8/11/2011

08-11-11 - Inflation - 4

More links :

Recent Decisions of the Federal Open Market Committee A Bridge to Fiscal Sanity (Acknowledging Henry B. Gonzalez and Winston
Quantitative easing - Wikipedia, the free encyclopedia
Fed Quantitative Easing Personal Finance Mastery
US Daily Index � The Billion Prices Project @ MIT
The June GDP deflator in the US Conspiracy theory edition � The visible hand in economics
Speculative-Investor.com
Sizing Up Sarah - Up and Down Wall Street - Alan Abelson - Barrons.com
Quantitative Easing A Beginner's Guide InvestingAnswers
PIMCO Investment Outlook - Skunked
Money, Credit, Inflation and Deflation
Mish's Global Economic Trend Analysis True Money Supply (TMS) vs. Austrian Money Supply (AMS or M Prime) Update
Michael Pollaro - The Contrarian Take - Forbes 1
Michael Pollaro - The Contrarian Take - Austrian Money Supply
Jesse's Caf� Am�ricain Austrian Economics True Money Supply, Deflation and Inflation
Inflation Update TMS (True Money) Status
Inflation Or Deflation Follow the Money Supply (Guest Post) EconMatters
Inflation Charting the Economy, Part 4 Robert Kientz FINANCIAL SENSE
Guest Post U.S. Dollar Money Supply Is Underreported ZeroHedge
Exploring Inflation Over the Past 10 Years Through Charts - Seeking Alpha
Charting the Course to $7 Gas - J. Kevin Meaders - Mises Daily

Now some random hand waving and incoherent thoughts.

The alternative money supply metrics like TMS or "M1 + deposit currency" show that the money supply has massively increased since the great recession (roughly the same as the fed "BASE" ). Historically TMS tracks inflation very closely. So far it appears not to be. One possible explanation is that we basically continue to be in a recession, which is driving prices down, while also inflating the currency to keep prices stable.

Of course M2 and M3 are still way down due to lack of money multiplier in our recessed economy. In theory if credit picks up again and M3 takes off, the Fed will crank back on the money supply and keep things under control. But I believe there are reasons to be skeptical that the Fed will ever really crack down on the loose monetary policy.

The PIMCO newsletter is surprisingly bleak -

the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation � surely unthinkable, 2) surreptitiously via accelerating and unexpectedly higher inflation � likely but not significant in its impact, 3) deceptively via a declining dollar� currently taking place right in front of our noses, and 4) stealthily via policy rates and Treasury yields far below historical levels � paying savers less on their money and hoping they won�t complain.

Basically the US has got itself into massive debt; I don't really agree that entitlements are the big problem, certainly not in the short term, but anyhoo. When you're a debtor, inflation is great for you - it makes your debt smaller. We fund the debt by selling treasuries. Our debt is much cheaper to fund if we can offer a very low return on treasuries. So the best option for the US government is clearly to inflate the currency and devalue the dollar (reduces our debt) while claiming that inflation is low (keeps treasury yields low).

In other crackpottery, QE is very strange. My very crude cliff notes :


To inject cash into the economy, the Fed bought treasuries from private holders
this takes out non-cash "paper" and adds to the money supply

The government is in debt; to finance that debt it sells treasuries
this gives the government cash in exchange for paper

So during QE, banks bought bonds from Treasury, then sold them to the Fed

Basically the Fed was just giving cash to Treasury, but passing it through banks so they could take a piece of profit

Oddly the US apparently has a law that prevents the Fed from directly buying Treasuries and thus supporting the government debt; also Bernanke and such claim they are not "printing money to monetize the debt" but really passing the money through the open market doesn't change much other than giving a slice of profit to the banks. Says the Dallas Fed : "For the next eight months, the nation�s central bank will be monetizing the federal debt."

Furthermore there is good evidence that QE largely backfired at injecting money into the economy. The problem is that with the fed funds rate at 0% and Treasuries at 2-2.5% , banks can take out fed funds, buy treasuries, then sell them to the fed under QE. Free money for the banks and the Fed gets to pay for government debt, yay.

This is certainly part of why bond yields are so low; they don't need to return much when cash is free. Apparently Japan has been through all this before. There's evidence that QE schemes basically never work; when the fed funds rate is near zero, all possible profitable investments that can be made already have been made, so why in the world would injecting more liquidity into the market help? The only explanation I can see is to intentionally devalue the currency or cause inflation. (of course as we'll note later, QE was not only a monetary policy, it was also a direct and corrupt subsidy for toxic asset holders)

Side note : the Dallas Fed uses Trimmed Mean PCE instead of Core PCE. If you read the press releases from the Dallas Fed or St. Louis Fed it is encouraging that there are still technocrats in government that are trying to be reasonably honest and do their jobs well. Of course they tend to get squashed by the people in power, but still ...

What is QE really doing? Propping up stock values and other investments (particularly MBS'es). Giving banks free profits. Createing an outflow of money from the US to emerging markets. Sending up commidity prices.

"QE effects on commodity markets have been significant. Between August 2011 and January 2011, commodity prices (as measured by CRB Index) rose by 14%. Oil prices have increased by around 20% and average gasoline prices have increased around 15%. Food prices (as measured by the CRB Food Index) have increased 12%, with some individual foodstuffs rising more sharply."

It's unclear to me how you can defend dumping liquidity into the system when banks were already sitting on massive amounts of liquidity with nothing to do with it other than hold it in the Fed (*) or treasuries. It's like watering a sick plant that's already soaked in water.

* = this is one of the funnier quirks; banks actually hold their large cash balance at the federal reserve, so when they got massive cash injects from QE the main thing that happened was that their balance of cash sitting in the fed went sky high, and the fed pays interest to the banks on that deposit - banks now have excess reserves (cash beyond their reserve requirement) around $1.5 Trillion sitting in the Fed, up from only $2 billion in 2007. If your goal is to get banks to lend more, why do you want to make it more attractive for them to leave cash sitting in reserves? This was yet another change in 2008 as part of the massive experiment of letting the Fed tinker with the economy in unprecedented ways. Some links :

Why pay interest on excess reserves - William J. Polley
macroblog �Why is the Fed Paying Interest on Excess Reserves�
FRB Press Release--Board announces that it will begin to pay interest on depository institutions required and excess reserve
Fed Paying Interest on Reserves A Primer - Real Time Economics - WSJ
Dudley Seeing Interest on Reserves as Tool of Choice Sparks New Fed Debate - Bloomberg

One common thread that I don't understand is why even a tiny bit of deflation is considered such a huge disaster that almost anything will be done to prevent it.

More links :

Yellen Defends QE Is She Right - Seeking Alpha
Satyajit Das Economic Uppers & Downers � naked capitalism
Mish's Global Economic Trend Analysis US Treasury Bull Market Not Over; Record Low Yields; Shades of Japan; Why QE3 Totally
How To Make $4 Trillion Vanish In A Flash Why Another Financial Crash Is Certain � The Oldspeak Journal
FOMC Meeting Participants See QE2 Devaluing the Dollar Global Economic Intersection
fed_all_short_stacked.png (PNG Image, 722x519 pixels)
Fed QE and SPX
Bernanke's Dilemma Hyperinflation and the U.S. Dollar - Seeking Alpha
Flim-Flam Economics � Monty Pelerin's World
BERNANKE IS SATAN � The Burning Platform

I can't imagine any way to justify the Fed purchasing MBS's and other such assets. The role of the Fed is supposed to be monetary policy, not subsidizing bad investments or otherwise interfering in markets. The Fed is not the SEC or Treasury. They just slipped it in as part of "QE" which is supposed to just be increasing the money supply and bought $1.25 B of MBS's without even attempting a fair valuation of them. That's basically an illegal expansion of the TARP program. The amount of toxic MBS that the Fed owns now dwarfs what Treasury holds.

Another odd footnote is the fact that banks are no longer required to mark-to-market MBS's and similar products, so we have no idea what's really on their balance sheets.

Another funny one is that Fannie/Freddie have gone from about 20% of the mortgage market to about 80% since the collapse.

If it is the Fed's role to moderate volatility, then it must also slow growth in over-exuberant times. It has shown no willingness to do so in recent years and I can't imagine that it ever will, given the political corruption and collusion that drives decision making. It's like having a train conductor that stokes the fire when you slow down but refuses to use the brakes when you get going to fast.

More links :

The Mess That Greenspan Made Is all this exit strategy talk warranted
Market Talk � Mark-to-Market
Mark-to-market accounting - Wikipedia, the free encyclopedia
Initial Fed Audit Shows Web of Conflict of Interest FDL News Desk
Hussman Funds - Weekly Market Comment Things I Believe - December 20, 2010
Hussman Funds - Weekly Market Comment The Recklessness of Quantitative Easing - October 18, 2010
AEI Relief from Mark-to-Market Accounting

No comments:

old rants