MISUNDERSTANDING THE EFFECTS OF QE2 WAS A GRAVE MISTAKE….
No story has dominated the market news flow in the last year like QE2. From its very inception I said the program was a “monetary non-event” and not going to achieve its targets for several reasons (it’s not money printing, it doesn’t alter the amount of outstanding private sector net financial assets, it’s not debt monetization, etc). But perhaps more importantly, I’ve discussed the potential negative effects the program could have through the channels of misconception. In other words, the myths of “stimulus”, money printing and debt monetization were all likely to fuel investors with a misguided perception as to how the program would impact the real economy.
I have called this effect an embedded disequilibrium in the market caused directly by the Fed and exacerbated by market participants who quite simply don’t understand what QE is or how it actually works. From the perspective of the Fed, they thought they could “keep assets higher than they otherwise would be” (infamous last words of Brian Sack of the NY Fed). But because QE had no transmission mechanism through which it could impact the real economy it in fact only created a disequilibrium between market expectations and the real economy via psychological channels. And as the real economy has sunk we’ve seen much of this embedded “Bernanke Put” come out of the market in the last few months.
In just the last 24 hours we’ve seen the wheels come off of the “Bernanke Put” bus. The markets appear to be realizing that the Emperor truly does have no clothes, that QE isn’t all it was cracked up to be and that the Fed can’t save the economy with their magical printing press (don’t worry – the Fed doesn’t print money anyhow, but that’s for another day).
Back in April I wrote a piece describing the enormous risks in the market due to this put:
“In a similar note to thought #1 – there is the potential for a very frightening market development in the coming years (work with me through this hypothetical). Let’s say the Bernanke Put continues to cause asset prices to deviate from their fundamentals – the economy continues to recover (marginally), but the Bernanke Put becomes so ingrained in market perception that the disequilibrium in markets expands. This results in an imbalance so severe that market bubbles appear (could already be occurring in the commodity space). What happens to the market if the disequilibrium Ben Bernanke causes results in some sort of serious market dislocation similar to 2000 or 2008? All it would take is a minor exogenous threat to cause a global panic. It could be surging oil, a slow-down in China, a repeat of the Euro scares….The result would not only be economic slow-down (into an already weak developed market), but potentially crashing asset prices as bubbles have a tendency to overshoot on the downside. But it’s not the recession that would scare the markets. It is the potential backlash against the Fed.
After three bubble implosions in less than 15 years (all somehow directly tied to Fed intervention), I think the public would call on Congress to revisit the Fed’s dual mandate, its impact on markets and whether their actions over the last 20 years have been appropriate. The rational response would be to reduce the Fed’s role in markets. From a societal perspective I think this is an enormous long-term positive. The sooner we get the Fed out of the market manipulation game the sooner this economy can stabilize, definancialize and get back to becoming the economic growth machine that it has been for so long. For the markets, however, this would be a traumatic event. Imagine 20 years of Greenspan/Bernanke Put being sucked out of the market…it might sound far fetched right now, but I have a feeling the Fed will be far less involved in markets at some point in my lifetime. It might be wishful thinking, but I am confident that America will wise up to the destruction this institution causes by constantly distorting our markets and economy.”
Now, I think it’s a bit hyperbolic to say that the markets have lost faith in the Fed entirely, but I think we’re certainly seeing the market lose some faith in the Fed’s omnipotence. 20 years of flawed monetary policy, mythical thinking about the workings of our monetary system and misguided market intervention bring us to this point. Unfortunately, misguided policy has now created such disequilibrium in the markets that the backlash has the very real potential to cause real economic declines. So buckle up folks. We’re living in a golden age of economic transformation and theory. Unfortunately, that means we have to erase the decades of myth and fantasy perpetuated by the same neoclassical economists who got us into this mess in the first place (most of whom are still driving this bus). And that’s going to cause a great deal of policy error, misconception and uncertainty. Hopefully in the end we’ll come out of this a bit wiser. One can hope….
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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67 Comments
I just saw a survey result on cnbc asking whether investors had
confidence in the FED. 70% said no confidence.
this could be a knee jerk reaction though — along the lines of
the equities baby crying and having tantrums
It is a mess. Everyone needs to decide what principles they operate under. No principles, you will be rolled over.
Are you selling your crystal ball any time soon? It seems like a good one.
Ha. Everything’s got a price, right?
Crystal ball or time machine? It matters because one can be easily stored and the other cannot. And while a time machine would be worth a lot of money I just don’t have the room in an NYC apartment for something like that. I’ll start the bidding on a crystal ball at $1,000.
Its like printers and printer cartridges. The crystal ball is surprisingly affordable, the money is in the long-term service contract that goes along with it.
)
I like to think of Cullen as a modern day Cassandra. Hopefully the powers that be decide to listen before Troy burns.
Awesome post Cullen.
Old school yield curve analysis would state that a flatten of the yield curve is restrictive policy. Would you agree?
They aren’t flattening the yield curve just for the hell of it or to rearrange deck chairs. They are doing it for Obama to forge ahead with his mass automatic refi program to put more cash into the pockets of voters. No other explanation makes sense, and the biggest clue is Ben’s committment to buy mortgage backed securities with the money that comes in from refis of the existing ones. Cutting the 30 year rate will allow refis to be done at very low interest rates. Even as low as 2%. To make it work, the Fed will eventually have to buy up all the new MBS that come from the refis and hold them to maturity, but they have plenty of money to do that right now without printing more.
My only question is whether Obama (or his appointees at Fannie and Freddie) will have to competence to make the mass automatic refi program work? All of their mortgage restructuring programs have so far been big flops.
My concern with the Fed’s policies isn’t that they are ineffective, but that the goals are wrong. They seem to be doing everything they can generate credit growth. It hasn’t worked, but if it had, that would have been a terrible outcome.
The Fed seems to believe that the only problem with their policies is that they haven’t done enough. Will they ever be forced to conclude that ZIRP, QE and the twist don’t lead to credit growth in the current environment? And, if they reach this conclusion, what might they do then?
This is your best post so far!
I’ve enjoyed walking through the economic fires, policy mishaps with you and the other here for some time.
For what could be a bad week in the markets has turned out to just be a normal week for us.
Thanks CR again..that’s all. Thanks for educating me on MMT and the true mechanics of many of the operations I still am learning about. Can’t thank you enough…for also openin the diolgue up to not sensor many commentors. Even the crazy questions helped me because it allowed more seasoned thoughtful readers to explain different aspects. That helped me connect the dots. You really created something special here.
Your site is like my personal advisor. Something happens and I come here to read the minds of the TPC.
Time value of money either is in premiume or discount.
The world stewards of our economies continue to beleive we are in the premium stage when in fact we are in the discount phase.
When the world is puking we will have entered into the transition phase…the chasm between the premium and discount phase.
Time value of money either is in either a premium, transition or discount phase.
The world stewards of our economies continue to beleive we are in the premium stage when in fact we are in the discount phase.
When the world is puking we will have entered into the transition phase…the chasm between the premium and discount phase.
I’m not sure the wheels of the bernanke put have come off. I wonder had the fed increased the balance sheet would the market of rallied. I don’t think very many people truly understand or believe yet that QEs are a non-event.
Is the market throwing a fit or is it realizing the fed’s impotence? I think it will take more time to see.
I’m scared the fed will try more QE if deflation kicks in. In the end, it may take further follies by the fed to prove their impotence. So its good, but bad at the same time. I just hate to see main street have to deal with the pain when some fiscal policy could help.
I also think that the market expected QE and plunged when it did not get it. The misconceptions have not gone away. I read a lot of posts on Seeking Alpha and the vast majority of people still think QE is money printing that devalues the dollar and therefore you have to buy gold, and stocks go up, and all of the other familiar memes. Karl Marx had the brilliant idea that exposing misconceptions does not devoid them of the power to still guide human behavior. Essentially all human ideas are more or less misconceptions. You can see this in Kuhn’s analysis of scientific revolutions where a new paradigm replaces an old one. They are both wrong in the sense that they don’t represent perfectly the reality they are supposed to represent. They are just useful approximations.
I already knew the Greenspan put or the Bernanke put didn’t exist. When no asset class goes up in price but down then that put from the FED is “”Dead in the water”".
The notion that a central bank can rescue the stock- or the bondmarket is absurd. The only that’s holding up is the Treasury market. But if banks/investors/traders/speculators have severe liquidity problems then they WILL sell everything including T-bonds. And that’s the point where the gig is up for any government. The Greenspan/Bernanke put is a notion that’s made out of hot air. Like the notion that the FED (or any other central bank) can determine (long/short term)interest rates.
Ok Bond Vigilante/Willy2/Ron Artest/MetaWorldPeace
“47% of the US 14.7 trillion U.S Federal Government debt is held by the Federal Reserve and the government itself, such as the social security trust fund. Add to that the 22% foreign official holdings(mainly central banks) and almost 70% of the debt of the U.S govt. is held by non-market/non profit oriented investors.”
Global Macro Monitor
Sooooo I hope they change the cold call laws to allow you to solicit the 30% avialable pool to convert into the Bond Vigilante Gang…cause just doing some simple math on what I would estimate based on the numbers…your Bond Vigilante gang doesn’t stand a chance.
Based on the numbers here I agree with you about the notion of the Fed being able to determine rates. It’s not a notion..
There are so many allegorical and physical metaphors to describe the action of the US bond market – Icarus, or defying gravity. That market is acquiring a dream-like (nightmarish if you are rational) quality that is so headed for a crack-up. To think that investors are frantically abandoning stocks, gold, inexpensive quality assets of all types for one than can never be settled at maturity on any other basis than Ponzi is truly insane.
“but I think we’re certainly seeing the market lose some faith in the Fed’s omnipotence. ”
Apparently a lot of people weren’t listening to Bernanke when he pointed out earlier this month that the Fed had done what it could and it was now up to Congress to do something. I think the message was clear, but people like to sail along with their old ideas intact.
“The sooner we get the Fed out of the market manipulation game the sooner this economy can stabilize, definancialize and get back to becoming the economic growth machine that it has been for so long.” Amen, amen, amen.
The Fed thinks it is the fourth branch of the federal government, and that its dual mandate is an excuse to try to play God. In reality, it is the running dog of Wall Street and its constant overreaching has led us to our current economic crisis. From 1913 to 1929: sixteen years of pyramiding debt, and then the Crash of 1929. Glass Steagall is repealed in 1999 and after nine years of pyramiding leverage, we have the Crash of 2008. Bernanke and Greenspan should be run out of town on a rail and the Fed’s charter should be revoked.
I’m a bit surprised the how well the market (yield curve) responds to Fed.
If that breaks down, the Fed will be shown to be completely inept.
So…over the long term won’t ZIRP actually make our problems worse by increasing the funding liabilities of the pension system? CALPERS alone is estimated to be underfunded by ~$600 billion. I can’t imagine the recent market action and 30-year bonds at 3.1% is going to help matters.
I guess the Fed can legally step in and buy muni bonds too, but I think that’s a dark path we shouldn’t take.
You mean like decades of Japanese-style infinitesimal bond rates and perhaps declining equities when pension funds have allocated 8% returns? (We’ll ignore for the moment the declining additions into the pension funds, too, and what that does for projections.)
What’s happening in Greece is a sideshow for what’s slowly creeping towards our shores. Perhaps not as great a wave, but … We, too, have made unfeasible promises and proffered unrealistic expectations to an entire generation of highly vocal and politically active constituents.
The era of unfulfilled expectations is nigh. It ain’t gonna be pretty.
QE1 and QE2 were not non-events when we consider their impact on the economy. They were designed to bail out the banks the hidden owners of the FED. My simplistic view is that every few years, these banks wring out a pint of blood out of the country, and then go back to becoming leeches. This time something seriously went wrong: instead of pint, they took out buckets full and no wonder that infusions are not working… The major organs of the economy are failing.
Great column! Chartalism, keynesianism, “feudalism”, central planning, social statism, mixed economies and free markets have all had their day. Being human realities or human ‘constructs’ none are perfect. Perfection of course, is not an alternative. Only one idea, in practice, pragmatically delivers: the free market idea inherent to classical liberalism. The political component of ‘political’ economy, i.e., it’s understanding of human nature, is probably the most important feature within the principles of classical liberal political economy and it’s natural law foundation. Power in fact, does corrupt while unchecked and unlimited power leads to unchecked corruption. Every political or economic system which has been dependent on being misunderstood by it’s participants has failed and failed ‘ugly’. (The current collapse in confidence being the latest example). My concern regarding MMT is it’s dependence on a misunderstanding of the nature of money itself and the role of the central authorities in fostering and maintaining that misunderstanding among the masses. Money becomes scrip and is dependent upon coercion for it’s acceptance. The system then becomes dependent on the ‘coercers’ and their good nature and altruism. Central planning is a necessary feature of MMT and central planning is at the root of the current crisis. The question is not about the competence of this set of planners versus another but of the ‘fatal conceit’ of planners everywhere.
Correct any misunderstanding I may have but fiat money depends on legal tender laws and taxation in order to maintain confidence. If the revenues generated by those taxes are immaterial to the ‘fisc’ (as I believe is the position of the chartalist) due to the printing press then the purpose (of the coercion) is to lend credibility to something which would otherwise have none. It would be wholly dependent on the police power of the state. Of course fiat money is always a creature of the state. The problem arises due to the fact that the state, if left unchecked, develops interests of it’s own which have always and everywhere been used to rationalize the destruction of private savings and property to maintain those who issue the depreciating currency. The state no longer serves the people but the people serve the state.
I don’t reject the notion that a corrupt state will ruin its currency. But let’s be clear about something else. ALL money requires confidence. There’s nothing unique in fiat money in this regard. Money is always debt. Debt is based on trust. Credit comes from the latin word creditum which is derived from the word credere which means to believe. All money (even gold) is based on a belief and the trust between men and women that we will ensure the value of that “money” via various forms of productivity, care, wellness and sound stewardship.
Wonderful answer, Cullen. We are always at all times social animals and there’s no “pure” state of nature one can appeal to. That’s the problem with such orthodoxies.
bastiat, taxation is what gives the fiat money its initial push, so to speak, but, once accepted or started rolling, fiat money can exists and have value due to all the usual reasons (convenience, general acceptance, etc.) More than that, I doubt any fiat money can exist for long based only on the force to tax, because this would lead to political breakage (in other words, if you always have to force the currency down the throat of your population who refuses to accept it without this coercion, then some political development – say, a revolution – will take place sooner or later.)
“the purpose (of the coercion) is to lend credibility to something which would otherwise have none.”
That’s the mistake. US dollar obviously has credibility beyond just the possibility of extinguishing your tax liability.
Of course any means of exchange implies a level of trust. Trust is earned, it can’t be forced. Why would you trust an entity which can only maintain it’s ‘value’ through coercion? How is that “sound stewardship”?
Were you coerced into becoming a citizen of the USA or where ever you are from? You and all other citizens are free to leave at any time. There’s nothing coercing you into this union. Perhaps your ancestors made a mistake berthing you here. That’s not really your fault, but it’s also not the USA’s fault. All citizens must understand that the point of a currency union is to achieve some higher level of prosperity through our interconnectedness. I think the USA has built a pretty amazing union here. And if you disagree you can leave. Austrians seem to like anarchist societies. I hear Somalia is quite nice this time of year.
“Anarchist societies”, “You are free to leave”,”When you use the term central planning you prove you don’t understand..” Setting up a veritable ‘circle of strawmen’!
From your comments, I’m not sure you understand what ‘central planning’ is. The ‘modern monetary system’ which you so uniquely understand, is dependent on top-down,central planning, (how is it not?). I think you’d be better off taking the time to understand the organic law of the United States before you attach yourself in such an unqualified manner to a theoretical ‘monetary system’ which is greatly at odds with the spirit of our constitutional, federal republic.
Your use of the term is derogatory as is most people’s. It is meant to imply that the US govt is centrally planning a society and that the govt is not run by the people and for the people. BIG DIFFERENCE.
“Why would you trust an entity which can only maintain it’s ‘value’ through coercion?”
Again a mistake! It is not only through coercion that the dollar maintains its value (I though I made it quite clear in my comment) and in general, the government does not govern only thru coercion. Austrians can scream all their want about trampling of freedoms, but in the end people in general prefer voluntarily to surrender some of their freedoms for the benefits of living in the modern society. The libertarian societies are a nice abstract concept about as practical as communist societies.
The us dollar, like all fiat currencies, will be credible until it isn’t.
So? I am alive till I am dead. Dude, this is very deep!
The trend is your friend until it ends. It’s not all about you, bud. I don’t believe we’ve ever seen a sound, commodity backed currency used to paper a wall.
“don’t believe we’ve ever seen a sound, commodity backed currency used to paper a wall.”
Yeah, especially given that commodity backed currencies are extinct. Sure, we’ve never seen a T-Rex get killed by a handgun either. So?
And there were many, many problems with commodity backed currencies. How about counting the number of depressions, not mere recessions, that US had under the gold standard?
True, paper actually comes in handy for a number of different things whereas shiny rocks serve practically no purpose at all.
And the trend of human evolution is one that some people might reject, but no one can ignore…..And it’s moving away from the days when we threw rocks at eachother and worshipped shiny things….
We don’t worship shiny things? I beg you to reconsider this position given the impending release of the iPhone 5.
I don’t think we’ve ever seen a sound commodity backed currency system either.
They always fail with a massive adjustment – because they are not fit for purpose in a credit based economy.
That’s why there aren’t any out there at the moment of any significance.
You may want to believe then… http://www.archiexpo.com/prod/maya-romanoff/gold-leaf-wallcoverings-51599-149922.html
McLaren also used it as heat reflective coating on the engine bay of the F1 because it is the best material for the job.
There is a history here. Thousands of years. You guys have some terrific stuff on this site but you’ve got to move away from the strawman arguments and circular reasoning. No one is worshiping shiny things, merely acknowledging human nature and the ‘fatal conceit’.
Strawman? I have logged thousands of hours. Published thousands of pieces of work. Put in endless research. Strawman? My work is well documented and has been largely borne out as very accurate over the years. I don’t even see your argument. All I keep hearing is these general statements such as “wait til yields rise” or “wait til faith in the currency runs out”. Trust me, I would love to hear a well reasoned argument that can counter my work. You might even persuade me that I am wrong. But I have yet to run into one single Austrian or gold bug who has shown that they understand how fiat money works or even how their own commodity money works…..If you have a sound argument then let’s hear it…..The floor is all yours.
Look, bastiat, it is one thing to say that such and such currency will fail because of such and such, concrete problems, and a totally another thing to just go on proclaiming “all things come to end”. The former is useful, the latter is a useless truism, with 0 illuminating contents. It is like saying: “don’t buy this car, it will break”. Huh? All cars break, sooner or later so we shouldn’t drive cars? Or, all cars end in a scrapyard, so, we should stick with horse-driven carts, since those never go to scrapyards?
Commodity based currencies went extinct for a reason. Commodity or pegged currencies restrict economic growth. Decision to save by any one agent in such economies necessarily deprives some other agent of income. Price stability under such economies is also a myth – in fact, while long term inflation might be lower, short term volatility in prices is usually much higher: so much for “stability”.
Bastiat-
In an attempt at levity to connect you too the TPC and rather than against I studied the phrase strawman to find some way to make a funny.
Candidly…it seems somewhat rude considering the efforts of many to try with no axe to grind, no fees to charge, no people to please, no lectures, and no agenda but a sincere desire to be helpful. A sincere desire to offer solutions to the problems that clearly have caused social unrest, put good men and women out of work, and indebted families to creditor banks who see this as business as usual.
I am NOT a liberal, am not a licensed MMT teacher but I came here because I was attracted to Cullens no agenda work. He gives freely his time and help. I hope you respect his efforts by avoiding the disrespecting name associated with straw man.
question for cullen…if qe is a monetary none event ten why bother doing it ?
why does the fed and markets feel it provides stimulous ? surely qe must have some effect ?
please explain( i am a layman…an engineer)
As hard as it might be to believe, they flat out don’t understand how the monetary system works. Have you read my primer on this? http://pragcap.com/resources/understanding-modern-monetary-system
There’s also the aspect of doing something rather than doing nothing. Actions are undertaken, most likely to stave off anxiety. Poor Bernanke seems to be coming down with an acute case of OCD!
It’s more like a “Bernanke naked put” now.
The exchange above reminds me of why I suspect this site is named “pragmatic” capitalism and not “religious” capitalism or “absolute” capitalism. I’ve come to see MMT not as a set of doctrines and a growing orthodoxy with “age-old principles” and appeals to the “nature of man” and “fatal conceits,” but rather a growing set of functional principles that have their truth and meaning in their consequences–this is the great American pragmatist point of view in fact–one that the great American liberal John Dewey, but also William James, Charles Peirce, and others outlined for us at beginning of the last century. It’s a way of thought, not an effort to uncover “final truths.” It’s forward looking and functional, deriving meaning from outcomes, consequences, and results–not from tired orthodoxies and absolute claims about the nature of things.
Don’t know if this is the place for a confirmation but it seems me IF the “Gold bugs” prevail and we drop our fiat currency for gold we either make it non convertible in which case it’s nothing more then a balanced budget without the amendment to the Constitution or we allow conversion in which case everybody including China line up to remove our Gold from Fort Knox.,
Can somebody tell me if i’ve got this correct.
Right. The problem with a gold standard is that it handcuffs a country in the same way the Euro currently does. So, if you love crisis and want to be like Europe then go support the gold std. There’s a good reason why it failed….
wait id say Europe is failing because countries took on debt that they could not afford. The EU accepted them into the union even though they knew they would have great difficulty following the financial rules.
Cullen you seem a little sensitive about “strawmen”. If so don’t be, many of us respect and appreciate you, Randy, Marshall, James, Warren and others at UMKC without whom we would be in as much dark as our “fearless” leaders.
you have to listen to tom keene with ryding n meltzer on this it will warm your heart i swear (after a tough friday all-around)
http://historysquared.com/2011/09/23/alan-meltzer-on-the-feds-flawed-reasoning/
Cullen,
Why is M2 increasing then?
The rise in M2 doesnt account for the aggregate losses youre not seeing from an M3 picture. If you look at ShadowStats actually youll see that the increase in M2 hasnt led to M3 increase….
I see, where can I find the M3 numbers. A quick search leads me to find that the Fed stopped publishing M3 numbers.
Also what do you think – GATT and WTO has essentially lead to exporting of jobs to cheap labour nations (Asia, Mexico etc..). We are living in a corporate driven and not sovereign driven world.