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On QE & Supply-A Dated Perspective
In December of 1974 I was kid on an FX desk for a Swiss Bank in NYC.
History gave me a lucky break. The dollar was in the crapper at the
time. Too much debt and no plan to deal with it was the problem then. To
stabilize the dollar and shore up a weak international balance sheet
president Ford announced that Treasury would auction off gold. Because
Switzerland was a big player in the gold biz my bank was involved. I
ended up having a role in the process. Along the way I made some
observations that have stuck with me. I look at QE and what lies before
us and wonder if history might repeat itself.
Back in 74 the gold price plunged on the news. The dollar finally found
some demand. Equity markets rejoiced. I attended meeting at Treasury on
the gold sales. I got to meet some real players. The initial assumption
was that the gold price was in for a long-term plunge. There simply was
not enough buyers for the AU that was coming up for sale.
We could not have been more wrong. The first auction was over
subscribed. Each following auction was for larger amounts and saw bigger
demand. This continued for a few years until the next bombshell came.
In 1978 the IMF announced that it too would sell gold. (The US told the
IMF to do this).
From 1975 to 1980 the US Treasury and the IMF sold a combined 42 million
ounces (1300 tonnes). What did the price of gold do while all that
selling was going on?
The price of gold went up nearly every week for five years. The more the US sold the more the market demanded.
The numbers back then look silly by today’s standard. The whole 42mm oz
were sold for a measly $25b. But numbers were different back then. For
example, the Dow closed 1974 at 580. Today it is 20X’s higher. I would
use the same multiplier to value the scale of those long ago gold sales.
The current value in gold terms is still only $60b. But the comparison
to the size of GDP and money supply makes its impact closer to $500b.
Therefore it isn't so different in size than Mr. Bernanke’s QE-2
program.
My lesson from this history is that when governments are selling
something of value it just increases the demand until the government
selling is ended. Can history repeat itself? In reverse?
In 2011 the Fed will be buying dodgy securities at the highest prices in
history. The market is anticipating the coming demand and driving up
prices on the assumption that there will not be enough sellers when the
real POMO action starts.
What happens if those auctions are blowout successes? What if the Fed stands up one day and says, “We will buy $25 billion”,
and the market offers them $150b? What if each of these big POMO buys
sees a B.T.C. of 3 or 4 Xs? What if the big holders like China, Hong
Kong, Korea, Singapore, OPEC and Russia say, “If they are buying, we are selling”.
Put yourself in a position of foreign CB that holds boodles of unwanted
Treasuries. Now, in comes the Fed buying huge slugs at premium prices.
Those same big holders all hate QE and the negative impacts they are
feeling from it. How many of those CB’s will just vote with their feet?
One or two and this turns into a rout,
The first few big POMO buys will probably not be conclusive. We need to
get a few under our belt. However, should we see a pattern where the
supply of paper that comes out at the auctions overwhelms the Fed's
buying interest we are going to have a very big problem on our hands.
There are many who have said that the US financial system will end on
the day that there is failed Treasury auction. I have never believed in
that. The Fed is there to print money and insure that there will be no
failure. But it will be an interesting muse of history if the US
financial system comes under a big strain as a result of some spectacularly successful
auctions. But those reverse auctions would result in holders lining up
to either wash their hands of US paper or to reduce what the own by
significant amounts.
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Bruce is right about this.
Won't repeat earlier statements too much: #704875
Hyperinflation doesn't start with a CB going nuts with the printing press, it starts with a dump of the currency. The point is that CBs, slowly over time, have already printed enough excess currency to trigger shock inflation, but that excess is sitting overseas. Hyperinflation is triggered when foreign holdings come screaming back home which tends to happen around major destabilizing events such as government coups. If the inflationary shock is great enough and the CB loses all control, the economy collapses, taxation becomes impossible and then the Zimbabwe style printing begins.
If we look at a possible scenario of hyperinflation, then we have to look at potential triggers for a flight of Eurodollars back home to the USA. We might be looking at one now (the potential for a bond dump, as Bruce suggests).
All around the world we have foreign CBs, sovereign wealth funds, retirement funds, etc learning more about the all-pervasive fraud that is the US economy and concluding that there can be no salvation. They'd love to extricate themselves from this mess, but they haven't had much opportunity to do so.
Now here comes the Fed offering to sit on the bid with what seems to be limitless depth and let's face it, QE looks to be here to stay. If the Fed resorts to money printing to provide that depth then it exacerbates the problem. Everyone knows it, but they also know that if they get out early, they get out better than those who get out later. So get out, they will.
I expect that Bruce is right. The more firmly the Fed sits on the bid, the more sellers will come out of the woodwork to dump out of a horrible position at a reasonable price while they still can. They know what the liquidity risk is, and they'll want to exit while the Fed is there.
In exchange, they'll receive Eurodollars that are becoming increasingly worthless. The only sensible thing to do with those is to offload them to any sucker who'll take them which will increasingly be no one outside the USA.
So the nightmare scenario is that surging volumes of Eurodollars come screaming home looking to swap for any American-based asset of value, sending prices through the roof. The Fed can retaliate to the limit of its foreign currency reserves.
So this it a possible path to the hyperinflation scenario that ZH fears, but I think ZH is wrong about things here because the Fed knows all too well just how much deflationary power it has at its disposal thanks to ever growing piles of fraudulent MBS shit that it has on its books. Let a few of the TBTFs actually fail, or dump toxic assets to market, deliberately take an enormous loss to counter out all that inflation.
It's ingenious. In the end, foreign holdings of US dollars come flooding home to make good all the fraud that the Fed is holding on its books. The US financial system survives, prices don't go to the moon and all the foreign dumpers end up looking like idiots (poorer idiots), having overpaid for assets.
Of course, it won't be clean, it will be messy like hell. Money flows will have to be engineered so that the clown bucks end up in the right place (to plug the enormous hole that the Fed is about to open up on its balance sheet), which is going to mean a whole swathe of new taxes because, let's face it, the Fed *is* the govt.
http://removebernanke.org
ALL AMERICANS SHOULD SHORT BAC. IT IS YOUR PATRIOTIC DUTY. A JOURNEY OF ONE THOUSAND MILES STARTS WITH THE FIRST STEP.
Very right, just a bit early.
There's another big factor here which is how QE2 interplays with Chinese and other EM traditions of exchange rate manipulation. They do so by accumulating dollar assets, namely Treasuries. Until August, foreign central banks were collectively doing that at a pace of about $30b a month, according to Fed custody data. All foreign buyers including private were accumulating about $55b a month, according to Treasury data.
The combined effects of "QE lite" and QE2 are reducing net issuance of Treasuries to the market from around $120b to around $20b a month. That means all traditional long-term buyers, foreign and domestic, are having to sharply reduce their accumulation of Treasuries. Foreign central banks have already made a big adjustment, accumulating only about $10b a month since August, by Fed data. Private foreign buyers presumably also sharply reduced their accumulation of Treasuries, and might have sold off (data's not out yet). The dollar has long been propped up in relative FX terms by foreign accumulation of Treasuries, and the sudden reduction of that is the mechanism by which "QE lite" and anticipation of QE2 caused a >10% drop in dollar FX rates. It looks to me like there's still some more of this adjustment left to be made.
As for foreign central banks turning into net sellers, the ones with enough weight to really worry about are China and Japan. For now they both seem much more concerned about fighting appreciation of their currencies vs the dollar. If they suddenly became net sellers of Treasuries, their currencies would go ballistic.
The thing to watch is the real interest rates on Treasuries, which are going increasingly negative. That's especially true if you look at dollar inflation from the perspective of what China or Japan buy with dollars - mostly raw materials. In those terms, Treasuries and dollar assets in general are a ridiculously bad store of value, and rapidly getting worse.
Here is something funnier-you get your beloved gold standard back, price fixed at let's say $100 an ounce, and the price of everything deflates.
That would be progress indeed but it won't happen.
Bruce, Spot on...the only question is really: How can we spot when this is first occurring (for those of us not "connected")...
Mr. Krasting as always thanks for the insightful post.
All government asset purchase programs in history follow the same path. By definition an asset purchase program is paying a higher price than the market would pay.
Why would there be any private demand if purchasers have to pay the price the government paid? It would mean accepting an implied loss. So when the government is a buyer, everyone else is a seller.
Except if it's gold, in which case the government is a confiscator. Bonds are for douches anyway, it's like getting your cut from other people's taxes, despicable.
i understand this, more supply equals more demand, people don't want something they can't buy. during the stock bull market companies which issues new stock actually saw the price of their shares go up, because more float meant bigger institutions could afford to own it. this market today is a bull trap, low volume on the way up, and the bid disappears suddenly. of course when everyone is in the trade on gold, what then?
trade gold for real estate
Thoughtful post, nice factual discussion of the '70s.
Somehow IMVHO this feels different.
IMVVHO the CB's have agreed on the "need" to keep the game going longer.
Who thinks the ChiComs give a hoot about their own people rather than being in cahoots w the intl banking cartel?
Meanwhile the US financial system goes more and more Japanese w zombie banks sucking up capital which mostly only goes into circulation elsewhere or spent by financial zillionaires and their underlings. First it was very short term rates at record lows. Then the 1 year. Then the 2 year. Now it's the 5 year. Why should it stop at that?
Japan, bitchez!?!
No, it'll trickle down, just like Saint Ronnie said so keep your mouth open and pray.
It seems that this proposed program would yield great confusion for the USD.
If the auctions are highly successful, this would indicate that there is a desire for traders to distance themselves from USD assets, namely government bonds. That would mean that with a decreasing faith in the currency, the relative value of the USD would decline.
But since the auctions are successful, that would mean that the US would have to raise interest rates in order to attract more buyers of bonds which would, in turn, would increase the relative value of the dollar.
On the other hand, this would be like the Fed monetising OPD (other people's debt...), which would erode the value of the dollar- but, those traders would now have a lot of money to put to work, most likely in the US equity markets, which, in turn, would put a floor under the declining value of the greenback.
Or am I just cuckoo?
:D
Yes it is a self correcting process. If the dollar collapses to a point where condos in Miami look crazy cheap to anything in Europe the capital will come back. But this is not a short cycle, just the opposite. Along the way there will be big ups and downs. At some point the corrections will have teeth and that would be a point of transition. There is not one chance in a million we will get that transition right. Alas. What makes it fun...
Speaking of cuckoo...have you seen the video of Lord James of the UK House of Lords claiming that some seriously high-dollar foundation wants to give the UK about 22 Billion pounds. No strings. No interest...nothing.
See for yourself that the man is not a fruitcake...
http://forums.joerogan.net/showthread.php?s=ca02c721846bd99bd6186bab87fce653&p=3719765#post3719765
Looks like someone is waging a counter insurgency of their own.
Hearts and minds, bitchez.
Damn orly, you post on the rogan board??
**Edit: Just watched the video. Bizarre.
Frankly, I have never heard of the rogan board, so I neither endorse nor deny the content of the site. I followed the trail from Alex Jones' Infowars.com from the transcript and simply found a video of it to post.
The honourable Lord suggests that either the Rothschilds or the Pope (or someone else with a boatload of real money...) is willing to backstop the UK for free! Out of the kindness of their hearts, I am so sure...
Bizarre is right.
In poker it is called "running bad". The novice, who has studied and memorized the odds and watched the WPT on TV gets frustrated at losing increasingly larger bets on hands that should have been winners, reasons that he has been losing because he has not been beting high enough, goes all in and is surprised to get 4 eager callers.
Excellent concept. Good post.
When a government is selling an asset, there's a good chance it's the wrong decision, so you should be buying. And, just as you imply, if the government is buying assets like credit and treasuries in 2011, it's probably the wrong decision too. And one should sell 'em everything.
GG
What about Iran and China buying gold?
Bruce,
Have you been following what Jim Rickards been saying lately re: QE2?
http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2010/11/5_Ji...
http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2010/11/6_J... (audio interview)
"So, here’s the bottom line on money printing, or QE if you prefer. If nothing happens, the whole thing was a waste of time. If inflation takes off, the Fed will have to choose between holding bonds and letting inflation get worse or selling bonds and going bankrupt in the process. Since no entity goes down without a fight, the Fed will naturally hold the bonds and let inflation take off. Do not ask about the exit strategy from QE; there is no exit. "
This makes sense, but....How could the Fed actually go bankrupt if it can create new dollars at will? I guess that is why there is no exit strategy from QE.
massive, massive props to the KingWorldNews. I've been listening more & more. They have a fresh Fleckenstein interview thats well worth listening to.
I will now.Tks
b
And when they dump the treasuries, where will the money go first...?
Brazil.
And don't forget....
If Mr. Fed buys securities, matters not who issued them nor sold them to the Fed, they pays in dollars, inflating the US money supply.
(soft coughing sound, ah-hem mumbling something about inflation expectations, PM and commodity prices continuing upwards, ah-hem, mumble, mumble, soft giggle)
The Fed, and ultimately the U.S. public will end up being the bagholders of the debt. The real finale will be when countries dump the dollah in favor of IMF SDR's, so watch for this catalyst.
Uh, wrong tense.
http://www.imf.org/external/np/fin/tad/extsdr2.aspx?date1key=2010-10-31
China, 2008: 789M -- 2010: 8.1B
This time is different
What if they held an auction and everybody came?
+100!
Sounds like the title for a porn film, made in the Mariner Eckles building.
Shoulda been my title....
I think that what happened was that Mr. Paul Volker took actions over time that made the dollar worth holding. The maximum CD rate that I recall was around 18%.
No interest income on those gold holdings.
But that solution is probably not feasable with China holding so any dollar assets. We are getting to live in interesting times.
Great story about '74-'80 gold action. I guess I never realized the price run-up happened as the U.S. was unloading inventory like that.
Your supposition seems quite plausible but it isn't a reverse scenario of the 70's gold dump....it's almost exactly the same: the biggest player announces that he is selling shine (or buying shit)...and everyone else rushes to market.
Got Gold?