Category Archives: CBs

QE follow up

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It’s been about a week, and the initial reactions are already wearing off and markets settling in.

The lasting effects are those of the income lost to the economy as the Fed earns the interest on the securities it buys instead of the economy. This reduces the federal deficit and is a ‘contractionary’ force. At the same time the Fed removes securities/duration/convexity/vol from the economy which tends to lower the term structure of risk free rates some and further reduce volatility as well.

Initially the long end sold off on the presumption that QE works to lower the output gap/restore growth and employment, which means the Fed would, down the road, be hiking rates in response to the improving economy.

However, as the reality that QE doesn’t work to support aggregate demand sinks in, long end yields can come down on the anticipation that future growth prospects are not good, increasing the odds that the Fed will be keeping rates low that much longer.

Likewise, it’s a mixed bag for stocks, though overall modestly supportive. QE doesn’t improve earnings prospects, and serves to keep growth down, but the lower interest rates help valuations, and high unemployment along with productivity increases work to keep unit labor costs down.

Europe has solved the solvency issue, but it’s all conditional on bringing deficits down, and so far it looks like they are all working to keep doing exactly that, and with no prospects for material private sector credit expansion or export growth,
GDP can continue to be negative.

Then there’s the US fiscal cliff. Everyone agrees deficit reduction slows things down, which is why they say we shouldn’t do it now. But they also therefore know it will slow down things whenever they do it in the future. So how hard should it be to come to recognize that slowing things down is actually the point of deficit reduction, and is appropriate only for that reason? Apparently it’s impossible. And the fiscal cliff is already taking its toll as anticipated contracts for next year along with purchases are being delayed.

So without some kind of fiscal paradigm shift I don’t see much good happening, and even the muddle through scenario is now at risk.

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Mafin 2012 Genova, Italy presentation

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Very good!
One suggestion, in caps:

In reality, BECAUSE AN OVERDRAFT AT A CENTRAL BANK *IS* A LOAN FROM THAT CENTRAL BANK, central banks have no option other than supplying the amount of reserves banks require to settle payments through standard operations, bilateral lending, or intra-day overdrafts.

Yet, it can unilaterally set the interest rate on reserves borrowing and reserves holding.

Revising the quantity theory of money in a financial balance approach

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ECB’s Weidmann Says Unlimited Money Creation Risks Inflation

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Only with fixed fx, where ‘money creation’ is better described as ‘deficit spending’.

Shame shame shame.

ECB’s Weidmann Says Unlimited Money Creation Risks Inflation

By Jeff Black and Jana Randow

September 18 (Bloomberg) — Bundesbank President Jens Weidmann said central banks that promise to create unlimited amounts of money risk fueling inflation and losing their credibility.

In a ceremonial speech in Frankfurt today, Weidmann, who opposes the European Central Bank’s plan to spend unlimited amounts on government bonds, spoke of the responsibilities that central banks have to preserve the value of money.

“If a central bank can potentially create unlimited money from nothing, how can it ensure that money is sufficiently scarce to retain its value?” he asked. “Is there not a big temptation to misuse this instrument to create short-term room to maneuver even when long-term damage is very likely? Yes, this temptation is very real, and many in the history of money have succumbed to it.”

While Weidmann didn’t directly address ECB policy, he is the only central bank governor from the 17 euro nations to publicly oppose ECB President Mario Draghi’s plan to help curb the borrowing costs of member states engulfed by the region’s debt crisis. Weidmann, who has warned the bond-buying policy is tantamount to financing governments, said today that central banks were given independence to ensure the power to create money couldn’t be abused by politicians.

“If one looks back in history, central banks were often created precisely to give the monarch the freest possible access to seemingly unlimited financial means,” Weidmann said. “The connection between states’ great financial needs and a government controlling the central bank often led to an excessive expansion of the money supply, and the result was devaluation of money through inflation.”

‘Extraordinary Privilege’

The independence of central banks is an “extraordinary privilege” and not an end in itself, he said.

“The independence serves much more to establish with credibility that monetary policy can concentrate without hindrance on keeping the value of money stable,” Weidmann said. “The best protection against the temptations inherent in monetary policy is an enlightened and stability-oriented society.”

Weidmann’s speech forms part of a series of events in Frankfurt on the theme of money in the works of Johann Wolfgang von Goethe.

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QE

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QE in the US has again done what it’s always done- frighten investors and portfolio managers ‘out of the dollar’ and into the likes of gold and other commodities.

And because sufficient market participants believe it works to increase aggregate demand, it’s also boosted stocks and caused bonds to sell off, as markets discount a higher probability of higher growth, lower unemployment, and therefore fed rate hikes down the road.

But, of course, QE in fact does nothing for the economy apart from removing more interest income from the economy, particularly as the Fed adds relatively high yielding agency mortgages to its portfolio.

As ever, QE is a ‘crop failure’ for the dollar. It works to strengthen the dollar and weaken demand, reversing the initial knee jerk reactions described above.

But the QE myth runs deep, and in the past had taken a while for the initial responses to reverse, taking many months the first time, as fears ran as deep as headline news in China causing individuals to take action, and China itself reportedly letting its entire US T bill run off.

But with each successive QE initiative, the initial ‘sugar high’ is likely to wear off sooner. How soon this time, I can’t say.

Global austerity continues to restrict global aggregate demand, particularly in Europe where funding continues to be conditional on tight fiscal. Yes, their deficits are probably high enough for stability- if they’d leave them alone- but that’s about all.

And as the US continues towards the fiscal cliff the automatic spending cuts are already cutting corporate order books.

And oil prices are rising, and are now at the point cutting into aggregate demand in a meaningful way.

Yes, the US housing market is looking a tad better, and, if left alone, probably on a cyclical upturn. And modest top line growth, high unemployment keeping wages in check, and low discounts rates remains good for stocks, and bad for people working for a living.

Too many cross currents today for me to make any bets- maybe next week…

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St. Louis Fed gets it?

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Email from Scott Fullwiler:

Check this out . . .

“As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills.6 In this sense, the government is not dependent on credit markets to remain operational. Moreover, there will always be a market for U.S. government debt at home because the U.S. government has the only means of creating risk-free dollar-denominated assets”

Somehow they then go on to say that there can be crowding out if the US is not dependent on credit markets. Doh!

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Why is Putin stockpiling gold?

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He’s probably afraid of Draghi’s policies?

Or got long gold in his personal account, has his CB run it up for him to sell?

No telling!

Why is Putin stockpiling gold?

By Brett Arends

September 5 (WSJ) — I can’t imagine it means anything cheerful that Vladimir Putin, the Russian czar, is stockpiling gold as fast as he can get his hands on it.

According to the World Gold Council, Russia has more than doubled its gold reserves in the past five years. Putin has taken advantage of the financial crisis to build the world’s fifth-biggest gold pile in a handful of years, and is buying about half a billion dollars’ worth every month.

It emerged last month that financial gurus George Soros and John Paulson had also increased their bullion exposure, but it’s Putin that’s really caught my eye.

No one else in the world plays global power politics as ruthlessly as Russia’s chilling strongman, the man who effectively stole a Super Bowl ring from Bob Kraft, the owner of the New England Patriots, when they met in Russia some years ago.

Putin’s moves may matter to your finances, because there are two ways to look at gold.

On the one hand, it’s an investment that by most modern standards seems to make no sense. It generates no cash flow and serves no practical purpose. Warren Buffett has pointed out that we dig it out of one hole in the ground only to stick it in another, and anyone watching this from Mars would be very confused.

You can forget claims that it’s “real” money. There’s no such thing. Money is just an accounting device, a way of keeping track of how much each of us produces and consumes. Gold is a shiny and somewhat tacky looking metal that is malleable, durable and heavy. A recent research paper by Duke University’s Campbell Harvey and co-author Claude Erb raised serious questions about most of the arguments in favor of gold as an investment.

But there’s another way to look at gold: As the most liquid reserve in times of turmoil, or worse.

The big story of our era is not that the Spanish government is broke, nor is it that Paul Ryan apparently feels the need to embellish his running record. It’s that the United States, which has dominated the world’s economy for several lifetimes, is in relative decline.

As was first reported here in April of last year, according to International Monetary Fund calculations, the U.S. is on track to lose its status as the world’s biggest economy—when measured in real, purchasing-power terms—to China by 2017.

We will soon be the first people in two hundred years to live in a world not dominated by either Pax Americana or Pax Britannica. This sort of changing of the guard has never been peaceful. The declines of the Spanish, French and British empires were all accompanied by conflict. The decline of British hegemony was a leading cause of the First and Second World Wars.

What will happen as the U.S. loses its pre-eminence?

Maybe this will turn out better than similar episodes in the past. Maybe the Chinese will embrace an open society and the rule of law. If you believe that, there is probably no reason to hold any gold.

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Cliff on ECB

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Over 6 weeks ago we distributed the attached Eurosystem Solutions paper.

It described the unique non-standard measures being used for by the Eurosystem and ECB to address bank solvency and national solvency issues and the movement towards a real solution involving the ECB.

Now the ECB has announced what is very close to the real solution: unlimited bond purchases.

Regardless of conditionality, or even in spite of conditionality, this is the crossing of the line into the notion that there is an entity that can credit accounts in Euro in unlimited amounts.

While conditionality is the apparent necessary circumstance, and it’s likely national authorities will play along, these ECB purchases will have to take place regardless of conditionality. If Spain says they can’t comply, is the ECB going to let them default? The ECB has done all this to avoid Spanish default.

The best case is for the markets to recognize the ECB backstop and so regular purchases aren’t very necessary. There will be lots of movement towards coordination of budgets and banking supervision.

But the ECB line has been crossed.

Sixteen years after our AVM/III July 1996 Bretton Woods conference that identified the severe credit problems with the looming Maastrict rules (1/1/99), and eleven years after Warren’s famous paper on the potential European credit crisis “The Rites of Passage” we are finally seeing the necessary repair to the EMU.

There still remain political obstacles, court challenges and the like, but the imperatives to avoid a complete collapse of the Euro financial system have driven virtually all the important constituents to this necessary path of solution.

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Gold standard thoughts

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>   
>   (email exchange)
>   
>   On Fri, Aug 24, 2012 at 5:28 AM, Dave wrote:
>   
>   When you get a chance could you send a quick note out on problems with this type of
>   thinking?
>   

The reasons nations have gone off the gold standard isn’t because it was working so well and their economies were doing well. The reason they go off, like the US did in 1934, was because it was a disaster.

Historically nations suspend their gold standards in times of war, when they need their economies to function to the max. If a gold standard was so good for an economy, why suspend it when you need max economic performance? Obviously because it is not conducive of maximum real output.

The ideological issue is whether the primary function of the currency is to be an investment/savings vehicle, or a tool for provisioning government and optimizing real economic performance. In a market economy you can’t fix the price of two things without a relative value shift causing you to be buying one of them and running out of the other. Likewise, you can’t sustain full employment and a stable gold price if there is a shift in relative value between the two.

A gold standard is a fixed exchange rate policy, where the govt continuously offers to buy or sell gold at a fixed price.

This means the holder of a dollar, for example, has the option of ‘cashing it in’ for a fixed amount of gold from the govt, and a holder of gold has the option of selling it at a fixed price to the govt.

Therefore a new gold discovery which causes gold to be sold to the govt is inflationary and tends to increase output and employment, and a gold ship sinking in transit or a sudden desire to hoard gold is deflationary and tends to decrease output and employment. And there’s nothing that can be done about these relative value shifts, except to ride them out. The only public purpose served (by definition) is the stable nominal price of gold set by Congress.

With a gold standard, like any fixed fx regime, interest rates are necessarily set by market forces. With the govt’s spending being convertible currency, it is limited to spending only to the extent it has sufficient gold reserves backing the currency it spends. With gold reserves generally pretty much constant and not expandable in the short run, this means govt spending is limited to what it can tax and/or borrow. So when the govt wants to deficit spend, doing so by ‘printing’ new convertible dollars risks those dollars being ‘cashed in’ for gold. Govt borrowing, therefore, functions to remove that risk by delaying conversion privileges until the borrowings mature. This means the govt is competing with the right to convert when the govt borrows. In other words, the holder of the gold certificates has the option of either converting to gold or buying the treasury securities. The interest rate the treasury must pay therefore represents the indifference rate of holders of the convertible currency between cashing in the currency for gold now or earning the interest rate and not being able to convert until maturity. Note that it’s in fixed exchange rate environments that govt borrowing costs have soared to triple digits as govts have competed with their conversion features, and that govts generally lose those fights as the curve goes vertical expressing the fact that at that point there is no interest rate that can keep holders of the currency from wanting to convert.

Note that this also means the nations gold reserves are the net financial equity that supports the entire dollar credit structure, a source of continuous financial fragility and instability.

It’s all here in a paper I did in the late 1990’s.

Hope this helps!

A few more thoughts:

Being on the gold standard doesn’t prevent a financial crisis, but it makes the consequences far more severe.

We were on a gold standard when the roaring 20’s private sector debt boom lead to the crash of 1929 and the depression that followed. 4,000 banks closed before we went off gold in 1934, and it was only getting worse which is why we went off of it.

Gold would not have prevented the pre 2008 sub-prime boom, but it would have made the consequences far more severe. Including no Fed liquidity provision to offset a system wide shortage due to hoarding and banks bidding ever higher for funds that didn’t exist, most all firms losing inventory financing and being forced to liquidate inventories as rates spiked competing for funds that didn’t exist, and no deficit spending for unemployment comp as federal revenues fell from the collapse. In other words, the automatic fiscal stabilizers we rely on can’t be there. Instead it’s a deflationary disaster that only ends when prices fall sufficiently to reflect changes in relative value between gold and everything else.

Note that the recent decade of gold going from under $600 to over $1,600 is viewed as a sign ‘inflationary’ and a 250% ‘dollar devaluation’ as it takes 2.5x as many dollars to buy the same amount of gold. But if we were on a gold standard, and all else equal, and gold had been fixed at $600 back then, the same relative value shift would be manifested as the general price level falling that much in an unthinkable deflationary nightmare.

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BOE Says QE Benefits to Economy Counter Harm Done to Savers

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Nice to see they are getting challenged on this.

With govt the net payer of interest to the economy the critics should ultimately win this one. You would need some seriously skewed propensities to spend to overcome the raw interest rate channels.

BOE Says QE Benefits to Economy Counter Harm Done to Savers

By Jennifer Ryan

August 23 (Bloomberg) — The Bank of England defended its quantitative-easing program against criticism that it affected savers, saying these costs must be weighed against the economic benefits and that the plan limited the depth of the slump.

“Without the bank’s asset purchases, most people in the U.K. would have been worse off,” the central bank said in a report published in London today. “This would have had a significant detrimental impact on savers and pensioners along with every other group in our society. All assessments of the effect of asset purchases must be seen in this light.”

The report is a response to a government request that the central bank explain the impact of its bond purchases, which began in March 2009 and will reach 375 billion pounds ($596 billion) in November. It aims to counter a government claim that loose monetary policy penalizes “savers, those with ‘drawdown pensions’ and those retiring now.”

The central bank said QE widened the deficits in defined-benefit pension plans that were already facing a shortfall before the program started, though that burden may fall on employers and future employees rather than those nearing retirement now. The impact on defined contribution plans has been “broadly neutral.”

Asset-Price Impact

The central bank also said that QE helped to boost other asset prices, benefiting returns on pensions and other savings. The comments echo those made by Deputy Governor Charles Bean in February, when he said the impact of QE on assets such as equities provides an “offset to the fall in annuity rates.”

The effect “is thus more complex than it seems at first blush,” Bean said in a speech that month.

“By pushing up a range of asset prices, asset purchases have boosted the value of households’ financial wealth held outside pension funds,” today’s report said. However, those holdings “are heavily skewed, with the top 5 percent of households holding 40 percent of these assets.”

The Bank of England said the biggest factor in the drop in interest income that savers receive from deposits was the reduction in the key interest rate to a record low of 0.5 percent, not asset purchases.

Explaining the widening of deficits in defined benefit pension plans and the fall in the annuity income that can be purchased from other pension funds, it said the “main factor” has been the fall in equity prices relative to gilt prices.

This “was not caused by QE,” the central bank said. “It happened in all the major economies, much of it occurred prior to the start of asset purchases, and stemmed in large part from the reluctance of investors to hold risky assets, such as equities, given the deterioration in the economic outlook. Indeed, by boosting the economy, monetary policy actions in the U.K. and overseas probably dampened this effect.”

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