One of the few clear correlations between QE2 and anything else was the surge in margin debt.  The Bernanke Put is the equivalent of telling traders that they have the green light to just go crazy within their margin accounts.  Of course, 20 years of economic folly hasn’t been enough to convince the Central Bank that promoting this sort of policy is sheer madness so we continue to implement policy like QE2 with the hope that it will generate a “wealth effect” or some other mythical growth even though it does nothing to alter the net financial assets in the private sector.

In case you’ve been asleep for the last year it’s undeniable that the economy has weakened further with each consecutive quarter that QE2 went on.  In other words, this program has been one of the greatest failures in the annals of central banking history.  Even its long-time cheerleaders have now turned against it.   Still, we hear chatter of QE3 as if we need to throw more you know what against the wall with the hope that it will stick…..

QE2 had one undeniable effect though.  It caused investors to go crazy with misconception.  And much of this was implemented with borrowed dollars.  NYSE margin debt soared throughout the program and declined by $10MM for the first time in June in anticipation of the program’s end.  That loud sucking sound you heard in the market today was the margin calls that these traders are now receiving.



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

Cullen Roche

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

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  • http://pragmaticcapitalism michael schofield

    Real traders got out quite a while back. If QE3 should materialize where would the trade be? I’m thinking precious metals.

  • El Viejo

    Ha! Yeah, I went all bonds and cash 2nd week of July. Don’t claim to be a real trader though. I get the feeling that QE3 will not resemble QE2 and with gold already going parabolic I dunno. I have never been a fan of gold and silver. I lived through the Hunt Bros folly and was turned off by it.

  • George H

    Now we are at the bottom of the trading range 1250-1350 (plus minus a couple of percentage).

    Cullin: do you still think we are in muddle through situation that this range holds, or this looks like a more credible correction that can be 20% from high (1370 – 20% = 1100) given the new economic data coming out this past few weeks?

  • pigfarm

    Maybe I’m early on going long here for the month but I like these levels and here’s why.
    1. Weekly chart SPY first hit of the 50 MA since last year
    2. Weekly chart SPY 125 is also 618 retrace from 8/2010
    3. Selling is on heavy volume today, exhaustion selling could be near
    4. Huge bearishness in the media contrarian, indicator for me
    5. Monthly time frame still upward trend
    6. Weekly time frame still in up trend
    7. August is generally light volume month which favors upside. I expect selling to subside after this week.

  • El Viejo


    Did you see this? http://www.zerohedge.com/news/jpmorgan-warns-even-more-disappointing-non-farm-payroll-number-friday

    We are almost in panic momentum right now. I’ve resisted buying the dip successfully for the time being. Maybe I’ll buy in Friday. The market has caught up to the fundamentals right now and that may take some really good news to turn it around.

  • pigfarm

    I hope they keep managing the nfp numbers expectations down. It makes for good pops.

  • Andrew P

    Maybe QE3 will be Bernanke buying up millions of units of foreclosed real estate and putting the Fed in the landlord business. If each property is on average 250K, the cost for 4 million of them would be a trillion dollars. It would become the biggest landlord in the US, and would pump a trillion dollars onto bank balance sheets. Property prices wil be supported. However, this will decrease the net assets of the State and Local sector, since the Fed, a Federal Agency, does not pay State or Local taxes. Entire neighborhoods and even entire cities could disappear from the property tax rolls forever. I’m sure the SEIU punks will like those apples.:)

  • http://pragmaticcapitalism michael schofield

    The Fed buys a trillion dollars worth of junk real estate- if that wouldn’t make you buy gold I don’t know what would! Anyway I’m not a fan of gold. It’s just the only trade I like right now. If the S&P crashes 1260 hard I’ll have to consider a short on something.

  • CP

    If it caused stock market investors to pile in, then how come you say it had no effect on real investments? How can it impact one and not the other? Why should these types of investment be positively correlated at other times, but not now? If margin debt is all about QE, then why is it lower now than in 2007? Where’s the logic?

    This is what’s called cherry picking the evidence.

  • http://www.pragcap.com Cullen Roche

    You are sounding like a quasi-monetarist again. People don’t build new offices and hire new people when they hear that the Fed is “printing money”. But they might run out and buy some gold or other hedges against the potential rise in inflation. Hell, they might even hoard cotton in China (which happened) or do other irrational things…..Secondary markets are not primary markets. Secondary markets are not the real economy. But honestly, I don’t expect to convince you of anything so no reason to respond. I know your position and I know you’re not changing it. I respect it, but I don’t see the point of these back and forths when you write the initial comment knowing your position is never going to change….


  • CP

    You say that people expected higher inflation, which means that expected real interest rates were lower, which means that, ceteris paribus, real investment was higher. To say that there is no impact on the real economy is illogical. As I said, it’s cherry picking.

    I see Barton Biggs was saying today to expect a different kind of QE next time – maybe buying homes. Now where did I see that idea before?

    Of course you didn’t actually answer my questions above, but hey, I know your position and I know you’re not changing it.

  • http://www.pragcap.com Cullen Roche

    I talk to a lot of traders and entrepreneurs every week. When QE was announced I did not hear one single entrepreneur say that that program would cause them to increase capex. But I heard just about every one of my trader friends say they were increasing their speculative bets. So, let me ask you a question. What in the world makes you think that QE would cause businesses to hire more people and expand? After all these months (even though it’s now 100% crystal clear that I am in the 0.1% of the entire world who got the QE analysis right) you still have yet to explain the transmission mechanism through which QE actually works….

  • CP

    What we gossip about isn’t the same as what actually happens. Investment has been on the up again, after the economy looked like it might stall last year:


    What’s more, from being directly involved in the decision making process, I can tell you with 100% certainty that QE2 made a difference to some of that. In that case, perhaps the biggest difference it made was to confidence. At least one individual thought that the Fed had drawn a line in the sand and shown it was willing to act. Now, personally I think the Fed will have a hard time repeating that trick if they stick to a QE2 type formula, but I’m just reporting what happened.

    As for an economic explanation of the transmission mechanism, I must have answered that question at least 3 times now. I could repeat it, but let’s just stick to the mechanism we’ve been discussing here. Higher expected inflation means lower expected real interest rates, which ceteris paribus means higher investment. What part of that doesn’t make sense?

    As I’ve also said before, QE isn’t the only thing happening and any version of QE that goes via the banks will struggle, but the point remains that it has an impact. I suspect it would be a long time, and many iterations before we get to a version that makes a massive difference – because the Fed will be both cautious and divided. But those versions are always possible, and it’s wrong to dismiss out of hand the only policy tool that we realistically have available.

  • http://www.pragcap.com Cullen Roche

    Now there’s a fancy piece of datamining. You talk about “real” this and “real” that and then don’t show the inflation adjusted data. Priceless really. Real gross domestic investment has been declining on a YoY basis since QE2 started so that blows a nice huge whole in your entire argument. This one chart alone basically disproves everything you’ve said with regards to the efficacy of QE2. The rate of change actually reversed when QE2 started so your theory is completely backwards!

    LIke, the QM’s, you keep saying that the confidence fairy comes along with QE and makes the economy all better. But you still can’t describe one single real life example of how it works. I don’t know one single entrepreneur who hires people or takes his business cues from the Fed buying bonds. You’ve been staring into that textbook way too much…..You need to get out on the street more and talk to real-life people. This is the problem with modern day economics. The Scott Sumner’s and Ben Bernanke’s of the world, who have zero real business experience, are the ones influencing policy with their pie in the sky economics.

  • CP

    1. I’ve just told you a real life example.

    2. When you say “You’ve been staring into that textbook way too much…..You need to get out on the street more and talk to real-life people” you are just letting yourself down again with your ignorant and insulting language. You behave very childishly when you dish out this stuff and then get upset when people respond in kind (see the Mosler post and others previously). Either treat people with respect or grow up and expect to be treated the way you treat others.

    3. Contrary to your prejudices, I happen to be a “real life person”. My background is in business not acedemia. Currently I own private equity and through that I am still involved in investment decisions today.

    4. You persistently fail to answer questions, so I’ll repeat one. Higher expected inflation means lower expected real interest rates, which ceteris paribus means higher investment. What part of that doesn’t make sense?

  • pebird

    So we have a bump of about $100 billion from the end of 2010 (when QE2 basically started) through Q1 2011. Wow, big deal – most of the increase of nominal investment is correlated with the stimulus spending through 2009.

    Higher expected inflation in consumer prices increases investment, while higher expected inflation in asset prices increases speculation. What we are seeing is everyone running for the lifeboats because the QE-induced increase in asset prices looks like it won’t be sustained.

    We will end up with lower inflation/continued deflation along with low interest rates and low investment – a la Japan.

  • http://www.pragcap.com Cullen Roche

    Here we go again with the ad hominems and circuitous discussions. I didn’t insult you so I don’t know why you feel the need to call me names. If you can’t handle the fact that I said you read a textbook too much then you really need to toughen up a bit and stop being so damn sensitive.

    I answered your question with a chart that very clearly showed you that higher expected inflation is leading to declining real investment. So your whole theory is wrong. What part of that did you not understand? I know you don’t like to admit when you’re wrong, but this is just getting flat out absurd. Just say it. The data doesn’t mesh with your theory. You’re wrong. Get over it and stop wasting my time with your useless comments.

  • http://www.pragcap.com Cullen Roche

    Also, don’t ever tell me how to behave here. This is my website. I have been incredibly patient with you and I’ve reached out to you on more than one occasion in an effort to be forgiving. I said nothing today that you should take so emotionally. So when you come here and call me “ignorant” and “childish” you’re just doing more of the same. A lot of readers have complained about your behavior in the past whereas there is a near universal agreement that I am one of the most tolerant and patient site moderators in the blogosphere. I have no idea where you get the balls to come here and act like this and pretend like I have done some grave injustice to you. It’s absurd and I am tired of it. Grow up. I will not warn you one more time. If you want me to treat you like a little kid who can’t play nice with everyone else and can’t ever admit when he’s wrong then that’s fine. I’ll treat you exactly how you deserve to be treated.

    And if you want to start a website where you get millions of hits per month then be my guest. You can go there and treat people however YOU want. But don’t EVER come here and tell me how to behave. I treat my readers very well and I have never had a problem like this with anyone else. You are the ONLY one. So, look in a mirror and stop trying to project your issues on everyone else.

  • CP

    Oh grow up. Your comment was ignorant and insulting and you know it. You know nothing about me. Looking at your bio, I would bet that I’ve pushed thru more real investment in my life than you ever will do, yet you say I need to get out and meet real people. Grow up.

    And no, you didn’t answer the question. Here’s the question again:

    Higher expected inflation means lower expected real interest rates, which ceteris paribus means higher investment. What part of that doesn’t make sense?

    You say you answered this with a chart. All the chart says is that YOY real gross investment declined. It doesn’t say why. There are a ton of reasons for it to decline. As I said above “QE isn’t the only thing happening”.

    The logic of why QE means higher investment is clear. Why don’t you try to address the logic? Is it because you can’t?

  • Peter D

    “Higher expected inflation means lower expected real interest rates, which ceteris paribus means higher investment. What part of that doesn’t make sense?”

    I think inflation expectations mechanism makes sense in theory but failed in practice either (a) because the expectations did not really increase in aggregate (which is why Krugman and Sumner want the Fed to actually commit to higher inflation) or (b) because in real life the agents don’t really optimize their investment using the real rate. From my understanding, MMT doesn’t really reject that the real rate may play a role in moving consumption/investment forward, but that this role is very ambiguous and unreliable. It might also act with a big lag.
    Think of a business that expects high inflation, but today’s demand is very depressed. Will it necessarily go out and invest, given all the unsold inventories, even if it were sitting on piles of cash and expecting inflation? Studies found that humans don’t always behave like utility-maximizing agents of the classical models.
    Btw, see some good posts on monetary policy on Trader’s Crucible:

  • CP

    You still don’t answer the question. Here it is again:

    Higher expected inflation means lower expected real interest rates, which ceteris paribus means higher investment. What part of that doesn’t make sense?

    Let’s say you’re right that real investment and stock market investment doesn’t correlate. How does that answer the question? It doesn’t.

    I don’t see why you keep going on about real investment declining. So what? Can’t you understand that there are many variables at work? My only point was that dollar investment turned down and has since turned up. I don’t claim that QE2 solved everything. Far from it.

    Equally, where did I claim that QE2 would work? Tell me. Just more false claims with no back up.

    I guess the truth is you can’t answer the question I put. Peter OTOH has had a good go, so I’ll reply to him.

  • CP

    I was wrong to say “YOY real gross investment declined”.

    Of course it didn’t. It increased. It just didn’t increase at such a fast rate. It was never going to go on increasing at 25% pa. Clearly, my point remains: so what?

  • http://www.pragcap.com Cullen Roche

    I’ve wasted a lot of time responding to your comments and your childishness. I am not doing it anymore. You demand these answers of me because you aren’t familiar with my positions. Well, before you insult someone you should at least have the courtesy of trying to understand their positions first. You don’t even understand my position yet you feel like it’s okay to come out and accuse me of “cherry picking” data in your initial comment. Absurd.

    Your comments are now being moderated. I’ve had ONE problem reader before and he’s learned to conduct himself so well that he’s no longer being moderated. So, this makes you 1 in a million. I literally never have to do this. So congratulations. When you grow up it won’t take 6 hours for your comments to get published…..Enjoy the free comment and feel free to insult me personally as much as you want. I won’t be responding anymore. I should have learned this lesson from Fullwiler and the other people who warned me about you long ago. Instead, I got suckered into your game of schoolyard insults and now I look like a fool. Well done. No more.

  • http://www.pragcap.com Cullen Roche

    So, when the rate of increase goes from 25% to 3% you say that’s improvement. Let’s take a survey of economists based on the latest GDP data. Do you hear many people saying that Q1 GDP was “good” because it “increased” at 0.4% when it was increasing 3.5% a year ago? No one in their right mind will agree with this notion of yours. This is total madness.

    I don’t know what you’re smoking, but it must be some great stuff….These conversations with you are beyond ridiculousness. Do you read the stuff you write here before you post it? No wonder your perception of QE is so fantastically wrong…..

  • CP

    Peter, why do you say the theory failed? How do you judge that? Do you mean that the economy hasn’t recovered ergo it failed? If so, how do you eliminate the other factors from the result e.g. the balance sheet recession? How do you know that we just didn’t do enough?

    Or do you mean that you have some specific evidence that it failed? In which case, what is it?

    I agree with your comment about utility-maximizing agents. I don’t think people will necessarily behave “rationally”. When fear predominates, they will minimize risk, perhaps excessively. It’s all about animal spirits. But one way that I think policies like QE can work is via the reduction of fear. See my anecdote above about one of my colleagues deciding on an investment last year.

    In a way I agree with him. Last year it seemed that deflation may be reappearing. The Fed said this was unacceptable and took action. That, I argue, is more likely to inspire confidence than if the Fed says: “We’re not going to do anything. Deflation may become locked in and real interest rates go up, but we’re not sure we can do anything about it”.

    Even if the mechanics of QE itself had no impact on inflation, if people see the Fed willing to act, it increases confidence. Not total confidence, just more. More confidence then means more spending, which in itself means higher inflation. Not “high inflation”, just not deflation.

  • LVG

    Cullen, just so you know, I’ve had multiple run-ins with CP. He pretends to be civil, but then as soon as he realizes he’s wrong he gets very abusive and the ad hominems start flying. You should have banned him long ago.

  • Peter D

    CP, there is no sure way to know whether the theory failed or not enough of it was applied, you’re right. The same goes for fiscal stimulus (the MMT solution), more or less, when people say, “see, we threw all this money at the economy and the demand still did not pick up”.
    I am also not saying there was no real effect from the monetary policy. But here is my understanding as to why monetary policy might not necessarily work:
    1) It removes interest income from the economy, which is deflationary (you might recall the Fed refunded something like $70Bn in profits from its Tsy holdings to the US Treasury)
    2) Monetary policy assumes that savers will turn into spenders when interest rates are low enough. The way I see it, this can hardly happen, as bringing forward consumption is very hard. Nobody says: boy, the interest rate is so low, I better sell my Tsys and go buy a widget.
    3) Monetary policy assumes that low interest rate will bring forward investment. I think that this might happen in some circumstances but not in the other. I think there are more overriding determinants for that, such as the state of aggregate demand. Inflation expectations, for example, are fine, but they are still expectations, while lack of demand and unsold inventories are the cruel reality staring every business in the eyes. While on paper one could find an interest rate which would equilibrate the investment and saving, it seems to me that under some circumstances there is really a trap, such that even negative real rate will not do (and something else will break before actual investment will come forward)
    4) What happens in my view is that excess monetary base may drive demand for some asset classes – such as real estate (not our case now, but nonetheless), art/antiques, commodities, gold, foreign currency, etc, some of which – especially commodities and forex – could have inflationary effect on the economy. But (a) this is the bad inflation – not the one which is the goal of monetary policy; this is not an inflation that would spur investment and which results from increased demand and (b) this would still come with some unknown multiplier which is hard to estimate ex ante or even ex post.
    What is also likely to happen is that the monetary base will be just absorbed. I know that the private sector in aggregate cannot rid itself of the additional base, but who said that preferences for holding the base don’t change with interest rates almost at zero lower bound? Scott Sumner talks about the “hot potato” of cash, but I am not sure that at some point the last guy to get the cash does not just shrug and stuff it in his pocket.
    5) Who knows what happens to velocity? If the “hot potato” is passed very slowly, which also seems to be the case nowadays, with people holding to cash in anticipation of opportunities and general uncertainty, then, again, the inflationary effect is being offset.
    6) Additional mechanism monetarist have in mind is something like “ M0 > cash balances > financial assets > nominal wealth > bank lending > broad money > NGDP” (I am quoting W. Peden commenting on Sumner’s blog.) Increased bank lending in response to increase in nominal wealth may happen in normal times, but, again, these are not normal times.
    All this suggests to me that the mechanisms of monetary policy are not too well understood and that its impact is sometimes too murky to judge.

  • CP

    Peter, I pretty much agree with that. The impact is murky, it’s hard to tell. My point is just there is some impact, and given that fiscal stimulus is off the table, we need to do a better job of understanding the impact. Specific points would be:

    1. MMT folks often say that QE2 didn’t work, in part because the banks just sit on the resulting excess reserves. That’s fine, but they can’t then claim that there is a deflationary impact due to the withdrawl of interest income from the economy. They can’t have it both ways. If this is limited to bank reserves, then there is no deflationary impact.

    2. Even “bad” inflation has good effects in these circumstances. Firstly it fends off the deflation spiral. Secondly, it reduces real interest rates. In a normal economy, bad inflation is just bad. However, in the 1930s, in Japan for the last 20, and here today, it’s not.

    3. There is, for sure, at least one version of QE that would increase AD. Buying enough pvt homes would do that. So the question then becomes, is there a version between QE2 and the home buying version, that would also work?