The Answer is Nobody Knows

The "Nut Wizard" is going to com in real handy because the acorns have escalated their fall from the trees if that is possible! There must be a metric ton of acorns in my front and back yard.

Everyone Sees Something Different
I always love a chart like this one from dshort.com because everyone sees something different:

Some may say that the move to fiat smoothed things out and that effective management of the monetary supply made recessions less frequent. I of course see something else entirely.

As is the norm in human business history, things tend to get too hot. The red/green sections under the gold standard almost balance perfect as things tended to get corrected at some point. All this chart shows me is that inflation has been standard operating procedure for 50 years and thus no malinvestment has ever really been accounted for, just papered over. It took the biggest credit bust in history just to print a small red blip recently. You can make what you want of that view point, but that is what the chart says to me. Maybe you think economists and the government have become much smarter over time, hee hee.

The Answer is Nobody Knows
I wanted to try and tackle a key item over the weekend after I had some more time to think about what I wanted to say. Instead I have been struck by what I have been reading regarding Quantitative Easing and figured as I am sure I have no idea what the deal is, I may as well throw my thoughts out there to be ridiculed.

It all started with EconomPics's question from last week:

With that said... I completely understand why Japan is intervening in the currency markets for economic purposes (a strong yen is hurting exports), BUT isn't the ability to literally print an overvalued piece of paper the ultimate prize?
For years, counter-fitters have printed worthless paper in the hopes of using it to buy things of value, but with Japan they can do this legally! Why not open up the printing presses and use that new currency to buy goods of value from abroad (I'm not talking other currencies, I'm talking REAL assets)?
To me this will result in at least one of the following (though, I'm sure there are 1000 more):
A weaker Yen (i.e. the goal)
Inflation (i.e. the best thing that could happen to Japan so that monetary policy would actually work)
Nothing to the Yen or to inflation, which means you got a bunch of real assets... for free.
What am I missing?

I had an answer on tap for this, but wanted to see what smarter folks than I had to say first. The comments section was pretty bare.

Kid Dynamite hit upon a similar theme yesterday:

So, here's the question: Gross acknowledged "printing money" for quantitative easing, and advocates it heartily. We already know from our prior discussions of Modern Monetary Theory (MMT) the government need not tax in order to spend - they can just spend - they can just print money (of course, there may be consequences if they do this). Why then, is it a problem to cut taxes by $2T, but not a problem to just print $2T for QE? Said differently, we don't need taxes to "pay" for the budget - we can just print money for that too/instead. Said a third way, why not get rid of QE, and use the $2 Trillion for tax cuts instead?

I guess it's possible that what Bill Gross really meant is that we can print $2T for QE, but we can't print another $2T in the form of tax cuts, because THAT would be too much for the dollar to handle...

Again, I was looking forward to some real meat, but the comments got bogged down with terms and pointing out how one example of something in a broad sense was "not right" or whatever. The answers were again a bit lacking.

In the comments KD asked simply:

When the Fed buys treasuries, the effect is temporary - more bucks are freed up in the financial world to chase less assets. Since we all think that the Treasury will be able to pay back their debts, this is TEMPORARY - and will be reversed if/when the Fed's holdings of Treasuries mature, and the reverse happens - the money goes back in to the Fed (that's what I meant earlier when i said used the terms "unleashed" and "Reigned in)

I'll give you guys another example: what if the Fed took everyone's MSFT shares tomorrow and paid them current price - that's an "Asset swap" right? investors used to have MSFT, now they have cash.. guess what - they'll go use that cash to buy, who knows - IBM. AAPL... the point is - it's "inflationary" in the real world sense - it drives prices higher

Fed buying Treasuries does the same thing.

Again, no real answer.

Here at EconomicDisconnect I like to help! I will supply my answer and while it may be wrong, at least it is a no baloney answer.

Up front you should know that I was a long term inflationista bordering on hyperinflationist. I correctly figured on the policy moves the FED and others would make and correctly estimated the amounts. A funny thing happened though, nothing I figured to occur because of this ever did! The money supply never expanded really (as measured by velocity or money in the actual economy). While I would argue that preventing massive deflation in the stock market and property markets (and yes these two items would be FAR lower now) this is not really super duper inflation.

Faced with this real world observation, I had to review what I was thinking. Beers help this process immensely.

To start, this discussion only pertains to treasuries and cash swaps. I am of the firm belief that the MBS paper bought by the FED is a swap that will never balance out, hence the FED has printed some amount of the 1 trillion plus of that paper it swapped out. The losses are not 100%, but neither are they small losses. This is cash that will remain in the system.

At the very heart is that the money the FED is supplying the banks with is not going anyplace. No one can really argue this. I do believe that small potion of this cash has made its way into the stock markets, supported by Algos and computer driven trading to take the market higher, but surely not anywhere near the amounts available. If not for the flash crash induced scare in the markets a while back, you would be hard pressed to find a chart as bullet proof as the S&P since March 2009.

Now back to the questions. Why can't Japan "print" money and buy real assets? Because this is an unacceptable practice. I know that sounds stupid and amateur, but is is true! It is true that the US has spent over a trillion dollars in deficit, but had Bernanke really dropped a trillion from the proverbial helicopter at malls across the US to regular people we would be discussing dollar support lines at 40 rather than 80 right now. Again, what's the difference?

It is my belief that these games of book keeping legerdemain are nothing more than crude tools with which to look like a not so credible threat to really do something stupid. The banks have reserves now that if used in classic fractional reserve lending would cause the very hyperinflation many seem to think is going to happen any day now. What do I mean?

I have to admit, I just deleted about 5 paragraphs of writing after I re-read it all and I was not getting to what I wanted to say. It is weird that I have a way off looking at this in my head, but I cannot write it out so that it sounds correct to me. Maybe this makes my whole post a waste as I am probably really dumb, but I will simplify.

We know that banks are flush with cash and we also know they are not going crazy with it, even buying up even more treasuries with cash they were swapped by the FED! This means one of two things:
-There is no desire to use this money (poor loan prospects, etc)
-This money was never meant to circulate

Now I like to think banks have learned something about loan quality, but I think it a stretch to say they cannot find anything at all worth a shot. Either their losses are so severe they cannot loan out the cash at low rates and still make good with the FED later. Is that macro observation priced into the markets? Wow, that is huge if true.

Or maybe all this intervention was just for show. Make the banks flush with cash so they will "loan to each other" (another debunked falsehood) and extend credit to the economy. As I have said, leveraged up via fractional reserve banking we should be running at 8% inflation right now easy.

None of this is happening.

I am left with the only idea that stays with me. This money was never meant to be circulated and was a ploy by the FED to target interest rates and take them to forever lows. This has happened. This was supposed to get the US consumer so jazzed about being able to go into even more debt at better rates they would go nuts and buy houses again. All the bought were Ipads, with cash savings instead. Small business was supposed to jump at the chance to expand by utilizing all time low rates, but these rates have been here for a while and are not going anywhere so why expand into a weak economy? Again, this all is happening and makes sense.

So it was all a bluff? A psychological ploy? I think it was and is. I think there was a clear agreement between parties (FED/Treasury/Banks) about this before it all happened. Don't bother with the tin foil hat comments, it is more likely than unlikely.

The danger here is that the FED will go over some line at some point and become a credible threat to do something stupid. Maybe issuing cash and taking the reins off of the banks. Use your imagination on what that could include.

I still am not happy with how this post turned out and would welcome any ideas. Maybe the answer is nobody knows what QE is or does!

Have a good night.

We Have Nothing To Fear but Inflation Psychology Itself!

It cooled down here today. The humidity went away, but the temps stayed high. I have no problem with that. Crazy storms went through last night when the cooler weather smashed into the hot and humid air! Lots of lightning, thunder and wild winds.

Merrill Lynch cuts Lehman Rating a Week After Upgrade
I know I would never buy a stock just because some guy on tv ( hello Cramer) or a investment firm said to. For some reason markets do tend to move when the "buy, hold, neutral, sell" ratings are changed one way or the other by analysts. Enron was a buy of course the day before they closed the doors forever, so you can guess the value of these ratings. AAA all the way!

I mention one of these changes today only for the context it provides to my theory that the usual suspects have no idea what they are doing right now. As if we needed any more proof, look at this from Yahoo Finance (Reuters):
Merrill cuts Lehman rating a week after upgrade
Wed Jun 11, 2008 3:39pm EDT
NEW YORK (Reuters) - Merrill Lynch downgraded its rating on Lehman Brothers Holdings Inc (LEH) to "neutral" from "buy" on Wednesday, just a week after upgrading the stock, and Lehman shares fell 8.4 percent.
Merrill analysts Guy Moszkowski and Patrick Davitt lowered their price target to $28 from $36, saying Lehman's "business mix is poor for this environment," according to a research note obtained by Reuters.
Lehman's shares, which were already down after a report that it may look to raise more capital and amid a broader decline in financial stocks, fell to $2.33 to $25.17 in afternoon trading on the New York Stock Exchange. The stock fell as low as $24.97 during the session.
"Clearly we don't like removing the Buy rating just a week after putting it in place, and at a price 10% lower," the Merrill analysts wrote. "But it seems clear to us now that the move to Buy was premature."
But Moszkowski and Davitt said they expected the brokerage would survive because of a strong liquidity position and access to the Federal Reserve discount window.

MER analysts were wrong by a long shot just last week, but this new report should be taken seriously? In the words of John McEnroe "YOU CANNOT BE SERIOUS!" And what is with a "neutral" rating for a firm the writers of the report themselves pin the survival of on continued access to the FED discount window? Without the special emergency facility of the FED, LEH would be finished? What happens after August when the FED's cash is all done? I guess there will be another report at that time.

We Have Nothing To Fear but Inflation Psychology Itself!
On June 3rd I included a quote from Mr. Bernanke that clearly showed how he saw inflation as an issue. To recap:
"A rough stabilization of commodity prices, even at high levels, would result in a relatively rapid moderation of inflation, consistent with the projections of Federal Reserve governors and Reserve Bank presidents for 2009 and 2010"
Here we see Bernanke is not concerned with high prices we get stuck with per se, just that those increases may not "moderate" and thus will stoke "inflation expectations".

Today Federal Reserve Vice Chairman Donald Kohn had the same theme running as well, from Reuters:
Reuters
Fed's Kohn says risks of inflation psychology higher
Wednesday June 11, 11:40 am ET
WASHINGTON (Reuters) - A steady rise in energy prices has fueled an inflationary psychology in the United States and could be a problem if it does not reverse, Federal Reserve Vice Chairman Donald Kohn said on Wednesday.
"Repeated increases in energy prices and their effect on overall inflation have contributed to a rise in the year- ahead inflation expectation of households," Kohn said in remarks prepared for delivery to a conference organized by the Boston Federal Reserve Bank in Chatham, Mass.
Kohn said evidence that longer-term inflation expectations have edged up is a particular worry.
"Any tendency for these longer-term inflation expectations to drift higher or even fail to reverse over time would have troublesome implications for the outlook for inflation," he said.

Besides the usual roundabout, broken sentence way of saying things that Kohn has, you see once again that the FED types have no moorings in reality. They are worried that the doubling of your energy bill over the past year, in no small part due to the FED's own mistakes, will become something you actually think about! Imagine if people began to assume that the prices of food and gas and other items will keep going up! Inflation expectations running amok! Oh No!

To the FED, that you are paying $4 a gallon for gas is not important. What is important is that you do not fear you will be paying $5 a gallon in the near future! Too funny. If you screwballs at the FED had been up to the task, I would not have to fear $5 gas, or $4 gas, or even $3 gas. Keep the acronym lending facilities open. Keep accepting "AAA" rated mortgage crap paper for treasuries. Keep bailing out firms that deserve to fail and I can guarantee inflation psychology will keep going up. And up. It is called looking around and seeing what is going on around you. Some people do it. The FED should give it a try.

Have a good night.