MORE EVIDENCE THAT QE DOESN’T WORK
I’ve made some fairly good calls over the last few years, but I don’t attribute a single one of them to any sort of prescience, brilliance or great knowledge. Most of these cases are simply due to the fact that I’ve studied a great deal of market history.
When I said the housing bubble was the greatest risk to the equity markets in 2006 it was largely due to the fact that the price action in U.S. real estate was almost perfectly identical to residential real estate in Japan in the 80′s. When I said the banks were likely a buy on March 10th 2009 it was almost entirely because I had studied the history of past asset class declines (Nasdaq had declined 93% from its peak in 2001 – the same exact percentage decline at the bank sector’s low). When I said the bailouts were likely to have a muted impact on the Main Street recovery it was almost entirely due to the fact that the Japanese had implemented a similar plan in the 90′s with poor results. This isn’t brilliance. It’s just research. Anyone can do it. But here we all are pondering the impacts of quantitative easing when we have historical precedent and despite poor results most investors and policymakers seem to be saying “this time is different”.
Of course, the whole theory behind QE revolves around the idea that the Central Bank can reduce long-term interest rates. If they can reduce rates they can make other assets more attractive, they can create a refinancing effect, they can entice borrowing/lending and they can alleviate the pressure on debtors. All of this will theoretically help boost aggregate demand and result in sustained recovery. There is only one problem with all of this. There is no historical evidence that QE actually works to lower interest rates. I’ve already highlighted the two most famous cases – the USA and Japan where interest rates rose throughout the programs, borrowing remained weak and the economies remained weak.
One instance that is less well documented, however, is the case of quantitative easing in the UK. The following chart shows the duration of the program and the interest rate effect:
The conclusion is obvious. Interest rates do not decline during a program of quantitative easing. In fact, in all three cases I’ve highlighted interest rates rose throughout the program. This is extremely important to understand because without the intended interest rate decline there is simply no argument in favor of this policy. There is no refinancing effect, there is no reduced rates to borrow at, there is no fundamental change in the economy. This is why, after all three instances, the economies remain(ed) very weak. QE is merely an asset swap. It doesn’t alter net private sector financial assets. It does not reduce rates. It does not create jobs. It does not boost aggregate demand.
Thus far, the only thing QE appears to do is drive asset prices higher without being supported by any underlying fundamental change. This is largely due to the psychological impact of QE and the falsehood that QE = “money printing”. Thus far, this psychological impact of QE has backfired on the Fed as input costs have surged and the Fed has inadvertently begun to reduce corporate margins. If the goal here is to keep “asset prices higher than they otherwise would be” then the Fed appears to be winning their battle. Unfortunately, there is no evidence showing that there is a fundamental reason why QE would justify such a move. In fact, the market collapses following the end of all three major historical QE programs appears to prove that this is bordering on ponzi Central Banking and nothing more.
Mr. Bernanke appears to be ignoring the simple historical facts. And those who ignore history are destined to repeat it.
Does anyone really trust that Bernanke knows what he’s doing? He missed the crisis after it started. he downplayed it and then acted too late. He misdiagnosed the crisis. He’s done nothingto help Main St. Hell, even his banker buddies look like they might be in trouble again. What has he done right? Obama’s biggest mistake might have been reconfirming Ben Bernanke.
so now they are also using toothpicks to build their house of cards.
signed, finger on the 3x short button
Given that this move in the interest rate was occurring during a more global rebound across many markets (read reallocation to more risky assets), can’t we also say that the BOE QE helped to mitigate a move that otherwise would have been much stronger?
That’s what BS (Brian Sack) says: http://www.ny.frb.org/research/staff_reports/sr441.pdf
There are lots of variables at work here if you’re to make this assumption. Overall, the net change would appear to be the most important to me, however. If we are truly in a deflationary recession then Ben isn’t worried about rising rates. If rates were rising as many believe in 2009 this would likely occur under the guise of inflation. But that’s clearly not the concern here so I think the argument that rates would be substantially higher simply doesn’t pass a common sense test.
The net change in rates shows that borrowing rates haven’t budged all that much for the Japanese, the British or the Americans. These policies haven’t really done much of anything to influence interest rates.
Brian Sack’s conclusion in the piece posted above by SS are perhaps one of the greatest cases of datamining that I have ever seen. The conclusions are based on the price actions of the days on which the announcements were made. Therefore, he’s taking the short-term adjustments in market psychology and assuming that the market doesn’t adjust. That’s like saying that the stock market should be 10% higher because of the flash crash or that the Yen should trade 1% higher because the BOJ intervened last month. That’s absurd. Markets aren’t efficient, but they’re not stupid.
The UK QE programme took place at a time when the government deficit was soaring through lower tax take, higher spending and bank bailouts. So the supply of Gilts increased. The Bank of England bought virtually the whole of the gilt issue that year. This came at a time when the panic movement out of other assets into gilts had stopped.
Without the Bank’s action I think it obvious that long interest rates in the UK would have gone up significantly more than they did. So QE can and does lower long rates.
Whether that will flow over into more real activity is quite another matter. I think that absent fiscal stimulus it’s largely a waste of time holding down long rates on gilts and Treasuries. But that’s not the same as saying you can’t do it.
The fatal flaw in such an assumption is that rates would have adjusted higher as soon as the govt stopped buying the bonds in February. But that didn’t happen. If these central banks were really altering the curve that much there would be an adjustment at some point. But rates just keep going lower which is a clear reflection of the nature of our predicament – low growth & disinflation.
No serious economist from left to right thinks interest rate is the problem right now, so clearly lowering interest rate is a red herring from the FED, the real intention is to inflate stock market. If you assume QE is to lower interest rate, you are making a wrong assumption.
Does QE generate inflation? Absolutely, but not here, it generates inflation in emerging markets, liquidity goes to where money is made, that’s why we see huge inflation pressure all across asia. In that regard, QE is absolutely stimulative from a global perspective.
US-centric view is outdated.
Int rates are the only thing the Fed controls so of course it’s allabout rates. QE is not inflationary. It’s just an asset swap. Asias inflating is not due to QE.
Judging from what you are saying, you don’t have enough knowledge in these things. The asset swap thing is ridiculous, economic system is a dynamic system, trying to use static accounting identity to explain how the system works is laughable to say the least, it’s day and night.
When what you are arguing for is against what is happening in reality, you have to look at yourself and say maybe you are wrong. Faber is right, you print enough money and you’ll see inflation, Japan is different, Japanese Yen is not reserve currency, US $ is reserve currency and everything is denominated in $$.
QE will be open ended and unlimited by the way, it has too. The unintended consequence of open-ended unlimited QE is people will feel free now to pile money into oil and other commodities, which will suffocate the economy. No free lunch, Ben.
TPC — during other QE experiments in Japan and the UK, did we also see the collateral effect of sinking currencies and spiking commodity prices in those countries?
In short, no. QE has a FAR lesser impact than most think it does. It’s really just a shuffling of assets. I truly think Ben is using it to gain access to a backdoor bank bailout in case he needs it. The one thing QE can truly be effective in doing is altering the risky assets that a bank holds.
I vote backdoor TARP – not stupid just sinister
yes that’s what i told you two weeks ago. its all about saving the banks no matter what price the rest of the economy suffers. ben will destroy the currency and the economy to save his banker buddies. the only answer is to eliminate the fed and the sooner the better. hopefully the new batch of republicians will wake and at least rein the fed in.
JEREMY GRANTHAM seems to agree that FED’s intention is to manipulate the stock market. But his view on debt and growth is incorrect, his argument doesn’t pass the common sense thought process, I think Richard Koo is right, when debt level is too high, we enter a balance sheet recession.
10 year 2.7%, do you still believe QE is to lower interest rate? But the yield rises! No, QE is never to lower interest rate. If QE is to lower interest rate, then after looking at what just happened, Ben should announce he is not going to use QE, that’ll send the yield down sharply. This is a very simple thought process to prove that QE is not about interest rate.
Writing the same comment here 10 times doesn’t make it so. You clearly aren’t familiar with the goals of this policy. Ben Bernanke and other members of the Fed have been VERY clear about their goals via QE.
Bernanke at Jackson Hole:
“The FOMC has also acted to improve market functioning and to push longer-term interest rates lower through its large-scale purchases of agency debt, agency mortgage-backed securities (MBS), and longer-term Treasury securities”
And no, QE is not money printing. The monetary base expansion via QE is not adding net new financial assets to the private sector.
Make up your mind, TPC, you cited JEREMY GRANTHAM to make your point, and you cite Richard Koo for another, but these two disagree, and JEREMY GRANTHAM agrees with me, and disagrees with you, do you really read what you post?
Again you cite Marc Faber to justify your bearish view on the market, but his view is completely different than yours, what gives?
Sorry, it’s you who doesn’t understand these things. Look, open your eyes, and have some simple thought process, don’t just find everything that justifies your view, even though what you cited is 180 degree from yours.
I figure this blog has no value to me, bye.
Whoa now non_economist. I post lots of things from various people. Just because I post it doesn’t mean I agree with it. My opinion pieces are my own. The other videos and write-ups from other authors are simply to provide a more balance perspective. For instance, I totally disagree with Marc Faber’s inflationary outlook, but that doesn’t mean I am ignoring it. And I think the reader is wise to consider the fact that I may very well end up being wrong. Therefore, we should consider all possible outcomes, but please don’t confuse every story here as if it is MY opinion….
Let ‘em go TPC. Frankly I’m sick of readings his posts.
agreed…enough of a combative attitude
There’s one one of them at each mkt top…it’s a good sign actually.
yeah, what ever happened to that guy and his bank stocks? i think his name was chris?? i wonder how his bank of america shares are doing…
TPC: Have you read the WSJ report on the likely Fed decision here:
http://online.wsj.com/article/SB10001424052702303891804575576533845166848.html
This suggests that QE won’t be as large as the market is anticipating.
Saw that. Thanks.
They should have written a story about how QE has real no economic benefit….Size, in this case, doesn’t matter. This isn’t the Paulson bazooka. Ben is basically fiddling around with water pistols. The size of it doesn’t matter in the end except that one looks a lot bigger than the other.
So this begs the question… do you trade on what you think reality is, or do you trade on what you think everyone else thinks is reality? (the old beauty contest question)
Those interested in a pretty balanced perspective on QE might want to read the Kocherlakota (voting member of FOMC) speech from a few days ago. He nicely sums up why QE won’t work:
“What is the ultimate impact on the overall economy of this shift in risk? In the baseline models used by central banks, all bondholders are taxpayers. In these models, QE is essentially shifting risk from one pocket to another. As a result, the increase in tax risk (what I’m calling the fourth effect of QE) completely undoes the decrease in interest rate risk (the third effect of QE). QE ends up having no effects, except for those associated with any new forward guidance that it signals. QE will have nontrivial effects over forward guidance in the context of a more realistic model in which people differ from one another in some relevant way. Along those lines, we might think that some people are active participants in the Treasury markets. Others are not. Then, if the Fed buys long‐term Treasuries, it takes risk from the former group and imposes it on the second group. The ultimate macroeconomic impact of QE depends on the extent to which the extra tax risk deters economic activity on the part of this second group. We know little about this effect, either theoretically or empirically.”
Another way of saying is this is what I’ve been saying. It’s just an asset swap. We remove interest bearing assets from the pvt sector and swap them with cash. Net net, the move will likely prove to be an altering of assets and little more. It will have no real economic benefit.
http://www.minneapolisfed.org/news_events/pres/kocherlakota_speech_10142010.pdf
Missed this.
I wonder if the limits & ineffects of QE are beginning to be appreciated by the Fed. But they can’t just announce this to all the momentum traders out there.
Along with this, what are your thoughts on Ben’s famous 2002 helicopter speech. Do you believe most of his actions outlined in that speech are ineffective (mostly asset swaps ala QE) or do you think he can actually get some traction with his helicoptering?
The thing most people don’t realize is that a helicopter drop is not really in the arsenal of Fed operations. A helicopter drop is technically a fiscal operation and would be carried out by Treasury via deficit spending. So yes, in a balance sheet recession, I believe the Fed is largely impotent aside from psychological warfare and altering the composition of pvt sector financial assets.
TPC,
You’ve done an exceptional job explaining why QE does not work, and certainly will not provide us with the effects the FED is shooting for. However, this is the first that I’ve seen a voting member of the FOMC openly admit this fact, although I have been hearing more uncertainty out of the various members lately. Which poses the question, if you(TPC), the readers here, various others, and now even members of the FED can see and admit the ill gotten effects of QE, then why go forward with it at all next week. What is Helicopter Ben missing, or trying to accomplish…besides inflating equities in hopes that will spur future growth?
Andrew,
This is a phenomenal question. I’d love to stand in front of Mr. Bernanke and ask him myself. I think he truly believes it can and does work. Then again, I really don’t think Mr. Bernanke understands how our monetary system works (it would be a blasphemous comment if his results over the last 3 years had been positive).
My more sinister belief is that he is simply reigniting the program so that he has a backdoor bank bailout. He knows Congress will not approve another bailout so he’s putting QE2 together just in case housing turns south again and the bank balance sheets go up in flames again. This way, he can swoop in and buy MBS by the billions without needing Congressional approval.
Smart or sinister? I don’t know….Probably both.
TPC,
Thanks for the response, I appreciate it…and agree with you. I think he clearly misunderstands the effects of the very policy he is going to, and to some extent already has, put in place. It’s unfortunate that the one man who is supposed to understand how it all works, seems to be misguided. I do however believe that he feels this is the last ‘best’ option available to the FED. Who knows, maybe he will surprise us next week…regardless it should certainly be an interesting couple of weeks/months watching this play out.
The asset swap is a backdoor bailout of banks, because it converts today’s risk on banks’ balance sheet into tomorrow’s loss on the Fed’s balance sheet. $1T of MBS at face value is more risky than $1T of Tsys. As and when a loss is realized (ok, in future) by failure of low-quality MBS on the Fed’s balance sheet, how’s it different from money printing (at that time)?
i.e. QE(MBS) = future money printing.
TPC:
Help me understand your logic, and trust me I have followed your writings. But if the Fed Buys treasuries or mortgage securities from the open market (QE,) and holds them on their balance sheet, they are freeing up they money they pay for them to be deployed elsewhere in the economy. It does in fact create more free capital because the fed has taken over the liability of those bonds. The Fed doesn’t have to balance its books, or go to the tax payer. So help me understand why it doesn’t create more money?
http://www.pimco.com/Pages/RunTurkeyRun.aspx
Now, however, with growth in doubt, it seems that the Fed has taken Charles Ponzi one step further. Instead of simply paying for maturing debt with receipts from financial sector creditors – banks, insurance companies, surplus reserve nations and investment managers, to name the most significant – the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers. One and one-half trillion in checks were written in 2009, and trillions more lie ahead. The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves. I ask you: Has there ever been a Ponzi scheme so brazen? There has not.
William H. Gross
Managing Director
Isn’t it amazing how there is a growing chorus of investment legends and gurus calling the Fed a ponzi scheme? And yet no one makes a big deal about this. The people should be furious about what is going on at the Fed. These policies are so misguided it’s almost surreal.
Hi, lots of good stuff here!
Let me add that qe can’t be ponzi. Ponzi is when payment can only come externally. In the case of the Fed/US Govt, all spending is via the issuance of ‘new’ govt liabilities. That is, Fed spending is via crediting bank accounts on its own spread sheet. It is entirely an internal operation. The notion of external finance is inapplicable.
Also, qe only shifts the duration of outstanding govt liabilities. Govt spending in the first instance is a credit to reserve accounts on its own spreadsheet. Tsy securities are alternative accounts at the fed called securities accounts. and cash is the third alternative liability offered by the US govt. The identity is net spending = cash plus reserves plus tsy secs.
Shifting duration is one factor that alters the term structure of rates. Others include market anticipation of future fed funds rate settings, and technicals of supply and demand duration in total.
As monopoly supplier of net clearing balances (reserves) the fed in fact has control over the entire term structure of risk free rates, not to say it directly and proactively exercises this control.
Last, the fed buying secs is functionally identical to the tsy not issuing them. So the direct way to enact qe is to have the tsy stop issuing the bonds in question and only issue, say nothing longer than 3 month bills, etc. Better still, with a dispensation from Congress, not have the tsy issue any securities, and let the net spending remain as reserves, which are functionally identical to one day t bills.
The remaining question is what is a function of the term structure of rates. What generally gets ignored is the interest rate channel. Note that with today’s low rates govt debt service is lower than it was even though the total debt is a lot higher. And the Fed owning 2.3 trillion of securities means the fed gets the coupon income and not the private sector. When the Fed turned some 50 billion over to the tsy that was 50 billion in income the private sector would have had, so qe functions as a tax in that regard.
And Japan has had long term mtg rates of 3.5% or less for a very long time and I don’t see signs of a housing bubble? Yes many blame our housing bubble on low rates.
Nor is there an equity bubble in Japan? Yes, pe’s are higher, but that’s been a one time adjustment and hasn’t led to a general ‘inflation’ of asset prices?
Bottom line- i strongly support a permanent 0 rate policy, but recognize through the interest rate channel and supply side effects (keeps costs of investment, production, and holding inventory down) it’s generally highly deflationary. That’s a good thing- it’s means that for a given size govt, we can enjoy much lower taxes than otherwise.
http://www.moslereconomics.com
Great comment Warren. Thanks.
As far as Ben Bernanke’s true intent with QE – 2 (3,4,5,…)
Never attribute to Malice that which can be explained by INCOMPETENCE.
I was having this conversation with someone this morning. I said I thought QE2 was a preemptive bank bailout so he can swoop in and buy MBS when the housing market goes into the tank again. The response:
“you’re actually assuming that Bernanke is prescient and proactive. Neither is in his repertoire.”
Hey TPC. Long grateful time reader. It’s been fun watching you debunk QE. Let’s just hope more people start paying attention.
Looks like Bill Gross at PIMCO has finally got with the program too!
A very interesting post on their site above.
Hussman, Grantham, Gross, Faber, etc all saying QE is misguided policy and generally ponzi….I’m sure there are many others I’ve forgotten.
Not Krugman. In his latest, titled “The Worst Economist in the World” which I read, thinking he finally admitted to it, he says:
Seems to me he is conveniently assuming higher inputs prices can be passed along to the consumer; not likely.
Krugman is one of these guys that believes you can talk inflation into an economy. In Japan he was in favor of targeting an inflation rate as high as 300% if it needed to be. He thought that would just get everyone to react and respond differently. I know the Fed likes to herd people around and whatnot, but that’s just not how it works in the real world. When I don’t have money to spend because I have too much debt my spending is dictated by that and not by what some guy in Washington is saying.
Krugman has long admitted that QE does nothing except alter perceptions, but he still advocates the policy. Now, here we are with a mountain of evidence showing that it doesn’t do anything and more and more qualified market practitioners coming out against the policy every day and PK feels the need to defend himself by saying that surging commodities don’t matter.
He needs to ask Kimberley Clark and ArcelorMittal if rising commodity costs matter. Better yet, ask them how that will influence their hiring trends.
TPC,
I think the argument that grantham really disagrees with you may not be right anyway, though undoubtedly he does in some respects. Don’t we all disagree with each other in somne respects?
Grantham seems to me to be arguing that debt growth above GDP doesn’t lead to sustainable increases in the rate of growth, and when extended too far actually reduces GDP growth.
He does feel it allows asset bubbles to develop through greater and greater use of leverage, the resulting pschological and momentum effects which eventually burst. He is not saying that lower rates will always result in debt growth. In fact, my understanding of his beliefs (and I have read every letter he has ever released) is that at some point it does not work. He explicitly points out in the recent letter that this might be the time when thngs work differently. Also, he said the same thing during 2005-2007, that the interventions at some point would not work and the economy and market would collapse anyway.
Exactly how different is that from what you say? To sum, he believes excessive debt growth leads to an unproductive allocation of captial, assets which do not produce the cash flows to service that debt and a balance sheet recession. Sounds like you to me.
I didn’t mean to imply that I disagree with Grantham. Just that when I post something written by someone else readers should not assume that I fully agree or even partially agree. In Grantham’s case, however, I almost always agree. He’s one of the best. How could you not agree? He is one of the few macro theorists who is an absolute must read.
He is absolutely a must read, I was just arguing against non economist, who seems to believe there is some large gap between your thoughts and his. That conclusion smacks of him reading into Grantham what he has been arguing. Confirmation bias seems to have distorted his understanding of Grantham.
According to Hyman Minsky’s analysis of the financial cycle — which Richard Koo is using also, as well as the MMT’ers — this is the culmination of a long financial cycle that ends in what Minksy called “Ponzi finance,” which is the use of leverage to service leverage, banking on ever-increasing asset prices, which is of course unsustainable. The resolution of the inevitable debt-deflation crisis involves deleveraging and rebuilding balance sheets, and liquidation of malinvestment before a new financial cycle can begin. If this is not handled properly by the monetary and fiscal authorities, a depression can develop, although this is reduced with the automatic stabilizers now in place since the Great Depression.
Instead of diagnosing and treating this, the people in charge are acting like this is a business cycle alone, whereas it was the ending of the financial cycle that spilled over into the real economy. As a result they are misdiagnosing the issues and mistreating the problem.
On one hand, the fiscal arm (Congress) is side-stepping the problem by not providing enough space for deleveraging and saving to rebuild balance sheets, as well as to close the output gap in the real economy. The stimulus was too small and not well directed. However, Warren Mosler thinks that it was large enough and still has enough oomph left to lift the economy more, along with the ongoing automatic stabilizers. So, it that there are green shoots again, even though fundamental financial indicators are rotten at the core owing to a mountain of toxic debt. However, if fiscal austerity would be implemented after the election, all bets are off, since a turndown in the real economy would exacerbate the financial situation by making debt more difficult to service.
On the other hand, the monetary arm (Fed) is perpetuating the stage of Ponzi finance by trying to lift asset prices and “create some inflation” by raising the price level. However, true inflation only occurs as funds available result in nominal aggregate demand that exceeds the productive capacity of the real economy to respond with supply. Therefore, the Fed is trying to wag the dog’s tail, and the dog is just going to get annoyed and bite the hand.
Turning to another issue, the Fed can control the yield curve through purchasing long bonds, but this could involve a lot more buying than the Fed is up for, so inadequate QE could provoke (erroneous) inflationary expectations resulting in interest rates rising a bit, as the data above suggests. If the Fed wants to drive up LT bond prices, it has to be prepared to do what it takes, as long as it takes, and I doubt that Fed members have the stomach for this now, with the economy not actually tanking (yet).
I agree that the Fed is (surreptitiously) buying up dreck, and likely intends to eat it, which is really a disguised fiscal operation that Congress probably won’t like one bit once it realizes that the Fed is end-running it. Another example of the command economy at work, doing things that don’t work as planned.
Hussman, Grantham, Gross, Faber, etc all saying QE is misguided policy and generally ponzi…
They’re either jumping on, or, they knew it all along, and this blog, and others, have brought the conversion from behind closed doors to the general public. In the past, these discussions fell into the category of “Information is Power”. It’s all out there now. Thanks TPC!
where’s the 5-star bar when u need it
Fed is losing traction… fissures appearing. It is MORE than significant when Bill Gross et al question your policy publicly.
The market is undeterred though. Bill Gross comes out and says QE won’t do anything and yet there are still lemmings who jump in and buy every dip. When this trade reverses it’s going to be nasty. There will be one huge rush for the exits. The greedy feeling on these dips is palpable.
No QE2 will only benefit Bill Gross. His bond funds are close to collapse.
It sounds more likely and is illustrated in your graph for the UK that interest rates drop in anticipation of QE. This means that various bond traders (including PIMCO) buy early in the hopes of selling to the central bank at a higher price. After QE goes into effect the traders sell, lowering the price and raising rates. Sounds like the money printing of the 1970s in US when they found that only unanticipated increases affected the economy and markets. Ie, if a 6% increase was expected, an 8% increase was needed to be effective. Unfortunately this leads to ever increasing expectations with disastrous results.
Fed may now be setting the expectations low to achieve this effect.
In his Nov 21, 2002 speech entitled Making Sure “It” Doesn’t Happen Here,
( http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm )
Bernanke said:
“…… If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.
So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities.9 There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well….”
I wonder what the market reaction will be if the FED only calls for an explicit interest rate without neccessarily quantifying a QE amount???
QE2 is mostly marketing … just like Tide … “new and improved; with extra super duper whitening bubbles and billions of enzymatic little scrub brushes”. The good news (if you can call it that) is that people will buy the new Tide.
The no net new financial assets to the private sector. This statement is patently false and can only be true if the debt held at the Fed were eliminated. It is not. The previous MBS holders now have Federal Reserve Notes. The people paying mortgages at bonds held at the Fed still have the debt while the Fed holds the MBS asset. The Fed is a private corporation (and an enemy of the people of the United States).
As far as the real economy is concerned, QE has never worked and it will not work this time around.
The only thing QE does is inflate asset prices via inflation.
The Fed hopes that rising asset prices will assist the economy due to the wealth effect. This is the sole purpose of QE.
Unfortunately, QE will NOT bring down unemployment anytime soon.
TPC:
Help me understand your logic, and trust me I have followed your writings. But if the Fed Buys treasuries or mortgage securities from the open market (QE,) and holds them on their balance sheet, they are freeing up they money they pay for them to be deployed elsewhere in the economy. It does in fact create more free capital because the fed has taken over the liability of those bonds. The Fed doesn’t have to balance its books, or go to the tax payer. So help me understand why it doesn’t create more money?
Tim,
The operation is just an asset swap. If the primary dealers wanted to go out and buy stocks or invest some amount of cash in something there was nothing stopping them before. They hold highly liquid treasuries that can be sold in the market tomorrow. There is nothing stopping them from selling tsys and then turning around and using that cash to invest in something else.
All the Fed is doing is buying the tsys from them. The PD’s get cash reserves. What has changed? Nothing. Only the term structure & composition of the bank balance sheet. Instead of a highly liquid tsy bond they now hold reserves. It’s entirely possible that these banks could turn right around and buy tsys again. Saying that there is more money in the system after this operation is a lot like saying that there is more cash in the system after you sell a stock tomorrow.
TPC: I want to agree with you, but when I sell a stock, the cash I receive comes from the system and stays in the system. It balances out. But if the Fed were to buy that stock, they create money from outside the system to buy that stock from me. The cash that would have been used by someone else to buy that stock is still there to be used for other purposes. I understand banks have reserves and ample liquidity, but if nothing else, QE increases that liquidity.
I just don’t follow your logic that QE is a swap. Doesn’t make sense and it seems there are lots of really smart people who disagree with you.
Tim,
TPC is wrong in his assessment and I can show you why. So, read on:
The Fed is creating money and buying newly issued Treasuries; the bond auctions of the past few months prove this fact.
So, the Fed is creating NEW money, the US government is taking on FRESH loans by issuing new Treasury bonds and the Fed is financing these loans by creating NEW money. THIS IS INFLATION 101 because the government is borrowing additional money and the Fed is creating money to finance these loans.
That is very very wrong. Govt bonds are only auctioned off in response to fiscal spending. This is elementary, PS. Besides, as I have repeatedly shown treasury bonds finance nothing. You clearly do not understand how our monetary system functions. I welcome comments, but this is so far off base that I would appreciate it if you not confuse people further.
Mr. Prag Cap,
Your fundamentals and definitions are TOTALLY wrong.
I know what I am talking about.
“Govt bonds are auctioned off in response to fiscal spending” what are you trying to prove???
The central bank is printing/creating new dollars to lend to the US government, which the government will spend in the real economy. That newly printed/created money will end up in the economy – this is inflation or dilution of the money stock. Every other argument is bogus and nonsensical.
Before you dismiss my thesis, go and get your facts right – otherwise, all your innocent readers/followers will go broke.
Inflation has no correlation with money velocity or net increase in private sector assets. Inflation is an increase in the quantity of money in the economy and central banks create inflation at will, and they do so in collusion with the bloody governments.
go and get your facts straight, otherwise, stop writing twisted economic jargon
Tim,
Have you read the Kocherlakota piece above? He is on the FOMC. He says:
“Second, QE creates more reserves in banks’ accounts with the Fed. The standard intuition is that this kind of reserve creation is inflationary. Banks can only offer checkable deposits in proportion to their reserves. Economists view checkable deposits as a form of money because, like cash, checkable deposits make many transactions easier. In this sense, bank reserves held with the Fed are licenses for banks to create a certain amount of money. By giving out more licenses, the FOMC is allowing banks to create more money. More money chasing the same amount of goods—voila, inflation.
This basic logic isn’t valid in current circumstances, because reserves are paying interest equal to comparable market interest rates. Banks have nearly $1 trillion of excess reserves. This means that they are not using a lot of their existing licenses to create money. QE gives them new licenses to create money, but I do not see why they would suddenly start to use the new ones if they weren’t using the old ones. With that said, I have indicated in earlier speeches that $1 trillion of excess reserves does create a potential for high inflation at some point in the future if the FOMC does not react sufficiently fast when it starts to see inflationary pressures. But I do not see this risk as being heightened in any meaningful way by banks holdinge ven more excess reserves than what they are holding today.”
Also see this piece from Hoisington which explains how changes in the monetary base are not changes in net money in the system:
“The monetary base, bank reserves plus
currency, does not fulfill these functions and hence
does not constitute money. To paraphrase Friedman
and Schwartz, the base, which is also known as highpowered
money (currency in the hands of the public
and assets of banks held in the form of vault cash
or deposits at Federal Reserve Banks) cannot meet
these criteria. The nonbank public – nonfinancial
corporations, state and local governments and
households – cannot use deposits at the Federal
Reserve Bank to effectuate transactions. Moreover,
currency is not sufficiently 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”.
http://www.hoisingtonmgt.com/pdf/HIM2010Q2NP.pdf
So you can see, there has been no change in the net financial assets of the private sector. Ben is trying to talk the market up and he is succeeding so far. But he can’t talk the real economy up and that is why this program is destined to fail just like it did in Japan.
If the Fed bought $100B in new California 2% bonds directly from the State Treasury (it is legally allowed to do this!!), the previously insolvent state would spend the money immediately on goods and wages, and private sector assets and bank deposits would increase by $100B. If the State used half of its $100B helicopter drop to retire old high rate debt, that would reduce private sector assets by $50B, but the state workers and vendors would still be spending an extra $50B.
If the Fed merely bought up existing California bonds from banks and hedge funds, private sector assets would not increase, and the interest stream paid to the private sector would be reduced.
QE can work to create inflation, but it does depend on what is bought and who it is bought from.
True and I have tackled this already:
http://pragcap.com/qe-muni-buying-game-changer
Would never happen though. This would be the Fed implicitly acting as treaury. They would never do it. It would be a political nightmare. But you’re 100% correct that this would be similar to a helicopter drop.
This is EXACTLY what the Fed has been doing!!!!!!!!!!!!!!!!!!!!!
It has been creating new dollars and buying newly issued Treasuries; thereby lending newly created money to the government, which has been spending this money.
This is INFLATION 101.
Either you believe this, or you are going to lose your shirt in the next few years.
PS, that is wrong. If they create money to buy the Treasuries than they are just replacing one asset with another. You seem to think that a treasury is somehow less “money” than reserves. That is patently untrue. A treasury is just as able to be used to purchase something as reserves. The treasury however produces more income, so in fact private sector income is reduced, which is deflationary, not inflationary. For the fed to print money, they would need to just credit reserves and spend it somewhere. That would be inflationary. In our system, that is a treasury function though, not a Fed function. So, until they print money by spending freshly created reserves without buying treasuries or other government obligations, they are not increasing the money supply.
PS, also when the Fed buys treasuries they are not lending to the government. They are buying from private actors, thus that money has already been lent to the government.
Lance,
When the Fed creates new money and buys Treasuries, there is NO swap of ‘assets’.
A Treasury security is NOT an asset, it is a LOAN taken by the US government.
So, when the Fed prints money and makes a fresh loan to the government and takes in a Treasury security in return, it is injecting new money into the economy via the government! This is inflation 101!
Lance & Mr. Pragcap,
If the Fed prints money and buys existing Treasuries, then one could argue that there is no inflation because this is an asset swap between the seller of the Treasury and the Fed. Amount of money in circulation does not change.
However, if the Fed prints money and buys new Treasuries straight from the government at an auction, then, this is inflation 101. This is what has been happening!
If the Fed buys up the entire Treasury 10 yr bond issuance at an artificially low interest rate, it will hold Treasury rates at that low level. It did this during WW II in order to keep the Treasury’s war financing costs manageable. The Government imposed wage & price controls, and issued patriotic war bonds to sop up the excess cash that would otherwise be chasing a limited and rationed supply of goods.
Fast forward to today.
If Bernanke financed the entire Federal defecit at a rate near 0% (directly to the Treasury), everybody looking for a place to invest money at a positive return would have to avoid T-bills and bonds, since the auction rate would probably go negative. If T-rates went negative, bank rates could go negative as well. The only place to put money would be in commodities, stocks, and risky debt. In essence, a truly serious QE program (monetizing the entire government defecit) is a way to force the public to invest in risky assets by eliminating any positive return from government debt.
Most people don’t know this, but the Fed IS legally allowed to monetize State debt as well. Bernanke is allowed to buy up the entire bond issues of insolvent states like California, Illinois, Nevada, Florida, Michigan, etc.., just like they way the ECB is buying Greek and Irish debt. And state governments will spend that money immediately, putting cash into the private sector. No one can deny that this would be very inflationary if it was done. Ben’s helicopters may yet fly!!!!!
1) The Fed can only buy 35% of any single issuance.
2) It would be a political nightmare if the fed tried to buy munis.
3) There is no historical evidence showing that QE actually drives down rates.
TPC: I am not trying to argue, but I must have lost a step somewhere in the fed’s purchase of treasuries on the open market. You seem to say it does not increase money in the system….fine. But, since there are so many others that seem to disagree or don’t understand, is there a diagram or something that can show why this is so?
I read the Hoistington link. But still not clear.
Tim,
I think the idea of equilibrium is confusing you. Imagine what happens when you buy tsys from the govt at auction. You can do this yourself. What will happen is that they will issue you a note just like they do with the PD’s. That note will be an interest bearing federal reserve note (basically your paper dollars with interest). What happens when that note matures? They issue you cash and the debt is retired. This isn’t any different than what happens when the govt buys back its debt. They receive the tsys and the PD’s get cash reserves. The key here is that the cash used to originally buy the tsys was ALREADY in the system. The fact that tsys were sold did not change anything. It only changed the term of your paper.
Is that more clear? You can see that when your debt matured you didn’t suddenly have this injection of liquidity. You had the liquidity all along. All you did was change the term of the note.
Tpc : I hear what you are saying, but when I buy a government note or treasury, it takes my money out of the system (avail money in the economy for spending). When the fed buys a govt note or treasury, it does not take money out of the economy because the fed purr based it with newly credited fed debt. I understand this does not create new money in the system, but it does allow otherwise unavailable investments to go elsewhere seeking other returns on capital. When the govt spends, congress that is, it clearly puts more money in the system. But when the fed buys that govt debt it created, it also forces other investment dollars to find other places to go. That’s the crux. Where does it go?????
Is that where the confusion lies? People realize that money otherwise spent on treasuries is forced to go somewhere else to find a place of return creating the “effect” of monetary creation ? Hmmm…..
Tjohnson,
When the Fed creates new dollars and buys a portion of new Treasury issuance, this act DOES create new money in the system and this is inflation 101!
Don’t barge in on conversations you clearly know nothing about.
Tim,
Except when you buy a treasury, it does not take money out of the system. It goes to someone else. Also, since the treasury is highly liquid, you can always use it yourself to spend, either through selling it or using it as collateral.
It is even more explicitly true with a primary dealer who considers reserves and treasuries as interchangeable from a liquidity standpoint.
Please don’t be so arrogant! Isn’t this a public blog???
Why do u keep telling me I’m wrong, when u clearly know nothing about how money comes into existence and why money creation IS inflation!?
Instead of demeaning my comments, why don’t you prove them wrong by reason?
Huh?
If QE does not drive down rates, why is the Fed buying Treasuries?
Of course, artificial demand for Treasuries keeps rates suppressed artificially!!!
What are you talking about Mr. Prag Cap?
Please stop writing stuff which makes no sense. U lose credibility
Right. So you know something the President of the Minneapolis Fed doesn’t know….Hmmmm.
TPC, I think maybe we should inform the Fed that one of their presidents doesn’t understand monetary policy as well as PS does. Hahaha.
The President of the FED knows everything. He just does NOT want the sheeple to find out what these crooks have been doing!!!
The bankruptcy of the US is not an accident, it has been designed by the cartel of banks known as the Federal Reserve System, which is neither Federal, nor does it have any reserves!!!!!
I guess this well explained post implies the QE has the effect of boosting confindence in asset prices , helping prices above fundamentals. In the absence of QE, what would happen to asset prices or confidence in asset prices? If asset prices where to fall, what would be the impact on the real economy?
Mr Prag Cap,
Soaring food prices, copper at $3.8, gold at $1,340, oil at $82
Some disinflation!!! LOL
Yes, because commodities are a predictor of inflation. Just like in 2008 when oil was at $150. That was so inflationary wasn’t it?
I don’t have the time to give you an economic lecture but I will say this:
Commodity prices rise as a consequence of monetary inflation. There is a lag between cause (money creation) and effect (price increases), so the commodity price increases today are only a symptom of the monetary inflation which has already occurred between 2008 and now.
Arrogant? I’ve been very patient with you and given you your stage here to repeat the same message day in and day out. The problem is, none of your commentary is supported by anything besides YOUR opinion. You’ll notice that I generally provide sources and evidence proving what I say. You, on the other hand, just scream about how you are right and everyone else is wrong. I’m fine with you having an opinion, but when you barge in on conversations and start poisoning someone’s mind who is trying to learn then you become a liability to the audience here. It’s not appreciated. If you’re going to “lecture” people in the future it better be backed up by evidence.
I always present facts. YOU on the other hand keep presenting your flawed opinion as gospel! PLEASE STOP telling people why the fed buying newly issued treasuries does not result in inflation! Because it does!!!
Very persuasive article. I hope Mr. Bernanke has not trapped himself into a single pre-baked view of the world.
But I have two questions for anyone that can answer correctly…
1. Does QE increase national debt?
2. If yes, does it therefore increase future taxes?
VLC,
QE does not increase national debt. The national debt only increases when the US government takes on new loans by issuing Treasuries.
As and when federal debt goes up, the government must find new ways to service this debt, therefore it raises taxes.
OK… thanks very much for your reply. And if you know of any good article which points this out, please post a link.
My next question…
If QE is a way to create money, but without increasing national debt or taxes, why is it worse than creating money by increasing national debt (and taxes)?? So long as the Fed does not create more money than is actually needed or up to some notion of the value of the nation’s total assets, then it seems a perfectly reasonable method to create money; in effect as a national service. Why is this not a reasonable approach to creating money? And presumably if they do create too much, there must be an equally simple way to destroy the excess, no?
Many of you seem to think Bernanke may be sinister…. better that, than incompetent!
OPEN CHALLENGE TO MR PRAG CAP
Mr. Prag Cap,
You have been pounding the table and saying that QE does not result in inflation.
Now, I will show you HOW and WHY QE (money creation) is inflationary:
Suppose the US government needs to borrow $100. Usually, the government would buy it from investors who would send $100 to the government and the government would give them an IOU (Treasury certificate) in return.
Now, for whatever reason, suppose investors in the world do not want to lend this money to the US government. In this case, the Fed steps up to the plate, prints $100 and lends this money to the US government and in return, the US government gives it an IOU (Treasury certificate).
In the second instance, QE (money printing) DOES result in inflation BECAUSE now the money in circulation has increased by $100. In this case, there is no asset swap. $100 of new money has reached the government which will then turn around and spend this newly printed money in the economy and ultimately, this newly printed cash will reach the private sector.
NOW, I challenge you to disprove my argument above and I dare you to tell me how the second instance does NOT cause inflation.
The Fed has been buying newly issued Treasuries for months and this is inflation 101. Now, instead of dismissing my thesis, I invite you to discredit me with facts and clear explanations.
Go on, show me why I am stupid and you are the man.
If you fail to discredit me, then promise you will never say that QE is not inflationary.
That’s easy. When the Fed buys back debt it is simply buying back a note that was already issued by the US govt. So, it goes like this. The US govt spends some amount of money, bonds are issued to account for this and then the Fed comes back and buys the bond. Big deal. It’s not lending to itself. The US treasury isn’t getting this money and spending it. That’s not how our banking system works. Govt debt doesn’t fund anything. These are pure monetary operations and they’ve been going on for ages.
The Fed is an independent entity whose operations are not subject to Congressional budgetary constraints.
“The intent of Congress in shaping the Federal Reserve Act was to keep politics out of monetary policy. The System is independent of other branches and agencies of government. It is self-financed and therefore is not subject to the congressional budgetary process.”
http://www.federalreserve.gov/generalinfo/faq/faqfrs.htm#7
http://pragcap.com/mmt-101
http://pragcap.com/n-y-fed-explains-government-spends-issues-bonds
Mr.Prag Cap,
U r so wrong on so many accounts, that I don’t even know where to start!
So, let me correct you in a systematic manner:
a. “The US Treasury is not getting this money and spending this” – This statement of yours is so silly and I am totally shocked that you would write something so naiive as this!
If the US Treasury is not spending this money, why is it borrowing it? Of course, the US Treasury spends the money it raises from Treasury issuance. Have you not seen the out of control spending by the US Treasury or government??? Have you never heard of the budget deficit which is around 9% of GDP?
b. “Government debt does not fund anything” – Really now? So, if government borrowing does not fund anything, who pays for the wars, who pays for social security, medicare and medicaid and why does the US have a monster budget deficit?
When the US government borrows money by issuing new Treasuries, it ALWAYS spends this money in the real economy and this INCREASES the quantity of money in circulation. This is INFLATION 101.
Honestly, now that I have ripped your bogus arguments apart, you should be man enough and admit your error in judgement. And if you don’t, I will lose all respect for you and stop participating on your boards.
What I will not stand is if you continue to act as though u r right, please admit your mistake. If you want to discuss this further, I dare you to post this exchange of ours on your homepage as an entry and then you will know how many people will laugh at your stupidity.
The spending comes first. The bond issuance comes second. You didn’t read the links I provided.
Good BYE!!! I’m NOT going to waste my time on your ridiculous self serving website any longer. All you do is insist (even though you are totally wrong) that you are right and like mr. bob prechter, you keep beating the same drum!
Good luck to you and all the other deflation bugs, good bye.
Well, currently calling for more disinflation with a risk of deflation….Anyhow, good luck to you.