Friday, October 29, 2010


I have always been socially liberal and fiscally conservative. Not to the extreme in the sense insofar as I take no issues with debt raised for long-term investment be it education, R&D, trains, Chunnels, or the like, things likely to maintain value and use for many years, and which yield externalities that are in the Public Interest. Nor do I find fault with a bit of counter-cyclical intervention now and then. However, I take issue with credit as a seeming birth-right, and believe that pricing credit too low is more often than not, as dangerous and ultimately dislocating as setting the price of credit too high. I am on record as such for a rather "extended period" (in Fed speak). After all, I am a saver, so it is natural to desire one's savings afforded protection in real terms.

I say these things because in the process of the following provocation, I do not wish to be categorized as a perma-anything, excepting perhaps a perma-skeptic, but in particular do not wish to be labeled an apologist for overly loose money - something that would be patently false.

I must further admit in order to insure the proper stamping of my anti-easy-money-credentials that I am as concerned as anyone about the concept of quantitative easing. I understand that it can be seen as dilution. And in many circumstances - certainly historic ones, printing was hazardous.

But here, today, being inquisitive and hopefully provocative, I must ask the frank question, what is the big deal about a bit of quantitative easing under the present circumstances? Hear me out. Look back over the past 25 years . Witness the ballooning of asset prices. The credit that has been extended and therefore money created, has been, in a single word, enourmous. No, actually ENOURMOUS!! I do not need to reproduce all the graphs that luridly depict this vertiginous reality. And they [asset prices] are still high, as any owner Schiller-measure, or owner of an inner London 2br flat can testify to. This money has already been created. And not only has it been created, it has been spent. And the cascade effects too have already spilled over and paid for the beneficiaries' Porsches, and Hampton or Nantucket digs. Yes, these asset prices and the S&P 500, might continue to go higher. But credit is and will likely remain constrained for a long time. Deleveraging continues apace. Asset prices - both real estate and equity remain elevated, and could easily compress a great deal more under the continuing scenario of limited credit, limited domestic investment opportunities, diminishing construction and consumption spending as a percentage of GDP, aging populations, high and long-term rising energy prices and the perception of the fiscally-constrained state.

Now focus on Japan. Here, too, witness the slow inexorable grind of rates lower during, yes, twenty-five years. The aging of the population. The rising ratio of national debt to GDP. The falling asset prices. No matter quantitative easing. The conjured liquidity seemingly disappears into one black-hole after another, unable to have any meaningful priapic impact upon velocity of money, asset prices, inflation or economic activity. These are vivid images, but accurate depictions. And why? It is not clear we even know.

Lets look at some numbers on our turf. Not the real precise numbers because I am lazy and in a rush for you to contemplate my point before hurling insults back at me, but rough back-of-envelope numbers will do for illustrative purposes. US GDP is $14 trillion. Equities have quadrupled over twenty years. US public market aggregate Market Cap is, I don't know $14 trillion? And private unlisted values - maybe quarter to half as much again? US Bond Market values - combined Federal, corporate, mortgage, municipal, are probably close enough to $30 Trillion, and who knows what the size of privately extended loans are on US bank balance sheets, but it must be a couple of trillion. Net real estate equity value - the unencumbered portion NOT accounted for in market cap of listed and private companies, must be several trillion. These values reflect money already out there. Asset values that already inflated by the massive credit binge during more optimistic times. These, like Japan, are likely compressing in a very long term move. The aggregate net worth of $40, $50 maybe $60 trillion, could be compressing to $30, $40 and $50 trillion respectively. Or, like Japan, lower, and over a longer period. So, one trillion of QE has no bearing on anything (unless you are the guy who has sold them duff assets for real money that you can transform quite easily into a large edible Philadelphia Hoagie. For more or less the same price as one transformed it ten years ago. Would two trillion do anything? In the scheme of things, it would seem, probably not. Oh, sure it might get the speculative juices flowing for a nanosecond (as it did in intermitant intervals in Japan) when traders attempt to front-run this government stimulus package, special budget, or the much vaunted QE, but this would turn out to be but a small blip in velocity, as it flatlined, seemingly forever, or beyond the patience of any reasonable trader or even long-term investor.

So this must be good news, and you now think me an optimist, right? Well, if you recall, virtually all Japan's largest banks needed recapitalisations by ten years after-the-fact. As did the finance companies, and the brokers, and many life insurers. Some needed several and some still need them, twenty-five years later as the inexorable deterioration in asset quality and repayment was eventually reflected in diminished asset prices which was eventually reflected in capital conjurations by pen-stroke, to insure systemic "solvency". Quantitative easing? This was like throwing a few pebbles into a gigantic sinkhole, hoping eventually to fill it in. Inflationary fears? Yes. Inflation? Not in anything subject to Peak Credit and the overhang, like home prices, the S&P, or the wages you pay your secretary. At least that was the experience in Japan. Where did it all go? Why does it not, to this day, make people hyperbolic in their vilification of authorities who have, to the objective observer with no preconceptions about how large the BoJ's balance sheet should be, preserved a semblance of normality in what otherwise have been something else. Maybe that something else is preferred. Maybe that something would have been better. Tea-party-ers and inflationista's certainly seem to think so. Maybe Japanese asset prices are falling for other reasons, and our asset prices are different. Better. They will respond because, ummm, because they are American. Perhaps, but only if they were in aggregate NOT overrvalued by $10 or $15 trillion or some other equally large (or larger) number. I am not sure I would want to make the case that outlying commuter suburbs with no reasonable public transport links are fairly valued in an era of peak oil. What IS the right price? Who knows, but where is fat tail? Seems like the left side - before the right side, at least before desperation sets in, and a trillion here or there is hardly desperation in the grand scheme of market values. Is this better or worse than inflation? I do not really know...


Anonymous said...

The problem with QE is that it doesn't address the core of the problem. It more of an extend and pretend policy. I'm not a Mellonite, but at some point we have to find a reasonable way to tackle the debt overhang.

Well articulated post by the way.


Alan G. said...

It seems to me that the small blip in speculation caused by QE goes to benefit the same criminals responsible for inflating asset values in the first place. And let's be clear, it was caused by fraud, not optimism.

It would be much easier to have this discussion once the perps are behind bars.

Anonymous said...

A great summary.The analogy makes me somewhat suspicious that you also write incognito for the FT (or vice versa).

Anonymous said...

I was going to write a detailed post laying out all the negative implications of asset prices (and institution's) not realizing the losses that have already occurred. But you already know them.

We once had a Cassandra who wrote a scathing post after one of the intra-meeting cuts (might have been the famous Kerviel cut, don't remember) damming a future Ben Bernanke to a retirement home with all the individuals he has and continues to impoverish. Now we have a Cassandra writing seeking apologist. Unbelievable.

"Cassandra" said...

The difference between sinhole and sinkhole is just a single letter.

RJ - Ouch. But to be fair, the Kerviel cut was kind of silly. Nothing had gone overly pear-shaped except a few highly leveraged quants, and New Century. And no one knew precisely when it would happen...perhaps several years later - I wasn't timing the thing. I think if grey matter serves me without re-reading, I was against overt policy facilitating continuation of bubbleville. I do not (nor should anyone) have a problem with cheapening money as a countercyclical move as a principle. But a swoon in the S&P is hardly a cyclical move... I do encourage you to re-read [this post] again and think if the ad-hominem is deserved. I am not arguing for or against anything, except trying to predict the halftime score of the fixture in progress, and as such, more trying to understand a phenomena: Why could Japan print so much money, concurrent to massive and persistent govt deficits and not see the emergence of even the slightest signs of nsacent inflation? I think Richard Koo understands (and articulates) what is happening better than most. My intentially provocative post was more than anything a question to myself trying to ascertain whether the recent missives about the imminent demise of the dollar and the global financial system were warranted or, possibly hyperbolic hyperventilation of the type seen when the Euro was en route to par but a few weeks ago. When so many jump up and down on one side of the boat, one should take note - because they may be indeed be about to be imminently right or they may be right but way early or way way way early. My gut feeling has been, and remains that QE, QE2 or no QE2, a (or several) further deflationary-frights lie between here-now and the feared (by me too) systemic meltdown inflation melt-up what have you. I am interested in you taking a whack at the thesis laid out, for the price of me being wrong in my assertion is significant - so much so that tail hedging may be wise. But understand, it is not ideologically driven. I think its clear I am wearing my agnostic hat in this post.

joe said...

Big C: I say these things because in the process of the following provocation, I do not wish to be categorized as a perma-anything, excepting perhaps a perma-skeptic, but in particular do not wish to be labeled an apologist for overly loose money - something that would be patently false.


You are an apologist for loose money, provided it benefits wealthy and well-connected. You supported bailouts for insolvent financial institutions, rather than putting them into chapter 11, wiping out shareholders' equity and recapitalizing the institutions by converting the bondholders and counterparties claims to equity.

And you continue to support easy money policies to squeeze money out of individuals and real businesses, in order to continue to bail out the big banks.

If that isn't being an apologist for crony capitalism, I don't know what is.

Anonymous said...

To call the Kerveil cut "kind of silly" is polite by a factor of 10.

That said, you are probably right that my ad-hominem is unfair, and I apologize. You probably don't remember that I commented on that post that the Fed had an irrational fear of letting asset prices clear, and that is the larger point. I think it can be stated as fact that asset prices that are supported through policy that have losses (unrealized) which have already occurred is theft of potential prosperity.
It's about cash flow.
Money put to work, and debt incurred, during the bubble have balance sheets that cannot foot to the economic reality on the ground. They were only floated by the marginal extension of credit and the subsequent rise of asset prices. In other words, top line revenue would have never have supported the balance sheet structure. Some of us recognized this, and fortified our balance sheet to prepare for the storm ahead, with cash on hand as an option of opportunity to come. That opportunity lasted about ten days. If you do not allow asset prices to get 'cheap' you will never induce shrewd capital to deploy itself into positions that will allow it to offer gainful employment. So Koo is the doctor who advises more blood letting. Keep the weak alive at the expense of us all (as an aside, and you should know this well, to little attention is paid to the cultural and demographic differences between Japan and the United States, which I think goes a long way of explaining why it never 'worked' there). QE2,3, 4 just extends the malaise, and makes the tail that much fatter. Look, I'm not a rabid Mellonite. By all means, QE away to support deficits to feed and shelter people, but just make sure the GE's, and the Wachovia's, and the GMAC's and all the rest get restructed and realize the losses that are a fact. And RFC those assets out on the pram for us to utilize so we can get out of this god damn mess.
So you're right, we shift in between animal spirits ignited and the deflationary reality of the balance sheet situation. Further QE will only go to support those who already failed by allowing them to push out maturities b/c of yield starved money , thus the rent seeking snide. But they're not likely to secularly hire anyone, as balance sheet reality will cause them to continually right size. So $2 trillion doesn't really 'matter' in the sense that anything will materially change. It merely brings us one step closer to the point of pure intellectual panic when it will, in a negative way. (I see now though how we'll get through that as well, and ponder the day of a free bond market, so scratch me from the apocalypse camp, it has already happened).

I'm closing on my first home tomorrow (stay with me). I looked at it last Sunday, made the builder an all cash offer on Wednesday. He's going to lose $60-$80K on it. But it's over. Losses taken and life moves on. The idea that the good times are just around the corner is what is killing us. Rising asset prices are dead. Cash flow is king.

Happy Halloween

"Cassandra" said...

Joe, - I did not approve of Mellon-esque liquidation because forced selling of assets into a vaccuum would serve no useful purpose. I would not have been unhappy to see haircuts all around with equity (and possibly pfds) wiped out, and subordinated bondholders haircut or all manner of good/bank, bad/bank approach. However, I am cognizant of (a) the risks of this (large haircuts) approach to raising new capital, and (b) that ownership of most of these institutions is reasonably democratic and widespread through pensions, insurance contracts, and ordinary private savings. The latter is not an argument for saving them, just that I am not a buyer of arguments that suggest they should be liquidated because somehow ownership is set apart from the people. As for management, we might agree more than you know...

That said, my post was not addressing this. My post was to examine at the meme that QE/QEII QE are imminently inflationary. We may well see inflation, but I would posit it will come from developing nations economic growth,their own loose policy mix and and growing resource usage, rather than QE.

joe said...

That said, my post was not addressing this. My post was to examine at the meme that QE/QEII QE are imminently inflationary. We may well see inflation, but I would posit it will come from developing nations economic growth,their own loose policy mix and and growing resource usage, rather than QE.


Your post is addressing the bailout of the big banks. They are still insolvent, and Bernnake and Geithner intend to let the banks earn their way out of insolvency by riding the yield curve, through squeezing money out of households and non-financial businesses through borrowing cheaply from them and lending dear to them. QE does nothing for households and non-financial businesses because the banks are not passing along the benefits of QE. Instead, the banks are hoarding the liquidity, to earn their way out of insolvency.

As for liquidation of banks, I said nothing about liquidation, which is "chapter 7" bankruptcy. I said "chapter 11", and conversion of creditors and counterparties' claims into equity. It is easy enough to prevent a liquidation of an institution, provided the Fed extends DIP financing, and bribes the bare minimum of stakeholders to ram through a plan of reorganization.

As for inflation, I have trouble seeing how Bernanke's QE can cause inflation because the mass of workers can't absorb price increases. Their wages are being depressed due to global wage arbitrage. I don't understand how you can get major inflation without a wage-price spiral.

Eclectopedic said...

An excellent summation, thank you! I see no great problem with QE, but also no great solution. The perp walks one of your readers mentioned are the real necessity, in my opinion. After that, fiscal stimulus focused on basic research, education and replacement of our horrifically deteriorated infrastructure would probably jump start the system, just as it did in the 30's.

Digger said...

QE is inherently deflationary as it deprives the non-governent sector of interest income. Any positive response will be because people mistakenly think it is inflationary. The Fed can increase bank reserves all it wants but it cannot force people to borrow.

QE is a duration shift. It has no mechanism for increasing the net financial assets of the non-government sector. This new tool may help visualize the effect:

One blogger besides Warren Mosler that understands QE and has written numerous times lately on this is Cullen Roche at

Counter Inurgency, Deficit Terorist Unit

Magento Themes said...

Price hiking can be controlled but problem is that State Gov is using it for deficit control.

Magento Themes

Liminal Hack said...

Cassandra I agree. Maybe not for the same reasons though.

My view in fact is that zirp is the natural outcome of any fiat money economy, and I say that not as a goldbug but purely as a recognition of the fact that in the final analysis an asset costlessly created (fiat base money) and expanded to whatever volume might be needed cannot attract any yield in any equilibrium situation.

So the asset price bubble of the last 40 years is not a bubble, its a fiat economy finding equilibrium.

Further, the notion of lending money to an institution which can print that money itself is a nonsense.

What is the right nominal interest rate on a 25 year nominal bond that has no nominal risk and changes hands every couple of months?

Somewhere in the region of, oh, zero maybe?

Transport a nominal bond back to the 19th century and what have you got?

A golden goose. The form our government debt takes today would rightly have been regarded as alchemy back then.

Are we now all alchemists? Can you have a 'yield by fiat'. I don't think so.

Liminal Hack said...

Digger, interest income will not be treated as such if the real return is negative.

Interest income is IMO not needed to induce people to invest in economy A unless there is a lowish risk investment in economy B which has a relatively high nominal return which is accessible from economy A. Japan is the obvious case here.

If there was nowhere for japanese savings to go that was materially better than investing in japan, japan would not have a deflation problem if the BoJ committed to maintain the broad money supply at a constant level.

Lastly, a key force that is and has been depressing yields is the increased penetration of financial markets and increasingly fast communications technology. Even with decent underlying growth I still believe that markets will always find quality illiquid investments and make them liquid somehow, thus equalising yields.

Equalising yields on assets of more or less equivalent risk is what markets are supposed to do. They are only going to get better at this. If you follow this logic to its endpoint, you can see for example why 25 or even 15 year lending is not really required if one can always find a roll-over solution.

What securities exist that have a 25 year duration that never or rarely trade or are not securitised during its life actually exist?

burnside said...

In terms of global trade policy, I view QE as an opening salvo against mercantilist policy/net export nations, which include, as it turns out, several regimes otherwise friendly to the US.

All discussion of imminent inflation rests on considering the domestic economy in isolation. Commentary critical of the Federal Reserve and Treasury regarding QE seems to be satisfied to brand rapid credit creation inflationary here at home, while failing to register the effects of exported inflation on major exporting nations.

Geithner said early in his tenure that policy would be misunderstood and unpopular, hence politically expensive. And so it has been. He can hardly proclaim the US has launched an initial salvo in a trade conflict, particularly as it affects a few long-standing allies.

Export economies are beginning to choke on dollar/credit surpluses. You can't game them as you can tariffs, and you can't maintain currency pegs against them either - not on this scale - without blowing up your economy.

Some offshore powers depend on US political calculus halting a continuation or intensification of QE. I wouldn't bet on it.

Common Schlemiel said...

Am I missing something in the previous posts?

1) Various entities earn 100 billion $$$, based on mortgages, appraisal fees, mtg servicing fees, securitization and public offerings and government revenue from higher property valuations (thus higher net income wihtout changing property tax rates and the ensuing re-elections based upon "No tax increases!"), etc.
2) Real estate pyramid collapses.
3) Federal gov't prints money to purchase resultant bad assets.
4) All those who should have known better (big institutions and their "special" clients) earn 100 billions $$$ in asset appreciation.
5) Prudent savers do NOT get the opportunity to purchase assets as rtealistic value, as "bailout" provides price supports.
6) All gov'ts continue to collect taxes on inflated property values.
7) Besides addition money in circulation, wages must remain elevated to enable more real estate purchases by the drivers of the economy, the consumers.
8) Inflation based upon artificially supported asset valuations.

Am I missing something?