QE2 Explained...

[charlestudor2005]

Originally Posted by OliviaHoward

I have a money tree out back, so I’m good.

Hope it's similar to the horse of many colors and bears fruit in many currencies.

[I B Hankering]

This posted tonight



Record Wholesale Turkey Prices May Just Be the Beginning
By BRUCE WATSON
Posted 5:40 PM 11/23/10
Generally speaking, it takes a while for monetary policies to have an impact upon consumers' wallets. But for families buying turkey this Thanksgiving, the effect of quantitative easing may be quick and unpleasant. Currently, wholesale turkey prices are hovering around $1.09 per pound, the highest they've ever reached. This represents a 28% increase over 2009's prices and a 37% increase over 2008's. While many retailers are selling birds below cost to draw in customers, fans of free range, organic or other specialty birds are likely to feel the bite.

Several factors have contributed to the rising price of turkeys, including the fact that they were undervalued in 2008. But one major factor may be quantitative easing. Trying to protect against deflation, the Federal Reserve poured money into the economy in 2009 and 2010. In the process, it spurred at least some inflation, particularly pushing up the prices of securities and commodities.

Among other things, the easy money resulted in more costly energy, which is used to raise turkeys, and oil, which is used to bring them to market. Because of corn-based ethanol production, the price of corn is tied to the price of oil, which means corn prices have also gone up by 47% in the last year. Since 70% of turkey feed is composed of corn, this has further fueled a rise in turkey costs.

http://www.dailyfinance.com/story/re..._lnk1%7C186129

[Guest050715-1]

Originally Posted by charlestudor2005

Hope it's similar to the horse of many colors and bears fruit in many currencies.

It’s hard to say what’s safe. Currencies value is all over the place for many different reasons. China’s holding a fictional value on their currency to hold present exports from their factories. We couldn’t spur the value of the dollar if we tried. The euro is in trouble because of the EU bailouts. Gold is so high who’d buy it.

But don’t be such a downer Charles. It was just a joke. Regardless what we do, the rich will stay rich by-and-large because of their connections, inheritance and their ability to earn more on their passive or otherwise investments. And one way or another, this depression will end – eventually. We can drag it out. We can shorten it. But regardless, eventually it will end, and then we will start right back over again on a freight train towards the next economic downturn. It’s cyclical.

[woodyboyd]

Originally Posted by CaptainMidnight

In my opinion, the route from QE2 to general price inflation may be somewhere between curcuitous and nonexistant, especially in an environment of continuing deleveraging with all the deflationary pressures that implies. But the route to bubble formation is not so indirect!

It might seem mysterious and conterintuitive that we could have experienced a falling money supply (M3). After all, hasn't the Fed pumped out tons of money with almost two years of ZIRP and over $1.5 trillion (with another $600 billion to come soon) added to its balance sheet for all these asset purchases?

Yes, but money is two-dimensional: Quantity and velocity. On the surface, it may seem that supply has been pumped out on a virtually unprecedented scale, but it is not acting like it usually does -- that is, the multiplier effect of fractional reserve banking, among other things, is not working in the usual way. That means that the "velocity" of a very big pile of money is abnormally low. It's sort of a breakdown of the old "quantity theory of money", and that can happen especially in the short run when velocity is low and unstable. Who knows where it will end up over a longer term? That's why I think QE is a little like grabbing a tiger by the tail.

Great post, CM!!

The creation of money has been one of those things that I have had to look more deeply into. My guides in this case have been Mish Shedlock and his mentor, Steve Keen.

One of my all time favorite posts was here, http://globaleconomicanalysis.blogsp...cal-model.html

"Assume for a moment you invent a magical printing press. Your machine can print hundred dollar bills so good that the US Treasury cannot distinguish them them from the real thing. The bills are perfect in every way. Now assume you print $5 trillion worth of those bills and bury them in your back yard. Is this inflation? Surely not. Would it be inflation if $5 trillion in bills were spent and entered the economy? You bet. The key then is not how much the Fed prints, the key is how much of that money makes its way into the economy."

The buried $5 trillion would then be money that had zero velocity.

A while back, a friend of mine tried to convince me to buy silver when it was selling for $4 or so an ounce. It is $28 now. He told me that the federal reserve was not the only one that created money. He said private banks and Fannie Mae could as well. To be honest, I really didn't get it. I agreed with him that the dollar was way overvalued then, but I thought investing in emerging markets was a better route than silver. In essence, we were both right.

I know we don't have a lot of economists here, and money supply numbers IMO are almost made to be confusing. Let me make this as simple as possible. M0=cash
M1= M0 (cash) + checking accounts
m2= m1 + individual money market accounts
m3= m2 + institutional money market accounts

Now for the quote from Mish's post

"Two hypotheses about the nature of money can be derived from the money multiplier model:

1. The creation of credit money should happen after the creation of government money.
2. The amount of money in the economy should exceed the amount of debt, with the difference representing the government’s initial creation of money.

Both these hypotheses are strongly contradicted by the data.

Testing the first hypothesis takes some sophisticated data analysis, which was done by two leading neoclassical economists in 1990.

If the hypothesis were true, changes in M0 should precede changes in M2.

Their empirical conclusion was just the opposite: rather than fiat money being created first and credit money following with a lag, the sequence was reversed: credit money was created first, and fiat money was then created about a year later:

There is no evidence that either the monetary base or M1 leads the cycle, although some economists still believe this monetary myth. Both the monetary base and M1 series are generally procyclical and, if anything, the monetary base lags the cycle slightly.

Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to “seed” the credit creation process, credit is created first and then after that, base money changes." End of linked post.

This theory of money creation is very interesting to me. It shows then the fed is not the head of the dog but rather the tail. Money is not created by the federal reserve then but rather by those that create credit/debt: Fannie Mae, Freddie Mac, Citibank, JPmorgan, Morgan Stanley, and yes Goldman Sachs. The federal reserve then is just printing up money in response to those extending credit.

So credit creation or destruction may be more important than money supply, and this graph shows credit is still being destroyed, http://pragcap.com/consumer-credit-c...-to-contract-3

So the theory goes (and I agree with said theory) that credit leads to a jump in the money supply. If credit goes down, so should money supply.

And when credit is created, the person or party lending the money is taking a risk that the borrower will pay him or her back. However, given the amount of debt the consumer is in, http://dailybail.com/home/chart-shoc...nderstate.html, it seems to me that credit and therefore the money supply have no way to go but down regardless of what the fed does.

What does this mean for investors? Don't buy for a moment the notion that cash is trash. Cash is king. Investments then that generate cash (stable, dividend paying stocks or bonds that are low risk) are the way to go. Also, holding cash and getting 0.1% interest is not a bad way to go if the money supply is shrinking.

[Can I Play Too???]

Normally, banks do create money on their books by issuing debts to borrowers but, however, for the money to be actually created the debt must be paid back plus interest.
It is up to the borrower to pay back the loan. The fed reserve is most def the head of the monster. In qe's they issue treasury bills and bonds to people, banks and companies. Recently, they have been artificially inflating the stock market through permanent market operations in which the Fed issues bonds through the us treasury Dept which is bought by primary dealers from which the fed buys up and gives them cash.
"These transactions are with banks, public, and firms. When the Fed buys bonds in the bond markets it pays for the bond by creating new Bank deposits at the Fed. These new Bank deposits at the Fed add to banks excess reserves, and can therefore form the basis of a multiple expansion of the money supply through new loan creation by banks."
Then (primary dealers) they buy up blue chips in the stock market. *They are openly monetizing debt and inflating the stock market but the john q public is too dumb to realize that this causes inflation.
"Now the Fed is openly and actively buying dodgy debt from the government as well as from the private sector. "
"When we add in agency debt, mortgage-backed securities, and various other corporate debt programs, we find that the Federal Reserve is printing up roughly $15 to $30 billion dollars a day [up to 3 times a week on Pomo days] just to keep things limping along."
Your assertion that cash is king is flawed by the very nature of the word fiat. Soon toilet paper will be worth more than our dollar.
"In the case of QE2, $900 billion will be diluted to purchase US treasuries so the primary benefactor of the QE will be the U.S. federal government and the financial institutions selling that debt. However, capital flows can rarely be controlled and the newly created money will find its way into other markets and asset classes.
Interestingly, the $100 billion per month figure that has been mentioned as the target rate for QE is almost exactly what is needed to roll over maturing treasuries coming due - so it could be argued that the plan is to effectively finance the U.S. federal debt which would eventually lead to a complete monetization of the treasury market.
"QE2 PROJECTED TO SEE INFLATION RISE BY 10-20%!"
It's confusing but I hth those who are confused about qe=pomo.
Also the formulas for m1 are antiquated and don't take into account the money the fed prints to buy the treasury bills. Therefore m2 and m3 money supply is also miscalculated which might be the reason why m2 and m3 are not disclosed by the fed.

[Fast Gunn]

There is a reason why economics is still referred to as the "Dismal Science".

There are numerous competing theories floating around on what is needed to fix the economy, but to my mind, nobody really seems to have a handle on the problem. It's a huge problem with world-wide ramifications and permutations.

I remember Alan Greenspan speaking on national television and it was hard to just grasp what he was saying, but generally he did seem to affect the economy for the better with his policies.

Maybe what Ben Bernanke needs to do is to bring him and other heavy weights in for consultation and to reassure the public that they understand the problem and here is what they are doing to repair the damage that George Bush did to the economy with his foolish wars and poor planning.

President Clinton left the country with a very hefty budget SURPLUS.

Does anyone remember the halcyon days when this country even had a surplus?

I wish President Obama well in digging this country out of the deep hole that the Bush dug us into when he squandered our country's treasure and reputation.

[I B Hankering]

Originally Posted by woodyboyd

What does this mean for investors? Don't buy for a moment the notion that cash is trash. Cash is king. Investments then that generate cash (stable, dividend paying stocks or bonds that are low risk) are the way to go. Also, holding cash and getting 0.1% interest is not a bad way to go if the money supply is shrinking.

It’s a fiction to suggest that there is no inflation attributable to QE2. Fed Chairman Ben Bernanke first suggested QE2 on August 27, 2010, and a perceptibly significant rise in inflation began soon after. Despite a 10% unemployment rate, food costs are soaring. The charts below track the impact inflation is having on the costs of commodities.

The banks, rather than loan the money that they are receiving from the Fed (via QE2), are, instead, speculating in the market, i.e., bonds, stocks, commodity futures, etc., rather than loan it to John Q Public. Say what you will about money supply, the fact remains that the average U.S. citizen is paying substantially more to exist than he/she was at this time last year. Interest earned on savings accounts and checking accounts is not equal to the rate of inflation; hence, depositors are losing, rather than earning, money. There is no silver lining for those on fixed incomes or those who are not deeply invested in the market and/or own gold or silver. Senior officials in the Fed concur.

“Some experts, including several senior Fed officials, worry that the bank reserves will quickly turn into loans when the economy recovers, pushing up prices, as there will be more money chasing fewer goods.

“For instance, Charles Plosser, the president of the Philadelphia Federal Reserve Bank, called the reserves “kindling” for a potential inflationary fire [hyperinflation] if not managed carefully.

“Plosser told reporters earlier Thursday that the large amount of bank reserves was one reason he wasn’t concerned that the U.S. would fall into a deflationary trap.”

http://www.marketwatch.com/story/bernanke-dont-call-it-quantitative-easing-2010-11-18

“Americans and the world will continue to suffer a Fed head that, with every utterance shows how very unequal he is to his job. A self-proclaimed expert on the 1930s, Bernanke continues to intervene in the economy despite clear lessons from that decade showing that government intervention then turned what should have been a brief downturn into a Great Depression.”

http://www.ocregister.com/opinion/bernanke-275994-demand-make.html

[woodyboyd]

I know everyone who is loading up on gold wants to believe there is big inflation, but there really isn't.

http://www.bls.gov/news.release/cpi.htm

"Over the last 12 months, the index for all items less food and energy
has risen 0.6 percent, the smallest 12-month increase in the history
of the index, which dates to 1957. The energy index has risen 5.9
percent over that span with the gasoline index up 9.5 percent. The
food index has risen 1.4 percent, with both the food at home index
and food away from home index rising the same 1.4 percent."

I agree with you, IB that commodity prices are up big. However, much of those prices have not been passed on to the consumer.

Overall demand for goods is still down 11% from the peak in 2008, goods supply is still more than ample, and money supply is down, so how are we getting rising prices?

Originally Posted by I B Hankering

The banks, rather than loan the money that they are receiving from the Fed (via QE2), are, instead, speculating in the market, i.e., bonds, stocks, commodity futures, etc., rather than loan it to John Q Public.It’s a fiction to suggest that there is no inflation attributable to QE2. Fed Chairman Ben Bernanke first suggested QE2 on August 27, 2010, and a perceptibly significant rise in inflation began soon after. Despite a 10% unemployment rate, food costs are soaring. The charts below track the impact inflation is having on the costs of commodities.

You nailed it. So the fed in their infinite wisdom thinks that higher commodity prices are going to save the economy. Where do they come up with this crap??

Eventually, commodity prices fall to a rate close to their cost of production. When you see the price of sugar double to 30 cents a pound in three months like we just have, and the cost of producing the most expensive pound of sugar is 15 cents, it is easy to say we are in a sugar bubble. And you can say the same about oil, copper, soy corn ETC.

And when this commodity bubble bursts like all bubbles do, you could be sure the fed will be making the asinine statement that they can not really predict bubbles. Unlike the other bubbles though, in this one, the fed is actually giving the banks bubble gum.

[discreetgent]

Fascinating release of documents on how much the Fed put into the market starting in December 2007. Forget about TARP, everyone was getting money. Some companies like AIG that got bailed out with one program, had funds that bought in and made money on another of the Feds programs.

[Fast Gunn]

There is a real financial mess going on out there in the world today.

When entire huge companies in our country and even entire countries like Greece and Ireland need to be bailed out, it does give one pause.

The Federal Reserve needs to do something and to their credit, they are doing something, but that something should be intended to help the entire country, not primarily Goldman Sachs!

[pjorourke]

Its amazing we never heard any call for regulating the pay of GE execs and they borrowed more TARP like money than BAC. Oh wait, they are green supporters (for marketing) and own NBC which shilled for Obama. Nevermind.

I fucking hate crony capitalism.

[charlestudor2005]

Originally Posted by pjorourke

I fucking hate crony capitalism.

But, PJ, I thought you'd approve. It's the most lucrative kind of capitalism.

[Texas Contrarian]

In at least one regard, QE2 seems not to be working all that great, since 10-yr. yields have gone up 30-40 bips during the last month or two. One of the stated goals was to drive bond yields down in order to support the housing market and to push asset commitments into risk categories such as equities. But perhaps the goal was largely to prevent yields from rising more than they otherwise would have.

But what concerns me most is not what the effects of QE2 may or may not be, but the fact that I believe there are likely to be several more cycles: QE3, QE4, etc. Who knows where all this ends?

Debt monetization tends to create perpetual dependency. The Federal Reserve is simply accommodating disastrous fiscal policy (large structural deficits) by promising to buy up almost all net new issuance of 7s and 10s through midyear 2011. Treasury officials need not worry about undersubscribed auctions as long as they can just take the newly issued bonds around the corner to the Marriner Eccles Building!

At some point, the Fed is going to have to engage in quantitative un-easing -- that is; it is going to have to unwind all this by selling most of those bonds off its balance sheet. In my opinion, hanging on to a growing multi-trillion dollar debt securities portfolio year after year would dangerously destabilize the monetary system.

The unwinding would involve trying to unload a very large collection of notes and bonds in an environment where the deeply-indebted developed world is expected to borrow about $11 trillion in 2011 alone.

We have backed ourselves into a very tight corner, and this points up the dangers of grossly irresponsible fiscal policy.