What sane person would argue that the economy of the late 20th century and early 21st century isn’t a Bubble Economy? If a person is sane and argues it then they are a fool. It’s writ large everywhere you look; Bubbles Я Us.
Profit is a sort of perfume for a certain set of people, don’t you think? And the more obscene the profit, the better. Risk aversion? What risk aversion? When you’re a member of a certain set of people, there is no risk aversion. For you, there is no risk-reward curve because there is no downside. Too Big To Fail bailouts, i.e. TARP, ensure you’re made whole when your scam implodes ensuring you at least get your corpus back if not a little less profit on it than you anticipated with your hare-brained financial scheme.
One of the most dispiriting results of the ongoing Great Recession that started in 2008, is that seemingly no one learned from it except those who caused it and benefitted from it. Everyone else has been too apathetic to even give a hoot, or if they were/are inclined to give a hoot they lack the intellectual capacity to comprehend the magnitude of the fraud that was, and still is being, perpetrated. There is one other group that’s almost as pernicious and duplicitous as the architects of the Bubble Economy; the marginal, versus institutional, investor class that hangs on every word issued by the architects’ pundits. Bluntly put, these people are pathetic in their attempts to pump the price of gold and their audacity to think they have any influence whatsoever in investment schemes and outcomes. They’re suckers of the worst sort, and if they’ve realized investment returns at all, it’s by sheer luck that they’ll braggadociously attribute to their stellar financial acumen. They’re the ones who read and incessantly cite sources such as David Stockman and Zero Hedge as though those sources are separate from the system they decry 24/7. I have news for you folks, although I know you won’t listen to sound advice, those sources are in The Game and talking their book. You’re The Mark. Silly you.
What prompted this post is the persistent disinformation that’s disseminated about the nature and purpose of Quantitative Easing (QE). As America winds down its QE program, the ECB is just getting starting on their QE program and the Japanese have been following suit for several years now, although it’s nothing new for Japan since it’s been engaging in various forms of QE off and on now for a couple of decades or more. Keep in mind, QE is a broad term and can mean very different things at different times. Broadly interpreted, QE is central bank meddling in the economy to influence investment decisions and outcomes. There are myriad ways in which central banks can accomplish QE, so each QE program is unique, but all QE programs share a similar general purpose. Even within a QE program, each QE round can be distinct from another. For example, QE1 implemented in America in 2008 swapped short-term interest bearing assets on certain member banks’ balance sheets for longer-term interest bearing assets (mortgage-backed securities (MBS) that were virtually worthless, by the way — or the value of which was greatly compromised). QE1 along with TARP removed the clog thus restoring flexibility to investors. QE2 and QE3, in general intent and sentiment, did very much the same thing except the asset swap was somewhat different — it was short-term lower interest bearing treasury notes for longer-term higher interest bearing treasury notes. The effect was a bolstering of investor confidence and overcoming the investing community’s ephemeral bout of risk aversion. The goal was to avoid asset deflation and if more bubbles get inflated in that process, so be it and all the better.
Despite the official pronounced purpose of the American QE program, it certainly could not have been about stimulating the productive economy because it did no such thing. It did accomplish what I asserted in the previous paragraph. It mitigated asset deflation and helped blow some more investment bubbles in the process. The equity and commodity markets are the smoking gun as is witnessed by the following graphs:
As you can see with commodity prices, the precipitous rebound and rise has long since leveled off and a floor has been established, thus the mitigation of asset deflation. With The Fed tapering its QE program, does it signal that a floor has finally been established for America’s equity markets? We’ll see. As always, time will tell. But what can be said is that when you change your perspective about the intent and purpose of the American QE program, you quickly realize it was a resounding success.
What the American QE program was not was inflationary money printing as has so often been asserted by gold bugs and their unwitting dupes. Why would The Fed do that? Despite your hatred of that “venerable” institution, it’s not incompetent and it’s not stupid. It’s charge is to maintain the financial status quo, and the financial status quo is to protect concentrated wealth and further concentrate it.
Concerning QE, money printing and inflation, I’ve made the argument against that at this blog many times prior to this blog post, but I’m making it again. And you know what? It’s not even an argument at this point. It’s fact. QE is not money printing and did not, and will not lead to inflation. If you continue to tout that you are either a fool or a duplicitous asshole who should have your face smashed in until it’s no longer recognizable because you’re the worst form of traitor — a sycophant who carries water for those who pat your head and toss you crumbs. This author covers what QE is and isn’t suitably. He doesn’t go far enough in my opinion in clarifying The Fed’s true purpose for QE, but his analysis otherwise is spot on and comprehensive. It’s not flawless, but it’s good enough for government work.
Why QE Isn’t “Printing Money” and Hasn’t Led to Inflation…Yet
MATTHEW KERKHOFF 11/19/2013
It’s evident that Yellen’s approach to monetary policy is consequently the same as Bernanke’s, and that QE is here for the foreseeable future. With that in mind it’s time to explore the Fed’s actions in more detail.
Talk to anyone on Main Street, Wall Street, or the media, and you’ll constantly hear the phrase “the Fed’s printing money.” But talk to Bernanke himself, and he’ll tell you with a straight face that the Fed is not printing money. Where does this discrepancy in interpretation come from?
Let’s begin with this – the legal responsibility of printing currency in the form of physical US notes resides with the US Treasury, not with the Fed. All printing presses are owned and operated solely by the Treasury. In our modern economy, the need for physical notes is driven by consumer demand (to use as a medium of exchange), and the physical deterioration of existing notes. As of July 2013 there was approximately $1.2 trillion dollars of US currency in circulation – a tiny fraction of the actual amount of money in circulation.
It’s more accurate to say that the Fed is “creating” money, not printing it. And to this statement Bernanke will nod his head in agreement. When the Fed creates money, it does so digitally by increasing the balances of the reserve accounts that are held at the Fed by its member banks.
I know what you’re thinking – so the Fed is creating money not printing it, big deal. Well you’re right, it’s a matter of semantics. But therein lies the beginnings of substantial misunderstanding as to how the Fed’s QE policy actually works.
In speaking with investors I hear time and time again that the Fed’s relentless printing of money is increasing the supply of dollars, which will result in massive inflation, if not hyperinflation. There are problems with this simplified line of reasoning.
It may come as a surprise, but when the Fed creates money, this new money does not increase the amount of money in the economy (there are some minor exceptions to be detailed later). Instead, the new money increases the size of the Fed’s balance sheet. The impact to the economy has to do with the composition of the money supply only. This claim demands more explanation so let’s use the current $85 billion dollar per month QE program as an example.
When the Fed creates $85 billion, it uses this money to buy bonds – typically split 50/50 between US Treasuries and Mortgage Backed Securities (MBS). Here is what’s important: When the Fed creates and gives $85 billion in reserves to its member banks, it removes $85 billion worth of assets (bonds) from the balance sheets of those same member banks. The result is that no new net financial assets enter the economy. This bears repeating. Every time the Fed injects $85 billion in reserves (assets) into the economy, it removes $85 billion worth of assets from the economy. This process is not a one way flow of money into the economy, as interpreted by some.
It’s much more accurate to think of the Fed’s QE program as an asset swap. In fact it’s even more accurate to think of it as a liquidity swap. More on that in a minute. The important concept here is that every time the Fed creates money, that money does not increase the total money supply in the economy, it increases the size of the Fed’s balance sheet. I’ll go into more detail in another column, but the size of the Fed’s balance sheet is not as important as many will argue because it effectively sits outside our economy (again with some exceptions).
As I mentioned, quantitative easing should be viewed as a liquidity swap. In this context liquidity refers to the ease with which money can be used. Think of it like this: Cash in your bank account can be used at a moment’s notice to purchase goods and services, make an investment or be lent out. However, cash (in the form of equity) in your home, cannot be easily used for these purposes (you must sell your house or acquire a line of credit first). The cash in your bank account is highly liquid, but the cash tied up in your home is not.
Now let’s take this understanding and apply it to the banks, the QE process and the money supply.
Note: Discussions on the money supply and the various “money aggregates,” M0, M1, M2 etc. can quickly become complex. For the purpose of this article I’m going to keep things simple and we’ll get into the specifics later.
A diagram may help convey the actions taking place through quantitative easing. In the picture below, the whole pie represents the total money and credit supply (the two are basically interchangeable) in the economy. The blue area represents low liquidity money and credit (such as bonds, IRAs, 401Ks etc.) and the yellow area represents high liquidity money and credit – which is the portion of the total money supply that is immediately available for lending, investing or to chase goods and services.
The important thing to understand is that money that is not liquid (the blue area) cannot easily be lent, and it cannot easily be spent – the two critical pillars to driving economic growth. That money is effectively “tied up.” When the Fed engages in QE, it is taking bonds (low liquidity instruments which reside in the blue area) and it is exchanging them for cash reserves, which can be lent and/or used to purchase assets. Cash reserves are part of the yellow area (high liquidity). This means that the high liquidity component of the money supply is growing in relation to the low liquidity portion, but the total money supply does not grow. The way the total money supply in the economy grows is through bank lending – a function of our fractional reserve banking system and the subject of a separate column.
To summarize: The economy grows through investment, spending and consumption. Quantitative easing is a process by which low liquidity instruments (bonds) are replaced with high liquidity cash reserves. These new cash reserves are available to banks for lending – which drives investment, spending and consumption, or they can be invested – which drives the capital markets higher. Even though the Fed is creating money each month, this money winds up on the Fed’s balance sheet in the form of bonds. From the economy’s perspective all that happened was an exchange of low liquidity assets to high liquidity assets – assets which if lent or spent, can now help fuel economic growth.
QE has potentially severe implications for inflation, but not directly from the QE itself. Instead the inflation will come as a result of a dramatically increased total money supply resulting from bank lending. QE does enable more bank lending, but the lending must take place for the total money supply to grow. A follow-up to this column will examine bank lending in more detail. For now, I will leave it at this: Bank lending is dismal, which is why the total money supply has not increased as much as anticipated. The money which the Fed is making available for banks to lend is not being lent out, and is instead working its way into asset prices and accumulating in the reserve accounts of member banks. If and when that money begins to flow out as loans – then we will need to be acutely aware of inflation showing up on our doorstep.
Lastly, the other goal of QE is to keep long-term rates down (through bond purchases), which further helps to increase lending and consequently investment, spending and consumption.
I’ve greatly simplified this explanation and left many rocks unturned for the sake of time and space – we will explore these further and in more detail down the road. I figured this was a good place to start. If you have any questions or need clarification, don’t hesitate to shoot me an email and I’ll try to address in future remarks.
It’s an excellent analysis but I disagree with his “yet” caveat. There isn’t going to be a “yet.” Banks aren’t going to lend like they once did simply because you can’t draw any more blood from these rocks they’ve created. Too much of the population is no longer credit worthy, if it ever was. There’s nothing left to tap. That’s the wealth concentration trap. Eventually you kill the golden goose who lays the golden wealth eggs and there’s no wealth left to concentrate. Then it’s a matter of maintaining what wealth you have concentrated in the past or slowing its attrition. I’m not sure if it’s at that point yet, but I suspect that point is approaching. I assure you every effort will be made to defer that point indefinitely because at that point, the Message In The Bubble becomes quite clear, and it will read as follows:
If you can read this message, you’re fucked