Thread: Alert: QE II Has Lit the Fuse

Alert: QE II Has Lit the Fuse

Thursday, November 11, 2010, 1:41 pm
by cmartenson

For a very long time I have been calling for, expecting and otherwise anticipating the day that the Federal Reserve would begin openly monetizing government debt. http://www.chrismartenson.com/martenson ... st-cut-all I knew the day would come intellectually, but in my heart I hoped it wouldn't. But with the Fed's recent decision to directly monetize the next 8 months of federal deficit spending, that day has finally arrived. I have to confess, while my prediction has proven accurate, I’m still stunned the Fed actually did it.

In this report I examine the risks that this new path presents, what match(es) may finally ignite the decades-old pile of dry fuel, what the outcomes are likely to be, and what we can and should be doing in preparation.

How is this Quantitative Easing (QE) different from the prior QE?

There are two main points of departure between the two QE programs:

* The level of global support for such efforts
* Where the money was/is targeted

Let's take the second point first.

QE I consisted of all sorts of liquidity efforts that went by various acronyms, but the main act was the accumulation of some $1.25 trillion in MBS and agency debt. Some might note that taking MBS paper off the hands of financial institutions, which then bought treasuries with the cash, is little different than the recently announced QE II program because at the end of the day, money was printed and Treasuries were bought. In this regard, they're right.

But let's be clear about something: the first QE effort had the specific aim of repairing damaged bank balance sheets. That is, banks and other financial institutions had made some colossally poor and risky financial moves that didn't work out for them. They needed some help, and the Fed was more than happy to oblige by handing them free money to patch up their losses.

Of course they didn't do this outright by saying, "Here take this money!"; they did it somewhat sneakily. But when the Fed hands you huge piles of money (for your dodgy debt) and then let's you park that very same money in an interest bearing account at the Fed, there's really no difference between that and just handing you free money. No difference at all. If the Fed ever offers you free money that you can then park in an interest bearing account with the Fed, you should take them up on it, and you should do it as much as they will allow.

Indeed, that's exactly what happened. These parked funds are called "excess reserves" and this chart clearly displays the massive program undertaken by the banks and the Fed:



Now, it's also true that the Fed does not pay a lot of interest on this money, just 0.25%, but on a trillion dollars that pencils out to some $2.5 billion a year, handed straight over to the banks. I call this program "stealth QE" because it is nothing more than printing money and handing it over to the banks with a slight bit of complexity thrown in just to put the dogs off the scent. A couple of billion may not sound like much these days, but I raise it to illustrate the many and creative ways that QE I was about getting the banks back to health, and not much else.

So QE I (and the ‘stealth QE’ program) was directly aimed at banks to help them repair their balance sheets and make them whole on their terrible decisions and losses. It turned out, though, that fixing the banks did absolutely nothing for Main Street. The rest of the economy remained mired in a rut, with banks either unable or unwilling to make additional loans. They kept their QE lotto winnings and parked them with the Fed.

QE II, then is about getting thin-air money to the government which, the Fed rightly assumes, will immediately spend and push out into the economy. Here's how the head of the Dallas Fed, Richard Fisher put it in a recent talk he gave:

A Bridge to Fiscal Sanity? http://dallasfed.org/news/speeches/fish ... 101108.cfm

The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt.

This is risky business. We know that history is littered with the economic carcasses of nations that incorporated this as a regular central bank practice.

There it is in black and white. You might want to read it a couple of times to let it sink in. The Fed is directly monetizing the next eight months of excess(ive) spending by the federal government and is doing it despite being perfectly aware of the extent to which history is littered with the remains of those who have traveled this path before.

Presumably we are supposed to console ourselves with the idea that the Fed will be successful where others have failed, and sometimes failed miserably. Yes, we are talking about the same Fed that fueled that last two destructive bubbles by keeping interest rates too low for too long; failed to see the housing bubble as late as 2007 for what it was, and apparently entirely lacked the capability to foresee any of the current mess. That Fed.

The one run by the gentleman who said this to the House Budget Committee on June 3, 2009,

“Either cuts in spending or increases in taxes will be necessary to stabilize the fiscal situation…The Federal Reserve will not monetize the debt.â€

Sterilizing Money at the QE Corral

Interest-Rates / Quantitative Easing
Nov 13, 2010 - 06:39 AM

By: Richard_Daughty

There are a lot of intricacies in the Federal Reserve's evil ways, especially as concerns creating $900 billion in the next six months in another round of quantitative easing, and one of them is explained by Daniel R. Amerman of DanielAmerman.com. He says, "There is something else essential for investors and savers to understand about the process which the Federal Reserve has just outlined. The Federal Reserve is not directly purchasing treasury bonds from the US government. Instead, US banks are purchasing the bonds from the US Treasury to fund the deficit, and then selling an equal amount of other bonds (likely at a nice profit) to the Federal Reserve."

If you are a normal person, then you are positively terrified by the prospect of inflation, which means that you are terrified of the Federal Reserve creating so much, so incredibly much, so staggeringly much, so unbelievably much money - which is to be almost $900 billion in the first six months of 2011 - because a lot less monetary insanity than this gigantic clot of extra money caused ruinous inflations in stocks, inflations in bonds, inflation in consumer prices, inflation in housing, inflation in the sheer suffocating size of government and severe, bankrupting macroeconomic distortions and mal-investments.

Obviously, then, I am on to something when I say that "Inflation is the worst thing that can happen, other than the Earth being invaded by creatures from outer space to make us their slaves, forcing us to mine di-lithium crystals on some barren planet in the faint, farthest reaches of the Federation of Planets."

So, besides keeping an eye on the skies for alien invaders from outer space and watching the neighbors to see what nefarious schemes they are plotting against me, I keep tabs on the money supply.

Mr. Amerman, whom I now suspect of being in concert with my wife to cause me to have a heart attack and die on the spot from the sheer horror of it all, writes that "by the end of the Federal Reserve's mortgage security purchase program (the previous 'quantitative easing'), about 10% of the approximately $12 trillion in US banking system assets consisted of sterilized money held at the Federal Reserve."

Sterilized money? What's that? It sounds a lot like the end-days of my relationship with Susan, when she suddenly announced that, from now on, if I wanted to kiss her, I had to first sterilize my lips with boiling water. As you can probably guess, things went downhill pretty fast after the first few times! Parenthetically, looking back on it, it was not worth it.

My amorous misadventures aside, the answer is that "while a (desperate) central bank wants to be able to spend money without limits, letting that new money escape into the general money supply can lead to major inflation in a hurry. So with the previous rounds, the Fed and ECB each used their 'sterilization' powers to essentially put a corral up around the new money, and keep it from escaping out into the economy."

He goes on that "because the banks can't really spend their 'sterilized' money, but must have an ever larger share of their balance sheet assets consist of those economically meaningless excess reserve balances."

He figures that by June of next year this would mean "about 16% of total US bank assets would consist of 'sterilized money', i.e. balances at the Federal Reserve that can't be used anywhere else."

I immediately saw this as a chance to get my own economic house in order! At breakfast, I happily told the kids that I was going to quadruple their allowances! This wonderful news made them, as they said, "Happy for the first time in our miserable lives!"

I admit that I positively reveled in smug self-satisfaction as they fell all over themselves apologizing for hating my guts, and apologizing about how they regret calling me a horrible, stingy, miserly, gold-bug, silver-bug, worthless loser of a father who spends every dime on gold, silver and oil stocks so that I can make a lot of money when their prices shoot "to the moon" when the monetary insanity of the Federal Reserve creating so freaking much money, so that the insane Obama administration can deficit-spend almost $2 trillion a year, makes inflation in consumer prices start climbing to hyperinflationary levels.

After I was finished eating and having had enough basking in the fawning adulation, I broke it to them that while I was indeed quadrupling their allowances, being the generous, loving father that I am, I was "sterilizing" the money by making them keep it in my bank account.

Well, their reaction was immediate outrage, as compared to the lack of it demonstrated by the silly "journalists" (in every sneering, disrespectful, pejorative use of the word) of the mainstream media and neo-Keynesian econometric halfwits infesting the majority of the nation's universities at such a monetary monstrosity.

Their loud hostility was not quelled one iota by my gently reminding them that the Federal Reserve was doing this same thing right now, and the Fed's bank account has risen by more than a trillion dollars in one year, and which is apparently okay with the "silly 'journalists' (in every sneering, disrespectful, pejorative use of the word) of the mainstream media and neo-Keynesian econometric halfwits infesting the majority of the nation's universities" as mentioned so prominently in the previous paragraph.

Well, what started out as a delightful breakfast with the family soon devolved into a distressing shouting match of sorts, with the kids telling me, "We hate you more now than we ever hated you before!" me yelling at them, "Morons! If you knew the kind of inflationary horror that is going to happen to us because of the Federal Reserve creating so much money, then you would happily give up one of your three generous portions of cold gruel per day to let me buy MORE gold, silver and oil!" and my wife pleading, "Everybody please shut up and calm down!" to no avail.

It was scene of insane pandemonium for awhile, which we can all agree shows the degree of insanity rampant in the world today, as is this sterilized quantitative easing, which Mr. Amerman says is "an insane strategy for a government that is desperately trying to revive the private sector economy, which is one of the reasons I find further sterilization to be unlikely."

With all due respect to Mr. Amerman, I figure that the money was not actually sterilized at all, and although it did not enter the economy as a result of business and consumer loans, it entered into the economy via government deficit-spending.

Which, if either, is worse than the other from an economic standpoint is, of course, a matter for rigorous theoretical analysis, which means that it won't come from me because it sounds like work, and I hate even the word "work,", even if I could do the analysis, which I can't because I haven't a clue how to even start.

But I like making money without working, and I know (thanks to the Austrian Business Cycle Theory and 4,500 years of history) that buying gold, silver and oil will make me a lot of money because of all of this monetary and fiscal insanity.

And all without lifting a finger, which is so deliciously brainless that I say, "Whee! This investing stuff is easy!"

http://www.marketoracle.co.uk/Article24255.html