• Blog
    Blue Sunburst Peak Prosperity Logo

    Alert: QE II Has Lit the Fuse

    by Chris Martenson

    Thursday, November 11, 2010, 6:41 PM

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).

Related content
» More

61 Comments

  • Thu, Nov 11, 2010 - 7:21pm

    #1
    denrgj

    denrgj

    Status: Member

    Joined: Sep 05 2009

    Posts: 1

    Re: Alert: QE II Has Lit the Fuse

    As Always, another excellent post with excellent perspectives.

    I have just finished listening and watching CNBC interview Jeremy Grantham….From an investment standpoint it is a Full Five Star.  At about 18 min. he says “We have entered a period where we are running out of everything.  I think it will become devastatingly clear to everybody.  We went through a  paradigm  shift about 5 years ago”  

    http://www.zerohedge.com/article/jeremy-grantham-fed-has-spent-last-20-years-manipulating-stock-market

    He goes on, and it is devastatingly clear his message.  

    The entire video – sorry for the drama here – but it really MUST be watched.

    For those of you who don’t know of Mr. Grantham, he is one of the most respected investment professionals in the business over the last 35 years or so.  He is astute, well spoken, broad in his perspective, and has been extremely successful in understanding and reacting to the markets. 

    BTW, he is very direct in his criticism of the FED, and possible currency/tariff wars.  The gamble you refer to in your article will not work, and in fact has never worked in the history of fiat currencies.

     

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 7:42pm

    #2
    leweke1

    leweke1

    Status: Member

    Joined: Dec 18 2008

    Posts: 16

    Re: Alert: QE II Has Lit the Fuse

    Right on time Chris.  We knew monetization was inevitable while hoping we were wrong.  We hope “The Gamble” works while knowing it’s false hope.  As I posted a few days ago, looking at the evolving world picture, I’ve had a kind of “someone got murdered just up the block” feeling for about a couple of weeks now.  It becomes more apparent that various preparations will not have been a waste, while pondering what else to do as things progress in the coming seasons.

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 7:44pm

    #3

    Travlin

    Status: Gold Member

    Joined: Apr 15 2010

    Posts: 524

    Re: Alert: QE II Has Lit the Fuse

    Even though Chris has prepared us intellectually for this day, I still find myself stunned by seeing it.

    I keep thinking of the Titanic after it hit the iceberg.  As I remember, the chief engineer who designed her was on board.  He calculated that based on the rate they were taking on water the ship was doomed to sink in a few hours.  He informed the captain that nothing could be done to save her.  When the call to life boats first went out many refused to board them.  The North Atlantic was very cold and dark, the ship appeared sound, and most people where still eating, drinking, and dancing.  There was a great change of heart as the ship began to list and those that left later fared badly.

    It has been many years since I read A Night To Remember, by Walter Lord, but it is a classic study in hubris and human psychology.  http://www.amazon.com/Night-Remember-Walter-Lord/dp/0805077642/ref=sr_1_1?ie=UTF8&qid=1289503078&sr=8-1 

    I can’t help feeling that our own chief engineer has made the calculations and the end is now in sight.

    Travlin

     

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 8:10pm

    #4

    Poet

    Status: Platinum Member

    Joined: Jan 20 2009

    Posts: 981

    Re: Alert: QE II Has Lit the Fuse

    Dr. Martenson:

    I am not of means, and I am not be an enrolled member. So thank you so So SO SO SO much for making this enlightening article free.

    Poet

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 8:13pm

    #5
    Plab20

    Plab20

    Status: Member

    Joined: Oct 06 2009

    Posts: 0

    "paper" to "things." link is broken

    link appears to be set as a mailto

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 8:24pm

    #6

    Adam Taggart

    Status: Platinum Member

    Joined: May 25 2009

    Posts: 2919

    Re: Alert: QE II Has Lit the Fuse

    Plab20 – thanks. Link fixed.

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 9:49pm

    #7

    rmurfster

    Status: Member

    Joined: Apr 17 2008

    Posts: 15

    Re: Alert: QE II Has Lit the Fuse

    What to expect?  Read this report from the National Inflation Association (http://www.inflation.us).  My jaw hit the floor.

    NIA projects that at the average U.S. grocery store it will soon cost $11.43 for one ear of corn, $23.05 for a 24 oz loaf of wheat bread, $62.21 for a 32 oz package of Domino Granulated Sugar, $24.31 for a 32 fl oz container of soy milk, $77.71 for a 11.30 oz container of Folgers Classic Roast Coffee, $45.71 for a 64 fl oz container of Minute Maid Orange Juice, and $15.50 for a Hershey’s Milk Chocolate 1.55 oz candy bar. NIA also projects that by the end of this decade, a plain white men’s cotton t-shirt at Wal-Mart will cost $55.57.

    Read the article at: http://www.inflation.us/foodpriceprojections.html

    Get the full report here in PDF format: http://inflation.us/foodpriceprojections.pdf

    Richard

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 9:52pm

    #8
    Doug

    Doug

    Status: Platinum Member

    Joined: Oct 01 2008

    Posts: 1387

    Re: Alert: QE II Has Lit the Fuse

    Chris,

    A few days ago you suggested that people might want to wait a couple weeks to buy PMs hoping for a correction.  Does this change that advice in anyway?

    Doug

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 10:01pm

    #9

    Romans12.2

    Status: Bronze Member

    Joined: Jul 15 2009

    Posts: 33

    Re: Alert: QE II Has Lit the Fuse

    I have the same question as Doug.   We purchased $500 face value 90% silver last week..felt alot different than when we paid $17/oz a year ago.  Is it still time to buy, I mean if you are holding onto cash? 

    Or does it makes sense to just buy more and more food?

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 10:05pm

    #10

    Nichoman

    Status: Silver Member

    Joined: Nov 01 2008

    Posts: 140

    Re: Alert: QE II Has Lit the Fuse

    Here’s another signal…try municipal debt funds…crashing prices since the announcement of QE2 per Karl Denninger.

     

    Nichoman 

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 10:35pm

    #11

    deflationdan

    Status: Member

    Joined: Aug 06 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    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.

    The Fed has been monetizing Treasury debt since Open Market Operations was instituted. That is one way they attempt to keep overnight lending rates between banks close to their target rate — by buying government debt from the public.

    In 2008 the FOMC announced that they would be targeting longer-term treasuries in their overnight purchasing. This is nothing but an extension of that program.

    Dr. Martenson may be confusing ordinary monetizing of government debt with direct purchase of treasuries at government auctions. There has been no announcement of that action by the Fed. Section 14 of the Fed charter does not allow direct purchases.

     

    .

    Login or Register to post comments

  • Thu, Nov 11, 2010 - 11:51pm

    #12

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    ‘Brazil retaliated by buying dollars.’

    Funny way of ‘retaliating,’ isn’t it? 

    Under a fiat currency system, it’s a global race to the bottom. The only effective way to retaliate against a reckless monetizer (e.g., the U.S.) is to monetize at the same rate yourself, preferably by buying the monetizer’s own currency to drive it up in value. It was called ‘competitive devaluation’ in the 1930s. Nothing has changed since.

    The Bubble potential here should be obvious to all. Largely driven by trade imperatives, overseas governments are defensively buying dollars without regard to their intrinsic value, for strategic reasons.

    When the day comes that value is restored, the dollar will have a long way to fall.

    The dying Bretton Woods II currency regime is a textbook definition of ‘perverse incentives.’

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 12:04am

    Reply to #11

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=deflationdan]

    Dr. Martenson may be confusing ordinary monetizing of government debt with direct purchase of treasuries at government auctions. There has been no announcement of that action by the Fed. Section 14 of the Fed charter does not allow direct purchases.

    [/quote]

    If you work through the double-entry bookkeeping, there isn’t the slightest difference between POMOs conducted with primary dealers, and direct Fed purchases from the Treasury — except that in the former case, a middleman pockets a fee on both sides of the transaction. This is exactly what you would expect in a public-private partnership administrated by Goldman Sachs alumni.

    Here’s how it works in Da Hood. Under Section 14 of the Fed charter, if I wanna buy a dime bag of heroin on a Brooklyn street corner, I gotta give my money to a punk 14-year-old kid who disappears for couple of minutes and comes back with my glassine bag of dope. Having a cutout involved protects both parties, when we’re workin’ on the shady side of the street, ya know? He don’t face adult prison time if da narcs hassle us.

    If Section 14 didn’t apply, I could ring the doorbell at my connection and meet him face to face. But the price would still be a dime, I reckon. So why not observe the social proprieties? Section 14 lets junkies feel good about theyselves … lets everybody collect a piece of da action.

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 12:17am

    Reply to #10

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=Nichoman]

    Here’s another signal…try municipal debt funds…crashing prices since the announcement of QE2 per Karl Denninger.

    Nichoman 

    [/quote]

    Thanks for spotting this, Nichoman.

    Karl Denninger doesn’t seem to have sussed out the reason for these muni bond crashes. It’s cuz Ambac — the second-largest insurer of municipal bonds — filed for Chapter 11 bankruptcy this week.

    http://www.reuters.com/article/idUSTRE6A75EW20101108

    This is one of those long-tail events whose full dimensions won’t become clear for awhile. Suddenly, many AAA insured muni issues are no longer AAA credits, when the insurer itself is busted. Most muni issuers will soldier on, but suddenly their credit quality is effectively downgraded to their own local resources, which may be borderline junk.

    Evidently Ambac didn’t have the corrupt political connections to be bailed out like AIG. But the impact of Ambac’s meltdown (it now trades for 15 cents on the pink sheets) may affect Main Street America much more than AIG ever did.

    If your local or state government planned to issue bonds next year, they may find themselves cut off from floating any more debt. They just can’t get any respect from skinflint investors … not without Daddy Ambac to cosign the note.

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 1:26am

    Reply to #11

    Chris Martenson

    Status: Platinum Member

    Joined: Jun 07 2007

    Posts: 5025

    Re: Alert: QE II Has Lit the Fuse

    [quote=deflationdan]

    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.

    The Fed has been monetizing Treasury debt since Open Market Operations was instituted. That is one way they attempt to keep overnight lending rates between banks close to their target rate — by buying government debt from the public.

    In 2008 the FOMC announced that they would be targeting longer-term treasuries in their overnight purchasing. This is nothing but an extension of that program.

    [/quote]

    If you followed the link, it was to a 2007 article where I opined that money printing was the plan.

    Through the years I have quite actively followed the Fed and it’s actions in some detail.  I invite you to peruse the archives.

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 1:30am

    Reply to #7

    LogansRun

    Status: Silver Member

    Joined: Mar 18 2009

    Posts: 311

    Re: Alert: QE II Has Lit the Fuse

    NIA is an organization that I don’t hold in high regard after their last video.  Very thin arguments with high amounts of hyperbole.  Just my opinion but……

    https://www.peakprosperity.com/forum/end-liberty-full-version/47209

    [quote=rmurfster]

    What to expect?  Read this report from the National Inflation Association (http://www.inflation.us).  My jaw hit the floor.

    NIA projects that at the average U.S. grocery store it will soon cost $11.43 for one ear of corn, $23.05 for a 24 oz loaf of wheat bread, $62.21 for a 32 oz package of Domino Granulated Sugar, $24.31 for a 32 fl oz container of soy milk, $77.71 for a 11.30 oz container of Folgers Classic Roast Coffee, $45.71 for a 64 fl oz container of Minute Maid Orange Juice, and $15.50 for a Hershey’s Milk Chocolate 1.55 oz candy bar. NIA also projects that by the end of this decade, a plain white men’s cotton t-shirt at Wal-Mart will cost $55.57.

    Read the article at: http://www.inflation.us/foodpriceprojections.html

    Get the full report here in PDF format: http://inflation.us/foodpriceprojections.pdf

    Richard

    [/quote]

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 2:58am

    Reply to #1
    Farmer Brown

    Farmer Brown

    Status: Silver Member

    Joined: Nov 23 2008

    Posts: 159

    Re: Alert: QE II Has Lit the Fuse

    [quote=denrgj]

    As Always, another excellent post with excellent perspectives.

    I have just finished listening and watching CNBC interview Jeremy Grantham….From an investment standpoint it is a Full Five Star.  At about 18 min. he says “We have entered a period where we are running out of everything.  I think it will become devastatingly clear to everybody.  We went through a  paradigm  shift about 5 years ago”  

    http://www.zerohedge.com/article/jeremy-grantham-fed-has-spent-last-20-years-manipulating-stock-market

    He goes on, and it is devastatingly clear his message.  

    The entire video – sorry for the drama here – but it really MUST be watched.

    For those of you who don’t know of Mr. Grantham, he is one of the most respected investment professionals in the business over the last 35 years or so.  He is astute, well spoken, broad in his perspective, and has been extremely successful in understanding and reacting to the markets. 

    BTW, he is very direct in his criticism of the FED, and possible currency/tariff wars.  The gamble you refer to in your article will not work, and in fact has never worked in the history of fiat currencies.

    [/quote]

    Has anybody located this video on youtube?  The ZH cnbc video stream is horribly slow and all chopped up, at least for me – can’t get it to load right.  Never have that problem w/ youtube videos.  

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 3:09am

    #13
    songbird

    songbird

    Status: Member

    Joined: Apr 16 2008

    Posts: 3

    Re: Alert: QE II Has Lit the Fuse

    Farmer Brown –

    I went to the CNBC site and had no trouble with the video.

    Songbird

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:04am

    Reply to #9

    Damnthematrix

    Status: Diamond Member

    Joined: Aug 09 2008

    Posts: 1132

    Re: Alert: QE II Has Lit the Fuse

    [quote=Romans12.2]

    I have the same question as Doug.   We purchased $500 face value 90% silver last week..felt alot different than when we paid $17/oz a year ago.  Is it still time to buy, I mean if you are holding onto cash? 

    Or does it makes sense to just buy more and more food?

    [/quote]

     

    Personally…….  I’d buy the things I will need post crash. Like the two piglets we bought last Sunday.

    And a Mig Welder on eBay just ten minutes ago with tax refund money… Tongue out

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 9:55am

    #14
    simentt

    simentt

    Status: Member

    Joined: Jul 05 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    ‘Brazil retaliated by buying dollars.’

    Funny way of ‘retaliating,’ isn’t it? 

    Under a fiat currency system, it’s a global race to the bottom. The only effective way to retaliate against a reckless monetizer (e.g., the U.S.) is to monetize at the same rate yourself, preferably by buying the monetizer’s own currency to drive it up in value. It was called ‘competitive devaluation’ in the 1930s. Nothing has changed since.

    My thoughts exactly, Machinehead – to protect our industrial strength we need to make sure our currency does not gain too much strength (forget that this would give us cheap raw materials that our whole society could benefit from).

    The best way to do this, is to buy foreign currencies that are losing value – essentially, we’re destroying the value of our own products to make sure they are worth  less than our competitors products.

    Essentially this looks like corporatism – we’re sacrificing the wealth of our civilian population to keep our exporting industries competitive. This to avoid having the industry re-tool to a world with cheaper raw materials and imported goods and ahigher standard of living.

    -S

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 11:04am

    #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    Q.E. is not the same as money printing. If the government spends, they are printing money. But not Q.E.; it is an asset swap, where treasuries are swapped for reserve balanses. It changes the composition of the bank’s balance sheet and the duration and interest of government liabilities. And an increase in the monetary base is not inherently inflationary…banks are not reserve constraint; there is no demand for loans. See for instance the nice graph at http://hussmanfunds.com/wmc/wmc101025.htm ; historically, a rise in the monetary base is accompanied with a proportional drop in de money velocity, and has a negligable effect on nominal GDP. There are also many data out there that Q.E. doesn’t stimulate private sector lending, look for instance at Japan, where they tried years of Q.E.

    “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.”

    The Fed is taking an interest bearing asset of the balance sheets of banks. You should take that loss of interest into account. And if you compensate for that, it is even slightly deflationary.

    “So QE I (and the ‘stealth QE’ program) was directly aimed at banks to help them repair their balance sheets and make them whole on their terrible decisions and losses. It turned out, though, that fixing the banks did absolutely nothing for Main Street.”

    I totally agree with that. The purpose of QE1 was not to help Main Street. It was to repair the banks balance sheets.

    I am not a proponent of Q.E., far from it. But not because I think it is inflationary. It is not. One of the biggest problems of Q.E. is that the perception of QE is that it’s inflationary, and that may lead to a shift in investor’s portfolio’s. This is very dangerous; it leads to unintended consequences based on false fundamentals IMO.

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 11:54am

    Reply to #7
    egwiley

    egwiley

    Status: Member

    Joined: Sep 24 2010

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    Richard,

    I didn’t look into how they came up with the numbers so not saying they aren’t valid. However, I learned a while back that NIA is directly associated with penny stock pump and dump operations. For whatever it’s worth.

    Best Wishes,

    Eric

     

     

     

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 12:42pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    Q.E. is not the same as money printing. If the government spends, they are printing money. But not Q.E.; it is an asset swap, where treasuries are swapped for reserve balanses. It changes the composition of the bank’s balance sheet and the duration and interest of government liabilities. And an increase in the monetary base is not inherently inflationary…banks are not reserve constraint; there is no demand for loans.

    See for instance the nice graph at http://hussmanfunds.com/wmc/wmc101025.htm ; historically, a rise in the monetary base is accompanied with a proportional drop in de money velocity, and has a negligable effect on nominal GDP. There are also many data out there that Q.E. doesn’t stimulate private sector lending, look for instance at Japan, where they tried years of Q.E.

    [/quote]

    The ‘money printing’ aspect, I would suggest, lies in the Fed committing to purchase $1 trillion worth of Treasury securities over the next eight months, when it does not actually possess $1 trillion in cash to make such purchases. Any other economic actor, lacking the cash or the ability to borrow it, would be stymied.

    Not the Fed, though. When the Fed buys Treasury securities with POMOs, they credit the sellers (primary dealers) with reserve balances which didn’t exist before the POMO. These new reserve balances are thin-air money. No real economic production underlay their creation. The Federal Reserve got ‘something for nothing’ (Treasury securities) when it had no actual resources to purchase them, other than the Congressionally-conferred ability to create ‘legal tender’ reserve balances.

    Even at this point — even if the new ‘thin-air’ reserves merely remain idle — the process is inherently fraudulent. The defect in the ‘mere asset swap’ scenario is that one of the assets (the new reserves) didn’t exist before the swap. 

    It’s as if I offer to swap my Ferrari for your Lexus. ‘But you don’t have a Ferrari, MH,’ you reasonably point out. ‘That’s okay, Remy — not to worry. You just sign over your title to me, and I’ll CREDIT you with a brand new red Ferrari that’s just coming off the assembly line today. Trust me!’

    Whether these new reserves turn into inflation sooner or later or never is another matter. Various paths to inflation exist — banks lend the reserves; or the Fed merely accommodates fiscal deficit spending (Hussman’s scenario). The Federal Reserve has been studying Japanese deflation as a cautionary tale for 20 years now. Obviously they didn’t understand it, because they’ve fallen into the same liquidity trap themselves. 

    What one can conclude is that central bank monetization (including literal money printing in cash-based economies) is a necessary but not sufficient condition for high inflation. All inflationary episodes involve monetization; but not all monetizations produce high inflation. Obviously monetization is a risk factor; it’s patently bad behavior which tends to be associated with a range of related social pathologies.

    In an enlightened society, chronic offenders such as the Federal Reserve Board deserve treatment and counseling, not harsh prison sentences. Laughing

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 1:12pm

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    First, I’m not arguing whether the monetary system in the U.S. is fraudulent or not; I am just trying to illustrate how it works.

    What is important is that it was the government, not the fed, who created the financial assets out of thin air. By spending, the government appropriated goods and services and issued a government liability in return, whether it is cash or a treasury. It is the government who added net financial assets to the private sector; not the fed. Deficit spending IS inherently inflationary.

    By buying treasuries, the Fed just alters the duration and yield of the government liability. I think an apt analogy is that the Fed just substituted “saving” accounts (treasuries) into checking accounts. Instead of an interest bearing asset of 1.2% (for instance) the bank now holds a reserve balans yielding 0.25%. It does not add net financial assets to the private sector. Spending power of the private sector does not increase. 

    “What one can conclude is that central bank monetization (including literal money printing in cash-based economies) is a necessary but not sufficient condition for high inflation.”

    Not really. Even without monetization (increase in monetary base), inflation can increase, if the money velocity increases (M*V=P*Y).

    “…but not all monetizations produce high inflation.”

    And that is exactly the point….as hussman showed the money velocity is proportionally falling with the increase in monetary base. And thus has an increase in MB no effect on nominal GDP (whether through inflation or rising production).

    “The Federal Reserve has been studying Japanese deflation as a cautionary tale for 20 years now. Obviously they didn’t understand it, because they’ve fallen into the same liquidity trap themselves.”

    Exactly! And therefore Q.E. is not really changing much on a fundamental level. It has had some other very negative (and unintended) consequences however.

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 2:58pm

    Reply to #11

    deflationdan

    Status: Member

    Joined: Aug 06 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    Machinehead wrote:

    “If you work through the double-entry bookkeeping, there isn’t the slightest difference between POMOs conducted with primary dealers, and direct Fed purchases from the Treasury — except that in the former case, a middleman pockets a fee on both sides of the transaction. This is exactly what you would expect in a public-private partnership administrated by Goldman Sachs alumni.”

     

    There are at least three subtle differences between ordinary treasury debt monetization through Open Market Operations and direct buying by the Fed at government auctions. Hence, the reason for Section 14 of the Fed charter.

    1. Purchasing treasuries from the public increases the probability that there will be a market for government securities when the Fed needs to sell the debt to extract reserves from the banking system.

    2. Having the banks serve as middle men insulates the Fed from the government thereby maintaining its sovereignty, giving them the illusion of power over economic forces.

    3. When the Fed agreed to purchase longer-term securities directly from the Treasury to help fund World War II, it wasn’t until  Accord of 1951, after much feuding and fussing, that the Treasury allowed them their sovereignty once again.

    Whether or not this extra 600 billion FRNs will prevent our return to sanity is unknown.

    -dan

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:12pm

    Reply to #7

    rmurfster

    Status: Member

    Joined: Apr 17 2008

    Posts: 15

    Re: Alert: QE II Has Lit the Fuse

    I agree about the “shadyness” of their last video.  I watched it and can’t stand videos like that.  Although, I must admit that I did agree with some of what they said, just didn’t like the delivery.  Having said that, the Inflation Report isn’t full of hyperbole, just taking true inflation stats without any BS adjustments and extrapolating.  I especially liked it because the NIA report exposes the same manipulation tactics (Hedonics & Geometric Weighting) as Chris does in the Crash Course that the government uses to manipulate the Inflation Statistics.  Admitingly, it may be a worst-case scenario, but still worth the read.

    Richard

    [quote=LogansRun]

    NIA is an organization that I don’t hold in high regard after their last video.  Very thin arguments with high amounts of hyperbole.  Just my opinion but……

    https://www.peakprosperity.com/forum/end-liberty-full-version/47209

    [quote=rmurfster]

    What to expect?  Read this report from the National Inflation Association (http://www.inflation.us).  My jaw hit the floor.

    NIA projects that at the average U.S. grocery store it will soon cost $11.43 for one ear of corn, $23.05 for a 24 oz loaf of wheat bread, $62.21 for a 32 oz package of Domino Granulated Sugar, $24.31 for a 32 fl oz container of soy milk, $77.71 for a 11.30 oz container of Folgers Classic Roast Coffee, $45.71 for a 64 fl oz container of Minute Maid Orange Juice, and $15.50 for a Hershey’s Milk Chocolate 1.55 oz candy bar. NIA also projects that by the end of this decade, a plain white men’s cotton t-shirt at Wal-Mart will cost $55.57.

    Read the article at: http://www.inflation.us/foodpriceprojections.html

    Get the full report here in PDF format: http://inflation.us/foodpriceprojections.pdf

    Richard

    [/quote]

    [/quote]

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:14pm

    Reply to #15

    Chris Martenson

    Status: Platinum Member

    Joined: Jun 07 2007

    Posts: 5025

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    (…) therefore Q.E. is not really changing much on a fundamental level. It has had some other very negative (and unintended) consequences however.

    [/quote]

    In a Ponzi system, trust and faith are quite fundamental to the continuation of the scheme.  When one party (the Fed) can create money out of thin air in exchange for freshly minted government debt, irrespective of how many muddling intermediary transactions there might have been, then some layer of vital trust is eroded.

    The thing about Ponzi schemes is that they work until they don’t.  

    Money is an agreement between people.  It is like a contract.  When one party is constantly eroding and violating that agreement, that contract, then the money loses some of its utility.

    And when that money is created entirely out of think air, then confidence assumes a very large and quite fundamental position in the equation.

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:17pm

    Reply to #15

    JAG

    Status: Gold Member

    Joined: Oct 26 2008

    Posts: 307

    Re: Alert: QE II Has Lit the Fuse

    [quote=machinehead]

    The defect in the ‘mere asset swap’ scenario is that one of the assets (the new reserves) didn’t exist before the swap. 

    [/quote]

    MH, putting aside the legality issue for a moment, how is this anymore inflationary than a “thin-air” loan created by the banking system to allow someone to purchase an existing asset, such as a foreclosed home? Given a constant monetary velocity, both of these processes should be equally inflationary, should they not?

    Thanks in advanced….Jeff

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:29pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    What is important is that it was the government, not the fed, who created the financial assets out of thin air. By spending, the government appropriated goods and services and issued a government liability in return, whether it is cash or a treasury. It is the government who added net financial assets to the private sector; not the fed. Deficit spending IS inherently inflationary.

    By buying treasuries, the Fed just alters the duration and yield of the government liability. I think an apt analogy is that the Fed just substituted “saving” accounts (treasuries) into checking accounts. Instead of an interest bearing asset of 1.2% (for instance) the bank now holds a reserve balans yielding 0.25%. It does not add net financial assets to the private sector. Spending power of the private sector does not increase. 

    [/quote]

    When the Treasury sells debt, the public exchanges cash for longer-dated Treasury obligations. This adds to the stock of debt. But I would not call it a ‘thin-air’ process — the public already held the cash to purchase the Treasury debt. 

    In the second paragraph, you are inherently treating ‘the Fed’ and ‘the government’ as a unified entity. An argument can be made that they should be consolidated for accounting purposes, although the Federal Reserve’s capital stock is privately held. But under current institutional arrangements, they are treated as separate entities. Under the separate entity assumption, Federal Reserve liabilities (bank reserves) and Treasury debt are not interchangeable ‘government liabilities.’ Bank reserves can be used for pyramiding bank lending (if they so choose), whereas Treasury debt held by banks cannot.

    If the Fed and Treasury were consolidated for accounting purposes, then the Fed’s holdings of Treasuries and the Treasury’s liabilities to the Fed would cancel out as intersubsidiary obligations. From this point of view, under QE2 the unified Treasury/Fed has merely credited banks with a trillion dollars of fresh reserves, apropo of nothing. This is the essence of ‘money printing,’ and it has no necessary connection to either Treasury borrowing or Treasury spending under a consolidated accounting analysis.

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:29pm

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    “In a Ponzi system, trust and faith are quite fundamental to the continuation of the scheme.  When one party (the Fed) can create money out of thin air in exchange for freshly minted government debt, irrespective of how many muddling intermediary transactions there might have been, then some layer of vital trust is eroded.”

    I agree that trust is essentially in a fiat system. And it might very well that Q.E. erodes that trust (which is one of the unintended consequences I talked about).

    However, Q.E. just swaps one government liability (treasuries) for the other (reserve balances). It does not add financial assets to the private sector. It does not increase spending power; it is not inherently inflationary. Government spending is.

    There is a lot of fuss about QE that I think is fundamentally wrong, and that investors make decisions based on those wrong ideas. And that is very dangerous; it can very well create bubbles in commodities which will hurt businesses and individuals.

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:36pm

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    Unfortunately I have to run, but I think most of your points are technical and do not change the idea.

    One quick point: reserves are not part of the money stock…and increase doesn’t matter as long as it is not accompanied by an increase in loans. And that is not happening. Banks are not reserve constraint, not before and not after Q.E.2.

    And another quick one 😉 : Banks can already post treasuries as collateral to obtain reserves.

    Thanks for the reply and I will reply more throroughly tommorrow!

     

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:36pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    Even without monetization (increase in monetary base), inflation can increase, if the money velocity increases (M*V=P*Y).

    As Hussman showed the money velocity is proportionally falling with the increase in monetary base. And thus has an increase in MB no effect on nominal GDP (whether through inflation or rising production).

    [/quote]

    These two sentences contradict each other. Although an exogenous increase in velocity could produce inflation, Hussman’s real-world data shows that it doesn’t happen.

    All real-world inflations involve monetization. There is no documented instance where, in the presence of a stable monetary base, velocity suddenly just took off like a rocket and prices went wild. 

    This scenario is about as likely as a gravity reversal. Wink

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:44pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    One quick point: reserves are not part of the money stock…

    [/quote]

    That may be true on your planet. But here on Earth, the Federal Reserve defines the monetary base as:

    3. The monetary base, not break-adjusted and not seasonally adjusted, consists of (1) total reserves plus (2) required clearing balances and adjustments to compensate for float at Federal Reserve Banks plus (3) the currency component of the money stock plus (4), for all quarterly reporters on the “Report of Transaction Accounts, Other Deposits and Vault Cash” and for all those weekly reporters whose vault cash exceeds their required reserves, the difference between current vault cash and the amount applied to satisfy current reserve requirements.

    http://federalreserve.gov/releases/h3/Current/

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 4:51pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    Banks can already post treasuries as collateral to obtain reserves.

    [/quote]

    I believe you’re referring to repos.

    But the chain of causation is critical: the Fed initiates repos to add reserves to the system.

    It doesn’t work in reverse: a bank can’t demand on its initiative for the Fed to buy or borrow its Treasuries. It can only sell or lend them to another financial institution, which doesn’t alter the aggregate quantity of reserves as a Fed repo would do.

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 5:00pm

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    ok..was not being careful. What i meant is that the monetary base is the basis on which loans, and then deposits can be created. Reserves just sit in the reserve system until they are used to create loans. If no loans are created based on those reserves, they just sit idle. This is what is happening right now. This post was already from my phone, so really the last post tonight 😉

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 5:45pm

    Reply to #8

    nickbert

    Status: Silver Member

    Joined: Jan 14 2009

    Posts: 282

    Great Googly-Moogly... Gold at $1360's, silver below $26

    [quote=Doug]

    Chris,

    A few days ago you suggested that people might want to wait a couple weeks to buy PMs hoping for a correction.  Does this change that advice in anyway?

    Doug

    [/quote]

    Well speaking of corrections…..

    Was there any news that JUST came out that would explain such a sudden and sharp drop, like the silver margin rules changes we had seen earlier?  I haven’t seen anything yet.  I just want to be sure this is the usual high volatility in PM’s at work, and not something more ominous.  Markets are down too, but not by a huge degree.  Yet.

    Regardless, I won’t begrudge the potentially good buying opportunity… my plans to purchase more PM’s in the next month might turn out to be good timing for me.   For once Tongue out

    – Nickbert

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 6:39pm

    Reply to #8

    Chris Martenson

    Status: Platinum Member

    Joined: Jun 07 2007

    Posts: 5025

    Re: Great Googly-Moogly... Gold at $1360's, silver below $26

    [quote=nickbert]

    [quote=Doug]

    Chris,

    A few days ago you suggested that people might want to wait a couple weeks to buy PMs hoping for a correction.  Does this change that advice in anyway?

    Doug

    [/quote]

    Well speaking of corrections…..

    Was there any news that JUST came out that would explain such a sudden and sharp drop, like the silver margin rules changes we had seen earlier?  I haven’t seen anything yet.  I just want to be sure this is the usual high volatility in PM’s at work, and not something more ominous.  Markets are down too, but not by a huge degree.  Yet.

    Regardless, I won’t begrudge the potentially good buying opportunity… my plans to purchase more PM’s in the next month might turn out to be good timing for me.   For once Tongue out

    – Nickbert

    [/quote]

    Why, yes, I do have a point of view on this, thanks for asking!  

    On Wednesday of this week, in response to the silver margin hike, I said this:

    We’ll see what happens next, but the past patterns were brutal for longs. If you were thinking of buying silver or gold or any other commodities my advice would be to wait a couple of weeks to see how this all sorts itself out. I will note that bull markets are marked by long marches upwards with sharp retracements, and bear markets with the opposite. So I am happy to sit back and observe.

    Also, noting that the Fed wouldn’t exactly cry if commodities cooled off here, I would conclude that there would be some measure of official relief at a big downdraft as this would support the Fed’s decision to openly monetize government debt.

    That stands for now.

    Login or Register to post comments

  • Fri, Nov 12, 2010 - 10:08pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    Q.E. is not the same as money printing. If the government spends, they are printing money. But not Q.E.; it is an asset swap, where treasuries are swapped for reserve balanses. It changes the composition of the bank’s balance sheet and the duration and interest of government liabilities.[/quote]

    Let me expand on the point I mentioned earlier, about working through the double-entry bookkeeping.

    The conventional accounting point of view treats the Treasury and the Federal Reserve as separate entities. You are referring to them as a consolidated entity, which is also a valid approach. But it has to be applied consistently. 

    Let’s merge the Treasury and Federal Reserve into ‘The Government,’ and analyze the processes of borrowing, spending, and QE2. We can look at either the government’s balance sheet or the public’s. Since we’re all members of the public, let’s do the transactional bookkeeping from the public’s point of view.

    1. The Government sells $1 trillion of debt:

    Public’s assets:
    Government bonds — plus $1 trillion
    Bank deposits — minus $1 trillion

    2. Since the government operates hand to mouth, rarely holding large cash balances, in a few days the cash raised in the debt sale is spent on goods and services purchased from the public.

    Public’s assets:
    Bank deposits — plus $1 trillion
    Goods and services sold — minus $1 trillion

    Let’s stop and take stock. When Steps 1 and 2 are combined, bank deposits cancel out. The net result is that the government purchased $1 trillion worth of goods and services with $1 trillion of debt — promises to pay in the future. Since bank deposits are unchanged, the M1 money supply is unchanged. The money supply remains undiluted.

    3. Now the Government announces QE2:

    Public’s assets:
    Bank deposits — plus $1 trillion
    Government bonds — minus $1 trillion

    Now when we combine Steps 1-3, Government bonds also cancel out (added in Step 1, subtracted in Step 3). This time, the net result is that the Government purchased $1 trillion in goods and services by creating $1 trillion of new deposits. Issuance of debt wasn’t even necessary. The Government could simply purchase goods and services by using its sovereign monopoly over the banking system to create new deposits. (In cash basis economies, this is done by printing banknotes.)

    Calling this merely a duration swap of government liabilities is logical sleight of hand. The government bonds which the public held in Steps 1 and 2 did not add to the money supply. But the deposits which they hold after Step 3 DO add to the money supply. These deposits were created by diluting the value of the earlier, smaller money supply.

    It’s also a mischaracterization to say that the Government spends money into existence. Spending financed by taxing or borrowing (Steps 1-2) does not create new money. Spending financed by increasing the money supply (Steps 1-3) does create new money, by definition.

    The real world evidence is that while the dollar was metallic-backed from the 1790s to the 1930s, there was no net change in the price level. 1930s prices would have been recognizable to George Washington. Government spending rose and fell; debt levels rose and fell. But because monetization was limited to purchases of gold and silver (whose supply is subject to practical limits), the expansion in money supply over those 140 years paralleled economic growth. Accordingly prices displayed no enduring trend.

    Since the wholesale monetization of debt started in the 1940s, prices have exhibited a permanent, multifold rise. During this inflationary era, deficit spending and debt monetization have gone hand in hand. Although deficit spending may correlate with inflation, it doesn’t necessarily cause it when monetization (the real cause) is underway simultaneously. This is the case right now — trillions in deficits, trillions in monetization.

    The argument against monetization is that it adds to economic uncertainty. Consider where we are today: no one knows whether QE2 will lead to boom or bust. No one knows whether prices will explode (e.g., copper) or crash (e.g. housing). No one knows whether interest rates will soar (e.g. 30-year T-bonds) or crash (e.g., 5-year T-notes).

    Bottom line, diluting the money supply to finance spending creates economic distortion — it masks the true cost of government, which would be painfully obvious if all spending were financed by taxing and borrowing. This is a terrible way to run an economy. It subtracts from, rather than enhances, economic efficiency. But the Fed’s deluded academics, bereft of common sense, are unable to see this.

     

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 2:55am

    #16

    Stan Robertson

    Status: Gold Member

    Joined: Oct 07 2008

    Posts: 516

    Re: Alert: QE II Has Lit the Fuse

    Pejorative look at QE2: Wrong in places but still funny.

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 11:01am

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    [quote=machinehead]

    [quote=remcoxyii]

    Even without monetization (increase in monetary base), inflation can increase, if the money velocity increases (M*V=P*Y).

    As Hussman showed the money velocity is proportionally falling with the increase in monetary base. And thus has an increase in MB no effect on nominal GDP (whether through inflation or rising production).

    [/quote]

    These two sentences contradict each other. Although an exogenous increase in velocity could produce inflation, Hussman’s real-world data shows that it doesn’t happen.

    All real-world inflations involve monetization. There is no documented instance where, in the presence of a stable monetary base, velocity suddenly just took off like a rocket and prices went wild. 

    This scenario is about as likely as a gravity reversal. Wink

    [/quote]

    Suppose at one instance in time, the private sector sits on cash due to economic uncertainty. Then, things are starting to look brighter, and they are going to invest/spend again. Money velocity increases, while the money supply is still constant (assuming they finance spending with the cash they are already sitting on; not by creating new loans). Just a change in behaviour made the velocity increase.

    I think that scenario is a bit more likely than a gravity reversal. (But it was a theoretical example FWIW).

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 11:31am

    Reply to #15
    dbworld

    dbworld

    Status: Member

    Joined: Sep 14 2009

    Posts: 10

    Re: Alert: QE II Has Lit the Fuse

     remcoxyii and machinehead, Thanks for the commentary. Cudos to both. Got a bit dizzy at the end but couldn’t help from reading this great exchange of opinions..

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 11:48am

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    First of, the government doesn’t need to issue bonds to the public to finance spending. It is just a way to control the money supply.

    OK, now your example. To consider the impact on inflation you should look at ALL government liabilities. Spending power is what drives inflation. In step 1 and 2, 1 trillion of financial assets are added to the private sector. That is the inflationary event. Again, the amount of bankdeposits does not matter; it is the amount of TOTAL government liabilities that matter, and, in your example, it increased with 1 trillion. Step 3 merely changes the composition of those government liabilities.

    Let me give another example.

    -Suppose the government buys a service from me worth 100k, by crediting my bankaccount with 100k. Now, 100k financial assets are added to the private sector, increasing spending power.

    -Suppose I want to use 50k for consumption and 50k I want to safe. Now, the government issues a 100k treasury auction, and I decide to participate for 50k. I now hold a 50k bankdeposit, 50k treasuries. The other 50k treasuries is bought by another private sector participant. So the money supply in step 1 and 2 is unchanged.

    -Now the central bank comes, and buys my treasuries for 51k (price must be higher, otherwise I wouldn’t sell, because I voluntarily chose this asset allocation). I now have 101k in my bankaccount.

    So it was the government spending which caused the increase in spending power. The central bank just changed the composition of my asset allocation. But, most likely, I am not going to magically spend that 51k on goods now….I chose to save in the first place, and that motive did not change due to central bank intervention. The only thing that might have changed is that it chased me out of treasuries. But, since my motive didn’t change, I most likely reinvest that money in for instance agency debt. Or put it in a savings account. I see no reason that I need to spend it now (although the Fed really wants you to do it). (also note that the 1k extra due to Fed intervention is likely more than offset due to the loss of interest)

    Even if I somehow were to magically spend it, it was the GOVERNMENT spending which made it possible in the first place.

    You say it yourself:

     This time, the net result is that the Government purchased $1 trillion in goods and services by creating $1 trillion of new deposits. Issuance of debt wasn’t even necessary. The Government could simply purchase goods and services by using its sovereign monopoly over the banking system to create new deposits. (In cash basis economies, this is done by printing banknotes.)

    It is only step 2 that mattered in your example. And that is government deficit spending.

    So point is, worry about government deficit spending if you’re concerned about inflation; not Q.E.

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 2:55pm

    #17

    pinecarr

    Status: Gold Member

    Joined: Apr 13 2008

    Posts: 1121

    Re: Alert: QE II Has Lit the Fuse

    I’d be interested in others’  take on this article from Zerohedge, 

    “Is QE2 A Stealthy $90 Billion Gifting Scheme To The Primary Dealers?”

    http://www.zerohedge.com/article/qe2-stealthy-90-billion-gifting-scheme-primary-dealers

    We have previously discussed how due to the inability to know at what price (par or market) the Fed is buying back bonds from the Primary Dealers, there is a distinct possibility that due to the par-market difference, especially with many CUSIPs trading near record prices over par, the Fed may be implicitly letting PDs pocket the market-to-notional difference. The total, as shown below, could amount to over $40 billion. Furthermore, by avoiding the tight spread of on the run bonds, the Fed is effectively allowing PDs to pocket a huge bid/offer spread, which assuming a total size of ~$800 billion (low estimate) of all USTs bought over the (initial) life of QE2, aka QE2.5 and higher pre-extensions, amounts to $50 billion over the next 8 months. Since the money paid out is certainly not that of Brian Sack, but of the US taxpayers, to which the FRBNY has repeatedly demonstrated it has no fiduciary obligation, one can see why it is prudent to ask just how much leakage is occurring as the Fed is monetizing. Surely the Chairman can see why at a time when Wall Street is about to pocket $150 billion in bonuses, America can be a little concerned with the possibility that QE2 in addition to being a blatant debt monetization scheme, is also a direct taxpayer funding mechanism to the Primary Dealers.

     

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 3:08pm

    Reply to #15

    machinehead

    Status: Silver Member

    Joined: Mar 18 2008

    Posts: 241

    Re: Alert: QE II Has Lit the Fuse

    [quote=remcoxyii]

    First of, the government doesn’t need to issue bonds to the public to finance spending. It is just a way to control the money supply.

    [/quote]

    This is a characteristic assertion of an economic fallacy known as Chartalism, which recently goes under the moniker of Modern Monetary Theory.

    http://en.wikipedia.org/wiki/Chartalism

    The proposition is self-evidently absurd. I can assure you that if governments didn’t need to borrow to finance public spending, they wouldn’t go to the trouble of doing so.

    Chartalists assume that fiat currency issuers simply print all the thin-air currency they need, and merely auction bonds for sterilization purposes, to prevent the money supply from hyperinflating.

    This assumption gets the causation exactly backward. Governments have always taxed and borrowed to fund their spending. They still do. At every government on earth, spending equals tax revenues plus borrowing — no exceptions. 

    But at this point, Chartalists start the rhetorical sleight of hand with consolidated accounting, arguing that the central bank and the fisc collaborate to employ outright monetization as a source of revenue. Under current institutional arrangements, it just isn’t so. In the rare cases where this HAS occurred — e.g. Zimbabwe — a hyperinflationary collapse quickly ensued. 

    The Chartalist assertion that ‘to consider the impact on inflation you should look at ALL government liabilities’ contradicts the basic definition of money. Bank deposits are money (M1) because they are immediately spendable as currency. Long Treasury bonds are not money because they are not spendable; you must sell them to obtain spendable currency.

    Since the Chartalist fallacy rejects the commonly accepted definition of money, further debate is unproductive.

    If the Chartalist fallacy were true, we could print our way to unlimited wealth. Since no fiat issuer has ever succeeded in doing so [indeed, the opposite has occurred], Chartalism has been empirically proven — at least to my satisfaction — to be a delusion and a fallacy.

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 3:30pm

    #18
    data gatherer

    data gatherer

    Status: Member

    Joined: Nov 01 2009

    Posts: 1

    Re: Alert: QE II Has Lit the Fuse

    Chris (or anyone else) – what kind of solar water heater did you research?  Any recommended links to descriptions of options?

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 3:51pm

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    “This is a characteristic assertion of an economic fallacy known as Chartalism, which recently goes under the moniker of Modern Monetary Theory.”

    Yes. And I strongly believe it describes the current monetary system in the U.S. best.

    “The proposition is self-evidently absurd. I can assure you that if governments didn’t need to borrow to finance public spending, they wouldn’t go to the trouble of doing so.”

    You are thinking of a goldstandard system. In such a system, governments needed to borrow to finance public spending. Under the modern monetary system this simply isn’t the case. The Eurozone is different in that respect: the fiscal authority can not print there own currency, therefore, they have to borrow to finance public spending, and they can technically default, whereas the U.S. will not technically default, unless they choose to (this is exactly what Bernanke said in a Congessional Hearing), since the U.S. does not have foreign denominated debt. Ofcourse it could very well lead to hyperinflation.

    You even said it yourself: “ Issuance of debt wasn’t even necessary. The Government could simply purchase goods and services by using its sovereign monopoly over the banking system to create new deposits.”

    “Chartalists assume that fiat currency issuers simply print all the thin-air currency they need, and merely auction bonds for sterilization purposes, to prevent the money supply from hyperinflating.”

    Not hyperinflating, prevent inflating or deflating too much. Price stability is one of the Fed’s directives. Also, bond auctions are used to target the overnight rate.

    “This assumption gets the causation exactly backward. Governments have always taxed and borrowed to fund their spending. They still do. At every government on earth, spending equals tax revenues plus borrowing — no exceptions.”

    Governments have always taxed to finance spending in the past, because they needed to in a gold-based monetary system. Not in the modern monetary system after the goldwindow closed.

    “The Chartalist assertion that ‘to consider the impact on inflation you should look at ALL government liabilities’ contradicts the basic definition of money.”

    Exactly. And the relation between ALL government liabilities and inflation is much stronger than M1 and inflation. See hussman again.

    “If the Chartalist fallacy were true, we could print our way to unlimited wealth.”

    Not at all! If you spend too much and tax too little, it will just create inflation. No real wealth is then created.

    “Chartalism has been empirically proven — at least to my satisfaction — to be a delusion and a fallacy.”

    I have not seen such emprical data; please show it to me. I think some of your idea’s about modern monetary theory might be based on misconceptions, like the one that MMT says we can print our way to wealth. Is just doesn’t say that.

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 11:21pm

    #19
    Carl Veritas

    Carl Veritas

    Status: Bronze Member

    Joined: Oct 23 2008

    Posts: 66

    Re: Alert: QE II Has Lit the Fuse

    remcoxyii,

    $500.00 in 1980 has the same buying power as $1,325.48 in 2010        What caused this, and what would you call it?

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 11:37pm

    Reply to #19
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    $500.00 in 1980 has the same buying power as $1,325.48 in 2010        What caused this, and what would you call it?

    Price inflation, due to government deficit spending and excessive private sector credit creation. Why?

    Login or Register to post comments

  • Sat, Nov 13, 2010 - 11:53pm

    Reply to #19
    Carl Veritas

    Carl Veritas

    Status: Bronze Member

    Joined: Oct 23 2008

    Posts: 66

    Re: Alert: QE II Has Lit the Fuse

    Did anyone else do any spending, aside from the government?   

    Login or Register to post comments

  • Sun, Nov 14, 2010 - 12:02am

    Reply to #19
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    [quote=Carl Veritas]

    Did anyone else do any spending, aside from the government?   

    [/quote]

    Yes. I think I answered that in the previous post. What is your point?

    Login or Register to post comments

  • Sun, Nov 14, 2010 - 12:15am

    Reply to #18

    jturbo68

    Status: Bronze Member

    Joined: Aug 04 2009

    Posts: 99

    Re: Alert: QE II Has Lit the Fuse

    [quote=data gatherer]

    Chris (or anyone else) – what kind of solar water heater did you research?  Any recommended links to descriptions of options?

    [/quote]

     

    I purchased the following:

    Controller/Heat Exhanger/Pump Kit from :   http://www.solarhotusa.com

    Marathon Lifetime Hot water heater  :   http://www.marathonheaters.com/

    And an evacuated tube collector from :  http://www.apricus.com/

    I would recommend any/all of the above.

    I went this route because my state was giving a $400 rebate for energy star approved solar hot water and the solar hot/apricus system was certified.  It is a good system.

    Also,  I went with a drainback system over glycol, and overall think that is a lower maintenance/hastle way to go as it avoids problems of having overheated glycol when your pumps stop on a hot day.  In a failure state, the system just drains, to avoid stagnation.

    Be aware, that with a drainback system you must have a downslope all the way from the collector to the pump kit/drainback tank.

    Also be aware that the circulation loop will make some flowing/gurgling noises whenever the pumps comes on, until it has filled and purged the air from the circulating loop.  Not too bad, but noticeable for about a minute or two, probably  good to avoid running piping thru walls or floors near a living area.  I ended up running the piping down an outside wall and hiding the pipes in a section of downspout.

    John

     

    Login or Register to post comments

  • Sun, Nov 14, 2010 - 12:37am

    #20
    Carl Veritas

    Carl Veritas

    Status: Bronze Member

    Joined: Oct 23 2008

    Posts: 66

    Re: Alert: QE II Has Lit the Fuse

    The activities of both government AND central bank produces price inflation, over time.   Are you saying the central bank has nothing to do with this?

    Login or Register to post comments

  • Sun, Nov 14, 2010 - 3:53am

    #21

    idoctor

    Status: Bronze Member

    Joined: Oct 05 2008

    Posts: 33

    Re: Alert: QE II Has Lit the Fuse

    http://www.youtube.com/watch?v=4loKXyueAt4

    http://www.youtube.com/watch?v=YG3kMbUwMPM

    Login or Register to post comments

  • Sun, Nov 14, 2010 - 12:24pm

    Reply to #20
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    [quote=Carl Veritas]

    The activities of both government AND central bank produces price inflation, over time.   Are you saying the central bank has nothing to do with this?

    [/quote]

    No, I’m not saying that. Central banks influence reserves and interest rates, which both can stimulate lending. In periods where banks are reserve constraint and/or interest rates are too low, this can certainly be inflationary.

    However, today, banks are not reserve constraint. And interest rates can not be lower. Q.E. does not stimulate lending (and there is a lot of empirical data to back that up; look for instance at Japan).

    Login or Register to post comments

  • Sun, Nov 14, 2010 - 2:14pm

    #22
    plato1965

    plato1965

    Status: Bronze Member

    Joined: Feb 18 2009

    Posts: 86

    Re: Alert: QE II Has Lit the Fuse

     

     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.

       I think there’s room for some doubt here… will the USG actually avail itself of the facility ?

    Or might the new congress decide on austerity/responsibility…  ?

     http://www.youtube.com/watch?v=Bk57K4OGrAg

     

    Login or Register to post comments

  • Mon, Nov 15, 2010 - 2:05pm

    #23
    osb272646

    osb272646

    Status: Bronze Member

    Joined: Mar 14 2010

    Posts: 42

    Re: Alert: QE II Has Lit the Fuse

    Why do we let the politicians and the Fed get away with legitimizing their program by giving it a fancy name?  What is Quantitave Easing anyway?  QE, QE2, …… QEx.  What a joke.   To Joe Sixpack, it sounds like they’re doing something high falutin’, way beyond the grasp of the man on the street.

    We should stop playing along with these guys and call a spade a spade.  It’s Printing Inflation.  PI. 

    Login or Register to post comments

  • Mon, Nov 15, 2010 - 2:57pm

    #24

    h2oBoy

    Status: Bronze Member

    Joined: Jun 18 2009

    Posts: 30

    Re: Alert: QE II Has Lit the Fuse

    I have been reading Automatic Earth regularly and heard Nicole Foss speak this past weekend. Today’s post seems to go against my thinking and what I believe CM is suggesting. Can someone give me some feedback on their viewpoint of deflation and a rising $ vs devaluation.

    Article can be accessed at http://theautomaticearth.blogspot.com/

    In the fore- and after math of last week’s QE2 announcement by Ben Bernanke (by the way, I really like Frederick Sheehan’s observation: Ben Bernanke: The Chauncey Gardiner of Central Banking), a vast majority of the usual experts and analysts were convinced that A) the dollar would greatly devalue, and B) vast amounts of money would blow giant bubbles in markets across the world, especially in Asia.

    Since the announcement, though, the US dollar has gained some 4-5% against the euro, while last night’s plunges of -5.16% in Shanghai, -2% in Hong Kong and Indonesia, and -1.4% in Tokyo, don’t exactly corroborate the usual suspects’ bubble theories either.

     

    Login or Register to post comments

  • Tue, Nov 16, 2010 - 12:08am

    Reply to #15
    remcoxyii

    remcoxyii

    Status: Member

    Joined: Sep 11 2009

    Posts: 0

    Re: Alert: QE II Has Lit the Fuse

    [quote=machinehead]

    If the Chartalist fallacy were true, we could print our way to unlimited wealth.

    [/quote]

    I want to expand a little on this, as a last post on this topic not to bore anyone any further 😉

    MMT says government deficit spending increases net FINANCIAL assets in the private sector. But that is not the same as total REAL wealth. By spending, the government appropriates goods and services from the private sector. These represent wealth as well. So, although financial assets are added to the private sector by deficit spending, goods and “working hours/services” are “lost” by the private sector. 

    Looking at the whole picture, the currency created by deficit spending is a liability of the government, while it is an asset of the private sector. This nets out. So total real wealth (at least how I define it with common sense) in your society doesn’t change by deficit spending. However, it might stimulate productivity (or have a negative impact if fiscal policy is reckless) and create or destroy real wealth.

    P.S. Concerning treasuries I meant that treasuries are very often used as collateral for loans in the private sector. So treasuries can easily be leveraged to buy goods. So there is not much distinction between treasuries and reserves, if banks are not reserve constraint.

     

    Login or Register to post comments

  • Mon, Nov 22, 2010 - 12:33am

    #25

    Augustine

    Status: Member

    Joined: Oct 13 2009

    Posts: 1

    Re: Alert: QE II Has Lit the Fuse

    And then we have this interesting slide from here which hints that such levels of deficit monetization lead not only to rampant inflation, but to hyperinflation.

    Click to enlarge

    Login or Register to post comments

  • Mon, Nov 22, 2010 - 5:11am

    #26

    Travlin

    Status: Gold Member

    Joined: Apr 15 2010

    Posts: 524

    Re: Alert: QE II Has Lit the Fuse

    Thanks Augustine.  That was a very interesting link.  I followed it to another link about how hyperinflation would happen in the US that was even more interesting.

    How Hyperinflation Will Happen In America

    Travlin 

    Login or Register to post comments

  • Tue, Nov 23, 2010 - 5:29am

    Reply to #26

    Augustine

    Status: Member

    Joined: Oct 13 2009

    Posts: 1

    Re: Alert: QE II Has Lit the Fuse

    Thanks, Travlin.

    However, the article implies a rather fast pace of events (say, Weimar-style).  In my own personal experience as a Brazilian, the path to hyperinflation took a much slower pace, almost slow-motion.  And from what I have seen in the last 3 years, looking at the damage done to the currency and how inflation reacted, I believe that America will follow the Brazilian style, possibly because of sheer inertia of such a massive economy as America’s.

    I grant that this time is different because it’s global, but in Brazil hyperinflation happened because of a burst bubble in government credit, not too dissimilar to the current all-around credit bubble burst.  As a matter of fact, it’s following even a similar time-line to Brazil’s crash in 73, triggered by that oil crisis.  In this sense, then as now, the trigger that will put the last nail in the coffin will be oil again.  Then, oil ceased to be cheap; now, cheap oil ceased to be.

    I actually wish that I could research Brazil’s case better, but it happened some time ago (through the mid 90’s) and before the Internet was the data repository that it is now, so I rely a lot on my memory growing up in that period, as well as my father’s, and on some scant literature from then.  I think that it could be an useful reference to understand and even track the current hyperinflationary process.

    Cheers.

    Login or Register to post comments

Login or Register to post comments