Email sent to a friend this evening. He was commenting on the Yardeni article and why does it seem no one knows what the heck they are doing:
Hi R---
The article you read was...summed up: Ed Yardeni saying QE 1 did not work, QE 2 won't either.
So, assuming that is true, Why are Bernanke and the Fed doing it?
Because it's about all they can do. They have used up the big bullets in their gun.
They flooded the banking system with liquidity.
They set short rates at barely above zero...can't go any lower unless they offer negative interest rates.
Think about the strange world that would be.
Put money in a bank or in a 3 mo T Bill and get lets say negative 1% annual rate of return.
Put in $10K, get back $9900 in a year.
Possible but they don't want to have negative rates. t.
The big problem is the huge debt overhang from a 20 year building credit bubble that burst 3 years ago..
When that happens, it takes years to work it off and the process is inherently deflationary and if they do nothing and allow natural forces including deflation to work out, that leads to lower asset prices [think real estate and housing and a lot more] which leads to more foreclosures which pressures prices further and so on.
A deflationary spiral is a very messy affair.
Consumers and businesses hold off on buying as long as they can to take advantage of lower prices. There is not a lot of incentive to borrow money to buy any asset. [most economies depend on borrowing and spending]
When prices of assets go down that have a lot of debt owed on them, the debt has trouble getting serviced or in some cases can't get serviced and goes into default.
So, the Fed knows this and has been trying about every trick in a central bankers book to keep the deflationary forces from gaining the upper hand.
Thus, we get Quantative Easing 1 and QE 2 probably
He's in a tight spot and knows it.
He is hoping to buy enough Treasury bonds with money created out of thin air to drive T Bond prices up and yields down another full 1% which it is hoped will take the long term mortgage rates down another 1% and free up about $400 a month for those who hold mortgages on their house [on average-refinance]. With this extra money each month, he hopes it will help get consumer confidence up and spending going higher which is inherently anti deflationary and the economy needs more demand desperately to help drive the unemployment rate down..
Keep in mind that they have not started QE 2 yet but they have hinted broadly that is what is coming.
So that is what is going on. Bernanke is very smart and knows history. He's also been quite wrong in his thinking at times over the last 10 years, just as Greenspan was.
It's a tough job the Fed has right now. Possibly an unwinnable on good terms job.
Some say... let natural events unfold- quit meddling, and it is true, that would eventually "work", but it is unlikely the public would tolerate the fall out and consequences.
The aftermath of a huge credit and debt cycle bursting is in a sense is a battle between those who borrowed money and those who loaned them money.
Good chance one party gets hosed. [some times both]
If you let things go where they may without any Government interference, assets get tossed on the market [reclaimed by lenders] and sold [or I guess in some cases kept by the lender although usually the lender does not want to own the asset]. That often times creates a vicious cycle of lower prices, more foreclosures, more sales, lower prices.
Create a lot of inflation [if you can] and those who borrowed get bailed out by paying off the debt with devalued currency...those who loaned the money get hosed.
That's a traditional way out but we do have to think about the foreigners who have loaned us $Trillions and we have to think about who's going to loan us the new $4 Billion we borrow every day. That keeps some restraint on the instinct to say..."Screw the debt holders, full speed ahead with inflation and everyone who loaned money gets paid back in severely devalued dollars.
The fly in that somewhat immoral way out is that,
No one wants to loan you money on good terms in the future once they think you are up to that strategy of hosing them..
The way it is...Those who borrowed are feeling the pain if they can't make payments and lose the asset, but the folks who loaned the money don't really win because they do not want the asset back to be resold into a weak market. [their "on paper" loss becomes a realized loss]
It's all a very interesting chess game on a very big and complex scale.
And it is a chess game with several players and one of those players are the natural forces that are present in the aftermath of a credit and debt bust like we had. That is a very major player in the game.
One thing we know....It is much more difficult to fight and whip deflation than Bernanke figured. He said about 5 years ago...deflation?: No problem, won't happen because we have something called the printing press and can drop money from helicopters.
While that is exactly true and goes back to an example I have used many times to virtually prove we can get out of deflation any time [that example, print money out of thin air and send every family in the U.S. say $5K a month]...in the real world, he is finding out that theory does not easily meet the road. [that would be a clear signal to all who loaned money-especially our foreign borrowers that we have set upon a courser of paying all money loaned to us present and future back with dollars that are greatly devalued. We pay them back cents on the dollar. "Hey loan me $1,000. I'll pay you back your $1,000 in a year with money that only buys $700 worth of goods".
The Fed has expanded its balance sheet tremendously, banks are flush with new cash from the Fed and yet there is almost no inflation [1%, well below the threshold of comfort level] and that rate has been coming down. Despite all that extra cash [M-1 money],... M-2 and M-3 show almost no growth in the last year.
If inflation were so easy to create...the Japanese must be mighty dumb because they have been fighting deflation for 15 years and it is still a very clear and present danger they can't break from.
This does not mean the U.S will have deflation or can't have inflation [you read the article in which John Paulson predicts double digit inflation within 2 years]...it is merely a description of the current situation and what the Fed is grappling with...and why it appears no one in charge knows what the hell they are doing.
thanks, Mike
Meanwhile back at the ranch. Other than China and a few places... because we are in the aftermath of a credit bust and asset bubble, most developed economies are suffering from insufficient consumer demand [70% of the economy in the U.S.] and resulting very slow economic growth [even part of that growth has been artificial...the big Gov't spending Stimulus programs], so what every country wants to do is export more to goose their economic growth. What is the best immediate way to help one's countries exporters?
Have the currency go down against competitors.
Not a bad idea until everyone has the idea. That leads to what we currently are experiencing which is undeclared currency devaluations happening simultaneously but they can't all go down because up and down are relative to each other. [dollar up against Euro is exactly the same as Euro down against the dollar.k a currency has to be measured against something...another currency is usually the comparison ]
Japan is desperate to get the Yen down so they are intervening directly in the market to push it down so their exporters don't die an ugly death because the products they export price themselves out of foreign markets.
The U.S. wants a lower dollar to help our exporters. The Chinese are buying Yen to support it partly because the lower the yen, the worse it is for their exporters.
The end result is they are all going down against true, 2500 plus year old monetary unit, which is an ounce of gold.
As explained in the past.
A better way to look at the situation is to think of it as Gold is forever unchanged. An oz of gold is the same oz of gold as it was 2,500 years ago. What changes is the value assigned to it in various fiat currencies like the dollar, yen, pound, swiss frank, Aussie dollar, euro.
ON that score gold has been in a strong uptrend against all currencies because all currencies are getting debased. [which means if gold is a stable unit, the price of gold going up means the currency is getting devalued and also that [in the present case] those wishing to preserve wealth are less confident in the "full faith and confidence" of the Governments ability to remain solvent.
Even for those not owning gold, this matters, as currency strength or weakness ultimately affects purchasing power.
Gold is protection against Government mismanagement and outright attempts to devalue your money.
Both are occurring at present.
Gold is also protection against a government should that Government become successful in creating purchasing power destroying inflation .
Last...what inflation we do have is mostly in commodities. Coffee, cocoa, copper, wheat, corn, soybeans, sugar, etc. That is because these are priced internationally and they benefit from the ever fast growing demand and higher purchasing power from China and other fast growing emerging economies.
We pay world prices.
Sugar was less than $.15/lb a few months ago. I saw it last week at $.24/lb at one point. [with wheat and sugar, weather has also played a factor and of course higher wheat prices related to a shortfall in production due to dry weather [russia] means increased demand and prices for corn and beans.
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