did her level best at defending QE. I think she lied to us. This chart
was central to her defense of the busted policy:
Isn’t this graph nice. It shows that there is direct causality to an
increase in FRB holdings and jobs creation. For every $1mm purchase of
average life 5-year T-Notes that Brian Sack (NY Fed) makes, a new job is
created. Magical. Actually it is just self-serving bunk. Ms.
Yellen should be ashamed at using this. There is no evidence that there
is a direct relationship between QE2 and an increase in employment. I
hope some economists rip her apart.
I am not going to deny the relationship between low interest rates and
higher economic activity. That link has been proven. For example, ZIRP
can have beneficial effects. Similarly, a drop in long-term interest
rates is a pro-growth force. What the folks at the Fed have done is
assume that QE lowers LT rates and therefore promotes job creation. But all of the evidence confirms that QE2 has had the affect of increasing interest rates.
If Yellen wanted to be fair to the US citizens she would have prepared a
different set of slides. She would have shown a graph that proved the
relationship to lower (or higher) LT interest rates and economic
activity (employment). If she had shown (for example) that a 1% drop in
the 10-year bond DIRECTLY contributed to the creation of 600K jobs I
would have accepted that. I believe that most economists would have
agreed as well.
But that is not what is going on at all. LT interest rates are not
falling because Mr. Sack is doing POMO buy-ins of bonds three days a
week. LT interest rates are rising BECAUSE he is buying. How can that
be? Is the market ignoring the laws of supply and demand? Not really.
-QE2 is ending in 4 ½ months from today. (The last month will be small
amounts, totally discounted by then). There are only 87 trading days
till the (functional) end of this experiment. The market is already
looking beyond the corner on this one.
-QE2 is creating an opportunity for large holders of Treasuries to
lighten up. There is no certainty that they will return when QE2 ends.
If "they" do return, what price will “they” demand?
-QE has created uncertainty for investors. The Fed balance sheet is a
ticking time bomb that is going to blow up on them one day. How do bond
investors know this? Because the Fed has repeatedly told them so.
They have said in the press and to the public through speeches like Ms.
Yellen’s and even to Congress that they are 100% certain they can
reverse the impacts of QE. How are they going to do this? Easy, Yellen said it (again) in her speech:
raise short-term interest rates and drain large volumes of reserves
sell our holdings of MBS, agency debt, and Treasury securities
The bond market (collectively) reads these words and craps in its pants.
This is the worst possible scenario for the bond market. The largest
single holder of fixed rate paper in the world is going to become a
massive seller at some point in the future? Lovely prospect.
Think of it differently. What would happen to our capital market if
someday we got an announcement from China that they were selling their
~900b of holdings? The bond market would collapse of course. That will
(hopefully) never happen. But the Fed is now bigger than China and they
have said again and again that they are going to be a
seller. No wonder interest rates have risen in anticipation. Who would
want to own low yield, long duration paper when you are staring into a
double-barreled shotgun (Fed & Treasury selling at once).
I think the stock market looks out about six months. The bond market
looks out about a year. What is the message that Janet Yellen, Ben
Bernanke and all the others telling the bond market? The answer to that is in the chart that Yellen used to defend QE.
Notice that she has a 600b ramp up in assets. That is followed by a
run off of the portfolio less than one year after program completion. In the Fed’s own models they are assuming that QE2 unwinds starting in 2012. Just around the corner, so to speak.
There are three possible outcomes that I can see at this point.
I) QE2 will be extended and expanded. The Fed will buy an
additional 600b of bonds. I give this a 5% chance at this point. The
policy is disgraced. The Fed already regrets the timing of QE2. Heat
from Congress will tie their hands. The economy will be muddling along
and no additional “emergency measures” are justified. This is not a
strong bond market scenario.
II) Before June 30 the Fed announces that it will not extend QE2.
They confirm that they will hold the existing portfolio at the then
current level. The proceeds of any maturities of existing holdings will
be used to acquire more bonds (similar to QE-1-lite). This would
immediately make a lie of all the prior statements by the Fed that QE2
was a temporary measure. That it’s affects would be removed in due
course. This would be very unsettling to the bond market. The Fed would
be changing the rules to suit them. No one would trust any future
promises they made if they reverse course like this. This outcome is not
bond friendly either.
III)
Before June 30 the Fed announces that it will not extend QE2. They will say that they will take a wait and see policy. They will increase or decrease the balance sheet as and when they see fit.
I think the outcome will be #III. I see this as the worst possible
outcome for the bond market. The reason? This “preferred” alternative
translates into the greatest uncertainty.
Consider what the backdrop of economic news is likely to be in the
future. In 2010 the (phoney) calculations that the Fed uses to measure
inflation showed a YoY change of only 1%. It is impossible for this to
be repeated. While inflation may not get “hot” it will be on the rise.
When the monthly numbers prove that out the bond market will shudder. As
the inflation numbers move back up and pass the “desired” 2% the market
will worry every day, “When are they going to start selling” will be the only debate.
Here’s the bottom line Ms. Yellen. QE2 has added to uncertainly and
thereby increased LT interest rates since the policy has been
introduced. Increases in LT interest rates are a factor that would tend
to slow job creation. Ergo QE2 will prove to be a policy that creates a
drag (not a stimulus) on the economy/employment.
Man up Ms. Yellen. You folks have made a mistake. Don’t try to prove
what can’t be proven. Your own graphs show the lie. Your skewed
presentation is obviously flawed. You know that, the bond market knows
it. When you bluff like this it just scares the bond market more.
China;http://www.reuters.com/article/idUSTRE7090W120110110
BEIJING | Sun Jan 9, 2011 11:52pm EST
BEIJING (Reuters) - China should further diversify its huge foreign exchange reserves away from U.S. government debt to reduce its risk exposure, a central bank official said in comments published on Monday.
"We should change the single-currency focus on buying U.S. Treasuries and adopt a more diversified structure for foreign exchange reserves to reduce risk," Xu Nuojin, deputy-director of the People's Bank of China in Guangzhou, was quoted as saying by the Securities Times.
China should channel more of its foreign exchange reserves into resources and equities, Xu said.
Analysts estimate that about two-thirds of the reserves, which hit a record $2.65 trillion at the end of September, are parked in dollar assets, although the currency composition is a state secret.
Xu also urged the government to relax capital controls to enable companies to hold more foreign exchange earnings, which he said would help slow the rapid build-up in official currency reserves.
A slower rise in reserves could take some heat off the central bank when it sets monetary policy, he said.
QE and GDP bumps are producing increasingly less jobs than before.
Gov spending now yielding negative jobs. Yikes.
Romer's thesis, Keynes and the central planners are/were wrong.
Paradigm shift? Or, shifty central planners?
I like that Yellen is more direct than Ben about why the Fed is doing QE. They are both ardent ideologues who believe they are enlightened with the rare knowledge of how to tinker with monetary conditions to improve general well-being. But Ben is more of an ass-covering academic by instinct. He will never spell out exactly how he thinks QE will work, so that no one can ever prove he was wrong.
Monetary expansion can spur investment and hiring, even while long-term rates go up as they have been. Monetary expansion taxes conservative savers to subsidize risky investors.
It is however a time-limited subsidy in which the investor who wants to take advantage must guess how long it will last. Fiscal stimulus and tax cuts that aren't matched with spending cuts work similarly - the investor who depends on them must guess when they'll run out. QE2 and the Obama-Repub tax compromise not only extended fiscal and monetary stimulus, they gave investors the impression that authorities are willing to indefinitely extend monetary and fiscal stimulus. It's that impression of willingness to indefinitely extend that gave the biggest spur to hiring.
But this is very dangerous for the longer term. Because jobs that depend on risk subsidy are inherently vulnerable to austerity. And actually the authorities' willingness or ability to extend QE and 10%-of-GDP borrowing is likely to run out sooner than expected.
Thank you for another thought provoking piece, Bruce.
? What about #4 the Fed burns through the 600B exclaims it is a success and promptly launches an even bigger QE3
Sort of my #1. I think this is low probability outcome. Many here think exactly the opposite.
If we get your #4 the lights go out in less than 24 months.
Have you revised your odd's on the debt ceiling being raised by Congress? Seem to recall one of your articles from December mentioning this wild card given Timmy's ultimatum a week ago.
I have read recently, but can't find the source, that the Republicans plan to raise the ceiling in several small increments over time, rather than one big raise all at once. Their plan is to extract dramatic concessions from the democrats for each small, incremental raise in the debt ceiling. It would be interesting to see them try that.
A wild card. I think a new ceiling will be established. It could be for a short period of time. 18 months? that would imply ~2.5T. This would set the clock for an explosion before the next big election?
I agree...it will be option III.
It is the path of least resistance...politically. I only say that because it is a factor...always has been.
Their first mistake (if they were honestly a "monetarist" body) was lowering rates so drastically in such a short time period...they panicked and are now stuck in their own web of deceit with no rational option but to raise...but they can't.
Any opinion on floating rate bond funds...like DVF or ARK or are they about out of gas?
At any "rate" another fine article Bruce ;-)
Here's your chance. According to a MarketWatch video, the venerable Former Chairman Maestro has challenged any of his detractors to show where he was wrong.
His idea is that the "wealth effect" has translated into a dramatic increase in railroad car-loading in December and the double-dip recession has been off the table for a many number of months. After that, sorry, I had to turn it off.
http://www.marketwatch.com/video/asset/greenspan-prove-i-was-wrong-2011-01-07/881A4154-8710-4BCB-952B-219E94F704FB?link=kiosk#!881A4154-8710-4BCB-952B-219E94F704FB
Made it to 1:26.
But hey...by his own other admissions...he was wrong 30% of the time.
Which is, just what it says...what he had to admit to...LOL.
Oh well, happy days and caviar dreams...bubbles bubbles bubbles ;-)
LOL...thanks Orly...I'll see if I have a stronger stomach.
http://ppjg.wordpress.com/2010/04/28/where-is-that-ellusive-us-treasury-can-you-say-puerto-rico/
I thought the Federal Reserve keeps all of the money it gets, but this link says otherwise:
http://www.federalreserve.gov/generalinfo/faq/faqfrs.htm#6
It says:
The Federal Reserve's income is derived primarily from the interest on U.S. government securities that it has acquired through open market operations. Other sources of income are the interest on foreign currency investments held by the System; fees received for services provided to depository institutions, such as check clearing, funds transfers, and automated clearinghouse operations; and interest on loans to depository institutions (the rate on which is the so-called discount rate). After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.
Yes, but I always thought it funny that no one gets to audit their books. So lord only knows how big or what those expenses are. I know if it was me I would have shockingly bloated expenses, personal ball washers aren't cheap these days.
The article at the link given above details in what way and by whom the Fed is audited.
Number one initial discussion after QE2 announcement, how will they back out? 2nd, what is the time frame, and in what amounts?
and specifically, Who will buy? Under what guaurantee?
Yellen gave us a rough time frame to back out. But can they?
Conclusion, unworkable under any scenario close to normalcy. Its really hard to pin down what will break first in the debt markets. Globally, and then between the US and State governments.
We shall see what overall impact the debt ceiling debate has in all of this. I foresee the Rebuplican's capitulating very quickly on this debate. There is no real alternative except to allow the FED enough headroom to offset at least $2T in Ts over the next 18 months. The FED will be the buyer of last and only resort.
Mark Beck
those who are caught bluffing, very rarely ever show their cards, they just fold them and no one ever knows for sure they were bluffing (of course they still lost all their money they put into the pot)
Yes, and in this case, the Fed has gone "all in," so when they lose the money in the pot, it will be ALL the money.
if Yellen thinks the FEDs monet printing will create 3 million jobs by 2012 why dont they just double the money printing and creat 6 million jobs? that would go a long way to replacing the 8 million jobs lost during the depression. Better yet, why dont they triple the money printing and create 9 million jobs? that would be better and would mean jobs for everyone and the end of all the problems. <sarcasm off>
That is exactly what she is selling,
qe3, qe4...
I dont know how many more QE attempts they will try, but I've always thought eventually they will pull the plug on the stock and commodity markets and scare money into Bonds. What I dont really know will the the after effects. Obviously the "in-crowd" will know in advance and make even more money, but what happens to the overall scenery after that card gets played? What will the rank-and-file boomers do after that?
No plug is going to pulled for quite some time. Volker out and Dailey in, Greenspan harping on the "wealth effect" mantra, the FED is screaming they are not going to defend the dollar and they are going to buy any amount of bonds that the Chinese or anyone else wants to sell. It is about the banks and any discomfort the poor may feel is unimportant since they will vote for Obama regardless since what do they understand?
I think #1 is much higher probability as well. The huge mass of notational trillions of dollars of derivatives the banks hold is the tail that wags the dog and nothing else really matters. These are dependent on home prices so if the dollar has to halve from here so be it.
Good piece Bruce. I give your scenario #1 a much higher probability than 5% because I believe a large part of the reason for QE right now is to fund the defecits. Geitner doesn't have the bond buyers at these yields. Which makes this QE much more of a desperation policy than markets are currently discounting. We will see.
Also picked #1 so agree with GS, SS and USG.
The simple reasong behind the choice is that the rationale/justifcation for QE 1 and QE 2 has been nothing more than a public relataions shell game played out in the MSM. The first time it was a 1 off to save the world as we knew it. The 2nd time it was???........was it unemployment???.........the banks still were paid record bonuses off the 1st round until it took the experts (at distortion) 2 years to come to the conclusion that the employment levels may take 5 years to return to 'normal'........bonuses also coming for round 2.
There is no reason to assume that the FED has not thought through the implications of the turn that is coming as this phase nears completion.
The FED will never sell, at least not in the forseeable future. That is a bluff.
The path of least resistance is for the next phase of QE regardless of who has the majority in Congress since the politicos all just blow at every opportunity no matter the party or the president.
If Yellen pulls the sell trigger the market may tank like it was 2008 all over again. She knows it. The FED knows it and the market knows it.
Cocaine http://www.youtube.com/watch?v=Q3L4spg8vyo
i agree, thats what caught my eye as well......i think #1 is most likely 55%....perhaps you just forgot a 5
No, I meant 5%. You could well be right and this goes on endlessly. That would bring us a very bad outcome.
Bruce, I think you're right about the forward-looking time frames, especially for bond people.
The European haircut situation is accelerating rapidly. It's been clearly floated there's a haircut issue for 2013 in Europe, and that is driving up spreads right now ... and this is going to get 'priced in' and 'out of control' here pretty fast, with I think dramatic impact on the US bond situation as well, after we get some dramatic haircuts registered here in the EU, maybe even six months from now.
Big question here is how the Germans will play it, as they are the driver of the 'eurobond' bus, and they will be reacting both to their own disgruntled populace and to a few million people likely in the streets all across southern Europe, framing the limits of what can be done.
You once said I think there may eventually be some kind of a 'Brady plan' for the EU, and I think that is roughly correct.
The variable in Europe, which Americans have a hard time seeing, is that we really do have unafraid people-in-the-streets ready and capable to bring down the governments (admittedly, we don't have a government in Belgium anyway aside from the 'caretaker' kind, so we're ahead of the game, ha!).
While Greece is in riots and so on, we have graffiti on street walls in this sector of Europe saying that the Greeks are only the first. The austerity - cuts equations won't hold in extreme form (though benefits will be restructured as well), and on the other side I don't think the Germans will quite hold for printing and inflating and paying for everything without haircuts.
It is going to be some messy, perhaps newfangled combination, but I wouldn't be surprised if Europe has a colossal one-time Continent-wide bond re-structuring of epic proportions, later in 2011, along with maybe the eurozone in two pieces, just possibly.
With the US, as the bond market plunges, I think you may indeed have 'QE3' in a very violent form - except it will have the military involved and be a form of 'World War III' as a more fitting name for it.
Anyone in the US would be well advised to get a big chunk of assets out of there. Think about what Simon Black has to say, and the railroaded, slandered, imprisoned financial guy Martin Armstrong, nearly killed in his jail cell recently. That fate could befall many more in the USA, even the most 'straight-up' seeming chaps included.
"...along with maybe the eurozone in two pieces, just possibly."
I remember that Bruce proposed this idea as well in that there would be a Euro(a) and a Euro(b), representing the core vs. the outlier countries ("peripheral" Europe- always loved that term... /:). Euro(a) would immediately go through the roof, while Euro(b) would fall through the floor.
Ms. Merkel would never (be allowed to...) go for it, though.
I never got the idea of a split Euro. Seems to me if they come right off a system that doesn't work there might not be support to repackage it and try again. If/when the Euro pops isn't there a much better chance of a new DM rather then Nordic Euro? Seems it would be a better sell to Germany, and I have to assume they are going to be the ones throwing a fit anyway.
The chinese are going to prop up the Euro in it's life support system for a while. This could take longer that many here like to predict.
Ok fair enough. But isn't China riding the lighting as far as inflation/bubble turf to? What happens if/when their housing bubble busts and they have to deal with their malinvestment?
Also seems like they cannot prop up the EU and the USA, their economy is simply not large enough. If it comes down to propping up the USA or EU, which will they pick? I don't know, but if one thinks they will pick the EU, it makes the US situation a hell of a lot more grim.
EDIT:
If China does prop up the EU it still does not fix the long term structural problems, which will only grow. I cannot assume you mean to say that China will bankrupt itself to fund Europe forever. so when the EU runs into problems what will they do? Bailouts only kick the can.
Not forever, just as long as they can. A few billion here and there. They will play it as long as they can; it's in their best interest, wouldn't you? Besides, the FED has the printing machine and will keep it running to offset any lack of chinese interest in US bonds.
The chinese have empty cities? So what. It's not like they are a democracy.
Me, no. If I was China I would be out buying real things. I'm no expert on the EU, but I'm guessing when the rough times hit they will resort to protectionist policies, with perhaps propaganda such as "EU Alone" with an idea that the EU can support itself so something like that.
Where I China I would be looking at 2 things, my own bubble and taking down the West. The West in itself is already on the downswing, so why not give them a nudge? If the West were to collapse the inflow of capital into Asia, and China in particular could offset the bubble damage. Being the last one to die in a game of economic chicken has it's benefits, but to do so one must not waste resources. And if needs be China could pull the ultra distraction and just militarize out, it's not like they don't have 300 million men they wouldn't mind disappearing. This would not help their economy, but it would sure as hell distract the people.
You say empty cities don't matter, so when a nation is not a democracy they can ignore the laws of economics? Seems like the weight of history would disagree. The USSR came down for a reason.
What laws of economics are you talking about? The ones that say that the FED cannot buy it's own debt? If I was a chinese central planner and I was having unemployment problems, I would have the peasants tear down the empty cities and build them again.
And how will that feed them or raise their living standards? While the central planners believe in printing money and senseless progress they do nothing to add economic prosperity. Order in China is based on the promise of economic growth. If it's done via the pozni system it will explode quite spectacularly and the CCP will be replaced. China has a long history of peasant revolts, and I'm quite sure the CCP knows Chinese history better then I. Building and tearing down cities just uses up resources and makes no economic growth, just props the ponzi up a little longer. If one can order economic prosperity out of the citizens then why did the USSR fall? Indeed why did Mao's industrialization plans fail at achieving prosperity? There is more to economics then saying "Hey guys, dig some holes and then fill them and we will all be richer!", unless one is teaching economics in the US.
As to the Fed buying it's own debt, and? Central banks have done this quite a while and we all know where it leads. It's a none issue in this discussion, the Fed will paper over their problems till no one will take their paper. If anything this is an incentive for China to exit US paper, but can we not expect the same from the ECB unless Germany screams bloody murder?
I just can't resist changing your hole digging malinvestment anology to the following: Since they're Chinese couldn't they just take in each others laundry to acheive full employment?
The chinese can raise thier MARGINAL living standards for years to come; and then there is indicator manipulation a la BLS. I would worry more about the fast decline in living standards in ther west. The last I heard it was Greece that had riots, not Beijing.
That only works as long as the peasants can feed, clothe, and house themselves. After that, game over.
Funny how people tend to ignore that. Just like we could have 100% employment tomorrow in the US, just ban all motors and use of electricity. Imagine how many people could be employed hauling food from the Midwest to the cities, and then tilling those farms without machinery. 100% employment...and massive death which will bring about the need for wood for coffins, coffin makers, and grave diggers! More employment then we could know what to do with!
Not so sure about that. Yes, the EU is China's #2 export market. But the U.S. is #1. If inflation gets too far out of hand in China I believe they're looking at tremendous domestic instability, at best, with a possibility of outright civil war. A really hard landing could cause the same thing, though I ascribe lower probability to that eventuality. Thus, when push comes to shove, China will dump Europe in favor of the U.S.
China and the U.S. could, in a world of omnipotent benevolent social planners, have a bipolar symbiotic economy without everyone else. China can't be a successful autarky, though. The U.S. most likely can't be. Any other combination of two major economies would fail -- in particular, EU-China wouldn't work. If I ruled the world I'd have China institute a Marshall Plan FOR THE US. Cultural and political realities prevent that, though.
Very interesting theories, but how exactly do you envision the US getting involved in a WW3 scenario with Europe? Play it out in more detail if you please.
I suspect we will have another round of QE. While it may appear discredited now, once they launch "Operation Italian Debt Crisis", let equity markets drop 30% and stoke up sufficient fear, the public and government will be begging the Fed to come to the rescue again. I suspect this shit will go on for years, until the Fed has stuffed its balance sheet to the tune of many trillions, with Treasuries and muni debt. At that point, they will kill the current Fed, and replace FRNs with a new Federal Reserve currency. I don't see what alternative there is...
QE is not about jobs it's about stealth bank bailouts. Which means the TBTF banks must still be hurting bad. I bet the fed gets real balance sheets from the TBTF every month without mark to market.
Ditto.
She is absolutely right
putting more money out there will soothen the pain
No one out there is, can,will or willing to question the validity of issuance of debt in the name of a nation's people without a referendum[as in Iceland]
aaugh...forget it!Where's the party tonite!
Ever watch a carnival clown make balloon animals? He squeezes one part, stretches another, twists here and there and, voilà!, a poodle, monkey, whatever. The Fed is making little balloon QE animals to our rapt attention, while the bankers are busy picking our pockets.
Everybody is issuing bonds trying to get operating cash, and there are simply too many bonds flooding the markets, causing prices to drop and raising yields.
Fed comes in and buys bonds with money created out of thin air. It helps keep bond prices up and yields down, but floods new money into the economy causing the dollar to lose value and consumer prices start rising.
So it's one or the other. Stay out of the bond market and watch bond prices fall as yields rise, or buy up bonds with money created out of thin air and watch the dollar fall.
They prefer the former, buying up bonds to keep their finanncial sector friends happy (and keep them from going bankrupt), while the dollar loses value and consumer prices rise ...not that they care about consumers.
Neither one creates any jobs to speak of.
It's wealth transfer, plain and simple, what the Fed's been doing since it was created.
Fed only cares about Wall Street. It never has cared about Main Street.