THE BERNANKE PUT AND INSTABILITY IN COMMODITY MARKETS

The Fed has not been shy about taking credit for the recent equity price increases.  They claim that this so-called “wealth effect” will spill over into the real economy and create a “virtuous cycle” where nominal wealth creation leads to real wealth creation (they have that part backwards – real wealth creation leads to nominal wealth creation, but who needs facts anymore?).  But the Fed has also been quick to claim no part in the recent commodity price spike (also no mention of the continuing house price declines, but again, who needs all the facts when you can better prove your point by leaving most of the facts out of the equation?).

I have claimed that the Bernanke Put is a direct cause of a severe psychological imbalance in the market where investors begin to act irrationally based on false promises made by the Fed.  The truth is, the Fed’s ability to influence the real fundamental economy via QE is limited (this has become abundantly clear when one actually studies the intended transmission mechanisms of QE), however, they are having a powerful impact on market psychology.  This is where many economists lose sight of the forest for the trees.  They entirely ignore the human reaction to policy measures.  And in an environment where the Fed is maintaining low rates and literally telling people that they will keep “asset prices higher than they otherwise would be” it is simply foolish to believe that they are not inducing some level of speculation in various markets.

The recent bout of inflation in China and the floods in Australia have laid the perfect foundation for a fundamentally driven rally in many commodities.  Add in the Fed’s direct message to buy risk assets and you have all the ingredients for rampant speculation.  To believe that this speculation is stopping at equities is naive at best.  The fundamental story in the emerging markets and hence the commodity markets is far superior to the modest growth story in most US equities.  So, it’s only natural so see investors pouring into the commodity markets with the expectations of higher gains on the misconception of the Fed’s “money printing” and a sound fundamental backdrop.

The problem is, investors and speculators are taking the Fed’s words to heart and they are acting on them.  This remarkable video from Bloomberg (via Ed Harrison at Credit Writedowns) proves that speculators are in fact hoarding commodities.  It’s no secret that the Chinese believe the USA is largely causing their inflation problems via QE.  They’ve responded with their own Quantitative Tightening.  And while the fundamental story behind the Fed’s actions holds little water there is a dramatic and meaningful psychological impact and we are seeing it in real-time with our own two eyes (yes, that is a pile of cotton that a Chinese speculator is hoarding in his living room).

Quantitative Easing was never necessary to begin with.  The Fed panicked over the summer of 2010 due to a few negative data points and now they are attempting to justify a severe policy mistake rather than simply admitting wrong and removing the destructive Bernanke Put.  Recent market data proves that QE is nowhere close to achieving the goals it was initially set out to meet.  And now there is clear cut evidence that it is having a disastrous impact on the marketplace by causing severe instability in commodity prices.  It’s not merely coincidence that signs of this speculation began in August when the Fed initiated its “money printing” program.

(cotton prices have more than doubled in 6 months)

It’s time for the Fed to take responsibility not only for the equity rally, but also the rise in commodity prices.  Perhaps more importantly, it is time for the Fed to admit that it is having a highly destructive impact on market psychology and is only helping to fuel a speculative frenzy that is likely to increase price instability and market disequilibrium.

QE has failed to generate any sort of job growth in the USA.  There are now signs that it is creating severe price instability in many markets.  Therefore this policy measure is counterproductive to both of the Fed’s mandates.  It’s time to reconsider Fed policy and whether this approach is appropriate in the current environment.  To me, it is clear that it is not.

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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  • Dan

    take responsibility? fat chance.

  • FDO15

    They can’t stop the program. It would destroy their credibility (the little that they have left). They will let it run through June and we’ll see the massive commodity bubble grow larger. When it pops the emerging market economies will all crash and they will directly blame the USA. Great policy there Ben.

  • Anonymous

    not to mention the political instability they are causing in emerging markets where food costs can represent 50% or more of one’s total pay. hungry masses take to marching and protesting. we end up exporting our pain to the rest of the world. it is most unpleasant.

  • 3421138532110

    We’re in a runaway. Throw out your technical indicators, sentiments and historical data, this baby is going to the moon. You know this doesn’t end well….but in the mean time, JUMP ON OR GET THE HELL AWAY FROM IT!

  • D

    I think China was already beginning to show substantial signs of weakness before this whole mess came about in the first place. Now we have a situation where their issues are being compounded by the fed rather than directly caused by it. This most certainly will not pass without direct blame though. China’s empty growth and infatuation with becoming the largest economy in the world overnight was built on a toothpick base that would have cracked whether or not the Fed decided to create the current headwind. I laughed listening to the chinese media’s questions at the last presidential visit where every other question was regarding China’s power grab. The fact simply remains that Bennie’s decision makes a perfect scapegoat to a poorly planned economy.

  • Alex

    What I noticed about this video is that the hoarder is playing a risky game. His entire cotton harvest is stored a few yards away from his kitchen. A small mistake and his yearly income could go up in flames!

  • Coolidge Low

    How does the Fed begin the exit process? Can they? Trim tabs calculates that the Fed has been the only true buyer of equities over the last year or so. The public has been pulling money out. Insiders have been net sellers of their own stock, etc.

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

    Funds might flow out of mutual funds, but that doesn’t mean money is leaving stocks. All securities issued are always held by someone. So, if the public is net selling then someone is net buying. If households are selling stocks then it means institutions are net buying. The Fed, by law, cannot buy stocks.

  • harold hecuba

    the fed will never exit. there is no exit strategy. that is absurd. the last time they talked about an exit strategy they ended up increasing their balance sheet. it is downright comical now. good post cullen

  • Brandon Ferro

    QE will not be removed unless some outside factor forces the Feds hand – this is far from irrational speculation we are seeing; it is merely the markets rationally taking the irrational policy of QE to its most logical extreme. The Fed is knee deep in it now…

  • V

    Well it might create employment if security guards need to be hired to guard the hoarded piles of commodities!

    Of course as soon as the bubble ends, you have a pile of trained security guards with nowhere to go.
    Rinse and repeat.

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

    Right. How can they reverse this now? They’re too invested in it and they’ve published too many papers in recent months explaining how great it is….We’re going to see reversals and whatnot, but how do we not trade at all-time highs in most commodities by the time June rolls around? As long as the Fed is viewed as a money printer this speculative frenzy will continue….

  • http://www.pragcap.com james

    Cullen, it seems the Fed has been more about trying to repair asset bubbles rather then prevent them and Greenspan, who i assume mentored Bernake, was the king of this policy, but know that interest rates are pushed almost as low as we can go, whats next? Gold, commodities? I sit on an investment committee for a hospital where the consultant is recommending a 7.5% exposure to commodity futures and how can you argue with all the uncertainty about the future?

  • Mediocritas

    Forcing honest mark to market would cause a lot of the money being used to goose markets to promptly be sucked into a black hole.

    Problem is that the Fed is now the proud owner of a huge stash of toxic ABS and because it did not acquire that garbage under a repurchase agreement (to the best of my knowledge) it has consequently lost the ability to suck back in the specific cash it pushed into speculation via reserve swaps.

    The swaps were highly specific but the reverse swap can only be general (unless they invent a new mechanism) meaning that a whole lot of innocent third parties get hammered while harmful speculation is not entirely eliminated.

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

    Right. And they’re bubbles that they help create via their direct promotion of a financialized USA. Bernanke builds great big piles of tinder, doesn’t see when they catch fire, then puts them out, pats himself on the back and then builds a big pile of tinder again….

  • Tom Hickey

    The Fed let the genie (cognitive-emotional bias) out of the bottle and now can’t get the genie back in the bottle without breaking the bottle. This is not going to end well, and it will be interesting to see the finger pointing then. I don’t think that the Fed is going to walk away from this unscathed.

  • billw

    I never thought that I would see a worse president than Jimmy Carter, but then along came Obama. And I never thought that I would see a more irresponsible Fed Chairman than Greenspan, and then along came Bernanke. Basically between the two of them we are scr***d.

  • effem

    Bernanke is obviously in over his head. But let’s not let the others off the hook – where is Obama? Geithner? Congress?

  • T.W.R.

    I think the one thing that seems fairly certain is that when the correction does finally come, it’s going to be huge. Imagine if the markets creep up like this for another several months, another several PPI & CPI reports, etc. Then, in a speech, or in the minutes of a Fed meeting, it finally comes to light that not only are we going to wind up QE2 but also start unwinding the Fed’s balance sheet as quickly as possible. How does that not result in a very steep ski slope? The air is going to come out of this souffle a lot faster than it went in. I am speculating that the collapse will erase between 50 and 61.8% of climb from 1050 to wherever we end up. The good news is, that will probably be the best entry point this year. The bad news is there’s a lot of risk in just waiting for it. One way or another, I’ll be putting cash to work starting sometime next week. (And billw, for the record, I think Obama is a GREAT President — even if you think this run up in stocks is b.s. [which it is], the recovery in the economy is real. You have to give the guy credit for not screwing that up. All you need to do is look at the 1930s to see how foolish policy mistakes can make an economic downturn a LOT worse.)

  • Michael Covel

    Obama has played no role in the rise in equities. That’s Uncle Ben.

  • cc

    uncle Ben’s boss is Obama. If Ben is not doing what the boss wants he could be fired.

  • g dawg

    what happens if mr margin comes calling

  • mpath

    TPC..from what I heard (runor or fact I don’t know) the fed is buying futures. Whether it be through x, y and z PB’s I don’t know. But by propping up the futures, the coinsiding etf’s are jumping to catch up to the futures. They are using specific weighted stocks within the tef to drive them to par with the futures..and why we are seeing massive moves in the high flyers like aapl-nflx and some others.

    The etf markets has hit 1 trillion dollars this year..the highest ever. I have heard that many hedge funds are leveraging their capital at the highest levels seen since 2007 and using the double/triple etf’s. So they are leveraging on top of leveraging with their capital.

    So as real money is leaving the market, but has started to switch and come back just recently..the excess selling over the last year from investors has been soaked up by the 2x/3x etf’s. Now I am not sure if the fed can buy etf’s.if the answer is yes, then they may just be buying them instead of stocks..so they don’t break the law..like that really matters to Ben..lol

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

    They’re not legally allowed to buy futures. Now, the PD’s could do it and I have to admit that I have seen some extraordinarily odd trades during QE. For instance, the other night I was on the other side of 2 different large trades where the institution was clearly trying to jam the price higher. I have no idea why this trader would enter such large trades at the ask in a thin market at 3AM. And I’ve seen this many times. And almost every time it happens in the overnight market you can guarantee the market will rally 8 ES points the next day. I am not a conspiracy theorist, but I see this with my own two eyes.

    So, it’s definitely not the Fed, but that doesn’t mean there aren’t institutions jamming the prices up….

  • http://blogfirstrider.blogspot.com/ first
  • http://www.pragcap.com Cullen Roche

    The better question is, when will the hyperinflationists admit they were wrong?

    And before anyone decides to take my outlook out of context I’ll remind them that I called for deflation in 2009 (which was right), disinflation in 2010 (which was right) and am now calling for inflation below the historical average.

    http://pragcap.com/why-deflation-remains-the-greater-risk

    http://pragcap.com/where-is-inflation-headed

  • http://www.spx500dailyindextracker.blogspot.com Klaus Bohm

    …afraid, its far too late for anyone to do the ‘reconsidering’

    -in regards to the markets,every day the equivalent of an entire year’s GDP passes through the New York Clearing House and Chicago Mercantile Exchange in payment for trades in stocks and bonds, mortgages and packaged bank loans, forward purchase and repurchase contracts. Most of these trades take about as long as a roulette wheel takes to spin. They are driven neither by psychology nor by industrial technology, but are gambles based on computer-driven programs, or leveraged buyouts of existing assets

    -in regards to debt leverage,families, industry and the government have run too deeply into debt to afford to buy enough goods and services to keep the circular flow intact between production and consumption. Market demand and employment shrink. This is the problem that is plaguing economies today.

    Kind Regards

  • Jim

    I think the Fed’s policy is doing exactly as planned. They are giving money to the banks practically interest free. The banks are absorbing the US treasuries that China is dumping and the cost is coming out of our pockets, now in fuel and food prices, soon in undeniable inflation. The money that would go to productive use, has stagnated. How do we justify treasury bond, which are a claim on future taxes being given to the banks? I think that the US government should unilaterally enforce the following: Dollar for dollar money “lent” the the banks at 1% or less will immediately be paid back with the treasury bonds purchased. This would extinguish the debt without the future claim against tax revenue. I do not think that this would solve the US interest payment on debt issue that is about to crash the quality of life in the US but it would reset the clock by about a year and a half. Hopefully it would temporarily cure the banks of their folly.

  • Knight

    I dont think Obama has done a great job but Bush jr was a far worse President than Obama.
    Again I don’t think Obama has done a good job but he took over at one of the worst times in American history. His appointment of Ben,Timmy and Summers will be and have been his biggest mistake.

    Why QE3 will not happen is because Republican congress wont allow it to (might be the first good thing they do in 10 years) or the markets wont allow it. Driving up interest rates until he finally puts on the breaks. The Bernek is the devil.

  • Anonymous

    Haha, you finally admit it. So the effect is not purely psychological, but direct manipulation up by the PDs. Conspiracy or symbiosis b/w the Fed and PDs – who cares?

    This is you “psychological channel”, it is very real. Because the S&P 500 is the leading risk asset in the world, every risk asset is up.

    InvestorX

  • Anonymous

    The guards will switch to racket, do not worry for them.

  • Anonymous

    And Jamie Dimon and Lord Blank are Obama’s bosses, so if Obama fires their official representative Bennie, then they fire him.

  • Mercator

    It’s not merely coincidence that signs of this speculation began in August when the Fed initiated its “money printing” program.

    I must have missed something. I thought QE was an asset swap, not money printing??

  • Andrew P

    Give them 5 years. Extreme inflation does not start overnight. And Bernanke really has no exit strategy. He has to keep interest rates at zero to finance Obama’s enormous defecit.

  • harold hecuba

    ben patting himself on the back this morning.

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

    I don’t know why people keep getting so confused about my position on QE. I said QE would have no fundamental impact on the economy. I never said it couldn’t cause market participants to do crazy things like putting cotton in their livingroom….I’ve explained this 100 million times.

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

    Whoever said it was actually money printing?

  • Anonymous

    Actually I listened to 2 interviews of Bennie this morning:

    1. On 60 minutes he says that QE2 is not money printing, because there is not more currency (so a technical excuse, as he is printing them electronically) and because there will be only an insignificant change in money supply (so he admits that there will be a change after all)

    2. In front of congress, he said that QE2 is not debt monetization, because its not a permanent reserves increase, it will be reversed. So until proof of reversal, there is no difference b/w permanent and non-permanent monetary increase. It seems currently nobody so far believes that the Fed will reverse its policy.

    InvestorX

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

    The accounting behind QE is very simple and I’ve explained it 100 million times. Banks have cash, banks buy bonds. Govt gets cash, banks get bonds. QE implemented: Banks get reserves. Govt gets bonds.

    That is really easy to understand.

  • http://blogfirstrider.blogspot.com/ first

    “now calling for inflation “.”The better question is, when will the hyperinflationist admit they were wrong?”

    Collin why would hyperinflation comes before your progressive scenario of deflation in 2009, disinflation in 2010 and inflation in 2011. It would never shows up immediately and I do not think many people predicted it would.

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

    That is not the argument I have been hearing for many years. I keep hearing that hyperinflation will suddenly hit. We will go from no inflation to hyper in no time. There were millions of people saying that hyperinflation would occur in 2009 due to the Fed’s operations….millions. I only remember because I was one of the few people who was saying that the explosion in the monetary base would do nothing and I got a ton of pushback for it….

  • JJTV

    Cullen,

    Per L. Randall Wray’s Paper “The Commodities Market Bubble: Money Manager Capitalism and the Financialization of Commodities” do you believe the recent run up in the price of commodities would be absent if the Federal Reserve had not initiated quantative easing? From previous data prices of commodities were rising significantly between 2007-2008 even though the Federal Reserve did not start reducing the discount rate until later in 2007. In general, do you attribute the wild swings in commodity prices over the last 4 years to market speculation or Federal Reserve policy (perhaps a combination of both)?

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

    There is a real fundamental element to every bubble. There always is. But what turns a bull market into a bubble is that psychological change. The sort of change in psyche that makes a man collect a pile of cotton in his livingroom while convincing himself that this is a rational and normal thing to do. So yes, there is a very real fundamental backdrop for this move in commodities and it’s very likely that the commodity rally would have occurred, but it’s the psychological element that pushes a bull to bubble. How much of the rally is due to this psychological element? Impossible to quantify, but I think it’s pretty difficult to say that there isn’t an irrational psychological element involved when we see people stockpiling cotton in their livingroom. That’s like saying that it was normal for Japanese housewives to trade stocks in the 80′s or that it was normal when Americans started day trading in the 90′s….

  • MMTer

    No no no! It is money printing! Hyperinflation is coming!!!!

  • http://blogfirstrider.blogspot.com/ first

    “JPMorgan Chase even had a negative net borrowing rate of interest while it made 324 basis points in net margin. They were effectively paid to borrow, leading to a more than 3% interest rate spread on loans.”

    That’s how those guys generate income. With the blessing of BB.
    The FED the largest central bank in the world in a free country is not even audited so who realty know what they do.

  • Dennis

    I don’t get your last word here “Govt gets bonds.” What do you mean by that?

    I think I’m finally getting my head around the semantics. The money is created by deficit spending. The Treasury may choose/or not to cover some this by issuing treasuries. These bonds are put on the market, however, these days that market is weak. So the Fed takes some of these out of the market and puts them on their books (QE2). Interest on these is given back to the Treasury. So when people add this up it seems like the Fed is printing money. But I see how it’s difficult to argue that the Fed is not printing money because the Fed and Uncle Sam have a husband/wife like relationship. It actually doesn’t make any difference who is doing the printing in a practical sense. It all started with the deficit spending. Whoever buys these treasuries ends up with “reserves” on his books.

    Is this diluting the amount of US dollar/reserve currency in the world? Is the deficit spending like a fire hose in a pool or rain in the ocean? (agreed, fire hose in a pool.) In Sept 2008 the Treasury figured out that the pool was being drained big time, (e.g. deflation). So until now there has been no problem with over filling and thus flowing the pool (e.g. inflation).

    My question is, when the economy recovers at bit, will the powers that be have the “will” to reverse things?

  • http://blogfirstrider.blogspot.com/ first

    Collin.
    Ok, I did not read your post in 2009 so if some did predict immediate hyperinflation as early as 2009 they where absolutely wrong and not looking out there window since it was obvious every thing had stooped. My persecution at that time was that Governments around the world not face the reality of deleveraging and try to re inflate the system by flooding the economy with so call assets that only the treasury can create. I still think this is what they are doing and it will have negative consequences. I also hope that I am totally wrong.

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

    If you want to say that deficit spending is money printing then fine. But open market ops are not money printing. There is deficit spending occurring, but that doesn’t mean it is in any way related to what the Fed is doing.

  • Boston_AL
  • JJTV

    Cullen,

    I appreciate your prompt response. I would certainly agree with the irrational psychological element, as many people (money managers included) believe increasing reserves is the same as printing money, along with all the ills that follow. When I sit back and think about it further I have come to the conclusion that your point is correct. QE stoked irrational fears that manifested themselves into commodity speculation and hoarding, however, I’m not convinced that low rates of interest, taken separately, induce speculation. Am I wrong to think that? Going back to Wray’s Monetary Theory Class last semester he had fairly good arguments against low interest rates being the root cause of speculative bubbles(assuming no QE, etc.). What is your take?

  • http://blogfirstrider.blogspot.com/ first

    “There is deficit spending occurring, but that doesn’t mean it is in any way related to what the Fed is doing.”

    That is a Good point that “Dennis” is raising and is probably where most get confuse about the wrong perception that the FED is printing. To a large extent could we not say that the FED is the slave of the Treasury?

  • Rharaz

    Hi Cullen,

    Where I get confused is in trying to predict how the market value of the ABS the Fed purchased might affect inflation/deflation. For example, if the Fed purchased ABS at their “mark to model” value, but the market value of the ABS was only half of what the Fed paid, wouldn’t that cause inflation (or at least be dis-inflationary)? Assuming the Fed has purchased a significant amount of toxic ABS, is there any practical difference between what the Fed has done via asset swaps, and a bank selling its toxic ABS at market value in conjunction with the Fed creating money to give to said bank to make up the model/market value difference?

    RH

  • Rharaz

    Correction: “…wouldn’t that cause inflation (or at least help prevent deflation)?”

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

    Does this cause inflation? Or does it merely stop deflation? Big difference.

    Plus, the assumption is that these assets are all worthless. That’s a stretch to me. The Fed made a market in ABS and when they did the market recovered to its natural price. That’s their role as lender of last resort. It is good to stop solvent companies from going out of business due to irrational market behavior. The problem is, it’s impossible to put a true value on these securities. Nonetheless, I wouldn’t argue that it was inflationary. It merely stopped mass deflation from occurring….

  • Obsvr-1

    they were all furiously rubbing the Genie’s bottle.

  • Obsvr-1

    and I would have thought we wouldn’t see a more disastrous treasury secretary than Robert Rubin

    wait, Larry Summers what a colossal F-up

    *hit – then we get Hank Paulson a.k.a. GS Virtual Chairman of the Board

    nobody can be worse than the Hankster — Oh Damn – here’s Timmy

    … this just isn’t going to end well …

  • Silalus

    It’s a valid question, but as I understand it the answer is, “not really”- or at least not in matters such as QE. There are laws that force treasury securities to be issued based on deficit spending and those do go through the reserve system to predetermined buyers, however that is far from the limit of the Fed’s activities.

    Open market operations used to try and push interest rates up or down are determined to be necessary by the Fed board. (Mr. Roche has indicated QE couldn’t and didn’t work on that front, but it still falls into that category.) There is a dual mandate for the Fed to use these operations as well as some other powers (such as directly setting their rate as a lender of last resort and setting bank reserve requirements) towards a certain interest rate and level of employment.

    However within that mandate and the legal structure, for better or for worse, the Fed is given quite a free hand. It’s something like the fiduciary duty of a company’s CEO- they have a great deal of freedom in decision-making even though in theory they work entirely at the direction of the shareholders via the board of directors.

    A number of commentators pointed out that the Fed deploying QE itself was little more than an attempt at doing something rather than nothing. Deficit spending and stimulus became politically dangerous just before QE was announced. That is no coincidence. Congress and the president basically ran out of credibility to deploy that as a big hammer to deal with economic issues, so the Fed was left as the only entity that still had the capacity to take any stimulatory action and BB decided to try QE as better than nothing.

    That situation happened because they have a lot of independence, and aren’t just controlled by the treasury as it might seem at first glance. Now, whether that is a good idea or bad idea and what their actions can actually impact are other questions entirely… I’m speaking only of the legal and political situation, not the economic one.

  • Cap10jac

    Cullen, been reading this site for months. Just want to say thank you for the insight provided here by you and the contributors.

  • quark

    During the market crash of ’87′…I know I’m dating myself…when George Soros was rumored to been the soul driving the S&P down to ~190 there was ANOTHER rumor that the Fed stepped into the MMX when the futures were underneath cash at ludicrous levels. Through this action the Fed drove the futures to a premium triggering premium arbitrage in all the stock indexes and well…the rest is where we are now.

    Apparently the FED decided to forget making prudent decisions that resulted in effectively managing a productive and dynamic economy…instead they took action to inflate the hell out of everything as an admission to its incompetence and they started with the financials. I thought that the Fed went global with the housing market…I am humbled once again!

  • http://blogfirstrider.blogspot.com/ first

    Cullin.

    Deficit is more than 1.5 trillion. Gov Deficit increases the private sector assets
    by same amount. Deficit = 10% of GDP. If Growth is about 3% what as the other 7% produced and is this not what we should be concern about when predicting inflationary pressures instead of concentrating on the FED?

  • Moneta

    I think a lot of people consider 5-10% inflation hyperinflation.

    And anyone who even mentioned inflation was ridiculed a few quarters ago was ridiculed.

  • Anonymous

    “…low rates are having almost no impact on the markets…” why?

    Stock Price = p/e x eps
    Isn’t lower int rate cause higher p/e and cause higher price(assume the same eps)?

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

    Yes, but the continuing decline in borrowing means companies and consumers are not taking advantage of lower rates. There are some signs of a trend change here, but all in all monetary policy has proven highly ineffective throughout the last few years.

  • http://blogfirstrider.blogspot.com/ first

    Banks don’t make 3% interest rate spread on loans by passing the decrease to consumers. This happened before to lesser degree with Greenspan.

  • cc

    LOL well said.
    and USA is the model of democracy.

  • Silalus

    The problem with that to my layman’s eye is that the % of GDP measure doesn’t seem useful in predicting inflation. It is a very powerful political and social statement because it’s about how much the government controls what happens in the economy (who does what with which physical resources and where their output goes) but why would it be particularly related to inflation by itself?

    Deficit spending is highly relevant to inflation, of course, but wouldn’t it be only as related to it’s percentage of the total money supply as compared to growth, not as a percentage of GDP? After all, that is what actually has the capacity to debase the currency unless it is driving additional, legitimate economic expansion(read as: jobs and production unrelated to the financial industry). Of course Mr. Roche and other economists have much more comprehensive explanations that I’m sure are more accurate in determining the impact of specific different measures of the money supply, but that basic idea seems to be an important one.

  • Mark

    If any of you folks out there think that when the commodity markets do correct that equities will be unaffected, you need to look back only as far as the last bubble pop and observe how much good diversification did then. NONE!

    When these bubbles pop, given that margin requirements are only 3%, everything is hit at the same time.

    Keep your stops current and close.

  • http://blogfirstrider.blogspot.com/ first

    Mark.

    You are may be correct but things do not happen exactly the same way each time.

    In the late 70s inflation and commodities moved up sharply as the market moved down to new lows. We forget that Inflation is not the friend of stock markets for very long. As inflation came down in the 80s and 90s markets moved up at historic high.

  • Dennis

    Look, I’m just trying to connect the dots here. I’ve read Ellen Brown, Stephen Zarienga, Ron Paul (Ron Paul’s new bill (HR 459) to audit the Federal Reserve now has 79 co-sponsors, and the numbers keep growing!) , the other Dennis K, and they all say the same thing: “The Fed should get out of the business of printing money” and Uncle Sam should do that instead. But come on, through “deficit spending” Uncle Sam IS printing/creating the money. The Fed is “downstream” from that according to MMT. Do I have this right?

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

    Yes, deficit spending is money printing technically. It’s been going on for the entire existence of the USA and it will continue as long as the USA has a growing economy.

  • Dennis

    By my addition, QE2 is not a bad thing, it’s a godsend. The Fed, taking off the market lot’s of bonds and paying the present holders with cash created from thin air, makes our “deficit spending” something our kids do not have to obsess about. So what if the Chinese have quit buying US debt. Those new debts are, in effect, cancelled. The “National Debt” needs to be recalculated. It’s not $14 trillion, but much less.

    Deficit spending allowed this to happen, not the Fed per se. Further, the dilution of the world’s US dollars is not a problem at the present time since so much money went up in smoke in 2008. We are not over-flowing the pool of world wide US dollars and world wide reserves since so much money left the building in 2008. (US dollars are over 60% of the world’s money.) You keep saying that the current QE2 is fighting deflation, and is not inflationary at this time. I think most of us agree. If the deficit spending continues when our economy improves, THEN we are in trouble. I think it’s true that historically, the “Powers That Be”, can’t stop when things get better. They think that they caused the “better” so “please don’t stop”. That’s when we have inflation!

  • jj

    so where should one put money now? Maybe I. Oil stocks? Assuming a continued declining dollar, while oil demand starts to pick back up? Gold scares me, but maybe it can still go higher

  • beowulf

    The government can pay bond interest directly or it can pay interest on reserves (Fed’s annual earnings refund reduced by amount of IOR payments). Without letting FFR rate drop to zero, there’s no way around that choice. Since IOR rates are set at 0.25% and Treasuries longer than a year all have rates higher than that (though 3 month T-bill are at 0.09% today), its better for the Fed to buy up all long bonds and Tsy to just eat IOR cost.

    Better yet, Tsy can stop selling long bonds and just continually roll over T-bills. Since 0.09% < 0.25%, its literally cheaper to borrow money than to just print it. At the same time, I'd permanently cap rates (WWII T-bill cap of 0.375% would do fine, its higher than 3 month, 6, or 1 year rates today). If nothing else, it would cut by more than 90% the CBO's projected $5 trillion in debt service this decade. That's one way to cut the budget deficit without raising taxes or cutting discretionary spending (debt service is an automatic mandatory appropriation).

  • Bc

    Per Steve Keen aggregate demand equals GDP plus the change in aggregate (public plus private) debt. Two years ago demand collapsed because private debt stopped increasing i.e. The change in debt was negative going from some positive amount toward zero. Per Keynes Bernanke told congress to stimulate with deficits which produced a positive change in demand per Keen’s equation (also Minsky’s). This worked in 2010 but only by kicking the economy with a “credit impulse”. This is not sustainable however because aggregate debt cannot and will not increase without limit. Treasury would have to directly inject about fourtytwo trillion dollars as deficit spending to provide the net savings needed to allow deleveraging of our enormous debt burden. In this context our current deficits are a joke. To be effective, this cash spending by govt would have to constitute purchase of goods and services made by debtors. This will be viewed by asset owners as a disaster since the price/value of labor will go up while capital will flood the system debasing the value (not the price) of fixed assets compared to labor. For this reason change will be resisted but the forces are ineluctable and so much larger deficits are in store.

  • JNH

    Despite seemingly obvious reasons for QE2, the real purpose to is to intentionally keep interest rates low. Why. Adjustable Rate Mortgage resets in 2011 are in the millions. It would be financial armageddon if ARMs would readjusted upwards of 7 to 8% in this economy and the fragile state of countless banks. Prior to the meltdown, banks were “licking their chops” waiting for this day; imagine getting 8%+ on millions of mortgages for 30 years etc. “sugar plums were dancing in the heads”. I believe this was the reason for the insanity with CMO and subprime etal, it would have been the mother of all “gravy trains,cash cows and golden geese”.

  • JNH

    How do you see this ending?

    Great site, lots of intelligence here. Thanks.

  • JNH

    It just seems like we are on the precipice of a great financial calamity.