Rickards is wrong. There is no perpetual QE.

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Thinkor's picture
Thinkor
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Rickards is wrong. There is no perpetual QE.

Jim Rickards recently wrote a paper entitled "Perpetual QE - The stock is the flow".   Here is a link.

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2011/3/11_Jim_Rickards_-_QE_is_dead,_long_live_QE!.html

Rickards contends that the Fed's balance sheet has grown so large (owns so many securities), that the Fed can use the principal repayments to finance the deficit, thus extending QE indefinitely without enlarging the Fed's balance sheet.

He says

the size of the Fed’s balance sheet is now so vast that the reinvestment of principal payments from the existing assets will be enough to monetize a large portion of the Federal deficit without having to increase the total size of the balance sheet.

The problem with this is obvious.  When the Fed purchases a security it expands the monetary base by creating money to pay for the security, but when the principal is repaid that security disappears from the Fed's portfolio and money is destroyed just as when a security is sold by the Fed.   So,  by using the principal repayment to acquire a new security, the Fed only counterbalances the money destroyed when the principal repayment was made.  There is no net money creation without a net purchase of securities by the Fed and an expansion of its balance sheet.

If there's no net money creation, how on earth can you call it QE?

Another way to look at it is this:  The government has debt representing sales of its securities in previous years that it must rollover and it has new debt it wants to issue this year to pay for this year's deficit.   The Fed bought some of that rollover debt.  When the principal paid on treasury from two year ago, the Fed can apply that repayment to (1) finance the rollover or (2) finance the deficit, but it can't do both with out net monetization, which necessarily expands its balance sheet.

When the Fed stops QE it will stop monetizing the deficit OR the rollover, but the effect will be the same, interest rates shooting up,  a collapsing stock market, etc, etc. 

I've done a lot of looking around the internet.  No one seems to be questioning Rickards' analysis.  I think they are so dazzled by his reputation that they are not bothering with the due diligence of understanding not only his conclusion but his reasoning as well.

 

 

 

cmartenson's picture
cmartenson
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RIckard's analysis...funny thing

Great catch.  I actually have a whole piece written refuting that work by Rickard's largely along the lines you describe, but events swamped its release.

Short story, his reasoning is sound with regards to MBS paper, but goes completely off the tracks for Treasurys.  It's a matter of the difference between roll-overs and incremental Treasury issuances and the associated money flows, which he missed.

Again, well spotted.

Johnny Oxygen's picture
Johnny Oxygen
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I suppose its all smoke and

I suppose its all smoke and mirrors anyway.

The Fed has said at least 3 times that it will stop QE but didn't.

There is nothing stopping them from saying QE is dead and then continuing to print whatever they want 'secretly' since there is no transparency in the banks or government.

IMO its all a done deal. The bullet is in flight. We are just waiting for the impact.

r101958's picture
r101958
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Can't realistically stop QE

The Fed really can't, at this time, stop QE. It would be tantamount to unplugging the real estate market which is already on life support.

Jim H's picture
Jim H
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You can call it what you want...

But the end result is that by using the FED's balance sheet interest to create more incremental demand for US securities that would not otherwise be there, you are perpetuating the perversion that is QE... you are allowing us to spend beyond our means indefinitely, and not feel the pain of our profligate spending by manipulating interest rates downward (to some degree).  Taken to an extreme.. why not allow the FED's balance sheet to balloon to, say, $10 Trillion worth of Treasuries...   boy, that ought to throw off some great interest!  Actually, I vote for $15 Trillion, and a big tax cut to boot!

Thinkor (and Chris???)... you have just created the perpetual, painless money machine... Well Done!  You are talking accounting identities.. I am talking common sense.  

 

 

Jim H's picture
Jim H
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Even Better

Actually guys... your discovery of the painless, free money machine is even better than I had originally thought...   We all know that, in a rising rate environment.. the only way to not lose money on your bond portfolio is to simply hold to maturity.  Taking that principle one step farther... we realize the beauty of the newly invented perpetual money machine... it performs superbly in a rising rate environment!  When you roll over the principle... you get more interest than before on the new securities.   

You have just invented a means for Ben to raise interest rates, benefit himself, kill PM's, and support our ponzi Gov't financing all at the same time!  And here we thought the FED would be mark-to-market insolvent in a rising rate environment... NONSENSE!  Bring it on.     

 

h2oBoy's picture
h2oBoy
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Even better??

I listened to Rickards talk and, not understanding the concept, took his reputation and rested easier with my PM and miners. If there is more to this I feel everyone here invested in PMs hopes those who are able will dig deeper, follow this and provide the majority of us ongoing translations. Considering everything we're preparing for, understanding the landscape is key. QE or no QE or a hidden alternative....

Jim H's picture
Jim H
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I can't let this go....

So....  I don't know why this one sticks in my craw to the degree that it does..... but I feel the need to keep pounding away here.

You are both saying that use of principle repayments (retirements) to the FED to buy new Treasury debt is not QE.  That may have some semantic truth.... again.. an accounting identity.  

But:  As long as the US Debt Clock is spinning upward (currently at a rate of >/= $1.5T per year) we are creating new debt money.  When the FED adds their demand for new debt to that of the normal, exogenous buyers... they are participants in the creation of this new debt.  They (the FED) may not be adding more to their balance sheet (the painless, free money machine) by replacing one retired bond with another new fresh one... but to the degree that they are helping the debt clock spin forward.... regardless of semantics.... THIS IS STILL QE.        

 

cmartenson's picture
cmartenson
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Not letting it go...
Jim Hannah wrote:

So....  I don't know why this one sticks in my craw to the degree that it does..... but I feel the need to keep pounding away here.

You are both saying that use of principle repayments (retirements) to the FED to buy new Treasury debt is not QE.  That may have some semantic truth.... again.. an accounting identity.  

But:  As long as the US Debt Clock is spinning upward (currently at a rate of >/= $1.5T per year) we are creating new debt money.  When the FED adds their demand for new debt to that of the normal, exogenous buyers... they are participants in the creation of this new debt.  They (the FED) may not be adding more to their balance sheet (the painless, free money machine) by replacing one retired bond with another new fresh one... but to the degree that they are helping the debt clock spin forward.... regardless of semantics.... THIS IS STILL QE.        

I undertands why this sticks in your craw, I really do, and I am not advocating that we do this, I would certainly prefer that we begin the painful process of living within our means.   If we don't do this on our own terms it will be done to us, in a far more unpleasant way.

There, with that said, all I am commenting on above is the dynamic.  

"QE" refers to the act of creating freshly printed money to buy debt.  By definition is expands the allotment of base money.  Simply rolling over existing debt does not do this, it is money-neutral.

Consider these three scenarios:

  1. $1,000 in Treasury debt held by the fed 'comes due' (matures) and the Treasury has to pay $1,000 in principal to the Fed.  The Fed decides to use this $1,000 to buy another bond.  This is a 'roll over' and while money fleetingly jumps between accounts at the Treasury and the Fed and back again, what actually happens is that one CUSIP is exchanged for another.  Note that the base money is exactly the same before the transaction as after.  The Fed's balance sheet does not expand.  This act does not really help the Treasury get deeper into debt directly, only prevents the Treasury from facing rising interest rates as it has to attract sufficient buyers to sell the roll-over bonds to that the Fed formerly owned.
  2. A new $1,000 Treasury bond is floated at auction by the Treasury which needs more money.  The Fed buys this bond using brand new credit/money.  This is QE because it expands the base money.  The Fed's balance sheet expands.  This is what the current program does.
  3. Same transaction as in #2 but instead of using new money the Fed uses the cash flows from MBS paper it is holding.  This allows the Fed to buy more Treasurys which helps out the US government with its financing needs, but it does not create any new money nor does it expand the balance sheet.  This is the only mechanism by which we can support Rickards' claim.  This is 'stealth support' for government spending.

There is a small gray zone in here tha relates to the flow of interest money on the Treasury bonds.  Technially this is a cost to the US government but with the Fed returning most of it to the Treasury it could be said that the actual cost of capital to the US government is a fraction of what is reported.  For example, if Treasurys are yielding 3% but the Fed returns 2% then the cost of capital is 1% or one-third of what is reported.  This is a 'back-door' easing which is rarely discussed except in glowing terms about how the Fed "made" "record profits" that it "returned to the government" all of which is just pure horse pucks.  It is nothing more complicated than a compliant central bank printing up money and handing it over to the government.  

Hope that helps.

Jim H's picture
Jim H
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Thank you Chris

Thanks for taking the time to clear this up...   I really appreciate having a place where we can dig into these concepts and ring them out.  I personally think that stealth support for Gov't (deficit) spending is just as perverse as that which is technically "QE"...  

Troutbum's picture
Troutbum
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On QE II

The Fed buys its paper from Primary Dealers, I don't believe they are allowed to directly buy from the Treasury. When the Fed buys a T Bond or Note, it credits the purchase amount into the Dealers account at the Fed. No "money" is actually created until or if the Dealer ( think Chase or Citi) actually taps the Reserve Account in order to generate new Loans. It is loan creation that creates "money" and if enough loans are created you could increase the velocity of money, thereby possibly engendering inflation. But couldn't the velocity of money be negated by debt destruction or repayment in other parts of the economy? ( think Government vs Consumer). The Feds policy of ZIRP and QEII generally support asset prices (think equity prices being supported by low interest rates) and if the top 20% of households "Feel Better" they will spend $$. Whether or not this can overcome the loss of value in the real estate market is the essential struggle between inflation and deflation.

Thinkor's picture
Thinkor
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Reply to Troutbum
Troutbum wrote:

The Fed buys its paper from Primary Dealers, I don't believe they are allowed to directly buy from the Treasury. When the Fed buys a T Bond or Note, it credits the purchase amount into the Dealers account at the Fed. No "money" is actually created until or if the Dealer ( think Chase or Citi) actually taps the Reserve Account in order to generate new Loans. It is loan creation that creates "money" and if enough loans are created you could increase the velocity of money, thereby possibly engendering inflation. But couldn't the velocity of money be negated by debt destruction or repayment in other parts of the economy? ( think Government vs Consumer). The Feds policy of ZIRP and QEII generally support asset prices (think equity prices being supported by low interest rates) and if the top 20% of households "Feel Better" they will spend $$. Whether or not this can overcome the loss of value in the real estate market is the essential struggle between inflation and deflation.

I like to think of the MV=PQ relationship as M/PQ = 1/V = average cash balances required per dollar of transactions.  When people have cash balances above the desired level, they spend them (saving = spending on a loan to your bank or someone else) which has an inflationary effect. 

Debt destruction/repayment diminishes total credit, deflating the economy, motivating people to seek higher cash balances (lower velocity), so, yes, it does counteract the attempt by the Fed to inflate by creating more money - ye olde liquidity trap.

I think the reason ZIRP and QE2 will fail is that they depend on creating an illusion that good times are around on the corner, but they do nothing to correct the underlying structural problems in the economy, which will reassert themselves, as they seem to be doing.

 

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