Why QE2 Will Most Likely Continue; A Good Argument

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DEUS X MACHINA's picture
DEUS X MACHINA
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Why QE2 Will Most Likely Continue; A Good Argument

Peter Schiff wrote in his news article:

"According to the Office of Management and Budget, the U.S. government is expected to run a $1.6 trillion deficit in fiscal year 2011 (which expires in September). The Federal Reserve's current quantitative easing program is taking down a large share of that red ink. But "QE2" expires in July, and in fiscal year 2012, the Federal government is projected to run a $1.1 trillion deficit (that of course could grow if the economy weakens). An additional $1.1 trillion in Treasury notes and bonds will mature over that 12 month period. So in total, the Treasury will need to issue a total of at least $2.2 trillion in notes and bonds in FY 2012. This translates into quarterly borrowing needs of approximately $550 billion, more than double the average of the last two quarters. To put this into perspective, the entire U.S. personal savings rate is about $650 billion annually. Even if every dime of this amount were ploughed into Treasuries, we would still need to borrow or print another $1.6 trillion.

At the height of the financial crisis in Q4 2008, the Treasury issued a record $560 billion of notes and bonds. Fortunately for them, that spike corresponded neatly with huge inflows of funds into Treasuries as investors sought safety from collapsing equity and corporate debt markets. Will the Treasury catch that break once again? There may be another financial panic, but will investor reaction be the same this time around? Bill Gross, the founder and chief investment officer of PIMCO, the world's largest private purchaser of bonds, recently announced that he is reducing his Treasury holdings to zero. It is not clear what would convince Gross to get back into the market with both feet, but one might expect at minimum it would take much higher interest rates.

If private investors stay on the sideline, how does anyone expect the Treasury to sell its inventory without the support of a quantitative easing program from the Fed? Do they expect the Chinese to reverse course on their current policy and start heavily buying U.S. debt once again, irrespective of the damage to their own economy? That seems extremely unlikely given the drift in Chinese currency policy. More likely the Fed will remain the only buyer, meaning QE3, 4, and 5, are all but certainties. There should be no remaining doubts...the U.S. Government intends to monetize its own debt. Of course, as bad as things will be if QE  ends, it will be that much worse the longer it continues.  "

Thinkor's picture
Thinkor
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Sooner or later the Fed in

Sooner or later the Fed in fact will stop all QE because at some point the benefits of QE will be outweighed by its costs.  We know this because all inflations come to an end. 

The problem with Schiff's analysis is that it is not taking into account  the costs of QE.  He cannot be assuming that there are no costs, because he advocates ending QE.  But if QE must continue now, we must ask why it will stop later and not now.

I addressed this question in part in an earlier post, here,

http://www.peakprosperity.com/forum/feds-endgame/55217

where I described what I believed to be the Feds' endgame, where by "Feds" I meant the federal reserve plus the federal government (though I forgot to point that out), two organizations with the common goal of surviving through cooperation.

I want now to expand on this somewhat to consider all the important costs and benefits of continuing QE.

The most obvious benefit of QE to the feds is (1)  that it deflates the real value of the Treasury's debt.  Another major benefit is (2)  that it has postponed the coming collapse, giving them and their allies (the big banks, the unions. etc.) breathing space  to prepare for the collapse, continue transferring private assets now in the USA to safer repositories abroad, and figure out a strategy, probably reducing COLA's, to (3) deflate the real liabilities of the USA's entitlement programs.   A possible major benefit, if the endgame unfolds as I expect, is that (4) the Fed may be able to point to its substantial contributions to the US Treasury as evidence of its wise management.  That sounds ridiculous, but a lot of things that sound ridiculous are supported by majorities.

The costs of QE are (1) an even more precipitous drop in employment and the living standards of the people when collapse can no longer be delayed (2) high inflation and its accompanying ills, (3) more time for the Feds' opponents to organize, prepare, and perhaps rebel.  The first two of these will foment rebelliousness, which we already see with spreading assertions of states rights, demands for presidential candidates to have birth certificates, attacks on the Fed, attacks on the banks, etc.

I thought of including the loss of the dollar's status as the world's reserve currency, but I think this has already been accepted or planned, with the idea that the IMF will replace the Fed and the SDR will replace the dollar.  The US is being run by globalists, not American patriots, which is why, I believe, that disregard for the Constitution is accelerating with each new President.

I think that the biggest problem confronting the Feds is reducing the real liabilities of entitlements.  Such reductions will be extremely unpopular, yet they must happen.   There are many ways this could be accomplished, but intense crises will help to create a more receptive mood.  A temporary end to QE could be just the right approach to render entitlements vulnerable to inflation.    Once that happens, QE could resume until the debt and entitlements have been reduced to manageable proportions, or another dose of reality is necessary to get greater concessions.

I'm not sure that the Feds have thought about all this.   I wouldn't be surprised, but they might wind up at the same place just by doing the next obvious thing to maintain control.

I think it is going to be very hard to predict when the Fed will first try an end to or suspension of QE.  I don't expect a BOOB (bolt ouf the blue) attack, because that is not the Fed's style.  Even now their pronouncements  are creating within the minds of people that QE may come to an end on June 30th. That could just be a jaw-jaw policy to do whatever (restrain interest rates, reduce inflationary expectations, stop the fall of the dollar, etc.), but it will also at least  make it appear that the end of QE was seriously considered before being ordered.

 

 

DEUS X MACHINA's picture
DEUS X MACHINA
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yes!

Well done Thinkor, well done!

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Carodox
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Devil's advocate

Bear with me, Thinkor, I'm trying to figure all this out and have a few questions and comments and I'm going to play the devil's advocate.    Why can't QE go on indefinitely?  Who is going to tell the US they cannot monetize the debt.   The big economies of the world need the US to exist. They don't want to see financial Armegeddon because it would be suicide for them.   It seems logical that for the US to collapse, something else is going to take it's place, because the oligarchs need some place like the US.  Who might that be?   Is it not possible that if they create wealth in the financial markets, and some of that wealth will find it's way into the housing market, and unemployment will abate and they will point to it and shout, look, look, the probem is fixed.   The US can fix the problem if they increase their income other than by printing money.  They do have the power to tax.   They have not used that power in order to avoid a deeper recession, but when the numbers begin to correct, it will come. that is why so many with money are screaching about loss of liberty and freedom because they see it coming.  That is why they are moving their money.  They know they are targets and if the US needs money and the US is going to go down and collapse or it is going to pass some laws to confiscate their money, you can guess what they are going to decide.  

Look at this situation in Japan, all the stuff they cannot make, cannot use, etc.  Will not this be an economic advantage for the US businesses?  We'll be be shipping goods, cars & heavy equipment, helping rebuild Japan.  Won't this translate to some economic activity.

If by reducing entitlements, you mean delaying the age for SS, making it need based,  I don't see that as a big problem.  They are already talking about it.   Other than SS and Medicare, other entitlements are such a small part of the budget, much smaller than the interest on the debt (which is huge) that it probably would not make much of a dent.  As to the interest on the debt, when the Fed does QE, doesn't the interest the gov pays the fed gets go right back to the Treasury, at least most of it does.   I'm not sure how that gets booked.  I don't see why the US would borrow from other countries if they can do QE and get the interest back themselves.  What am I missing here?

And while I'm at it (playing the devil's advocate) even if there is a shortage of oil in the world, is it really going to hurt the US?  As long as we are standing first in line and we get our 26%, we're okay, right?   And we've been camping the oil, we've built an embassy in Iraq the size of Vatican city, have been protecting the Saudi's.   There is no rival militarily, so who is going to say that we are not going to get our 26% of the oil and be first in line.  It reminds me of the story:  If you are out camping with a bunch of guys and a bear shows up, you don't have to run faster than the bear, but only faster than the slowest guy.   What makes anyone think that a shortage of oil is going to impact every nation proportionately?  Won't the guy with the big guns be the last man standing?  Oh yes, the shortage of oil, will cause the price to spike, but I doubt the Saudi's are going to overcharge us who keep them in power.    (I wonder what message they are getting from the forment all around them?)

I'm not saying I'm right about any of this........these are just the thoughts that keep me awake when I'm trying to decide who to listen to, what to believe.  I like to look at all sides of the issue.   so please, someone, straighten me  out if I'm off base.

 

 

Thinkor's picture
Thinkor
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Although the empirical

Although the empirical record is unanimous that QE does not go on indefinitely, there may be some reason why this time there will be an exception. 

The basic theoretical argument for limited QE is that QE causes inflation which leads to ills so great that they exceed the pain of ending QE.  I think the causes of these ills are the redistributive effect and the debasement of the money. 

Wealth is redistributed, from savers to speculators, and income, from those who get the new money last to those who get the new money first, creating a lot of social conflict. It also leads to deterioration of existing capital as all resources head to feed the favored (welfare recipients, public unions, wealthy bankers, etc.) 

Debasement undermines faith in the monetary unit as a store of value (because it is constantly losing real value) and as a unit of account (because its value in the future is difficult to forecast). 

Ultimately, people riot in the streets, beat up politicians, etc. and refuse to use the government money and use whatever they are using for a store of value instead - gold, silver, cigarrettes, local scrip or whatever.   I'm sure there's a whole literature on the evil effects of inflation in particular cases, but this argument is good enough for me.  Remember, to quote Gerald Celente, "when people lose everything and have nothing left to lose, they lose it".  And they lose it quicker when they have a keen sense of injustice having been done to them.   The shock Americans are suffering has been so quick and so intense, it is like nothing a people have suffered before except from war or natural calamity.   But where's the war?  Where's the natural calamity?  Why can't things be like they always were?  It's THOSE GUYS!

QE by debt monetization in particular transfers resources from the producers to the welfare recipients and parasites.  Incentives for producing fall and incentives for gold-bricking and blood-sucking rise.  The government ends up like a serpent trying to satisfy its hunger by eating itself starting at the tail.  Eventually, the mistake will be realized as politicians are (marginally) smarter than snakes, although they share many other characteristics.

To address some of your other questions and comments:

* The financial markets contribute to wealth creation, but QE (simple printing of money) does not. 

* Taxes can be raised, are being raised, and will be raised further, but there is only so much you can get from people before they opt for not working.  I have always thought that one of the reasons the Soviets had so many great chess players, was that there was no point in working, so why not develop something the government can't confiscate - laying up their treasures in heaven, so to speak, where moth doth not eat nor rust corrupt.

* One advantage of QE is that for a while it will alleviate unemployment as the dollar is devalued, but on the flip side it will intensify inflation as foreigners buy increasing amounts of their necessities from the USA.

* I don't know what to say about Japan.  To the extent what they need to do is patch up their infrastucture, I would guess Chinese and Japanese workers and companies are going to benefit most.

* Entitlements are a very big part of the budget.  They have to go after medicare, medicaid, social security, unemployment insurance etc.

2010 pie chart federal budget

* Interest payments are not that big right now.  By monetizing the debt, the Fed can effectively eliminate them.  What they cannot do is stop the ensuing inflation caused by all the QE.

* I believe there is plenty of oil in the USA, but it will require application of new technology to extract it.  My guess is that won't happen with the current administration, which is very anti-business and sees all the real and currently available solutions to energy problems as fatally flawed.  Although in principle the US could use its military power to commandeer oil, rather than pay the market price, it's hard to see how a nation that can't win the war in Afghanistan is going to start successful new wars in Venezuela, Mexico, Saudi Arabia, Iran, etc.   I do not see Obama as a world-conqueror.  Might happen under President Trump though.

 

 

 

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