The Quantitative Beatings Will Continue Until Economy Improves

Monetary Metals's picture


The Fed’s purpose, when it comes down to it, is to buy bonds. Under their various “Quantitative Easing” (QE) programs, they sure have bought a lot of bonds. This pushes up the price of the bonds. Since the yield is basically the inverse of the bond price, this means the rate of interest falls.

This month, on rumors that QE will be tapered off and despite continued Fed bond buying, the yield on the 10-year Treasury bond has spiked from 1.63% to 2.12%. Will this be the end of the bull market in bonds and the start of rising interest rates in the US in earnest? I rather doubt it, as all of the dynamics that have created this bull market are still in place. And as the other bond markets of the world experience greater trouble (such as Japan today), capital will come pouring into the dollar and the Treasury.

It has been quite a bull market in bonds. Here is a chart of the yield on the 10-year Treasury.


UST 10-year


The recent blip is hardly noticeable on this chart, which shows the fall from 16%.

This is all good, right? It’s a bull market, so people are making money. The cost of borrowing to finance a new business is near its all-time low. The deficit to GDP ratio is kept in check by low interest payments too, as any Keynesian will tell you.

Not quite.

In the spirit of the boy who said, “The emperor has no clothes,” let’s ask a question. Where do the profits of the bond speculators come from? Who is on the other side of the trade? Who sold the bond short?

The borrower, who sold the bond, incurs a capital loss as the bond speculator gets his gain. Changes in the bond price are zero-sum: one side loses and one side gains. While they can borrow more money at a cheaper rate tomorrow, they can never make up the loss on the money borrowed at a higher rate yesterday. Their burden of debt rises as the rate of interest falls.

How does this manifest in the economy? A competitor can enter the business more easily. If the interest rate is lower, that means he can borrow the same amount of money and have a lower monthly payment. Or he can borrow more and have the same payment. Either way, he has a sustainable competitive advantage over the established business. If the rate falls again, then another new competitor can enter the market. The established business is pushed into bankruptcy, the first new competitor is on the ropes, and the newest is doing well. That is, until the next decline in the rate. The penalty for borrowing at a too-high rate is harsh.

This is certainly not good for the economy. To the extent that new money goes into the productive sector at all, it may be used to cannibalize existing businesses. The old debt is defaulted, and net debt increases slightly as the new loan is bigger than the old one. Churn is not real activity.

Even more pernicious, our endless non-recovery is not in spite of the Fed’s effort, but because of it. The interest rate is not exclusive to just one business. It is universal, applying to the whole market. Every business can borrow at the prevailing rate. When will they borrow? To oversimplify slightly, they will borrow when they see an opportunity with a net profit greater than the interest rate. This will push down the rate of profit of their market. The actions of a myriad of other businesses will push down the rate of profit in every market.

Let’s pause to consider this for a moment. The rate of interest is falling. This invites businesses to incur more debt. At the same time, their opportunities to profitably deploy the borrowed money are declining due to the very reason of falling interest rates.

The falling interest rate not only sucks capital off their balance sheet and threatens them with death by competitors who wait for a lower rate, but it encourages more leverage and makes them more fragile by lowering their profit margin. Who in their right mind would go deeper into debt for a reduced profit and a longer time to amortize the debt?

The Fed can no more improve the economy by buying bonds than a boss can improve morale by punishing employees. Their low interest rate forces the economy down into the mud and keeps it pinned. The Fed purportedly helps stabilize the economy compared to the gold standard, but it really achieves the exact opposite.

The chief virtue of the gold standard is that it keeps the rate of interest stable. Look at this long-term chart that goes back to 1790. There are spikes due to wars and policy blunders, but it is striking how stable it was prior to 1913 especially in comparison to the era of the Fed.


long-term Treasury graph


Today, the saver is disenfranchised. If he does not like the rate of interest, he can complain, but there is not much he can do, short of speculating on commodities or stocks. According to many sources I read, pension funds are becoming more underfunded. Why? It is because the net present value of the payout they must make to retirees is rising (as a mathematical function of lower interest), while their ability to earn a yield is falling.

Under gold, if the saver did not like the rate of interest he could sell the bond and take home the gold coin. His preference sets the floor under the rate of interest. No yield, no lending. No lending, no bonds can be sold. So the rate was forced higher. (There was also a ceiling, but the mechanism is only of academic interest today with falling rates.)

Stable rates preserved the saver’s ability to earn a yield, and also protected the capital of borrowers.

How do savers today expect their money to work for them so they can retire comfortably? Those with a defined-benefit pension plan don’t worry about it; they have outsourced the problem of finding a yield to third party money managers behind an opaque structure. As I noted above, most are badly underfunded and the prognosis is that underfunding will become worse.

Everyone else has a choice of believing in one or another myth. The first myth is that everyone can become a great trader, who is nimble, quick, and has superior and timely information. Burt Malkiel wrote a book called A Random Walk Down Wall Street, which debunks this notion. The average investor will not beat the market average. Net of costs and fees, he underperforms.

The other myth is that stocks and other assets will go up and up without limit. So one simply must buy and hold. Then the capital gains will pay for a comfortable retirement. This plan is no more feasible than the first.

The only thing that can pay for retirement is the return on capital put to productive use. This is a serious problem in our era of wholesale capital destruction.

Another reason why rising prices cannot pay for everyone’s retirement is unique to gold. A rising gold price is not a gain. It is just an artifact of using a falling dollar to measure gold’s value. If you have an ounce of gold, and the price doubles to $2800, you have twice as many dollars, but each of those dollars is worth half as much. You still have one ounce of gold. Only if you make a profit by earning more gold do you have a gain. While this was how people made a profit 100 years ago, today few are even thinking about how to do this.

It is high time they started again.


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The Wedge's picture

The old saying is true about gold. The real value of gold has not changed since the Roman empire. Which is the very characteristic that makes it worthy to base any currency. One ounce of gold will buy a man a fine suit of clothes then and today. Certainly 1400-1700$ will buy a decent suit. Some may say that 10,000$ would buy a fine suit or more but the average person would fall into the latter. Any difference seems arbitrary to me.

For stable growth, rule of law, society, you must have a gold backed currency as a foundation. And the central banks must be smashed, signifying world wide the return to the gold standard. The reset will then have a solid footing from which to build upon.

But we know that elite bankers and the powerful do not share my opinion. When the dollar begins to lose reserve status, their solution will probably be a global currency. Go big or go home. Just not sure the rest of the world will go along. Or more specific, China, Russia etc., non western countries.

Setarcos's picture

I offer an extract from a Global Research article, which helps me to further get my head around irrational Financialism ... which has repleced anything remotely resembling Capitalism and/or the Free Market:

Lesson 4

The third cover-up is more subtle.

This third cover-up is to do with the scam of artificially raising the value of the shares pledged to the TBTF banks.

You will remember that these shares, pledged as securities were shares quoted in the stock exchange such as the NYSE, the London Stock Exchange etc. The value have all plummeted and are worth a fraction of the value when first pledged to the banks as illustrated above in the case of Citibank shares.

Therefore, there is a need to jack up the value of the shares quoted in the stock market. This is common sense. If the value of Citibank shares remain at US$5, the bank would not be able to cover-up this glaring black-hole if these shares have not been sold to the FED or other central banks and remained on the balance sheet.

And in the case of the FED, sooner or later, even the common man on Main Street would realise that the FED has a lot of junk on its balance sheet.
Technically, in such a circumstance, the FED would be insolvent!

Bernanke’s infamous QEs were the solution. The new digital monies were applied to buy toxic assets of the TBTF banks (which in turn were converted into bank reserves) and US treasuries. The new monies were also diverted to the stock market to push up the value of the shares as well as to shore up the depressed housing market.

In the result, there was a rally in the market and the Dow rose to a record high, even higher than what was achieved in 2007 prior to the Global Financial Tsunami. Citibank shares rose by leaps and bounds as did other shares.

In technical jargon, this is “asset inflation” – the artificial rise in value of shares as a result of the FED’s digital monies being diverted to the stock market.
The net effect is that the “toxic shares” on the TBTF banks’ balance sheet also rose in value (albeit not to its original price) as well as those shares on the FED’s balance sheet. The losses of the banks were thereby reduced.

Lesson 5

Many have moaned and groaned that the FED ought to apply QE monies to Main Street and not to Wall Street.

To the FED, what is most important to the American economy and its superpower status is that the banking system must be protected and preserved as the foundation of the entire financial edifice is global confidence in the US$ fiat money. The US$ fiat toilet paper is the fuel that drives the US economy and is the most valuable US export, an export product that does not require any manufacturing or engineering skills or technology. All it needs is a printing press (or more appropriately a digital printing press).

The above explanation is at the most basic level as the above schemes and scams are merely to shore up the first tranche of the financial rubbish that have been dumped onto Main Street. We have not even addressed the problems of those toxic assets that have been packaged and re-packaged, re-hypothecated many times over in the Shadow Banking System. Suffice to say that if the FED cannot solve the problems at the most basic level, it would be futile to address the nuclear financial waste of the Shadow Banking System.


A point that I want to pick out is this:

"And in the case of the FED, sooner or later, even the common man on Main Street would realise that the FED has a lot of junk on its balance sheet.
Technically, in such a circumstance, the FED would be insolvent!"

Technically?  I don't think so.  The Fed and other CBs (plus the IMF, World Bank and BIS) ARE insolvent, because the whole basis/backing for "money printing" is "toxic assets" with only a "book value" ... which is really probably zero in many cases.

It all reminds me of when I was a lad studying book-keeping and double-entry book-keeping in particular.

By hook or by crook(sic) one had to "balance the books", including by entries presuming that debts would be repaid and assumptions about the worth of "good will".  But even when, in my case, the company I worked for was viable (though now defunct) the whole procedure was very iffy and open to manipulation, if not fraud.

To cut to the chase:

By their own rules/accounting procedures, the bankster/financialists are in the process of destroying their own corrupt system, because their notional books are only 'balanced' by mostly worthless 'assets', which have to be sold at some point ... but to who?  Martians?  (I can't see the BRICS continuing for much longer, either because they are pissed-off, or also going down the tube.)


Reci's picture

With QE as the new standard, the rich never have to worry about losing their wealth to bad investments again in a free market as the Fed is basically saying this is the "bottom" here.  We may not send the market much higher but we certainly won't let it go much lower.  We'll destroy the currency before we allow any wealthy stock holders to go bankrupt.  The top percent may rejoice in their permanent status as the country leadership by authority of the non Federal "Federal Reserve".  So while your savings are somewhat protected by the FDIC, the elites wealth is super protected by the Federal Reserve and backed by the value of the money itself.  As a result, the elites can "invest" more money into controlling the political process which prevents that accumulated wealth from a corrupt system being taxed, reclaimed or lost to another participant in the "market". We truly have gone full circle with hierarchical economic classes now where if you want wealth, you better be born into it or be very very lucky. 

The funniest thing I've noticed lately is how all the uber rich are looking for press coverage of their "charity" to the poor classes to protect themselves from the public perception of being uncaring and benefactors of a destroyed free market and fair system.  Heck, Bill Gates has enough money from his corrupt capitalism days to buy the entire Congress off and change all the rule books back to a more equitable system but he would rather enjoy his "protections" under this new system and spend time building toilets for third world countries to show what a stand up guy he really is despite his past efforts to operate a monopoly with dirty business practices.  I guess the rule is to do as much evil as necessary to acquire the wealth then do just as much as you need in order to purchase your Saint hood.  One thing is for sure and that is that our corporate owned "free press" will be more than happy to sell you positive coverage for a price as they don't have anything of real investigative value to air.

newworldorder's picture

"The Fed’s purpose, when it comes down to it, is to buy bonds."

I would amend your observation thusly. The Fed's purpose is to buy UNLIMITED AMOUNTS of bonds, based on the shortfall needs of supporting government obligations.

All other purposes atributed to the FED are suspect and meant to confuse/misdirect the un-informed.

ebworthen's picture

"Who in their right mind would go deeper into debt for a reduced profit and a longer time to amortize the debt?"

Our government.

Clowns on Acid's picture

Lockhart says "We will beat you up or we can beat you down". Who da feck does this guy think he works for.... the IRS ? !

In a May 22 interview, Williams said any move to reduce the pace of bond buying could be followed by an increase should the economy weaken again.

“Even if we do adjust downward our purchases, it doesn’t mean we’re now in some autopilot of moving in the same direction,” Williams, 50, said. “You could even imagine a scenario where we adjust it downward based on good data and then adjust it back” if the economy weakened.

madbraz's picture

Stopped reading when you said that QE pushed up prices of bonds.  At the very least, look up the data before jumping to your preconceived conclusions.  All QEs have been bad for treasury bonds, fact.  Take away QE and treasuries resume their rise as their status of safe haven is unquestionable - wether you like it or not.

Bastiat's picture

So $85 bln per month in Fed demand has no impact on price?

madbraz's picture

Yes, not a positive impact on price.


What is the negative flow out of equity markets without QE in billions?  At what size does the repo market work if you took away multiple rehypothecation and lowered NY Fed securities lending from $20 billion a day to less than $10 billion a day?  What is the real shortage of collateral (read treasuries, which are scarcer by the day)?


I'd venture to guess that if you take away QE and some of these "invisible" support schemes, the negative flow takes equity prices down by more than 30% from these lofty, record levels.


That's $6 trillion that suddenly doesn't exist in equity pricing.  Do you think the equity outflow of these retail accounts would flow where?  To treasuries, mmf, munis and utilities.  That dwarfs QE.












Bastiat's picture

Interesting, thanks for elaborating.

orangegeek's picture

NASDAQ100 has done very well under QE.


Nothing but up.


Too bad there are 50M Americans on food stamps, 11M on disability and record low labor participation rates (which makes the unemployment rate a lie)

Handful of Dust's picture

Housing sales have plunged with just a tiny rise in rates to 4.25%....wait till the mortgage rates revert to the norm.....

laomei's picture

Gold? Silver? Watch how they just beat that down all day long

stacking12321's picture

i'm watching, but i haven't seen them beat it down.

this gold maple i have here, is still 31.1 grams, just like it always was.

Downtoolong's picture

Quantitative Beatings. Perfect.

Ben, please stop helping me, it hurts too much.


Solon the Destroyer's picture

That's a great title, but this article is only repeating what has been said here for years in the ZH comments.  ...In a much more succinct fashion than this piece.

Apparently the author doesn't realize that people here read Fekete long ago and have been promoting his message for ages.

I also note that there is no credit to Fekete anywhere  in this article despite in being a regurge of things the Professor has written about many time.

But hey that's a Weiner for you.

bonin006's picture

I never heard of him before, just looked him up. Looks interesting.