With The G-4 Central Banks "All In", Pimco Speculates When QE Finally Ends

Tyler Durden's picture

With economic analysis no longer a relevant consideration in the New Normal as Jeff Gundlach explained yesterday, the only real question since the advent of global QE, first in the US, then in Japan, soon everywhere else, is when does the Fed stop. And not just Taper, because while the Fed may slow down the flow pace of liquidity injection one month, it will promptly reaccelerate it just after when risk tumbles, but the structural, and terminal end of QE.

Our previous speculation on this topic has focused on the eventual increase in interest on reserves, both in a rising rate environment and simply from perpetuation of reserve expansion, as well as the Fed's relentless monetization of duration risk: recall that Bernanke owns 30.5% of all 10 Year equivalents currently, a number which is set to hit 100% by 2018, but which will break the bond market long before that. In brief: open-ended QE is anything but, at least until the Fed breaches it mandate and start "monetizing" outright risky assets just like the BOJ - a step it very well may be forced to engage in.

So to supplant the critical perspective on when/if the Fed finally pulls the plug we present the following observations by Pimco's Richard Clarida who looks at the end of QE from a more conventional macroeconomic perspective. His thoughts are presented below in their entirety.

But before absorbing the full analysis, here is Clarida's punchline distinguishing between those who believe the Fed is doing something positive, versus those who, correctly, understand it is Ben Bernanke's own fault for clogging up the monetary transmission mechanism, and for de facto "breaking the market" which is now - like a liquidity-addicted drug addict - impossible to visualize a world in which the Fed does not provide zero-cost training wheels from here until eternity:

QE detractors... see something quite different. They see QE as not responding to the collapse in the money multiplier but to some extent causing it. In this account QE – and the flatter yield curves that have resulted from it – has itself broken the monetary transmission mechanism, resulting in central banks pushing ever more liquidity on a limper and limper string. In this view, it is not inflation that’s at risk from QE, but rather, the health of the financial system. In this view, instead of central banks waiting for the money multiplier to rebound to old normal levels before QE is tapered or ended, central banks must taper or end QE first to induce the money multiplier and bank lending to increase.

This is absolutely spot on, but unfortunately this "liquidationist" path to fixing a problem that should have been addressed five years ago is now a dead end, as Bernanke knows he can not end QE in some interim phase without achieving (runaway) inflation or all that he has "accomplished" for the market, if not the economy will be undone. Even if, ironically, the market crash that results, would be just the debt-liquidating economic catharsis the developed world has been begging for since the advent of central planning.

Oh well. Let's just hope this time is different.

Anyway, without further ado, here is PIMCO on Reflation in the Balance

  • Four of the world’s major central banks are now “all in” when it comes to ballooning their balance sheets in correlated, if not coordinated, efforts to achieve escape velocity in their economies.
  • In accounting for the impact of quantitative easing on two key balance sheets, we are able to interpret, monitor and calibrate the programs currently in place. This in turn can help us prepare portfolios if – or when – sentiments and inflation expectations shift.

“It is sometimes better to study a balance sheet than it is to believe a model”


Rudiger Dornbusch, 1980

With the Bank of Japan’s recent “shock and awe” decision to double down on quantitative easing (QE), four of the world’s major central banks – the BOJ, the Fed, the Bank of England and the Swiss National Bank – are now “all in” when it comes to ballooning their balance sheets in correlated, if not coordinated, efforts to achieve escape velocity in their economies.

These programs are enormous and untested, and they risk serious unintended consequences even if they ultimately succeed in reflating these economies. QE is controversial, but it’s also not well or widely understood – primarily because there is no agreed upon model for how it works. And theoretical economic models themselves can sometimes get in the way, obfuscating instead of illuminating.

Still, it can be worthwhile to account for QE even if it may be difficult to model it. In accounting for QE’s impact on two key balance sheets – those of a country’s central bank and its commercial banking system – as well as the relationship between them and nominal gross domestic product (GDP), we are able to interpret, monitor and calibrate the QE programs currently in place. And as these programs continue, this framework should be able to provide a more or less real-time signal and explanation for why these programs are succeeding (or failing).
Two key ratios
We begin with two key ratios that are essential to accounting for QE.
k ≡ M/PY
In monetary economics, the “Cambridge k” ratio is the ratio of the broad money supply – currency plus the checkable and time deposit liabilities of the commercial banking system – to nominal GDP. It is a concept that was developed by John Maynard Keynes and others, who tried to understand – and, yes, model – it in the 1920s. Later, in The General Theory of Employment, Interest and Money, Keynes developed a theory of liquidity preference, which hypothesized that over a business or credit cycle k would depend inversely on the rate of interest on “bonds.” But Keynes also argued that the demand for money – and thus k – would depend on a precautionary motive or in certain circumstances (deflation) a speculative motive to hold money. He argued that in slumps k is not constant or even mean-reverting but rises with the demand for safe assets. Note that in an open economy there can be a global precautionary demand for the money supply of a safe haven or reserve currency so that k can and does fluctuate (a lot) with global risk appetite. This makes it much harder for central banks to model and predict money demand in the real world than in the textbooks.
x ≡ M/B
The “money multiplier” reflects the endogenous creation of broad money by the banking system. It is pro cyclical: In slumps, banks would rather keep reserves at the central bank than lend them out. As they do so, credit creation falls. Note that the central bank controls B (the size of its balance sheet) directly, but it can only influence the money multiplier – and thus the stock of broad money – indirectly though monetary policy. This slippage between the levers of monetary policy and the supply of broad money is especially acute when, as is the case in all four QE economies, banks want to keep enormous excess reserves on deposit at the central bank at rates far lower than they could earn on extending new loans.
Nominal GDP growth
Nominal GDP growth can always be accounted for by the growth in the central bank balance sheet, the observed change in demand for broad money and the observed change in the money multiplier.
 %?nominal GDP ≡ %?P + %?Y ≡ %?B + %?x - %?k
Note that this equation is an identity, not a theory or model of how changes in the central bank balance sheet influence nominal GDP growth. However it can be used to interpret, monitor and calibrate any observed slippage between the growth in the balance sheet and the growth in nominal GDP in terms of observed shifts in money demand and the money multiplier. And for this reason it is quite useful. Moreover, any theory or model of QE must be consistent with the above relationship between the balance sheet, the money multiplier (credit creation) and money demand.
The QE parade in pictures
The following four charts (all drawn to the same scale) each apply this framework to the Fed, BOE, BOJ and SNB. QE supporters look at these charts and see an endogenous and, to date, justified response by central banks to a largely exogenous collapse in the money multiplier (commercial banks in the bunker hoarding reserve deposits at the central bank instead of extending credit to the private sector) and a surge in the public’s desire to rebalance portfolios in favor of money at the expense of holding fewer risky assets. And of course the rise in balance sheets, while huge, has not been sufficient to restore nominal GDP growth to its old normal pace. According to this view, had QE been excessive, nominal GDP would have surged, and of course it hasn’t.
QE detractors look at these same charts and see something quite different. They see QE as not responding to the collapse in the money multiplier but to some extent causing it. In this account QE – and the flatter yield curves that have resulted from it – has itself broken the monetary transmission mechanism, resulting in central banks pushing ever more liquidity on a limper and limper string. In this view, it is not inflation that’s at risk from QE, but rather, the health of the financial system. In this view, instead of central banks waiting for the money multiplier to rebound to old normal levels before QE is tapered or ended, central banks must taper or end QE first to induce the money multiplier and bank lending to increase.
What are the limits to balance sheet expansion?
Recall from our accounting relationships we can always write:
B/PY ≡ k/x
Thus if there are limits to balance sheet expansion, that is equivalent to saying there is a limit to the ratio of money demand to the money multiplier. We have just discussed two opposing views of QE and the money multiplier x. While there is disagreement about the causes of the fall in the money multiplier, all would agree that a rebound in the money multiplier and in bank lending – for whatever reason – would be a positive indicator of the healing of these major financial systems. And note from the above equation it would tend to reduce the size of the balance sheet relative to GDP by boosting the denominator.
There is much less disagreement about what has happened to money demand under QE. Money demand k has been boosted in these countries by the Keynesian precautionary demand motive and as well for the U.S., Japan and Switzerland by global safe haven/flight-to-quality capital inflows. Note that this effect is especially evident in the Switzerland chart. A fall in money demand due to a normalization of global risk appetite and/or expectations of rising inflation would limit balance sheet expansion in these countries by reducing the demand for money. However, also note: The SNB and BOJ want more inflation and the Fed and the BOE are within some range willing to tolerate it. Finally, a weaker currency in any of these countries could also limit balance sheet expansion by reducing the demand for money, but it is well to remember that as all four of these countries are now doing some form of QE (or in the case of the U.K., is poised to resume as necessary), the net impact on exchange rates among the four to some extent cancels out.
The bottom line
I find this framework useful for organizing my thinking about the relationship between QE and nominal GDP growth, and I hope you do too. The era of QE will finally come to an end when these programs ultimately succeed – or fail, with the costs overwhelming the benefits.

While I have focused on the experience of individual countries, there are potential global externalities, benefits and costs to QE that are also important. As of now, commodity prices and the price of gold do not suggest that markets are worried about the global inflation consequences of QE. But only two years ago, when there was trillions less of QE in the global financial system, they were. This reminds us that sentiment and inflation expectations can shift. If and when they do, the exit dynamics from this very crowded global QE trade will likely be more complex than they may appear: nasty and brutish for those who are short.

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partimer1's picture

Can anyone take a look at the DJX options today?  Dec13 95, 110? huge volume.  Is someone betting the whole collapse ?   any insight? 

Divided States of America's picture

Even though I think the logical thing to happen is for a stock market collapse to happen.....I think it is in their best interest to let this thing slide down slowly as to not throttle the sheeps....however, it dont mean US stocks will drop even if everything is collpasing around you. USD is the safe haven currency...whoever owns USD will need to plow into something and as US stock prices get hit as well, there will be bids for them because of the divvy yield. Look I hate the US markets ramping every fuckin day but theres a reason for its resilience...and I aint gonna lie on CNBC like Larry Fuckin Fink or Jim Cramer saying everything is A-OK....it aint.

However, buying protection is a must now and whoever bought those DJX options is playing the smart way to hedge against a collapse...dont short...just buy way OTM put options....cheap insurance imho

DeadFred's picture

Relatively cheap maybe but someone just put $1.18 million into positions down to DOW 9500 and as far as I can see this is naked puts, not part of a spread. Someone has some cajones or inside info to put such serious money into those positions.

Thanks for the heads up PT1

max2205's picture

They will drag this out till 20,000 or 30,000 Dow...we be dead by then

seek's picture

I'd point at Nassim N. Taleb, but he closed his fund. It's a very similar trading strategy to his, though. I know Universa Investments is continuing with the same strategy.

Someone is either hedging on expected bad news, or making black swan type bets.

DeadFred's picture

Tyler has been known to recommend cheap far OTM puts as his favorite investment. Ya wanna fess up Tyler?

Stoploss's picture

  %?nominal GDP ? %?P + %?Y ? %?B + %?x - %?k   LOLOLOL!!!!!



Fucking fools.........................

DeadFred's picture

Update: Thy're still buying. Now 2 million in large purchases with the later buying in higher strikes. DOW at 9000 in Dec13 makes these positions worth $56 million. I wonder what they know?

partimer1's picture

If I understand correctly, DJX is the large Dow index option (either 5X or 10 x), and it's not cheap one to buy.  The volume is too big for small hedging.  I watch option volume regularly, and this is very unusual.  

fonzannoon's picture

"nasty and brutish for those who are short."

short what? Commodities and gold?

ssp2s's picture

"Short what?"  My question as well.

partimer1's picture

I just told you its the DJX option.  You can check the CBOE website on the intraday volume.

fonzannoon's picture

I have mentoned this a few times and I probably sound like a crazy asshole. But i went to get lunch just now and the place I went to had a sign "we no longer accept $100 bills". They say it's counterfeiting reasons. I have seen this in several other places. Has anyone else noticed more and more of this? They are replacing the $100 bill in October. I have a weird feeling the admin is going to goose the economy by playing games when that happens.

IndicaTive's picture

I've seen it popping up as well. Six or seven places. I've converted my at-home cash reserve to 50s. I have yet to see it at my local coin shop, but want to be prepared.

NotApplicable's picture

Thing is, fifties are even more scrutinized than Benjamins, due to their rarity in circulation.

Pallets of twenties is where it's at!

I fed a $100 bill into a cash machine at the phone company office yesterday, and surprisingly enough, it took it without any human intervention.

seek's picture

I commented about this same thing a few months ago, I started getting so much hassle on 100s about a year ago that I switched to 50s and select the new 50s I get for reserves at home.

If the counterfeits weren't being found and rejected at the bank (thus costing the shop money), the shops wouldn't care. Ergo it must be happening with sufficient frequency to make them bother to put up a sign.

ekm's picture

It's been going on for 5 years already in Canada.

Thousands were counterfeited so bank of canada came up with plastic money last year.

We have some new and extremely ugly $100 bills and $50 bills and since a couple of months ago, $20 bills

fonzannoon's picture

The question is, when do they cut off the old ones from being currency in a short span of time.

Dr. Engali's picture

They have you by the nuts when it comes to fiat. If they can't force you into the banking system then they'll make what you have worthless.

bank guy in Brussels's picture

Yes, ugly paper money is the new trend

The 7 denominations of the euro notes, up to € 500, roughly in the classic 7 colours of the Newtonian spectrum, were quite pretty

Now we have a new ugly € 5 euro note for 'security reasons' starting to replace them

But the euro-zone is breaking up soon anyway ...

Hongcha's picture

Degrading currency is a definite sign of a civilization turning to shit. 

Dr. Engali's picture

I've been seeing it all over the place Fonz which is bothersome because I keep all my cash at home in $100 bills. If they think the current biils could be counterfit wait unti the new monopoly money comes out.

fonzannoon's picture

I'd be really careful if I had a big stash of $100's.

I have in laws that burned stacks of their currency back in their old country because the game changed overnight.

SAT 800's picture

Yeah; seems like a very odd idea.

QQQBall's picture

The 100 bill is start of move to eliminate paper currency. Essentially, stores are repudiating the currency so "Safe and Secure" digital money will be required, which will also track every penny you spend or earn

ParkAveFlasher's picture

De facto capital control.  Likewise, HSBC just told me I can not pay my monthly mortgage in cash at the teller window.  It would imply that I am removing cash from an account in order to pay into another.  The circulation of cash must be controlled in order to create demand for it, thus a quietly, slowly ramped, creeping capital control system has been ebbing into daily financial life. 

FML and yours too.  Cyprus is indeed a template, if you slow down Cyprus frame-by-frame, it would look like what's happening here.

bank guy in Brussels's picture

Way back in July 2010 on ZeroHedge, Bruce Krasting did a great piece on how the US Fed and government might suddenly be very motivated to replace all the current currency notes, with 'red money' that is already printed ... making all the 'green money' notes held all around the world, invalid within 90 days or so


Rustysilver's picture

So, what hapens to 100's notes overseas. If you holding a lot of them where do you go to exchange them. Bank?  They would probably want so ID, etc.

Interesting times.

SAT 800's picture

It's always been a popular model with debt trashed fiat systems; the Mexican New Peso; various Argentinian currencies, the Braizilian currency changes; etc. etc. I think it's one of the more likely possibilites. It be because of "national security"; nobody knows what that means; but they know they're not supposed to complain about it. Solves a problem for the govenment; lot of cash they'll never have to redeem.

valley chick's picture

QE will never end ..period.  If anything it will increase...move along nothing to see here...


Headbanger's picture

QE causing the collapse of the monetary multiplier is an excellent observation!

Who would want to lend at interest rates well below the default rate?

And the Bernanke couldn't figure this out!!??  

GVB's picture

FED should've known, because wikipedia knows. Therefore FED knows. This is no speculation. It has already been proven in the past. http://en.wikipedia.org/wiki/Money_multiplier


Implications for monetary policy See also: Monetary policy

1. The multiplier plays a key role in monetary policy, and the distinction between the multiplier being the maximum amount of commercial bank money created by a given unit of central bank money and approximately equal to the amount created has important implications in monetary policy.

If banks maintain low levels of excess reserves, as they did in the US from 1959 to August 2008, then central banks can finely control broad (commercial bank) money supply by controlling central bank money creation, as the multiplier gives a direct and fixed connection between these.


If, on the other hand, banks accumulate excess reserves, as occurs in some financial crises such as the Great Depression and the Financial crisis of 2007–2010, then this relationship breaks down and central banks can force the broad money supply to shrink, but not force it to grow


2. By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can "encourage" an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, “no nothing,” simply a substitution on the bank’s balance sheet of idle cash for old government bonds.

— (Samuelson 1948, pp. 353–354)

Edward Fiatski's picture

A reminder, "The next release of the tentative outright Treasury operation schedule will be at 3 p.m. on May 31, 2013. At that time the Desk will publish information on transaction prices for securities included in the operations listed above."

Get your buttplugs ready, rational/irrational exuberance is about to commence.

SAT 800's picture

Jeez; you made me laugh tea up my nose.

Inthemix96's picture

The smart money is moving out, Greek un-employment is running 60+%, the Spanish un-employment playing catch up, seething tensions running wild in most of the EU, people getting desperate and pimco basically saying QE could end?

When this does go off folks, you will witness a once in a lifetime event, I hope everyone is prepared and ready.

This will not end well.  Lets hope the anger is directed where its due.

Rustysilver's picture


As always, the anger will be redirected. Such is history and such is life.

CrashisOptimistic's picture

Except wait.

Things were broken and not working and QE was begun as a cure.  Now this article declares that QE must be removed to fix things. 

But if it was broken before QE, and QE was the cure, how does removing it do anything other than go back to the situation where things were broken?


Q4 GDP was 0.4%.  Q1 latest revision 2.4% on a bounce.  Sequester didn't start til March 31, and projected Q2 GDP is 1.5ish%.  Those numbers are WITH QE.

How do you declare victory and remove stimulus at 1.5%?

rubearish10's picture

Kinda like too miuch of a good thing. QE shelf life died at after round one.

Sach Mahoney's picture

What's the end-game for QEternity?  Bernanke spots employment at 6.5% as his proxy to shut down the printing press. What if we achieve 6.5% by attrition, Americans dropping out of the workforce? It's all a crock.  They misdirect, lie, cheat and steal.  When we get to 6.5%, they'll claim some other reason to keep the money spigot open.  It will take a crisis going the other way that forces them to change policy....when the dollar can no longer compete and starts its long painful drop into oblivion, or when inflation really does materialize, despite all Government attempts to manipulate the inflation numbers lower....and SS/Entitlements COLA higher.  The only rational way out is through free market forces, dilution, wealth distruction, balance sheet writedowns, bankruptcy, etc.  

IamtheREALmario's picture

If I am interpretting this correctly then the ENTIRE purpose of QE to this point has been to stabilize the banks. To fix the economy monitary policy must be normalized and become predictably normal. In other words, value must return to being more important than free cash dropped from Ben's pornocopter.

Not sure how they will accomplish this in light of the ballooning of the warfare/surveillance state. It is sucking so much money that it cannot afford a normal economy.

QQQBall's picture

Yes, the FED (bank) is giving "free" money to (Banks); then the Banks deposit it at back the FED (bank) and get paid interest in Excess Reserves and BANK execs pay themselves huge bonuses for their great performance (sarc/)... Now how would that help taxpayers other than postponing the inevitable collapse and enriching the banks?

mendigo's picture

Bill sees everything thru eyes of an investment banker.
Capitalism is not about doing the right thing or the smart thing.
Doing the right thing requires intellect, hard work, risk and luck.
The financial markets are predominantly a sham to the core. A sham from which smart people can skim huge wealth while accomplishing nothing. Efficient allocation is a theoretical concept which has little use in practice.
Ben has succeeded spectacularly in rewarding is incompetent and selfagrandizing compadres. That is why they are richer than I. in part.

Party on.

buzzsaw99's picture

Here's an equation: A x T = H

A = angle of the dangle

T = thrust of the penis

H = How hard the fascist globalist billionaires and banker pricks are fucking over america.

Dewey Cheatum Howe's picture

Deflation is going to be trigger. It is almost here now. Central Banks hate deflation with a vengeance. QE is going to create deflation if they can't fix the TBTF banks and get that liquidity out into main street and out of the stock market. If you've ever run a real business were you have to price goods or services to the general public, if no one is buying once you cut everywhere else the only place left is in margin aka prices. Business operating budgets which include product pricing are not manipulated directly by Benny Boy if anything they take a defensive posture and adjustment downward to how he is draining liquidity from main street. When that happens en masse you got deflation. Regardless of what everyone says cash flows matter and so do budgets. If you don't think cash flow matters just point at the stock market and say QE, E.O.D. right there. Budgets matter when the cash flow is weak to nonexistent. Some may argue well if the FED injects credit into the economy via things like loans for cars, houses, school etc. well even in a healthy economy those are things people tend to buy with the help of credit and in this case they aren't generating enough to afford the payments on said credit. You may say well extend credit so they can buy shit like food well think about if you can't generate enough money working to pay your food bill you are already in deep shit, only difference is whether your subsidy is the credit card company or the credit card company aka EBT card sourced from JPM either way it ain't stimulating the economy. Non discretionary items that should be affordable but need to be bought on credit is only a short term fix the end result is the same if people can't generate real wealth to pay for things. It is a bubble and it bursts sooner or later. There is no way around that reality.

surf0766's picture

QE never ends. They print until dollar reaches 0 and then they will still be optimistic of a turn around.. Bunch of asswipes.

chart_gazer's picture

QE will not end until the fed monetizes enough US debt that historical interest rates can be allowed without blowing up the US gov budget. Keeping the interest on national debt in the $300-400B range, at 4-6% rates the amount of outstanding debt  they can confortably service is $6-8T.  Considering only debt owned by outsiders (approx 9-10T), fed still needs to buy 1-4T. At $45B/mth it will take them 2+ years on the short end, 10 years on long end.  This is too long, they will accelerate the buying. We will have much more QE before we have less of it. And remember, once the debt is on the fed balance sheet they will "poof" it away. The debt to GDP discussions are nonsense. Inflation, from the newly printed $, will be what brings it all crashing down.