GOLDMAN: LOWER INFLATION RISK CREATES HIGHER ODDS OF QE3
Goldman Sachs says there is a strong likelihood of inflation slowing in the coming year. And this means the Fed is likely to try to create more inflation via further QE. In a recent note they said:
“The weaker data on economic activity have clearly raised the probability of renewed monetary easing by the Federal Reserve. In his monetary policy testimony this week, Chairman Bernanke’s main argument against renewed easing was that inflation is now significantly higher than it was in the summer of 2010. Indeed, the core CPI for June released on Friday showed a pickup in the 6-month annualized inflation rate to 2.5%, clearly above the “mandate-consistent” rate of 2% or a bit less. However, we may well have seen the highest inflation figures. Exhibit 5 shows that underneath the surface, both the “median” and “trimmed-mean” indexes—statistically based measures of underlying inflation that may be preferable to the better-known core CPI—showed a notable slowdown. Therefore, we still expect core inflation to slow substantially on a sequential basis over the next year.
Moreover, if the economy returns to recession—not our forecast, but clearly a possibility given the recent numbers—Fed officials would undoubtedly ease anew even if inflation is close to their target. Indeed, Chairman Bernanke laid out the possible options for such a move in his monetary policy testimony this week, namely a change in the forward-looking language in the FOMC statement, a cut in the interest rate on excess reserves, and—last but certainly not least—an increase in the size and/or composition of the Fed’s balance sheet.”
This is accurate in my opinion and really gets to the heart of why the Fed’s policies are so misguided. Because QE does not alter net financial assets it does not actually alter the private sector’s economic standing. Therefore, referring to QE as “stimulus” is entirely wrong. All QE has been proven to do is alter nominal asset prices via psychological channels. And while there are broad beliefs that this generates a “wealth effect” the most recent bout of QE confirms my original beliefs that QE would be a monetary non-event and would instead serve as a margin squeeze on the entire economy as the Fed does indeed help create higher cost push inflation which actually resulted in lower real GDP….Furthermore, we all know, after 20 years of the Greenspan and Bernanke put, that the Fed can help further financialize the US economy by keeping asset prices higher than they otherwise would be. Unfortunately, because we haven’t learned form our past mistakes, we continue to repeat them….
CR,
“All QE has been proven to do is alter nominal asset prices via psychological channels.”
Yes I agree. But do you think if QE was implemented properly (ie: targeting price rather than volume) it can actually be effective? If so, what 10-Y T market yield would be stimulatory to the economy?
Keep up the good work!
But do you think if QE was implemented properly?
I certainly don’t. It was a non-event. What is needed is fixing the balance sheet recession. Either by reducing taxes on the middle class (a bunch!), ending the payroll tax or starting a massive WPA jobs program to fix our infrastructure.
Instead of making statements of the obvious, i.e. that weak economic data raise the likelihood of QE3, perhaps Goldman Sachs could tell us which politicians they’ve recently bribed – sorry, I meant tell us in what ways they have recently been “doing God’s work”.
Instead of making populist moronic statements on Pragmatic Capitalism, why don’t you make your ignorant comments over at ZeroHedge where your ignorance will fit right in.
WOW! Almost makes me think that some people here work for The Firm, which would make me really happy cause may be next time they could end up pushing for a Treasury Sec. that understands MMT.
Ralph Musgrave is only using official Blankfein’s terminology to make a bit of a joke, I would definitely not call him a moron or a populist because of that. And I agree with his point that the data presented does not bring too much info to a thinking person. It would be great to see an analysis of the value to the economy of QE3 and whether or not there could be more interesting alternatives. Like for example using their economic knowledge and political cloud to push for the right solutions in the open, as if they really gave a damn about the USA’s future.
And BTW, GS is actually fully backing Romney according to their current political donation track record. It seems that Obama has managed to make lots of enemies in WS w/o really doing anything significant to reduce the over-financialization of the economy – that is statesmanship of the worst kind.
The way I see this playing out is another leg down in housing occurring in the winter due to three factors: the traditional seasonal weakness on-top of a weak summer rally (~1%), decrease of the jumbo loan limit (down to $625,000), and increased foreclosure sales by undercapitalized banks (BAC, C). This will register as a decrease in the inflation numbers, causing the Fed to go back to their playbook.
I imagine the Fed will incorrectly diagnose the positive response of QE as a result of the purchase of MBS and the ineffectiveness of QE2 as the result of ineffectively pushing down Treasury yields. As a result, any form of QE3 will result in the purchase of MBS as a result of the Fed not knowing better, with the functional targets of attempting to arrest the housing decline and bailout out the weak banks (again).
“Because QE does not alter net financial assets it does not actually alter the private sector’s economic standing.”
QE also effectively allows the government to borrow at 0%, as interest payments on bonds owned by the Fed are remitted back to the Treasury. This impedes those parts of the private sector that need to borrow at market rates, where those private entities compete with the government for access to resources. It also artificially numbs the government to the need for deficit reduction, because it is not paying the full market rate for borrowings.
You misunderstand the monetary operations of the US federal government.
http://pragcap.com/resources/understanding-modern-monetary-system
The government does not compete with the private sector for funds. A treasury sale of bonds is just the opposite of QE, its a swap of reserves for bonds.
“You misunderstand the monetary operations of the US federal government.”
In what way?
“The government does not compete with the private sector for funds.”
I said that the government competes with the private sector for resources. I mean physical resources – labor, materials etc.
“A treasury sale of bonds is just the opposite of QE, its a swap of reserves for bonds.”
This is not correct. The government is legally obliged to buy bonds to cover the reserves it creates. The Fed can do so (or not) at its discretion.
In addition, a treasury sale of bonds creates new bonds. QE does not destroy bonds.
Sorry: “The government is legally obliged to buy bonds” should be “The government is legally obliged to sell bonds”.
Stop debating useless issues.
QE3 is baked in the cake and will be followed by QE4, QE5 into infinity.
Yes, it does not make economic sense but the Fed is not acting for the benefit of the society – it never has and never will.
The day you guys realise the true agenda of the central banks, you will understand why QE infinity will now follow.
This is a war between the bankstas and the people – open your eyes and forget about all the economic mumbo jumbo including Austrian school, Keynesian or MMT!!!
WAKE UP SHEEPLE; YOU ARE BEING ROBBED IN BROAD DAYLIGHT!!!!!ARGGGGGGGGGHHHHHHHH!!
Yes, the FED will try to implement QE3. But when all asset classes go down the drain in price and the USD through the roof (like in the 2nd half of 2008) then the FED is “”pushing on a string”". The FED can only try QE3, 4 or 5 when there’s a willing speculator who’s willing to borrow that money to long one or the other hot “”long”" story.
And it seems there’s one MAJOR indicator turning a corner. That indicator is bonds spreads. That’s where the rubber meets the road.
While some of what you say about QE is true, there’s still a huge disconnect between these comments and your claim that Japan’s biggest problem was deflation.
If Japan’s biggest problem was deflation, why should the same not apply here? And, given that you agree that QE counters deflation, why do you see no value in this?
The fundamental objective of QE is to put more money in people’s hands by making banks more willing to lend by increasing their reserves – it swaps treasuries for reserves. The fundamental problem with this approach is that it doesn’t work. Bank lending is not restricted by its reserves, QE just increases the amount of reserves and no money flows to the economy. That is why Cullen and others talk about pushing on a string. Banks do not want to lend independently of how high their reserves level is.
At the same time, the perverse effect is the fact that most people wrongly believe that the Fed is “printing money” and therefore rush to buy commodities to protect themselves of inflation or to speculate that others will want to protect themselves from inflation, which ends up raising commodity prices creating the worst kind of inflation: producer prices go up but incomes do not and therefore you are just reducing profits – companies cannot pass their full price increases to customers – and end up crashing down again. The whole cycle only drives instability and therefore inflicts more pain in the economy.
The Fed cannot really solve this private balance sheet recession. The only way to create healthy inflation is to raise aggregate demand and to do that you need to increase Federal investments (and note that I use investments, and not spending) and reduce taxes on middle class people – that is money that will be spent and/or used to reduce their debt levels.
Until the political leaders understand this there is no way out, but rather this up and down dance. Add to this situation the set of budget cuts coming down the drain, that will be extremely hurtful, and we have a rather gloomy forecast for the economy. This is why only the II World War ended up taking the USA out of the great depression. I just hope that we do not need a war of such proportions this time.
There are several problems with your argument, but the main one is that it doesn’t address the real world. The reality is that we won’t see the govt spending and deficits that you would like. Cullen, you and I can pontificate all we like about what should happen, but the Fed has to deal with the world as it is. And that world is one of insufficient demand. If we did have demand, we wouldn’t have seen QE2 in the first place. So, given insufficient AD, what should the Fed do? Reduce short term interest rates??
Cullen is right to say that deflation was central to the problems in Japan, but wrong to think for some unexplained reason that the same doesn’t apply here. It does, and if the Fed doesn’t respond next time deflation gets near again, we will find out what it’s all about.
CP,
I am still working on that CA response. Promise! I’ve just been slammed lately.
What is your logic behind the idea that QE worked?
Thanks,
Cullen
QE clearly didn’t solve our problems, and I agree with you that, the versions of QE used so far can’t completely solve our problems. But even the current version of QE does more good than harm, and in the absence of govt action, is necessary. I think that, compared to what would happen without QE:
- expected real interest rates are lower
- the dollar is lower
- inflation is higher
- asset values are higher
- investment is higher
In some situations, some of these things would be harmful, but in a balance sheet recession, they help.
I would also see what has happened so far as only one, fairly conservative version of QE. In contrast, consider a version where the Fed bought private homes (or other non-bank assets) instead of Treasuries. If they did that, it would act in an almost identical way to the govt spending/deficits that you have called for.
For illustration, if they bought every home for double its current market value, or its value in 2005, the balance sheet recession would vanish over night wouldn’t it?
Buying homes at marked up values is unrealistic and the worst form of malinvestment. They might as well just send everyone a check rather than distort the market in such a manner.
You still don’t explain how QE helped. Specifically, what was its transmission mechanism. For every positive you claim, I can claim an even worse negative. We can start with the fact that housing is down, commodities have risen substantially, cost push inflation has soared and real GDP has declined. I don’t see a shred of evidence linking QE to the idea that it was a net positive for the economy….
Buying up homes is not malinvestment. Building too many McMansions, or laying too many miles of telecom cable are examples of malinvestment, because they are mis-directing real resources. Here we’re not directing real resources at all, so it’s not malinvestment. It may be (intentionally) inflationary, but it’s not malinvestment.
You say we may as well send everyone a check, and you’re right, it’s much the same. It’s much the same as giving everyone a tax break, for example. But the point is, despite what you say, it’s much more realistic than those similar mechanisms, because they rely on govt deficits. To be realistic, we have to accept that we’re not going to get big deficits. They’re just not politically possible. We need to start looking for the alternatives, and a broader version of QE is one of them.
The homes example is just illustrative, but it proves the point that QE could end the balance sheet recession. I don’t see you arguing that it wouldn’t, you’re just saying it isn’t realistic, but I don’t really see why. A more practical version would involve, for example, the Fed allocating $100 billion installments to a real estate fund, which bought assets at market value, starting with the most depressed areas. We’d maybe need federal budget for a few hundred people to run the fund, but this is a manageable number, even in austerity. There’s no reason it couldn’t be made to work.
As for the current version of QE, the transmission mechanisms are the ones I gave above. But it’s important to note that these are, as I said, “compared to what would happen without QE”. We can’t tell what the world would have been like without QE, but there are logical reasons to expect the conditions I described above. It makes no sense to say that housing is down, or GDP is down so QE must be to blame, because there are other factors at work here too. If you want a version of QE that definitely sends housing up, I’ve given you one.
Also, on the subject of other factors at work, I think you make too big a deal of the link between QE and commodity prices. It’s impossible to separate out all the factors, but I would argue, for example, that supply issues have been a much bigger factor in food prices than QE has been. I would also argue that there is no reason to believe that commodity prices would have risen any less if recovery was being driven by govt spending, with no QE.
For example, any time we increase global aggregate demand now, we’re going to see oil prices going up rapidly. That’s the way it’s going to be until something structurally changes the supply and demand imbalance in oil. What spare capacity there was in conventional oil, has gone. Even the Saudis are investing in heavy oil and things they wouldn’t have touched before. Given that we’ve also had political revolution in the middle east, it’s hardly surprising how oil went up. It would have done anyway, regardless of QE.
Well, before we take this conversation a step further we should acknowledge that the Fed is not legally allowed to buy houses. They are limited to only federally insured paper, which includes Treasuries and mortgage-backed securities insured by Fannie Mae and Freddie Mac. So, it’s all a moot point. If the US govt were going to buy pvt homes it would have to come in the form of deficit spending. As you said, that’s just not happening.
It’s also important to note that high levels of mortgage related debt also contribute to other harmful effects in this structural environment. Among these are, reduced discretionary spending for extended periods of time, higher bankruptcy since it is highly unlikely that people will be able to service debt for 30 years since income is not stable, and reduced household formation. Propping up asset prices now just sets us up for a harder fall later on.
See http://www.themoneyillusion.com/?p=10061 for the last one.
It’s not a moot point: first because it shows that at least one form of QE could end the balance sheet recession. There’s no economic reason why it couldn’t, and I don’t see you making that argument.
Second, it’s not actually clear what the Fed can and can’t buy – and what it can buy can always be extended. Many people said it couldn’t do TALF before it went ahead and did it. The fact is, so long as it’s not spending Funds given to it by the Treasury, it can go ahead and spend how it chooses. Even where there are restrictions on the assets it can hold on its balance sheet, as Bernanke has noted before, this is no real impediment to the Fed making loans to another body, like a special purpose vehicle, that holds the assets directly on its balance sheet. Same result.
The Fed also has an “unusual and exigent circumstances” clause that allows it to do pretty much anything it wants in those unusual circumstances e.g. deflation. Bernanke has said before that if deflation actually appeared, he would want to extend the type of assets that they buy, and I believe him.
Wulfrum – you have it backwards. The policy would reduce the mortgage burden, not increase it. It’s not there to set off a housing boom, it’s there to stabilize the market. One of the metrics would be something like: once you get within 10% of the 2005 price in a given area, you stop buying there.
I had a look back at TALF, and what I’m outlining here is really just an extension of that. TALF shows that what I’m describing is possible.
TALF also uses an SPV to hold the assets. I don’t see a big distinction between real estate and the sorts of assets involved in TALF – student loans, credit cards, small business loans and the like. Matter of fact, the assets I’m talking about are probably better quality.
The only question is whether we still have “unusual and exigent circumstances”, because those were legally necessary for TALF. To me, the answer to that is obvious: of course we do. Balance sheet recessions don’t come around to often. The unemployment situation by itself is “unusual and exigent”. The danger is that we come to think of it as normal.
http://kingworldnews.com/kingworldnews/King_World_News.html
Zulauf talks about inflation peaking as well……
BofA Needs to Build $50 Billion Cushion for Housing Losses (Bloomberg)
http://www.bloomberg.com/news/2011-07-18/bofa-mortgage-settlements-magnify-capital-strain-as-50-billion-gap-looms.html
Moynihan, 51, has booked about $30 billion in settlements and writedowns to clean up mortgage liabilities at the biggest U.S. bank since succeeding Kenneth D. Lewis last year … The company reports second-quarter results tomorrow and has told investors to brace for a loss of as much as $9.1 billion.
“The charges have had the effect of reducing mortgage uncertainty but have pushed dividend increases further into the future,” Richard Staite, an analyst with Atlantic Equities LLC, said in a June 30 note. Staite and Goldberg both estimate that Bank of America needs to raise $50 billion to comply with the new capital requirements, designed to build a buffer against losses and avert a repeat of the 2008 financial crisis.
Under rules prepared by the Basel Committee on Banking Supervision, Moynihan has to achieve a 9.5 percent ratio of capital to risk-weighted assets between 2013 and 2019. That’s based on a 7 percent minimum and a 2.5 percent surcharge imposed by regulators on the largest companies whose collapse would pose a threat to the banking system.
Moynihan’s task was complicated after he underestimated how big the capital surcharge would be. The bank counted on 1 percentage point, an assumption based upon “fairly senior information saying that was a reasonable number to use,” Moynihan said in a June 1 conference. The 2.5 percent announced last month means an extra $27 billion burden.
Higher odds for QE3 ? When I look at the silver-gold ratio then QE3 is already being rolled out.
The analysis is off a bit. QE is all about the stock market. Lower stock market levels (S&P 1150) will create QE3 — not lower inflation although that might be the excuse for it for propaganda purposes.
The world outside the US is in no postion to pay another Imperial Tax.
The US petrocurrency is destroying all Capital formation.
“The US petrocurrency is destroying all Capital formation.”
Isn’t there a lot of that going on right now? Maybe even too much, looking at, for example, industrial capacity utilization in China, their empty housing complexes, etc, with investment still making up half their GDP?
Sorry , I have a very narrow understanding of capital formation such as new energy plants, technological & agricultural innovation etc etc
Houses and the like is just consumption in my book – some necessary and some not.
Liked what Warren Mosler said about QE some time ago:
“The mood now is there will be QE 3,4,5 or whatever it takes until it does work.
Like the kid in his car seat who keeps turning his toy steering wheel as much as it takes to turn the car.”
Yes, that’s a good one.
What we need is more and better jobs. What happened to them? Big Money decided they owed this country nothing and moved them with the help of tax incentives. The American people provide these creeps with the safest place on earth to do business- and they owe us nothing?? Congress does nothing to promote jobs because it would possibly transfer wealth which is not the goal of Big Money. It’s OK to transfer wealth up but down, that’s SOCIALISM! (Note: social policy is not the same as socialism). What does this have to do with the Fed? Well, the Fed is about all we have to work with. I would agree that QE leaves something to be desired but I dont think it has been a complete bust. Bumping up stock prices, which influences wealth perception, and lowering borrowing costs is better than nothing. I would agree though that each successive QE will become more problematic. Even more problematic is a government that can’t lead us to more middle class wealth. That is the answer to the balance sheet recession.
“government that can’t lead us to more middle class wealth.’
It never did. What the Government created is not the middle class its the entitlement and welfare class.
Sorry did not mean to post as anonymous.
I also see my name. I was posting as raddadd.
Cullen, first, let me express my gratitude for your site which is one of the bests, if not the very best.
Having said so, I have to admit that I completely do not agree with some of your theories. I specially cannot find common ground with you on the role of a government. I mean governmental investments. It seem to me like you don’t care about quality of a governmental spending which (according to you) should counterbalance a deleveraging of private sector. But in my view, it is a very shortsighted policy, because in many cases it leads to waste of resources in the long run. The simple truth is that in the long run it doesn’t matter if investment is public or private – it should be profitable to pay off interests and principal. I know, you will say: “US wont go bankrupt”. Yes it is true. But inflation and taxes are the same. Therefore someone have to pay – there is no free lunch.
Anyway, all MMTiers, please introduce yourselves with new piece from Hoisington http://www.hoisingtonmgt.com/pdf/HIM2011Q2NP.pdf
TT,
I am keenly focused on efficiency of govt spending. That is why I have not supported much of the spending over the last few years. In my treatise I said:
You might review the entire document here. I refer to the importance of productivity many many times….
http://pragcap.com/resources/understanding-modern-monetary-system
might i ask what are the long term productivity gains in the public sector versus those in the private sector. what we are seeing in the US is a massive and unprecedented shift of capital towards the public sector. if this has been a questionable practice in the past, what on earth makes it such a good idea now ?
There has been no substantive decline in wages vs productivity in the USA. It’s been uneven across wage earners (thanks is large part to financialization), but on a broader scale the two have tracked nicely.
http://pragcap.com/wp-content/uploads/2011/07/comp.png
Dear monetary theory = please meet gold!!!
Gold may just explode because all of these monkeys have no idea what they’re doing.
But do not think the Fed is ignorant for a minute. They have a limited tool set, and BB is gonna widen it considerably, imho.
QE 1 and 2 did just what it was supposed to. So will QE3 and that will probably do more…
“Therefore, referring to QE as “stimulus” is entirely wrong.”
CR – let me take issue with this again. QE is indeed financially stimulative, in the following manner: QE reduces funding costs to ZERO. As in nada.
The most recent round of $600B in QE transferred $600B in treasuries from the Treasury, to the private Sector and finally to the Fed’s balance sheet. Treasury has to pay interest to the holder. The holder in this case is the Fed. For argument’s sake – lets say the blended interest rate is 3%. That is $18B a year in interest that the Treasury pays the holders (the Fed). The Fed turns around and returns this “profit” to the Treasury. Net cost to Treasury for this $600B: $0
That’s a net drain from the pvt sector. If they remove 600B in paper paying 2% and replace it with 0.25% paper then they’re reducing interest income to the pvt sector.
So shouldn’t that cause a slight increase to the dollar?
The net loss to the pvt sector is something like 10-20B. In a forex market as large as the USD that’s not moving the needle an inch.
Right, but at least it is not the dramatic weakening that most think. And doesn’t that set up a future wakeup call?
Future wake up call meaning what exactly?
I really don’t understand FOREX and I’m grasping at tools to help me out concerning the EURO and the Dollar. It is just a gut feeling, but I think I see a future much weaker Euro and with Dr. Bernanke not too eager to QE3 that the dollar could go very strong to the Euro sometime before next year this time.
Or at least a reduction in the weakening of the dollar.
Boy I may get flamed for this. This time they need to QE the people and hand out the money to us. This is the only way for more stimulus to work.
Most will spend the money helping the community and crank up some jobs.
Never thought I would state this.
That’s called deficit spending. And it should come in the form of tax cuts as I’ve long proposed.
will the fed ever be audited?
nevermind, if they went broke they could simply bail themselves out.
Tax cuts produce economic growth that increases tax revenues down the road via a larger tax base paying taxes at somewhat lower rates. It’s the Laffer Curve, supply side economics, Reaganomics etc. If you look at the growth in tax revenues over the years, it worked as stated. Of course, spending grew much faster than revenues in the welfare-warfare state beloved by Democrats and Republicans alike.
MMTers, watch out. You’ll be cast as closet Reaganites for your love of tax cuts.
Wow thought I would get flamed. I came to this site originally to flame all you idiots. I bought into the rhetoric. I knew something was wrong and read your threads and the MMT makes sense. Trying to talk to friend is a different story. They call me a Marxist. We have tried everything else and it is not helping the country and Cullen how would that be done with tax cuts? If you could explain that a bit further I would appreciate it.
I look at the politics and the crap out of washington and some of the pundits and know one they are lieing or they just do not understand. A mind is a terrible thing to waste and alot of folks are wasting away, even when you try to explain to them and give them facts.