I’ve spent a great deal of time analyzing and attempting to explain the possible ramifications of QE2 since it was first announced a year ago. My research led me to believe that there was no real substantive transmission mechanism through which QE2 could possibly impact the real economy given the current economic environment (balance sheet recession). But there was something else occurring as a result of QE2 and I believed it was causing severe distortions in the markets and resulting in a massive disequilibrium that threatened the real economy.

Before QE2 was inititated, Brian Sack, Executive Vice President of the NY Fed made the following statement:

“Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.” (emphasis added)

Brian Sack and the other proponents of QE2 have justified the program in large part due to its portfolio rebalancing impact, wealth effect and other various market impacts. I have repeatedly stated that these effects are largely overstated and that the program was highly misguided, was misleading the public and likely resulting in a market disequilibrium that put the real economy at risk. In my opinion, false conclusions from decades of neoclassical economics has resulted in little to no distinction between markets and the real economy due to the efficient market hypothesis and the general belief that markets fairly represent the real economy. I think this is terribly flawed.

In my paper titled The Destabilizing Force of Misguided Market Intervention, I said:

“we are still at risk of a major dislocation due to the Fed’s severely misguided policy of QE2 and the market’s dramatic misinterpretation of it.”

What occurred when QE2 was inititated was one of the most fantastic market misinterpretations I have ever witnessed. A relatively harmless program (QE2 was nothing more than an asset swap with no true transmission mechanism that would alter either the private sector money supply, private sector net financial assets or the real economy) was incorrectly described as “debt monetization“, “money printing“, “stimulus” and other descriptions that implied QE2 was having a massive impact on the real economy through various channels. This couldn’t have been farther from the truth.

What QE2 definitively caused was a massive distortion in investor sentiment due to a general lack of understanding. Equities, commodities and other markets appeared almost entirely invulnerable as long as there was this belief that the Fed was backstopping the market. In other words, the Bernanke Put was in full effect. I have described the negative impact of the Bernanke Put on several occasions (see here and here) over the last year.

So what has occurred during QE2 is little to no real economic impact, but this massive psychological impact that has mostly impacted the markets as investors expected a certain real economic impact. As we all know now, that economic impact never materialized. So, prices were bid up as the Fed fueled the market with the misconception that it was achieving some real effect on the economy. But all this really did was generate a massive distortion.

In April I asked how the Fed was going to let the market down without causing a collapse in prices. But as equities collapse and wipe out the entire gains from QE2 it’s now clear that the market is quickly recognizing the true impact of QE2 – nothing. And the distortion and disequilibrium is resolving itself. Unfortunately, the Bernanke Put and such misguided policy creates no real economic impact, but distorts prices in such a manner that, when prices correct, the real economy can be substantially impacted as uncertainty, fear and volatility cause disturbances in the real economy. So in an interesting sort of way, QE2 is doing more harm than good.

In addition, one of my greatest fears as a result of QE2 is that the Fed is hurting its credibility via its own misinterpretatons of this program. Last November I said:

“The Federal Reserve has placed its credibility at risk while also creating market distortions due to misconceptions surrounding a policy that very few people actually understand. This is not only unhelpful in solving the actual cause of the current crisis, but creates extreme disequilibrium in markets that only makes matters worse.”

Make no mistake. The current market collapse is not merely a coincidence. It is the direct result of the fact that the Fed created a distorted market environment. The current economic weakness and other global instabilities are merely an excuse for the collapse we are now seeing around the globe. And now the Fed has to accept the fact that their policies have helped contribute to the slowing economy.


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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  1. My word Cullen. You’ve achieved the holy grail of economic understanding with your work on QE2. You’ve taken an in-depth understanding of the monetary system and combined it with behavioral finance to create an stunningly accurate market portrayal.

    I am not going to lie. I thought you were full of it last year when I first read that you thought QE was not money printing. But you’ve been beyond vindicated.

    Thanks. And well done.

  2. No offense, but I find it pretty scary that someone like yourself seems to understand all of this so much better than Ben Bernanke.

  3. Yes, thank you for the analysis. I spent a good portion of my economics conversational time over the last year trying to convey what you showed us last year. Like you, I had my doubts around March-April (when lots of ‘bona fide’ indicators of recovery were providing many with confidence). Like you, I take no pleasure when I make calls that play out when they have negative repercussions.

    C’est la Vie. At least you know you have a rational appraisal of reality; something that I believe will become only more valuable as more uncertainty grips many with fear.

    Thanks for offering your thoughts to us, and good luck.

  4. P.S. You made a typo in naming your other article: The Destabilizing FORCE (not For) of Misguided Market Intervention.

  5. No offense taken. I find it rather disturbing also. Although I certainly don’t claim to understand monetary ops better than BB I do find it odd how they justify these programs with so little empirical evidence. I don’t blame him for trying after all. Much is demanded of him and he simply doesn’t have the tools to achieve his goals. So I don’t blame him for being creative. But I find it inexcusable to ignore the evidence as an excuse to keep trying failing policies….

  6. gold is in the process of ‘pricing in’ QE3…..more bad policy after bad.watching these clowns for the last 20 years how could anyone expect anything else?

    they will use their only blunt tool to keep the plates spinning.

    more changes on the horizon to discount(in the CPI) ANYTHING that goes up in price to save money on SS checks….if/when housing ever comes back i bet they discount housing’s effects, too:

    “More formula changes are on the horizon. Vice President Joseph Biden heads a budget cutting committee, and the committee says it has a plan to reduce government expenses by a $220 billion, over ten years, by making the CPI calculation “more accurate.” Savings will be achieved on Social Security cost of living increases, Medicare reimbursements, TIPs interest servicing expense, and a host of other government expenses tied to inflation. All are indexed to the official CPI, and all these expenses will go more slowly if the reported level of the consumer price index does dow

    The… new proposals will help the CPI reflect “how people change their spending patterns when prices increase” …[and] require the BLS to consider the fact that people use less of things that rise quickly in price. For example, let’s say people shift to buying very small fuel efficient cars because they cannot afford the price of gasoline. People are forced to use a lesser volume and weight of gasoline and the government argues that, as a result, the overall inflation rate has gone down. If and when this new legislation becomes law, the BLS will dynamically change the CPI formula to change the weighting of various goods and services, reducing the percentage assigned to goods that rise in price, and increasing the percentage assigned to goods that fall or are static.”

    the rest at:


  7. Soon we will be much closer to an equilibrium value, since we are this morning in the phase of big shocks where DAX moved down roughly 9% in little more than 1 hour.

    Scenario 1: Only the QE2-Bubble will be retraced. This means we are mostly done with crashing and the DAX movement this morning was a selloff. This scenario will quite likely true, when FOMC announces something about Bazookas today.

    Scenario 2: DAX around 5200 and S&P500 around 950 could be possible target regions. This are the highs of June 2009.

    Then the QE2 Bubble would be completely and the QE1 bubble would be half retraced. This is a bit exaggerated, but markets like to act in this way ;). This scenario is likely if in the FED announcment is no word about bazookas.

    Other views?

  8. Alternative theory, same conclusion.

    QE2 was intended to provide support to eurodollar reserves in response to the first Greek default scare (an unexpected Greek default would hammer certain eurodollar banks, particularly French). In the aftermath, Greece stabilized, possibly due to the support of QE2 adding confidence, or possibly not. Either way, QE2 support didn’t end up being needed to deal with Greece at that time so expanded reserves instead went speculating, exacerbating the equity melt-up and contributing to commodity inflation.

    Between Nov 2010 and Jun 2011 the Fed purchased $600B in US paper. In the same period cash assets of foreign banks increased by $630B while domestic banks hardly changed. Occam’s Razor: QE2 was intended for scared Europeans, I’d guess #1 BNP Paribas and #2 Deutsche Bank.

    Now Europe is imploding again and the support provided by QE2 will finally need to be drawn upon, meaning that whatever positions QE2 enabled must be unwound, thereby adding to existing selling pressure on commodities and equities. Although long delayed, QE2 may finally provide some eurodollar support as originally intended, though it will fall short of what is needed as it was never intended to cover Italy.

    Net effect for the US economy? Higher equities and lower GDP due to higher commodities during the time that QE2 was not needed. Minimal support to domestic lending as QE2 was not primarily intended to provide it.

    So I share CR’s conclusion, that QE2 actually did more harm than good, I just don’t agree on the motivation for it.

  9. Mediocitas: “QE2 was intended for scared Europeans”

    Very intersting view and I will think carefully about it.

    Until now my view was that QE2 helped crisis countries in the EMU considerably because of the liquidity injection into the overall market. Now this aid is missing and the ECB has to step in. Since ECB doesnt want to create bubbles, it uses pellet guns instead of bazookas, which might turn out to be too weak …

  10. Awesome piece, thank you for your work! When can we expect to see your book? Cement your position in economics history.

  11. “the Fed created a distorted market environment.”
    “Federal Reserve policy makers are likely to embark on a third round of large-scale asset purchases, moving “more decisively” to secure the U.S. recovery, said Harvard University economist Kenneth Rogoff.”

    The patient is still on steroid the problem is that the Doctor is the pusher.

  12. The market is a spoilt child that has now unwound all QE2 gains (except GOLD) miraculously upto the day of FOMC meeting. THey are whining and Ben is going to invariably listen. Because that is what they have done for over a decade. LTCM was the original sin.
    Anyway, I find it curious that Gold and CHF are somehow aloof from this unwind. Maybe they have to break before the selloff is over.

  13. So, it was just an asset swap eh?

    MMTers just close their eyes to the fact that the Fed created the cash out of thin air to buy Treasuries. I don’t care whether you call it money printing or asset swaps, it’s just a shame you use MMT to hide the truth: more dollars were magicked into existence.

    Also, you completely ignore the ‘real wordl’ facts.

    TARP, QE, QE2: none of them were ever about ‘helping the economy’.

    All of them had one purpose, and only one: to keep the banking elites afloat for one more bumper bonus payday. Hank Paulson (ex-Goldman) knew this, and he succesfullt scared the dunm US politicians shitless to get them to hand over $600b.

    Bernanke was handing billions each week on a plate to the Primary dealers as they flipped the recently issued T-bills back to the Fed, every time costing the US taxpayer money.

    And it’ll keep happening, as the banks have no way out of this hole, other than bankrupty. So, QE, in whatever form, will continue for years, the dollar will sink, then plummet, then welcome to US hyperinflation.

    Pooh pooh it again and again Mr Roche, but watch it happen.

  14. if cash assets rose by the same amount as QE in size and remained so than where did the money that “went speculating” come from? if cash assets went up by that amount does that not imply that the QE reserve injection just sat there in its most liquid form?

  15. Cullen, you were the first, and others have followed with your asset swap description. What I find interesting is you are not referenced or credited very often. BI is an exception. Sometimes Seeking Alpha. I think you are a bit of an anomaly, or threat. But there’s no doubt, and I scan a lot, you have captured the flag as the place to go for those seeking cause/effect interpretation of economic jargon.

  16. One good thing in all this is that there are more nice and safe dividend paying stocks out there.

  17. Cullen,
    I know you have discussed at length previously and it maybe timely to show a snapshot of the yield curve at the beginning and end of QE2 (similar to wealth effect snapshot of the S&P posted yesterday). Part of the Fed’s communicated goal with the program was to stimulate economy by lowering yields, yet it appears that QE2 (plus a range of other economic variables) has mildly raised mid to longer term yields.

    Also, I recall part of your critisism of QE2 was that the government was buying a fixed # of bonds (that produced a market yield) rather than declaring a target yield and buying at any volume required to achieve that yield. Even if the Fed had done the later, you conclude (and probably justly) that because of the private sector deleveraging lower long term yields would provide some relief but be insufficient to achieve to support job creation and the necessary economic growth.

  18. Cullen,
    The dollar has retraced only some of the losses from QE2. The one thing that Bernanke HAS accomplished is dollar devaluation. Forget gold. What do you think about the dollar against other currencies? Why has QE2 accomplished this selloff?

  19. My view, QE2 bought time, nothing more than time… because the crack is here and could be done a year ago. A year ago that GOP could force the no-debate about debt… So QE2 showed US can buy their own debt, now they show they can do default, or to carry other countries to default using the agency annotation. Cullen has to be aware between what they said in public and what happen and is simple naïf they don’t know.
    The misunderstanding between real economy and market is us, real economy is that countries can consume per capita ten or more times than others, and that can be like that forever. We cannot use FX market to follow on with the rule of the neoclassical economy or the cold war economy. We have a huge gap to fill between the two world and they simple do it. Market is global, but the real economy we see is local because we are local… We need some more steps down…

  20. “They are whining and Ben is going to invariably listen’
    Exact , At times its almost as if its not a market base on valuation but a trading place based on guessing what the Fed will do.

  21. I appreciate Cullens and others comments on here. At this point another round of QE seems fruitless. The economy seems to be at “damned if you do and damned if you don’t”. What is likely to happen from the federal reserve? What are the effects on interest rates? Obviously rates should go up, but when? How will this effect the housing problem. And how soon could we see inflation take off? I know there are a lot of “what if’s” in my questions but the direction of this economy seems to be written in cement.

  22. This is just the end game for Volcker’s disastrous policies – too many commentators suffer from a attention defecit disorder caused by this electronic age.
    The richest country in the world exported nearly ALL of its capital abroad both human & financial to save a symbolic currency.
    The Euro masters have been doing similar physical damage to Europe over the last 15 years – this time to create a currency.

    A currencies strength is not always correlated with its economic potential.

  23. If we stay in this dollar system we will QE to near infinity – you see there is very little to productivity give credit to – therefore they will just give money back to the treasury over 10 to 20 years.
    And that only if kids going through school today can be retrained into doing something productive.

  24. Cullen-

    Looks like the dollar’s about to rally. What are your thoughts regarding the dollar considering your above statements?

  25. I believe the Z1 flow of funds during that period also showed large inflows into equities as well. Maybe us stupid retail investors were asset swapping with the Euro banks!

  26. I would agree with your assessment Cullen only in the fact it may have sustained the correction a bit longer than it otherwise would have taken to fall. QE though has nothing to do with price action. It is the same argument as those that say inflation was going to slam us, have no idea what money really is or how it works. Deflation never left as the debt problems that caused it never left. All you have to do is look at the indexes to see that the credit peg (in USD never left). It has been like this since 1994 which is why all idexes move in synchronized pattern. You know what happens in Asia generally happens in New York. What happens first is people lose faith in their government. This happened about two to three years ago with Obamas lies and all the western world leaders lies about fixing a problem they caused to begin with over thirty years of promising things they could never deliver on. The second part is losing the people losing faith in their central banks (ie. the Federal Reserve) where they thought they had control of the problem which produced optimism only to find out they never had control of anything. This problem is bigger than any central bank (even the Fed) has the ability to control without going broke itself. 600 billion versus a 750 trillion in derivitives in USD’s floating around out there in the shadow banking system. Even the Fed can’t control this kind of leverage. Now this debt and leverage is contracting again. Now is when people will lose faith in the so called Fed Put which was never there to begin with. Keep up the good work.

  27. Dear Cullen,
    QE2 was all about the Fed buying treasuries to drive investors into higher risk assets to create a “wealth effect”, which was supposed to stimulate the economy and increase consumer spending. This leads me to think about the real purpose of the goverment issuing treasuries, which you have said many times is not to fund the deficit, but to withdraw liquidity from the private sector. Why then does the government continue to sell treasuries at a giddy pace thereby reducing the private sector liquidity, when the Fed is trying desperately to stimulate consumer spending? The two actions seem to be mutually exclusive.

  28. This is enlightening.

    I did some reading on eurodollars and unlike US bank reserves, euro-dollar reserves do not have the same banking restrictions and thus can find themselves speculating on commodities and the stock market. There is still no “causation” and now I need to read into flow of funds, but I think MMT can be generalized to account for the differing nature of eurodollar banks/reserves that can be invested. At least I am not aware of that distinction of reserve types ever being made in MMT.

    And I’m being a bit of stickler here but I recall being sternly corrected in one of my posts after stating the bank reserve increase from QE2 were being used by banks to speculate in commodities. The counter-point that was made, was that legal restrictions prevented US bank from speculating with reserves. Which for US bank is obviously valid but for eurodollar deposits this may not necessarily hold. Tsk tsk tsk. In fact I recall a number of doomsday and educated pundits that were ridiculed for not understanding the banking system (and MMT) and specifically for claiming erroneously that QE2 reserves were leading to speculation/inflation. To be fair, I don’t claim they know or distinguish between eurodollar reserves and US bank reserves but there appears to be some possibility for truth in their assertion and perhaps more.

    Anyone please feel free to correct me if I understanding on this is off.

  29. Nice article Cullen! I sometimes question what I view as your often generous assessment of the motivations of the people in power, but am consistently impressed with your economic analysis. I have learned a lot from you, thanks! krb

  30. Cullen-

    The psychological impact of QE2 to investors, and in return to the equity and commodity markets (with the exception of gold and silver) demonstrated an almost bubble like implosion since late July. This is in support of your observations of QE2; however, PRUDENT fiscal spending by the public sector seems to be one of the only ways out of this to create a surplus in the already weakened private sector. What transmission method do you propose to help encourage private sector spending? I would think a further reduction in taxes, like Short-term capital gains reduction and other reductions would also help incentivise the private sector to spend… If my understanding of MMT is correct, then lowering taxes should be a stimulus in this time as taxes only take away liquidity from the system (and create a demand for the monetary units- i.e. dollars), but are not necessary for government spending.

  31. Michael,

    Are bonds really that much less liquid than cash? Would altering the outstanding bonds increase the “liquidity” of the spenders and alter their desire to save relative to their incomes? The evidence from QE2 says no.

  32. I doubt very much that they have learned from this experience because they can attribute the current dive to a multitude of other factors and they would not exactly be wrong.

    Just as markets can remain irrational for long periods of time, governments and policy makers can also remain irrational for long periods. Especially policy makers that rely heavily on monetary policy and obviously believe in it.

  33. I read a while ago (March) that one effect of QE2 was that many of the parties that sold their treasuries to the fed turned to the overnight repo market as an alternative way to earn some interest on their new cash balances, and then the borrowers on the repo market used the borrowed funds as collateral to leverage purchases of riskier assets.

  34. Hardly. Even Cullen credits learning from Warren Mosler, Randy Wray & Bill Mitchell.

  35. forgot to credit Cullen for increasing the readership of Mosler/Wray 10x;
    takes expanded writing to recruit new audiences

    bill mitchell has a huge readership, but caters to a more academic crowd

  36. Cullen, you are spot on on your comments regarding the balance sheet recession.

    I will point out, however, that you were until recently the proponent of the theory that we would “muddle through” with our economy and the stock market would march on from it’s recent highs. So taking the angle that “I warned this would happen” should also review why your projections for the economy this year were off.

    It is not possible to achieve sustainable GDP growth above 2% with the current private debt levels, regardless of public sector spending or MMT theories to the contrary. There is no free lunch, there is no blue pill.

  37. One of my (few) criticisms of MMT is the very strong US focus and not enough attention paid to international factors. Although a case may be made to ignore many international factors that are not directly tied to the US dollar, the same cannot be said for eurodollars. Eurodollars matter and they matter a lot.

    Unfortunately, the Fed does not publish much data regarding the “other” USD fractional reserve system. It has enough trouble keeping tabs on what’s going on in the US.

    You’re on the right thread. The Eurodollar fractional reserve system is very much the wild, wild west. With regard to the mechanism of how QE2 -> Eurodollar -> commodity & equity inflation, I recommend reading the work of Prof John Mason. Here are some examples:




  38. LOL. Gary from UK, I think one of the rioters must have knocked you in the head with a beer bottle.

    Please tell us why The Fed and Federal Government’s only interest are “banker bonuses”? Does it have something to do with tin foil?

  39. Cullen great piece. But 2 nits to pick.

    1. Letting the housing bubble inflate was worse than QE2. Greenspan had tools that he did not use to deflate it.
    2. As you might already understand the reason for the slightly better fundamentals during QE2 is deficit spending. As Warren Mosler says the deficit spending lets us muddle through.

  40. Thomas, anyone reading my work over the last 3 years knows that I’ve been more bearish about the macro picture than not. I’ve said the stimulus would help us muddle through but that the BSR would persist until the debt levels were paid down. My market approach has always been an extension of this macro approach and I have been a proponent of trading. And I’ve generated excellent risk adjusted returns over this cycle. Readers who follow me closely know I’ve made some incredible calls over the years….So, the implication that I’ve been “wrong” is highly misleading in my opinion. I am not sure if there are many macro theorists who have been more right than I have…..both in the economics and the trading…

  41. Woah! Highly valuable stuff mediocritas, will have to factor all this in the effect of future policies and try to keep up with the flow of funds.

    Very nice.!

  42. More great work Cullen. You do a great job weaving a lot of inter-related but complex ideas into a coherent and concise analysis. I hear the Fed research staff is hiring! My jaw dropped when I read Sack’s “…asset prices will be higher than otherwise would be…” statement last year and it still does today. It should go down in history! It is truly amazing that the Fed believes that nominal wealth creation (on the back of a flawed theory no less) would lead to real wealth creation. And as you point out, did they not consider what happens when the psychological support that is QE is pulled out?

  43. Good job Cullen. I am a follower of your website from more than one year ago and remmember perfectly your explanations in many articles about what is and what not is the QE2.
    They helped me very much as all of your work explaining how works the modern monetary system. Now I think that I am a privileged man with all of this knowledge that here in Spain is seldom known even among professionals of finance.

    You wrote before that during some period in this year you thought that you could be wrong about QE2. I suppose that this is because the profits of companies better than expected and the stock markets soaring.
    Well, I never doubted that your analysis was correct (QE2, the non event), but thought that if the FED swaps to the banks Treasurys for cash, maybe they use some of this cash to buy risky assets to get some income (they loose coupons of Treasurys) So in this case, hundreds of apples in the shelves helped to sell more.

    Thank you very much for publish your fantastic work.

  44. Let’s think about how this transaction works that you are proposing. The Fed does an OMO, assume with a non-bank dealer. The dealer’s account at his/her bank increases. The bank’s reserves increase. You’re suggesting that this deposit of the dealer’s ended up as an asset for the offshore bank. The only way that happens is if someone lends it to the offshore bank, or if the offshore bank sells something to the dealer for it (same as the offshore bank offering a Eurodollar to the dealer). OK, fine, but note that you don’t need QE at all for this–Eurodollar banks could offer accounts at anytime in order to acquire US bank deposits; QE has nothing to do with it unless it somehow makes eurodollars look more desirable–possible, but that’s not what you were arguing, it seems.

    Offshore banks don’t hold reserves, they hold deposits at US banks. The ECB has a reserve account, though, and it can lend to euro banks with accounts at the ECB in $ after a cb swap with the Fed. This is why post Lehman the Fed did $600B in these swaps–to calm eurodollar mkts. And during QE2, the Fed again set up the swap lines in case of a Euro crisis–as you say, it didn’t happen. So, in the case of a crisis, the Fed will come through with more cb swaps; QE won’t be necessary and wasn’t for this purpose.

  45. From Warren Mosler’s bio at http://moslereconomics.com/about/: 1982 – Present: Founder and Principal, Illinois Income Investors (III) – Developed numerous successful strategies that utilized US Government securities, mortgage backed securities, LIBOR swaps and LIBOR caps, and financial futures markets in a market neutral, 0 duration strategy. Originated the ‘mortgage swap’ in 1986. Orchestrated the largest futures delivery to date (over $20 billion notional) in Japan in 1996. Created the current euro swap futures contract.

    So, you’re saying that the guy who did these things doesn’t understand int’l financial factors or eurodollar markets? Really????????

  46. OK, let me correct myself here. Reading the Mason piece, his transmission mechanism is the same as mine. As such, your (Mediocritas’s) explanation could certainly be valid–I was under the impression you were saying something different (sorry!!! I think I still had Durden’s stuff in my brain). However, this could also be a simple side effect of QE2 rather than the intended effect of QE2, or it could have been a desirable side effect in the views of the FOMC–we’ll know which of the three only perhaps when the Fed has to publish its transcripts in about 5 more years.

  47. Again, though, it still stands that this could operationally happen without QE2, but (yet again, to confirm your point–which I now realize was your point and I incorrectly suggested in my first comment was not) QE2 could be an instigator.

    Regarding my earlier disagreement arising from my own misunderstanding, I was assuming the Durden/Brown argument that “the QE2 money went offshore instead of staying in the US and that’s why banks didn’t make any loans” which you clearly weren’t making.

  48. Strawman. I never said that. You did.

    I said not enough attention is paid to international factors, never did I say they didn’t understand international factors.

  49. Since the Fed has swaps in place already why would they need QE to help Euro banks? I am having trouble seeing how Mediocritas’ idea actually works to help those banks.

  50. Correct. ZH seems to trigger a hate response which overrides everything else. I had to learn that the hard way.

  51. I’m an absolute neophyte with respect to this eurodollar discussion, so my question here is very basic.


    Offshore banks don’t hold reserves, they hold deposits at US banks.

    So why is it so hard for the feds to track these accounts for tax purposes? Can’t this just be done through the US banks that hold the deposit accounts?

  52. So is there a way to format comments? Or is that only available on the message boards?

  53. There is something I do not get with Mediocritas hypothesis though, which is, why would QE modify the behavior of the big banks. They could have sold the treasuries w/o QE, and use the proceeds in the same way. If the only instigator was the loss of interest on treasuries, it seems to me that there are many other lower risk ways to obtain a return than to invest in commodities or to make loans to invest in commodities in the current market environment…

    I will appreciate any kind of explanation here, cause I am a bit lost.

  54. What is the transmission mechanism here Mediocritas? Replacing bonds with deposits doesnt improve their capital position. So how does this help the European banks?

  55. well said

    though I thought you were done quoting yourself after the first time. double dipped on that approach

  56. What is scary is that if an offshore bank applies sufficient leverage to these unregulated eurodollars deposits and bids up commodities or assets, you have the makings for a “Minsky Moment”. (That is as banks make profits directly or indirectly speculating on asset appreciation. And as they receive profits, they feel risk is manageable and and take on more risk and leverage until asset price collapse because of lack of insufficient new eurodollar credit to sustain price appreciation. Though in reality these systems need years to become unstable, but that is a nice little ponzi scheme.

    Ok this is all conjecture and leveraged 600 Billion can really only do so much damage, and perhaps it can in some part be responsible for our hard and sustained sell off we have seen. I guess we will find out the exposure our great banking system had to commodities and other assets over the coming earning seasons. I will have to look into profitability of the offshore operations and trading desks if we can get that insight.

  57. Thanks cullen for your fantastic work.

    2 Qs

    1, Are there any reason that Fed is very aware of what they do and how they communicate it, but they simply cant tell the truth cause propaganda is part of strategy?

    2, why cant Ecb print euro, just like fed, and buy piigs bonds so the spread narrow to the level of german bund?

  58. I think that the short answer is that they cannot by law – the ECB was specifically banned from being able to buy EU countries debt.

    The long answer is that last year they actually got a permit to cheat on their own rules in extraordinary circumstances, and they are doing it in extreme cases, like this week with Italian and Spanish debt, although not to the level you are proposing.

    Interestingly enough though the comparison with the US would be for the Fed to buy debt generated by the states, which, as far as I know, it is not doing. So in this case, the ECB is behaving more aggressively than the Fed.

    The equivalent to treasuries in Europe would be the so called “eurobonds” that would provide a single financing solution and single interest rate for all EMU members, which is precisely one of the solutions that Warren and Cullen et al. are proposing for Europe.

  59. OK, sorry. Though I’d disagree with your actual point, I’m batting .000 today, it appears, so I’ll stop. :)

  60. I read TPC as saying that QE2 created distortions that hurt the real economy through market psychology and related portfolio adjustments in favor of commodities and metals. Herding into commodities and metals was the result of inflation fears due to the “money printing” meme even though QE2 was just an asset swap of short and medium duration debt (Treasuries) for zero duration debt (dollars). Perception became its own reality.

    What this tells me is that the madness of crowds matters even under MMT, and that a sudden loss of faith in the dollar and zooming velocity, similar to what did in the Pound in the 1980s, is far from impossible if our leadership continues to look for and rely on monetary solutions, even though under a pure MMT approach huge slack in the economy should allow for plenty more monetary stimulus without adverse effect on inflation or velocity. Isn’t this what the current price of gold is telling us? Gold as portfolio insurance and fear barometer makes it much more than just a shiny rock. Volatility is another tell.

    TPC, you may alienate your audience of MMT classicists, but money managers have to make a buck and call them as they see them; college professors have tenure. I recall taking a shot or two on this site when I first started commenting here, because I was worried about market psychology and the madness of crowds as an independent variable that might be a big wild card in MMT analysis. Am I OK now after QE2?

  61. Isn’t it true that QE was electronic money creation? In other words, the assets that the fed swapped for treasuries were created ex nhilo (electronically) by the Fed? Am I mistaken about that? If I am not mistaken, then where did the money come from to purchase the treasuries?

  62. Really good analysis Cullen, and you are not alone. I saw one analyst on Bloomberg today that said basically the same thing. Don’t remember his name but he was on the noon hour program with Tom Keene. I have also read a few other analysts that are in agreement with you in that it was not “money printing”, but that the Wall Street group believed that it was and that was what led to their belief in the “Bernanke Put”.

  63. Of course is isn’t their only interest, or even the primary one, but bankster bonuses do get recycled into Obama campaign coffers (maybe Romney gets some too). Remember, he let the bailed out banksters get record bonuses in the first place, in 2009. He did not have to.

  64. You’re welcome to disagree, even I am not entirely certain that the Fed’s primary motivation was to support foreign PDs. As you say, we won’t no for sure until we see internal Fed memos. My guess as to motivation is as good as anyone’s however the end results of the Fed’s actions (regardless of motivation) seem very clear and I think we’re all in agreement.

  65. The only difference is duration, and interest income to the private sector. Bonds provide more interest income than cash, which has zero right now.

    If the Fed wanted to pump cash into the private sector, perhaps they could buy gold.

  66. The “law” as to what the ECB can and cannot do is largely meaningless. There is no higher authority that can actually stop them from doing something that a majority of the ECB board votes to do. The main obstacle is political. How do they justify to the Germans buying Italian debt but not German debt? Perhaps they should buy the debt of EU States in amounts based on some generally applicable formula so that the more responsible States like Germany do not feel slighted or aggrieved.

  67. I’m fine with all that. I was referring to the suggestion regarding MMT and int’l factors/eurodollars when I said I disagreed–probably true that it doesn’t get as much attention in the MMT blog world, though.

  68. The transmission mechanism is explained by Prof. Mason in the links I posted above.

    I think people are over-thinking this. The simplest explanation is often the right one: there was a run in the eurodollar system. The Fed was slow to react (with QE2) and by the time it did, QE2 was (probably) no longer needed as Europe stabilized Greece its own way.

    Think back to the setup for QE2: http://www.safehaven.com/article/20842/the-forgotten-flash-crash-one-year-later

    Greek CDS were starting to blow out but the market took little notice. The euro tracked down in a nice inverse relationship (one that I traded and that didn’t enjoy watching break down later due to QE2). Eurodollar banks were likely already experiencing pressure on eurodollar reserves as fear in Europe began to grow. Greece quickly began to matter, a lot, another Lehman, causing the Flash Crash. Cash assets of foreign banks diverged markedly, increasing as eurodollar banks panicked. The exposure of BNP Paribas to Greece, for example, was, and still is, significant. Those CDSs pay out in USDs, threatening eurodollar holdings. The euro, predictably, tanked.

    QE2 looks like the Fed’s response to ease eurodollar pressure, reduce disorder in US Bond markets (by providing an unshakeable bid) and, in a round-about way, prop up the euro (which I didn’t like one bit). Eurodollar banks took the opportunity with both hands. They’d just had a very close shave and were scared of it happening again (rightly so).

    Meanwhile, there isn’t a whole lot of incentive for eurodollar banks to reverse the trade and go back into Tsys. Yields are terrible and prices, while likely to hold up fairly well, aren’t guaranteed to have a whole lot of upside. Thanks to the Fed, if you want yield, you have to stay away from TSYs. Meanwhile the situation in Greece is no better, CDSs today are far above where they were in 2010:http://www.bloomberg.com/apps/quote?ticker=CGGB1U5:IND

    More concerning, France is in launch phase: out http://www.bloomberg.com/apps/quote?ticker=CFRTR1U5:IND

    Yet markets (until recently) don’t seem so concerned. There’s a hefty dose of crazy in the Fed’s kool-aid.

    Eurodollar banks are still wearing the brown pants in fear of a sovereign default, declaration of credit events and CDSs triggering, all contributing to a run on eurodollars. They’d better be because Europe certainly does not look stable right now. I don’t think the situation is any more complicated that this. QE2 was the Fed doing what a central bank is primarily designed to do, stabilize a (eurodollar) bank run.

  69. I don’t see how the two could be related. We know the swap lines achieve this goal. But the timing is odd as well. You’re saying the Fed was a full SEVEN months late to act on the Euro crisis? The timing is more than conspicuous. It just doesn’t make sense. The Euro crisis broke out in early 2010. QE2 started in November…..I don’t doubt that the Fed may have thought they could help Euro banks somehow, but the timing is odd and the results are certainly poor. I guess we agree in the end no matter what though. QE2 didn’t do much….

  70. Recall the frustrating game of bailout ping pong during 2010. I can’t forget it because I got whip-sawed constantly until I gave up. The Germans were in on a bailout, then they weren’t, then they were, then they weren’t. The IMF were involved, then they weren’t, then they were. It went on and on.

    If we set May 5 and Nov 10 as the watershed dates (~6 months) it’s fair to pull the right date in because a decision like QE2 doesn’t get made overnight. Given that there was no actual default, it’s easy to imagine that they mulled it over for weeks if not months. Unlike 2008, there wasn’t an actual default, just the threat of it, so the urgency to act was reduced, they had the luxury of time.

    Being primarily a European problem, I’m sure the Fed would have preferred to sit back and let the EU/ECB/IMF deal with it, hence the lengthy delay. Certainly the initial talk out of Europe in early-mid 2010 sounded promising but time and time again, it turned out to just be talk. I remember getting excited and disappointed through several iterations. Eventually, the Fed decided enough was enough and acted to stabilize the situation. Maybe it did achieve that, maybe it didn’t (and the situation self-resolved). Either way, Greece didn’t end up defaulting (yet) and the rest is history.

    Half a year had passed.

  71. It just doesn’t make sense. We’ve had this conversation before, but there’s no reason why a bank wouldn’t desire to hold Tsys during a banking crisis. And as we see during each flare up, Tsy’s rip. Banks can’t get enough of them. Scott explained this a few months ago:

    ” US Tsy’s are absolutely just about the best thing to be holding in a crisis. Look at what happened to Tsy rates each time a crisis has kicked up. Look at what happens to repo’s on Tys rates. If a bank needs cash or refinancing, it can’t do much better than to be holding a Tsy. They were so in demand for collateral during the 2008 crisis that the Fed had to accept lower quality collateral in repos and discount lending to not reduce the qty of Tsy’s outstanding, while the Tsy had to re-open issues that were going on extreme special.”

    I personally think Mason is reaching here. There’s no reason why QE2 would really help the European banks anymore than they could help themselves before given their Tsy holdings and swap lines….

  72. Well, I’ll defer to you on that.

    I arrived independently at chartalism but only encountered the MMT acronym a couple of years ago. I only know “MMT” from the blogs, which I do find to have a pretty strong US focus. (I’m not American myself). Can you recommend other blogs/sites that take a more global view of MMT?

  73. Maybe they think they need to get to cash, but none of this means it’s helping them in the end. And that’s really the bottom line. I think we agree that QE2 isn’t really helping the Euro banks, right?

  74. Eurodollar banks clearly increased cash assets, as we can see, so, by logic, there must have been a strong demand for cash over TSYs. I can only make my best guess as to where that demand came from and I’m pointing at Greece. To explain the demand for cash over TSYs, I’m putting it down to a combination of direct runs on eurodollars and to defensiveness as a consequence of CDS positions.

    For a while there it really looked like Greece was going to go, triggering CDS payouts when it did. Settlement occurs in USD (eurodollars in this case) giving exposed banks a motivation to trade away TSYs and “cash up”. Maybe there’s a better explanation but I can’t think of one (yet).

  75. I think we agree that QE2 isn’t really helping the Euro banks, right?

    Right, and I think you’d also agree that it isn’t helping ANYONE! And it’s not just about numbers in the ether and bank profits. Recall that government fell in the Middle East and people actually got killed because of food price inflation. Seeing as I attribute commodity inflation largely to ZIRP and QE2, I therefore believe that Ben Bernanke has blood on his hands. A pretty strong statement? I’ll double down, the man is guilty of a crime against humanity.

  76. Yeah, you’re clearly right. I don’t know M. Maybe there’s something more complex going on here than I can understand….If you find out some more details on all of this I hope you’ll let me know. I am certainly not saying you’re wrong. Just that Mason’s research doesn’t completely add up IMO. Thanks as always.

  77. If you find out some more details on all of this I hope you’ll let me know

    Well, I could be completely wrong and it might be your angle that is right. Maybe they really *did* just do this for the perceived benefit of the wealth effect. The day I insist on being 100% right (without hard evidence) is the day I give up being a scientist, hang up by lab coat and embrace dogma.

    This is just a discussion of alternate hypothesis and one day we might have empirical data to know the right answer.

  78. The Fed has, at all times, an infinite cash asset, yet we don’t have infinite inflation because that cash is dormant.

    By swapping TSYs for some of this infinite cash all that happened is that the TSYs became dormant at the Fed alongside the infinite cash asset.

    Net assets outside the Fed didn’t change in value, only in flavor. (TSYs transformed into cash).

    The whole process is sterilized because when the Fed sells its TSYs back to the market, the cash it gets in exchange goes back into dormancy with all the other infinite cash.

    In addition, because TSYs earn income, the Fed injects it back into the external world in order to preserve how things would have been if the TSYs were still out there. This is achieved by the Fed handing over income earned to the Treasury. Another way the Fed can divest itself of unwanted profits (it would be deflationary if the Fed sat on them), is for the Fed to pay them out as interest on reserves.

  79. As the US debt-to-GDP ratio rises towards 100%, policymakers will be tempted to inflate away the debt. This column examines that option and suggests that it is not far-fetched. US inflation of 6% for four years would reduce the debt-to-GDP ratio by 20%, a scenario similar to what happened following WWII.


  80. The ECB can’t print money because in the foundation of the european monetary union this was explicitly forbidden.
    Why? Because the printing of money is joined to the issue of new debt. Think in the balance of the ECB: the new money is a liability that must be balanced with new government bonds in the assets. But, each country of the EMU issues its own bonds, so what bonds should buy the ECB with the new money?

    A solution would be a mix of bonds weighted by the PIB of the country issuer. But the problem here is that the ECB would be forcing to get into debt to every country each time new money is created. And Germany didn’t allowed it.

  81. No way to use inflation (at least at that level); no demand is available for that, money flow is not going down, to the mass. In other hand we cannot go in this direction, we should downgrade the entirely Western Countries asset through FX – currency devaluation, first USD then Euro to equilibrate the demand/offer balance. US has absolutely enough potential to pay its debt in USD as soon you want, but not before USD is going down enough, EUR is deleveraging its social-system to find the equilibrium. Inflation must be in synchrony with salaries rising and low cost-import-commodities (raw materials)… as it was after WWII….. and that’s is exactly the opposite they are looking for…… it has a point, and we are not ready yet…

  82. I think the arguments of both of you are right (you bring good thoughts, Medi!).

    What comes to mind, though, is: I think BB and others at the Fed/Treasury etc. logically have to understand MMT (in order to come up with things like coordinating auctions, engaging PDs as market makers etc.), but don’t communicate it.
    So indeed I think BB didn’t intend to help the US economy with QE2 in particular, but mainly to help (European) banks. But imagine him saying this!

    So I conclude never to underestimate the Fed’s intellectual understanding of what’s going on, although they never communicate it like that.

  83. The Bernank understands all this just fine. He knows QE is not truly effective, that it distorts markets and ultimately may do a lot of damage – especially to the Fed’s credibility.

    The reality is that QE2 was a hail-Mary.

    The Fed is out of bullets.

    (They used the last one on themselves)

  84. I think Warren and Bill’s sites are quite a bit more int’l in focus, certainly than the KC site. In both cases, still an emphasis on US (and AUS with Bill), but Warren’s running the research arm of his hedge fund and he publishes most stuff that comes out from the people assigned to other regions with his own commentary added. (In his book, Warren explains two of his biggest paydays–not coincidentally as a result of his understanding of MMT–which occurred in Italy and in Japan.) The KC blog has about 10-20% on Euroland, but only once in a while on anything else. Bill and Randy have consulted for numerous countries even outside of Euroland (in fact, most all of them are outside), but that rarely shows up in the blogs.

    As for research, I would start with Jan Kregel, currently at Levy. He’s got a lot of stuff on reforming the financial system of late, but he ran the research arm of UNDP Finance (among many other things) up until a few years ago and several of his pieces were published at Levy. He did some good stuff within the last year of BoP, too. If you’ve never spent much time looking into his research, he’s truly phenomenal–definitely one of the very most intelligent people I’ve ever known and probably will ever have the pleasure of knowing. Encyclopedic.

    Don’t know how much this helps, but it’s a start.

  85. M @3:14am

    I’m with you and Cullen there, completely. Thank you for the good discussion.

  86. Could this be the transmission mechanism? I came across this statement at http://www.contraryinvestor.com/2011archives/mojun11.htm :
    “Although it’s just our perception, the banks used the money to trade the financial markets (remember that banking system excess reserves can be used as collateral for futures and derivatives contracts – how convenient).”