10-Nov-10 News -- Europe and Asia bash quantitative easing

[vincecate]

The Fed can't go bankrupt because it's not in debt.

Right. The Fed is making its own money out of thin air. A regular bank has depositors that it owes money to. That is different.

[Higgenbotham]

On the rest of it, it's true that only the Fed can create base money, or monetary base as they call it. But the banks, hedge funds, and so on, through derivatives, have created synthetic forms of money that within the context of the economic and regulatory environment that was created acted as good substitutes. By the same token, synthetic derivatives can be created that will effectively wipe out base money or any other form of money for that matter. For some discussion of that, there were some articles that came in front of the public when the ECB did their rescue package that explained that concept.

[Higgenbotham]

That will create a huge further demand for Treasuries, which will be
satisfied either by the US issuing more Treasuries, or by existing
Treasuries selling for much higher prices. Either way, money is being
created through debt. And if the price of some Treasuries goes up,
then the price of all Treasuries goes up, so that every portfolio of
Treasuries in the world becomes more valuable, creating an asset
bubble.

Reading Armstrong's latest, he makes some interesting comments that I think are applicable.

http://www.martinarmstrong.org/files/Th ... 1-1-10.pdf

The Fed has its models that work most of the time. The idea is that they will bide some time and there will be another bubble. Bernanke mentioned in the Washington Post editorial on November 4 that this stock market bubble would somehow be virtuous. I can't remember the wordsmithing that was used, but obviously he expects it to continue for the foreseeable future, as does Wall Street.

Armstrong mentions there is a small fraction of market movement during phase transitions that negates those models and crashes result. I'm seeing that we may be on the cusp of something like that right now.

Whereas QE2 by most models would be considered expansionary, if long rates begin to rise, and they are, then I can see the possibility that the asset and commodity bubbles can crack much more quickly than almost anyone can imagine given how the Fed has stacked the house of cards. The reserves the Fed has created will likely then flee back into treasuries but my bet is that they flee into the shorter end of the curve. If rates out on the long end continue to rise as asset prices crash, the crash will be self-reinforcing. Even as long bond rates around the world rise, US long bond rates may also rise by lesser amounts. This in my opinion would be the perfect financial storm for the US stock market.

http://quotes.ino.com/chart/index.html? ... =&w=&v=d12

The brief discussion Armstrong did about natural disasters following economic disasters is interestingly enough something I also thought about recently and mentioned in this thread. If the scale of the economic disaster is larger, the effects of the natural disasters that follow will probably be nonlinear with respect to the smaller crises. He briefly mentions the 14th Century crisis. Very interesting.

[vincecate]

On the rest of it, it's true that only the Fed can create base money, or monetary base as they call it. But the banks, hedge funds, and so on, through derivatives, have created synthetic forms of money that within the context of the economic and regulatory environment that was created acted as good substitutes. By the same token, synthetic derivatives can be created that will effectively wipe out base money or any other form of money for that matter. For some discussion of that, there were some articles that came in front of the public when the ECB did their rescue package that explained that concept.

I don't really see how derivatives can destroy base money. If I think of a $100 bill, derivatives can cause it to move from one person to another, but I don't see it being destroyed by derivatives. Any more info on how to find those articles?

[Higgenbotham]

On the rest of it, it's true that only the Fed can create base money, or monetary base as they call it. But the banks, hedge funds, and so on, through derivatives, have created synthetic forms of money that within the context of the economic and regulatory environment that was created acted as good substitutes. By the same token, synthetic derivatives can be created that will effectively wipe out base money or any other form of money for that matter. For some discussion of that, there were some articles that came in front of the public when the ECB did their rescue package that explained that concept.

I don't really see how derivatives can destroy base money. If I think of a $100 bill, derivatives can cause it to move from one person to another, but I don't see it being destroyed by derivatives. Any more info on how to find those articles?

Some. I remember Goldman was mentioned and it seems like the articles appeared on Reuters. It was about the time the Euro was going down a lot last Spring and Summer but it hadn't bottomed quite yet. A few years ago, I also read about the fact that t-bill only money market accounts could be comprised entirely of synthetics and not real t-bills. I don't know how either one of these things are done, but haven't thought much about it. I'll think about it more and let you know if I come up with anything.

[vincecate]

So the Fed is buying the bonds from the banks who buy it from the Fed. That will create a huge further demand for Treasuries, which will be satisfied either by the US issuing more Treasuries, or by existing Treasuries selling for much higher prices.

The Treasury is making totally new bonds at the rate of about $100 billion per month, as well as selling bonds to cover all the bonds that come due. With the Fed buying at about $100 billion per month they are just covering the regular Treasury supply. This is not really a "huge further demand".

In a bubble speculators drive up the prices to crazy levels. Eventually the supply of the thing is enough to overwhelm demand and the price collapses. Speculators have been buying bonds thinking that QE2 would drive prices up. These speculators may well have bought more than $600 billion.

There is a fundamental problem with the Fed trying to drive up bond prices by printing money. In the longer term the printing money reduces the value of the dollar and so also reduces the value of the bonds. It can work short term, but if it goes on long enough this printing money to drive up bond prices will fail. Longer term is like 2 or 3 years, and we are reaching that point.

The prices of bonds are really at crazy levels. Getting 1% or 2% for locking yourself into US dollars for 1 or 5 years when the dollar frequently drops 1% in a day, is crazy. Bonds can only go higher as interest rates go down. When interest rates are this close to 0% the bond prices can not go "much higher". When something can not go higher, it will start going down soon. The risks/reward is not sane. US Bonds are a bubble that will pop. I think the stock market will crash about when the bond bubble pops. I think this is soon, like in the next 6 months. Time will tell.

Over the long term, stock yields and bond yields go up and down together (like compare 1980 to 2010). So I think that anyone who expects a major stock market crash should not view bonds as a good investment.

[Higgenbotham]

So the Fed is buying the bonds from the banks who buy it from the Fed. That will create a huge further demand for Treasuries, which will be satisfied either by the US issuing more Treasuries, or by existing Treasuries selling for much higher prices.

The Treasury is making totally new bonds at the rate of about $100 billion per month, as well as selling bonds to cover all the bonds that come due. With the Fed buying at about $100 billion per month they are just covering the regular Treasury supply. This is not really a "huge further demand".

The Treasury has been issuing additional debt for a long time, so the market has had something to absorb for a long time. Now the market doesn't have any net new issuance to absorb. Of course, it's not that simple, but that seems to be what we are talking about.

In a bubble speculators drive up the prices to crazy levels. Eventually the supply of the thing is enough to overwhelm demand and the price collapses. Speculators have been buying bonds thinking that QE2 would drive prices up. These speculators may well have bought more than $600 billion.

According to ICI, net inflows into bond mutual funds have been averaging around $30 billion per month, long before QE2 was announced. That's a pretty small subset of the market so it's clear that the public wants bonds in quantity. On the other hand, I'll bet a good part of that isn't government bonds.

There is a fundamental problem with the Fed trying to drive up bond prices by printing money. In the longer term the printing money reduces the value of the dollar and so also reduces the value of the bonds. It can work short term, but if it goes on long enough this printing money to drive up bond prices will fail. Longer term is like 2 or 3 years, and we are reaching that point.

All things being equal what you're saying is true in my opinion. But again, it depends on how much is created and what happens to the money as well as the economic and regulatory environment as to the significance of these actions. It's also true that the dollar fell for years before the Fed got involved with QE programs and the banks were taking advantage of low interest rates to issue money substitutes based on securitized credit. How much of that will be unwound over the coming months?

The prices of bonds are really at crazy levels. Getting 1% or 2% for locking yourself into US dollars for 1 or 5 years when the dollar frequently drops 1% in a day, is crazy. Bonds can only go higher as interest rates go down. When interest rates are this close to 0% the bond prices can not go "much higher". When something can not go higher, it will start going down soon. The risks/reward is not sane. US Bonds are a bubble that will pop. I think the stock market will crash about when the bond bubble pops. I think this is soon, like in the next 6 months. Time will tell.

OK, first of all 1 or 5 years is not a bond. 1 year is a bill and 5 years is a note. I'd agree that 30 year bonds are overpriced, but that is my opinion. Is the market wrong? I think in this instance it is. On the other hand, I think getting 0.5% in a short term bill is a great deal. Reason being, I will lose money almost anywhere else - stocks, real estate, bonds, you name it. If a 30 year bond is at 4.2% (current price), the price will go up a lot if the yield falls in half. Reason being, you have to lay out twice as much principal at half the yield to get the same coupon. I don't know how buyers at the exchange determine 30 year bond prices, but the history is here: http://futures.tradingcharts.com/chart/TR/M

Over the long term, stock yields and bond yields go up and down together (like compare 1980 to 2010). So I think that anyone who expects a major stock market crash should not view bonds as a good investment.

Bond yields bottomed in the early 40s. Stock market PEs also bottomed in the early 40s. Thus, stock market dividend yields should have reached a relative high in the early 40s. I don't have all my charts in front of me, but do know that much.