Open Thread…Have At It….

I am pretty swamped with other stuff so I haven’t had time to focus on the site much, but feel free to talk amongst yourselves or throw a question my way.  I know there’s a lot going on in the economy and the markets in the last few days so I’ll try get around to it later today or over the weekend.  Hope the choppy market isn’t treating you too unkindly!

Cullen Roche

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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  1. OK, I asked for this post today… but in the meantime used the now restored forum… so I’ll just copy and paste:

    Cullen, I found the following pie chart:

    Is it accurate? Or more precisely, was it accurate (it’s 2 years out of date)?

    At the time there was $14.3T in “U.S. National Debt” (which the footnote on the chart says is more precisely called ‘”federal” debt’).

    I assume this $14T in debt was all auctioned by Treasury. True?

    You’ve mentioned before that about 20% of Tsy debt is held by commercial banks… I was never sure what that 20% meant though. Was that 20% of:

    1. The full $14.3T? (100%)

    2. The “U.S. public” held debt of $4.15T? (29% of $14.3T)

    3. The non-(Tsy+Fed) held debt of $8.72T? (61% of $14.3T, where 61% = 100% – (32% + 7%))

    Final question: What percentage of the full $14.3T in U.S. Treasury debt is held by Fed deposit holders?

    I assume that all of the 32% labeled “U.S. govt” (red) are Fed deposit holders (GSEs? SS?). The Fed itself (7%) doesn’t hold Fed deposits as assets (only liabilities). Then that leaves:

    A. Foreign central banks: some fraction of the “foreign” 32% (32% = 100% – (29% + 32% + 7%) on the chart).

    B. Foreign governments? (do they have Fed deposits apart from their central banks??) — also part of this 32% “foreign” segment.

    C. International organizations (IMF… any others? World Bank? OPEC?) — Are they also lumped in with the 32% foreign segment?

    D. Commercial banks, both foreign and domestic, specifically the subset of these banks that hold Fed deposits (I know not all banks have Fed deposits). — As mentioned above, this part must come from the 61% which is the non-(Tsy+Fed) segment.

    • Shoot! … replace all occurrences of “non-(Tsy+Fed)” in the above with “non-(US gov + Fed)” … since Tsy doesn’t hold it’s own debt of course!

    • I have not read all your FAQ, but I’m not sure I agree with the following: “It does not matter how you get into that situation. Hyperinflation works the same if you lose a foreign war, a civil war, a dictator goes crazy, a government with excessive foreign debt, nationalizing too many businesses, rampant corruption, productive collapse, excessive regulation, a regime change, too many taxpayers fleeing high taxes, a massive depression, or whatever.”

      To me, hyperinflations also mean that people are rejecting the currency. Those exogenous events that you say don’t matter seem to be very important — and without at least one of them occuring (at a severe level) — I submit that merely having the high levels of federal debt you mention are not enough to produce hyperinflation. Inflation, or maybe even high inflation for a while — but not hyperinflation. I’m thinking only of the USA in that regard, which should remain one of the world’s most dynamic economies for a very long time — and one of the largest.

      Does it make sense that Japan hasn’t had hyperinflation in recent years because those none of those exogenous events that you say don’t matter have not occured?

      • So blaming hyperinflation on exogenous events allows people to continue to believe that debt and deficits don’t matter. If Japan gets hyperinflation next month then people will pick some event to blame it on. Perhaps the Tsunami that caused them to turn off all their Nuclear Power plants and so have to import lots of oil not denominated in their currency.

        The problem with this “its all due to exogenous events” is that there is no predictive or scientific theory to falsify. In my explanation of “out of control monetization due to out of control government spending, debt, and deficit” you can test and see that each case has this.

        Now the events leading up to it do matter, but the hyperinflation works the same once you have the out of control spending, debt, and deficit.

        I think Japan will get hyperinflation by the end of the year.

        • I wouldn’t say that debt and deficits don’t matter. I share your concern about the trend in US federal debt, but I’m not so concerned about the next few years. If we set aside the exogenous events idea for a moment, then we will still need a total lack of confidence in our currency for hyperinflation to occur. Is it fair to say that the ability to service the federal debt is more important than the amount of debt relative to GDP?

          That points to my concerns, say 20 or 30 years from now, when obligations for Social Security and Medicare become so much larger relative to projections on payroll taxes (and other federal revenue) collected to pay those benefits. It’s all well and good to say (for now) that debt and deficits are not a problem relative to the total produtive capacity of our economy, but some of the projections I’ve read about Social Security and Medicare seem way out of proportion to what our economy might be producing.

          You mentioned elsewhere on this thread that Japan is the canary in the coal mine. Hard not to agree with that point, although some might say that their new QE experiments are obviously too risky.

          You say that there is no predictive or scientific theory to prove (my word) that hyperinflation is all due to exogenous events. I’ll look at your blog again, but isn’t it true that in each of the hyperinflations in the last 100 years, there’s been some exogenous events? That may not prove causation, but it shows very high correlation.

          If you’re right about Japan getting hit first, perhaps we’ll see how hyperinflation works without the loss of a war, a true regime change, a total collapse of production, etc.. The world will just stop believing Japan can service its debt, right?

          • Hyperinflation does not start with a complete loss of confidence in the currency or government, it ends with that. To start there are just a few more people getting out of bonds, so the central bank monetizes a few more bonds. And the more the central bank monetizes, the less people want to hold bonds. This snowballs from a very small loss of confidence to a very big loss of confidence over the period of hyperinflation.

            If you stick with the 50% per month inflation, so there are only 56 cases, it is possible you can point to an exogenous event for each one. The question is is that really the cause or just the trigger? If you go with the 26% per year inflation as the cutoff there are many more cases of hyperinflation and many of them have no big external issue. Right now Venezuala has over 26% inflation and I can bet their debt and deficit are in big trouble but not at all clear you can really blame some exogenous thing. In any case, the was the exogenous thing causes hyperinflation is by getting the debt and deficit out of control.

            There was 24 hours last week where the Yen went down 3% relative to the dollar. The yield of 5 year Japanese Government Bonds (JGBs) was 0.35%. The total interest compounded for 5 years was about half as much as was lost in the value of the currency in 24 hours. It is foolish to hold JGBs. As some people start to get out the central bank will monetize faster. It will then be even more foolish to hold JGBs. In the last 30 days of reporting they increased the base money supply by 6%. So people are already getting out. The snowball is rolling. I don’t think it has 6 months to go.

        • “I think Japan will get hyperinflation by the end of the year.”

          How can anyone write that with a straight face? Hell, they can’t even manage to keep their stock market inflated. Real estate prices where I live are increasing at a glacial pace. And supermarkets simply cannot make price hikes stick. The claim that this is all going to fall apart at the seams in 6 months is ridiculous. The mind boggles, until the mind realizes that the writer has probably never set foot in Japan.

          • Vincent has been predicting hyperinflation in many places for many years by the end of a year….

            • Cullen, I think I said the next couple years for the USA and was wrong. I don’t think I ever made a timed prediction for any other place, except now Japan. I really think I am right on Japan, we will know soon enough.

          • If you read my Hyperinflation FAQ and really understand it I don’t think you would say it is ridiculous to expect hyperinflation in Japan soon.

              • Yes, I am putting my money where my mouth is. It is why I would really like anyone to point out any flaws in my logic or errors in facts before it is too late. :-)

    • I’m no economist or apologeticist for any theory, but I lived through the inflation of the seventies and to me it seemed like a big increase in aggregate demand for goods by the baby boomers that could not be quickly met with productive capacity. The boomers were riding a wave of high-tech jobs and were changing jobs often for better salaries. Corporations moved abroad both to escape taxation and to meet the demand with cheap Chinese labor. Volcher raised interest rates to squelch the demand. People were borrowing money on their credit cards because there was a cap on the interest rate that CCs could charge. I worked in the field of computer controlled automation for factories. They could not get enough of it because they were producing more goods with less labor.

      In the following article it mentions two reasons for the hyperinflation of Weimar and Zimbabwe and they are foreign currency obligations and lack of productive capacity.

      I did not see any mention of these two things on your site. I’m no expert, but your site seems to focus the CB and borrowing by the Federal govt. 70 percent of US debt is held by Americans. (mainly retirement funds if I’m not mistaken)

      You did mention Japan and for me Japan is the canary in the coal mine. I just simply can not get excited about US debt or inflation yet. Others feel the same way it seems:

      • Yes, I think Japan is the canary in the coal mine. I think they go first. But after they go the US does not get 2 lost decades. They might go within 2 years or 2 months. Now people think hyperinflation does not happen to western democracies. Once that myth is shattered the US will not have so much time.

        I do mention those things as some of the ways that debt and deficit get out of control. But I think the key point is that debt and deficit get out of control.

        • I wish I could be so assertive in life.
          But I am happy you are not managing my money.

        • The US and Japananese economies are a little different. Japan has a much more constrained economy than the US, but they also have more cooperative(patriotic) population although the latest generation seems to be less responsible than the older gens. Their CB tends to control for 0% Inflation rate whereas the US controls for a 2% CPI. ABE tried to loosen it recently for the sake of exporters of course.

          A strong YEN buys resources such as oil at a better price. This is why they relied a lot on Nuclear Power, but the Tsunami ruined that. (Smog control was another reason they went nuclear) I was in Japan for two years in the 70′s. The smog was unbelievable. The US has its own oil to a degree. We also get most of the oil we use from Canada.

          The US Economy is also at least twice as Big as Japan’s and Japan’s debt is twice ours. We are also the world’s reserve currency and I know that can change in a heartbeat, but I think it is not a major concern for a while.

          I understand that debt and deficit can get out of control (debt being accumulated deficit over time), but that gives our system and the FED a great deal of flexibility.
          You mentioned Feedback Loop. There is a device in electronics called an Op Amp where a portion of the Output is fed back into the Input and this can cause “Snowball” effect or act as a “Slippery Slope” just like you stated and maybe this is because populations can’t be controlled.

          However, there is also something called a PID Control Loop(See Wiki) that looks at an Input with relationship to a desired Control Setpoint and it then adjusts the output based on how far the Input is from the Setpoint. Interestingly, in some systems a PID loop that only uses the P tends to control at some offset. I wonder if this is why 2% CPI seems to work best for the US Economy.

          And then there is the future of our demographics. (The retiring Baby Boomers.) When most people retire they spend a great deal less. This has got to have a negative impact on the Inflation rate. Peter G. Peterson’s book “The Gray Dawn” written a dozen years ago warned of this problem and he said that Japan was one of the first countries it would hit. Other countries mentioned were: Italy, Spain, France and some Scandinavian countries. It’s funny how those are the very countries having problems now.

          We have aborted 30 million out of the next generation and I believe this is why congress was slow to act on the illegal immigrants. Those immigrants may be paying either yours or my SS to a degree.

          I like these “Open Sessions”. It allows for off topic discussions. Anyway, nice chatting with you.

      • I remember the inflation of the 70′s clearly. I was a teenager (and began college) then, and was instructed at age 14 to get a job because I had to start buying my own clothes. My favorite brand/type of shoes went up in price by nearly 50% in 12 months.

        I would call that sort of inflation “too much money chasing too few goods”.

        What Vincent Cate is suggesting is what, too much debt causing a severe lack in confidence in our currency and the safety of U.S. Treasurys? Is the Fed’s current version of QE really monetizing the federal debt? That discussion was started on Pragcap by Cullen after this open thread.

        I still believe that the productive capacity (and actual economic production) of the U.S. economy will keep us out of hyperinflation for many, many years. As I’ve stated above on another comment, it’s the long term I’m worried about, when Social Security and Medicare swell (maybe) out of proportion to the rest of the economy.

        • The Vince Cate theory of hyperinflation is that there is a set of positive feedback loops that usually lead to the destruction of the currency. Positive feedback loops usually end in the destruction of something. The main positive feedback loop that starts things off if that the more the central bank makes new money and buys bonds, the less other people want to buy or hold bonds. But the less other people want to buy or hold bonds, the more the central bank has to buy so that the government can keep in operation.

  2. Cullen: After the last couple of days do you still feel the same way about the panic over surging interest rates??

    • MMT/MR thinks that the central bank sets the interest rates. The idea of rates shooting up makes as much sense to them as gold prices plunging to a gold bug. :-)

      • I wonder about that too — but how will we know? The 10 year treasury yield is up to 2.5% and 30 year fixed mortgages moved up to a bit over 4%.

        Nervous markets push bond prices down, but the next time there’s a new treasury auction, can the Fed really just let all the primary dealers know that 2.1% (just for example) is really where they want the yield? How would we find out if the Fed’s wishes came true in such a scenario?

        • The Fed can buy all of the bonds and so set the price, but if it does this while a government is spending twice what they get in taxes it loses control of the money supply. This is how hyperinflation happens, central bank monetizing for a government that has lost control of spending. It is hard to stop as the government would not have enough money to spend, since half comes from selling bonds and the central bank becomes the only buyer of government bonds.

  3. QE is like beer goggles. It makes otherwise unattractive assets temporarily more attractive – but inevitably you wake up, realize what you’ve done, and wish you hadn’t.

    So which is more irrelevant – the Fed or Hilsenrath? Not a trick question…

  4. What role do you think David Beckworth “Safe Asset Theory” has played in this weeks sell off? Fed backing off and China’s banking problems?

  5. Why do you think muni ETFs have been hammered so bad (worse than TSY and corporates) in the past few days?

  6. Did a warning ever go out on this website to shorten maturities on bonds and bond funds? If so, I somehow missed it. I figured that with inflation running so low, and drifting lower toward 1.5%, how bad could 10 to 12 year intermediate bonds get hit? To my dismay, found out that they got hit quite hard, especially since the 6/19 Fed mtg and Bernanke press conference. Will bond yields trend even higher from here? Or have they temporarily topped out (and bond prices bottomed out)?

  7. I am going to be the party pooper here but this is Friday’s post from the Supra Master of The Universe Of Investing, Porter Stransberry.
    To think that this guy has gotten rich with his newsletters by selling fear mongering garbage is just depressing.

    I quote :

    “Today’s Friday Digest is something totally different… I (Porter) believe it’s time to prepare for a crisis – to really prepare. And I think you’ll find my advice on how to prosper over the next few years to be unlike anything you’ve read from me before in these pages…

    This is it… The 10-year U.S. Treasury market is beginning to collapse. The debt crisis that began in 2007 is now set to continue. Individuals, nations, and corporations don’t become wealthy and powerful by going into debt. Everyone knows this… But this reality has been warped by drastic efforts to manipulate our system of money and banking.

    Even so, these facts remain: Americans owe more money, collectively, than ever before in our history – far, far, far more. We owe at every level: $17 trillion at the federal level; $13 trillion in mortgages; another trillion in student loans; nearly $3 trillion in state and local government debt. Put all of these numbers together and you end up with a $60 trillion pile of obligations. That’s nearly four years’ worth of our entire country’s total production.

    To make sense of the numbers, just take a bunch of the zeroes away. Put these facts into a storyline that’s become all too common in America. Our economy is like a tattooed thug living in Detroit. In between burning broken-down cars and selling crack, he makes $16,000 a year working “security” at a local nightclub. Outside of busting heads, he has no real skills.

    And why would he want to work hard to acquire them? Thanks to his public school education, he is convinced other people have a moral obligation to provide for him… especially rich people. They will give him health care, a clean apartment, a phone, etc. In his worldview, that’s what’s fair.

    And if they won’t? He’s got no qualms about firing first and taking what he needs. After all, they owe him. For now though, he’s doing great.

    The Korean grocer up the street gave him a credit account. In only a few short years, he’s run up a $60,000 tab. What are the chances he’s going to drastically cut his expenses, work hard to get a promotion, and find a way to repay these debts? Zero. What are the chances he ends up knocking over the Korean grocer and teaching him something about life in America?

    You may object to my metaphor. But believe me, it’s far more accurate than most people are comfortable talking about. We live in a country that’s coming apart at the seams – financially, culturally, morally, and spiritually. The reason is simple. We have collectively become addicted to living way, way beyond our means.

    My favorite example about how absurd our debts have become? The state of New Jersey still owes $110 million for a football stadium (Giants Stadium) that was demolished in 2010. It won’t retire this debt until 2025.

    Similar debts exist on defunct or torn-down stadiums in Houston, Kansas City, Memphis, Seattle, and Pittsburgh. These stadiums are physical reminders of the absurd promises the government has made to its citizens.

    On top of the debt it now owes, our federal government has promised its citizens $124 trillion of additional benefits. That’s more than $1 million per citizen. That’s not only more money than we could ever finance with tax revenues, it’s considerably more money than all of the privately owned assets in the United States (roughly $99 trillion).

    Keeping this lie alive… the lie that we can afford our debts (or even our defunct stadiums)… has become the most important national goal. That’s why everything stops when Federal Reserve Chairman Ben Bernanke speaks. Our obsession with Fed policy statements is the best proof I have that we’re far more concerned with maintaining “The Great Lie” than we are at actually building a better real economy.

    Have you ever told a big lie? Did you ever exaggerate something to hide a weakness or insecurity? Or maybe you lied to cover a big mistake you’d made. Did you get away with it? Or did maintaining the lie suddenly consume all of your attention and energy?

    Seemingly forgotten in our obsession to maintain the fiction of our solvency are the huge costs of lying, running our country on Asian loans, and keeping the printing press churning. Nobody notices that the purchasing power of the dollar is down by almost 50% in the last 10 years… or that real wages have been falling since the early 1970s… or that almost half of the able-bodied men in our country no longer work. Nobody mentions that most of the students at most of the urban schools in our country either don’t graduate or can’t achieve test scores above minimum standards. Sooner or later, the consequences of our lies will fall upon us.

    I’ve long warned that when the “End of America” comes – when our ability to maintain the lie I describe above collapses – you’d see the U.S. bond market crash… And the telltale sign – the most important indicator – would be the rate of the U.S. 10-year Treasury.

    I’ve been warning people for years that this crash was inevitable. And for many years, I’ve been made to look like a fool. The Fed has used its awesome power to manipulate the 10-year Treasury yield lower and lower, creating yet another massive financial bubble. But…

    I knew it could not last for a very simple reason: With every new dollar it created, the Fed further undermined confidence in the financial system itself. The 10-year U.S. Treasury yield not only represents the borrowing costs of the U.S. government, it represents faith and trust in the world’s system of fiat money and sovereign debts. By cheating that system, the Fed is destroying it.

    I’ve spent much of the last several years warning people about what is about to happen and trying to convince them to take precautions before it was too late.

    But let’s face it… my work is mostly for wealthy people who mainly want to continue to be wealthy. So I’ve focused on how to prepare for these changes from the perspective of an investor – someone whose primary goal is to earn a return on his capital. I had precious little to offer regular wage-earners.

    But the real danger right now is mostly to the middle class in America. Your taxes are going up. The number of people you will be forced to support (those on disability, food stamps, or Medicare… retirees… people living in war-torn countries…) is soaring. And your ability to pay for these benefits is being destroyed by global competition and the decline of the dollar. America is promising everyone more. And you’re the person who will have to pay.

    Make no mistake… Every time the president says only the rich will pay taxes, just imagine he’s saying “you.” That’s far closer to the truth.

    So far this year, almost 700 Americans have handed in their passports and given up their citizenship. They’re doing so knowing that the U.S. Senate plans to pass a law that will permanently bar them from the country. They won’t be allowed to return, not even to visit family. Even this draconian measure isn’t slowing the pace of people emigrating from America. The numbers are up about 50% from last year. The rich are leaving. And with them will go their capital and our standard of living.

    So… what can you do if you’re already struggling to maintain your standard of living? How can you hope to maintain your lifestyle as your wages collapse and the rate of economic growth slows or even reverses?

    I believe your best alternative is to find a way to build your own business. I decided to build my own business out of necessity. I was fired from the only job I’d ever gotten in finance in 1999.

    I still feel a sense of necessity. If I’m right about the coming financial disaster in America, the odds that my financial research company will continue to prosper are not good. So I’m in the midst of starting another company – a consumer-products firm.

    The core idea is simple: Everyone wants and can afford a little bit of luxury in his life. I’m working to improve the quality of a basic task, something most of us do every day. I’ve gotten a substantial amount of interest from several top executives at major companies, whom I’m recruiting to join me. This isn’t a lark. I have a great idea – something that could create a substantial amount of wealth and something I could feel very proud to have built.

    I don’t want to reveal more right now. And yes, I know, the odds that I’ll succeed are low. The point is, I’m not going to sit still and watch my standard of living decline. I’m going to take every possible step to safeguard my income and way of life. I am not going to be the guy who tells his wife we can’t afford that anymore. That’s going to be someone else. I guarantee it.

    Nothing good is going to happen for you in your life unless you make it happen. This is a harsh, but important reality…

    As an entrepreneur, I’ve gotten used to this fact. But for most people, it is an impossible hurdle. Most people can contrive an infinite number of reasons why they can’t do something for themselves. I used to think it was impossible to coach people past this inertia. But…

    I’m reading a book that has changed my mind. I believe this book will become a true classic. Anyone who reads it and follows its advice will become vastly more successful. It is, without a doubt, the best book I’ve ever read on how to build a new business. It’s where the opening quote in today’s Digest comes from.

    I’m using it as my guidebook. The book covers the basics – including how to brainstorm for new business ideas, how to partner, and how to sell your business. It includes contrarian ideas that I know from experience are real secrets to success – like why you should never negotiate.

    But the best part of the book – and the part I’m sure you won’t find anywhere else – is the author’s ideas about how to manage your health and spirit while you’re going through the rigors of entrepreneurship. I can tell you that I discovered the same valuable keys – how important it is to exercise, sleep, and be grateful. And I can tell you that when my life gets out of whack, I return to the same kind of daily practice this book describes.

    Even if you never start your own business, I believe this book can serve as a guide to maintaining your happiness in the face of what’s likely to become a tough economy. It might sound strange to say this, but I wish I’d written the book. I think it will be as useful over the next few years as what I publish. It can teach you how to handle pressure, stress, failure, and success. Without these skills, all of the best financial advice in the world won’t make much of a difference.

    I have more details to share in a coming Digest about this book… to help show you why it’s such a vital guide to thriving in the coming years. And we’ve put together a special offer with the author to help introduce his ideas to as many subscribers as possible… Stay tuned…”

    • Too funny, this guy. First he rants that all of us are living way beyond our means. But later on he says, “Everyone wants and can afford a little bit of luxury in his life.”

      He should have stopped at:

      “I’ve been warning people for years that this crash was inevitable. And for many years, I’ve been made to look like a fool.”

      He seems determined to remain one.

      • He’s a very nice guy and I enjoy his respectful debate style. Even if he’s been wrong….who knows, maybe he’ll be right one of these days….

  8. Felix Zulauf is quoted in this weekend’s Barron’s: “”People are trashing cash, but it will outperform stocks and high-yield bonds and emerging-market bonds,” says Zulauf. Unlike other markets, “in cash you don’t lose,” and the U.S. dollar will be the strongest currency around. Because the greenback constitutes more than half the world’s funding sources, “whenever you have credit-system problems in the world, the dollar strengthens against virtually everything.” Zulauf would keep about 30% in cash to be ready for opportunities once the corrective phase ends. He would pay down debt — including a mortgage — keep 5% to 10% in physical gold, and about 30% in “the best-of-the-best blue-chip stocks.” Also on his list: A few high-quality bonds, such as the five-year Treasury, which yields 1.4%.” See:
    Cullen and readers, do you agree with the advice to keep 30% in cash for the next 2 to 3 months? What do you think of Zulauf’s advice?

  9. Cullen,

    A few other have already asked about interest rates. Let me take a shot by framing it this way.

    You have said that interest rates are like a dog on a leash; if the dog strays too far, the Fed will yank the leash and rein in the dog.

    Ten year Treasury yield have gone up 50% in the last two month, which seems to be a huge percentage move in such a short period of time: more than just noise. Likewise, yields on other maturities have also risen.

    Now, nothing Ben has said changes the fact that the Fed Funds Rate remains unchanged, which from my understanding influences all other yields along the curve. So, how do we explain this surge in rates?

    Ben claims rising rates reflect improvements in the economy. Really? Since the beginning of the year we have had a fiscal drag from increased FICA taxes, some other tax rate increases, and the Sequester. Is the economy really that strong to also support higher interest rates?

    Can higher rates really help the consumer at this point, who is still deleveraging? Maybe the banks will start loosening lending, because they now can make a larger spread. One thing is certain, interest rates on deposits will remain low, and there will be no pass-through income to consumers from that.

    Sensing a bubble (sic) maybe the Fed wants to take some of the steam out of the equity market sails? None of this makes much sense. Sure everyone is probably overreacting. What’s your take?

    • No, the long bond has risen ONE PERCENT in the last few months. And it remains near all-time lows.

      The key to understanding the dog analogy is understanding the dog. Most of the time the dog is akin to a Chihuahua and it’s easy to rein him in when he gets out in front. But when the economy strengthens that Chihuahua is actually more like a furious pitbull and the dog actually starts to pull the FEd. That is, a strong economy forces the Fed to respond. You could say that a supply shock economy is similar, but that’s not what we’re discussing here. Either way, the Fed can ALWAYS set the rate on the length of the leash. In a strong economy with the dog yanking it can still pull the leash very tight. But the Fed is likely to get yanked around. The Fed controls the interest rate curve, but it doesn’t necessarily control the strength of the economy (the dog).

      • After a little rise in bond yields, It is interesting to see who is coming out of the woodwork :)

      • Yes, one percent is not a large move, all the way back to 2011 levels, oh my.

        But, I don’t see a strengthening economy. Do you? With inflation low and trending down, is it even a Chihuahua economy? I understand your analogy, and I don’t see where the dog is in charge here, and expect the leash to be pull in the not too distant future.

        Add mortgage rates rising almost three quarters of a point, FICA increase, Sequester, the dollar rising, I cannot fathom how this economy is improving, and consequently, other than fluctuation, why rates are rising so rapidly.

        • I think my main point is that we’re highly unlikely to see rates continue moving higher in this kind of an environment where inflation remains low. I think your hyperinflation scenario implies a supply shock of some kind and I just don’t see it happening. More likely, the USA is like Japan and has an aggregate demand shortage, not an aggregate supply shock. That means low inflation is the base case….This is not the 70′s….

          • Cullen,
            You are confusing me with a different Vincent :-)In the future I’ll use Vinnie. :-):-)
            Kindly reread my posts, without the reference to supply shocks, or hyperinflation scenarios. Then your responses might make more sense to me.

            Actually, I’m trying to win an argument with someone who is a big Kyle Bass advocate and is betting against the BOJ and Japanese debt instruments. I’m trying to explain how the Japanese CB and the Fed control interest rates. Although they may fluctuate, the CB sets the rates. I opined that if he makes money, it will be for the wrong reasons: Japan’s economic policies will succeed, not the government unable to fund it self.

            The problem is I’m at a bit of a loss over the past few days explaining why rates are going up here in the US, when intuitively, instinctively, higher rates is the last thing our economy needs at this point in time. It appears the Fed thinks otherwise.

            Again, please reread my posts. Thanks. And, thanks for your contribution to my understanding.

            • Oops! I’ll have to reread! Bear in mind, there’s a Vincent here who is a rather famous Pragcap hyperinflationist for years running now. :-)

              • If you were confused, just think how confused I was. :-)

                Odd, Vincent is not a common name, and I frequently use it, as opposed to Vinnie, or Vince, so people remember me.

                But I’ll take the responsibility for not realizing there are other Vincent’s in the world. You have your hands full just trying, over and over again, explaining that there just ain’t no inflation.

                When you have spare time, check out this wonderful web site that graphically charts economic releases, with notations of past events to add prospective.


              • This other Vincent thinks the Yen is about to crash as Japan heads into the hyperinflation feedback loops and that Kyle Bass is right about Japan. This other Vincent is not at all surprised to see interest rates going up and things that when Japan increases their money supply by 6% in just 1 month that they are already in the grip of hyperinflation but almost nobody sees it yet.

                • Sorry Vincent this other Vincent is on the opposite side of your argument. It is my friend, who believes this.

                  This is what I recently communicated to him via email:

                  What does “fiat” mean, and what does “fiat currency” mean? Where does fiat currency come from? Can we “run out of fiat? And, do we have to borrow fiat to get it?

                  A sovereign government, by law, creates its own currency. By fiat. It owns its currency and can pass any law it wants to regulate its currency. If it decides to print it, the presses are located in the basement. And, if it can print it, why does it have to borrow it?

                  • Since I am on the other side, let me take this one. Almost every country, including Weimar Germany and Zimbabwe, use a central bank to create money and loan it out or use the new money to buy government bonds. In this way it is theoretically not inflationary as the money is supposed to eventually come back. The flaw in this idea is that government just keep borrowing more and more, so the money supply just keeps growing.

                  • It doesn’t HAVE to borrow it. But today’s arrangement is what MR calls a contingent currency issuer arrangement where the govt has basically outsourced money creation to pvt banks and chooses to borrow the money from them. The govt could change that overnight if it wanted, but for now we have a system designed around inside money or bank money and the govt must support that system whenever it destabilizes.

            • Here is a good discussion on what maybe made IR rise and what did not:


              My take is based on Ray Dalio: QE has priced in a negative liquidty premium so to say on all assets – bonds and stocks an Carry currencies and EM debt. When QE stops (mkt anticipating that in 6 months), then ALL assets drop, USD rises. This is what we got.

          • Cullen, At what point on rising rates would you begin to entertain the idea that the dog may be wagging the tail? You clearly argue that it is the fed that controls rates. It is clear that the fed does not want rising rates in a muddle through recovery that depends on a housing recovery.

        • The hyperinflation Vincent thinks that the 10 year going from 1.6% to 2.5% in 2 months is a huge move. Saying, “it is just 1%” is not reflecting the magnitude of the move. If you are a company thinking of borrowing money to do a stock buyback your costs have gone up 56% in 2 months. You might well decide not to do anymore stock buybacks.

          • PS One of the big things holding up the stock market has been companies borrowing money at crazy low interest rates to do stock buybacks. If this ends the market could go much lower.

            • And if the market goes much lower that means a stronger not a weaker dollar more than likely. You can buy more with stronger dollar buy less with weaker dollar. Hyperinflation is a super weak, like weaker than a sick kitten, dollar.

          • It’s rather absurd to talk magnitude of the move when the nominal rate is so low. Someday Fed Funds are going to go from essentially zero to half a percent. Let’s say that they are 0.1 now. Oh my God!!! That would be a 500 percent increase. And a meaningless statistic, too.

            • The velocity of money is partly the result of interest rates. To the velocity of money the difference between 0.1% and 0.5% is huge. When the velocity of money starts going up is when we will start seeing the inflation, and things will spiral out of control.

      • The TLT bond fund is down 13% since early May, based on the 1% increase in interest rate. The 10 year bond went from about 1.6% to 2.5% in just 2 months. Even at the higher 2.5% interest it will take 5 years earnings just to make up that loss. Many investors will not be looking at this and saying, “it is just 1%”, they will noticing the 13% loss. A few more 1% increases in the interest rate and most people will be dumping their bonds. This is when the out of control monetization starts.

    • Some good points Vincent, I am starting to reevaluate how much credibility the FED should be given as well as authority.

      I see why the ZEROHEDGES of the world draw big crowds.

      The FED leads everyone (BY THE LEASH)to believe one thing and then 2 months later it LEADS THEM in another.

      There needs to be a PUBLIC (FOR The People) Counterbalance to the FEDs “FOR the Banking Sector because the simple employment mandate with the skewed metrics the fed uses is Great for Banks, and Not so good for middle America.

  10. Question: Since loans create deposits and money is basically created by the private banking system with the Fed facilitating, then loans and deposits should track each other. However, since 2008 deposits have diverged from loans in aggregate by 2 trillion $$. Zerohedge (please don’t ban me from your site!) says this gap is the result of QE.
    This particular “Tyler Durden” seems to be interested in mechanics of banking as you are, but adds in a few twists that I was not aware of………….. Can you comment on how deposits can diverge from loans by 2 trillion $$ in 5 years time in light of QE being just an asset swap?


    • Yes, QE works in two different ways. The first is directly through banks. In this case, the Fed simply swaps reserves with a bank for its t-bonds. In the second case, a bank divests a nonbank of its t-bonds and issues a deposit. The bank sells the t-bond to the Fed. The latter case results in an increase in outstanding deposits without a new loan. BUT, the net financial assets of the pvt sector remain the same since the pvt sector simply swapped assets. This isn’t nearly as impactful on the economy or inflation as some sensationalize.

      • Thanks Cullen, that helps. The second part of my question, which may be a bit complicated for me to follow (your response) involves how you know that primary dealers/banks are not creating money ex nihilo to lend to the US gov’t in the original purchase of T bonds. Since the private sector is creating the $$ originally ex nihilo, say $85 billion dollars, to purchase the T-bond, the Fed now holds $85 billion and the bank holds a T-bond worth $85 billion, just longer term. Now, with QE, the gov’t repos the T-bond and credits the bank with $85 billion in zero term “cash” (reserves). Since the gov’t has already SPENT the $85 billion that it is issuing the bond for, that money is in the private sector already. And now there is another $85 billion in the banking sector, courtesy of QE that can chase assets in a way that T-bonds cannot chase…… Where am I going wrong?


        • In this particular time frame, the NFA of the private sector seems to be dependent on gov’t spending into the private sector, since there is no loan demand from the private sector for the banking industry to fund. This forces all loan creation to be from the banks to the gov’t as the gov’t spends……private banks creating the money to lend to the gov’t in return for a T bill IOU. But, as you say, you can’t walk into Walgreens with a T bill and buy anything. I’m not sure I’ve seen you account for the difference between an asset swap between private sector entities, versus an asset swap between gov’t and private sectors. The results are very different.
          If a bank creates a loan that is to the private sector entity, even if ex nihilo, the bank holds a note (like my mortgage). But that note cannot purchase goods. But if the bank funds the gov’t ex nihilo and then the gov’t buys back the note to retire “in its black hole balance sheet” you now have DOUBLE the zero term assets floating around…the ones the gov’t spent into the private sector, plus the zero term bucks credited to the bank in repo-ing the T bill. Seems like this changes the velocity of money drastically in a subsector of the private sector (the financial industry). There is therefore inflation in economic subsectors that are subject to speculation by the financial industry, but no inflation in the goods that would be purchased by the base population.
          So, I am arguing that the way that money (credit) is being created is a vast distortion to the normal flow, in that longer term instruments, which would dampen the oscillations are being pulled out of existence and being replaced by zero term instruments that are totally fungible…

          Thanks, Cullen!

        • I think it is also worh emphasizing that the capital position of the banking system (i.e. their ability to make loans ) remains unchanged.

  11. In reading your article on velocity of money and likening it to the body’s circulation (I’m an MD by training), it seems like the transmission mechanism (heart) from the Fed to the general circulation (public NON-banking sector) is absent, leading to a congestion of fluids (money) in the banking sector with no aggregate demand to get the money out of the smaller circulation of the finance community and into productive endeavors (equivalent to the pulmonary circuit being overloaded, while the general blood pressure in the body is dropping). Only FISCAL spending by the gov’t has kept the general body muddling along, and driven corporate profits, as your most recent chart indicates..


    • QE puts money directly into the public’s hands.
      The public holds an extra $85 trillion in deposits a month instead of bonds.
      As Cullen says above, the Fed then puts the bond on its ‘black hole’ balance sheet. Conventional wisdom is that the Fed has to do something about this T-bond, which leads to lots of handwringing, but MR pretty much admits the bond has been monetized and implies there are no negative consequences to this. I’d like to see more discussion about the Fed’s balance sheet and what it means.
      The problem is that the public just uses that money to buy another type of investment instead of spending it. The public may be using that money to just buy *another* T-bond — again, the long result is that spending is being monetized.

      • $85b, not $85t, and not all of it is being used to buy T-bonds. Some of it is being used to monetize housing bonds.

        • No, I don’t think that the debt is being monetized, because all money is created ex nihilo. The problem is elucidated (I think) by my comment above yours. The problem is subsector glut (financial industry) of entirely zero term instruments. The distortion comes from not breaking down “the public” into subsectors. You and I (assuming you are not vacationing in the Hamptons right now) are not seeing a lot of that zero term money that the Fed is distributing. Since the gov’t is constrained by law to balance their budget by issuing a T bill of x duration to cover any short funding that occurs, you end up getting 85 billion distributed fiscally to 300 million people (gov’t transfers entitlements etc), and another 85 billion distributed to a MUCH smaller pool of bankers. The effects are showing up as a marked redistribution of wealth from a larger population to a small percentage of those that can obtain $$ in large quantities from the gov’t.

          • clarification. When I say a glut of zero term instruments, I’m referring to QE repoing the T bills and replacing them with cash reserves….


            • … which have to go somewhere, right? Nobody wants to hold 0 pct cash, so it gets spent buying an investment asset from somebody who then must turn around and buy an investment asset to get rid of the 0 pct cash. Hot potato. The glut gets bigger and bigger until … what? The cash all goes back to the Fed in exchange for the bonds on the Fed’s balance sheet? Or new borrowing? Or, conspiratorial, until the government seizes the 0 pct cash to hand directly to the cash-starved public?

              • The hot potato concept is nonsense. Someone who sells a bond wants cash. The buyer of the bond wants bonds and not cash. No hot potato. Just buying and selling. The hot potato ignores the fact that both buyer and seller have a potato of some type and they sell them to one another….

      • Johnny: “The problem is that the public just uses that money to buy another type of investment instead of spending it. The public may be using that money to just buy *another* T-bond”… There is very little money being created right now via loans from banks to the public sector at large. This results in very sluggish velocity. To the extent that the people accumulating $$ in the financial services industry spend that $$ on washing machines and restaurants, that money starts to circulate. but when they use it in a casino to bid against each other for race horses, oil contracts, megamansions, and control of corporations (equities), which IS a form of spending, little of this wealth becomes widely distributed. It IS being spent, however, as Cullen emphasizes with the federal govt, HOW it is being spent is not greatly benefitting the majority of the public, but only a very small subsector.

        • That’s what I tried to say.
          I am not so sure that money is not being created by traditional loans — the housing market is going back up, car loans are increasing, investment margins are up, student loans are growing, not sure about business investment. Is there a source to see the amount of loan creation?


            First graph shows total commercial loans… the point being that we are just now getting back to the 2008 levels of lending…

            Housing market is confusing to me. Lumber prices crashing? I suspect some of the $85 billion per month conversion from long term to zero term assets are now chasing housing in the own to rent market, drying up supply, tho’ that may be changing. Car loans? can you say: Subprime?? haven’t we done that before?? Student loans?? from where, private industry (Sallie Mae) or the gov’t. And if insured by the gov’t, aren’t we back to moral hazard again?? Are we the general public re-leveraging before we’ve DElevered?? I don’t know how to read these tea leaves, J., but I tend to agree that very little got changed in the 2008 crisis, leaving us vulnerable to it happening again…
            See the most recent article in the ONION for example!!


            • A very good paper, showing that most of QE is with the broad public and not with Banks and this is equivalent to printing Money of about $2tr.

              • That’s not a “very good paper”. It doesn’t even mention the fact that the t-bonds are removed from the pvt sector and essentially offset the creation of money. If you’re going to talk about “money printing” then you better also mention the unprinting of the T-bond. If you don’t you’ll miss the entire point of QE and why there’s a deviation in deposits.

                • Cullen,

                  you should differentiate between where the Money Comes from (in case QE it is “printed” ex nihilio) and how it is spent – buying bonds or thrown as a partial fiscal gift in case of QE1. The way the “printed” Money is spent does not Change the fact that it is printed.

                  So looking only at Money “supply” – the Zerohedge “paper” very well explains how the Money supply increased in spite of flattish credit creation. Even if market participants are not richer, the marginal Utility of “cash” went down and the marginal Utility of savings vehicles (bonds, stocks etc.) went up. The economy did not benefit much if at all (maybe actually had a negative Impact due to misallocation of resources).

                  • The ZH situation where deposits deviate from loans is not interesting in the least. It’s simply scenario two as explained here.


                    Lots of people who don’t fully understand QE make a big fuss over it and say that it’s more interesting than it really is. It’s not interesting. It’s just a non-bank seller of t-bonds. No conspiracy theory. No more inflationary than scenario 1. No nothing really. Just a different type of seller with one more step in the chain of transactions. I don’t see what the big fuss is about.

                    • I never said it is a conspiracy or more inflationary than it is. I said it is interesting because it shows you that most of QE went with the public and not banks and thus it printed about $2tr of dollars that were directly added to M2.

                      Result is:
                      – QE is money printing
                      – M2 grew in spite of stagnant bank lending

                      => Risk assets received a boost and would probably have sucked more and longer than without QE.

                      So this answered my question: How much of QE was with non-banks? Now I know that most of the reserves were not sitting idle at banks, but were transformed in $2tr of deposits.

        • One more thing (I hate filling up the comment section, but then it is an open thread:)
          To your point that loan creation to the public is slow, this speaks to the belief that the economy grows through loans.
          In my view, however, the public needs higher wages and better jobs, not another line of credit. We tried to grow the economy in the 00′s in the home equity loan business and it didn’t work.
          Understandably, higher wages will lead to more lending, as Joe Public will borrow more when he believes he can pay down the debt. But we need to start by focusing on wage increases. Structural things — build social capital, promote education, entertain the idea of policies that bring jobs back to the U.S.

          • Higher wages would indicate an increased supply of $$ to circulate among the population at large, the 99%.. I agree with you. The question is…where does the money come from that PAYS those higher wages?? It either has to come from capex, which would involve corporations starting to circulate their cash troves (money already in existence, but stagnant) or money creation by banks in the form of new loans. (corporations can’t CREATE money) they can only produce goods that other people use money to pay for. Once again, I see it as a problem of even distribution and velocity. Right now, we have neither, tho’ “muddling along” we may be slightly improving?? maybe?? hopefully??

            • Can we get the $ to increase wages from all that money sloshing around in the financial sector? Or could it be that all that money tied up in asset prices is an illusion?
              I see radical measures in the next decade if we have a repeat of 2008.
              If we can truly create money ex-nihilo without inflation then maybe it’s just a matter of time (and the right crisis and the right Fed chief) before we use that power to funnel that money directly to the public.

              • lol, good question. Sure, we could get that money sloshing around all those capitalists and bourgeois 1% er’s and redistribute it! I think marx and lenin wanted to do something like that! “all that money tied up in asset prices…” It only takes two bidders to get a Jackson Pollack painting to $30 million dollars. If one person decides to sell that painting to another wealthy patron of the arts and distribute 30 mill to his/her workers……well, there’s another answer.

                Money is ALWAYS created ex-nihilo. It’s always been a question of who’s going to do it, the gov’t or a group of private individuals, and how it is to be regulated. If you tried to run this economy on the amount of money in existence when greenbacks were first printed up, you’d be in big trouble. An elephant has more blood than a mouse. And in the last 150 years, we’ve grown up a bit. The question still remains the same…who is in charge of creating the money that gets circulated?…….

  12. With this low interest environment the “marketing of credit” is very weak. When interest rates were higher and the ability to get loans paid-off either by selling them to somebody else (together with government backing and/or loan insurance), then taking the cold cash in. The “marketing of credit” was over the top — constant cold calls, TV adds, promoters and writers, etc. These days that’s all gone.

    In the last few years there has been a sea change, Uncle Sam is the only one actually providing the needed 2% inflation. The banks and non-bank institutions have left the building. When Volker raised the interest rates to the moon, he CAUSED inflation in my opinion. Banks and non-bank institution fell all over themselves marketing credit. Until there was nobody interested in 20% loans, out of control credit creation was the norm.

    So now — the Fed has taken a large amount of Uncle Sam’s debt off the market so when interest rates are raised the interest payments will go back to Uncle Sam or be written off. They no longer can add substantially to the mythical “national debt”.

    I think with HIGHER interest rates we will see more marketing of credit and an improved economy so that we can start up the boom-bust cycle once again. What do you think?

  13. Cullen, I was reading your exchange above with rpurdy (and I’ve read your pieces on QE)… it sounds liek QE actually is a ‘kind’ of money-printing if the Fed is purchasing T-bonds from non-banks. Whereas before the QE, non-bank t-bond holders had a financial asset that can not be used to purchase commodities, equities, and groceries…. after the non-bank sells it’s t-bond and gets deposits, the non-bank now has funds that can be used to purchase commodities, equities, and groceries.

    Although the net financial asset position hasn’t changed, this does sort of seem like money-printing… precisely because the private sector has more ‘spendable’ dollars. If you disagree, why?


    • That’s like using the quantity theory without context though. If spending is a function of income relative to desired savings then QE’s “money printing” doesn’t matter. That’s because the savings of the private sector remain the same before as after (which is why I also think QE is powerful during a big deficit and not when it wanes, because incomes rise!). If you’re going to claim the non-bank transaction is “money printing” then you MUST also show that the t-bond was unprinted. I think you have to put it in the right context….I don’t mind people saying QE is “monetization” so long as they can explain the context appropriately and that means explaining the unprinting of the t-bond and making a clear distinction between fiscal policy and monetary policy. Most people use the “money printing” or monetization terminology to frighten people into thinking there’s raging inflation coming….A sound understanding of QE squashes that.

      • If the T-bond goes onto the ‘black hole’ of the Fed’s balance sheet, hasn’t it has been ‘unprinted.’

          • You said elsewhere in this thread that in QE the ‘Fed takes the t-bond out of the pvt sector and basically just puts it in its black hole balance sheet.’
            In other words, the Fed takes an asset that has a debit and a credit and turns it into a pure credit.
            So, revisiting the Peter-Paul explanation of deficit spending.
            The U.S. takes a dollar from Peter to pay Paul and gives Peter a bond. Then it takes the bond from Peter and gives him back a dollar.
            To begin with, Peter had a dollar. Not Peter has a dollar and Paul has a dollar.
            Like you say, Uncle Sam can do this all day long as long as he doesn’t cause inflation.

            • You’re still confusing monetary policy with fiscal policy. We’ve been over that already. The Fed is not financing the Tsy. That implies a lack of demand from the pvt sector. If you can prove that then be my guest. But you can’t. And the evidence from QE2 ending proves that theory wrong. The govt doesn’t need the Fed to buy bonds in order to sell its inventory AND maintain low interest rates….If you don’t get it then you just don’t get it….Not sure I can explain it differently. Could there be an environment in which the pvt sector loses its appetite for bonds and the Fed must buy? Sure. But that’s a hyperinflaton. Surely you’re not implying that we’re in a hyperinflation or on the verge of one, are you? Vincent Cate has been making that precise mistake here for years….

              • The Fed is buying bonds.
                It doesn’t matter that you think the public would buy the bonds. I will even grant you that.
                But the Fed is buying the bonds, so the public can buy other assets instead of bonds.
                And once the Fed buys bonds and tosses them into its black hole, then Peter has given Paul a dollar and then got another dollar back after some sleight of hand.
                Everything you write leads us to that conclusion. We can debate whether this will cause inflation.

                  • I think the inflation argument is getting in the way here. So many people are trying to argue for and against inflation that the facts are being shaded a bit.
                    You’ve said that deficit spending adds a Net Financial Asset, in the form of a bond, to the system.
                    What QE appears to do is that it adds a Net Financial Asset, in the form of a deposit, to the system.

                    I actually think this would be more palatable for the public if it was presented like this. The public freaks out because it believes bonds have to be paid back with higher taxes someday. QE just shows the bonds don’t have to be ‘paid back.’

                    • You can insist all you want that the Fed doesn’t do fiscal policy, but at the end of the day Paul gets the deficit spending, Peter gets his dollar back and the bond disappears.
                      And there is just enough sleight of hand that we’re supposed to pretend it’s not happening. Why is that?
                      Own it. Defend it.

                    • If you want to imply that the Fed is needed to fund the deficit then be my guest. Just don’t spread that message here because its wrong.

                    • Cullen, clearly in Zimbabwe and Weimar Germany the central banks money creation was enabling the government’s deficit spending. Without talking about exogenous events, just looking at what the bank is doing and the debt and deficit, what criteria would you use to say if Japan’s central bank is enabling Japan’s government’s deficit spending?

                    • I would point to an aggregate supply problem. They’re totally different scenarios. Japan doesn’t have a supply problem. They have a massive demand problem. I think low inflation in Japan and the USA are far more likely than high inflation or hyper…..

                    • Not necessarily saying the Fed *needs* to fund the deficit, just that in a roundabout way, by buying bonds, it is doing exactly that.
                      QE also keeps demand for bonds going. It will be very interested to see if the Fed can turn off the spigot without panicking the markets.
                      QE should be causing inflation, according to most theories, so that’s why it’s confusing people on both sides of the argument. You seem to be trying like heck to argue that it’s not adding money to the system.
                      I’m not married to any theories about inflation. I think it’s too complicated an issue, it’s come in too many forms (stagflation, for one) for us to make confident assessments.

                    • “What QE appears to do is that it adds a Net Financial Asset, in the form of a deposit, to the system.” – JE

                      JE, a QE related deposit is indeed a Financial Asset but not a “NET” Financial Asset. It is an asset of someone in the private sector but a liability of another (the bank). It therefore nets to zero. No new financial assets have been born.

                      I like to think of NFA as equity. QE doesn’t improve anyone’s equity, with the possible exception of QE1 where the Fed was buying trash for cash.

                    • Geoff, back up.
                      Deficit spending adds an NFA in the form of a bond. QE turns that bond into a deposit.
                      So waling it back, the deficit spending ultimately added an NFA in the form of a deposit.
                      So why not just do that in the first place? Because that’s where it is going — the Fed is starting to buy back the bonds to try to get money flowing.

                    • Cullen, why do you think a supply problem means a central bank is enabling deficits and a demand problem means it is not enabling deficits, with the same amount of central bank monetizing of bonds? How can you say that turning off all the nuclear plants and having to buy oil for electricity generation is not a supply problem? Are there any objective criteria that you could explain so that I could know without asking which central banks you would say were enabling deficit spending and which were not? If Japan got hyperinflation next month would you then find a supply problem or exogenous event to point to?

              • The Fed just talking about maybe buying a bit slower in the future has made interest rates jump up in the last couple months. Doesn’t that prove that they are what has been holding interest rates down?

        • I presume you mean that it “hasn’t been unprinted”. For all practical economic purposes, it has. The Fed doesn’t take its balance sheet to Wal-Mart and buy groceries….

      • I guess i meant “monetization” when I said money-printing. I definitely know thing inflation or hyperinflation is just around the corner.

        I see the distinction you’re making and agree with it. But I think it’s a bit misleading to say that QE is only an asset swap (which it is) when one of those assets (t-bonds) can not be spent on groceries and the other asset (deposits) can be spent on groceries.

        Whether or not it will actually be spent has to do with the private sectors desire to save, etc. So again, I’m not in the inflation and hyperinflation camp. Far from it.

        But there does appear to be some monetization going on with QE.

        • sorry “I defintely don’t think inflation or hyperinflation is just around the corner” (is what that line should say)

        • It’s fine to explain QE as monetization if you explain it correctly. Yes, QE definitely increases the moneyness of the outstanding pvt assets, but that doesn’t necessarily mean higher inflation.

          • thanks for your efforts to explain this stuff, Cullen. I don’t think it is an easy subject. I’m like JK. I don’t believe in the inflation/hyperinflation scenarios because they also require other factors to be in play in addition to increased “moneyness” of assets. However, I do think it makes a difference in the economy and the markets when Peter and Paul both end up with dollar bills in their hands as opposed to Peter having a bond and Paul having a dollar. It seems like that would change the velocity of money in certain subsectors of the economy as we have seen.


          • Cullen. Thanks. This has been a point of confusion for me for a while. Now I understand. Appreciate your comments!

  14. perfect string to ask my question on….

    When the bond matures at the Fed, doesn’t the opposite happen and the money vanish; and then the bond market has to step in an allocate money to buy the bond replacing the previously owned Fed bond. right?

    The way I’m looking at this, if the Fed stops buying bonds (especially short maturity) then this thing turns into the opposite of QE, all those financial assets have to rush back into buying government bonds. right?

    When the fed ends QE, are they still committed to keeping the same net level of bonds on their balance sheet or will they let them roll off and vanish.

    • In theory, yes. In practice the government borrows more and more every year. The only way it pays off last years bonds is with money from selling more bonds this year. If the government is running a huge deficit and nobody but the central bank wants to buy bonds, then it has lost control of the money supply and it just keeps growing.

      • The Fed’s goal is 2% inflation each year compounded annually. Since the banks have stopped creating fiat currency in the form of credit since 2008, and since a huge amount of credit $s went up in smoke and off the books in 2008-9, where is the 2% per year going to come from. The answer is deficit spending. It’s not a problem, it’s the goal.

        • I meant “net credit” from the banks and non-banks — less loans more deleveraging.

    • In addition to what Vincent Cate said, the Fed hands over its operating profits to the Treasury on a quarterly basis, so the Treasury actually ends up with most of the P&I it pays the Fed anyway.

      • I can see the interest, but I don’t think the Fed remits the principal. After all, the interest does represent a profit for the Fed, but not the principal: That principal is a liability on the Fed’s balance sheet, so paying it back is like paying back a loan taken from a commercial bank I would think: interest is profit and builds equity at the bank (i.e. the bank either deducts from the interest payer’s deposit if the payer pays out of a deposit at that bank, or else the bank receives reserves from the payer’s bank should the payer bank elsewhere: either case interest payments create equity for the bank). Principal paid back, however, just means that the lending bank erases from both sides of the balance sheet (with the payer’s deposit at the bank) or else receives reserves in exactly the same amount as the amount of the loan that’s erased (should the payer hold a deposit at another bank): in either case, principal payments don’t change the bank’s equity.

        So in other words, it makes sense that the Fed would remit it’s accumulating equity to the Tsy (from interest payments), but if it remitted the principal the Fed would quickly start accumulating negative equity! I’m pretty sure the Fed does not accumulate negative equity.

        Take a simple example:

        Assets: $100 Fed deposit
        Liabilities: $100 T-bond

        Assets: $100 T-bond
        Liabilities: $100 Fed deposit for Tsy

        Now the Tsy pays back the principal:

        Assets: $0
        Liabilities: $0

        Assets: $0
        Liabilities: $0

        So far so good. Now Fed remits the principal (what I DON’T think happens):

        Assets: $100 Fed deposit
        Liabilities: $0
        Equity: $100

        Assets: $0
        Liabilities: $100 Fed deposit
        Negative Equity: $100

        Result: Just as if the Fed had created money for Tsy! This sounds like an MMTers dream, but not reality.

        That’s why I don’t think this happens! Tsy can go into the negative equity zone, but I don’t think the Fed ever does.

  15. Cullen,
    Your post on QE seem to focus on the front end of the transactions. I probably missed the post on the back end. Would be great to see a “life of a QE bond” post on your blog.

  16. Off topic: last year at this time Mike Trout’s stats were phenomenal and quite a bit higher than what his stats are today. His stats tailed off at the end of last season, whereas his stats this year may go up at the end of the season. It’s a long grueling season, which can be tough on rookies and especially older players. This year the long season should be easier on him. Just an opinion.

  17. Cullen,

    If the dollar continues to strengthen, then US exports will decrease, imports will increase, the trade deficit will widen, and unemployment will rise? Right?

    Also: Let’s say QE was mainly a placebo with very little real impact. But it may have had a big psychological impact on investors who believed that the Fed would not allow stocks to fall. (The Bernanke Put)Now that the psychology has changed, shouldn’t we expect a reversal in margin debt, stock buybacks and other investment predicated on the Bernanke Put?

  18. JE, I ran out of room above so am replying down here. Thanks for the clarification. I now see where you’re coming from. The govt deficit adds NFA, but since you believe that QE is financing the deficit, then QE ultimately facilitates the addition of NFA.

    I disagree, but at least I now feel you, dude.

  19. Technically QE is not a very big effect as Cullen has noted. Psychologically it appears important, probably because most people don’t understand the numbers. The effect on MBS is technically larger because MBS are not as liquid as Tsy. The Tsy market is $500 B/day, and the Fed has increased it’s holdings to about 12% of outstanding Tsy. In QE1, and 2, Tsy yields actually went up during QE, not down, and they are going up again, which should make it clear that market sets prices.

    The Fed isn’t monetizing the debt, because when the bond reaches maturity, the Treasury has to pay off the par value of the bond with cash. Margin interest is a tiny part of the market, and it is nearly perfectly correlated with the market, which means that it tells you nothing except that some hedge funds or other market participants always operate at a consistent margin level.

    Almost all structural factors lead towards deflation. It’s amazing there are hyperinflation believers out there. In contrast to what many expect from the Fed, Bernanke seems to be ahead of the curve rather than reacting in terms of inflation. We don’t have the same structural problems as Japan and so it is possible we will continue to muddle along, but if we move to real deflation from the current almost zero inflation, things are likely to get bad again, and then there will be nothing monetary policy can do.

    • “When the bond reaches maturity, the Treasury has to pay off the par value of the bond with cash.” Where is the law on this “fact”. Just asking, I have no clue.

      • When a t-bond matures the government doesn’t pay it off with cash as John says. The government either borrows more money to pay off the bond or it rolls it over.

        • This has been true and is “MR” for bonds held by the public. However, at this time the Fed has a balance sheet holding US debt to an extent that we have never seen before. You say: “The government either borrows more money to pay off the bond or it rolls it over.” where is the law that says this vis-a-vis the Fed held USA debt? Again, I don’t know. Isn’t it more likely that they bonds are in effect “bought back” by the wife in this husband/wife relationship. I’m trying to find the answer to a question. I believe Cullen has said that the Fed and Tres. can do what it wants with these holding. There is in “fact” no law at all about this.

    • I’m beginning to think there is actually a bigger QE effect than just psychological, which is what I’ve believed and read on this website for the past couple years. Cullen’s educational focus has been to get people to see that this is an asset swap, that changes term structure, but NOT money printing (except possibly in the case of QE1 where MBS and other bank held paper that was marked to fantasy that could not be marked to market, was exchanged at par for dollars.) Yes, it is true it is an asset swap. But there is a big difference in swapping a T bill for cash contained in the private sector, versus exchanging a T bill for cash coming from the Fed. In the first case, the private sector has no overall change in term structure…it is just one entity exchanging with another…Peter now hold the T bill, Paul now holds cash. And this exchange can be done ad infinitum without affecting term structure overall in the private sector. But, with QE, Peter and Paul are now BOTH holding zero term instruments (cash). So, with QE at 85 billion per month, there is now an addition of 1 trillion dollars of new “moneyness” over the past year that was not present before. Note, I am NOT saying there are a trillion new NFA flooding the world to create the dread hyperinflation scenario, just a change in term structure of a trillion..uh, units of account…. (whatever the correct terminology would be..)
      I’m not sure how anyone can/could predict exactly what would happen when this occurs. I can say that on a personal level, if I suddenly have a million cash as opposed to holding a million dollar IOU that would be paid in 10 years, I’d probably make different investment decisions. And I think that is what has happened with the QE’s…


  20. Hi Cullen,

    Just wanted to make a suggestion to the website.
    It maybe helpful to have a “Views” bit next to the date, number of comments and author/source on the front page under each article’s title.
    It would help irregular viewers filter through the articles and get to the more popular ones. And maybe help you see which articles/topics are most interesting to your viewers.

    Thanks for the hard work on the website, genuinely helps us plebs!


  21. Cullen,

    Perhaps QE is nothing more than a vehicle for the FED to create negative interest rates. Since the US dollar is our number one export, Hedge Funds and Prop traders can lever up, going short USD and long assets. With real interest rates recently going positive since The Bernank first stated tapering may come into play, Hedge Funds are rapidly unwinding the QE carry trade.

    They could care less that QE buys $4-5 billion of bonds in a market that trades $800 billion a day in MBS and Treasuries. Once interest rates went positive and the real cost of the carry trade became much more expensive it pays to be first out the door and not wait around to see if and when Bernanke cuts back his buying.

    That huge sucking sound you hear is US dollars coming home — just how much carry trade yet remains to be unwound is the answer as to when you’ll see a stabilization in bonds around the world.