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Thursday, October 21, 2010

Transcript: 408 The Sinking of QE II

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Today on the podcast, Joe Stiglitz, the unintended consequences of the Fed's monetary policy, and the throw of the dice that is QE2. But first this.


Tom Busby of the Diversified Trading Institute

The weak of constitution may want to cover their ears.


There you have it. Gridlock. The recipe for recovery. Even if Republicans sweep, their plan seems to be no plan, so gridlock is all that is necessary.

The Demand Side contention that what business needs is customers is so Twentieth Century. This new economy. Cheap money and foreign exposure are what will make our country prosper, and of course, no regulation. Leave markets to be structured by the big players.


Notes on Meeting with Wall Street

Maggie, transcribe these and distribute them to the inside list

Met with Wall Street at the Regent Park 10:30 AM Attorneys present but not participating

Street seemed to have an elevated notion of its value in the operation, as usual. Began with extended comments on its value to entrepreneurship, business development and capitalization and investor participation.

I indicated that was old news. Previous outcomes were an indicator of poor perrormance. We've busted the model to keep them out of court and out of the red. Humor was not appreciated. Street's performance iven in previous periods was actualized at levels far below promises.

Real economy counterparties fared very badly. Even ignoring the grunts at the household level, which we do, many actors are considering remedial action or legal recourse. Substance is far below claims. Maggie, Get Tom to talk to Research about developing a ... ah ... scenario to explain why the breakdown in mortgage foreclosures is the government's or the grunt's fault. We have to shift liability from Street.

That said. Street is now talking like the managing partner, not the financing arm. This could be bad. For the company. Good thing management does well even when stockholders don't. Street reads it the same way we do. Hang on to the cash until some customers crawl out from under the rocks.

Meanwhile, let the gummint take the hit. We paid them enough.

Street wants us to come in on the retirement question. Not sure about this one. Street sold the 401(k) as the private sector pension plan. Busted. Prospects of replacing social security with stocks are busted. Now the best tack is to replace social security benefits with tax cuts. States and municipalities have pensions are being sucked dry by zero interest. Street says we can have it both ways. Cheap money and renege on the pension contracts. I'm not sure. Tea party anger can only go so far. Street says put some ads on the TV during the football game. It's worked before. Good thing we're not stockholders.


Now from Joseph Stiglitz

Two pieces, one on the domestic situation and another on the international ramifications of Helicopter Ben.


Joseph Stiglitz speaking to CNBC.

Next Stiglitz looks at the unintended consequences of the Fed's easy money. The long-time position of Demand Side is that monetary policy as practiced by the Fed hasn't worked and won't work. Here Stiglitz points to the real effects, destabilization internationally.


Joseph Stiglitz

Outlining the dangers to the international economy.

But backing up a bit, economists on the domestic front have been singularly unimpressed with the prospects for QE 2.0, and many wonder exactly how it is supposed to work. Will bringing down long-term interest rates really dislodge the mountains of cash on the sidelines? Likely not. It's a liquidity trap.

Some say quantitative easing will increase expected inflation. An increase in expectations will what? Increase long-term interest rates, one would think. But we've seen no inflation so far in the Fed's easy money. And we've described the reason. The Fed doesn't control the money supply. Simply printing money doesn't mean it will be lent and leveraged. That needs the prospect of profitable investment. Not present in the U.S. today.

Others say the increase in the price of financial assets will make people feel wealthier and get them to spend. Really? The wealth effect is a difficult one to see when households have taken trillions of dollars off their net worth in the past three years.

Would the Fed buy more private securities, particularly the garbage, that is, the riskier ones? That would be thematic, but no less foolish than the first buy of mortgage backed securities. Anyway, with the audit coming up, the Fed is unlikely to step too far outside its legal authority.

And QE could and probably will cause the dollar to weaken, which encourages exports and discourages imports, presuming other nations watch without matching the move. In fact, dollar weakness is happening, and as we just heard Joe Stiglitz say, it is replete with unintended consequences.

The main reason that QE will work this time is that it has to. The Fed is the only game in town. Ignore past performance. Hope for Papa Ben to make something out of nothing.

In other words, it won't work.

How is the the Hysterical Matron of the Market handling this? We end today's podcast with analysis from Comstock Partners.


For the third time in a little more than ten years Wall Street has embraced a dubious narrative to drive the market higher in the face of crumbling fundamentals. In early 2000 the conventional wisdom discarded over a hundred years of valuation history in denying that the market was in a bubble driven by speculation in internet-related stocks. In late 2007 investors again drove the market to a peak, insisting that the subprime mortgage problem was just too insignificant to impact either the economy or the market. And if anything did go wrong, the good old Fed was there to ensure that the worst outcome would be a so-called "soft landing". In both cases the economy went into a recession and the market dropped more than 50%.

Now, once again the economy is struggling, and investors are depending on the Fed’s impending announcement of QE2 to bail them out, driving up the market in anticipation of the news. That the economy is deteriorating is obvious. If not, QE2 would not even be under discussion. The problem, though, is that after TARP, the stimulus plan, Fed purchases of $1.7 trillion in mortgages and Treasuries, near-zero interest rates, cash for clunkers, homebuyer tax credits, mortgage remodifications and unemployment insurance extensions, there is little more that the Fed can do that they haven’t already done. The Board has used all of its conventional tools and some not so conventional, and now is in the position of entering into a great experiment with unknown outcomes and possible unintended consequences. The truth is that the Fed cannot use monetary policy to force companies, banks and consumers to take credit that they do not want.

The problem was well presented in an August op-ed column in the Wall Street Journal by Alan Blinder, a former Fed vice-chairman and colleague of Ben Bernanke at Princeton. The article, called "The Fed is Running Out of Ammo", outlined three options for the Fed—-expanding the Fed’s sheet further, changing the "extended period" language in the Fed’s statement or lowering the interest rate on bank reserves. He then demonstrated that each of these options had negative political consequences, economic drawbacks or limited effectiveness. He concluded by saying that if the economy didn’t pick up, it would be time to use even this "weak ammunition", although he obviously didn’t think it would be of much help.

Blinder is a main-stream economist, and we doubt that his views differ much from the majority of the FOMC. They must know that they are about to implement a policy that has never been tried before on this scale and that the outcome is extremely uncertain. However, with the White House and Congress in gridlock, the Fed knows that they are the only game in town. What they are hoping to do is increase the Fed’s balance sheet, induce the banks to extend a lot more credit, lower long-term interest rates, spark spending by consumers and business and raise the inflation rate, which they regard as too low.

That from Comstock Partners

The bottom line is that monetary policy hasn't worked, won't work, and can't work. It is demand that is the only way out. Aggregate demand will not be provided by the private sector. The only way out -- public sector spending -- is barricaded by political hacks and economic ignorance. The financial sector has become the economy's master, not its servant. Welcome to serfdom.

1 comment:

  1. QE with the Fed buying bank assets will only inflate commodity bubbles and when they burst there will be more grief for the economy. If the extra funds were of municiple bonds so that states could rebalance their economies that might help. Though longer term I see further destruction of US safety nets and the creation of a huge underclass, who will be a massive burden on society, through crime and disorder. While the economy will need to be restructured unless there is a shift in resources away from the top 5% the bottom 95% cannot recover.