QE1 was largely sequestered in bank reserves at Fed.
QE2 will allow Bawney and Harry and Boehner to run amok.


http://www.chrismartenson.com/blog/alert....


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. Intellectually knew the day would come, but in my heart I hoped it wouldn't. But with the Fed's recent decision to directly monetize the next eight 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 lets 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 after 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?

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 for what it was as late as 2007, 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.”

~ Ben Bernanke

In summary, the difference between QE I and QE II is that QE I went primarily to the banks and QE II is going directly to the government. While this may be something of a semantic difference, it shows that the Fed is changing its strategy again. We might ask: Why this shift, and why now?
How is QE II being viewed outside of the US?

In a word, poorly.

The German finance minster called the Fed's application of US monetary policy "clueless" and argued that the Fed decision would "increase the insecurity in the world economy."

China was predictably unhappy too, but initially used more diplomatic language:

Xinhua: G-20 Should Set Up Mechanism To Monitor Reserve Currency Issuers

BEIJING (Dow Jones)--China's state-run Xinhua News Agency published a commentary on Tuesday calling for the Group of 20 industrial and developing economies to supervise the issuance of international reserve currencies, and harshly criticized the U.S. Federal Reserve's new round of quantitative easing.

The G-20 should "set up a new mechanism that effectively monitors the issuer of the international reserve currency, especially when it is not able to carry out responsible currency policies," Xinhua said, making an apparent reference to the U.S. as the issuer of the dominant reserve currency.

"Considering the influence of the policy moves in the major international reserve currencies on the global economy, it is necessary for the issuer of the international reserve currency to report to and communicate with the G-20 Group before it makes major policy shifts."

All of the above is loosely coded diplomatic speak for "The US really bummed us out here; it should have stuck to the agreements we thought we had after the Pittsburg meeting. Going off-script like this was really not appreciated. We think an intervention is needed here."

Later, an advisor to the Chinese central bank went further and called the US actions "absurd."

PBOC Academic Adviser Questions Dollar’s Global Role

Nov. 9 (Bloomberg) -- Li Daokui, an academic adviser to China’s central bank, said it could be seen as “absurd” that the dollar remains a reserve currency after the financial crisis.

Here are a few other selected expressions of dismay from around the world:

United States receive criticism from all sides because the decision to print money

U.S. decision to pump 600 billion dollars into the economy has sparked a wave of strong disapproval. World leaders, who are preparing for the G20 summit in Seoul this week, warns that the move will complicate U.S. global economic recovery.

G20 tensions rise over the future of the global economy

The US last week stoked the simmering tensions by unveiling plans for another $600bn (£370bn) of quantitative easing (QE), on top of the $1.7 trillion already in place. The dollar crashed in what is being seen as the latest round of competitive devaluations, as nations seek to debase their currencies to help domestic industry.

Brazil retaliated by buying dollars. Xia Bin, a member of the Chinese central bank's monetary policy committee, branded the US stimulus plan "abusive" and warned it could spark a new global downturn. German finance minister Wolfgang Schäuble accused the US of breaking the promise made at June's G20 in Toronto, saying he would "speak critically about this at the G20 summit in South Korea."

Just two weeks earlier, G20 finance ministers at the warm-up summit in Gyeongju, South Korea, had pledged to refrain from competitive devaluation and Tim Geithner, the US Treasury Secretary, had promised the US would retain its "strong dollar" policy. At Seoul, the US will be facing accusations of empty rhetoric.

The harmonious language of hope at the Pittsburgh summit has now given way to something brazenly belligerent. The Brazilian President, Luiz Inácio Lula da Silva, has said he will go to the G20 meeting in Seoul ready "to fight." For President Obama, who has just lost a bruising midterm election battle, it will mean another painful encounter.

Greece Hits Out At Money-Printing Nations

Speaking on Jeff Randall Live, George Papaconstantinou warned quantitative easing only serves to stoke up inflation.

"You get inflation. You get a situation that's out of control. People lose their purchasing power. It doesn't get you very far," he said.

In summary, QE II has been described by several major trading partners as "clueless," "abusive," "absurd," and even resulted in a lecture from Greece on the subject of printing. By the time you are getting lectured by Greece on monetary actions, it might be time for a bit of self-reflection.

It is not too strong to suggest that something of a tipping point has been reached in regards to how the US is perceived as a leader on financial and monetary matters.
Why this is important

Okay, so the US's international friends are a little upset with it for deciding to print up the better part of a trillion dollars out of thin air. What's the big deal?

The big deal here is that the OECD countries have a monster borrowing bill set for next year. There needs to be some level of cooperation, and fair play is going to be required in order to pull this off:

$10.2 Trillion in Global Borrowing

Next year, fifteen major developed-country governments, including the U.S., Japan, the U.K., Spain and Greece, will have to raise some $10.2 trillion to repay maturing bonds and finance their budget deficits, according to estimates from the International Monetary Fund. That’s up 7% from this year, and equals 27% of their combined annual economic output.



Just ponder those numbers for a bit. The average borrowing across 15 major developed countries is 27 percent of GDP(!) Ask yourself how dependent the entire OECD world is on a smoothly operating financial system in order to merely function next year.

Having the perception out there that the US is being run by clueless (or 'abusive') individuals is not going to help the situation much.

In order for the requisite levels of borrowing to be pulled off in a smooth and uninterrupted fashion, there can't be any hits to confidence and no major disruptions can happen. Everything has to run with clockwork precision. It is against this backdrop that I view the profoundly undiplomatic statements directed at the US as quite a bit more serious than some other observers.
Conclusion

By choosing the path of money printing (instead of austerity like the UK), the Fed has decidedly placed the US on a very risky course. I see the outcomes as almost binary: Either this works, or it doesn't.

If this gamble works, business will pick up, unemployment will drop, tax revenues will flow again to the states and federal government, the sun will continue to rise in the east, and roses will bloom in the spring.

If the gamble fails? Then we can envision an enormous devaluation event for the US dollar, with the Fed having to choose between defending the dollar (via rising interest rates) or preventing the federal government from a fiscal emergency brought about as a consequence of rising interest rates. And by "fiscal emergency" I mean being forced to slash expenditures by as much as 50% in order to service rapidly escalating interest-carrying costs on the short-term portion of the fiscal debt load. But that's a death spiral, because cutting government spending is the same as cutting GDP (it's practically 1:1), and every cut to GDP leads to lower revenues, which will necessitate more expenditure cutting, et cetera and so on, until 'the bottom' is reached.

I wish there was some sort of middle ground on this one, but I can't quite see it. Either the Fed's efforts work or they don't. Let's hope for success.

In truth, I‘ve long predicted that the day would arrive when the Fed would monetize government debt, but I hoped that it would never come. Because hope alone is a terrible investment strategy, I prepared for this event years ago by accumulating gold and silver as the core of my portfolio.

But now the rules have changed again, we are on a slippery slope, and gold and silver were always meant to be my "transition elements" put there to help shepherd my wealth through the transition period as the world's fascination shifted from "paper" to "things."

Now that we're "almost there" in terms of the required shift in perception necessary to call an end to one period (the "king dollar" period) and mark the beginning of another, it's time to begin considering the places, timing, and ways that these transition elements can be redeployed to take advantage of the second part of this story.

In particular, concerned minds are looking for answers to questions about what might happen next and how to insulate oneself from monetary madness. These questions are explored in detail in Part 2 of this article (free executive summary; paid enrollment required to access).

Quote:

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

But it will be different this time!

-Uwe-

this is utter nonsense.
QE2 isn't going directly to congress..(how, would that even work???)
The Fed is buying treasuries, the offset transaction is increasing bank's excess reserves. The banks still have massive amounts of junk on their balance sheets, estimated between 4-700 billion. hence the 600bn number. The Fed can't force banks to lend, and as long as the are getting paid on the reserves and need to mask their junk, why would they? We are still in a liquidity trap. The Fed is hoping that by flattening the yield curve, companies will start to borrow again and refi (i.e., banks don't lend money, companies go direct to the capital markets!) with the thinking "ah, cheap money, might as well borrow and then make more stuff". This is pure nonsense. Companies will expand, banks will lend, if there is demand. This is totally irrelevant to QE and money supply. And, by the way, completely irrelevant to "inflation".
There is no demand.

With QE1, the Fed bought agencies and MBS from the banks, allegedly making them whole at par on toxic assets.

This time, the Fed is buying Treasury debt being used to finance Federal appropriations given that tax receipts are inadequate and external lenders are withdrawing. The primary dealers are just the intermediaries that flip the treasuries over. Their net balance sheet positions (aside from their juicy margins) will be unchanged.

Don't agree. Government can fund the deficit anyway, without QE2. The Fed and private investors have been funding Congress's debt for a while now.
The investor demand is still very high. The Fed can also still sterilize if they want (which, given the banks still have huge bad debts wouldn't surprise me).
And if foreign investors (the minority) don't want to buy, so what.

"The Fed can also still sterilize if they want (which, given the banks still have huge bad debts wouldn't surprise me)."

That's the rub.

Reportedly, they are NOT sterilizing this round.

http://danielamerman.com/articles/Moneti....

Sterilizing would have the Fed selling some bonds ($600T) to the PDs for cash. That's the last thing the banks want to part with here, strapped as they are. Fed has scheduled POMOs for every day next week. Doesn't sound like sterilization to me. Its been awhile since I've heard of any reverse REPOs, and the few they did were puny.

yeah I know most think because Ben hasn't mentioned the word he won't. I don't expect complete sterilization either, but I also see all the trash the banks have on their b/s. Again, bottom line, the only thing happening here is that instead of the government getting buyers for their debt the normal way, which they can, the Fed is buying it directly with "new money". It isn't like this new money is going to reach the people. I also doubt it will debase the dollar much. Last I looked, investors aren't flocking to EUR or JPN.

Quote:

It isn't like this new money is going to reach the people.

I disagree. What does government do with money? It either spends it on the salaries and pensions of civil servants, defense contractors or other "public works", or it gifts it to people outright via various welfare and entitlement schemes. In any case, it gets into real peoples' hands as opposed to ending up as excess bank reserves on deposit with the Fed.

I think the real question is whether the quantity of this new money is more or less than the amount of money being destroyed by ongoing de-leveraging and asset deflation, and how much this new money will be levered up.

-Uwe-

btw, since QE2 is a monetary move and is not a fiscal move, the question should be what will happen to the yield curve, right? The aim is to press it down and flat. This has nothing to do with fiscal policy other than it whets the appetite of Congress to increase the budget with lower funding rates. But their appetite is whet as it is.
IF and when the yield curve flatlines, I see no reason why this will incent banks to lend more or make borrowers suddenly more credit worthy.

Then the question of the dollar. Sure, foreign investors will dump treasuries, but what alternatives do they have? Will they get out of USD and buy, say, Euro sovvies instead? I think there will be a major shift into USD equities and corporate bonds. ie. no fx change, only asset mix in the (foreign) investor portfolios. but that's just me.

Uwe, the government will anyway be able to raise funds to cover more spending, they don't need the Fed to increase the monetary base for that to happen. So even without QE2 (or QE period), as long as investors are willing to lend to COngress, they will. So then the question is what is the impact to the economy of increased governmental spending? Aka "stimulus".
Practically zero.

Quote:

the government will anyway be able to raise funds to cover more spending, they don't need the Fed to increase the monetary base for that to happen.

Ah but could the government issue these amounts naked into the marketplace without causing a self-defeating blowup in bond rates? With the size of the debt at present, even a small rise will blow a big hole in the budget.

Exactly. IMO, they are doing this at least partly to avoid waking Bonzilla.

Of course, there's another way they could keep the bond rates low, which would be to crash the equity and commodity markets, but then we'd have our second dip immediately.

-Uwe-

Ican, nope. Investors sit on a war chest of abouts 120 trillion. They are squeezed between "high" yielding pure junk, and severe low yielding safe. Not much in between (that they can trade in and out of). Even if they had to pay 75bp more, its peanuts, and with ponzi effectiveness would just issue more to make up for the difference.

This is about flatlining the yield curve to make borrowing (by consumers, our only hope for survival) irresistible. And if the Fed has to "secure" this (by being the player), instead of relying on finicky investors who may or may not demand a few extra pips, who gives a ****. They are controlling interest rates along the entire curve, period.

For the PD's it's a godsend because they can front run with precision. For ****ed up foreign countries they are royally*****ed because in one stroke by Ben, their monetary policy has been hijacked. Why? Because the Treasury yield is what every ****ing loan on the planet is benchmarked against.

Snow, those things aren't done without consequences. If they debase the currency in that way an oil shock is virtually guaranteed, then those consumers will be able to consume little more than basic necessities.

Ican, nope again. You have insights as to why the USD/Eur or USD/JPY will drop? I don't. Oil is in USD, so what do you mean? Look at the oil futures, prices are all speculative, tankers are full. In soft commodities prices are inflating due to supply/demand. Hard commodities a mix between spec and supply. Food is a great case study. You have 2 billion people who want to move from basic survival meals into high protein diets, and there isn't even close to enough arable land in the next 20 years to sustain it. But all this is irrelevant to QE2!

Prices are all speculative, but where does QE money go? By virtue of the POMO laundering process, it is guaranteed that at least some portion goes into the hands of speculators! Another part of that money is directed at those very same speculators as well when it is spent. Didn't the last QE go virtually exclusively to investment banks?

to support the stock market. Which is manipulated of course by the IB's. Look, Americans lost a huge chunk of net worth. The solution is to rebuild it, by hook or crook. It won't be in real estate, so next best thing. That way, the J6P can feel rich again and borrow money (margined on his new bubble asset). And so we begin again. I am not sure of your questions because they appear to be self-answering.

I don't think all prices are speculative. Not timber, for instance. Or milk/dairy. Or pork. Not in the commodities that can't easily be cornered.