6-Nov-10 News -- International fury at quantitative easing

[Higgenbotham]

I have no idea what this means, not a clue. If anyone can explain it, feel free. Unless he's talking about where banks get their money to buy bonds, but that's not the subject at hand.

Bernanke defended the Fed's decision earlier this week to buy $600 billion in government bonds to push interest rates even lower. Some critics worry that the move will be inflationary.

"Sometimes you hear the Fed is printing money. That's not happening," he said.

Bernanke explained that the money to buy the bonds comes from deposits that banks place in reserve at the Fed.

http://jacksonville.com/business/2010-1 ... cksonville

[vincecate]

When the Fed does this is it buying treasuries for new money.

It is, but earlier you said and are still saying the new money will be given to the Treasury to spend, directly or indirectly. The question is, what's going to happen to the money. For now, the treasuries are locked up on the Fed's balance sheet doing nothing. That's why people like James Galbraith are saying this is only a duration swap and he's right that it is...for now.

If you net out all of the transactions involving treasuries, what you will find is the government will get $100 billion per month in cash and spend it and the Fed will print $100 billion per month and get the treasuries. Again, it does not matter if there are banks in the middle of this or if the transactions are done on computer or with real paper money.

Also, governments never pay their central banks back. Treasuries will be "locked up" at the central bank till it closes. And in the US case any profits the central bank earns go to the government, so the US does not really even pay interest on the debt held by the Fed (it pays it and then gets it back). If you had a banana republic where the treasury just printed money and spent it you would have the same net effect as what we now have. This always goes badly.

You can look at government bonds as money with a delay built in. And so if you swap 10 year bonds for new cash you are just doing a duration swap. But when this happens, money that would not have been available for 10 years becomes available to spend now. It is inflationary, no matter how you look at it.

[vincecate]

I have no idea what this means, not a clue. If anyone can explain it, feel free.

"Sometimes you hear the Fed is printing money. That's not happening," he said.

It is very simple. People understand that printing money is bad. So Bernanke feels he must say he is not printing money so people don't get scared. Maybe he thinks to himself, "all we did was hit some buttons on a computer", but he knows this is the same thing. In his "helicopter paper" he talked about a "printing press or the electronic equivalent". The longer people don't understand the longer the dollar will last. So Bernanke lies.

[Higgenbotham]

When the Fed does this is it buying treasuries for new money.

It is, but earlier you said and are still saying the new money will be given to the Treasury to spend, directly or indirectly. The question is, what's going to happen to the money. For now, the treasuries are locked up on the Fed's balance sheet doing nothing. That's why people like James Galbraith are saying this is only a duration swap and he's right that it is...for now.

If you net out all of the transactions involving treasuries, what you will find is the government will get $100 billion per month in cash and spend it and the Fed will print $100 billion per month and get the treasuries. Again, it does not matter if there are banks in the middle of this or if the transactions are done on computer or with real paper money.

That's true if US government debt is increasing at the rate of $100 billion per month, which is about right from what I know.

At the same time, there are mortgage securities that have been decreasing in value and are once again continuing to do so. The $100 billion per month in cash is likely going to be used to cover those losses (eventually) or sit unused as reserves to cover those eventual losses, so there is no inflation until that changes. In the meantime, the banks can temporarily use those reserves to gamble if they want to. So you may see things that are exchange traded like cotton and oil go up, but avocados and Alaskan salmon, for example, won't. I use avocados as an example because I've seen avocado prices continuously drop for about 3 years but nobody talks about it. If banks pump commodity prices at the margin, that will be deflationary because consumers will have to reduce purchases, which is part of what aggravated the collapse in 2008.

A few months ago, we talked about how this all boils down to how big the deflationary hole is. I estimated $6 trillion at the time (I think it's a bit bigger now) and you estimated something less. They are going to make an attempt to chew through that at a rate of $100 billion per month for now.

[Higgenbotham]

I have no idea what this means, not a clue. If anyone can explain it, feel free.

"Sometimes you hear the Fed is printing money. That's not happening," he said.

It is very simple. People understand that printing money is bad. So Bernanke feels he must say he is not printing money so people don't get scared. Maybe he thinks to himself, "all we did was hit some buttons on a computer", but he knows this is the same thing. In his "helicopter paper" he talked about a "printing press or the electronic equivalent". The longer people don't understand the longer the dollar will last. So Bernanke lies.

My thought was the reporter didn't hear what he said, but if that's what he really said in the last line I quoted, God help us all. This:

Bernanke explained that the money to buy the bonds comes from deposits that banks place in reserve at the Fed.

I have no idea what this means, not a clue. If anyone can explain it, feel free.

PS: I will reword Bernanke's statement to reflect what I understand to be the reality. "Higgie explained that the money to buy the bonds (comes from deposits) is created out of thin air by the Fed and credited as a deposit that banks place in reserve at the Fed." That's the closest I can come to making a true statement while at the same time making minimal changes to the wording of the statement from the news story.

[John]

Do you guys want me to move the posts in this thread
to some other thread?

John

[Higgenbotham]

Do you guys want me to move the posts in this thread
to some other thread?

John

I think we're OK here as all of this has to do with QE.

One last thing. I was talking about a $6 trillion deflationary hole that is growing. But I should say this. If Krugman was saying $8-10 trillion in QE2 would be needed to stop deflation, he is probably right (that is probably the actual size of the hole or its projected size in a few months). Since I can only look at public information and guess, his numbers should be better than anything I can come up with. We would hope anyway.

[vincecate]

I watched a video of Bernanke saying some people are afraid that "quantitative easing" is some new and untested policy where they don't know how it will work out. So he tried to reassure people by saying, "it is just monetary policy". He can not explain it in simple terms of "printing money", as people would be very afraid. So today I found one more euphemism for printing money to add to my list, "just monetary policy".

[John]

Dear Vince,

Here are some things for you to think about.

1. You say that the Fed can "print" an unlimited amount of money. But
as I've been saying, that's politically impossible. You're seeing
that today. The Fed's "modest" QE program is generating an enormous
political backlash, both nationally and internationally.

Once again, I can make the point that a so-called "gold standard" is
completely irrelevant. If the politicians want to weaken the
currency, then a gold standard won't stand in the way; if the
politicians don't want to weaken the currency, then a gold standard is
irrelevant.

2. When I wrote about an international "race to the bottom," you said
that this would weaken the dollar and create (hyper)inflation. Once
again, that's impossible. You can't weaken all currencies at once.
When one currency weakens, another strengthens. If there's a race to
the bottom, then all currencies remain equally weak or strong.

3. Meanwhile, the CPI keeps falling into deflation levels, as it did
in America in the 1930s and in Japan in the last 20 years. This is
generational, and QE has nothing to do with it.

I cannot see any realistic scenario that leads to any sort of
inflation.

John

[vincecate]

1. You say that the Fed can "print" an unlimited amount of money. But as I've been saying, that's politically impossible. You're seeing that today. The Fed's "modest" QE program is generating an enormous political backlash, both nationally and internationally.

The Fed at $100 billion per month will be essentially covering the whole deficit of the US Federal government. This is not a "modest" amount of money by most measures.

I don't mean that they can print an unlimited amount this month, Ben would get in trouble. But if people stop buying government bonds and want cash for bonds they hold as they come due, the political pressure on Ben will be to buy more and more bonds so the government can pay off the bonds coming due. The backlash internationally will be that they dump their bonds and stop buying new bonds. This will add to political pressure for the Fed to print/buy more.

I think we are less than 2 years from when they start printing/circulating $1,000 bills. Other central banks worked with political pressure to make hyperinflation. I expect the US central bank will too.

Once again, I can make the point that a so-called "gold standard" is completely irrelevant. If the politicians want to weaken the currency, then a gold standard won't stand in the way; if the politicians don't want to weaken the currency, then a gold standard is irrelevant.

2. When I wrote about an international "race to the bottom," you said that this would weaken the dollar and create (hyper)inflation. Once again, that's impossible. You can't weaken all currencies at once. When one currency weakens, another strengthens. If there's a race to the bottom, then all currencies remain equally weak or strong.

You may be imagining that when China prints yuan they buy up dollars or yen and so take some of those out of circulation. This is not the only way things can go. They can just print money and spend it (ok some bonds may change hands between central bank and government). The US will not be buying up any other currencies when they print money.

Don't think about any "gold standard". Think about my 1/10th oz gold coins or 1 oz gold Kugerands or something. Or silver coins. US customs classifies pure gold coins with a stamped weight as "currency" not merchandise. The currency symbol for gold is XAU and the units are 1 oz. Really.

Now all the paper currencies can "race to the bottom" as each country prints more of their paper. Theoretically they might even each maintain the same ratio to dollars that they had at the start of the race. In this case the "dollar index" would stay the same. So in this sense it could well look like the dollar is not getting stronger or weaker relative to other paper currencies. But nobody is printing gold like that, so it is not part of the race to the bottom. When the race starts the best currencies to hold are gold and silver. These get more and more valuable when measured against any of the paper currencies in the race. Also, commodities get more expensive when measured in a rapidly printed currencies. Seems like the race has started.

I really expect all the paper currencies to weaken when measured against commodities or the two hard currencies, gold and silver. Most paper currencies are backed by dollars, so when the dollar falls they will fall too, even if they were not trying to be part of the race. Again, it seems like the race has started.

3. Meanwhile, the CPI keeps falling into deflation levels, as it did in America in the 1930s and in Japan in the last 20 years. This is generational, and QE has nothing to do with it.

I cannot see any realistic scenario that leads to any sort of inflation.

The CPI is not falling 30% like it did in the 1930-1933 timeframe when people were taking gold coins out of the Fed's Ponzi gold standard where they had 2.5 paper dollars for every dollars worth of gold while saying all paper dollars could be turned in for gold. Also, the CPI is rigged now.

If you think printing money has nothing to do with inflation, why have taxes? Why not just print money for all government expenses? The $100 billion per month printing is about 40% of the Federal governments spending. Why not just cancel every kind of Federal tax and print $250 billion per month?

Most people hold short term bonds now. If people stop buying bonds and are getting their bonds paid off as they come due, the government/Fed is going to have to print a huge amount of money. Maybe $4 trillion to cover bonds coming due in the next 12 months. How is this not a realistic scenario for inflation?

Note, there are many real countries that have already tried printing money for all their deficit spending. If deficit spending/printing is like 40% of government spending it always causes big inflation. Always. When inflation is clearly higher than bond interest rates people stop buying bonds. With debt levels of 80+% of GNP and deficit spending of 40+% of spending, then when bond sales fail and the government/central-bank has to print to cover bonds coming due it always causes hyperinflation. I link to a couple books in my document that cover some of this history.

I am expecting you and Mish to understand hyperinflation right before the rest of the world does. Be sure and let me know when you do.