people in motion

people in motion

vendredi 14 septembre 2012

FED Decision

QE3 : The FED Panicked

But Don't Fight the FED
It is extraordinary that the Fed would announce an open-ended "we'll print as much as it takes, as long as it takes" policy. Chairman Bernanke is sending a signal to the markets and to government that the economy is bad and getting worse and that the Fed will do its part as everyone expects them to do. This is a clear signal to the markets and the world that the Fed stands for monetary inflation. They don't know what else to do.

One may ask why none of these policies have led to economic recovery. Why didn't QE1 work? After all they told us then that it would promote "sustainable economic growth". By the time QE2 was released we heard much of the same thing: it would "promote a stronger pace of economic recovery". Had QE1 worked as they said, why did they need QE2? Now the Fed tells us again that another round will "support a stronger economic recovery".

The chart shown (*see detailed explanation in "The Role of Money Suppply") attempts to show that each round of QE has been less effective at boosting nominal GDP. The vertical bars show the dates of QE1 (orange) and QE2 (light blue), the money supply (TMS2- aqua-blue line), and GDP (thin black line with its own scale [left]). The result is that economic growth measured by nominal GDP has been largely illusionary.
The truth is that GDP is not a very good measure of economic growth, at least when the Fed increases the money supply through QE. Since GDP measures spending, if new money is injected into the economy, there will be more spending and thus GDP will increase. The second point is that "printing" money never creates organic economic growth. In fact it never has at any time in history.

That begs this question: If QE1 and QE2 and Operation Twist didn't work, why would QE3 work?

The quick answer is that it will fail like its predecessors.

What can we expect the consequences of QE3 will be?

1. Money steroids will give a temporary boost to the financial markets as evidenced by today's euphoric response to the Fed's announcement.

2. The impact on organic economic growth will be nil even though it may slightly increase GDP by Q1 2013.

3. Unemployment will remain high.

4. Economic growth will stagnate, if not decline, through the remainder of 2012 as money supply growth declines (TMS2).

5. Post Q1 2013, economic activity will again stagnate, assuming there are no policy changes or political changes (Romney is elected).

6. Europe and the rest of the world's economies are in decline which will further depress the U.S. economy.

7. Price inflation is a guessing game. My guess is that it will remain within the Fed's parameters. The key to price inflation will be credit creation through lenders and, while lending has shown some life (mainly the big banks with big companies), it is likely to flatten again as the economy stagnates, thus inflation will remain "Japanese."

8. Interest rates will remain around their historic lows. While the housing market is showing some signs of life, its recovery largely depends on job growth which will remain subdued.

9. How much QE is a good question. I cannot see that any Fed chairman would print endlessly to a point of high price inflation. That would require much greater amounts of QE-type monetary stimulus plus it would require banks to lend, which means businesses would be willing to borrow, thus expanding credit and money supply to much higher levels. QE is not an efficient way to price inflation, and in a stagnating economy, borrowing will remain flat.

Promise to let the economy recover before raising rates. The Fed is going to try to persuade investors and the public that it’s really going to keep interest rates low until the economy actually recovers all its lost ground, even if that means breaking its own informal rules about how to formulate policy in the face of rising inflationary pressures.

If you are a true believer and feel that the Fed is correct, you have to ask yourself hard questions about your assumptions since the Fed has been consistently wrong in their forecasts and policies. Now they insist on pursuing the same failed policies. Why would they work now?

The Fed continues to follow the same wrong policies as it has since the beginning of this depression. We now have one of the longest depressions in history that has been caused by the Fed and the fiscal policies of the Bush and Obama Administrations. They are devaluing the dollar, destroying capital, thwarting growth, and cheating savers out of their hard earned money. It is a cruel blow to the 23.1 million un/under-employed in the U.S. who need economic growth to create jobs. We need a new direction.

The Role of Money Supply

If much of our positive economic data, especially manufacturing, employment, and price inflation is tied to monetary policy, then that begs the questions of where is money supply (MS) now, where is it heading, and what will the Fed do?

The Fed has been trying to stimulate the economy by making credit available to banks, by keeping interest rates (Fed Funds) at near zero (ZIRP), and by direct injections of money into the economy (QE, quantitative easing). Those policies as anticipated by the Fed have largely failed. In a truly recovering economy, credit would be expanding because businesses would be borrowing in order to expand and hire. Interest rates would be so attractive to borrowers, they couldn't resist expanding through borrowing. The problem is that it hasn't worked.

What is happening instead is that economic gains are coming largely from quantitative easing, a once-in-a-lifetime policy of last resort. While Chairman Bernanke denies it, creating money out of thin air (QE) has the same effect as printing new currency and throwing it out of the Chairman's proverbial helicopter.

Look at how QE has expanded the Fed's balance sheet from securities purchased on the open market, which is how the Fed creates new money:

As you can see, its balance sheet exploded during the Crash (QE1) and has continued to grow (QE2). The Fed has injected about $2 trillion into the economy since 2008. One can't deny that such injections have impacted the economy. It has rewarded the financial markets (S&P500: 3/6/09=666; 2/14/12=1,350), it has rewarded the multinationals and exporters, and it has caused a positive CPI despite massive deflationary forces.

MS itself has been on a rocky track, but it has expanded in response to QE. Bank credit expansion (loans) is the easiest way to cause MS to grow. While the Fed has made massive amounts of credit available to banks, without loan demand lenders are satisfied to keep it locked up at the Fed (excess reserves). Without landing activity, in order to make MS grow, the Fed has found it must inject new money directly into the economy via QE .

To measure MS, I use the Austrian concepts of money supply, what is called "Austrian" or "True" money supply. Specifically I use what I consider to be the most accurate "Austrian" data which is from Michael Pollaro's The Contrarian Take (with his kind permission), which looks like this:

As you can see the percentage YoY change of TMS2 (bright blue line), the data which I think is most accurate, is actually declining. What does this mean?

Let me try to explain this with a more detailed, and unfortunately, a more complicated chart. This is the same chart as above with an addition of the QE events (vertical salmon and blue bars), the addition of GDP data (black line), and the addition of the NBER's dates for the Great Recession as a vertical gray bar. The scale on the inside of the chart on the left shows quarterly changes in GDP from 2006 to Q4 2011, and it is shown on the black line. I have exaggerated GDP by showing percentage changes of GDP on a quarterly basis to make it fit to Pollaro's chart and to make my point clearer.

What I believe this chart shows is that, after a delay, quantitative easing has caused much of the "recovery" by increasing MS which in turn has increased GDP.

In terms of measuring money supply, I use the bright blue line (TMS2) which shows annualized changes. If you are a believer in M2, Pollaro shows that as well (dark blue line). QE1, starting in November 2007 and ending in March 2008, brought a huge infusion of new money into the economy, about $1.3 trillion in only 3 months. The Fed, as you recall, went on a massive buying campaign which including a lot of "bad" assets (GSE debt, etc.). GDP is a lagging indicator, but as you can see it was well on its way down by Q1 2007 as real estate values collapsed and Lehman went under. By Q4 2009 GDP started to pick up which was a 6-month lag from the end of QE1.

As the effects of QE1 wore off, as one would expect it to do in the face of massive deflationary forces, GDP began to stall out and unemployment continued to climb. By October, 2009 unemployment reached 10%, and people were talking about a jobless recovery. GDP peaked in Q4 2009 and started declining again in Q1 2010. The Fed took action starting in November 2009 through June, 2010, and QE2 brought another $600 billion of new fiat money into the economy over a four month period. GDP bottomed out in Q1 2011 and since then it has been expanding but at a snail's pace. On a YoY basis GDP is stagnating, but not declining. Again, there was about a 6-month lag between the end of QE2 and GDP turnaround.

To those out there who see this as an exercise in curve fitting, faulty logic (post hoc ergo propter hoc), or Monetarist theory, these data are consistent with Austrian Business Cycle Theory (ABCT) and one would expect to see these results after flooding the economy with fiat money. I believe that the gains, such as they are, are not "real" in the sense that they are not based on real savings, but on fiat money which always redirects capital into projects that eventually will become malinvestments.

When money is injected in the QE fashion, it takes longer for the money to get into the farther reaches of the economy. When you think about it, the cash initially goes to the Fed's Prime Dealers and they use it to make investments, which indirectly leads to productive activities, but takes time to expand beyond, say, New York City. Bank credit expansion through loans is a more direct transmission into productive activities rather than investment activities (businesses borrow to expand business, consumers borrow to buy homes and cars).

The thing about GDP is that it is not necessarily a very good measure of economic activity in the sense that it measures what we spend. If you inject more fiat money into the economy it means there will be more spending and a higher GDP. More spending doesn't always mean that those activities will be productive and lasting. That is especially the case with QE. But, for whatever it's worth, the world pays attention to GDP and so will we; it's just very tricky footing for forecasters.

It appears that TMS2 MS growth is declining. One look at the above chart will confirm this. This has to do with a lot of factors, but mainly it is occurring because QE2 is wearing off. This is occurring despite the fact that we are finally seeing modest increases in bank lending activity:

Another MS factor to consider is what is happening in Europe. The European Central Bank and the Bank of England are inflating: the ECB with purchases of sovereign bonds and LTRO (Long-term Refinancing Operations), and from QE with the Bank of England. According to Michael Pollaro, some of this money is finding its way back to U.S. Treasurys.
That being the case, declining MS growth is likely a stronger trend than is apparent.

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