The Wall Street Journal ran this open letter to Ben Bernanke from many noted economists, professors and fund managers.  The list is a who’s who of Wall Street and the general message is not dissimilar to what Sarah Palin and Glenn Beck (not exactly the people you want to be next to when making economic prognostications) have been saying – in essence, cease and desist Chairman Bernanke.  While I agree with the general message of the letter (that QE should not be allowed to go forward) it also shows the great level of sheer misunderstanding when it comes to QE.  This one policy has generated more misunderstanding than any policy measure I can remember.

Many of the people on this list have been warning about bond vigilantes while also comparing the USA to Greece for several years now.  Of course, they’ve been terribly wrong and it is entirely due to the fact that they do not understand how the US monetary system works.  Their general fears of inflation and a crashing dollar have been far off the mark for reasons I have discussed in great detail. What’s unfortunate is that these are many of our best minds.  These are the people driving the economic bus.  It’s no wonder this country is in such an economic hole.

The full letter is attached with some commentary:

“We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued.  We do not believe such a plan is necessary or advisable under current circumstances.  The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.”

The LSAP should be discontinued, but not because it causes inflation or currency debasement.  In fact, it will cause no such thing as QE involves no printing of new money (Chairman Bernanke explicitly stated as much) and has a marginal deflationary bias.  In addition, its impact on interest rate is questionable at best as we’ve seen in Japan, the UK and the USA during QE1.  As I have shown, the early evidence shows that the program is counterproductive.  This program should be ended so as to maintain the credibility of the Federal Reserve and stop all market distortions that are occurring due to the sheer misconception surrounding the policy.

“We subscribe to your statement in the Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.”  In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”

Yes, in a balance sheet recession monetary policy becomes quite ineffective.  If the government is going to provide aid to Main Street (not Wall Street!) it should do so via fiscal policy.  A tax cut (such as a payroll tax holiday) is not only politically feasible, but would do a great deal in combating the debt problems that American households currently confront.

“We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.”

Inflation does need to be pushed higher, but it needs to be pushed higher by an increase in aggregate demand.  This will not occur because the Federal Reserve decides to provide the banks with more reserves.  Since QE does not increase the money supply this policy will not cause inflation. As I’ve described many times in the past, QE is just a simple asset swap.  Just as it did not cause inflation in QE1 and in Japan earlier in the decade.  IT IS NOT MONEY PRINTING!

The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.

Cliff Asness
AQR Capital

Michael J. Boskin
Stanford University
Former Chairman, President’s Council of Economic Advisors (George H.W. Bush Administration)

Richard X. Bove
Rochdale Securities

Charles W. Calomiris
Columbia University Graduate School of Business

Jim Chanos
Kynikos Associates

John F. Cogan
Stanford University
Former Associate Director, U.S. Office of Management and Budget (Reagan Administration)

Niall Ferguson
Harvard University
Author, The Ascent of Money: A Financial History of the World

Nicole Gelinas
Manhattan Institute & e21
Author, After the Fall: Saving Capitalism from Wall Street—and Washington

James Grant
Grant’s Interest Rate Observer

Kevin A. Hassett
American Enterprise Institute
Former Senior Economist, Board of Governors of the Federal Reserve

Roger Hertog
The Hertog Foundation

Gregory Hess
Claremont McKenna College

Douglas Holtz-Eakin
Former Director, Congressional Budget Office

Seth Klarman
Baupost Group

William Kristol
Editor, The Weekly Standard

David Malpass
Former Deputy Assistant Treasury Secretary (Reagan Administration)

Ronald I. McKinnon
Stanford University

Dan Senor
Council on Foreign Relations
Co-Author, Start-Up Nation: The Story of Israel’s Economic Miracle

Amity Shales
Council on Foreign Relations
Author, The Forgotten Man: A New History of the Great Depression

Paul E. Singer
Elliott Associates

John B. Taylor
Stanford University
Former Undersecretary of Treasury for International Affairs (George W. Bush Administration)

Peter J. Wallison
American Enterprise Institute
Former Treasury and White House Counsel (Reagan Administration)

Geoffrey Wood
Cass Business School at City University London

A spokeswoman for the Fed responded:

“As the Chairman has said, the Federal Reserve has Congressionally-mandated objectives to help promote both increased employment and price stability. In light of persistently weak job creation and declining inflation, the Federal Open Market Committee’s recent actions reflect those mandates.  The Federal Reserve will regularly review its program in light of incoming information and is prepared to make adjustments as necessary.  The Federal Reserve is committed to both parts of its dual mandate and will take all measures to keep inflation low and stable as well as promote growth in employment.  In particular, the Fed has made all necessary preparations and is confident that it has the tools to unwind these policies at the appropriate time. The Chairman has also noted that the Federal Reserve does not believe it can solve the economy’s problems on its own.  That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators, and the private sector.”

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

Source: WSJ


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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  • http://none GLH

    I suspect that when the WSJ said “improvements in tax, spending, and regulatory policies,” it didn’t mean what you have in mind. I can only imagine that the WSJ means more of the policies of the last 30 years: tax cuts for the rich and big corporations, spending cuts for the rest, and more deregulation. In my mind the rag is just a propaganda machine for people like Rupert Murdock and will never offer any real solution to the present problem. But, I do agree with you on the solution.

  • Jo

    TPC, you may be right about QE; you may be wrong.

    However, you must get past the place which prevents countenance that Bernanke might lie about something….he would, does, has, and will.

  • NotSoSure

    Are you so sure that Seth Klarman, Jim grant and Jim Chanos don’t understand? If those people disagreed with me I would rethink what I was saying and I sure as heel would not be as cocksure as you are.

  • Greater Fool

    Ironically, this open letter to the Fed will only give them further cause to keep QE2, if only to maintain the appearance of independence. This has become a battle for Fed credibility.

  • charles

    Your comment or aftethought is vey interesting. Watching this from Europe,
    I am highly surprised to see such a wave of domestic backlash, the WSJ
    blog having also reported surveying the academics.
    It is somewhat amazing to witness such an institution, an organization employing 5 000 économists, enter such a dangerous path, blindly refusing to see the ‘risky externalities’ at work. Some kind of post-modern twist on the Russia roulette…

  • David

    I agree. TPC – I’ve read your reasons why you think QE is not currency debasement, not inherently inflationary, etc. You may be right or not. But please do not appeal to statements from Ben Bernanke to support your points. The man is a chronic liar, a fool or both.

  • Publius 10

    Prag Cap, I think Bernanke thinks his twin policies of zombie households and QE will undercut the nominal pegs that mercantilists have to the US dollar. I think his theory is that QE will give him mild deflation in the US, and high inflation in China and other mercantilist countries due to investors money flowing from the US to those countries.

    I don’t know if Bernanke can make this work or not. But it’s the only logic I can see for him trying QE. Devaluing the real value of the US dollar compared to the real value of the RMB and other pegged currencies, to shrink the trade deficit, which would help the US deleverage.

  • Z

    BB may be a monetary lunatic, but he is not stupid. He is not ignorant of the power of misconceptions, and is actively using them in pursuit of his and Wall Street’s agenda.

    Now, are the authors of the letter ignorant of the fact that market distortions are being created by Fed’s policy of smoke and mirrors and public’s misconceptions about them? Highly unlikely. I tend to believe that they are just being pragmatic as they challenge Bernanke with his own weapons: they use public misconceptions about QE, most of all about money creation and inflation, in order to generate enough public pressure for Bernanke to back off.

  • Patrick

    Monetary formula aside, the reason QE1, QE2 and the QE’s that may come should be halted is because it interferes with the market determining the winners and losers. When the crisis started over two years ago we should have done NOTHING. The folks saying doing something was better than nothing because the system would have collapsed cannot know that. They are just postulating as they are with QE2. The system should have been allowed to collapse. Capitalism is not fragile it adjudicates winners and losers very quickly. That is it’s history. You doubt me? Study financial history from 1500 to 1913. It is extremely robust.

    So of course the interveners didn’t listen and look where we are now–trillions down a rat hole with the possibility of the world spinning out of control.No one held to account. Great job keep up the good work.

  • Diffused

    In the Fed’s response:

    “…the (Fed) has Congressionally-mandated objectives to help promote both increased employment and price stability. In light of persistently weak job creation and declining inflation…”

    Isn’t declining inflation promotive of price stability? Has the Fed somehow confused declining inflation and deflation? (Notice the Fed didnt come out and say the “d” word. That would have been a faux pas.)

    “The Fed…is confident…”

    That can’t be good.

  • Diffused

    Unfortunately, it’s probably also become a partisan political battle. Isn’t that Bill Kristol’s name on that list?

    Unless I’m mistaken, he’s neither a “noted economist, professor or fund manager”.

  • JH

    When we all know the money from QE is coming out of Treasuries and flowing into commodities and emerging market carry trade, blowing yet another bubble; and to say it is not inflationary is just not true. But inflation is not the real danger; the real danger is the next crash that will follow the commodity bubble, as it will take other markets down with it. It is just the same game being played over and over with different asset classes, and each time they crash the boys on Wall St. win and the people loose.

  • haris07

    TPC, With all due respect, you are taking the MMT reasoning to the next and wrong level. While agreeing with all the technical points with you, you fail to understand that printing $ (even if it is to retire an existing financial obligation and therefore not changing the monetary base) is inflationary because the fresly printed $ are being funneled to inefficient bubbles, rising prices of commodities, emerging markets and the like. Furthermore, as I have previously mentioned, these fresh $ are being created to retire obligations that presumably were used for productive purposes i.e. newly created $ are being used not to create “value” but for other inefficient purposes whereas the retired Treasuries were used for productive purposes.

    I will also point out that in the late 60’s and 70’s, there was sufficient slack in the economy and yet there was high inflation. Of course, Japan serves as a counter example to this….but there is one big difference, they run a current account surplus and we a current account deficit.

    Long story short, I am not sure Seth Klarman and Jim Chanos are sooooo off base here, with all due respect to you, these 2 (along the rest of them) deserve far more respect that you are attributing to them (I can be persuaded that the others may not necessarily be so deserving).

    I think you are likely to be surprised by how this unfolds….you may be right or you may be wrong (heck, I may be completely off base and wrong too – no harm in accepting that these things are complex and have never been tried before and so probably no one clearly knows how this will play out), but I think there exists sufficient doubts about your side of the story that you can stop trying to trash everyone else and agree that there remain sufficient doubts as to how this plays out than just keep tooting your same horn again and again.

  • Dan

    Alan Blinder has a piece on this in today’s WSJ.

    Too bad so much is being lost in the terminology. He also refer to “printing money” (which he puts in quotes), but he does not argue that it is, in fact, being done. Apparently there’s some sense in which this terms applies–as he uses it to school us in ECON 101. But it’s a particularly malleable metaphor–one that Sara Palin and others feel pretty comfortable with. In the end, we observe that it’s not the technical reality that fuels the debate, but rather the metaphors that make people feel they understand what’s going on.

  • hfm

    Agree. Although TPC has been deadly right in the past few years, it does not mean Seth Klarman and Jim Chanos is not worth listening. Too much confidence is dangerous.

  • http://none rhp

    I think there is a great confusion of terms. “Inflation” is occurring in certain sectors (commodities) while not occurring in others (housing). Starbucks is being hurt by “inflating” commodity prices while it is unable to raise end product prices due to a balance sheet recession among consumers. Just saying QE creates inflation without discrimination among the different asset classes involved leads to unnecessary miscommunication between people.

    Regarding James Grant. IN a recent interview he did admit that he bought “value stocks” in Japan around 1990…………. Sounded like he has yet to recoup that investment.

  • http://none rhp



    Thanks for keeping this forum open and civil! It has become an excellent place for me to learn in listening to you and all other contributors. This is the best of free speech and democracy!


  • http://none rhp

    BB does a terrible job of communicating. He says QE is not inflationary, yet he obviously enacted the policy to combat “disinflation”. ???

  • Dmitro

    Actually, lot of people commenting here did not read TCP’s comments carefully. As far as I remember TCP mentioned many times that QE indeed is just asset swap and non-inflationary TILL banks start lending money using those increased reserves at the FED. No new loans – no new money – no inflation.

  • roger erickson

    “these are many of our best minds” … uh, then we need to promote a new definition; quick

    options on the table are:

    1) letting all existing holders of short-term T-bonds make a bit of extra profit (to shore up the banks BB’s sworn to protect above all else, even citizens)

    2) “money printing” (operationally disproven but still reality to the herd)

    3) knee capping foreign mercantilists (& also distracting attention away from legions of domestic bank frauds)

    Relevance to US citizens? All bad for your pocketbook short term. All will lead to further protection of banks by letting unemployment float, and mkts sink. If any of these work, the sane thing for most investors seems to be to short all mkts (equity/metals/commodities) and wait for shit to hit the fan as strategy decisions are finally forced.

    Don’t consider going long again until Geithner is finally forced to resign? Then back to long innovation.

    It’s like watching economies barf up hairballs, and wondering which will take their medicine first & get it over with.

  • CFS

    It is hard for me to understand how QEII would be inflationary and would have pushed commodity prices up during the last two months when the first asset swap happened last week. Clearly, the perception around QEII is making the market pay higher prices for commodities and stocks, but that is nothing new. Three years ago the market perception was that house prices would never come down. And I do not remember any of these “economists, professors and fund managers” ringing any alarms about the sub-prime mess (including recently discovered fraud,) CDOs, and the absurd housing prices.

    As TPC has explained many times before, QEII is an asset swap. Medium term treasuries are purchased from the market in exchange for cash and a lower interest rate. This cash is not new cash. These are excess reserves that the private players did not legally have to own. They owned them because they were happy with the risk/return associated with those treasuries. To believe that they will swap treasuries by equities and commodities just because the Fed has given them the cash (they could have sold those treasuries anyway before the Fed swapped them) is a bit difficult to comprehend. Why would they move now from a low risk/return asset class to a high risk/return one if they did not want to do it earlier?

    We can put this is personal terms:

    Let’s imagine you have $100K in a 12-month CD (at 1.25% for example,) $10K in your checking account (at 0.25%), and $50K in your trading account, fully invested in equities and doing well. You have made that allocation decision and I suppose there is a reason for that – risk and return expectations. Now assume that your bank decides to call back the CDs and shifts your $100K to your checking account – reducing your overall rate of return.

    What will you do? I would assume that you would not use the “extra $100K cash” to buy equities, that would not make any sense, cause you had a specific asset allocation for a reason.

    If anything, you would move your money to another bank that does have CDs, or worst case to a money market account. You cannot escape the Fed, there is no other place to keep your money if you are a bank, and Tsys are way more liquid than CDs, so I do not see how QE is forcing banks or anybody into equities and commodities. It should force them into either cash(reserves) or as the Fed hopes, low-risk, real economy investments that would generate real growth.

  • TPC

    I disagree. While BB and I approach this from a very different theoretical perspective, we are still viewing the same monetary operations and BB gets it right. There simply is no money printed. It’s not even a debate. If you understand open market ops you know this. BB understands it.

  • TPC

    They all said the same thing about QE1 and how the explosion in the monetary base was an inflation risk. They were all wrong then and they’re all wrong now. So yes, I am disagreeing with them, have disagreed for a very long time and I think the evidence shows that they have all been wrong.

  • TPC

    The money isn’t technically flowing anywhere. Someone holds all of these instruments at some point. This is the point many can’t seem to understand. Banks don’t get rid of these reserves and then buy commodities. The only thing driving commodities higher right now is the perception of higher inflation due to “money printing”.

  • TPC

    Yes, and QE does not make banks more able to lend….If a lending boom ensues it will have nothing to do with QE….

  • Tom Hickey

    The purpose of QE2 is to drive financial capital toward higher risk. Global risk is high right now, and so the tendency is toward safety. The CB wants to reverse that tendency by shifting asset composition to higher risk assets by withdrawing tsy’s from the market. Therefore, the Fed is targeting quantity (600 B) rather than price (announcing an interest rate target) It is aiming at increasing the cost of capital and thereby eventually increasing prices. The Fed’s intention is to get some inflationary expectations going in order to reverse the disinflationary trend that is resulting in stagnation and threatening deflation. While there is a lot of brouhaha, there are not a lot of inflationary expectations actually showing up.

  • TPC

    Binder is working under the premise that banks are reserve constrained. He is using an old textbook that he probably wrote back in 1985. It is not correct. Banks are never reserve constrained. This should be painfully clear from Japan and QE1.

    It’s also unfortunate that he invokes the money printing term. In defending BB he is directly contradicting him.

  • squealer

    That’s very aggressive of you to call out some of these folks and assert that they “do not understand how the US monetary system works.” It’s also quite aggressive to say that they have been spectacularly wrong or “far off the mark” as their beliefs aren’t something that has to unfold over the next three weeks. I don’t know you personally – but I’m taking their word over yours any day.

    Further, stating that QE will not spur price inflation is extremely laughable. I offer into evidence the six month chart of wheat, corn, cotton and ask you to once again prove that CPI headline numbers give a precise picture of price changes facing US consumers.

    Lastly – the treasury issues debt, the federal reserve issues currency. The federal reserve has a balance sheet that holds yielding assets; one of its sources of capital to conducts POMO. If they’re not printing currency, please explain where the funds to purchase treasury securities are coming from.

  • psherid

    If the world decides the actions are inflationary then they are.
    Harken back to Soros’ theories on reflexivity in markets.
    Doesn’t matter if the world is right or wrong- the market just “is”.

  • Pal

    I have a bit of respect for your opinion having been a reader for some years but I would like to point out something which I think “you” don’t understand and I do use that emphasis solely as a writing emphasis.

    Understanding how humans arrive at beliefs is a very valuable subject and especially when trying to understand human behavior vs. textbook economics.

    C.S. Peirce’s [considered to be American greatest philosopher and often considered to be in the top 10 minds the USA ever produced] reference to his pragmatic maxim speaks volumes is a few short words.

    “Pragmatism. The opinion that metaphysics is to be largely cleared up by the application of the following maxim for attaining clearness of apprehension: Consider what effects, that might conceivably have practical bearings, we conceive the object of our conception to have. Then, our conception of these effects is the whole of our conception of the object.”

    Ok, nutshell. Whatever is perceived to be practicable implications of said is in fact the definition of said.

    The QE policies are seen as money printing / inflationary and that is in the fact the pragmatic definition of them.

    Keep up the quest.

    TPC – I have never rejected the notion that QE would cause markets to move. I have based many of my markets decision in recent years on the premise that the govt would intervene and attempt to fix this mess and ultimately cause markets to move enormously. Most notable is my March 8th bottom call in 2009 which was based entirely on the fact that the govt was ramping up a massive intervention.

    But that doesn’t mean perception is reality. The Fed can talk up inflation and get people to bid up commodities, etc, but that doesn’t mean it will ultimately succeed. Inflation will occur when real economic recovery occurs or the govt decides to actually drop money out of helicopters (it is not doing that via QE). Since QE has no real economic impact and is not money printing I have a hard time believing that BB is doing anything more than creating distortions in markets.

  • Angry MBA

    QEII is an asset swap.

    The MMT crowd keeps saying this, when it’s not at all relevant.

    The issue isn’t with the Fed balance sheet, but with the banks on the other side of the QE transaction. Those banks convert bonds into cash, and it is what happens to the cash position of those banks which results in more cash being added to the system. Even TPC can’t deny that their cash position increases as a result of QE, as the mechanics are fairly straightforward.

    The “asset swap” argument is a strawman, because the process of quantitative easing is ultimately about the balance sheets of those aside from the central bank. Nobody who advocates for QE is focusing on the assets on the Fed balance sheet, so it makes no sense to bring it up as if they are.

    Ultimately, QE2 is about making debt cheaper, in the hopes that companies will take on more debt and that at least some consumer debt can be refinanced. If you want to debate the merits or pitfalls of QE2, that’s what you should be focusing on.

    TPC – I swear you do not even read other comments because if you did you wouldn’t just come here and repeat the same argument day in and day out….

    The swap is not a strawman at all. The money that is coming out of the pvt sector and swapped for reserves is already in the pvt sector. To the penny. If you can explain to me that the money comes from somewhere else then you win. But you can’t explain that because the money is obviously already in the system. It’s like a stock buyback. The co announces a size, hopes the market ramps up their price, EPS get reduced and we all go along our merry way. But the co isn’t adding more money to the system. The money is already there. Whether you pay $50/share or $100/share. The co sets the buyback at a fixed amount and that’s where it ends. This is no different. So yes, it is a swap. Therefore, it is not inflationary in any way. Removing a tsy and replacing it with a reserve is not inflationary. That’s a very important point, but one that you don’t care to discuss for reasons unbeknownst to me.

    Your argument about MMT is the true strawman. You don’t understand MMT so you are using it to give the appearance that I am using some voodoo to base my argument around. But the truth is, this has nothing to do with MMT. It has only to do with understanding open market ops and you’ve made it very clear in recent months that you don’t understand open market ops. BB is not a MMTer last I checked and he fully admits that this is an asset swap and not inflationary.

    I have always said this is all about changing the term structure of bonds. But in the end it matters little.

  • haris07

    Semantics aside, I still disagree. I think QE is likely to be inflationary as it is creating excess $ w/o creating anything of “real value”. Excess $ are being recycled into commodities, emerging markets because there is higher yield there. Causes inflation there and here too since commodities are “global”. I define inflation not by some govt statistic as CPI, but a rise in the supply of money. While there are obvious deflationary trends that persist today (deleveraging) which counteracts inflationary forces, BB is hell bent on doing whatever it takes to get inflation. Me thinks QE 3 is likely, unless the $ and Treasuries sell off so badly that BB is forced to retract.

    At best, I think the impact is unknown. To say that this is definitely not inflationary is, in my opinion, not yet determined. And based on prices of commodities, the evidence so far is in favor of inflation.

    Another way to look at this is to take this to the extreme level, why stop at $600bn, why not $5 trillion? If inflation is certainly not possible with “asset swap” QE according to you, then what is preventing this taken all the way? After all, there is so much slack in the economy and banks aren’t lending, so just ramp it up all the way. I am not so sure that there are no inflationary consequences to printing excess $ to buy back Treasuries….then every government that had fiat currency would just print its way to handouts to citizens (assuming that there is slack in the economy) and keep getting re-elected. So simple….

    To call out Seth Klarman and Chanos as “it’s clear that none of them really do”….I am not so sure. The jury is still out on this one, I for one am not buying into your thesis that this is all non-inflationary and everyone is an idiot for thinking it is. A lot of folks are idiots, and Japan is a counter example, but I remain on the sidelines waiting for further evidence.

    TPC –

    1) Banks don’t lend their reserves. They don’t “get rid” of them. Just look at the reserve balances from QE1. They’re all there at the Fed. Just sitting there earning 0.25%.

    2) M3 has not risen since QE1.

    3) If they decided to buy $5T in tsys it would probably cause a huge spike in commodities as money printing fears increased and then we’d later regret the decision when we realized there was no real inflation and that they didn’t add any money to the system. It would be a 2008 repeat all over.


  • Pal

    As a 100% entirely unpaid philosopher it is a very interesting question / quandary we find ourselves in / talking about. I am not trying to be argumentative unless is contributes something of value. Mankind lives in a version of reality, a product of his own perception. Reality is separate from man. Man’s ability to access reality is limited by his abilities to hone and execute his logic.

    You could be right / correct about everything you state and yet it not come to be for reasons already stated. Now the interest issue is whether mathematical fact [in your belief] will trump human perception [belief that QE is inflationary].

    Thanks for your time.

  • Angry MBA

    The swap is not a strawman at all.

    It is a strawman for those of us who aren’t talking about it.

    We both agree that it’s a swap on a systemic basis. You can stop arguing about this as if we disagree about this aspect of it, because we don’t. Seriously.

    Where we disagree is whether this swap aspect is important. Since the issue of QE is the change in asset composition of the banks (not the central bank), the swap argument is not important; it misses the point of what QE is supposed to do.

    QE increases the cash position of the banks. Those banks convert bonds into cash. Everybody who understands QE knows this, as open market operations are the process by which interest rates are reduced in this system. This is not even debatable, this is simply how rate reductions are implemented.

    I understand that you don’t think that there is a meaningful distinction between the banks holding cash and holding treasuries. But you could make your argument on that basis, instead of claiming that the rest of us don’t understand what is going on, when we can clearly see the mechanics.

    One of the disconnects here is that MMT disagrees with traditional notions of money creation. You think that it is created through fiscal policy (deficit spending), while the Fed believes that it occurs through monetary policy (open market operations.) You can believe what you want, but you could at least acknowledge that you don’t see eye-to-eye with the mainstream about how one should define “money.”

    TPC –

    1) I have always maintained that QE changes the term structure of the debt markets. My argument has been that QE would not reduce rates to any degree that it influenced borrowing or other markets. And look at the bond market in the last few days. THE ENTIRE CURVE is higher than it was in late August. Even the 5 year tsy is back to August highs. QE is having no impact on the bond market all.

    2) The Fed can influence the money supply, but only at the horizontal level. They do not print money. So yes, they can technically influence the money supply, but without willing borrowers monetary policy is a blunt instrument.

  • NR

    Of course, QE2 is both an asset swap and also the printing of new money. If the FED buys bonds that are in circulation, the money supply will not change. TPC explained the process plain and clear. BUT if the FED buys brand-new bonds that didn`t exist before e.g. during a bond auction of the treasury, the money supply will change. This is brand-new money for the administration to spend. This money will lead to inflation if the money turnover accelerates as set out in the quantity theory of money.

    TPC – The Fed isn’t buying from tsy. They are buying from the PDs. Big difference. Federal spending is decided by Congress. Not the Fed.

  • Oroboros

    The issue here is that the QE process meddles with the supply / demand dynamic of Treasuries. The supply of the asset of Treasuries is being changed via the QE process.

    As you attempt to put your new found 100K to work, along with all of the others in the market who now also have new found USD in their accounts to invest, you will find the QE process has created an increased supply of USD and a decreased supply of Treasuries (though admittedly of roughly equal “value”). Investors can absolutely attempt to “reallocate” their portfolios as they were before, but there are now fewer Treasuries with which to do so. The price of those Treasuries that remain will thus go up, as these investors, yourself included, attempt to buy back what remains, their yields going down as a result.

    Now, if you hypothesize that investors are not seeking any particular yield target, simply an allocation distribution, then fine, they can reallocate as before – but at a lower overall investment return.

    If, however, you hypothesize that investors are aiming for a particular return target, then they are left in a quandary. More investors than not, in my belief, invest to make money (in fact, the more the better) within their parameters of safety. QE, however, has reduced their ability to make money via a previous method. Thus, if they wish the continue making the money they had previously at the rate they had previously, they must seek a substitute of some kind.

    I believe QE can be described as the process of reducing the supply of the particular asset – Treasuries – available for investment within the private sector, without reducing the overall amount of USD measured assets (including USDs themselves) within the market. I believe this process is an attempt to get the investment community to invest in riskier assets.

    It should force them into either cash(reserves) or as the Fed hopes, low-risk, real economy investments that would generate real growth.

    No offense, but what, pray tell, would these “low-risk, real economy investments” be? Munis, perhaps (just don’t look at the charts recently, though I imagine yield (and risk) are rising) – not quite as low risk as Treasuries, but lower than commodities or stocks. Loans to small businesses who aren’t asking for them? Loans to small businesses who are asking for them because they’re in trouble? Real Estate? I don’t mean to be an ass here, but what exactly are these low-risk, real economy investments which aren’t Treasuries?

  • Kyle F

    “The Fed’s position seems to be that more of the same economic policies are needed, even though they have failed to produce the advertised results. As microeconomist Steven Levitt (author of Freakonomics) documented, conventional wisdom is generally flawed since it fails to ask the right question about economic problems. We view the Fed’s econometric model as the personification of conventional wisdom.” ~ Hoisington Investment Management

    Example of Conventional Wisdom…
    “This approach [buying longer-term Treasury securites] eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.” ~ Ben Bernanke, Washington Post on 11/4/2010

    IMO, this “virtuous circle” to which BB refers is highly speculative. In fact, if precedent has anything to say on the matter, all of his “will lead to” statements brand extreme over-confidence. Hoping QE2 works as conventional wisdom suggests is about all that is going on. Unfortunately, it seems it is a very misplaced hope.

    On another note:

    “De gustibus non disputandum est, de gustibus disputandum est”. Do not dispute matters of preference, dispute matters of truth. TPC’s avid disagreement with other prominent names should be read and understood as an argument, either to be accepted or rejected. No more. We should read Jim Grant the same way. Do not be swayed by prestige…

  • nottpc

    One thing you don’t talk about is the fed is a vacuum cleaner. Net net does it increase monetary base? You say no. But does it not change complexion? If primary dealer sells a hedge funds treausries it goes to fed and I get cash. Now I need to do something with cash…any incremental purchases of risk assets now bastardizes the price over and above what they should be no? Doesnt mean money supply is higher…just means fed is sopping up treasuries and the resultant cash drives something else up. Prices of some things are too high and others too low due to this.

    TPC – Fewer bonds does not mean money “flows” into other assets. It just means there is more lower int bearing debt. They buy $600B in 5 year notes at 1.2% and exchange it with reserves at 0.25%. The banks can’t “get rid” of these reserves. They trade them within the banking system. It’s a lot like you selling a stock. When you sell a stock and you have “cash” do you rush out and buy more stocks and bid up the prices? No. You agree upon a purchase price with the seller based on both of your expectations. I don’t deny that there are investors running into risk assets and bidding them up. In fact, it is blatantly obvious in the commodity sector.

    BB hopes to make risk assets more attractive by reducing int rates. But we’re seeing yields soar in recent days! But my argument is that QE does not change the money supply and is unlikely to change the economic fundamentals and therefore this bidding up of risk assets is misplaced. He’s having an enormous psychological impact. That is indisputable. But most of it is based on misconception and not real improving fundamentals or changing market dynamics.

  • roger erickson

    QEII “should force them into either cash(reserves) or as the Fed hopes, low-risk, real economy investments”

    which the FED is hoping will include more real estate purchases;

    if Japan is any example, the FED is still spitting into the wind with this whole approach

    it’s all a battle over who takes the write down, the middle class & real economy, or the banksters; the real economy will win in the long run, so it’s only a question of how much lost output we’ll forgo while waiting to come to our senses

    that lost output is gone forever; and can’t be recovered; in contrast, we could easily recover from loss of ALL the banks

  • http://none rhp

    OK, someone tell me what is wrong with this line of reasoning: The FED’s entry into the Trsy market is like an 800 lb gorilla, buying up outstanding trsys. This is MEANT to increase demand for the treasuries through increased competition and lessening of mid-length supply, which should theoretically drive up the price of the trsys. The banks have no obligation to sell the trsys unless they feel they can get a profit from them (??this is an “open market” right?) so there has to be SOME incentive for them to sell their assets to the FED. I’m assuming that this could “inflate” the price of mid-term trsys, which the fed is targeting. And, I’m assuming this increased demand is an attempt to slightly lower interest rates on trsys by increasing the demand, and make them less attractive to world investors.

    It may not result in ANY change in money supply, but it does change the demand within a certain spectrum of trsys that can change pricing structures throughout the world. (And here, I would agree with “angry MBA”…….if the price of debt servicing falls, i myself would certainly look to refi my house again and free up more money for purchases).

    The world economy is not porous in its barriers. Seems like a water flowing analogy between certain semiporous compartments might be apt………a rise in compartment (inflation) may lead to a fall in another compartment (deflation). Seems like Bernanke is trying to influence where the water is flowing. Overall, the amount of water may not be different, but the demands in different compartments of the world economy may change. If the FED buys up treasuries (that have to offered back to it by banks for SOME reason), I can easily see world investors backing out of US currency and going other places, even if there is no change in overall money supply……..

    Educate me……..

  • Diffused

    A good primer on QE from a MMT perspective:

  • LVG

    The primary dealers have to participate in open market operations. That’s part of the agreement in becoming a primary dealer. The Fed doesn’t care if it benefits them or not.

  • http://none GLH

    Someone please correct me if I’m wrong, but the way I understand QE is that the Fed swaps short term assets for long term assets, but the assets go nowhere. The bank’s assets are held as reserves and the Fed pays a small percentage on them. The reason Mr. Bernanke wants the banks to have more reserves is that he believes they will spur lending. So, TPC says its just an asset swap.

  • http://none rhp

    LVG, so you are saying the banks HAVE to fork over the trsys to the fed at whatever price the fed offers?? thanks…..

    GLH, TPC makes the point that banks are not “reserve constrained” in their lending, and “more reserves” are not created, just the terms are changed from longer to shorter. THerefore, QE should not increase lending by the banks, at least directly.

  • LVG

    The banks sell the bonds to the Fed at auction. But they have to show up and make a market for the Fed.

  • Jack Sparrow

    You should love this TPC:

  • Jack Sparrow
  • Dan

    And ironic, then, that he proposes to take his readers through Econ 101.

    TPC – :-). I am listening to him now on CNBC. He is talking about how the reserves will “flow” into other markets and help generate lending. Yes, just like they “flowed” after QE1 and resulted in a whopping 25% DECLINE in total borrowing….Some “flow” there….

  • boatman

    while discussions about what should be done are interesting, i am more interested in positioning myself best for what will be done.

    and in the course of human events,irrationality rules and what should be done rarely is done. this is obvious from history, especially economic history.

    extend and pretend or paper over n hide is the rule of the day….the coming Eur debacle insures a precious metals bubble

    signed, bubble rider…….because that is what is available

  • haris07

    1. I know that banks don’t lend out reserves, no need to point that out time and again. However, my point is that there are excess $ in the system, driving down the value of existing $. That in turn causes a flood to emerging mkt currencies, forcing central banks there to mop up those excess $ by printing more money of their own. They then turn around and use the purchased excess $ to invest in US Treasuries. I UNDERSTAND THIS.

    2. My point is that there is an inflationary bias due to printing excess $ when there is no productive use to it. Print enough $ w/o creating “real value” and that is inflationary – period.

    Anyway, I am not very certain of this outcome either…I think all of this remains one grand experiment and we shall see. But I certainly don’t subscribe to your “it is certainly not inflationary” thesis.

  • JH

    So if it is not QE, that is driving the commodity bubble and causing emerging markets to be experiencing inflation due to foreign money flows, what is? The emerging markets are saying the money is coming from the US. I mean the public is sure not making these trades, it has to be Wall St and the banks, right?

  • JH

    Buying EUO and all comodities, but looking to get out early, things seem to be geting kind of hostle.

  • Dan

    The Fed pays more for the assets than it should. Its the quality of the money, not the quantity.The goverment distorted the price of asstets by propping up the mother of all assets-RE. This distortion from mark to market by bailing out the banks creates the delusion of asset inflation and the Fed rides with it.
    The tertiary affect on other assets allows the Fed to pay more than it should for treasuriesbecause the illusion/delusion has been sold. The quality of the dollar is really a lot worse than the market realizes yet. Therefore, the Fed is able to pay higher prices than it should to try and fight off coming deflation.
    Paying more than they should has the appearence of creating money, because everyone knows that the mother of all assets-RE is toast.

  • http://none GLH

    “Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).

    So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.”

    This quote is from Professor Mitchel’s blog and can be found under quantitative easing 101. Anyone can also listen to the video that TPC had the other day about Ben Bernanke’s talk at a Florida university where he too explained that QE is just an asset swap. Maybe the people on the list are responsible people, but as TPC has indicated that does not mean they understand QE.
    My point is that if the reserves are going no where, then most of the price increases in commodities, emerging markers, and the stock market is just speculation and maybe even front running by hedge funds. Correct?

  • boatman

    that road is getting shorter……i feel like i’m watching 2 trains headed wide open towards each other on the same track….from a spot on the great plains looking westward—where u can sometimes see things vividly so far away…..

    its like—don’t they know?….then there’s ben……geeeeez

  • nail

    agree, china has a dramatic inflation in the recent weeks after Big Ben announced the QE2

  • Jeff65

    Capitalism’s natural remedy of a deflationary bust is perfect moral hazard. The largest hardships are borne by those least responsible for the bust. This bust benefits many of the worst actors of the boom by enabling them to pick up real assets at bargain prices.

    If the government can not or will not step in to ensure equity during the bust, I’ll take inflation every time. Markets may sort out winners and losers, but regulation is required for any kind of fairness in the process.

    (TPC: For the record I agree that the facts show QE is not inflationary.)

  • Jeff65

    >I mean the public is sure not making these trades<

    Are you sure? Have you never heard of an ETF?

  • ron

    The great myth –

    ” Bank lending is never constrained by lack of reserves .”

    The disambiguated reality –

    “If [banks] are short of reserves then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).”

    [ ie. reluctant/ CONSTRAINED against using the latter facility because of penalty ]

    according to billy blog at

    Thank you Diffused .

  • Anonymous

    If there was no QE, will deflation/recession happened already?
    If no deflaton because of QE, can we say from relative point view that QE generate inflation(compare with deflation happened if no QE)?
    (sorry English is not my native language)

    TPC – No. The fears of deflation and double dip were overdone near the August lows. The ISM print of 56 on August 31st made that clear. I think it’s very far fetched to say that QE (or expectations of it) has done anything for the real economy thus far.

  • Paul

    Here is Barry Ritholtz comments about many of these rightwing signers and their record on the economy and the subprime debacle. I highly recommend reading this. It sheds a lot of light on the little faith anyone should have in these ideologues and their “open” letter.

  • Anonymous

    Is QE1 nothing to do with TARP in 2008? If bank did not receive money from government/fed will they bankrucpt already(include Goldmen Sachs)? If a lot of banks went bankrucpt, will there recession/deflation happened?

  • Mediocritas

    I don’t mind being in the minority when a deep thinker like Sarah Palin is in the majority. I think I’m even a minority member of the minority because I don’t see QE2 as a bad thing either. I wouldn’t ask Bernanke to cease and desist, just to modify the program a little.

    I don’t believe that the people demanding a stop to QE2 truly appreciate the black holes that exist out there in the economy. I see QE2 as a stealth bailout for the states, people need to consider what happens if California goes down when they demand a stop to QE2.

    As for the inflation story, I believe TPC has it right (and is very much in the minority). What we are seeing is speculation based on *expectations* of inflation, with those expectations being rooted in misinformation (that QE is money printing). Speculation is driving prices higher, causing producers to chase those prices, leading to oversupply in an environment of declining demand. Bad news for those chasing the inflation play in the long term…

    TPC – I agree Mediocritas. And what’s worse is that many of these people demanding BB cease and desist are doing it purely for political gain and are using QE to gain political favor with a populace that believes money printing is bad…..They’re taking advantage of people plain and simple. It’s sick.

  • Everyman

    After reading the comments on this post I am removing this group of Einstein’s from my book mark. You assumptions on what QE is doing and not doing is way off. All you have to look at is the effect on trade and commodities to see the “inflation”.

    Get out out your ivory towers and your BS “Political party red team blue team” thinking and look at the economic damage done to the markets, the economy, and our society.

    BB should be beaten with a tube sock full of wood screws for being a complete economic moron.

    TPC – That’s odd. I have explicitly argued that he is causing distortions in the commodity markets. Oh well. This site isn’t for everyone.

  • http://none rhp

    hmmm, thanks GLC and Ron. I go to billyblog as well to try to make sense of this. would be interested in TPC’s comments on “no reserve constraint” and “creating excess reserves” since usually Mitchell and TPC seem to be on a similar page.

  • TPC

    That is correct rhp. Banks do not lend their reserves. Several countries have no reserve requirements at all. This is also evident in QE1 when reserves exploded and bank lending fell 25%.

  • http://none rhp

    oops, sorry GLH (as opposed to glc). I went back and looked at Prof. Mitchell’s “101”. Here is another quote later on:

    “The conceptualisation suggests that if it (th bank) doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.

    But this is a completely incorrect depiction of how banks operate. Bank lending is not “reserve constrained”. ”

    I believe his first quote may be about how people or Bernanke view QE and not what actually happens (my interpretation) otherwise, it would seem to be a contradiction……..

  • ajit kumar

    Well TPC if QE doesnt do anything on net net basis, why is FED doing it?What are they hoping to achieve.
    Are you telling me out of all the majority financial whiz kids, no body understand that QE is hog wash. Are you saying market is wrong or prices are wrong (commodities, stocks etc)?

    TPC – So prices are always right? The fed knows what they’re doing. They’re trying to lower rates and talk inflation into the market. I’ve said it won’t work. That doesn’t mean they won’t try…..

  • ajit kumar

    Only principle I believe in is “The Price” is right

  • Ben Franklin Jr.

    Pardon me, just a dumb redneck here with a fancy name. But if the existing assets(tdebt) are exchanged for a previously non-existent asset(increased reserves) then does that not add to and subtract from balance sheets?

    The holder of tdebt gives the tdebt to the Fed, removing them from their balance sheet. The Fed then adds the tdebt to their balance sheet. The Fed in return increases the reserve account balance of the seller by a like amount. The reserve holder has in effect swapped one asset for another. The Fed has increase its balance sheet, but, and here is where I become confused, without having had an asset to trade in the first place. Either the Fed has created an asset to trade or there is an unknown source of asset of which I am unaware.

    The Fed has not ‘retired’ the tdebt because it has not returned to the issuer. The Fed is often quoted as saying that it is not a part of the Federal Government, and indeed it is not under the control of any agency of the Federal Government. Since the Fed is not the Government how has the tdebt retired? It has in fact not. It (the tdebt) is still outstanding on the books of the Treasury Department. When it issues interest payments they will travel to the owner of the tdebt, in this case the Fed.

    An open ended source of asset (the Fed) has swapped some of its asset for an asset that is still very much alive. So where do the assets of the Fed come from?

    Since the big bang, there has not been the creation of something from nothing. Not in science, not in bookkeeping. If the ledger shows an increase, it must also show a source, or you go to jail. But if you are the Fed the source turns out to be either paper currency or electrons. The end result is the same, the creation of money(asset) where there was none before.

    If currency is created (physical or electronic) is reduces by extension the
    value of all other currency in existence if there is no increase in productivity to account for the increase. Since the GDP in all likelihood will not expand at a rate needed to account for a nearly $1 trillion (QE2+POMO) infusion of funds, then inflation is the only possible result.

    You can line up the mirrors any way you like, the emperor is still naked.

  • http://none rhp

    @Ben Franklin, Jr.

    Actually the gov’t has ALWAYS created “money from nothing”. Can you imagine if we were trying to run our economy using only the $200 million that the Continental congress printed up in the 1780’s?? We wouldn’t be able to carry out the transactions required in a complex economic system. One of gov’t’s functions is to try to keep the money supply, credits, currencies, deposits balanced with the goods and services that need “money” to facilitate flow between people.

    This transaction between Fed and primary dealers does not NET anything new. The amount of cash the Fed dispenses to the banks is balanced by the trsys it acquired. The only way new gov’t assets w/o compensating liabilities enter the system is through fiscal spending by the gov’t, i.e payments of the gov’t to you and me via soc sec, medicare, armed forces, contracts between gov’t and private institutions.