QE3, Deflation and the Money Illusion

rcwhalen's picture

Update1/Chart -- The announcement last week by the Federal Open Market Committee that the central bank would initiate additional, open-ended purchases of residential mortgage backed securities (RMBS) was more than a little sad.   Let us count the ways. 

The first reason for sadness was the idea that people here in New York and elsewhere in the global financial community were actually surprised by the Fed’s move.  The FOMC is fighting deflation.  Credit continues to contract globally as much of the western world goes on a pure cash budget.  So while I would like to see the Fed raise short term rates, the fact is that the central bank has little choice but to support the markets.  But buying RMBS will neither help housing nor reverse the current deflationary spiral on which we all ride. 

The second reason to be circumspect is the fact that the Fed’s leaders continue to pretend that driving down yields in the RMBS markets will have any impact on the housing sector or the economy.  The two thirds of the mortgage market that cannot refinance their homes will be unaffected by QE3.  In fact, the latest Fed purchases are a gift to Fannie Mae and Freddie Mac, the TBTF banks and the hedge fund community.  A fund on the floor of our offices in New York actually started dancing around like little children shouting “QE3” after the Bernanke press conference.  

The link below shows a great chart from Credit Suisse of par RMBS vs 10 year constant maturity swap or "CMS."  Just how much lower does the Fed expect RMBS yields to go? 


“The entire move in MBS prices will go into profit margins,” one mortgage market veteran told the Berlin-New York-Los Angeles mortgage study group last week.  “FHFA has made sure that the mortgage market has oligopoly pricing and zero competition for the existing servicers.  QE3 is risk free profits for the unworthy.  And we wasted 40 years and Trillions of dollars fighting the USSR over the need for a free enterprise system?”

Unfortunately, since two thirds of the mortgage market cannot be refinanced, the effect of the Fed’s largesse will indeed go straight to the GSEs and Wall Street zombie banks.  This is the key, historical error being committed by Bernanke and the rest of the FOMC.  Instead of looking for ways to stoke consumer demand by restoring income and consumer income, the Fed is simply feeding subsidies to Wall Street.  Since the Fed does not think that savers like grandparents and corporations spend money, the error is magnified several orders of magnitude. 

The basic problem with the people on the FOMC today is that they are all Obama appointees who are by and large neo-Keynesian socialists in terms of economic outlook.  By spending all of their time trying to prevent the 50% drop in GDP which occurred in the 1930s, the Fed forgets or never knew that this catastrophe was the result of the disappearance of private sector capital – not a lack of government spending.  And why did this happen?  One word:  Fraud.  Bill Black has been talking about fraud for years,  So does Fred Feldkamp, the father of the good sale in RMBS.  And so have we at IRA and many others.  

The third sadness is that people still don’t understand that fraud is the core problem in the market economies.  Until you deal with fraud and start to restructure the trillions of dollars in bad assets now choking the US economy, no amount of Fed ease will reverse the contraction in credit.  This is not so much a monetary problem as much as a political issue.

Just as during the 1920s and 1930s it took years for our leaders to understand that securities fraud was the core issue menacing the US economy, today the same process of discovery and revelation grinds slowly forward.  Fear causes investors to withdraw from markets and save cash.  But because Chairman Bernanke and the Fed refuse to attack the source of the fraud – namely Bank of America and the other zombie banks – the US economy is destined for years of stagnation and eventual hyperinflation.  

Economists at the Fed think that the rising propensity to save is a function of interest rates, but no amount of financial repression is going to convince investors to take first loss on a private label RMBS until they trust the representations of the issuer.  Trust me on this since I am in the bank channel right now marketing a non-conforming RMBS offering.  

Just as the grey market banking sector collapsed from the peak of $25 billion starting in 2007, the confidence of the great market economies is collapsing under the weight of socialist economic prescriptions and cowardly advice coming from the legions of economists who work for large banks.  Most economists have figured out that the old linkages between savings, consumption and debt have broken asunder.  Yet none of these captive seers dares to suggest that the banks themselves need to be restructured.

Jeff Zervos of Jeffries is one of the key Fed cheerleaders.  He writes in a research comment: “The bottom line is that the Fed is printing money, debasing the currency and devaluing debt. The policy is redistributive, regressive and reflationary. It’s a nasty business for sure, and the truth must be obfuscated from the public. But if we want to avoid a second great depression, it is the right thing to do. Good luck trading.”

Good luck indeed.  So long as the Fed refuses to become an advocate for restructuring and merely keeps interest rates low, there will be no progress on the economy or jobs because aggregate credit continues to contract.  The Fed’s actions are not really growing the money supply much less credit, it is merely trying to slow the decline.  Whether we talk about the run-off of the private label mortgage market or the wasting effect of low rates on savers, the US economy is being put into a no leverage, pure cash model by the happy Keynesians who run the Fed.  

The fourth sadness is that mainstream economists from Zervos to Bernanke to Richard Koo at Nomura refuse to even talk about rebuilding private sector wealth creation.  In a brilliant luncheon talk last week at the Bank Credit Analyst investment conference, Koo accurately described the breakdown in the relationships between major economic aggregates.  He also illustrated nicely the jump in savings in Japan and the other major industrial nations following market shocks.  

But Koo, like most of our former colleagues at the Fed, thinks that only increased debt and public sector spending are the answer to the deflation threat.  But the key lesson of the Great Depression was that government must avoid actions and policies that cause private sector investors to flee the markets.  This is precisely the result we now see from the Fed’s actions.  

Now you might argue that the Fed is merely following the advice of Irving Fisher, the great US economist, who wrote in 1933 that vigorous monetary policy is needed in the face of debt deflation.  One must wonder, though, if Fisher would not scold all of us today for failing to attack fraud and restructuring at the same time.  Like most Keynesians, Fisher believed that government could manipulate income and investment via monetary policy. 

Yet even Fisher was guilty of embracing the same fallacy or "money illusion" that government can print money without affecting negatively consumer behavior.  As Ludwig Von Mises wrote in the new preface to his classic book, The Theory of Money and Credit:


“There is need to realize the fact that the present state of the world and especially the present state of monetary affairs are the necessary consequences of the application of the doctrines that have got hold of the minds of our contemporaries. The great inflations of our age are not acts of God. They are man-made or, to say it bluntly, government-made. They are the off-shoots of doctrines that ascribe to governments the magic power of creating wealth out of nothing and of making people happy by raising the 'national income'.”

Could it be that the monetary actions of the Fed and other monetary authorities around the world are scaring investors, eroding confidence in private markets and worsening deflation?  Most economists never consider that FDR’s anti-business rhetoric and policies helped to drive private capital formation to zero in the 1930s.  Likewise today, the Fed’s reckless and arguably illegal actions in terms of monetary policy are terrifying investors and members of the public around the world.  But all that Jeff Zervos, Richard Koo and their Keynesian/socialist pals that the Fed have to say is “good luck.” 

We need to take a new direction if the economic catastrophe predicted by luminaries like Paul Krugman does not come to pass.  The core principles are two: fight the fraud and restructure bad assets.  If we hold responsible those who have committed fraud against investors and at the same time move quickly to restructure and break up banks such as Bank America, we can restore public confidence in markets and reverse the deflation which is even now gaining momentum in the US economy.  Contrary to the assertions of Zervos and others, there is no need to hide government policy from the public view.

Restructuring is the necessary condition for credit expansion and job growth.  Without private sector credit growth there can be no jobs. Without justice for investors, pension funds and banks defrauded to the tune of hundreds of billions of dollars, there can be no investor confidence to support private finance.  And unless the Fed and other regulators in Washington break the cartel in the US housing sector led by Fannie Mae, Freddie Mac and the top four banks, there will be no meaningful economic recovery in the US for years. Instead we will face hyperinflation and social upheaval, both care of the well-intentioned economists on the FOMC.

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Cheduba's picture

I just had an idea.  We should plaster stickers on every gas pump in America explaining how the Federal Reserve is responsible for the pain they are feeling at that very moment while they fill up their tank.

It would definitely focus people's attention in the right direction.

malicem3's picture

Feds plan: run with their current policies until the dollar is bounced.

Mark123's picture

The way I see it the Fed had no choice but to keep buying government debt (directly or through their primary dealers).  If they stop then the entire house of cards collapses. I do not think it has anything to do with stimulating the economy - it is merely a giant band aid. 


Great article, and the point about addressing fraud is spot on.  However, how can you expect the "system" to attack itself?  I think we keep playing games until there is a collapse in confidence in the dollar....and that will be a long way out.


So Chris....for the next year how does the average investor play this?????  Do I go all in and buy Amazon, BAC, GS, etc?

geno-econ's picture

No, no, no. Keep away from consumer discretionary  stocks and financials. They will take hit on slowing consumer demand.   Iam thinking energy  and oil producers.  Even with lower demand they will reflect true value of currency and are crucial to human and industrial  survival.  Also go out and buy a Prius or Volt, learn how to do your own lawn and become self sufficient as best you can.  Would love to see Bernanke and Dimon do their own lawn.

ebworthen's picture

That's it, bail out the banks and the elites, punish the savers and retirees, force the middle class to liquidate assets to survive and push them into poverty, make more dependent on the government that condones casino markets and actively debases the currency as it removes rights and liberties dating back to the Magna Carta.

They are raping and pillaging every village in the kingdom; just doing it in wool suits at a desk with a ledger and a computer.

Sigep0612's picture

Americans can not handle the truth.  Politicians understand this.  It is better for US politicians to lie and cheat rather than face riots, food shortages, and untold hardships.  The deceit will continue until the system is fully engulfed in unsustainability.  The concepts of change which you endorse are admirable but unrealistic.  Think about the 47M on Food stamps.  The 9M on Disability (up from 4.2M in 2009).  How about the 38% of homeowners whose house is underwater?  Do you think Politicians want to be the bearer of bad news?   

We have Fed regulators with handcuffs on community banks.  Does that make sense when the big 5 are the problem?    Let the FDIC say to the big 5...we're divorcing you from FDIC insurance.  Let the consumer and businesses decide if they want to bank with the the big institutions.  But it's not going to happen, the cowardly politicans who are beholding to the bigs make the rules. 

The dollar will ultimately collpase.  My guess is late 2014.  It will be replaced by a basket of currencies.  To comprehend this....think of oil currently denominated in dollars being replaced by a a basket of 6 different currencies.  The price of oil to the USA immediately goes to $175 a barrel. The US currently uses 18M barrels a day of which roughly 10M are imported.  What does that do to the US lifestyle.  $8.49 for a gallon would be a bargain.   So again, this academic exercise of wishful thinking is great but the country is too divided (thanks to Obama who views our economic plight as a football game) and the politicans are too timid to actually rescue this once great country.      

malicem3's picture

Very realistic assumption. 2014 is so damn close it's hard for me to imagine but it's easily possible.

capltd's picture

Apparently the author discovered the error of his premise that the problem lies in the Obama socialists on the FOMC because he removed from his original article the comment by the mortgage group stating "Mussolini (a Fascist) would be proud." (see the original article on ZeroHedge without logging into your account).  This way he can still insist socialists (known for nationalizing banks) would instead protect the Oligarchs private equity in the banks with public funds - clearly a Fascist policy.  The Mortgage study group got it right.  This author proves his own political ideology is wrong.  Obama isn't a socialist he's a Fascist. Google Fascism please.

Snakeeyes's picture

Great article by Chris Whalen!


Bastiat's picture

Fed Evans: Commodity price moves are beyond scope of monetary policy -- netdania

Shizzmoney's picture

The bankers, corporates, and even military/police are going to learn the hard way:

It maybe fun now, but it's isn't so fun when someone gets an eye poked out. 

The QE3, and the "unlimited QE" stance, to me, signified two things:

A) They are admitting the economy is worse than it is and

B) It is run by people who want to keep it that way

Shizzmoney's picture

Financialization escalates the class war in a new way. For the last hundred years people thought the war was between employers and employees over workplace conditions, wage levels and benefits. But the debt overhead adds a new dimension in class war. Finance controls governments, especially in the public sector where unions typically are strongest. Most of all, financial lobbyists and the academic advisors they corrupt promote austerity and unemployment so as to drive down wages to a degree that could not occur in the company-by-company clash between industrial employers and their workers.

In the United States, Federal Reserve Chairman Alan Greenspan explained triumphantly to Congress that what was so remarkable since 1980 was that labor productivity rose by about 83 percent, but real wages didn’t rise. The Maestro found the explanation to be that workers had been obliged to take on enormous mortgage debts, education debts, auto loans, and live on credit-card debt in order to keep up with their neighbors. Their precarious financial situation made them afraid to go on strike or even to complain about working conditions, because if they are fired and miss a payment in their electric utility bill, the interest rate on their credit card jumps to 29 percent. And in America if you miss a few mortgage payments, you can lose your home. So many workers fear that they are “one paycheck away from being homeless.” That’s what the debt overhead has achieved for relations between labor and capital. The two-thirds of Americans who own their homes are afraid to complain and lose their job, because this would threaten their economic solvency and hence their social status.

What’s happening in Greece is similar. And for a dress rehearsal, look at Latvia, where neoliberals had a free hand. Two years ago, internal devaluation reduced its public sector wages by 30 percent. This helped drag down wages in the private sector. Cutbacks in public spending shrank the domestic market and hence employment – and spurred emigration of young labor. Workplace rights are being rolled back in a way 19th-century industrialists never dreamed they could achieve under democratic government.

Read more at http://www.nakedcapitalism.com/2012/09/michael-hudson-on-how-finance-capital-leads-to-debt-servitude.html#eDIxqtR0ktSRHHjq.99
lynnybee's picture

" We, in my family, have ground our spending to a halt. "   i have also withdrawn my consent from the system.   i proudly call myself one of the 'unbanked' now.   my paradigym shift was made early.    i've been burned enough by banks.   wake me up when we again earn interest on our meager savings from our low-wage jobs.    until then, my bumper sticker reads :  NO MORE BANKS !   

disabledvet's picture

Eh. I'm not sure what the consequences will be actually. You forgot to add the extension of Operation Twist here as well...which says to me the Fed is terrified of higher rates. PERIOD. My view of the MBS thing is simple: they chain of titles were broken...the banks actually owned nothing. So the Government buys it...there goes the legal liability. That's my take...for what it's worth.

Winston Churchill's picture

Its much better than that for TBTF.

Because the biggest fraud in the sceuritization chain was the theft of the money

going to pruchase RMBS bonds.The money was replaced by leverage at 40 times.

So that $40b per month is actually covering $1.6 t per month in hidden contingent

liability for them.

Isn't life grand if you're a banker.

geno-econ's picture

Whalen did a Whale of a job in pointing out deficiencies of QE ad infanatum.  ZH readers should distribute copies of article widely to Congress, Fed members, media, friends and nieghbors.  Also did a good job in discrediting Koo in being blind to need of solving consumer dilemma rather than bailing out banks who commited fraud in the first place.  Well Done !

Cole Younger's picture

"ZH readers should distribute copies of article widely to Congress, Fed members, media,"

Why? They are all in it together...

LouisDega's picture

Damn, My Alpine car stereo is going to cost me 600 illusions

Racer's picture

If MFG and all the other fraudsters and criminals are allowed to evade the law and steal people's money with no come back, then why should anyone in their right mind put any of their hard earned money in these criminals hands?


pavman's picture

Because if you have too much cash or wealth or whatnot, you're labled a criminal.  Whether they apply the title of terrorist or drug dealer, you're frucked if you don't use the system.

Getting Old Sucks's picture

Good read.  Send it to BB.

jayman21's picture

Hi Chris - Very nice read, then I hit this part.

"the US economy is destined for years of stagnation and eventual hyperinflation." Serious cognitive dissonance...

Hyperinflation is a political event, thought out history it has occurred due to people loosing faith in a currency.  As long as we have fools and dancing with the starts, we are going to have enough faith in fiat.  I do not agree with this that it will be related to credit expansion or contraction.


As for the fraud points.  Spot on....keep up the good fight and always enjoy reading your thoughts.

Winston Churchill's picture

And quinfinity isn't a political event ?


jayman21's picture

"And quinfinity isn't a political event ?"

Through which set of eyes?  The people reading ZH, or the regular sheep/Muppets?

aleph0's picture

Well said Chris ... Institutionalized Fraud 

The FED's Fiat-System Fraud may have lasted another decade had it not been for the WS-Bankstas joining in as well ... which simply accelerated the speed of the black hole's vortex.

booboo's picture

With regard to out and out theft, fraud (including taxes) people reason and justifiably so that they would rather stick it in a safe deposit box or in a mattress in lieu of having a thug with gun barrel or slick fund manager steal it right in front of them. Living with the thought that they were scammed or robbed far outweighs any speculative roll of the dice for a few more points. People are animals and those are the real "Animal Spirits" of one surrounded by fraudsters.

Central Bankers and progressives just cannot wrap their head around this because the live off of the stolen goods of others, so forget reforming them, they will never see the light until that mode of living off the fruits of others is several generations removed.

aleph0's picture

" fraud (including taxes) "

Income Tax was first introduced to the USA in 1913.
No coincidence of course.

Hindsight2020's picture

What would happen if people actually understood what was just stated here?


As others have said, thanks Chris.

malicem3's picture

I don't think people will truly "understand" what is going on.  It's kind of like everyone talking about the NFL games this past weekend at the office.  They think they know why <insert team> won or lost, but in reality they don't know shit about football.

illyia's picture

They will. But by then it really will be too late:

The most important thing you’ve never heard of

Right now, behind closed doors, bureaucrats backed by corporate interests are putting together a new free trade agreement that would slap regulations on everything from our internet to land usage to health and environmental regulations.

The specifics of the deal, called the Trans-Pacific Partnership (TPP), are largely unknown thanks to the veil of secrecy surrounding the negotiations. But details on what is being called the biggest free trade pact since the 1994 North American Free Trade Agreement (Nafta) are leaking – and a people-powered movement is stepping up to challenge it.


lynnybee's picture

truth.    it's all about the fraud, people.    most American citizens work hard & want to do good.    unfortunately, there are those in positions of financial & political power that are undermining the citizens & want it all for themselves.

Quinvarius's picture

Article of the year!

mogul rider's picture

Thanks Chris

Finally someone speaks the truth. I would be curious if anyone knows if there is a differential measure of public sector velocity of money versus private sector velocity of money.

We, in my family, have ground our spending to a halt. As business people we refuse to deploy capital when a slimy government apparatchik could give our competitor a few millions/billions to create a project or jobs wiping out our investment which used our own capital

We see this private sector expenditure decrease with our peers  as well every day.

private smart money is essentially off the table


well done Chris

Bartanist's picture

Nice article. I fear that before the real solutions can be implemented those who are "leading" (more accurately "taking") us down this path to destruction will have to rejoin humanity. Right now it appears as if they believe that they are above (the whole elitist concept that became a meme of the 21st centry is evidence) or separate from the masses of people and their apparent belief that they do not need us ... to survive and thrive.

Until they come to the realization that they are part of humaity and that their personal survival depends on the rest of us they will continue to act selfishly and anti-socially.

Racer's picture

The parasite that feeds off it's host will eventually kill it and therefore itself,

These banksters are parasites and unless the people wake up to the fact they are the host that is being eaten alive then all will die

Downtoolong's picture

…the effect of the Fed’s largesse will indeed go straight to the GSEs and Wall Street zombie banks.  This is the key, historical error being committed by Bernanke and the rest of the FOMC. 


Good article. The observations are right on.


But, I would caution against assuming the Fed has made an error. I would argue the inevitable consequences cited are exactly what the Fed intended. It’s not an error, it’s a strategy, disguised as stimulus, which they know they can get enough Muppets to erroneously believe is real.   

Jefferson's picture

The ludicrous notion that current monetary policies are determined by "well-intentioned economists at the FOMC" makes any analysis by this author rather suspect. The current situation is not the result of the incompetent bumblings of bureaucrats but rather a well-orchestrated and highly manipulated collapse of the global financial system.

honestann's picture

The federal reserve doesn't make mistakes.  Anyone who thinks the federal reserve has ANY goal other than to spew unearned profits into the large financial corporations that own the federal reserve --- is completely naive to the point of being braindead.

falak pema's picture

they are doing God's; aka the Oligarchy's, work. That was their brief from day 1.

If your underlying belief is that those who made America what it is, those who ran the industrial, political, financial and economic destinies of the greatest nation-state on earth, WERE God's true people when they created the FED at inception, then its only normal that it becomes religion to you as simple economic monk working his way up the ladder.

These men are today as they were yesterday, the servants of the elite of the USA; the chosen few; who are destined to run the world. If you buy that, your are brain dead to everyone else or to all perceptions which are contrary to that dogma. 

Saint Thomas of Aquinas, the MOST advanced scholastic that the medieval age produced; when the chips were down and he had to choose between Socratic/Aristotelian free will, extolled by Averroes, and divine chrisitian revelatory truth ; said this :

"For those who have faith in God no explantion is required, for those who do not have faith is God no explanation is possible."

By rejecting the very THESIS of philosophy that logic and science is a procees of ENQUIRY where the resolution to problem is uncertain by definition, Saint Thomas decreed that such enquiry was in fact totally fruitless as the resolution was PREORDAINED.

Now that is akin to being totally brain dead to a scientific, logical mind, but its revelatory truth, poured in concrete, to the BELIEVER.

You better believe it : Bernanke is a believer, or pretends to be in present dire conundrum, alike Saint Thomas of Aquinas, who conveniently dodged the bullet then; leaving it to the likes of Erasmus to pick up the flame of independent inquest through reasoning and empirical proof of concept. Fortunately for us, western civilization did not stay brain dead, like Islam went, around that same time we had Renaissance.

To come back to brass tacks : DOn't consider the FED as doing God's work; quite the contrary as the CB/fractional reserve model is flawed. Punish the fraudsters and wash out the bad debt. Ouch, what follows is beyond my third eye vision; i-eye I don't have as I haven't purchased i-phones! 


eddiebe's picture

And who, pray tell, will force these thugs to do the right thing for the working class?

BigDuke6's picture

Looking at history you can get the idea we are returning to a more feudal state...

the elites had to share with us after the horrors of the world wars demanded a more level playing field - now they are stealing it back.

eg Grand homes in the Hamptons turned from 1920's bankers residences to nursing homes post ww2 are now being bought back by the banksters at a rapid rate.

Does that answer your Q?

Quinvarius's picture

Stop calling them elites.  It only encourages them.  It is like letting mongo play with the other kids without his helmet.  Nothing good can come from letting a soft skull, with the strength of three men, rough house with the neighbors. 

BigDuke6's picture

Good point. Fuckers is better but i cant edit it now you've replied....

falak pema's picture

don't bad mouth honest fuckery please! And don't tell me you can't edit it.

Bartanist's picture

Obviously no one. They will either come to the realization themselves or the fabric of society will change and their successors a generation or two out will naturally become "better" humans.

LawsofPhysics's picture

Correct.  The herd will be culled.

tarpuranus's picture

Best read in a long time +100

Cursive's picture


Chris Whelan is always a good read.  Loved this:

A fund on the floor of our offices in New York actually started dancing around like little children shouting “QE3” after the Bernanke press conference.  

As for addressing the fraud, TPTB cannot address it because it underpins their status as TPTB.  Liberty and justice died a long time ago and the same people/academics who chided Japan about not writing down their bad loans are the same people following the same playbook here.  I'm convinced that the only change will come about in non-civil ways and many of us will be caught in that violent maelstrom.

Peter Pan's picture

Definitely a good read, because it exposes the lie behind Bernanke and Co and the idiocy in the persistent use of QE.

While QE does provide gold and silver with a lift, the reality is that the demise of the system and the failure of QE will give the greater boost not only in their relative prices but also in itheir position vis a vis the financial/economic system.