Richard Koo’s latest strategy note blasts the idea that QE2 is having a substantial impact on the global economy. Not only does he contend that QE is not helping the US recovery, but he also contends that emerging market economies are misleading when they imply that QE is the cause of their current inflation problems. Koo’s reasoning is rather simple. If the Fed cannot even substantially alter the US money supply then what makes anyone think they can alter China’s money supply:
“Chinese and Brazilian officials previously criticized QE2 with a similar argument. Objectively, however, I have to question whether the Fed is actually able to increase the Chinese money supply when it is unable to boost even its own money supply. The Fed implements quantitative easing by buying up Treasury securities in the open market.”
Koo’s more important point, however, is that QE can only work through the interest rate channels and that has clearly not succeeded. I have long argued that QE would have no fundamental impact on the economy and was destined to fail because the Fed is not implementing the strategy in a manner that would even allow them to control the lond end of the curve. Koo explains why QE is failing:
“The Fed's zero-interest-rate policy and quantitative easing will have almost no effect as long as the private sector continues to deleverage and demand for loans remains weak. No matter how much the monetary authorities ease policy, money will not start flowing and the money supply will not increase without private-sector borrowers.”
The tendency in recent weeks, has been to hail QE2 as a success simply because equity prices are rallying. But before we make any conclusions based on equity prices it’s important that we revisit the initial goals of QE. At the now infamous Jackson Hole speech in August 2010 Mr. Bernanke established the goal of QE:
“Specifically, the Fed’s strategy relies on the presumption that different financial assets are not perfect substitutes in investors’ portfolios, so that changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration.”
In a speech just two weeks later he further emphasized the goal:
“For example, a means of providing additional monetary stimulus, if warranted, would be to expand the Federal Reserve’s holdings of longer-term securities. Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates and thereby supporting the economic recovery.”
He finally cemented the goals of QE in the now infamous Washington Post op-ed, in which he admitted to targeting equity prices via QE:
“Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
So the targeted goal was clear. The Fed hoped to reduce long-term interest rates. By controlling the long-end of the curve in the same manner in which they control the short-end of the curve the Fed could accomplish a number of things: lower rates will make loans more affordable, reduce strains on debt burdened households and corporations, boost equity prices via relative vaule, increase confidence and ultimately help to generate jobs and higher incomes.
The Washington Post op-ed was unfortunately timed, because, no less than a few days after this speech, yields across the entire spectrum began to surge. Academics have made the argument that this was due to increased inflation expectations and is a sign that QE is working. They have further added that, even though rates are rising, they are lower than they otherwise would be. But let’s try not to view the world through our flawed economic textbooks. Let’s view it through the real world.
First, interest rates have increased. Regardless of the rate of inflation there is simply no denying the fact that credit has become more expensive since the Fed initiated QE. Corporate baa yields are higher so the cost of credit for corporations has actually increased in recent months:
Mortgage rates are higher. This is obviously not a good sign for anyone who was interested in buying a home in the last few months or was planning to refinance:
And of course, the targeted duration (7 year US treasuries) has increased:
What has been the result of these higher yields? Home prices have continued decline and mortgage applications have plummeted:
Total borrowing has continued to decline:
So we can see that the Fed has failed to keep rates low and achieve their goal of making loans more affordable. This has also failed to reduce strains on debt burdened households and corporations. While most pundits are quick to cite the success of QE in boosting equity prices they conveniently ignore the continuing decline in the consumer’s largest asset – housing.
Where the debate gets more cloudy is with regards to equity prices. Of course, Mr. Bernanke assumed that lower interest rates would increase the relative value of equities. Clearly, that is not the mechanism through which QE is impacting stock prices. The evidence from the recent rally in stocks shows that the rally did not in fact begin with QE so it’s debatable how much QE is even impacting equities. Equities actually declined throughout August despite rumors that QE was on the table. The ISM Manufacturing data from August, September jobless claims and Q3 reporting season (the three major catalysts that sparked the rally in equities) show that the Fed was likely overreacting to a temporary market decline and spike in jobless claims. QE2, in my opinion, was never even necessary and the fact that this economic data was so robust (before the program truly began) is sure evidence of this.
Thus far, it’s evident that the fundamental impacts from QE2 are weak at best. Where QE is likely succeeding (or failing depending on how you look at it) is via psychological channels. As I mentioned back in October, there is a clear positive correlation between Fed intervention in markets and equity market appreciation. This is, of course, the infamous Bernanke Put. Unfortunately, the Bernanke Put is much like telling your blind child that he will one day grow up to become a world class archer. I have never denied the Fed’s ability to talk up assets or generate irrational responses from market participants and I fear the Fed has set a dangerous precedent by once again communicating to markets that they will not be allowed to decline. If economic prosperity were as easy as keeping stocks “higher than they otherwise would be” then the Fed might as well just continue influencing stocks for the rest of eternity so the rest of us can just open ETrade accounts and go retire to the Caribbean. Who needs workers or productivity after all? Unfortunately, that’s not the way it works in the real economy. The Fed can’t just come in and buy bonds and send us on the path to prosperity. If it were that easy Japan would be the king of the world. But the common sense behind that escapes most of the Federal Reserve cheerleaders.
The recent spate of good news is welcome, however, it is disconcerting that the Fed appears to have convinced itself that it is doing us all some sort of favor by directly influencing investor psychology. As we saw repeatedly during the Greenspan era, this is the fuel for financial bubbles and continuing imbalances. As I said several months ago, the only thing scarier than the idea that QE doesn’t work, is the idea that it does work.
At Jackson Hole, Mr. Bernanke cited the primary risk associated with QE:
“However, uncertainty about the quantitative effect of securities purchases increases the difficulty of calibrating and communicating policy responses.”
Like most economists, I fear that Mr. Bernanke is ignoring the greatest risks to the market. These are not the quantifiable risks, but rather the unquantifiable risks. None is more potentially destructive than the psychology that drives risk taking and the madness of crowds. While the economy looks superb for now, it is unlikely that the Fed’s unnecessary meddling in the market will have no long-term negative ramifications. In his 2005 investor letter Warren Buffett said:
“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, ‘I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatised by this loss, Sir Isaac might well have discovered the Fourth Law of Motion: ‘For investors as a whole, returns decrease as motion increases.’”
Right now, investors are frantically chasing equities under the notion that the Fed will not allow asset prices to decline meaningfully. As this motion increases and stocks continue to melt higher the risks to the economy and the markets will increase with it and these unquantifiable risks will once again exert themselves in the form of the madness of men. Mr. Bernanke clearly believes he can contain the madness of men, and that might just be the maddest belief of all….
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Thanks for your thoughts. Great Buffett quote.
Reply 01/26/2011 at 2:24 AM jbrNice post, thanks. QE2 is not impacting interest rates according to Bernanke’s plan because borrowers and lenders know QE is a limited duration intervention – ie, temporary, not sustainable or permanent. It’s analogous to whether tax cuts translate through to increased spending or not – they do only if they’re perceived to be permanent. How Bernanke could fail to understand this obvious relationship is beyond me. Equities operate at a higher frequency and more on a momentum basis so equities traders do not require that QE be perceived to be permanent for them to act reflexly on the perceived (and real) dollar debasement. However, the setup (unintended consequence) is analogous to Portfolio Insurance of the past – by engineering a new Bernanke Put, and temporarily eliminating all perception of risk, traders are obliged to mark up the highest beta and lowest quality securities with no downside. The problem is that QE will soon end as it’s lack of economic benefit is combined with it’s very real economic drag – including rising interest rates and commodity inflation – the latter squeezing profit margins due to continuing unemployment and stagnant income preventing margins from being maintained (and lets not even get into the whole misallocation of capital into speculative and non-productive assets creating a greater structural drag on the economy). Once market participants realize the fed is cornered, that QE is ENDING, that it didn’t lower unemployment or interest rates, that it was the CAUSE of inflation and margin/profit erosion, that the Fed has no other magic bullets, and that EVERYONE is already long with no one to sell to, we will of course see the end game of “Portfolio Insurance” playing out once again. Will investors be willing to be sequentially conned yet again after suffering major equity losses THREE TIMES in a decade? Only HFT’s will be left for the Fed to try to manipulate good luck with that. The Fed’s credibility that it’s interventions can stabilize markets and raise asset prices will be totally debunked once and for all, and once that occurs, that in fact may be the end of the Fed as we know it once populism runs it’s course.
Reply 01/26/2011 at 2:47 AM alexRegarding your comment “Will investors be willing to be sequentially conned yet again are suffering major equity losses three times in a decade?”, I say probably, and sadly, yes.
The fact of the matter is that today people want to get rich quickly. Aeronautical engineers go to Wall St instead of Boeing, and ordinary folks want to trade their way to wealth. Just look through any magazine – ads for online brokers are EVERYWHERE!
Until this attitude changes, they could be plenty of bubbles with just the same results.
Reply 01/26/2011 at 3:11 AM InvestorXYou are absolutely correct. But as you say equity traders are always ready to speculate, even if their “stimulus” is temporary. So on this point I join alex, believing that we will blow bubbles as long as possible, until some bigger crisis takes the power off the Fed (e.g. a currency collapse).
Reply 01/26/2011 at 4:39 AM ObaMaoQE2 is not working as Bernanke began aggressively easing, the dollar has actually risen in value and interest rates have increased. Exactly the opposite effect of his intentions.With QE2, the Fed gave the green light for every country to try and manipulate its currency, and subsequent to that their trade policies. The US is supposed to be a leader and above that. QE2 has not put us any closer to economic prosperity.
Reply 01/26/2011 at 1:28 PM MisterOn CNBC Bernanke said QE2 was successful because the stock market rallied (last week with Steve Liesman)
He said the same rally happened during QE1
So in his mind he is saying the stock market is going up due to his actions so it is working. Hence you are arguing with the wrong person; get Bernanke on the line.
Reply 01/26/2011 at 3:04 AM Octavio RichettaCULLEN, you have got to read NT’s latest US economic outlook. Kasriel presents a different view on QE2. I think your readers would appreciate your thoughts on it. Kasriel sees fast credit creation as the most significant upside risk to his 2011 GDP forecast and he believes QE2 is doing/may do the trick.
Reply 01/26/2011 at 5:35 AM Cullen RocheI’m familiar with Kasriel’s work on QE. It is based on the false assumption that the Fed can influence lending by changing the amount of reserves. That is simply not how a modern banking system works in reality. QE1 expanded reserves by 1.3T and lending fell 25%!
Reply 01/26/2011 at 11:53 AM Bruce KrastingNice piece. I hope Ben reads it. But he is busy today.
I think the FEd will announce that it is moving toward inflation targeting as the bench mark for monetary policy. So a computer will say when to tighten or when to ease.
This policy will trump QE as the dumbest move of them all. It is just Ben hiding from having to make choices and be responsible for them. Now he will be able to blame a robot for his failures.
Reply 01/26/2011 at 8:11 AM harold hecubait really has become quite bazaar in a central bankers mind equity markets around the world determine the economy.
Reply 01/26/2011 at 8:20 AM MercatorIn spite of market euphoria, the real economy will soon resurface, after a temporary boondoggle. The consumer took a holiday, during the holidays, that’s all!. The next earnings season will show that the consumer is back to the hard work of deleveraging.
Reply 01/26/2011 at 8:59 AM wh10Cullen,
I still don’t see how the Bernanke Put works.
You show how QE2 has virtually no impact on fundamentals (in theory and in reality). This part makes sense to me. You even go on to argue the rally has hardly anything to do with QE2. But putting that aside, for the sake of exploring this phenomenon, if it even exists…
If we assume there is a false psychology, what exactly is the false psychology, arising from QE2, that is driving the rise in equities? You show some evidence that there is a correlation between POMO and equities, but what do you think investors are actually thinking? Trading that moves markets doesn’t come from the average Joe, who is much less likely to understand macroeconomics than the big wigs and institutions that do move markets. It has to be something more nuanced than “O, QE2 is here! Everything is alright, let’s go buy some stocks.” Especially when interest rates don’t even decline.
Thanks.
Reply 01/26/2011 at 10:22 AM Cullen RocheThe Bernanke Put is a put under the market. They plant a seed in the market that says “we are here to protect investors from declines”. Investors, naturally, run out and buy stocks aggressively since the govt has their back. This creates a certain level of undue optimism. It’s sort of like a football player who gets hurt in the first quarter. He goes into the locker room and the doc shoots him up with pain killers. The doc says, “don’t worry kid, you’re good to go”. So, you get back out there with the idea in your head that you’re not hurt. There is nothing wrong underneath the surface. You run around like a 15 year old kid. All the while getting smashed by 300 lb men who run a 4.5 40. You were told everything was fine. And you acted on it. But underneath there was no healing occurring. You were in fact getting even more injured. They say Monday is the worst day in the NFL. This is largely why. For investors, the worst day is when they realize that the economy is weakening and that the Fed can’t actually prop up markets forever.
Reply 01/26/2011 at 12:12 PM wh10But what is the seed that is planted, specifically with QE2? How do they convince the market that they “are here to protect investors from declines,” especially when you show in theory and in reality that they can’t create any change in the fundamentals? Unless you are referring to residual effects from the big bail out..
I understand what you are trying to say with the football analogy, but I don’t see the exact connection with the Bernanke Put in context of QE2. In the analogy, the doctor not only lies to the football player but he can actually temporarily take away his pain.
What is the equivalent for QE2? The Fed isn’t lowering interest rates with QE2, and they’ve never said “go buy stocks we won’t let them decline.” How would they even imply that, when, again, as you show, in theory and in reality the fundamentals don’t change?
Reply 01/26/2011 at 12:28 PM Cullen RocheIt’s exactly like shooting an injured football player up with painkillers. It gives him a psychological edge. Of course, nothing has really changed. He just can’t feel it. But he plays great in the second half. Then he wakes up on Monday morning and something is seriously wrong….
The put is a shot of medicine. A psychological edge. We run out and buy stocks with disregard for price, valuation, etc. None of this matters because the market will never really be allowed to fall. Bernanke told me so! Nothing moves markets like the madness of crowds and the govt has the power to influence this madness.
Reply 01/26/2011 at 12:32 PM wh10I hate to keep nudging you about this, but from my perspective, you keep avoiding my question. I’ll try to rephrase.
Are you saying that when the market sees the Fed take action, they ***ASSUME*** it will work, regardless of its real impact? So they do QE2, the market climbs, and that is the Bernanke Put?
What I am asking is *WHY* the market would EVER assume this. To me, it seems most people *don’t* trust the Fed, so none of this makes total sense to me.
The issue of moral hazard, which is relevant to the bail-out, seems to be a more valid source of dangerous market support. But I don’t see what so meaningless an event as QE2 has to do with that.
Reply 01/26/2011 at 1:02 PM Cullen RochePeople are greedy. Imagine you are a herd of hungry cattle. You approach a bridge and there are green pastures on the other side. Naturally, you all want to get there. But the bridge looks old and rickety so you are skeptical. The bride operator comes to you and says “I will not allow this bridge to fail”. He doesn’t do anything to the bridge. He doesn’t change the fact that it’s old and rickety. But he tells you he won’t let it fail. He’s a bridge operator and seems to know his stuff so you trust him. You take your herd to the other side. Halfway through, the bridge breaks, but half of the herd makes it across.
Why do herds chase rewards? Because we are greedy creatures. And when a govt entity says they will reward us we tend to play their games. Is it rational? No. But it happens.
Reply 01/26/2011 at 1:09 PM wh10So your position is that the Fed is taking advantage of a market that does not understand macroeconomics. That is the “Bernanke Put.” Then you think, even though QE2 is the greatest monetary non event of all time, the Fed is better off not doing it because it will rile false confidence in the markets.
I take issue with the term because to me it is slandering an entity for something it is not responsible really responsible for (namely the absence of fiscal policy and a market that does not understand basic macroeconomics). It misdirects blame, which should be focused on a market that doesn’t understand how things really work (and as a result causing a fake bubble) and a government that is not optimally utilizing fiscal policy.
Maybe the Fed gets MMT. I’ve read Scott F in a post write he has spoken with many Fed officials and they seem to understand this stuff. But it is their mandate to “not let it fail.” But what are they to do when the govt doesn’t respond? I guess you argue – nothing.
Reply 01/26/2011 at 2:01 PM MaxIt’s ridiculous to even talk about QE once you understand that it does nothing special. The only good thing is that it exposes the ignorance of most of the pundits.
Reply 01/26/2011 at 10:29 AM OroborosSomewhat related:
Check in the Mail or More in the Paycheck: Does the Effectiveness of Fiscal Stimulus Depend on How It Is Delivered?
(NBER Working Paper No. 16246)
Authors Claudia Sahm, Matthew Shapiro, and Joel Slemrod find that the reduction in withholding led to a substantially lower rate of spending than the one-time payments.
http://www.nber.org/papers/w16246 (not free for most people)
Specifically, 25 percent of households reported that the one-time economic stimulus payment in 2008 led them to "mostly increase their spending." Only 13 percent of households reported that the extra pay from the lower withholding in 2009 led them to mostly increase their spending.
Household economic conditions and other features of the stimulus program, such as its per-household size, also play a role in the spend/save decision, and therefore in the effectiveness of the fiscal stimulus. However, their effect is considerably smaller than the effect of the delivery mechanism, the authors find.
They observe that some households viewed the 2008 tax rebates as large enough boosts in their income to induce them to make a large purchase, such as a vacation or a car repair. In contrast, households received the 2009 tax credit as a small but repeated boost to their paychecks, so it may have been less likely to trigger a large purchase. Or, it may simply be harder for people to remember and report the extra small expenses that the tax credit induced.
The data for this study come from answers to the Thomson Reuters/University of Michigan Surveys of Consumers regarding the spending response of households to the fiscal stimulus measures in 2008 and 2009.
(source: http://www.planbeconomics.com/2011/01/06/the-effectiveness-of-fiscal-stimulus-depends-on-how-it-is-delivered/)
Reply 01/26/2011 at 10:47 AM RharazHi Cullen,
I’m still having trouble understanding how QE asset swaps work. I have a few questions:
1. When the Fed purchases agency debt, agency MBS, etc., are the dollars used in the transaction spent into existence, or do these dollars already exist?
2. Does the Fed then sell/swap these assets back after some period of time, and if so, does the Fed receive the same amount of dollars that they used to purchase the assets?
3. If the Fed sells/swaps the assets back for dollars, what happens to these dollars (are they extinguished?)?
I apologize if you have already answered these questions in previous posts. If you can provide a link, I’d appreciate it. Thanks again.
Reply 01/26/2011 at 10:47 AM Cullen RocheThis should help:
http://pragcap.com/mechanics-qe-transaction
Reply 01/26/2011 at 12:14 PM RharazThanks Cullen,
Your previous post answered my first question, but I’m still unclear as to what the Fed does with the assets after purchasing them. With regards to Fed purchases of Treasuries, I suppose the Fed could just hold them to maturity, correct? But if, for example, the Fed purchases a MBS for $1M, and it turns out the MBS is not performing as expected and has an actual (market) value of only $500K, can the Fed swap the asset back for $1M?
Reply 01/26/2011 at 1:19 PM Cullen RocheThey will hold it all to maturity is my guess. We’ll be talking about the size of their balance sheet for years. There is no need for them to sell the assets back. They can ease policy by raising interest on excess reserves. So, it’s really a moot point. Who cares what happens to those assets now? The Fed is just going to hold them as long as they need to….
Reply 01/26/2011 at 1:35 PM RharazIf an asset (like the MBS example I gave) is not performing, the Fed might not get all their dollars (i.e. principal) back, even if they held the non-performing asset to maturity, correct?
Reply 01/26/2011 at 1:53 PM jake woodI find your article confusing, you say QE is having no impact on the economy but then warn that bernanke is playing a dangerous game. I would argue that QE is clearly failing to have the impact intended, which was to lower interest rates. This is because bernanke fails to understand that he is reaching a tipping point where investors believe inflation takes over. Bernanke saw that QE 1 lowered rates and assumed QE 2 would do so even more. He is like the man who says if one pill makes me feel better then two should make me feel great. However like any medicine there is a point at which a good thing becomes a dangerous thing. The markets are telling us we have reached that point. QE 2 is not innocous, it is dnagerous. It is creating assets bubbles in equities and commodities. These bubbles especially in commodities will
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Thanks for your thoughts. Great Buffett quote.
Reply 01/26/2011 at 2:24 AM jbrNice post, thanks. QE2 is not impacting interest rates according to Bernanke’s plan because borrowers and lenders know QE is a limited duration intervention – ie, temporary, not sustainable or permanent. It’s analogous to whether tax cuts translate through to increased spending or not – they do only if they’re perceived to be permanent. How Bernanke could fail to understand this obvious relationship is beyond me. Equities operate at a higher frequency and more on a momentum basis so equities traders do not require that QE be perceived to be permanent for them to act reflexly on the perceived (and real) dollar debasement. However, the setup (unintended consequence) is analogous to Portfolio Insurance of the past – by engineering a new Bernanke Put, and temporarily eliminating all perception of risk, traders are obliged to mark up the highest beta and lowest quality securities with no downside. The problem is that QE will soon end as it’s lack of economic benefit is combined with it’s very real economic drag – including rising interest rates and commodity inflation – the latter squeezing profit margins due to continuing unemployment and stagnant income preventing margins from being maintained (and lets not even get into the whole misallocation of capital into speculative and non-productive assets creating a greater structural drag on the economy). Once market participants realize the fed is cornered, that QE is ENDING, that it didn’t lower unemployment or interest rates, that it was the CAUSE of inflation and margin/profit erosion, that the Fed has no other magic bullets, and that EVERYONE is already long with no one to sell to, we will of course see the end game of “Portfolio Insurance” playing out once again. Will investors be willing to be sequentially conned yet again after suffering major equity losses THREE TIMES in a decade? Only HFT’s will be left for the Fed to try to manipulate good luck with that. The Fed’s credibility that it’s interventions can stabilize markets and raise asset prices will be totally debunked once and for all, and once that occurs, that in fact may be the end of the Fed as we know it once populism runs it’s course.
Reply 01/26/2011 at 2:47 AM alexRegarding your comment “Will investors be willing to be sequentially conned yet again are suffering major equity losses three times in a decade?”, I say probably, and sadly, yes.
The fact of the matter is that today people want to get rich quickly. Aeronautical engineers go to Wall St instead of Boeing, and ordinary folks want to trade their way to wealth. Just look through any magazine – ads for online brokers are EVERYWHERE!
Until this attitude changes, they could be plenty of bubbles with just the same results.
Reply 01/26/2011 at 3:11 AM InvestorXYou are absolutely correct. But as you say equity traders are always ready to speculate, even if their “stimulus” is temporary. So on this point I join alex, believing that we will blow bubbles as long as possible, until some bigger crisis takes the power off the Fed (e.g. a currency collapse).
Reply 01/26/2011 at 4:39 AM ObaMaoQE2 is not working as Bernanke began aggressively easing, the dollar has actually risen in value and interest rates have increased. Exactly the opposite effect of his intentions.With QE2, the Fed gave the green light for every country to try and manipulate its currency, and subsequent to that their trade policies. The US is supposed to be a leader and above that. QE2 has not put us any closer to economic prosperity.
Reply 01/26/2011 at 1:28 PM MisterOn CNBC Bernanke said QE2 was successful because the stock market rallied (last week with Steve Liesman)
He said the same rally happened during QE1
So in his mind he is saying the stock market is going up due to his actions so it is working. Hence you are arguing with the wrong person; get Bernanke on the line.
Reply 01/26/2011 at 3:04 AM Octavio RichettaCULLEN, you have got to read NT’s latest US economic outlook. Kasriel presents a different view on QE2. I think your readers would appreciate your thoughts on it. Kasriel sees fast credit creation as the most significant upside risk to his 2011 GDP forecast and he believes QE2 is doing/may do the trick.
Reply 01/26/2011 at 5:35 AM Cullen RocheI’m familiar with Kasriel’s work on QE. It is based on the false assumption that the Fed can influence lending by changing the amount of reserves. That is simply not how a modern banking system works in reality. QE1 expanded reserves by 1.3T and lending fell 25%!
Reply 01/26/2011 at 11:53 AM Bruce KrastingNice piece. I hope Ben reads it. But he is busy today.
I think the FEd will announce that it is moving toward inflation targeting as the bench mark for monetary policy. So a computer will say when to tighten or when to ease.
This policy will trump QE as the dumbest move of them all. It is just Ben hiding from having to make choices and be responsible for them. Now he will be able to blame a robot for his failures.
Reply 01/26/2011 at 8:11 AM harold hecubait really has become quite bazaar in a central bankers mind equity markets around the world determine the economy.
Reply 01/26/2011 at 8:20 AM MercatorIn spite of market euphoria, the real economy will soon resurface, after a temporary boondoggle. The consumer took a holiday, during the holidays, that’s all!. The next earnings season will show that the consumer is back to the hard work of deleveraging.
Reply 01/26/2011 at 8:59 AM wh10Cullen,
I still don’t see how the Bernanke Put works.
You show how QE2 has virtually no impact on fundamentals (in theory and in reality). This part makes sense to me. You even go on to argue the rally has hardly anything to do with QE2. But putting that aside, for the sake of exploring this phenomenon, if it even exists…
If we assume there is a false psychology, what exactly is the false psychology, arising from QE2, that is driving the rise in equities? You show some evidence that there is a correlation between POMO and equities, but what do you think investors are actually thinking? Trading that moves markets doesn’t come from the average Joe, who is much less likely to understand macroeconomics than the big wigs and institutions that do move markets. It has to be something more nuanced than “O, QE2 is here! Everything is alright, let’s go buy some stocks.” Especially when interest rates don’t even decline.
Thanks.
Reply 01/26/2011 at 10:22 AM Cullen RocheThe Bernanke Put is a put under the market. They plant a seed in the market that says “we are here to protect investors from declines”. Investors, naturally, run out and buy stocks aggressively since the govt has their back. This creates a certain level of undue optimism. It’s sort of like a football player who gets hurt in the first quarter. He goes into the locker room and the doc shoots him up with pain killers. The doc says, “don’t worry kid, you’re good to go”. So, you get back out there with the idea in your head that you’re not hurt. There is nothing wrong underneath the surface. You run around like a 15 year old kid. All the while getting smashed by 300 lb men who run a 4.5 40. You were told everything was fine. And you acted on it. But underneath there was no healing occurring. You were in fact getting even more injured. They say Monday is the worst day in the NFL. This is largely why. For investors, the worst day is when they realize that the economy is weakening and that the Fed can’t actually prop up markets forever.
Reply 01/26/2011 at 12:12 PM wh10But what is the seed that is planted, specifically with QE2? How do they convince the market that they “are here to protect investors from declines,” especially when you show in theory and in reality that they can’t create any change in the fundamentals? Unless you are referring to residual effects from the big bail out..
I understand what you are trying to say with the football analogy, but I don’t see the exact connection with the Bernanke Put in context of QE2. In the analogy, the doctor not only lies to the football player but he can actually temporarily take away his pain.
What is the equivalent for QE2? The Fed isn’t lowering interest rates with QE2, and they’ve never said “go buy stocks we won’t let them decline.” How would they even imply that, when, again, as you show, in theory and in reality the fundamentals don’t change?
Reply 01/26/2011 at 12:28 PM Cullen RocheIt’s exactly like shooting an injured football player up with painkillers. It gives him a psychological edge. Of course, nothing has really changed. He just can’t feel it. But he plays great in the second half. Then he wakes up on Monday morning and something is seriously wrong….
The put is a shot of medicine. A psychological edge. We run out and buy stocks with disregard for price, valuation, etc. None of this matters because the market will never really be allowed to fall. Bernanke told me so! Nothing moves markets like the madness of crowds and the govt has the power to influence this madness.
Reply 01/26/2011 at 12:32 PM wh10I hate to keep nudging you about this, but from my perspective, you keep avoiding my question. I’ll try to rephrase.
Are you saying that when the market sees the Fed take action, they ***ASSUME*** it will work, regardless of its real impact? So they do QE2, the market climbs, and that is the Bernanke Put?
What I am asking is *WHY* the market would EVER assume this. To me, it seems most people *don’t* trust the Fed, so none of this makes total sense to me.
The issue of moral hazard, which is relevant to the bail-out, seems to be a more valid source of dangerous market support. But I don’t see what so meaningless an event as QE2 has to do with that.
Reply 01/26/2011 at 1:02 PM Cullen RochePeople are greedy. Imagine you are a herd of hungry cattle. You approach a bridge and there are green pastures on the other side. Naturally, you all want to get there. But the bridge looks old and rickety so you are skeptical. The bride operator comes to you and says “I will not allow this bridge to fail”. He doesn’t do anything to the bridge. He doesn’t change the fact that it’s old and rickety. But he tells you he won’t let it fail. He’s a bridge operator and seems to know his stuff so you trust him. You take your herd to the other side. Halfway through, the bridge breaks, but half of the herd makes it across.
Why do herds chase rewards? Because we are greedy creatures. And when a govt entity says they will reward us we tend to play their games. Is it rational? No. But it happens.
Reply 01/26/2011 at 1:09 PM wh10So your position is that the Fed is taking advantage of a market that does not understand macroeconomics. That is the “Bernanke Put.” Then you think, even though QE2 is the greatest monetary non event of all time, the Fed is better off not doing it because it will rile false confidence in the markets.
I take issue with the term because to me it is slandering an entity for something it is not responsible really responsible for (namely the absence of fiscal policy and a market that does not understand basic macroeconomics). It misdirects blame, which should be focused on a market that doesn’t understand how things really work (and as a result causing a fake bubble) and a government that is not optimally utilizing fiscal policy.
Maybe the Fed gets MMT. I’ve read Scott F in a post write he has spoken with many Fed officials and they seem to understand this stuff. But it is their mandate to “not let it fail.” But what are they to do when the govt doesn’t respond? I guess you argue – nothing.
Reply 01/26/2011 at 2:01 PM MaxIt’s ridiculous to even talk about QE once you understand that it does nothing special. The only good thing is that it exposes the ignorance of most of the pundits.
Reply 01/26/2011 at 10:29 AM OroborosSomewhat related:
Check in the Mail or More in the Paycheck: Does the Effectiveness of Fiscal Stimulus Depend on How It Is Delivered?
(NBER Working Paper No. 16246)
Authors Claudia Sahm, Matthew Shapiro, and Joel Slemrod find that the reduction in withholding led to a substantially lower rate of spending than the one-time payments.
http://www.nber.org/papers/w16246 (not free for most people)
Specifically, 25 percent of households reported that the one-time economic stimulus payment in 2008 led them to "mostly increase their spending." Only 13 percent of households reported that the extra pay from the lower withholding in 2009 led them to mostly increase their spending.
Household economic conditions and other features of the stimulus program, such as its per-household size, also play a role in the spend/save decision, and therefore in the effectiveness of the fiscal stimulus. However, their effect is considerably smaller than the effect of the delivery mechanism, the authors find.
They observe that some households viewed the 2008 tax rebates as large enough boosts in their income to induce them to make a large purchase, such as a vacation or a car repair. In contrast, households received the 2009 tax credit as a small but repeated boost to their paychecks, so it may have been less likely to trigger a large purchase. Or, it may simply be harder for people to remember and report the extra small expenses that the tax credit induced.
The data for this study come from answers to the Thomson Reuters/University of Michigan Surveys of Consumers regarding the spending response of households to the fiscal stimulus measures in 2008 and 2009.
(source: http://www.planbeconomics.com/2011/01/06/the-effectiveness-of-fiscal-stimulus-depends-on-how-it-is-delivered/)
Reply 01/26/2011 at 10:47 AM RharazHi Cullen,
I’m still having trouble understanding how QE asset swaps work. I have a few questions:
1. When the Fed purchases agency debt, agency MBS, etc., are the dollars used in the transaction spent into existence, or do these dollars already exist?
2. Does the Fed then sell/swap these assets back after some period of time, and if so, does the Fed receive the same amount of dollars that they used to purchase the assets?
3. If the Fed sells/swaps the assets back for dollars, what happens to these dollars (are they extinguished?)?
I apologize if you have already answered these questions in previous posts. If you can provide a link, I’d appreciate it. Thanks again.
Reply 01/26/2011 at 10:47 AM Cullen RocheThis should help:
http://pragcap.com/mechanics-qe-transaction
Reply 01/26/2011 at 12:14 PM RharazThanks Cullen,
Your previous post answered my first question, but I’m still unclear as to what the Fed does with the assets after purchasing them. With regards to Fed purchases of Treasuries, I suppose the Fed could just hold them to maturity, correct? But if, for example, the Fed purchases a MBS for $1M, and it turns out the MBS is not performing as expected and has an actual (market) value of only $500K, can the Fed swap the asset back for $1M?
Reply 01/26/2011 at 1:19 PM Cullen RocheThey will hold it all to maturity is my guess. We’ll be talking about the size of their balance sheet for years. There is no need for them to sell the assets back. They can ease policy by raising interest on excess reserves. So, it’s really a moot point. Who cares what happens to those assets now? The Fed is just going to hold them as long as they need to….
Reply 01/26/2011 at 1:35 PM RharazIf an asset (like the MBS example I gave) is not performing, the Fed might not get all their dollars (i.e. principal) back, even if they held the non-performing asset to maturity, correct?
Reply 01/26/2011 at 1:53 PM jake woodI find your article confusing, you say QE is having no impact on the economy but then warn that bernanke is playing a dangerous game. I would argue that QE is clearly failing to have the impact intended, which was to lower interest rates. This is because bernanke fails to understand that he is reaching a tipping point where investors believe inflation takes over. Bernanke saw that QE 1 lowered rates and assumed QE 2 would do so even more. He is like the man who says if one pill makes me feel better then two should make me feel great. However like any medicine there is a point at which a good thing becomes a dangerous thing. The markets are telling us we have reached that point. QE 2 is not innocous, it is dnagerous. It is creating assets bubbles in equities and commodities. These bubbles especially in commodities will produce inflation. John Hussman has an excellent analysis of this out which shows the more QE we do the lower interest rates must go to keep inflation at bay. As he correctly points out the Fed is playing a very dangerous game
Reply 01/26/2011 at 11:05 AM Cullen RocheThe point is that QE has no fundamental underpinnings. I think the borrowing data, home price reaction, refinancing, etc all pretty much prove that. The people that say it is creating a “wealth effect&#
Truly a crisis wasted. We are now destined to go right back to what we were doing before. I will not be surprised if we boom for a few years. But we all know there’s a bust just waiting to happen again.
Thanks for your thoughts. Great Buffett quote.
Nice post, thanks. QE2 is not impacting interest rates according to Bernanke’s plan because borrowers and lenders know QE is a limited duration intervention – ie, temporary, not sustainable or permanent. It’s analogous to whether tax cuts translate through to increased spending or not – they do only if they’re perceived to be permanent. How Bernanke could fail to understand this obvious relationship is beyond me. Equities operate at a higher frequency and more on a momentum basis so equities traders do not require that QE be perceived to be permanent for them to act reflexly on the perceived (and real) dollar debasement. However, the setup (unintended consequence) is analogous to Portfolio Insurance of the past – by engineering a new Bernanke Put, and temporarily eliminating all perception of risk, traders are obliged to mark up the highest beta and lowest quality securities with no downside. The problem is that QE will soon end as it’s lack of economic benefit is combined with it’s very real economic drag – including rising interest rates and commodity inflation – the latter squeezing profit margins due to continuing unemployment and stagnant income preventing margins from being maintained (and lets not even get into the whole misallocation of capital into speculative and non-productive assets creating a greater structural drag on the economy). Once market participants realize the fed is cornered, that QE is ENDING, that it didn’t lower unemployment or interest rates, that it was the CAUSE of inflation and margin/profit erosion, that the Fed has no other magic bullets, and that EVERYONE is already long with no one to sell to, we will of course see the end game of “Portfolio Insurance” playing out once again. Will investors be willing to be sequentially conned yet again after suffering major equity losses THREE TIMES in a decade? Only HFT’s will be left for the Fed to try to manipulate good luck with that. The Fed’s credibility that it’s interventions can stabilize markets and raise asset prices will be totally debunked once and for all, and once that occurs, that in fact may be the end of the Fed as we know it once populism runs it’s course.
Regarding your comment “Will investors be willing to be sequentially conned yet again are suffering major equity losses three times in a decade?”, I say probably, and sadly, yes.
The fact of the matter is that today people want to get rich quickly. Aeronautical engineers go to Wall St instead of Boeing, and ordinary folks want to trade their way to wealth. Just look through any magazine – ads for online brokers are EVERYWHERE!
Until this attitude changes, they could be plenty of bubbles with just the same results.
You are absolutely correct. But as you say equity traders are always ready to speculate, even if their “stimulus” is temporary. So on this point I join alex, believing that we will blow bubbles as long as possible, until some bigger crisis takes the power off the Fed (e.g. a currency collapse).
QE2 is not working as Bernanke began aggressively easing, the dollar has actually risen in value and interest rates have increased. Exactly the opposite effect of his intentions.With QE2, the Fed gave the green light for every country to try and manipulate its currency, and subsequent to that their trade policies. The US is supposed to be a leader and above that. QE2 has not put us any closer to economic prosperity.
On CNBC Bernanke said QE2 was successful because the stock market rallied (last week with Steve Liesman)
He said the same rally happened during QE1
So in his mind he is saying the stock market is going up due to his actions so it is working. Hence you are arguing with the wrong person; get Bernanke on the line.
CULLEN, you have got to read NT’s latest US economic outlook. Kasriel presents a different view on QE2. I think your readers would appreciate your thoughts on it. Kasriel sees fast credit creation as the most significant upside risk to his 2011 GDP forecast and he believes QE2 is doing/may do the trick.
I’m familiar with Kasriel’s work on QE. It is based on the false assumption that the Fed can influence lending by changing the amount of reserves. That is simply not how a modern banking system works in reality. QE1 expanded reserves by 1.3T and lending fell 25%!
Nice piece. I hope Ben reads it. But he is busy today.
I think the FEd will announce that it is moving toward inflation targeting as the bench mark for monetary policy. So a computer will say when to tighten or when to ease.
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