Zero Chance for QE3?
Against my blood pressure's best interest, I often try to seek out opinions contrary to my own just to see how the "other side" is seeing things.
Does anyone have any opinion on this article here? There were a couple of lines that made me think I was reading some sort of parody (which I've bolded).but perhaps I've been in the goldbug/Austrian camp for so long that I've forgotten how out on the fringe I am. On the other hand, this is a good overview and worth reading if you need a constant refresher on basic economic concepts, as I do. I would agree that "rhetoric" seems to be the order of the Fed's day — the psychological impact of nascent Fed action seems to keep the market afloat even sans any real action.
Zero Chance For QE3 – The Fed's Job Is Done
Stocks have moved dramatically on the "bad is good" theory of investing in recent weeks. That theory states that more bad news will motivate the Federal Reserve to go to QE3 and inflation will be the result, driving equities and other assets higher. The flaw in that thinking is that investors simply don't understand what QE actually does and why additional QE will not have any impact.
To assume that QE3 will work to expand money supply and regenerate inflation is a flawed assumption. Investors who are basing their investment decisions on QE3 are going to be disappointed. A little refresher course on Money and Banking should help to shed some light on the matter.
The fractional banking system and QE impact on money supply:
Let's consider the Federal Reserve's purpose for initiating QE. The goal is to inject liquidity into the fractional banking system so that banks can increase lending and in so doing expand money supply. It is a misnomer to assume that the Federal Reserve can create money out of thin air as some apparently believe. What they can do is set the stage for the fractional banking system to print money.
Keynes tells us what we need to do to stimulate economic growth when we are in a recession or a depression:
" … if Investment exceeds Saving, there will be inflation. If Saving exceeds Investment there will be recession. One implication of this is that, in the midst of an economic depression, the correct course of action should be to encourage spending and discourage saving. This runs contrary to the prevailing wisdom, which says that thrift is required in hard times. In Keynes's words, 'For the engine which drives Enterprise is not Thrift, but Profit."
The table below is revealing in that it establishes that we have done the exact opposite of what Keynes says is necessary for a recovery. What we have done since the start of the Federal Reserve's QE programs is increase savings.
Impact of QE1 and QE2 on Money Supply(trillions)
|Action||M2||Savings||M2 – Savings|
|QE1 start- Nov, 2008||7.995||4.032||3.963|
|QE1 end – Mar, 2010||8.502||4.963||3.539|
|QE2 start – Nov, 2010||8.747||5.297||3.450|
|QE2 end – June, 2011||9.165||5.717||3.448|
The table above shows a modest expansion in M2 during the QE years from $7.995 trillion to $9.926 trillion – an increase of 24% over the period which works out to be an annualized rate of increase of 7.7%.
By contrast, the two year period of time just prior to initiating QE1 resulted in annual increase of 6.7%. Considering the magnitude of the Fed action to inject liquidity into the banking system, an 1.1% increase in the rate of growth of M2 is insignificant.
The next number to look at is the savings portion of M2. Savings is broken out as a separate line item of the total M2 figure. According to Keynesian theory, we want savings in dollar amounts to decrease, remain flat or at least expand at a slower rate than the broader M2 number.
Here's why we want and need savings to remain at low levels. As Keynes points out, conventional wisdom suggests that you should save during times of uncertainty and economic contraction but that is the exact opposite of what we should do. From an individual perspective, this might be a wise decision but for the broader population to engage in a policy of paying off debts and saving virtually insures a continuation of the recession.
It's a rather circular process that is either working in the right direction or the wrong direction from a macro point of view. If we begin to spend at an increasing rate, the effect is an increase in the demand for goods and services. As demand increases more workers are needed. As those workers are hired, the unemployment number shrinks and more workers, now with paychecks, enter the consumer pool and begin to spend. That increases demand further requiring additional hiring to meet the demand. As the process continues, we eventually reach full employment.
The counter view is that we reduce spending, which reduces demand, which results in layoffs, which reduces the consumer pool, which reduces spending further resulting in further demand reduction and more layoffs. The result is an increasing rate of unemployment and shrinking demand, which impacts corporate profits.
The table above shows that we as a population have not reacted as we should to stimulate growth. Instead, we have taking what Keynes refers to as the "prevailing wisdom" path. We have paid down debt and increased savings. The reaction is a natural one in that we don't know when we might get a pink slip ourselves – best to prepare for it is the logic.
Savings have grown from $4.032 trillion to $6.377 trillion during the QE period – an increase of 57% versus the M2 growth increase of 24%. Savings has increased at a rate of 2.4 times the rate of increase in M2.
The last set of numbers above shows the real impact of QE – it shows the direction that spendable money has taken. To arrive at that number we subtracted the Savings portion of M2 from M2. The result is the amount of money we presume to be available for spending. Remember, as spending shrinks the economy contracts and unemployment moves higher.
The M2 less Savings number started out at the beginning of QE at $3.963 and ended at $3.589 on June 30, 2012. That is a reduction in real spendable dollars of 9.5% over the period. What we can take away from this is that the problems we are facing in our attempts to recover are in fact of our own making.
The Federal Reserve has gotten a bum rap from politicians and the public. They have done their job, which is to set the stage for a recovery. The Fed didn't create the problem in the first place but they did step in and did what they could within the scope of their powers to set the stage for a recovery. The fact that banks, politicians and U.S. citizens didn't cooperate is simply not the Fed's fault.
So what has the Fed done? The Fed has reduced interest rates all along the yield curve with rate cuts and Twist operations. Additionally they have flooded the banking system with cash. Let's take a look at how the fractional banking system really works.
The Federal Reserve operates as a guidance system for the economy by expanding or contracting money within the economy. They do that by increasing or decreasing cash reserves within the banking system.
The nation's banks must maintain a cash balance equal to 10% of liabilities, which means that they can't make loans when that cash position drops below the reserve threshold. When banks make loans, they are effectively adding cash into the economy. When loans are paid off they are effectively reducing cash in the economy.
When the Fed wants to expand money supply, it injects cash into the system by buying Treasuries that the banks own. The balance sheet impact is a reduction in Treasuries and an increase in cash on the banks' books and the exact opposite effect on the Fed's books.
Now the banks can increase the dollar amount of loans. So what has happened since QE1 and QE2? What we have done is nothing. The banks have been reluctant to loan and borrowers have been reluctant to borrow. Both groups have valid reasons for taking these positions but the impact is that we have fallen into a period of stagnation as a result and it is entirely possible that this deleveraging process coupled with self imposed austerity will continue. If that is the case, we can expect continued high employment and shrinking corporate profits.
The Feds frustration and what they will do this week
As we prepare for the announcement of additional stimulus, the Fed must be frustrated. Additional QE can accomplish nothing at this point. Here is why: All QE can do is inject additional cash into the banking system. It can't force the banks to lend it out nor can it force borrowers to borrow it.
The banking system is flooded to overflow with liquidity that is not being utilized. Further increases in that liquidity will not change a thing at this point. It would be like adding water to a glass that is already full to the brim. Adding water to the glass till it overflows will not make you drink if you are not thirsty.
The Fed is stuck in a situation where the only tool they have at their disposal is rhetoric. Actual QE is useless but since the public and in particular investors don't understand how the process works they still have the hope that the public will respond to the promise that the "Fed has their back."
Expect more of the same from the Fed this week. There will be no QE – that would be bordering on irresponsibility. There may be an extension or modification of Twist, which is designed to keep interest rates low along the yield curve. Of course, rates are already low and no one's borrowing, so that is not likely to have much impact.
As Bernanke told all those who actually paid attention in his recent Jackson Hole speech, Fed policy going forward is very limited in what it can accomplish:
"Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain and the use of nontraditional policies involves costs beyond those generally associated with non-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies. In addition, in the present context, nontraditional policies share the limitations of monetary policy more generally. Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly can't fine tune economic outcomes." Bernanke speech at Jackson Hole, August 31, 2012
Understanding "Fed speak" is not particularly easy if you don't understand the fundamental concepts of monetary policy. Hopefully after working your way through this brief explanation you now have a better understanding of how all this works. If not, I will try to translate.
What Bernanke is saying is we have done all we can do. We have flooded the banks with liquidity and flattened the yield curve like a pancake. It is now up to Congress, the president, the banks and the people to do their part.
Notwithstanding that position, the Fed will use what they refer to as "education and forward guidance" to keep our hopes alive. What we can expect from the Fed is a continuation of the current Twist program with some minor changes – probably a more open ended version of the current program. All that will do is keep interest rates down though. It won't force banks to lend or borrowers to borrow.
The Fed has primed the pump. There are massive amounts of liquidity in the banking system and large cash balances in the banks. The Fed can do no more.
Bernanke will conclude with his boiler plate remark:
"Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in the labor market conditions in a context of price stability." Bernanke speech at Jackson Hole, August 31, 2012.
I’m sorry, did you say something? 🙂
(that comment is intended for the writer of the article, not the person who posted it here)
Keynes must be shaking his head in his grave. It’s all over google qe3 gets the green light so….
more like qe infinity…..there will never be need for qe4, this can go on forever.
more like qe infinity…..there will never be need for qe4, this can go on forever.
Well D, assuming a perfect storm, correct planetary and star alignment, a couple of zaps from the HAARP array and some crop dusting from the chemtrailers it is theoretically possible that the FED can indeed inflate this mess away in a controlled manner at a very slow rate.
I figure by the time they’re done and have things under control, all the mess from Fukushima will have decayed away and people will still be debating global warming/climate change.
Does anyone else get the feeling that with QE3 the economy has been moved from intensive care to life support?
No question about it.. our worst fears are being realized. From ZH;
What happens next:
- Imminently, the Fed’s Open Markets Operations desk will commence buying $40 billion in MBS per month, or about $10 billion each week. Concurrently, the Fed which is continuing Operation Twist, will still purchase $45 billion in “longer-term” Treasurys, sterilized by the $45 billion or so in 1-3 years Bonds it will sell until the end of the year at which point it runs out of short-term paper to sell.
End result: every month through the end of 2012, the Fed’s balance sheet expands by $40 billion in MBS.
- Beginning January 1, 2013 the Fed will continue monetizing $40 billion in MBS each month, and will continue Operation Twist, however it will adjust the program so that it continues to increase its long-term holdings at $85 billion per month, without sterilization as it will no longer have short-term bonds to sell. It will also need to extend its ZIRP language “through the end of 2016” so all bonds 1-3 years are essentially risk free, as they are now, in effect eliminating the need to sell them.
End result: every month in 2013 the Fed will increase its balance sheet by $85 billion, consisting of $40 billion in MBS, and $45 billion in 10-30 year Treasurys, or the natural monthly supply of longer-dated issuance. The Fed will therefore monetize roughly half of the US budget deficit in 2013.
Putting it all together, the Fed’s balance sheet will increase from just over $2.8 trillion currently, to $4 trillion on December 25, 2013. A total increase of $1.17 trillion.
For me, the money line is this; “The Fed will therefore monetize roughly half of the US budget deficit in 2013. ”
Does anyone else get the feeling that with QE3 the economy has been moved from intensive care to life support?
Feels ominous. Seriously.
…as it all slowly unfolds. The tsunami keeps rising higher and higher juuuuust offshore while the MSM talks its happy talk and all the snoozing sunbathers on the beach debate whether they should reapply their SPF and catch another half hour of rays, or just go ahead and eat their picnic lunch in the shade of their umbrella. Great day in the morning but late ’12 and alla ’13 are going to simply be beyond belief — except for those who are habitués of PP, ZH, et Alia. Things are going to accelerate, and magnify, and I only wish I had three-point harness in large enough supply for all those I care about. As I type this, fire trucks in the distance are wailing their way to a fire somewhere not far away. How apropos. Carpe the f’ing diem, gang… And in the meantime, tomorrow night I play my occasional role as DJ for a freestyle dance party for a community I care deeply about (and amongst whom I have tried to raise consciousness — with some excellent results with certain folks, but with plenty of “chirping crickets” moments elsewhere.) When I’m done doing my thang and I hand off to the next Deej a floor fulla people in happy gyration, I will take my spot in the crowd and dance until I’ve gotten all my ya-yas out. Apart from prepping the garden for next Spring’s plantings at my new place, it kinda feels like that’s all there is left to do. May Fortune smile on us all. Fortuna favet fortibus… Viva — Sager
Here’s some more sage advice… TBH, I was thinking that more QE wouldn’t be announced this go-around, as it would lack the “surprise” element. Well, if there’s one thing the Fed is consistent on, it’s incompetency. I would agree that it makes sense for the Fed not to ease again; given the rational reasons for not easing again, it would make sense to short gold. Gah, it’s very hard for me to get my head around the sort of M.C. Escher thought-milieu that these people inhabit.
In a recent King World News piece, Michael Pento went on record saying there was a “99%” chance that the Fed would do another round of easing, and it looks like he was right.
Sell Gold Before Bernanke’s Address Today
By Jared Cummans
Here it comes, yet another chance for Bernanke to announce QE 3, and as has been precedent this year, another chance for him to disappoint markets. At his Jackson Hole speech, Bernanke stood pat by stating that the Fed was willing to help the economy, but was waiting to step in. But last Friday’s jobs report has put more pressure on Bernanke than ever. Though our unemployment rate dropped to 8.1%, it was another case of the government’s data being controversially reported, as fewer jobs were added. That combined with Mario Draghi’s willingness to step in for the EU has put a bullseye on Bernanke’s address to Congress tomorrow.
But while many investors will be hoping for a third round of QE, it seems unlikely that Bernanke will make such a move. Yes, last Friday saw a weaker than expected jobs report by 4,000 non-farm payrolls, but let’s also not forget that GDP revisions showed a jump from 1.6% to 1.7%. Minuscule, I know, but Bernanke and company have been extremely cautious about injecting the economy with more money for quite some time now, and resting their hat on a figure like GDP growth may be enough to justify a continued wait-and-see approach.
Many are of the thinking that because Draghi announced a program, Bernanke will follow suit, but that may not be the case. Keep in mind that Draghi’s program is specifically designed to ease debts of countries that can barely keep themselves afloat. The U.S. is already under a massive pile of debt, totaling to $16 trillion. More QE would only raise that number, as the funding would not come from a conglomerated source like the ECB. Instead, Bernanke’s reasons for QE would be to aid the stock market and stimulate growth; note that markets are sitting near post-recession highs even with last week’s sour jobs data. Our economy may not be in full force, but we are still a long ways from a recession, and therefore making it unlikely that Bernanke will pick tomorrow’s address to announce QE 3 [see also How Will Gold Perform During the Euro’s Make or Break Week].
We recommend selling gold short prior to today’s address, as a fair amount of the market has priced in a third QE and is simply waiting on its toes for the announcement. If it does not come, as we have predicted, gold will likely take a nose dive for the session, presenting a strong opportunity for active traders to turn a quick, handsome profit. We like the SPDR Gold Trust (GLD) for traders, as the fund traders more than 9 million times each day and offers an extremely active options market. Of course, standard gold futures will work just fine but may not be quite as liquid as this physically-backed ETF. Be sure to have your finger on the trigger during Bernanke’s speech, as the reaction from this commodity will be swift.