have cash, the bond disappears.

    This cash doesn’t come from someone else buying or selling assets – it’s exogenous – it’s not from “the market” flow of financial assets. (which is where the cash on the sidelines fallacy comes in – but it does NOT apply here!)

    The Fed’s QE purchases are the same. I tried to explain this multiple times while referencing TrimTabs.

  • TPC

    Starting new response at bottom….

  • Angry MBA

    I don’t disagree with TPC on his point that this isn’t necessarily inflationary

    I also don’t disagree with TPC about inflation, but my reasoning is somewhat different.

    TPC is arguing primarily from the basis that QE is an asset swap that reduces the overall quantity of money (MMT), while I’m arguing largely on the basis of the output gap (mostly Keynesian/ AD driven).

    TPC doesn’t disagree with the output gap argument, though, so we are generally in agreement, despite our divergent views on monetary systems. We may disagree in that I would allow for the possibility of the risk of commodity-driven inflation (stagflation), but in practical terms, I’m not presently worried about this, given present day conditions. I am inclined to think that commodities are frothy and will be due for correction before inflation risks become an issue.

  • tjohnson

    I just want to know what you all think about gold, stocks and commodities. Is gold going up because of this asset swap or not?

    Also, it seems to me, while it may in fact be correct there is no new money in the system, that there is increased liquidity that could be used to move the bond bubble to another commodities bubble.

  • TPC

    KD and Angry,

    The Fed isn’t printing dollars and dropping them out of helicopters. He is adding reserves to the banking system. Ben hasn’t added currency to the system. He has added reserves to the banking system. Reserves are held at the Central Bank. That’s just how it works. This hasn’t added more cash to the system. It has simply altered the term structure of the govts outstanding debts. Ben says this specifically. I have no idea why you’re both disputing this fact.

    If you sell your 10 year bond to the govt there isn’t suddenly more money in the system. All they’ve altered is the term structure of their liabilities. Bernanke clearly understands this. He knows he hasn’t printed up any new cash (he says so specifically!). There are the same number of financial assets in the pvt sector as there were before.

    What you decide to do with that money is up to you. Ben is hoping you will run out and bid up stocks even though there has been no fundamental change due to QE. Of course, as we saw in Japan, this worked temporarily and then failed magnificently. Why? Because the difference between a 5 year note at 1.2% and cash at 0.1% isn’t much. Are you really making portfolio altering decisions based on 1%? You’re moving from a virtually risk free instrument into a high risk instrument just because of 1%? I think the effect here is less than you’d like to think. You can claim that there is some great difference between the two, but we’ll just agree to disagree on that. Both are liabilities. One simply has a different int rate.

    But I’ll tell you one thing. If you run out and buy Apple tomorrow at $350, that note is gonna look mighty good in a few days. The fact that there are fewer 5 year notes on the market is not really a fundamental reason to buy stocks. At the zero bound the difference between owning a bond and “cash” is marginal. The important point here is that someone is going to hold the reserves in the banking system no matter what. They can’t dump them or remove them. So no, the net financial assets haven’t changed at all. All that’s changed is the term structure.

    Now, if the int rate effect materializes and this results in a lending and refinancing boom then I’ll be wrong….

  • Angry MBA

    If you sell your 10 year bond to the govt there isn’t suddenly more money in the system.

    Once again, you are skirting over the point that I addressed.

    In QE, the bondholder sells his bond for a cash premium. The cash position of that bondholder increases, today, when he converts his longer-term debt instrument into money. (Surely, you don’t deny that the individual bondholder who sells his bond for cash has more cash after selling the bond than he did just before he sold it.)

    Since that very same bond seller happens to be a bank, the central bank would expect (hope, pray) that the bank will then take its increased balance of cash, and create debt with it. Since this is a credit money system with fractional reserve banking, the central bank would like that bank to turn that dollar into several dollars of new credit.

    That’s where the cash is coming from. You continue to ignore the timing and the beneficiary of the cash, as if those things are irrelevant, when they are the whole point of the discussion.

    Now, if you are convinced that the sellers of bonds will do absolutely nothing with their money and that the lower market interest rate doesn’t do anything to encourage borrowing, then you will be right. But Ben is betting otherwise.

    An alternative way to express GDP is GDP = MV, where M = money supply and V = money velocity. Ben wants QE to increase money velocity.

  • TPC

    One more thing. As rates go lower 0% paper actually becomes more attractive. Why? Because you become indifferent between 0% and 1.2%. In the end, you should make portfolio decision based on fundamentals and not based on some interest rate you are accustomed to earning. If investors are in fact bidding up risk assets purely based on QE and not due to fundamentals then I would argue that the Fed is simply distorting the markets and nothing more. We all know how that ends. Just have a look at Japan. They did all this stuff. They bought stocks, corp bonds, etc. It worked temporarily and then the fundamentals came back into play and the govt realized they were just tinkering with the market and delaying the inevitable.

  • TPC


    We entirely agree that the goal here is to get more lending done. But what KD is arguing is that there is a mountain of cash piling up on the sidelines that now needs to be reinvested and will consequently drive up equity prices. I simply don’t think that’s true. Has there been some short term psychological impact? Perhaps. Has there been a fundamental change in the reason to own stocks? Not a chance. See Hussman this evening:

    “As a result of Bernanke’s actions, investors now own higher priced securities that can be expected to deliver commensurately lower long-term returns, leaving their lifetime “wealth” unaffected, but exposing them to enormous risk of price declines over the intermediate (2-5 year) horizon. This is not a basis on which consumers are likely to shift their spending patterns. What Bernanke doesn’t seem to absorb is that stocks are nothing but a claim on a long-term stream of cash flows that investors expect to be delivered over time. Propping up the price of stocks changes the distribution of long-term investment returns, but it doesn’t materially affect the cash flows. This reckless policy has done nothing but to promote further overvaluation of already overvalued assets. The current Shiller P/E above 22 has historically been associated with subsequent total returns in the S&P 500 of less than 5% annually, on average, over every investment horizon shorter than a decade.”

    This is exactly my point.

  • Angry MBA

    But what KD is arguing is that there is a mountain of cash piling up on the sidelines that now needs to be reinvested and will consequently drive up equity prices.

    As far as I can tell, KD is arguing that the bond purchases combined with lower yields will drive investors into riskier assets, resulting in higher asset prices, which could fuel commodity-driven inflation (i.e. the stagflation that traditional Keynesian economics failed to predict before the fact.) That is stagflation, which is different from the kind of “traditional” inflation that is associated with full employment. That isn’t a cash-on-the-sidelines argument.

    What Bernanke doesn’t seem to absorb is that stocks are nothing but a claim on a long-term stream of cash flows that investors expect to be delivered over time.

    That isn’t Bernanke’s position. His view is that companies will convert new debt into economic activity, that increases employment, that increases money velocity, that increases corporate earnings, that supports higher stock prices. The Fed is trying to create a basis to support higher prices, even if the multiples don’t change. This is the E in PE.

    Now, that position may be flawed; for example, perhaps cheap capital won’t stimulate economic activity, after all. But it isn’t fair to accuse the Fed of just trying to pump up the multiple when it’s clear that velocity is the end game. This is just monetarism in action.

  • Kid Dynamite

    TPC – I already explained above what Bernanke was saying about reserves above – and you completely ignored me. I wrote: {he meant “cash in circulation is not changing IF these proceeds just sit at the Fed in excess reserves, which is what happened after the FIRST QE.” At the same time he’s saying that, deliberately trying to confuse the common folk who don’t get it, he’s doing everything he can to force excess reserves into the system.”}

    Bernanke is being super sneaky by claiming that he hasn’t added more cash to the system because it all sat in excess reserves – that’s because QE1 didn’t work out how he wanted it to! And he’s trying to change that with QE2.

    Yes – I completely agree that this is not a helicopter drop.

    you wrote: “He has added reserves to the banking system. Reserves are held at the Central Bank. That’s just how it works.”

    No – he has added EXCESS reserves to the banking system – since you want to talk about this from a strict banking mechanics point of view, there is a huge difference. excess reserves can be withdrawn and spent. The more desperate everyone is for yield, the more likely excess reserves are to be withdrawn and spent/lent. The fact that this is all done electronically is irrelevant. But JP Morgan absolutely could have the Fed deliver a big pile of freshly printed cash (Federal Reserve Notes) to their offices instead, rather than having their account credited – if that would make it clearer for you. Of course it’s still not a helicopter drop because JPM exchanged something (treasuries) for this cash – they’re no wealthier as a result.

    Since I expect you’ll try to dissect that above paragraph with more confusion about reserves, you can imagine the scenario where JPM is acting as agent for you, TPC. On day 1, you have $100MM in Treasuries. On Day 2, post QE, you have $100MM in cash, and the sum total of everyone else in the market is EXACTLY the same as they were on day 1 – because THe Market didn’t buy your treasuries – an exogenous force did: THE FED. Net net, the Market owns $100MM less in treasuries and has $100mm more in cash.

    and no matter how many times I point this out, you continue to ignore it – the pool of STUFF that JPM (and everyone else) can buy with the proceeds of the Treasuries that they sell to the Fed is smaller – because the Fed is holding these treasuries now. The pool of targets for capital allocation is smaller. This, for the last time, is exactly why it’s NOT the Cash on the Sidelines fallacy.

    You also continue to ignore the boundary value theoretical scenario – what if the Fed buys ALL the treasuries? Dude – we JUST lived through this – lack of yield causes investors to increase risk and reach for yield. This isn’t some crazy theory of mine – it’s what happened in the last decade and blew up our system. we JUST went through it! (this is why I agree with you that Bernanke’s plan can only end in pain – new bubbles are not a solution to old bubbles bursting)

    Anyway, I’m done for tonight. I can’t continue to argue with you that cash is not the same as treasury bonds. good luck. (although I do agree with you that if everyone who sold bonds to the Fed during QE just left the excess reserves at the Fed, then there is no effect at all. as I explained above, if this happens, Bernanke will buy MORE bonds, until the reserves are spent)

  • TPC

    If that’s his position then I have misinterpreted it. But the bottom line is that the reserves in the banking system won’t change because of what the banks do. If they decide to buy other assets the same number of reserves will be in the banking system. The only reason why equities would rise due to QE is because of a fundamental change (such as lower int rates).

  • TPC

    This is the crucial point you’re missing. The reserves will stay in the banking system. They don’t get “spent”. They get traded just like stocks or bonds. The banks don’t get credited with reserves and then run out and “spend” them on other assets.

    Banks cannot change the amount of reserves they hold. They can transfer them amongst one another. But they don’t exhaust them or something….

  • Kid Dynamite

    “As far as I can tell, KD is arguing that the bond purchases combined with lower yields will drive investors into riskier assets, resulting in higher asset prices”

    you can probably stop it right there. Bingo. And Bernanke himself thinks that this might result in real economic benefit – I agree with TPC that it will not (Except for lower corporate borrowing costs)

    TPC – since you read Hussman’s piece this week, you should focus on the money quote, from Bernanke himself, which makes my point:

    “”The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence.””

    maybe I should clarify – i don’t think this increases aggregate demand, but it sure does increase prices.

  • Angry MBA

    Just have a look at Japan. They did all this stuff.

    The Fed is buying bonds because that’s how open market operations are conducted. When a central banks lowers interest rates, it does so by buying bonds.

    We’re quite different from Japan, on many levels.

    -Japan is export-driven; the US is consumption-driven
    -Japan builds wealth through exports; the US exports potential wage inflation via imports
    -Japan has lousy demographics, with a population doomed to shrink and age; the US will continue to add population into the foreseeable future

    Ultimately, Japan wants deflation for its retires and barriers to protect its domestic producers, at the expense of unbridled consumption. The US prioritizes growth and consumer prosperity, which precludes the US from living happily with deflation. These are major differences between us, and there isn’t much from Japan’s experience that applies to us; our challenges, advantages, and disadvantages are quite different.

  • Kid Dynamite

    “But the bottom line is that the reserves in the banking system won’t change because of what the banks do. If they decide to buy other assets the same number of reserves will be in the banking system.”

    GAH!! NO! you’re confusing and conflating two different transactions! When the Fed buys bonds in QE, the reserves INCREASE! The Fed creates them!

    When the banks spend these reserves, they flow somewhere else, and eventually end up back where they started – that’s a DIFFERENT transaction that does NOT increase reserves (although will increase asset prices, because there are fewer assets out there, because the Fed bought some of them and stuck them in their SOMA account and you can’t buy them!)

    anyway, I’m annoyed that after 2500 words of comments on this page you still don’t understand my position. Maybe if you approach it from a fresh start on a new day you’ll get it – it’s exactly what AngryMBA said it was: “KD is arguing that the bond purchases combined with lower yields will drive investors into riskier assets, resulting in higher asset prices”

    I am positively NOT arguing that this is sustainable, or that it creates real economic activity.

  • Kid Dynamite

    OMG man. Yes – correct – but there are MORE reserves as a result of the Fed’s action, which enables the banks to buy more stuff – (or make more loans) which results in asset price inflation.

    this is another way of putting it so that the layman can understand it, which is what i’ve said all thread: when the banks sell bonds, they get cash, which they then want to allocate.

    YOU are saying that having more reserves doesn’t MAKE them buy more stuff – that’s correct (and we saw that in QE1), but in REALITY, they will, at some point. If they don’t, BB will do it again. and again. and again. just stop, drink a cup of coffee or wine or scotch or something and think about what I’m saying.

  • tjohnson

    ok, guys, whatever. is gold going up or not?

  • TPC

    This is hopeless. The govt isn’t issuing more money. I am not sure where else we can go with this. You keep arguing that the money supply has increased. KD, you need to read the following:

    “The nonbank public – nonfnancial
    corporations, state and local governments and
    households – cannot use deposits at the Federal
    Reserve Bank to effectuate transactions. Moreover,
    currency is not suffciently broad to be considered a
    temporary abode of purchasing power. For Friedman,
    high-powered money can be properly regarded as
    assets of some individuals and liabilities of none.
    So, let us be clear on this subject. In 2008, when the
    fed purchased all manner of securities, to the tune of
    about $1.2 trillion, the fed was not “printing money”.
    Bank deposits at the fed exploded to the upside, the
    monetary base rose from $800 billion to $2.1 trillion,
    yet no money was “printed”. Deposits did not rise,
    loans were not made, income was not lifted, and
    output did not surge. The fed could further “quantative
    ease” and purchase another $1 trillion in securities
    and lift the monetary base by a similar amount yet
    money would still not be “printed”. It is obvious the
    fed authorities would like to see money, income, and
    output rise, but they cannot control private sector borrowing. If banks were forced to recognize bad
    loans and get the depreciated assets into stronger
    more liquid hands, it could be debated on how much
    reserves should be in the banking system. Until that
    cleansing process is completed it will be a slow grind
    to cure the one factor which makes the fed “impotent”
    and unable to “print money”….overindebtedness.”

    The money supply has not increased because of QE. It has POTENTIALLY increased….

  • TPC

    If you say so. I guess the Fed should just run out and buy up the S&P 500 then! It’s different here! :-)

  • Kid Dynamite

    Jeezus TPC – it’s definitely hopeless if you’re not even reading what I’m writing. have a good night.

  • LVG

    TPC –

    Dynamite isn’t arguing that there’s more money in the system. He’s just arguing that there are fewer bonds.

    But there’s a problem with his argument. Let’s say you own XYZ company and they go private tomorrow. They issue you cash and there are now fewer stocks on the NYSE. According to Dynamite this drives up the price of all the other stocks because there are now fewer investment options (even though there is the same amount of cash in the system). But that’s wrong. You might use your gains to buy other stocks, but that doesn’t mean the prices should go higher. In fact, we often see private equity cycles peak right with market peaks. For instance, think of 2007 when everyone was going private. You would think that this was really bullish for stocks, but it wasn’t. It was actually really bearish because investors were driving up stocks with debt.

  • LVG

    The main point here, imo, is that stocks move higher because their fundamentals improve. Not because money chases them. In fact, when money chases stocks higher it usually means they just fall harder when investors realize their error.

  • LVG

    If they bought all of the outstanding bonds then the investors would have cash. So what? That doesn’t mean they would have to buy anything else. They might be fine holding cash. They might be fine buying stocks. But the price they buy stocks at will depend on the agreed upon price and has nothing to do with the fact that the investors now have cash.

  • Angry MBA

    According to Dynamite this drives up the price of all the other stocks because there are now fewer investment options (even though there is the same amount of cash in the system).

    No, that isn’t quite his argument. His argument is as follows –

    -The former bondholders are now sitting on more cash as a result of the QE action converting those bonds into cash. –>

    -The returns on cash and risk-free assets are rotten, due to rates being so low. –>

    -The desire to improve returns over this now-prevailing low rate increases risk appetite. –>

    -Therefore, the increased demand for risk assets causes those assets to increase in price.

    It’s a pretty straightforward and rather traditional argument: When returns on debt suck, that’s when the returns on the alternatives (equities and the like) start looking a whole lot more interesting. (I don’t completely agree with this myself, but that’s what KD is saying.)

  • LVG

    Thats an equally bad argument. Stocks should only rise when their fundamentals improve. Falling interest rates are not synonymous with better fundamentals. It helps, but there are a lot of other factors at work here.

  • TPC

    This has been my main point about QE. If the fundamentals don’t improve then there is no reason for prices to rise.

  • Angry MBA

    Stocks should only rise when their fundamentals improve

    KD isn’t arguing about what should happen, he’s arguing about what he believes actually does happen.

    The market is rallying, stuff is getting more expensive and KD doesn’t like it. KD clearly doesn’t believe that these moves are based upon fundamentals, and he clearly believes that this alleged disconnect is a Very Bad Thing.

    These debates would be much easier if we would (a) avoid mischaracterizing other peoples’ arguments and (b) if we separated our personal preferences from our attempts at making objective assessments of the real world. It is quite possible to see events occurring in the market and to attempt to predict their course without advocating for the policy that is allegedly creating those events.

  • LVG

    -Therefore, the increased demand for risk assets causes those assets to increase in price.

    More cash doesn’t = more demand. If that were the case Zimbabwe would have been the richest nation in the world.

  • DanH

    The confusion here is stupid. TPC and KD are both right. There is not new cash being added to the system. The banks can’t use their excess reserves to buy stocks. They can only trade in the fed funds market. So it’s not right to say that there is now more cash. There is only more cash in the fed funds market. Now, if Goldman Sachs gets all these excess reserves they could technically feel better capitalized and go out on the risk curve in their other businesses. But ultimately, they have to exchange assets with another bank. So the key here is that the total financial assets remain the same in the system. The banks just have a larger capacity to lend and earn interest on reserves.

    The equity effect is from the removal of debt from the system. This reduces interest rates and should theoretically generate more loans and make other assets more attractive. This is all good in theory, but as many have said, ultimately the fundamentals have to make you feel better about owning high priced stocks. But on the whole, all of these assets are still held by someone. All financial assets are held by someone in a secondary market. So the prices are determined by how eager the buyer and seller are. Right now, buyers are eager for various reasons so stocks are going up. That could easily change.

  • Chris

    0% paper is absolutely worthless…there should always be a liquidity and default premium on bonds. Those holding treasuries are going to be in for a rude awakening, unless the FED in its infinite wisdom decides to start buying treasuries at negative rates there is no upside. Bernanke is playing with fire, when you enter a market in a big way exiting is very difficult. How he plans to end QE 2 without losing control of the treasury curve is going to be fun to watch. Nothing like an inverted treasury curve to drive market confidence if he messes up the exit…

  • Chris

    Gold is going up (in USD) until US monetary/fiscal policy makes sense (clean up the balance sheets, give savers an adequate interest rate). The danger of not paying any interest is that there is no reward for holding dollars. Borrowing dollars at near 0% is a speculators best friend (carry traders unite). TPC looks at things from a high level macro perspective (he has very interesting points), but the micro story plays a part too. The idea that QE 2 is going to work from a macro perspective is like rearranging the chairs on the Titanic. Its hope comes from changing inflation expectations and basically scaring people from hoarding dollars, both micro phenomenon. Bernanke is obviously hoping to drive investment/spending (if only someone would buy all those frickin houses), but may end up with commodity hoarding instead. When you play with gold you are playing in the central bank sandbox…I consider Zoellick’s comments on currency/gold unhelpful to the world economy, but who knows his motives…

    “Fifth, the G20 should complement this growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

    The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.”

  • Kid Dynamite

    LVG –

    your comment right here is the crux of the whole issue. In a textbook, or classroom, you are absolutely correct. In the real world, which is what I’m talking about, you’re wrong – we JUST lived through it. Abundance of low yielding or zero yielding cash and lack of low risk positive yield assets results in investors taking more risk – reaching for yield. When they do that, they act in a way you and TPC might call “irrational.” But it’s how they act regardless. Three/four words: Investors need yield/return.

  • Kid Dynamite

    Angry MBA, you complete me ;-). Although you may not agree with me, you positively understand what I’m saying.

    LVG – I replied to a comment of yours above along this line, and I”ll just repeat it here because it’s the entire crux of the misunderstanding here:

    re: “Stocks should only rise when their fundamentals improve”

    “your comment right here is the crux of the whole issue. In a textbook, or classroom, you are absolutely correct. In the real world, which is what I’m talking about, you’re wrong – we JUST lived through it. Abundance of low yielding or zero yielding cash and lack of low risk positive yield assets results in investors taking more risk – reaching for yield. When they do that, they act in a way you and TPC might call “irrational.” But it’s how they act regardless. Three/four words: Investors need yield/return.”

    think relative value… the more bonds the Fed buys, the cheaper stocks are relative to bonds. Now, you know, I know, TPC knows and Angry MBA knows that “cheap relative to bonds” doesn’t equal “cheap.” But especially now with no alternative riskless positive yield options, capital is “forced,” regardless of how irrational that is, into risk assets. Prices go up because buyers NEED return – while sellers are trying to avoid giving up their risk assets.

    the Elmo/Barbie example i gave above is actually pretty decent, I think.

  • Angry MBA

    I guess the Fed should just run out and buy up the S&P 500 then! It’s different here!

    It really is different in many respects. The main difference is that Japan never had a prayer of using strong GDP growth to quickly pull out of what proved to be its extended recession.

    Japan illustrates the long-run risks of what happens when a country places excessive bets on exports. Things go just swimmingly in the beginning when wages are low and conditions still lag those of one’s larger trading partners. But as domestic wages climb and prosperity increases, the end result is a strong currency that makes competitive exports more difficult but yet still props up domestic wages. That sort of export orientation is a recipe for protectionism and other defensive economic policies.

    Again, we ought to step back and see that Japan actually wants deflation. For them, the alternative (a US-style consumption-based, import-driven model) could be more difficult for Japan to support. The US model requires continuous growth in order to work, but Japan can’t possibly hope to have that, given its demographics.

  • Angry MBA

    If you want to claim that there is more “cash” in the system, then that’s fine

    There is more cash, that’s simply a fact. (They don’t call it “quantitative easing” for nothing.)

    Please keep in mind that not all of us are Austrian quantity-theory inflation mongers. I completely understand that $7 billion isn’t that much money.

    My point to you is that your MMT-driven focus on the Fed balance sheet, while ignoring the transaction that takes place with the bond seller, is rather misleading.

    The “asset swap” that you believe lays at the heart of the matter is completely irrelevant to my argument. I understand that the Fed is replacing debt of one duration and rate with other debt with different durations and a lower rate, but again, that doesn’t in any way whatsoever address my points, namely that (a) QE injects cash into the banking sector, (b) that cash injection speeds up the timing of the flows into the banking sector and (c) the real end game is about increasing business investment. The story is in the flow of funds, not in the mechanics of the accounting.

  • TPC

    Technically, there will be less cash. 7-9.2B = NEGATIVE. But you keep conveniently ignoring that. This argument is over the semantics of what “cash” really is. You guys clearly think cash is some unique asset class that is entirely different from a 2 year note that is bearing 0.3%. That’s fine. But it’s a technicality and purely semantics. In this environment, investors are indifferent between cash and a 2 year note. In their eyes it is practically the same exact thing.

  • Kid Dynamite

    TPC wrote: “In this environment, investors are indifferent between cash and a 2 year note. In their eyes it is practically the same exact thing.”

    this is so far from true it can’t even be argued.

  • Angry MBA

    In this environment, investors are indifferent between cash and a 2 year note.

    The recipients aren’t just run-of-the-mill investors, but banks. In theory, $7 billion in cash should become about $70+ billion in new bank credit, which should feed about ~$140 billion in spending, which equates to about a 750 bp increase in the “I” component of GDP.

    And that doesn’t include new debt floated through corporate bonds, any wealth effects, any multiplier derives from increased employment and other increases in money velocity, etc. The bank credit component is just a small piece of the game plan.

    It’s really about lowering interest rates. Presumably, corporations will float more bonds, and then deploy the cash that is raised by their bond sales. That drives up leveraged returns, which should (theoretically) support stock prices. The addition of debt should improve earnings, so the higher prices should (theoretically) be sustainable.

    Now, personally, I think that the effects of QE will be slightly positive, but muted. I still think that we’re stuck in a trading range that QE won’t fix over the long haul, and that it will take a while to bring down long-term unemployment, regardless of Fed policy. We need fiscal and legislative policies to kick start the economy, but there has been no political will for the type of stimulus (namely, a massive consumer debt reduction) that would fix this quickly.

  • TPC


    I think you’re too focused on the PM side of this all. Do you really think investors are making life altering decisions because their cash yields 0.2% less than the bonds the fed is buying?

    I don’t. This is the very essence of the liquidity trap. The fact that cash becomes a substitute for all other assets as prices fall and bond yields remain abnormally low. We’re not in an environment where cash yields 3% and 2 years yield 5%. This isn’t your normal environment and I think you’re entirely ignoring that.

  • Angry MBA

    Do you really think investors are making life altering decisions because their cash yields 0.2% less than the bonds the fed is buying?

    You’ve both been blaming QE2 for commodity inflation, so it would seem that both of you are answering that question in the affirmative.

    Now speaking for myself, I believe that there is a whole lot more than interest rates to drive what I see as the current commodities mini-bubble, and that the interest rate isn’t the primary driver. But you two seem to be on the same page with respect to this issue.

  • TPC

    No one ever said it was exactly the same. History never repeats itself perfectly….

  • TPC

    The commodity rally is due to the misconception that this is inflationary. Cotton prices don’t rise 50% in a month because of a .25% change in interest rates. It’s not even remotely fair to blame the move in commodities on int rates. That takes my whole point out of context.

  • Anonymous

    The commodity rally is due to the misconception that this is inflationary. Cotton prices don’t rise 50% in a month because of a .25% change in interest rates

    To those of us who don’t agree with MMT, we see open market operations, money printing and interest rates as being interchangeable. The Fed lowers the interest rate by engaging in open market operations, which turn bonds into cash, which heightens the risk trade. So you’re both in agreement.

    Both of you are also saying that this commodities to bubble isn’t being driven by fundamentals. The difference is that you claim that rising asset prices aren’t inflationary, whereas KD says that they are or at least sometimes can be.*

    *I would presume that KD’s definition of inflation is not the strict core consumer inflation measure reported by the BLS.

  • Angry MBA

    You keep bringing this back to MMT in an attempt to protect your previously inaccurate comment that money has been added

    That isn’t at all correct. I’m citing MMT because MMTer’s have a very different view of how money is created than do the rest of us.

    Given your belief in MMT, I presume that you believe that the government uses deficit spending to create money. But that position is very different from more orthodox views of money creation, which tie to the linkage between interest rate changes and bond operations. This is a fundamental difference between your position and the standard view, and I’m simply acknowledging that difference, as it is a critical one.

  • Kid Dynamite

    TPC wrote: “I think you’re too focused on the PM side of this all.”

    bro – that’s what matters – the real world investor actions/implications. Look in the mirror – you know this isn’t sustainable – you think stocks are overpriced – yet you own them anyway! because you have no alternative. it’s not what I think – it’s what is actually happening. I laugh every time I read Barry Ritholtz write “do you want to be right? or do you want to make money?” Greater fool trade! What a fantastic reason to own stocks! That’s Bernanke’s goal – make investors do what you consider to be irrational things – yet you yourself are doing exactly that!

    And yes, Angry MBA is right that I’m not talking about CPI.

    I also had another epiphany that is explaining some of your lack of understanding my point here: I THINK that you are thinking of corn, sugar, wheat, coffee etc as commodities. I’m thinking of them as asset classes. So yes – again, for the 50th time, when the Fed buys bonds, it does NOT make you use more wheat – but it can (and eventually does) make investors buy wheat as an asset class because investors are desperate for return. (which, thanks to the new crop of ETFs, is easier to do than ever).

  • TPC

    QE in and of itself does not create money. Ben Bernanke doesn’t dispute this. The only people that dispute this are people that don’t understand how the monetary system works. Two days ago you were arguing that QE creates money and that’s simply not correct. The orthodox view is not correct. Just type in “quantitative easing” and “money printing” into google and you’ll see just where the orthodox view gets you. It gets you to believe in a whole bunch of nonsense.

  • TPC

    I’ve never disputed the fact that asset prices could rise because of QE. I’ve disputed the notion that this was adding new money to the system and that this money was forced to chase a return.

    Clearly, we’ve both misinterpreted eachother’s arguments. My apologies. Let’s just go ahead and agree that this has been an irrational rally, it could continue and it’s not likely to have much of an impact on the real economy.

    PS – I am net short!

  • OTS


    Could you expand on the idea that the Chinese don’t fund America?

    I understand the idea that we (America) don’t need the Chinese to fund our spending because we can print as many dollars as we want. Then the Chinese accept those dollars in exchange for goods. Then they can either hang on to them or buy other goods with them. At some point in the future we need to recover those dollars do we not? At home the government can recover them through taxation but what do we do to recover the money once it goes out of the country?

  • Dawg

    TPC you are correct in stating that the banks trade T-notes for excess reserves/cash/shorter duration liabilities. No new money is created ON THE BANK SIDE. However, from the Federal Reserve’s perspective, they have reduced federal government liabilities without taking money out of the system. Money was thus technically created. Like KD mentions, in the boundary case the Fed could buy up every Treasury in existence. All Treasury holders specifically would be in a similar position financially, with the same amount of cash now as they previously had invested in Treasuries. However, there would be no outstanding federal debt and the money spent on goods and services by the federal government over the past several centuries would still be circulating in the economy. This wouldn’t be all of a sudden inflationary (unless Congress saw its newly cleansed balance sheet and decided to go nuts) because this money creation has technically happened over a very long period of time in which the population also grew. TPC is right about it not being BROADLY inflationary, although KD is right that debt monetization does technically mean that deficit spending has created fake dollars over time.

    Of course the Fed also has ways of reversing debt monetization by taking money out of the system (bank capital requirements, etc). Thus they also have the power to destroy money, not just create it.

  • first

    “Adding new money to the same supply of goods and services is inflationary. If there is no fundamental change in the goods and services outstanding then there is no reasonable reason for asset prices to change.”

    Is this not a contradiction ? It would be inflationary.

    Money that goes in to the fed can be sterilized but Bonds will not.

  • vjk

    Angry MBA:

    “The recipients aren’t just run-of-the-mill investors, but banks.”

    Commercial banks hold about 5% of total Treasuries only — the rest is owned by institutional investors, foreigners and “run-of-the-mill investors”. So, not much in the the QE2 provoked asset price dynamics depends on the commercial banking sector as such.


    The banks can’t use their excess reserves to buy stocks.

    The newly created cash (cash == reserves == “base money” == “interbank money”== M0), in many cases, is not even theirs. However, the bank is free to do whatever it wishes with the cash, including buying stocks, in the same fashion as it would with any deposit, say, your paycheck which when deposited becomes the bank’s cash holding.

    They can only trade in the fed funds market.

    This is incorrect. Cash is used to settle interbank obligations or to let the client withdraw nice green FRNs.

  • Michael Cullen

    I do not agree with your assertion that QE does not create money.

    The monetary base, (known also as base money or money base) is known as M0 and consists of coins, paper money (both as bank vault cash and as currency circulating in the public), and commercial banks’ reserves the central bank.

    In a QE transaction, the Central Bank (CB) buys treasury bonds from a commercial bank. As a result the total value of the commercial bank’s assets and liabilities have not changed, as only an asset swap has occurred at the commercial bank. But there is no asset swap at the Central Bank; the total value of the CB balance sheet has increased as a result of the purchase. The assets have increased, being a use of funds, and the liabilities have increased, being a source of funds. The asset is the treasury bonds purchased, and the liability is the increase in the commercial bank’s reserve account with the CB.

    Accordingly it is clearly incorrect to say that the M0 has not been increased (or that the Fed has not “printed money”) by the increase in the value of the commercial bank’s reserve account with the CB. M0 has increased, and that is beyond dispute.


  • Michael Pollaro

    I’m very late to this comment thread, but addressed this issue here…

    Bernanke is either clueless is intentionally trying to mislead

  • TPC


    Your analysis is not correct. Bernanke is right. He is not adding net new financial assets to the private sector.

  • Joe

    Think of it this way, that Debt the bank holds has a 5 year expiration, at which point it will be redeemed for cash. The fed is shortening that duration and expiring that debt for cash today instead of 5 years from now. That’s not creating anything new in the system (the debt to money conversion) it’s just shortening the time horizion of it.

    The Fed’s holdings (ie Reserves and US Debt) are not factored into money supply and debt. All profit the Fed makes is retired and credited back to the government (with the exception of funds for operations and research). The Fed has the ability to create and retire money. So when the fed “creates money” to buy debt, it’s exchanging dollars (Reserve Notes) today for dollars (Reserve Notes) in the future. They buy these from the banks, not the Treasury, so when redeemed the banks would be receiving Fed dollars no matter what.

    Their operations are currently interest targeting, not reserve targeting. As TPC has pointed out numerous times, they do not lack reserve supply and adding more reserves isn’t going to create any more inflation than is already present aside from financial assets inflating . However, it does have unintended consequences (front running the fed actions, capital flight to foreign assets, dollar depreciation due to low targeted return rates, “currency wars”, and most of all faith in the currency).

    All fiat currencies need faith in their values and whether actions are inflationary or not (and more accurately when rates are held low too long, artifically) the belief becomes self-fulfilling (a negative feedback loop). Fear of a dollar debasement leads to people fleeing it as a reserve leading to it falling more, but inflation based on debasement and purchasing power takes time (a lag) to get into the system. The higher equity prices today are not reflective of core inflation increases, it’s based on interest rates and expecting them to be lower (or stay low) for an extended period keeping the relative return of risk-free treasuries lower when compared to stocks driving up the price of relative assets, ie stocks and commodities. The debasing we see today is more in relation to foreign market inflation (foreign markets are raising rates to tamp down inflation making return in their currencies more appealing, leading to a net outflow of dollars)

    As for inflation, money supply and inflation are not perfectly correlated. You need demand and productive capicity for them to link. As Friedman described you can print 1 trillion dollars and bury it in your back yard, and it will not inflate a single thing but the ground. The slack in capicity utilization in our economy is not sufficient enough to see inflation simply from “printing money” (maybe it would if we were at fully utilization) or in this case “asset swapping”.

    Next up…dropping money from a helicopter and hoping for a “Wealth Effect” to set in!

  • Alaric Investments

    Yes, and there is no inflation if you strip out the ‘volatile’ food an energy components also.

    The denial of inflation is a common occurrence among governments, believe this and the ‘asset swap’ story at your peril.