QUANTITATIVE EASING 3 – ANOTHER MONETARY NON-EVENT?

* This post was written in 2011 before Mr. Roche founded Monetary Realism, which was formed due to several disagreements Mr. Roche and many other former MMT proponents had with the school of thought.  For more info on the difference in views please see here.  For more on MR’s views please see here.

Yesterday’s stock surge off the lows was attributed to comments by several Fed officials who said they are now in favor of the Fed implementing QE3 if the economy continues to deteriorate. I think it would be useful to review what QE2 did and what it did not do.

Now, before we begin it’s important to understand that markets are highly complex dynamical systems. No single policy is going to control these complex systems and it’s impossible to understand whether certain policies would have had differing impacts if implemented differently (or not at all). Therefore, we can only work with the facts we have and the reality that we see before us. This data will work within what has actually occurred and not within what may or may not have occurred without QE2 (such a study would be useless as its findings would be unsubstantiated).

Last year around this time I said quantitative easing would be a great “monetary non-event”. This was based on the idea that QE, as it was being implemented, lacked a transmission mechanism which would allow it to substantially impact the real economy. My prediction that it would matter very little to the real economy and my ideas that it was not “money printing” or “debt monetization” were all met with a great deal of controversy as these ideas were well outside of the mainstream beliefs. With a full year of data in the bag we can judge QE2 pretty definitively.

What QE2 did not do:

It did not help house prices:

It did not reduce the cost of a conventional 30 year mortgage:

QE does not appear to have substantially altered corporate bond rates:

It did not cause the consumer to go on a spending binge:

It did not cause an increase in hourly earnings:

It did not cause businesses to go on an investment binge:

It did not work through the traditional monetary policy channel of increasing loans:

It did not cause real growth to surge:

This is all consistent with my initial argument before QE2. My beliefs were based primarily on the idea that there was no real transmission mechanism through which QE2 could positively impact the real economy. It would not alter the net financial assets of the private sector, altering bank reserve balances would not increase lending and it would not work through portfolio channels in any positive manner due to the balance sheet recession. I believed the result would be little to no real impact, ie, being a “monetary non-event”. But before we make any sweeping conclusions let’s look at what QE appeared to do.

So what did QE2 do?

We know definitively, that the program was misinterpreated by most as “money printing“, “debt monetization” and other terms that implied that hyperinflation or even high inflation were on their way. It’s pretty clear now that that is not the case, but that didn’t stop markets from reacting strongly. We know, definitively, that speculative actions in the markets increased. (Some of these data points are controversial, but again, we are working within the reality that we can see and not what we believe to be true. Correlation does not equal causation, but this should provide us with a fuller picture nonetheless.)

NYSE Margin debt exploded at a 35%+ YOY rate during the program:

It also appears to have helped stabilize the equity market:

We all know that commodities including oil and gasoline prices surged during QE2. I don’t believe it’s a stretch to assume that the massive increase in leveraged speculation coincided with an eagerness to protect one’s self from what was believed to be a highly inflationary environment. This is consistent with a surge in commodity prices.

It helped fuel higher headline inflation:

Gasoline prices played a particularly important role in the surge in inflation:

QE also appears to have had a negative impact on the US Dollar. This is consistent with the idea of monetary easing:

What’s so interesting about all of this data is that the real world data appears to have deteriorated while the data from some markets appears to have improved. In commodity markets we saw massive price increases that did not coincide with subsequent growth in the US economy. Now, some of this effect could be due to overseas growth, but as the BOJ recently reported, I don’t think we can entirely rule out the idea that investors substantially increased their speculative bets during the QE2 program which influenced market prices. The margin data would appear to confirm such thinking.

What we got from QE2 was essentially one huge margin squeeze on the economy as investors protected themselves from inflation via their market hedges (helping contribute to cost push inflation via commodity prices), but saw little to no real-world impact (no offsetting substantive increase in hourly earnings). The result was an increase in inflation and inflation expectations, but no positive follow-through in the real economy to offset the negative effect of the cost push inflation.

Interestingly, this policy gets right to the heart of the discussion that was started the other day by Scott Sumner with regards to MMT and its intense focus on the real-world. Mr. Sumner said:

“I wasn’t able to fully grasp how MMTers (“modern monetary theorists”) think about monetary economics (despite a good-faith attempt), but a few things I read shed a bit of light on the subject. My theory is that they focus too much on the visible, the concrete, the accounting, the institutions, and not enough on the core of monetary economics, which I see as the ‘hot potato phenomenon.'”

This is the line of thought that leads so many to misinterpret QE and its effects. Efficient market thinkers make little distinction between the real economy and the markets. Markets after all, are believed to be good representations of the real economy. This feeds into beliefs like “wealth effects” and the idea that the Bernanke Put is good for the real economy. But as I’ve previously described, markets are anything but efficient. And the markets most certainly are not perfect reflections of the real economy.

I won’t rehash all of the actual monetary operations and the operational realities of QE, but the critical flaw in QE2 is that it had no real transmission mechanism through which it could fix a balance sheet recession and solve real world problems. Instead, it’s largely based on the myth of “wealth effects”, altering real interest rates (which most consumers and business have little to no awareness of), portfolio rebalancing effects and altering expectations.

Clearly, with stocks substantially higher than they were a year ago and the economy more fragile than it was when the program started, I think we can confirm that Robert Shiller was indeed correct about the effect of an equity market wealth effect – it’s highly overrated.

Altering real interest rates and portfolio rebalancing are fanciful sounding in an academic study, but in the real world consumers and business owners have little perception of real interest rates. Particularly during a balance sheet recession. What alters consumer spending habits is their spending desires relative to real earnings. In the case of QE2 we saw a decline in real earnings and a jump in inflation. This is consistent with consumers experiencing a reduction in their standard of living and it is not surprising that we have seen very weak consumer data in recent quarters as a result.

What primarily alters business investment is whether or not they have customers walking in their doors. Because QE did not alter the net financial assets of the private sector (it is merely an asset swap) it did not provide consumers with more spending power which would lead businesses to increase investment. More importantly though, real rates are most effective when they cause a releveraging effect in the economy. And herein lies one of the primary problems with monetary policy during a balance sheet recession. Consumers don’t want to take on more debt! So businesses might refinance, but without the increased business there is no reason to expect them to increase investment. These facts are abundantly clear from the above data on private investment and personal consumption.

Altering expectations appears like pie in the sky economics to me. I don’t deny that there is a certain level of truth to the idea that animal spirits play an important role in the economy, but they cannot be altered via the Fed bond purchases as we experienced during QE2. The problem here is that the majority of consumers and businesses make very few of their daily decisions based on the fact that the Fed might be buying some more bonds. Because this operation does not alter the net financial assets of the private sector there is very little reason to believe that it will filter through the economy in any sort of meaningful way. So, as I’ve often said, QE2 was implemented in a manner that is similar to telling your blind child that he/she might become a world class archer one day. It builds up hope, but doesn’t follow through with any real fundamental effect that will help the child achieve the dream you have implanted in his/her mind.

The various Fed banks and several academic studies have been released over the duration of the program that focus on the events themselves. These “event studies” include data on the days when the NY Fed was actually involved in buying bonds. I have previously argued that these studies are nothing more than datamining based on efficient market hypothesis. But markets are far more complex than this and are not nearly as efficient in their price discovery as some might think. An example of event studies might lead one to conclude that a particular stock’s earnings do not matter because the stock tends to decline in price on the day that they report their earnings. Of course, that would be a nonsensical thing to conclude, but a carefully devised event study could be framed in such a manner so as to provide credence to such a theory. These “event studies” ignore substantial market data over the course of QE2 and imply highly efficient markets. This is grounds for deep skepticism in my opinion.

In terms of its real effects QE2 could have actually been more of a drag on the economy than a form of stimulus. We know for a fact that the Federal Reserve turned over $73B in profits to the US Treasury in 2010 alone. That is largely interest income that is being taken away from the private sector as a result of their massive balance sheet expansion. Remember, this is interest income that the banks could have been earning. Instead, they are receiving 0.25% paper in exchange for their much higher yielding securities. QE does not add net financial assets to the private sector so the net financial drag appears to have been quite substantial.

It’s also important to quantify the effect of the surge in commodities when compared to the fiscal stimulus enacted at the end of Q4 2010.  We now know that Ben Bernanke believed that QE2 was necessary to help finance the extra spending.  Of course, MMTers know this is nonsense as an autonomous monetary issuer in a floating exchange rate system never “finances” its spending.  So, what’s interesting is that QE2 could have actually resulted in a tax hike via commodity prices.  Back in February I mentioned that there was a likelihood that gasoline prices would surge into the summer months.  This was worrisome because gas prices had already rallied into this strong seasonal period.  At the time I wrote:

“If gasoline prices were to average $3.75 by this summer it would be the equivalent of wiping out the entire tax cut that was recently passed.  If prices were to surge back to their 2008 highs it would be the equivalent of a $182B tax on the consumer since QE2 began.”

This indeed happened and it the consumer is now feeling the pinch.  It appears as though QE2 may have actually contributed to offsetting the entirety of the payroll tax cut enacted at the end of last year.*

In sum, it appears as though the positives (wealth effect, portfolio rebalancing and lower US dollar) were more than offset by the many negative trends that persisted. I am a bit surprised by the fact that some Fed officials are weighing another go at QE. The data appears undeniably weak arguing in favor of further “experimental policy”. We have had our experiment and it did not work. What is the point of trying it again? And have we considered the possibility that it could actually makes things worse? As a risk manager, this looks like an awfully bad bet to me. Granted, Dr. Bernanke isn’t in the business of portfolio management, but he is in the business of creating price stability and full employment. I don’t see how this program helps him achieve these goals.

What about QE3?

Now, the Fed could implement QE3 in various ways that would differentiate is from QE2. They could pin long rates and essentially define an inflation rate (this is essentially what the quasi monetarists are arguing in favor of, however, they reject the notion of the balance sheet recession so I think they’re still missing the key element in this economic downturn). Or they could buy other securities. I have trouble concluding that the risks here outweigh the rewards. There is no need at this juncture for the Fed to purchase other securities from the banks. Playing market maker in 2008 was effective. I said it would be at the time. But this is a very different environment. We don’t need the Fed to stabilize the mortgage market. What we need now is real help to the US consumer. Buying more securities at this juncture will only further increase the profits to the Fed which will reduce the net interest income to the private sector. This is entirely unnecessary at this juncture.

The other strategy that is often discussed is pinning long rates. This would certainly “work”. By “work”, I mean that the Fed can achieve any rate across the curve that it desires. All it needs to do is name a price and not a quantity at a specific duration and tell the market that it will protect this rate. The failure to do this has been one of the primary arguments I have used against QE2 since its inception. QE2 could never alter rates meaningfully because it was implemented incorrectly by targeting size and not price. But the risks with this approach are enormous in my opinion. Imagine the market’s response to the idea that the Fed is a willing buyer of however many bonds it needs to buy to achieve a 2% 10 year rate? If you thought the speculative ramp after QE2 was bad I hate to imagine what would happen after this. The debt monetization and money printing articles wouldn’t come off the presses fast enough. This could, in my opinion, only exacerbate the margin squeeze we have seen in recent quarters.

What can be done?

At this juncture, I think we have to recognize that monetary policy has failed us. This does not mean that monetary policy has been entirely ineffective. It just means that it has been far less effective than other possible tools. In terms of the various monetary tools, QE2 appears to have been a particularly ineffective policy response.

Dr. Bernanke would best serve the American people by going to Congress and explaining to them that we are suffering from an extraordinarily rare disease that he simply does not have the tools to combat. He should urge Congress to understand that it is impossible for the USA to “run out of money” and that this debt ceiling charade has been a failure to understand our monetary system. With very low core inflation he should explain to Congress that they can afford to help their constituents more. He should urge them to understand that we are nothing like Greece in that we can’t “run out of money”, but that austerity could make our economy appear similarly weak. He should urge them to pass an immediate full payroll tax holiday and help alleviate the burden on the debt laden consumer. It won’t solve all of our problems, but at this point it’s better than throwing more monetary policy at the wall hoping that it will stick. Perhaps most importantly, Dr. Bernanke needs to understand that further fiscal policy does not need the aid of monetary policy as QE does not serve as a “funding” source for the US government and could actually offset fiscal policy via other negative channels.

* This section was edited on 8/4/2011

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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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  • MS

    Nice Cullen. I am totally in favor of a payroll tax holiday. That would be one of the easiest things the govt could do to speed things along. Anything that could be done to increase the rate at which the market can deal with housing inventory would be great too.

    Beyond that, only time and household formation will get us through this thing.

  • wh10

    Monster piece.

    Cullen, how would you define a “consumer spending binge?” Looking at that graph, there was a temporary 1% absolute change in growth during the heart of QE, then of course lowering (but spending still growing).

    Also, for noobs like me, how does the value of the dollar lower? Can it simply just be based on speculative trading? How long can this last if there is no real inflation under it?

    I can see how this is an incredibly hard argument to win against people not seeing it through your lens. From an MMT perspective, what you say makes total sense. But to a hardcore monetarist, you’re essentially telling them it’s all an illusion and the market is wrong. That said, the first batch of graphs is some good support in your favor, but the opposite side will cling onto that fall in the dollar and increase in headline inflation (though btw, is by no means frighteningly high).

  • SS

    The bottom line is real GDP has tanked. End of story.

  • Willy2

    Intersting piece of work.

    When I look at the silver-gold ratio (going up) then it seems QE3 is already being rolled out. But it looks it has only a small numbers of beneficiaries: gold, silver, T-bonds. And that money doesn’t/didn’t go into the stockmarkets because they tanked. And it looks like it didn’t go into copper or crude either.

  • Wulfram

    Cullen,

    Could you elaborate what would happen if the Fed does decide to target the yield instead of purchasing set amounts? I understand that there may be a speculative boom in commodities, precious metals, and foreign currencies, but I wonder what impact it will have on the real economy. Also, what hedging investments would one make to shield one’s portfolio from QE3?

    I suspect that QE3 would accomplish little for the real economy. But the Austrian in me suspects we might see some financial gimmicks such as offloading FFF rated bonds as fast as the computers can securitize them onto the Fed balance sheet. Would that not be the same as money printing, considering that the Fed would be trading cash (worth something) for something around the equivalent of Borders equity?

  • http://ralphanomics.blogspot.com/ Ralph Musgrave

    Scott Sumner is in effect an MMTer, though I’m not sure he has yet tumbled to the fact. He attaches much importance to what he calls the “hot potato phenomenon”. This is simply the fact that when the private sector’s net financial assets rise (monetary base in particular), every private sector entity tries to get rid of some of this money (a point made over and over by MMTers). But since it is impossible for such money to disappear, the money (aka “hot potato”) gets passed from hand to hand more quickly. The net effect is a rise in demand.

  • http://www.3spoken.co.uk Neil Wilson

    The best the central banks could do at this juncture is to fix the interest rate where it needs to be for investment and then just state that they will purchase for cancellation any bond that drops below par.

    But it has to be in conjunction with some sort of fiscal stimulus among people with a high propensity to spend.

    The more time goes on, the more dogmatic the separation of Treasury and Central Bank appears.

  • Paul Andrews

    All three of the causal relations posited here are incorrect.

    An increase in “net financial assets” can occur simultaneously with either an increase or a decrease in the total amount of bank deposits and other credits (i.e. the hot potatoes).

    An increase in the amount of bank deposits and other credits can occur simultaneously with either an increase or decrease in the desire to pass them from hand to hand.

    The passing of bank deposits and other credits from hand to hand more quickly can occur simultaneously with either an increase or decrease in real demand.

  • Dennis

    I think you said this before, QE is like pushing a string. Since the interest rates are so low, banks and other financial institutions don’t want to make long term loans to anyone that has any sort of risk. As a result the amount of $US debt dollars is going down and down. We are in a deflationary situation with the US’s largest asset, property and homes. Loans are being paid off, or property is being confiscated by the banks and other financial institutions that created horizontal $US debt dollars. Many many folks simply can not find the money to pay the interest anymore. So they (11,000,000 from Mexico alone) are leaving us with this property that they sort of rented from the loan sharks. We thought we had a problem with south of the boarder immigrants, we do, they are LEAVING. OMG

  • Alastair

    Non-farm payrolls went up by about 900K over the period of QE2, why did you omit that graph?

  • GordonGekko

    I agree with the tax holiday but there is nothing to say that those with a job will not use that as an opportunity to pay down their debt … which is exactly what they should do! The American consumer has reached debt saturation and until enough has been paid down and/or defaulted on the balance sheet recession will continue.

  • Octavio Richetta

    A+!

  • nark

    This website and the discussions here seem very sensible, but i still don’t understand the state of any over-arching theory. is MMT just a few simple statements about the here and now, or have you managed to extrapolate these arguments into the future? i’m guessing that this is much more difficult.
    surely the details matter. bond holders may (for instance because they are retiring or dying) want their assets in another form? does anyone know where this leaves japan for instance? and how true do you think that it is to say that europe and the US are 15 years behind the japanese along a similar path?

  • F. Beard

    Remember, this is interest income that the banks could have been earning. Instead, they are receiving 0.25% paper in exchange for their much higher yielding securities. Cullen Roche

    Then why did the banks sell? And might they just turn around and buy more US Treasuries? In other words is this just stealth recapitalization of the banks? So is every QE just a gift to the banks?

  • Bill

    To speak about the OIl market without mentioning the disruption in Libyan oil supply is silly. It was a big fundamental shift in the oil supply as there is no equivalent replacement for Libyan crude. That has had more to do with the oil market than QE2.

  • ReturnFreeRisk

    Very well written. Your arguments have a lot of merit and I have thought like this for a while. However, it is nice to see them laid out so eloquently.

    If the Fed were to drop dollars out of helicopters, it would help. People would actually get cash to spend. And it would be like the government giving people cash through fiscal policy (transfers). Dont tell Congress. Just do it.

    I do not think Bernanke will do it. One, because I think the plan is economic repression (taking interest income out of the private sector like you outlined above), and 2) his concern is to keep the stock market up and shore up banks than individuals.

    Overall, we need new people at the Fed. The people who caused the bubble will not get you out. It never has been the case. We should have cleaned house instead of keeping the same old cast of characters – bernanke, geithner and summers.

  • John Zelnicker

    Ralph —

    Ok, I need some help here. I am totally unfamiliar with the “hot potato” phenomenon. Why does “…every private sector entity try to get rid of some of this money…”? And where are they getting rid of it? As a private sector participant, I may want to keep my increase in NFA, therefore increasing my savings and/or paying off debt. Also, I have been studying MMT for the past few months and I think I have a pretty good understanding of its basic tenets. But I don’t remember seeing anything like the “hot potato” idea in MMT. Perhaps it’s there under a different name, but the whole idea seems far-fetched to me. If you can direct me to where Cullen, Warren, Scott, Rodger, or other MMT experts have written about this, I would appreciate it.

  • JH

    Another shot of ether down the carburetor is not going to repair this broken engine.
    I believe the most likely scenario is another artificial run up in equities and commodities for a short time followed by phase 2 of this secular bear market. The Fed, being a one trick pony, will do the only thing they know how to do in a last gasp effort to extend this environment of Wall St. / Big bank profits.
    This is going to get ugly, really ugly.

  • Peter D

    “Hot potato” refers to the idea that people’s desire to hold cash (and banks’ desire to hold non-interest earning reserves) is very limited, so, they keep passing the hot potato of cash and reserves around, bidding up prices. See Scott Sumner’s discussions with MMTers here:
    http://www.themoneyillusion.com/?p=10178
    and here:
    http://www.themoneyillusion.com/?p=10238
    I don’t think this has to happen for several reasons:
    -at low interest rates the preference to hold cash may increase (the indifference level goes down)
    -with economy depressed, people hold onto cash in the face of uncertainty and to respond to investment opportunities
    -the velocity of the hot potato passing might go down relative to normal times

  • wh10

    But you could still have a hot potato that doesn’t transmit into increased prices of goods and services. Asset prices can change, no?

  • John Zelnicker

    Peter D — Thank you. I had read the first article you mentioned, but reread it and read the other one as well as a couple of articles by MMT’ers linked from there. The best I can get out of it is that the “hot potato” phenomenon contributes to the velocity of money. Is that right? Otherwise, I think you’re right that it may or may not happen.

    But even with those articles, I’m still a little confused. BTW, my reference to Scott was meant to be Scott Fulwiler, not Sumner. I am still looking for MMT writings that explain this desire to get rid of excess cash balances.

  • http://marketthoughtsandanalysis.blogspot.com/ binve

    Excellent study Cullen, very much agreed with your conclusions.

  • Peter D

    Right, except for leakages from the asset prices to goods prices. And inflation from asset prices is a “bad” inflation, meaning not the one we’re looking for to counter deflation. I also have a list of why I think the monetary policy might be not working here:
    http://pragcap.com/nyse-margin-debt-declines-with-the-end-of-qe2/comment-page-1#comment-67824
    Would love to hear your and other’s thoughts.

  • mpr

    “In terms of its real effects QE2 could have actually been more of a drag on the economy than a form of stimulus. We know for a fact that the Federal Reserve turned over $73B in profits to the US Treasury in 2010 alone. That is largely interest income that is being taken away from the private sector as a result of their massive balance sheet expansion.”

    I don’t get this: When I sell my treasury to the Fed the price I get presumably offsets my expected revenue stream adjusted by the prevailing rate of interest. (Which QE presumably has the effect of reducing).

    So the above amounts to the argument that higher rates are good for the economy because they cause treasury to spend more via interest payments thereby increasing
    NFA more quickly.

    On the other hand, doesn’t QE increase NFA ?: I have a treasury which trades for $100. After QE I sell it to the Fed for $102. NFA increases by $2. Moreover, all the other $100 treasuries go up by $2 whether the holder sells or not.

    This doesn’t help with the lack of transmission mechanism of course, which
    is why a large part of those NFA’s are sitting as excess reserves.

  • Peter D

    John, damn, typed a reply and it just disappeared, need to do it all over again.
    In short, yes, I think there is no hot potato if velocity doesn’t go up – if the holders of reserves and cash just hoard those.
    I know you meant Scott F. :)
    People should switch out of cash when the opportunity cost of holding it is too high – either because real interest rate is too high or something else. My question is to what extent people actually observe real interest rate and act on it?

  • Peter D

    “On the other hand, doesn’t QE increase NFA ?: I have a treasury which trades for $100. After QE I sell it to the Fed for $102. NFA increases by $2.”

    To the extent that the Fed pays a premium, yes, it creates NFAs.

    Regarding the interest removed, I also have the same concern as you do. But I guess what could happen is that the interest rate removed is not offset by other assets appreciation. Suppose I am selling my bond at par to the Fed, expecting to make money in the equity market. But I don’t make any money because equities are flat. I just lost the interest on the bond, right? The question can this happen in aggregate for the non-govt sector? I am not sure, need to think about it.

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

    Would it really be fair to imply that employment has been strong during QE2? I guess it just never even occurred to me to say tat employment has benefited enormously during QE2. Less than 100K jobs per month and a 0.4% decline in the UE rate. Maybe I am being unfair? If you think that’s unfair then I’d be interested in the counterargument.

  • http://neweconomicperspectives.blogspot.com Scott Fullwiler

    In my two pieces on coin seigniorage, I was essentially going at the “hot potato” effect here, particularly the second point, but it’s kind of a package deal since they all go together:

    “First, sellers of bonds were always able to sell their securities for deposits with or without the Treasury’s intervention given that there are around 20 dealers posting bids at all times. Anyone holding a Treasury Security and desiring to sell it in order to spend more out of current income can do so easily; holders of Treasury Securities are never constrained in spending by the fact that they hold the security instead of a deposit. Further, dealers finance purchases of securities from both the private sector and the Treasury by borrowing in the repo market—that is, via credit creation using securities as collateral. This means there is no ‘taking money from one person to give it to another’ zero sum game when bonds are issued (banks can similarly purchase securities by taking an overdraft in reserve accounts and clearing it at the end of the day in the federal funds market), as what in fact happens is that the existence of the security actually enables more credit creation and is known to regularly facilitate credit creation in money markets that are a multiple of face value. Removing the security from circulation eliminates the ability for it to be leveraged many times over in money markets.”

    “Second, the seller of the security now holding a deposit is earning less interest and can convert the deposit to an interest earning balance. Just as one holding a Treasury can easily sell, one holding a deposit can easily find interest earning alternatives. Some make the argument that the security can decline in value and so this is not the same as holding a deposit, but this unwittingly supports my point that holders of deposits aren’t necessarily doing so to spend. Deposits don’t spend themselves, after all.”

    “Third, these operations by the Treasury create no new net financial assets for the non-government sector (and can in fact reduce its net saving by reducing interest paid on the national debt as bonds are replaced by reserve balances earning 0.25%). Any increase in aggregate spending would thereby require the private sector to spend more out of existing income, or to dis-save, as opposed to doing additional spending out of additional income. The commonly held view that ‘more money’ necessarily creates spending confuses ‘more money’ with ‘more income.’ QE—whether ‘Fed style’ or ‘Treasury style’—creates the former via an asset swap; on the other hand, a true helicopter drop would create the latter as it raises the net financial assets of the private sector. Again, ‘money’ doesn’t spend itself. By definition, spending more out of existing income is a re-leveraging of private sector balance sheets. This is highly unlikely in the current balance-sheet recession, aside from the fact that QE again does nothing to facilitate more spending or credit creation beyond what is already possible without QE. The exception is that QE may reduce interest rates, particularly if the Fed or (in this case) the Treasury sets a fixed bid and offers to purchase all bonds offered for sale at that price—though this again may not lead to more credit creation in a balance-sheet recession and has the negative effect of reducing the net interest income of the private sector. (As an aside, a key difficulty neoclassical economists are having at the moment is they do not recognize the difference between a balance-sheet recession and their own flawed understanding of Keynes’s liquidity trap.)”

    I find words like “hot potato effect” and “hoarding” to not be useful at all, and in fact often mask a lack of understanding of the actual details involved in the point one is attempting to convey. Someone is deciding to hold some asset that is some liability of someone, or they are converting (or purchasing) it to some asset that is some liability of someone, or they are spending out of existing income. Be specific which one of these you are talking about and which assets/liabilities you are referring to and much confusion can then be avoided.

  • AWF

    Binve-you need to step back to longer time frame for clear picture of “The wave”

    The “Fast Money” crowd says this is a “Technical Breakdown” on the other hand

    The Mkts are reacting to a “Fundamental Awakening” and a “Fundamental Breakdown”

    Do you still have your Tin Foil hat?

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

    I have said that PCE needs to range in the 3-5% range to remain healthy and sustain organic recovery.

    QE doesn’t have a fundamental trigger to lead to a lower dollar aside from the fact that it is perceived as very easy monetary policy. It could be part perception, relative strength of the EUR (this is the primary cause in my opinion largely due to the insane int rate policy of JCT).

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

    Portfolio effects from QE3 are a very different story. I’ll post if it looks like it’s becoming a real possibility.

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

    Not sure I agree Neil. The Fed thought they had to help finance the tax cut via QE2. If this did indeed lead to high fuel prices then the commodity surge more than offset the tax cut. That’s bad policy in my opinion. Open ended QE purchases would be a dangerous line to cross in my opinion.

  • Nephric

    Excellent article, Cullen. A question about your statement: “We know for a fact that the Federal Reserve turned over $73B in profits to the US Treasury in 2010 alone.”

    Isn’t that turning over a MMT ‘verticle’ transaction that actually removed money from the private sector? Is the “net financial drag” actually deflation? So the end result wil be the exact opposite of the inflation everyone is worried about from QE?

    A nitpick here, but data is plural so ‘This data’ should be ‘These data’ in your second paragraph.

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

    The PD’s do the Fed’s bidding. That’s how the agreement works….

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

    Right. I would also add that it’s important to maintain a real-world perspective here. People save based on their desire to save relative to income. So, changing the income is the key variable here. Not changing the form of the financial asset. People need more income now. Not a different form of savings.

  • Peter D

    “A nitpick here, but data is plural so ‘This data’ should be ‘These data’ in your second paragraph.”

    Current English usage allows treating data as singular. Language is a living thing – it adapts. For example:
    http://en.wikipedia.org/wiki/Data:

    Data is accepted as a singular mass noun in everyday educated usage. Some major newspapers such as The New York Times use it either in the singular or plural. In the New York Times the phrases “the survey data are still being analyzed” and “the first year for which data is available” have appeared within one day.

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

    Int payments add to the deficit. Because the Fed turns its profits over to tsy this is pseudo fiscal austerity. Although it’s largely being taken from banks who are the worst kind of rentiers so don’t take my comments here as being too worrisome….

    Even if the Fed paid egregious above market rates (which they claim they’re not) they still wouldn’t offset the net drain. At best, I see this as offsetting to a large extent.

  • Different Chris

    As I explain it to my friends: I don’t need a raise (which would decrease the profit margin of my company) if I get a tax cut from a government that has no concern for profit because it is not revenue constrained.

  • Nephric

    Okay, Peter D. Thanks for that. Wish I could send that link back to my ol’ high school English teachers.

  • RA

    It’s important to understand that QE is primarily about the stock market. The Fed believes it drives the economy. QEII was a great success but the end of it deflated the market. Bet on QE3 at S&P 1150. If it goes lower than that, the Fed will be terrified.

  • John Zelnicker

    Scott — Thanx very much. I had read that piece and it seemed to make sense to me. While I agree that terms like “hot potato” do not add to understanding, I still need to figure it out. When (if) the private sector wants to rid itself of excess cash, does “getting rid of it” mean spending, investing, saving or some combination of the three?

    And, thanx for your answer, Cullen.

  • Different Chris

    “I agree with the tax holiday but there is nothing to say that those with a job will not use that as an opportunity to pay down their debt … which is exactly what they should do! The American consumer has reached debt saturation and until enough has been paid down and/or defaulted on the balance sheet recession will continue.”

    I look at it differently. In this balance sheet recession, the ‘average’ US citizen could use additional income (via tax break/holidy) to spend more into the economy if they are not debt burdened. Those who are debt burdened (as many are) would use the aditional income to deleverage, getting them (and the economy) closer to ‘healthy’. Even if the holiday added nothing to consumer spending because it all went to deleveraging, we’d definitely be in better shape because as a whole we would be closer to additional consumer spending. The deleveraging has to occur before the uptick in consumer spending (which leads to uptick in employment).

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

    The bottom line here, gentleman, is that my writing is not very good and never has been. If it were, I’d write books about things far more interesting than what this website discusses! :-)

  • mpr

    Well first that $73B is (more or less) the interest on the Fed’s entire balance sheet not just QEII, which is now $3T or so. Which makes sense since otherwise they would be getting an 11% avg. return as you say.

    Whether QEII adds or removes NFA depends on how much it changes the price of treasuries (all of them not just the ones the Fed buys). Its change in value of treasuries – interest forgone. This could be positive or negative.

    Even though I think QE probably increase NFA, I suspect NFA not a very useful way for thinking about QE. In any case, if you believe QE is deflationary you must believe Fed tightening – when the treasury pays more interest – is inflationary !

  • VRBII

    Cullen-

    Can you add any color to the equity markets today.

    We’ve hit our magic 10-11%decline. We’d look for a retracement back up.

    Equities just got more exciting for us. We’ve held 40% cash up until last week and now are down to 20%-30% overall across our four models.

    For every 10% move down our portfolios lose 1.3%. I’m just talking jibberish now because we just hit one of buy price points and I guess….I’m hoping I can get an honest answer from someone I respect.

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

    The Fed’s balance sheet is largely due to the QE’s.

    I think the other important factor in the “is QE inflationary” debate is whether it impacts commodities. I personally think it does although I know this is controversial. The effect here offsets the asset swap effect several times over so it’s the much more pertinent effect to focus on. I think QE generates inflation, as the Fed wants, but not the good kind. The data from the last year or so would appear to confirm this as real wages shrank.

  • http://www.sovereignmoney.com RobertM

    Cullen said:”…the markets most certainly are not perfect reflections of the real economy.”

    And I would say they are poor reflections of the real economy. The markets are mostly gambling by rich people that may or may not have any effect on the real economy (usually speculation on margin hurts the real economy).

    If anyone in government even cares about fixing the real economy and ending the balance sheet recession, which I doubt, then the simplest route is drastically reducing taxes on the middle class and starting a WPA-style jobs ELR program to end unemployment. Of course that’s not gonna happen with a Congress that has abandoned the drivers of the real economy, the middle class.

  • http://neweconomicperspectives.blogspot.com Scott Fullwiler

    As Cullen says, we need to remember the real world here. “Excess cash” is a theoretical term. How would that look in the real world? It would mean someone’s holding more cash as a % of their assets than they want to hold given relative prices of other assets. For an individual, this is easy to fix–buy an asset that earns more, or convert to something like a time deposit. In the economy as a whole, “excess cash” just means a shift out of cash an into other assets that earn more–this occurs until asset prices adjust upward (relative returns adjust downward) such that existing cash balances are not in “excess” any more. We would see this as a move out of, say, Treasuries and short-term near-monies into assets with more risk.

    Does it mean more spending? Perhaps, via a wealth effect as asset prices rise. But, as Shiller points out in the link Cullen provides, this isn’t a big effect. And, note that this is the path through which “excess cash balances” affect spending–it’s more spending out of existing income, not more income; for the latter, the effect on spending is much greater, and this effect is greater the lower the level of income is (i.e., the poor spend more of an increase in income).

    This is where many get confused–from basic accounting, “more money” and “more income” aren’t the same for the economy overall. The former is a portfolio shift of existing wealth, not an increase in it (albeit there is perhaps a marginal increase in wealth via capital gain), the latter is a $ for $ increase in wealth (i.e., before you spending income, it has been saved, and so your wealth has increased $ for $ with income).

    Note further that for the poor and many other up into the middle income ranges, an increase in income is for the most part the only way they receive an increase in “cash balances.” QE and other portfolio shifts have nothing to do with them unless it reduces interest rates (and Cullen shows that QE didn’t do this).

    The “hot potato effect” in the markets is simply this portfolio shift, which ends as soon as relative prices adjust. To assume this affect drives spending, one has to assume one or more of the following: (a) a very big wealth effect, (b) economically significant changes in interest rates (again, no evidence of this with QE), and/or (b) some behavioral change (that has never been explained by proponents) that leads to increased spending out of existing income.

  • Fred

    Here’s what’s missing: change in Exports and Imports as well as change in manufacturing exports especially. While early in the recovery, herein lies the key to bringing unemployment down and there is, frankly, only one data point that matters here: the USD.

    As long as the USD remains strong either as a result of safe haven buying or protectionist policies, unemployment is going to remain high. The only “tool” there ever was is to debase the currency without (a) failing to be circumspect about it and (b) setting off a global trade war.

    QE is quite effective at driving the USD down and that’s all that really matters.

  • The Dork of Cork

    Perhaps its just not long enough.
    Bear with me – post 1980 wealth was extracted from the US economy via interest rates / unsustainable consumption – interest rates declined as wealth was extracted and decapitalised in a psysical sense.
    Now the victim as been drained of nearly all fluids it cannot breath.
    QE2 returns interest to the treasury (synthetic greenbacks) it is a form of recaptilisation or emergency plasma – will this process take 20 -30 years ? Not unlike Japan
    I just don’t see much wealth remaining in the west – its gone possibility for good as most of the people with real world wealth generation , especially in applied science heavy engineering are dead or retired.
    Its the poisoned legacy of monetarism when CBs targeted interest rates rather then the base or credit aggregates.
    Karl Denninger is right on the money in that aspect at least , credit growth has outpaced GDP growth since the mid 60s at least.

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

    I mentioned the USD as a net positive. But it’s not enough to generate recovery (as should be clear from the RGDP figures). This economy needs a consumer boom (which requires a consumer fix) and not an export boom.

  • VRBII

    Good Stuff Cullen. Real Good indeed.

    BUT..with time I believe equity markets will come back down pre QE and thus like DR. Bens transitory inflation…I would argue the bolstering of Equity markets are in his words… “transitory” And thus to piggy back on why you say QE does nothing to help the wealth effect. I also would add when the binge is done the hangover ensues. If something creates an illusion..well your smart enough to fill in the rest.

    QE is a stripper. You get a rise for a song or two but when it’s done unless you provide more money it ends and your right where you stated. Except your a little poorer.

  • John Zelnicker

    Scott — Great, thank you. I think I’ve got it now. I agree that “wealth effect” is also a problematic idea and behavioral changes are awfully hard to pin down. I am much more concerned with the real world. I found Scott Sumner’s comment that MMT’ers “focus too much on the visible, the concrete, the accounting, the institutions, and not enough on the core of monetary economics, which I see as the ‘hot potato phenomenon.” to be kinda ridiculous to begin with.

    (BTW, your last paragraph has points (a), (b), and (b).)

  • John Zelnicker

    Cullen — I am absolutely convinced that the latest QE helped push up commodity prices. Traders scared of the “debasement” of the dollar fled to hard assets and all that extra cash bid up the commodity prices. It was a classic case of too much money chasing too few goods.

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

    I’ve been out since the last job’s report. http://pragcap.com/abysmal-jobs-report/comment-page-1#comment-63168

    No buy signal from me yet….

  • Different Chris

    I prefer a tax cut to a helicopter drop.

  • Different Chris

    I think it was that combined with a speculative run up. Commodities pop (for the reasons you outlined) traders rush in to get gains, up & up & up…

  • VRBII

    Thanks CR….I can’t tell you how Giddy I am.
    Not since my 2 day binge on ectasy, re-nutrients and G back in Vegas 2001 have I annoyed more people.

    I love good assets getting cheap!

  • Dismayed

    Interesting article, Cullen. And the comments here are far more thoughtful than what I’ve found on other blogs.

    I was ‘educated’ at the University of Chicago (MBA), but don’t worry – I was skeptical of what I was taught even when I was in school. Now I’m downright ashamed of what’s come out of U Chicago.

    I have a slightly different slant on QE2, but I do agree that it was ineffective. Yes, it succeeded in driving down rates. And that drove people back to the equity markets. In effect, people scrambled in search of higher returns, so the equity risk premium was lowered and the stock market rallied – as did the markets for other financial assets. Good for my 401(k), but not so good for the unemployed, or for the country as a whole.

    I’ll be digging through a lot of your older material. It looks like there’ a lot of good material. Thank you for your efforts.

  • Dismayed

    Interesting article, Cullen. And the comments here are far more thoughtful than what I’ve found on other blogs.

    I was ‘educated’ at the University of Chicago (MBA), but don’t worry – I was skeptical of what I was taught even when I was in school. Now I’m downright ashamed of what’s come out of U Chicago.

    I have a slightly different slant on QE2, but I do agree that it was ineffective. Yes, it succeeded in driving down rates. And that drove people back to the equity markets. In effect, people scrambled in search of higher returns, so the equity risk premium was lowered and the stock market rallied – as did the markets for other financial assets. Good for my 401(k), but not so good for the unemployed, or for the country as a whole.

    I’ll be digging through a lot of your older material. It looks like there’ a lot of good material. Thank you for your efforts.

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

    Let me know if you have any questions. I like to think I am helping as little as possible…..

  • beowulf

    Or give it to your employer on condition he add it to your paycheck.
    Apparently the word for that is (unless the linked writer just made it up) is a Pigovian virtual wage subsidy.
    http://blog.libertarian.org.au/2009/05/05/pml-on-tax-reform/

    Speaking of Pigovian, is velocity is the problem then impose a “hot potato” tax to have less of it. If quantity theory of money is right that P = V*M, the hot potato tax works whether it drains M with constant V, drains V with constant M or most likely, drains both..
    Congress doesn’t have to spend 5 seconds worrying about this, since Fed governors have authority to levy and adjust transaction fees on anything that moves through the Federal Reserve System (with the net earnings presumably passing through to Tsy).
    The services which shall be covered by the schedule of fees under subsection (a) of this section are—
    (1) currency and coin services;
    (2) check clearing and collection services;
    (3) wire transfer services;
    (4) automated clearinghouse services;
    (5) settlement services;
    (6) securities safekeeping services;
    (7) Federal Reserve float; and
    (8) any new services which the Federal Reserve System offers, including but not limited to payment services to effectuate the electronic transfer of funds.

    http://www.law.cornell.edu/uscode/uscode12/usc_sec_12_00000248—a000-.html

  • Lori

    It is really interesting analysis. I would advise you to start reading Marx’s economic manuscripts to understand better what is going and how the universal equivalent (the money) evolves. Then it will be much clearer that Chicago school teaches only apologetic of “free market”, which is far from free and efficient and that all those QE are only a tool for the next huge wealth redistribution. Monetary system is in a crisis, because credit money is something few people understand, because few have ever studied the money evolution.

  • billw

    Well thought out and written article. Thanks for your efforts.

  • Andrew P

    How about a “real world” QE3? It makes no sense for the Fed to buy bonds because doing the same thing again and again and expecting a different result is the definition of insanity. So, the Fed should buy real estate. Lots of it. The Fed should buy ALL foreclosed, defaulted, and otherwise distressed real estate in the US, and become the USA’s biggest landlord. In some cases, entire cities and regions will have to be purchased, by Eminent Domain if necessary. The Fed should hire management companies by competitive bidding to manage their portfolio of rental properties for the next 100 years. Now this would have a negative effect on States and Cities because a Federal Agency like the Fed does not pay State and Local taxes, but it would pump a lot of cash into the private sector. At the very least, it would retire a lot of bad mortgage debt, and allow the debtors to move in their search for jobs..

  • JWG

    Andrew P is on to something.

    QE2 was a failure in that it did more harm than good; the market’s reaction to it and the subsequent herding into commodities killed business margins and burdened consumers with high gasoline prices. TPC called it a non-event and it should have been, but “portfolio adjustments” as later described by TPC did the damage.

    Since it is inevitable that we will get a QE3 if the current adverse trend persists for another few days or weeks, it might be much different from QE2; a “qualitative easing” in terms of risk assets that will be acquired by the Fed rather than a quantitative easing used to acquire Treasuries.

    “Qualitative easing is a shift in the composition of the assets of the central bank towards less liquid and riskier assets… The less liquid and more risky assets can be private securities as well as sovereign or sovereign-guaranteed instruments.” (Willem Buiter)

    The Fed is limited statutorily in what it can buy, but it can buy a surprising number of different assets in normal circumstances, and in an “emergency” it can make a market in practically anything as I understand federal law. QE3 might be an LSAP program much larger than anyone now expects buying a much wider range of risk assets than anyone now expects.

    QE1 “worked” by being huge in volume ($1.8 trillion) and aggressive in buying impaired mortgages and agency debt at par, and QE1 didn’t “fund the deficit” because it bought only about $300 billion in Treasuries. Since QE uses keystroke money created by the Fed rather than tax revenue, and buying non-Treasury risk assets doesn’t “monetize the federal debt” or “fund the deficit”, QE3 might be politically much less toxic than QE2.

    There are a few more cards for the Fed to play, and it has been very creative during the GFC. My guess is 1040 or so on the S&P with a downward trend risking a return to a triple digit S&P gets us a bombshell QE3. Whether this third blowup of the Fed’s balance sheet causes another “portfolio adjustment” that hurts the real economy and breaks the camel’s back is the risk we will all run.

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

    Do we really accomplish anything by making a market in real estate? The reason QE1 worked was because the MBS markets became completely illiquid. They needed a market maker. The Fed did that. There is a market in RE. There are plenty of buyers. The problem is not liquidity. It is that there is still a supply/demand imbalance. Besides, the RE market is GIGANTIC. For the Fed to put a dent in it they’d have to buy millions of homes. Not only is this the worst kind of market manipulation, but it does nothing to solve the real problem which is that prices are still too damn high. The Fed would end this process faster not by buying homes, but by figuring out a way to force prices down. That would bring in buyers and stabilize prices…..But even then the balance sheet recession would persist as aggregate debt levels would be too high.

    The bottom line is that there’s no quick fix here. We have to muddle through to 2012 and hope the consumer can run with the baton by then…..

  • jnh

    Here we go again Wall street extorting the Feds to implement QE3 with this current sell off, I am certain Ben B. will cave or at he has an excuse now like in June of last year to print again. However, this time it maybe the real thing GDP 1.3 no ones waiting around to see what happens. We are in a real pickle my friends.

  • The Dork of Cork

    I am laughing – buying real estate ? … what productive function does that accomplish ? – its best that credit inflated assets reach cash price as quickly as possible so that they can be traded efficiently ( people can move to new areas when their real estate job is no more)
    QE 2 is a form of recaptilisation after 30 years of extraction.
    I think many commentators have a sort of attention defecit disorder.
    Its time to move on from the artifical credit economy – otherwise we are stuck.
    This changeover could take 20 to 30 years……………but may never heal as every time there is a new surplus it is extracted by the Street before it gains any productive function.
    Its hilarious really.

  • JWG

    In the late 1980s, a federal agency, the Resolution Trust Corporation (“RTC”), acquired and liquided a massive real estate portfolio acquired from failed banks in the savings and loan crisis that occurred late in Reagan’s second term. The RTC aggressively liquidated its massive portfolio over about 18 months, providing huge bargains in the process. The market suffered, but cleared rapidly as investors came out of the woodwork looking for bargains. Growth in asset values soon rebounded. It was a fiscal operation, funded by special bonds (I think).

    This time around, the Fed provides the capital in the form of keystroke money and not “taxpayer money”; the Fed acquires the massive portfolio at only a modest haircut (further bailing our the banks but closing those that can’t handle even a modest haircut); RTCII works for the Fed and acquires the massive portfolio; RTCII liquidates it aggressively; and the market first suffers then clears then rebounds, as in the late 1980s. Congress does its part by preempting the state court claims clogging up foreclosures and clouding title, thus removing the huge army of squatters that is the new Hooverville.

    It is both a Mellonesque liquidation, a massive clearing of title, an end to the squatter inequity and a massive banking bailout and liquidation of the weakest banks via the Fed and RTCII that deals with the real estate and banking disaster once and for all by clearing the market. Ronald Reagan was much smarter than people gave him credit for. We could name RTCII after him. And then name the payroll tax holiday and tax reform legislation after him that would accompany the real estate initiative and rocket the USA out of its doldrums. And by the way, also frack our way to energy independence in 10 years with a new TVA devoted to making the USA the Saudi Arabia of natural gas. I think that would wake the USA up, with an old school industrial economy rebound to boot. Maybe put a lot of young men (and women) to work exploring, fracking, digging, piping, trucking, building, and also retrofitting the transportation fleet and gas stations to run on natural gas. The unions would love it (did you hear that Democrats?). Also keep a lot of lawyers, consultants and environmental watchdogs busy (did you hear that Democrats?). Also cut CO2 emissions for those who think it matters (I don’t).

    It is a shame that the USA thinks so small and so scared these days. We could have done so much with $880 billion in stimulus; instead the Democrats burned it in the furnace of “aggregate demand”. FDR would have cried.

  • first

    The US has been on a reverse mortgage.

  • http://ralphanomics.blogspot.com/ Ralph Musgrave

    Cullen makes pretty well makes the hot potato point above when he says that QE “would not alter the net financial assets of the private sector”. In other words if net financial assets of the private sector DO rise e.g. when government / central bank cuts taxes and leaves more money in everone’s pockets, there is an effect. That is, spending rises.

    The fact that you in particular might want to keep your NFA is not very important. The important question is: what does the AVERAGE household do when supplied with more money. The answer seems to me to be obvious and very common sense: they spend a significant proportion of it fairly quickly. And this is born out by the evidence. See here:

    http://onlinelibrary.wiley.com/doi/10.1111/j.1745-6606.1984.tb00322.x/abstract
    http://www.nber.org/digest/mar09/w14753.html
    http://www.kellogg.northwestern.edu/faculty/parker/htm/research/johnsonparkersouleles2005.pdf
    http://finance.wharton.upenn.edu/~rlwctr/papers/0801.pdf

  • beowulf

    Ralph, that reminds me… didn’t you suggest a wage subsidy version of a job guarantee? Considering that new tax credits are easier to establish than new govt bureaucracies, that’s probably the way to go.

  • beowulf

    the Fed should buy real estate. Lots of it. The Fed should buy ALL foreclosed, defaulted, and otherwise distressed real estate in the US, and become the USA’s biggest landlord. In some cases, entire cities and regions will have to be purchased, by Eminent Domain if necessary.

    Couple of problems with that:
    First, the Fed never owns and manages real estate. If a bank fails it goes to FDIC.
    Second, the FRB has no statutory authority to purchase real estate outside the District of Columbia (for the FRB HQ) and each regional Fed bank can own its HQ, but that’s about it. The Fed governors are, like the book says, the Lords of Finance, but if they don’t have the power to buy real estate, they certainly don’t have the power to condemn by eminent domain.

  • Different Chris

    Thanks Beowulf!

    I beleive that the term ‘Pigouvian Subsidy’ was adapted to the original term ‘Negative Pigouvian Tax’. Pigqouvian tax- tax on the generation of negative externalities (like toxic waste or other production by products that harm the environment). So a ‘Negative Pigouvian Tax’ or ‘Pigouvian Subsidy’ is to reward/encourage positive externalites.

    Regardless, I like the idea!

    Best

    Chris

    P.S. I spell it differently because that’s how the professor who taught me about pigouvian taxes spelled it, for all I know she was wrong.

  • Willy2

    I am NOT surprised at all, QE2 didn”t help at all. The extra liquidity QE2 produced went into the banks firt and the banks loan that money for whatever long “”hot”” play speculators can find. But that money doesn’t go into “”losers”” like e.g. housing. But with more and more “”hot”” plays turning sour QE2 or QE3 becomes more irrelevant.

    What surprises me is that the USD(X) hasn’t gone up more. Seems foreigners haven’t started to sell their Agency paper/T-bonds (yet). And that would have pushed the USD higher.

    Read this:
    http://jsmineset.com/2010/09/16/central-banks-dump-57-billion-of-us-agency-debt/
    And our TPC still thinks the US doesn’t rely on the kindness of strangers.

  • Andrew P

    The Fed cannot force RE prices down, but Congress can. Suppose Congress enacted a law allowing underwater mortgage borrowers (I hesitate to call them “homeowners” because they own nothing) to petition an Bankruptcy court to order a short sale at auction in which there would be no deficiency judgement owed, no claim on the borrowers other assets, and no tax owed on the discharged debt, with the only requirement that the borrower needs to move for job related reasons to qualify. This would dump millions of defaulted and foreclosed properties onto the market, prices would be forced down, and the market would be able to clear. Of course a lot of banks (including most or all of the big ones) would brobably go under as well since they would be forced to take the writedowns that they are currently avoiding by any means necessary. The FDIC would sieze the banks and the Fed/Treasury would have to bail out the FDIC.

    This is the liquidation scenario that most of the politicians are desperately trying to avoid, so I don’t think they would do it. It would be very contractionary through at least one election cycle. Congress is more likely to enact a law instructing a Federal Agency to buy real estate to prop prices up.

  • John

    QE 3 rumors were responsible for yesterdays surge? Nah. More likely bargain hunting based on a realisation that maybe the sell off was overdone. If you look at the data points what changed from last week? Sure a double dip can’t be ruled out but it’s a long shot. As you opine this grimble is going to go on for the next 18 months during which we got to hope the consumer picks up the baton.

  • boatman

    we go to AA+ from AAA (SnP)…….back into the recession we never left, except for washington and wall street.

    you think thursday was bad?…….monday is the day after tomorrow.

    sooner or later there is going to be a BIG reset and it will not have anything to do with human beings deftly twirling MMT knobs for the benefit of all. it must have something to do with something that human beings CANNOT make out of thin air.

    the only things i am interested in investing in are things no one can make a derivative or a CDS out of.

    welcome to the beginning of the middle of the financial/soveriegn/currency crisis……and just TWO days ago barton biggs n bob doll were saying it was a place to pick up undervalued stocks.

    DOW to 5000 n gold to $5000 in next three years.

    and i wish it wasn’t true.

  • boatman

    oh, and QE-infinity is just a footnote when its all over.

  • first

    Now we know why the market was down 500 points. Information leaked charts and volume don’t people do.

  • Gary_uk

    S&P, great move boys.

    Will the US finally (ever) wake up to reality? Or will it keep spending and printing beyond its means?

    It’s very sad to see, but looking at the recent debt ceiling deal, politicians and the Fed seem happy to keep kicking the can.

    Every day hyperinflation becomes more likely, and gold creeps higher.

    But please remember, I am talking about reality, rather than MMT cloud cuckoo land, where Govts can just create money with no consequences.

    Have a great day, roll on Monday.

  • first

    Government(s) can have excellent rating and a suffering population.
    Romania was an example of a people starving wile its currency was very strong.
    If you tax your people to death ratings will improve. The King needs more income but the castle keeps expending.

    The goal should be to maintain a strong economy and government(s) that are not going bananas and are smaller as a percentage of GDP.

    As long as most Governments keep growing as a percentage of there countries GDP any improvements of there Credit Rating will be at the expense of growth. It’s a vicious circle supported by the disruptive International Monetary Fund’s that are great at imposing austerity and taxes wile and there over paid leader(s) do not pay any taxes at all.

  • flow5

    If QE3 was like QE2 the economy would slow even further.

  • flow5

    “the Fed can achieve any rate across the curve that it desires”

    FAT CHANCE.

  • first

    AAA Corporate Bonds 5 years 1.61%
    AAA Corporate 10 years 2.73

    US Treasury Bonds 5 Years 1.25%
    10 Years 2.56%

  • Dave Doe

    “The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.” Lord Acton

  • wally

    “People need more income now.”
    Meaning: they need a shift in the ratio of wages to consumer prices (indirectly: to commodities, since the wage increase has a recursive effect on the price of consumer goods) that favors wages… the opposite of what the Fed accomplished.

    There are few, or no, ways that government can accomplish this without increasing the debt load on government (tax decrease or pulling demand from the future – borrow to fund stimulus programs).

    And so here we sit in a political hell.

  • Jimmie

    It would be interesting to see charts of what happened with the cash banks and large corporations are holding – how that changed during QE1 & QE2. I imagine that the banks are holding on to a lot of the money that could have been loaned out and using it to hedge investments and such.