"Quantitative Easing??" Try, "Printing More Idiots"

Is the Fed Repeating
Wall Street's Sins?

Joe Nocera: At a certain point, Wall Street ran out of clients to sell [securitized debt] to. So the only way it could keep the machine going was to buy it themselves.

Jon Stewart: So, they infected themselves. At the end, they themselves became vampires.

[Which suggests] a new theory on the financial crisis: it occurred because of an idiot shortage. If I'm the Fed, I just print more idiots.

--Bethany McLean and Joe Nocera Interview; The Daily Show (11/16/2010)

That's it!

Instead of calling the Fed's current monetary policy something arcane like "quantitative easing," how about calling it "printing more idiots?"

At least, that's how I understand it.

Just like Wall Street ran out of "idiots" to sell securitized debt to, the U.S. Treasury has started to run out of investors to buy (more) U.S. debt.

China already stuffed to the gills with U.S. bonds?

Ditto for Japan, Singapore, South Korea, Saudi Arabia and all our trading partners on the other side of our yawning trade deficit?

No problem -- we'll buy the bills and bonds ourselves!

Two years, five years, ten years . . . you name it.

In fact, we -- the Fed -- will buy so much, we'll actually drive interest rates down.

Which is quite an accomplishment, given that long term interest rates have already collapsed, and short term rates are effectively zero.

Nothing could possibly go wrong with such a scheme . . . . right??

Flushing Savers From Their Foxholes

"Certificates of Confiscation" Once Again?

Certificate of Confiscation: 1970's term for bonds, certificates of deposit (CD's), etc. yielding less than (rising) inflation.

How do you get people (and corporations and banks) to stop hoarding cash, and put it to work, stimulating the economy?

Reduce interest rates to zero.

But what if that still doesn't do the trick?

Make holding cash not only unremunerative, but costly.

The best way to do that is to devalue the currency and/or create inflation, so that the value of cash steadily erodes, precipitating an inexorable stampede into . . . anything else.

Fleeing Cash

Which is basically what has been happening since late August, when The Federal Reserve signalled its intent to further stimulate the economy by printing more money (called "quantitative easing").

Since then, stocks have rallied about 10%, and commodities -- especially gold and oil -- are up anywhere from 15% to 40%.

Meanwhile, the dollar is down 8% against a basket of major currencies.

(Un)Intended Consequences

The problem with driving savers out of their negative-yielding foxholes is, what comes next?

The Fed hopes that all that liquidity will find its way into the stock market, driving up prices and creating a "wealth effect" that will spur spending and the broader economy.

But it's just as plausible that erstwhile savers will switch their affinity to something -- anything -- that promises immunity from central bank debasement.

That list includes: gold, silver, oil, wheat futures, Swiss francs, Australian dollars -- you name it.

As those things appreciate, they create inflation, which punishes consumers, which hurts the economy.

Can you say, "full circle?"

Bernanke's High Wire Act

Disconnecting the Heart Monitor

In my post last week titled, "Approaching the Zero Bound," I characterized the Fed's plan to buy hundreds of billions ($600 billion, it turns out) in U.S. debt as a "hypodermic needle to the economy's heart."

Actually, that analogy is not quite complete.

The Fed's money-injection plan, also known as quantitative easing, is like administering a hypodermic needle to the heart . . . after disconnecting the patient's heart monitor.

That's because the Fed's injection mode of choice -- buying up U.S. securities -- suppresses a key market signal: interest rates.

How's that?

Normally, when inflation kicks up, demand for loans becomes overheated, etc., buyers of U.S. debt balk, causing demand to flag -- and interest rates to rise.

Now, enter the Fed, and quantitative easing.

With the Fed guzzling U.S. debt -- goosing demand -- interest rates stay low or even go down.

As Bloomberg columnist Caroline Baum puts it (my paraphrase): 'playing with the yield curve is like trying to fool Mother Nature. Instead of increasing demand for goods and services, printing money just raises asset prices.'

Sure seems like the stock market agrees.

Financial e.coli

Laws, Sausages -- & Securitized Mortgages

Laws are like sausages — it is best not to see them being made.

--Otto Von Bismarck

To "laws" and "sausages," now add "securitized debt," circa 2004-2008.

It turns out that Wall Street's financial sausage factory was even more toxic and laxly run than previously thought.

The latest chapter is apparently a breakdown in the very essence of what makes a securitized mortgage, securitized: the link between the mortgage, and the property securing it.

Due to sloppy or non-existent documentation, investors in such paper may not have rights to the collateral -- millions of homes -- after all; if that's correct, "fasten your seat belts, it's going to be a bumpy night," as Bette Davis might put it.

Financial e.coli Outbreak

As the daily headlines (continue to) make clear, the financial e.coli outbreak traceable to Wall Street has sickened not just the U.S. economy, but a good portion of the world economy.

If a real sausage factory caused 1/1,000 of the harm, it would be shut down, fined into oblivion, and its operators jailed.

Much the same fate would befall the government inspectors responsible for overseeing the factory; the private company that put its Good Housekeeping seal of approval on the factory's output; and any other actors associated with the shameful enterprise.

How shameful?

Imagine the uproar if a corrupt food inspector -- charged with abetting food poisoning -- defended itself by claiming that its bogus ratings were "protected free speech," as the credit ratings agencies are now risibly arguing.

Calling Upton Sinclair

So, what's happened to Wall Street and its enablers, post-crash?

And exactly what is their defense to the foregoing?

In the hope that doing so would somehow revive the economy Wall Street wrecked, the Federal Reserve and Congress have actually showered Wall Street with more money since 2008 (courtesy of quantitative easing and TARP, respectively).

Meanwhile, Wall Street has escaped responsibility of any sort by arguing -- try to keep this straight -- that: a) the financial sausages it sold were not tainted with e.coli; but b) if they were, it was because investors wanted to buy tainted sausages; and c) should have known the sausages were tainted; because d) Wall Street told them they were.

Or not (see, SEC v. Goldman Sachs).

And "a." through "d." don't really matter, anyways, because of "e.": selling tainted financial sausages . . . was all perfectly legal.

Any political commercials out there discussing this??

I didn't think so.

P.S.: What do you do with an e. coli -tainted batch of (financial) sausage? Recall it.

Approaching the Zero Bound

"An Attempted Hypodermic
Straight to the Economy’s Heart"

A fascinating, even feverish dialogue is taking place right now -- joined by some of the financial world's most influential thinkers -- concerning what will happen next week, and what economic consequences will flow from that outcome.

The elections next Tuesday?

Try, the Fed's much-signalled intention to initiate another round of quantitative easing (also called "printing money") when it meets next Wednesday.

Here is Bill Gross' take, from his perch at PIMCO, the nation's (world's?) largest investor in bonds:

Quantitative easing is temporarily, but not ultimately, a bondholder’s friend. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead-end where those prices can no longer go up. Having arrived at its destination, the market then offers near 0% returns and a picking of the creditor’s pocket via inflation and negative real interest rates.

--Bill Gross, "Run Turkey, Run"; PIMCO Investment Outlook (Nov., 2010)

So why do it?

Because the Fed, caught in a liquidity trap, is out of other options.

Gross again:

Ben Bernanke can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it (more quantitative easing) is all he can do.

--Bill Gross

Will "it" work?

Gross, whose credentials are as good as anyone's, thinks the jury's out.

Bubbles as Policy Tool

Grantham: 'Almost Criminally Inept Fed'

The Federal Reserve's asymmetric policy of stimulating stock moves by setting artificially low rates and then leaving the bull markets, when overstimulated, to bubble over, is dangerous. It is probably the most dangerous thing to inflict on a peace time economy with two possible exceptions – runaway inflation and a housing bubble.

--Jeremy Grantham

Leave it to Jeremy Grantham to lay bare exactly why the Fed has so many market watchers -- myself included -- baying at the moon in exasperation.

On the one hand, it denies any duty or ability to contain the damage from asset bubbles (or even recognize them!).

On the other hand, it pursues policies -- first zero percent interest rates, now quantitative easing -- guaranteed to inflate serial bubbles.

Grantham devotes most of his current quarterly letter (see, "Night of the Living Fed") to explaining why this is irresponsible, and -- in the case of housing -- especially dangerous.

Amongst other things, in their wake burst asset bubbles leave squeezed consumers, taxpayers, savers, retirees, pension funds, states, and municipalities -- and, when they are compelled to clean up the mess, ultimately a broke Fed and federal government.

Grantham again:

Distorted asset prices have been like the deliberately misplaced signal lanterns, which the Cornish, in the stormy west of England, used to lure ships onto the rocks for plunder. Individuals, as well as institutions, were fooled into believing that the market signals were real, that they truly were rich. They acted accordingly, spending too much or saving too little.

So what does Grantham prescribe, besides not inflating any more bubbles?

Noting on the one hand the "army of non-frictional unemployed ready to get to work," and on the other hand the country's "dreadfully deteriorated infrastructure and desperate need for improvements in energy efficiency" . . . Grantham thinks it's obvious.

You owe it to yourself to read the entire article.

King Derwin's Magicians -- and Ours

Waiting on Economists'
"Chants and Charms?"

"A mighty good chant," said the King, looking very pleased. Are you sure it will work?"

All the magicians nodded together.

"But," said the King, looking puzzled, "How long will it take?"

"Be calm, oh, Sire, and have no fears," chanted the magicians.

"Our charm will work in ten short years."

--"The 500 Hats of Bartholomew Cubbins," by Dr. Seuss

Watching an inspired production of the famous Dr. Seuss story by The Children's Theatre yesterday, I couldn't help noting the parallels between King Derwin's magicians, and Barack Obama's economic magicians.

Just like Dr. Seuss' magicians, our government magicians profess confidence that their "spell" -- TARP, zero percent interest rates, quantitative easing, etc. -- will have the desired effect.

King Derwin pronounces the magicians "fools," and promptly dismisses them.

Meanwhile, in the real world, we are giving our latter-day magicians more power, and waiting for their chants and charms to work.

P.S.: How do you say "economist" in Japanese?

Profiting from Bubbles: 'Grab Marshmallows'

What's an Investor to Do?

[But] as long as the music is playing, you've got to get up and dance.

--Former Citigroup CEO Chuck Prince

Perplexed by a stock market that (inexplicably?) is once again on the rise -- along with all manner of commodities (oil, gold, silver, etc.)?

That, despite at best conflicting economic signals (continuing weak employment numbers, constricted lending, soft housing, etc.).

You shouldn't be.

Behind the scenes, the Federal Reserve has signalled its ongoing commitment to print money as a way to stimulate the economy, via a mechanism euphemistically labelled "quantitative easing."

"Grabbing Marshmallows"

So how should investors play such an environment?

If you have the stomach, take Barry Ritholtz's advice (my paraphrase):

When the Fed adds even more gasoline to the conflagration, [investors] should grab some some marshmallows and sticks and head over to the boy scout jamboree campfire.

--Barry Ritholtz, "Do You Wanna Be Right, or Do You Wanna Make Money?"

Note to the intrepid: the trick is not waiting around for the embers.

Proposal: A U.S. "Dividend Holiday"

Tapping Corporate America's Cash Hoard to Reward Investors & Stimulate the Economy

Money is like manure; it's not worth a thing unless it's spread around.

--Thornton Wilder

Let's see if I've got this right . . .

The economy is decelerating now because the federal stimulus to date has run its course, and additional federal stimulus risks drowning the U.S. (further) in red ink and endangering its very creditworthiness.

Meanwhile, corporations sit on the mother lode of all cash hoards -- an estimated $2 trillion for just the S&P 500.

All this, as shareholders have just suffered the worst decade investors have experienced . . ever: nominally down 20% from where they were . . . in 2000.

And that's before accounting for the stock market's sickening volatility, or a decade's worth of inflation that masks even more erosion in investors' wealth (my label for the foregoing toxic brew: 'risk without return').

Three Birds With One Stone

So, to summarize:

The challenge now is to get money into the hands of deserving people -- who will actually put it to good use -- without making future generations pay for it.

Anyone else have a light bulb go off?

Here's mine:

Give corporations an incentive to disburse their cash hoard; then, give shareholders an incentive to spend it.

The simplest way to do that would be to declare a Dividend Holiday through the end of 2010 during which the federal government would waive taxes on all dividends.

Carrot won't work?

Then consider a stick: taxing corporations on excess undistributed cash.

Either way, such a bold step would have three benefits (and few costs):

One. It rewards long-suffering shareholders.

Why is that important?

Abuse shareholders long enough, and eventually they will "take their marbles and go home."

After the 1929 crash, an entire generation learned not to put their money in stocks.

That attitude threatens capital formation, future innovation, and arguably capitalism itself.

Deprive savers of a return on their investment, and they lose their wherewithal to finance their retirements.

Guess where they'll turn to for help.

Two. It takes the money away from overpaid CEO's.

Incredibly, the average S&P 500 CEO now makes almost $10 million annually, up 700% since 1980.

Meanwhile, workers' wages during that time have stagnated, and investors -- to belabor the point --are worse off than they were a decade ago.

As the saying goes, money -- like manure -- isn't worth anything until it's spread around.

Three. It relieves the pressure on the Federal Reserve to print more money, and the U.S. Treasury to borrow more.

According to that famous physics theorem, the First Law on Holes, "when you're in one . . . stop digging!!"

Having dropped interest rates to zero and kept them there, Ben Bernanke is now resorting to raw injections of liquidity (called "quantitative easing") to stimulate the economy.

Enough!

There's plenty of money in the economy already.

The challenge is to get it circulating, productively, again.

No, Not THAT QE II!!

First, the Trial Balloons

What is all this fuss I hear about the Supreme Court decision on a "deaf" penalty? It's terrible! Deaf people have enough problems as it is!

--Befuddled spinster Emily Litella, one of Gilda Radner's several characters on the original Saturday Night Live.

Emily Litella comes to mind as the murmuring about QE II is getting louder.

No, not that QE II (pictured above).

Rather, they're talking about another round of quantitative easing by The Federal Reserve.

Because the Fed has already lowered interest rates to zero, its remaining weapon to stimulate an apparently flagging economy is to simply print more money (the fancy name for this is "quantitative easing").

In practice, that's accomplished by buying up new U. S. debt -- debt which the government has been more than happy to issue lately.

First broached on the blogosphere perhaps a month ago, the drumbeat in the MSM (main stream media) is growing discernibly louder the last 10 days or so.

P.S.: Growing up in the Twin Cities, I was confused by why everyone was making such a commotion over the West Bank. By age 8 or so, I finally figured out they were referring to the one in the Middle East.

I thought they were referring to the one across the Mississippi from the East Bank of the University of Minnesota.

"Bloodletting" Economists

Economic Theory, Then & Now

The U.S. is now 234 years old, and yet over half the nation’s money supply was created since Helicopter Ben took over the flight controls four years ago.

--David Rosenberg; Chief Economist, Gluskin Sheff

It's hardly a saving grace for today's financial mess, but it HAS been gratifying to see an entire generation of muckety-muck economists abruptly lose their hubris regarding their colleagues of yore.

As epitomized by the last two Fed Chairmen, Alan Greenspan and Ben Bernanke, the prevailing mindset amongst contemporary economists has been that their Depression-era peers were little more advanced than medieval doctors, who went in for bloodletting and other harmful quackery.

The reason for that belief?

Those in charge during the Great Depression ignorantly presided over a collapse in the money supply, with a consequently ruinous effect on credit availability, debt repayment, and wages and prices generally (indeed, the Depression was characterized by a devastating deflation).

Fighting the Last War?

Fast forward to today.

"Helicopter Ben" Bernanke and the U.S. Treasury have now injected -- depending on how you count -- somewhere on the order of $10 trillion in liquidity into the U.S. economy.

And that's just since 2008.

Zero percent interest rates. TARP. Son of TARP. Federal guaranties. Bailouts. Direct equity infusions. Subsidized mortgage rates. Quantitative easing. And on and on.

The result?

No Great Depression II, but certainly not a robust recovery. And at the cost of trillions in potentially crippling, new U.S. debt.

In fact, by printing so much money, Mr. Bernanke has ushered in what economists call a "liquidity trap": monetary policy has eased so much -- in fact, to 0% -- that further easing has no effect.

In fact, it's impossible (cue, quantitative easing).

Back to the ???

So, where do we go from here?

Not necessarily 'back to the '30's.

Personally, I'd settle for the '50's.

How Many Parachutes?

Pick Your (Economic) Metaphor

The real question is, now what? Government interventions are only meant to light a fire under the real economy and unleash what John Maynard Keynes called our "animal spirits." But government dollars can't sustain growth.

Like it or not, the stock market is bigger than the Federal Reserve and the U.S. Treasury. The stock market anticipates only future profits and prosperity, not government-funded starter fluid. You can only fool it for so long. Unless there are real corporate profits from sustainable economic growth, the stock market is not going to play along.

--Andy Kessler, "The Bernanke Market"; The Wall Street Journal (7/15/09)

Kessler's is one of the better takes I've seen recently on "where we're at now" (a rapidly growing genre of Op-Ed pieces lately).

Here's my, somewhat starker take:

Parachute #1, monetary policy -- the Fed's control of (short-term, wholesale) interest rates -- has been fully deployed for quite some time. Once rates are zero, you're done. (Eventually, so-called "quantitative easing" ignites inflation fears.)

Parachute #2, fiscal policy -- also known as government spending -- has now been deployed in the form of what I'll call "TARP, SCHMARP, and GARP" (sorry, lost of track of all the ad hoc acronyms some time ago -- maybe that was the point).

The economy's rate of descent now seems to be slowing.

How far away is the ground? Do we have any more parachutes?

Stay tuned . .

P.S.: if you're new to all this economic metaphor-stuff, "soft landing" seems to get recycled every 10 years or so.