Guest Post: Alert: QE II Has Lit the Fuse

Tyler Durden's picture

From Chris Martenson

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. I knew the day would come intellectually, but in my heart I hoped it wouldn't. But with the Fed's recent decision to directly monetize the next 8 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 and 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 let's you park that very same money in an interest bearing account at the Fed, there's really no difference between that and just handing banks 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 on 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 that money and push it 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 economic carcasses 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 as late as 2007 for what it was, and which 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, they 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 the US 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.


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 are 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? There we can envision an enormous devaluation event for the US dollar and 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, etc. and so forth 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, enrollment required to access).

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HarryWanger's picture

That story is dated 11/10. 

SheepDog-One's picture

My God, it was from YESTERDAY? Cant have that! Means the story is irrelevant, 'old news' or something. BTW hows that ramp job doing? Looks kinda weak to me. They better get the DOW about 100 points green or else the day is a big loss.

HarryWanger's picture

In FX world that story might as well be 3 years old. Look at the EUR in real time right now. That's the point, junior.

SheepDog-One's picture

Hey Harry hows that ramp to green goin? In FX world real-time I mean of course.




Oracle of Kypseli's picture

Let me jump the line here.

If by law the fed and or treasury are not allowed to hand money to private companies, a defacto creative hand over, must be against the law also and be prosecutable. If any attorneys here, please weigh in. 

Shameful's picture

Good luck getting standing.  Supremes have already ruled that the individual taxpayer has no standing when it comes how tax money is spent in his name.  Was a challenge a while ago to the way CIA was handling it's books illegally, US v. Richardson IIRC.  Trust me you won't get justice against Leviathan in the courts, the courts are vastly in favor of the Fed Gov.

minus dog's picture

Yeah, expecting actual fair and equal enforcement of the law actually requires, you know, the rule of law.  Who'd have thunk it, eh.

doolittlegeorge's picture

TARP was illegal.  Period.  This has been acknowledged as such in public by none other than Paul Volcker himself.  Needless to say "he wasn't expecting to be arrested, either."  What do we have here?  "It's not illegal if the government does it."  Period.

Rasna's picture


Don't pay any attention...

Harry drifts in and out when the prevailing wind blows in his direction...

It's not worth it.

RECISION's picture

By the time you are getting lectured by Greece on monetary actions it might be time for a bit of self-reflection.


They are both democracies, right...

masterinchancery's picture

Or...efforts to separate Germans from large quantities of

Imminent Crucible's picture

"Either the Fed's efforts work or they don't. Let's hope for success."

Is he kidding?  The Fed's efforts are designed to transfer a $900 billion inflation tax to consumers while paying the banks to front-run the Fed's Treasury purchases.

Let's hope they go down like the Hindenburg.  Maybe then the bankers will swing from lamp posts.

Sudden Debt's picture

He who lies once...

If QE2 doesn't do the trick. QE3 and QE4 might or at least QE5 will trigger a financial poopoo mess.

A Nanny Moose's picture

Fool me once, shame on you. Fool me twice....oh nevermind.

trav7777's picture

Fool me once, shame me twice...this sucker could go down

Chris Jusset's picture

Or, perhaps, QE1 through QE8 are merely preludes to QE9, QE10, and QE11, in which case we should just trust Banana Ben's long-term perspective, and delegate more power to him.  Beginning in 2006, Banana Ben had promised that the Fed's monetary policies would not create any bubbles ... and we should trust Ben in this regard. 

-1Delta's picture



PCQ MUB- Cali going under???

Fraud-Esq's picture

Remember, while this fake Blackrock Deficit Commission rolls out their findings....that shareholders in major industries will not give up anti-trust exemptions and will continue to set prices for Medicare...

The Fed would have NEVER, under any circumstance, monetized debt to feed Americans who were starving to death and dying for lack of food. They will chuck them at private christian and religious charity, as usual. "Feed them!"

The Fed did, however, monetize debt to bail out the TOP of the pyramid, the top .0005%, of which, don't forget, at least, 30% are not American citizens per se. Int'l capital is not American, America is just the current capital, as was London, before it. The capital is where the strongest Navy and military is located, never a value judgment. BTW, that's why nuclear weapons won't due. You need the strongest conventional forces.

Keep that in mind while they monetize...   

financeguru500's picture

How about the alternative,

Other countries throughout the world continue to experience troubles similar to greece & iceland while the U.S. maintains its current level of prosperity. We keep printing and borrowing but everything continues on. I think this is a very real possibility.

Vampyroteuthis infernalis's picture

As much as I hate to admit, the printing will keep us afloat while other sovereigns are sunk. It is the race to the bottom (or hell) and we have the biggest submarine. It is amoral to the core.

In the end, countries like China are going to be forced to sell UST. It is much easier to default on our own citizens. No international incidences to deal with.

LowProfile's picture

Not sure about your reasoning here.

Assuming all fiat goes to zero (global repudiation), then we are left with barter, and I'm not sure the USA has the best barter position.

So really it comes down to "whadda want for that?" and "whatcha got?".

ME has oil.  America has food and some heavy machinery production.  Russia has all of that, but not quite as developed.  Europe has some food, and nice factories.  Japan has nice factories.  SA has food and some oil.  China has a lot of cheap shit factories.

Basically, I want to be anybody but China.

Now, I'm not thinking for a minute we won't come up with some medium of exchange, but it eventually comes to "what are you getting for your XXX and what can you then exchange your XXX for?"

doolittlegeorge's picture

we do set up nicely for barter in the USA actually.  The problem of course is "we bailed out the banks."  They won't allow it to work where it really can.  Nice thought, though.

Nikki's picture

China has more than just cheap shit factories. They have 100% of the factories that make stuff that moves electrons...

Calmyourself's picture

How is this a real possibility?  Are we on some fiatsco island where the world does not matter anymore?  Oil, rare earths, missile launches off Cali, Bueller, Bueller...

Cognitive Dissonance's picture

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, enrollment required to access).

What a tease. He's just getting to the climax and bang, pay up sucker. However, in this case, it will money well spent. :>)

On another note, this is a wonderful example of how deep and encompassing denial, bargaining and false hope seeking is for the average Joe, not Chris. Even though Chris as been warning this would come for years, even he admits it's very difficult to accept. And while he has prepared for it financially, it's still emotionally difficult.

Imagine how difficult it will be for those who don't know what's coming.

SheepDog-One's picture

I guess the first point didnt stick very well...many more 'airplane contrails' soon to be seen across our skies.

cougar_w's picture

That's what the Hopi Indians claimed.

Notice that they've already skipped. Crafty bastards.

xenophobe51's picture

Where did the Hopi Tribe go? Last time I was in Arizona they were just doin' their thing over in the four corners area.

HarryWanger's picture

"Money well spent"? Hardly. Martenson has been singing the same tune for years. I kinda think you can figure our "part 2" on your own.

InconvenientCounterParty's picture

Prudence can have a pretty wide time envelope. Balancing complex factors in a way that places appropriate action and allocation of resources is very tough given all the spun and inverted information out there. If you are responsible for the lives of others, a large dose of prudence will definitely help you sleep at night.

Raging Debate's picture

When I realized this is a balance sheet recession and what caused it in 2007, I spent the entire summer getting the emotional outbursts out of my system.

Bob Sponge's picture

I still get them, but better to get it out of your system.

Assetman's picture

Agreed with the teasing part.  And given where the dollar is heading, it may well be money well spent.

At some point in the process, the Fed lost all confidence in foreign buyers to take up the slack and guarantee a low yield for the Treasury-- but it's of the Fed's own doing.

At one time, I would have expected to the Fed to come in an engineer an correction in the risk trade, as doing so would likely attract flight of quality capital from throughout the world.  It appears their desire to artifically inflate risk assets and give the appearance of 'recovery' trumped any alternatives that would have hinted of austerity.  And the reasoning likely is... that the banks still can't afford to take auterity, maybe ever.

It's too bad, too, because now the Fed has little alternative but to monetize debt-- as the rest of the world (well ones with a credit balance) decides to take their marbles and play elsewhere.  Instead of seeing a more logical cycle of deflation/reflation to set things back into equilibrium-- the Fed appears to be embracing the reflate Govt/reflated banks approach.

What's the real problem here?  It's that a constant cycle of reflation will create massive imbalances in asset prices and invite hyperinflation.  The Fed essentially would need to rely on "self-austerity" measures by the government and by the banks to get things back into balance.  The former is a likely "no" at least in the near term.   And the banks are a 'hell no' as its reliant upon massive bonuses to keep the fat cats happy.  I can't see foreign capital coming back for a long time under this backdrop.

What I do see is a period of denial of the masses... a realization... and then, revolution.

Eternal Student's picture

That's a pretty good summary. I'd take issue with the assumption that the big banks are going to make it out of this. I'd also take issue with the "revolution" part, if by that you mean a successful violent revolution. But other than that, yes, an excellent summary.

Assetman's picture

Thanks for the kind comments, ES.

I do agree with you that the final result on the Big Banks will result in Major Fail.   In the meantime, you have a Federal Reserve that is doing all it can to pull the big banks out of insolvency.  Problem is, they are also trying to bail out Big Goverment as well-- in BOTH instances, by printing money.

On the revolution part, it will start out peaceful-- and may remain that way for some time.  My hope is that we get to the stage of realization before the 2012 elections, as replacing the corrupt with people more reform minded may help quell the masses.   The process of equilizing these growing imbalances, though, will be painful and invite civil unrest.

minus dog's picture

People are already quietly putting up with all sorts of shit that, in the past, would have started some heads rolling.   I don't know if that means people will put up with anything, or if they'll get tired of it that much sooner.

Calmyourself's picture

Now there is something I have been waiting for, why?  Supposedly other sovereigns and hedgies etc. been buying our debt and essentially taking up the slack?  Why is the Fed now taking up the slack has the rubicon been passed and there is no further offshore demand for our debt or is there some strategic reason for this and right now?  Newbie question probably but is there any data to support complete foreign dropoff?

Agent P's picture

"What a tease. He's just getting to the climax and bang, pay up sucker."

No different than getting to the back room and finding out the stripper is also a hooker...looks are free, but touching will cost you.

I'm going to do here what I do there...keep my money, go home, and rub one out.

Bolweevil's picture

One of his first recommendations is to get settled emotionally about disruptions.  I was egotistically resistant until my Ah ha moment.  Chris helped.

apberusdisvet's picture

How do you say "we are so fucked" in Chinese?