When the Fed initiated QE2 they had visions of lower interest rates in mind.  This would result from “portfolio rebalancing” and these lower borrowing costs would lead to higher economic activity as businesses took advantage of the low rates to invest in their businesses. The St Louis Fed recently described this as one of the primary goals of QE:

“As prices increase, interest rates fall. As interest rates fall, the cost to businesses for financing capital investments, such as new equipment, decreases. Over time, new business investments should bolster economic activity, create new jobs, and reduce the unemployment rate.”

Of course, that’s not exactly how things played out.  While the academics like to point to real interest rates as proof of success of QE, the real proof is in the pudding.  And the pudding doesn’t taste so good.  Total borrowing at commercial banks has continued its steady descent downward.  There has been a net decline in total borrowing since QE2 began!

But what QE2 has done is spark a mania in speculation.  And according to the NYSE’s margin data there is near record borrowing occurring.  According to the March data margin debt is quickly approaching its all-time highs.  As I noted last week, this surge in borrowing is not a sign that QE is “working”, but rather, a sign that it is only fueling the very same sort of imbalances and unproductive economic activity that got us into this crisis in the first place.


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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  • k

    the culture of socializing losses while the speculative classes prosper continues. but Cullen doesn’t that mean they can never take their foot off the pedal? Because even if QE3 ends, they will maintain the size of their balance sheet by reinvesting prepayments and interest on the MBS/ABS part of their portfolio. get this, i bet they start the rate hike cycle before they shrink their balance sheet. cos if not, since the duration of their holdings has increased, the DV01 of those assets would be with the Primary Dealers… and they can’t have those losses…

    i’d rather they create a biz lending authority much like fannie/freddie was for home lending. at least if that becomes bloated like fannie/freddie, main street would have at least gotten some love by then….

  • hbl

    QE actually accelerates the decline in bank lending! Few (including MMTers!) seem to recognize this point, but I’ve seen the theory confirmed in circuitist Marc Lavoie’s writing after I blogged about it. There is similar suggestive evidence from during Japan’s past QE.

    In brief, QE *does* increase the broad money supply as a direct consequence of the Fed’s operations (money as traditionally defined, excluding treasuries), but the private sector still gets to choose the size of the money supply (i.e., money supply is endogenous). And one way it sheds the excess money is to favor funding via non-bank lending (bonds, etc) over bank loan funding. The former type of lending expands the money supply, the latter doesn’t. The mix is as much a determinant of the money supply size as is the amount of total borrowing.

    The margin debt expansion is interesting (and a bit scary!), and without it, bank lending overall would probably be contracting faster.

  • jswede

    exactly. not inflation, but massive speculation, on margin, in commodities.

  • SS

    I think you’re the only person i read who actually understands what QE is doing. Thanks for clarifying in a world of mass confusion.

  • Cullen Roche

    Lance Roberts has a very good piece with a different perspective on the same chart. Very enlightening:

  • Cullen Roche


    What is your explanation for the causation of the acceleration in the decline?

    PS – It looks like we all owe you a debt of gratitude for your visualizer. I didn’t know that was your work. Thanks.

  • OntheMoney

    Jason Geopfert of SentimenTrader sent out a note this morning showing how, subtracting free credits, margin debt at NYSE brokerage firms was reaching levels matched only twice before – November 1999 and June 2007.

    His overall measure of available cash, expressed as a percentage of total S&P cap, has been exceeded only once in the past 20 years – mid-2000.

    Putting all the pieces together, I suspect we’re beginning the final move of this bull market.

  • hbl


    You’re welcome on the visualizer — I’m glad it’s helped a few people!

    On the topic of bank lending contracting… I looked more closely at the latest US data after my last comment, and it’s not clear to me that it really is contracting faster overall in parallel with QE. But of course, it’s impossible to disentangle the layers, as there are multiple dynamics in play at once. It could be that without QE, bank loans would have been on more of an upswing by now. But check the graphs from Japan in my post below, as that evidence seems more persuasive to me and covers a longer time period.

    Here is my explanation of the causation on the money supply topic in all its gory detail:

    It’s possible I’m wrong on the interest rate theory side of it, as I haven’t seen substantial confirmation of that speculation, but the general premise appears supported by the Lavoie paper that commenter Ramanan cited. I’ve been meaning to do a new post on it, but here’s a relevant excerpt from the Lavoie PDF linked to in the update to the post above:

    “…for apparently the demand for money and the supply of credit are determined by two independent mechanisms. In the Lavoie and Godley model for instance, the demand for credit, at the end of the period, depends on the part of investment expenditures which has not been financed by retained earnings and new equity issues…” etc in section 9.3.1. (When Lavoie says “equity issues” I think from what I’ve read elsewhere that he means traditional equity plus all other liabilities including bonds).

  • Michael Covel

    It seems clear that the Fed believed the only way out was to create more bubbles — knowing full well that the new ones would pop too.

  • Cullen Roche

    The transmission mechanism is more interesting to me. The only conclusion I can come up with is that non-bank lending is increasing due to the change in psychology that QE creates. In other words, it’s the Bernanke Put. And the Put gives traders confidence to go further out on the risk curve.

  • Anonymous

    The proof of the pudding is in the eating.

  • hbl

    I agree that QE affects psychology and therefore which assets people are most eager to buy and what they will bid.

    As I see it the actual transmission mechanism is that on aggregate QE will result in more short duration assets held by the private sector than it desires (because it’s an exogenous change imposed by the Fed), which will raise the private sector’s propensity to buy securitized products, bond offerings, equity offerings, etc. Those entities receiving funding via those methods will be corresponding less likely to fund via bank loans as a result of funding themselves from these other sources.

  • Cullen Roche

    Right, but this isn’t the issue. The issue is low aggregate demand. Corporations are sitting on record cash piles and high debt levels. They don’t need more debt. They don’t need more cash. They need higher revenues. I don’t see how more debt issuance at the corporate level changes anything.

    You might be interested in this piece by Rob Parenteau discussing this phenomenon. So yes, while QE might force a portfolio rebalancing and higher corporate debt issuance I fail to see how this stimulates the economy. It appears to be driving M&A and that’s just about it.

    Any thoughts?

  • Anonymous

    “…Corporations are sitting on record cash piles and high debt levels. They don’t need more debt. They don’t need more cash. …”

    1. They need cash(prepared)in case the recession last for a long time.
    2. It’s the lowest interest(their business cost) they can get.

  • Michael Covel

    The Fed’s new bubble(s) creation appear a Hail Mary to buy time…hoping economic development might happen. And if that doesn’t work out at least the next -50% equity correction would come from Dow 13,000 instead of 6,000.

  • hbl

    I agree that the main issue with the economy at present is low aggregate demand. I intended my comments to be very narrowly focused on what the balance sheet impacts in the private sector are as a result of QE.

    My conclusions (if correct, which is not a given) add even more support to the idea that QE is a non-event! I certainly wasn’t trying to suggest QE is stimulative. If the private sector really has full control over the money supply then that’s even one more nail in the coffin of the “QE is money printing” argument — i.e., the Fed’s asset swap can be “undone” in a sense by the private sector! (That is, it can adjust the mix of short and long duration assets it holds to match portfolio preferences).

    As for corporations not needing more debt at present… that’s certainly true of a great number of them, but the economy is very dynamic and there are always some companies net borrowing, others net repaying, and others doing nothing with debt. We mostly focus on the totals, but even if debt is being reduced on aggregate, there are still companies borrowing. Perhaps the smallest businesses especially, as they are not all flush with cash? Either that or getting new equity infusions (from founders or venture capital) and the like, which is roughly equivalent. Every individual business that turns to non-bank lending instead of bank loans would contribute to the dynamic I describe, even if the total economy-wide debt figures showed deleveraging.

  • Cullen Roche

    Gotcha. Nice thoughts. I hadn’t approached it from that perspective. And great website. You should write more!

  • hbl

    Thanks! :)

  • Willy2

    “”OE decreases the amount of banklending””. I consider this to be a load of crap.

    The only way I could imagine that QE decreases bank lending is that traders know that QE is active and that they don’t want to finance “”long term projects”” like mortgages and loans for companies. But they seem to be willing to lend money for “”short term projects”” like speculation in stocks, bonds, commodities.

  • Willy2

    QE does stimulate the economy ! But not in the way a lot of people think. QE has pushed up the price of e.g. copper. Production costs are at about $ 1 but the price is at about $ 4. Thanks to QE and as a result of QE the speculation in copper. But then copper miners see their profit margins rise and start to produce more copper and even start increasing their production capacity. And the increase of production creates jobs. But sooner or later the price of copper WILL come down to about $1 or lower and then the (financial) pain will be much larger. So, in the short run QE helps to stabilize the economy but in the long run the pain will be much more severe because there’s no real demand/consumption.

  • Coolidge Low

    “Stocks have reached what looks like a permanently high put (plateau). Recent quote by Mr. Bernanke.

  • B Ferro

    But you’re a trend follower right? So it’s balls to the wall long until those MAs rollover, correct?

  • jt26

    Interesting. But, couldn’t the non-bank lender convert to bank lending at anytime via bank borrowing and pledging the bond as collateral (and vice versa … securitization)?

  • freemarketeer

    I had some bad pudding recently. Thanks for bringing up suppressed memories :(

    If I understand correctly, Bernanke was engaging in a psychological experiment by causing a boost in asset prices. There was some positive economic effect in that companies will pre-buy in an inflationary environment, as opposed to destocking in a deflationary environment.

    Investor sentiment is quite bullish, and some reading I recently saw had CEO sentiment near all-time highs, but there’s a certain amount of reservation. Companies are beating est’s, but raising guidance to incorporate the beat – effectively leaving forward guidance unchanged. It’s safer, with a lack of going concern risk, but it’s not exactly party time.

  • firts

    That is absolutely clear.
    Alan Greenspan says “the Fed is out to lower the value of the dollar” and Ben Bernanke says “the Fed wants to increase asset prices.”

    “The whole idea of pumping money into the bond market,Bernanke admitted himself was to get asset prices up.” “Artificially higher asset prices are supposed to make people act richer. They are suppose to spend more money.

    This is like a replay of 2008 with a back stop from the fed.

    Hold on to the wealth you have.”The markets can destroy bad debt. They don’t need any help from the feds”.

  • Nemesis

    Remember that the conventional belief is that Japan’s slow-motion debt-deflationary depression occurred and has persisted because the BOJ did not print enough money for QE I during the Asian Crisis (the first Japanese banking crisis) and QE II (post-9/11) during the ’00-’03 global crash; therefore, the BOJ failed to talk up price inflation in order to dissuade a deflationary mindset taking hold among Japanese firms and household.

    Of course, this is a silly post facto rationalization, and incorrect, as well. The peak Japanese Baby Boom demographic drag effects took hold in the late ’90s and early ’00s, just as is occurring in the EU and US today, and soon will in China. The underlying structural debt-deflationary effects of a secular demographic drag cannot be solved by expanding bank reserves and the gov’t spending money at an unprecedented rate. Japan has proved that conclusively, and the US and EU are in the process of doing the same.

    Bubble Ben Shalom Zimbabwe and the Inkjets are all backslapping each other and proclaiming that they saved the world . . . again, the third time since the Asian Crisis in ’97-’98. What they do for an encore is anyone’s guess, but I suspect that it will eventually result in one or more crashes and Fed and US gov’t insolvency, as all the banksters and politicos know to do for any problem is print and borrow and spend more debt-money at compounding interest in perpetuity.

    And the more historically and fundamentally overvalued equity and junk debt assets become, the larger the next crash will be.

    To those who think “the market” is infallible, it’s time to examine closely history and human nature. “The market” is a reflection of the collective human ape mass psychology, and we human apes are anything but infallible.

    Therefore, “the market” is “wrong” as often at the worst time for most participants than it is “right”. And it is only a matter of time before we find out, yet again, just how wrong we, i.e, “the market”, are (is) today about tomorrow.

  • Cullen Roche

    Actually, Japan’s banking crisis was largely due to free market policy with regards to regulation. Not because the govt didn’t respond with enough spending….

  • Nemesis

    “Actually, Japan’s banking crisis was largely due to free market policy with regards to regulation. Not because the govt didn’t respond with enough spending….”

    No, Cullen, more homework is required, as well as a broader lesson in the history of banking, bank crises, and debt-deflationary regimes during Long Wave depressions of the 1670s-80s, 1720s-30s, 1770s-80s, 1830s-40s, 1890s, 1930s-40s, and Japan since 1998.

    Japan’s banking crisis was caused by what caused virtually all banking crises of the past: bank lending grew faster than economic output until a faster-than-exponential trajectory occurred, achieving a cumulative differential growth between lending and GDP of an order of exponential magnitude, after which bank loans could no longer be serviced at the trend rate of growth of GDP, incomes, profits, etc., especially with the Japanese Boomer demographic drag taking hold (as is occurring in the US now).

    Thereafter, bank loans had to contract 30-40% (an equity prices by 65-80%), the monetary base reach 1:1 with bank loans, and bank cash and securities assets reach par with bank loans.

    What happened in the US and EU in ’05-’07 WRT to bank lending growth (and asset prices) is what happened to Japan in ’96-’97 and coincided with Peak Oil in ’05-’08, and a similar cumulative exponential order of bank lending to GDP has occurred in China as of 2009-10.

    How surprised most observers and market participants will be when the US monetary base converges with US bank loans and US bank cash and securities assets will match the monetary base and bank loans, requiring a combination of further declines in bank loans and ongoing charge-offs, ongoing expansion of the Fed’s balance sheet (QEX), and increase in banks’ cash and Treasury assets well beyond today’s levels.

    Unfortunately, we are no more than one-third of the way through the debt-deflationary regime WRT the scale of debt deflation (deleveraging), and China has yet to begin, although the beginning of the process is imminent.

    Once China-Asia enters the global debt-deflationary regime’s trajectory, the Almighty cannot print enough fiat digital debt-money credits to save us.

    The entire world will be required to consume tens of trillions of dollars in equivalent value of assets to fund gov’t deficits and receipts, liquefy bank and business balance sheets, business operations, and household spending in the years ahead.

  • Cullen Roche

    And why did their lending outstrip real productivity? Because there were no rules in place to constrain the bankers.

    This is why the 1800s were a banking mess. The free market doesn’t self regulate bankers very well….

  • Nemesis

    “And why did their lending outstrip real productivity? Because there were no rules in place to constrain the bankers.”

    There were plenty of rules, only no one wants to be the one to take away the juice from the punch bowl at the rip-roaring party, as the saying goes.

    When was there a time when rules applied to human nature, especially to that of banksters?

    And now that the banksters doing the Temple of Mammon’s god’s work on Wall St. are the de facto owners of the corporate-state via the US Treasury, who has any power to check their plundering ways? Parasites feast off the host until their is no blood left and they have to turn on each other.

    When banking is not a highly regulated utility function with some form of strict reserve standard, banking by definition is a fraud or a Ponzi scheme, particularly a fractional reserve systems.

    Consider that the US banking and financial system has been one bubble, crash, and bailout since the 1970s, whether it was in junk debt, unreal estate, scams (aka stocks), commodities, etc.

    Yet the US central bank is credited with being the model institution for maintaining “price stability” and a smoothing out of the business cycle over the past 20-30+ years; and the proponents say this with a straight, earnest face.

    Yet, these are the Masters of the Universe on which our financial and economic well-being depends, for better or worse. Bubble Ben Shalom Zimbabwe, a nice guy, no doubt, is the classic rentier-financier-co-opted, ministerial Jewish intellectual with everything vested in the corrupt, self-contradictory system. Even if he did not believe a word of the academic clap-trap that passes as truth, he could not say so or risk losing everything.

    His Faustian bargain with the god of Mammon on Wall St. might get him some accolades today, but he risks the implosion of the system on his watch, the Fed being discredited or worse, and history being unkind to him and his masters.

    Then again, it is said that “history is dead”; therefore, long live history, but may we never live it as our future as its lessons imply we will.

  • Everyman

    Gee, I think ZeroHedge has been reporting this for about 2 years now.

    The idiots at the FED RES need to have their nether regions blowtorched for their lack of intelligence.

  • Cullen Roche

    Are you trying to convince me that the housing boom would have happened with a 20% down law? Because you will never ever be able to convince me of that….

  • SS

    Zero hedge has been reporting the collapse of the US economy for 3 years now. Anyone following their advice has been blown out of the water. They’re falling on the precious metals crutch because it’s the ONLY thing they’ve been right about.

  • firts

    There is no need for a 20% down law when when Government “does not” guaranty loans and bail out looser. When there are consequence to your actions the need for rules diminishes proportionally.

  • Everyman

    That is WRONG SS, because the basic timeline refutes that. The Crash was in March 2008. So how do you think ZH was starting then? Your response is another like those that pillary FoxNews and do not even watch, you jump to idiotic uninformed conclusions and the facts and truth be damned.

    ZH has been reporting on this particular issue for TWO YEARS, so even the slow children can get it, and it is backed up with facts and really data. Most of what I see on the PUMPER DUMPER blogs that are basically BTFD are not worth dog poo. Nothing, no analysis, other that “You can’t fight the FED”, or “GREEN SHOOTS”, or my persona favorite that shows a complete lack of ability in basic analysis, “the trend is your friend”.

    NOTHING can be inferred with the level of manipulation or the resultant damage done by these f-ing idiots at the FED. They are criminals helping ceiminal banker cabal. They need to choose, country or profits. You want to argue “Free Market”< fine then, let's not back or bailout losers that take on too much risk and then cry when it goes south.

    ALL of those idiots at GS, AIG, MS, JPM that go on and on about "free markets" and the necessity in their mind of minimal regulations is the equivalent of criminals complaining about confidence and theft laws. Anyone that thinks these guys are brilliant are following putrid sewer filth. Simple as that, this is not the "high water mark" of capitalism. It is the High water mark of corruption and generational theft.

    Buy a clue dude.

  • JWG

    ZIRP, QE and trillions in deficits are arrayed against powerful deflationary forces in the context of institutional corruption and a leadership vacuum in the USA, and increasing instability abroad due at least in part to US monetary policy. There are inevitably going to be huge imbalances in key economic variables that will lead us to say, after the next explosion and crash, that it was all so obvious. The problem is that when we are living in the middle of the scenario it isn’t so obvious.

  • Michael Covel

    B Ferro, correct on TF. My post here was not trading advice, nor a prediction, just a political/economic observation.