Fed Undertakes QE3 With $40 Billion in MBS Purchases Each Month
bloomberg.com
bloomberg.com
Say your company brought in $1M a year in revenue and you had $1.04M in debt and growing. Say you had 40% margins and were trying to service that debt with your 400k of gross profit.
You would not be in business long.
The fiscal reality of the US government is the same save for one key fact: they can print money. As a result, they can carry on this sorry fiscal situation for an amazingly long time, but not forever.
Japan has been in this situation more than a decade. They remain powerful.
This state of affairs will affect you as a company in these ways:
1. Your taxes must go up. This isn't a political thing so much as bottom line math thing. The more they take in revenue from you, the less they have to borrow or print and the longer this whole system keeps going. They can tax the rich at 100% and still not have nearly enough money to service their current debt, let alone the constantly increasing spend.
2. Market certainty will go down. No one wants increased taxes - politicians or citizens. This pressure from both sides creates things like the coming 'fiscal cliff' where either we reach a budget cutting agreement or draconian cuts go into effect. The market hates not knowing and people spend less in these cases. It looks like there will be a pattern of these occurring in the foreseeable future, which means less people spending less money with your business.
3. Dollars will be worth less. To hold the true value you receive for your service steady, you will have to increase the number of dollars you ask for from customers. Unfortunately, these customers will have less dollars in their pocket because wage inflation tends to trail price inflation. Be aware that as long as the US can borrow money and keep interest rates on bonds low as a result, inflation reported by the feds will remain low. It also pays to be the tallest midget. US dollars remain the world standard, so when there is a panic in Europe or Asia, people rush to buy our bonds, which bolsters our dollar and purchasing power relative to other nations. This ends when the market no longer believes we can pay. This could be tomorrow, next year, in 10 years or never if we really get our act together.
4. The dollars you've earned might not be worth much when you go to spend them. Say there's nothing to worry about for the next 10 years, but then it gets so bad that the market says 'enough, we're not buying these bonds anymore USA.' The USA at that point can print the money and pay the bonds with it or default. Either way, the dollars you earned through sweat and tears aren't worth much and the business that made them isn't attractive to customers at the "new normal" price points. At this nearly worst case point, you are poor, hit from both sides of the inflation game. This is one reason any thread of this nature has at least one mention of 'Gold!', as it holds its value no matter what the government does - assuming you can both hold onto it and trade it for fair value when you need it.
This means that for nearly 100 years the USA has been able to print dollars and have much of the effects of this monetary inflation absorbed by foriegn countries that needed to hold dollar reserves.
Or put another way, there is a massive amount of inflation that has been exported. It will remain overseas so long as the dollar remains the worlds reserve currency.
But as that changes, and the dollar loses credibility due to this "Quantitative Easing" (which is nothing more than a euphemism for monetary inflation) at some point the rate of people switching from dollar reserves to other reserves- gold, yuan, whatever-- will reach a tipping point and as the dollar declines ever faster people will panic to get out of the dollar.
This is like an axe over our heads. We've got hyperinflation built in, because once that turning point happens, the panic will trounce the dollar, and that will imediately force the government to crank up the printing presses even faster- trying to outrun these ramifications, and we'll wake up one morning in Zimbabwe.
And I'm not kidding about it happening "one morning", when this happens it often happens very fast. The Ruble lost half its value between breakfast and lunch when it happened. In argentina it was a matter of weeks.
Neither of those currencies were world currencies.
No way to know when it will happen, or exactly how-- we've been helped by europes problems. Since they've been going down faster they have made the dollar look good in comparison.
We've also been helped by China's dependance on exports- as europe went down and we slowed down, that's hurt china, making them not look as relatively strong compared to us.
Finally we've also been helped with outright manipulation of the market. One of the key indicators is the price of gold (which is really the price of dollars measured in gold.) The FOMC is an entity within the fed whose job is to "stablize prices" which is also known as market manipulation, and it takes big chunks of that QE money and uses it to short gold. Notice how gold was on its way to $2,000 when they killed that momentum and brought it back to $1,500? That helps shore up the percieved value of the dollar.
If this sounds like conspiracy theory, google GATA and read the details-- the FOMC minutes come out eventually and their interventions in the gold market are documented.
I can't say what a fair value for gold is, but it is well north of $2,000. (Say if you compared the monetary inflation in dollars since the last time there was gold peg to the gold price then.... )
But so long as people are made to believe that a currency is stable, they will keep using it and the currency remains stable.
When people realize the currency is worthless paper being pumped out at insane levels, then it will be treated as such and quickly attain that market price.
Dollar is still the worlds reserve currency, therefore, we need not worry about the effects of inflation. IF dollar somehow lost its standing as worlds reserve currency, then we are doomed.
The latter is not going to happen anytime soon.
BTW, GATA looks like a very spammy website. I immediately closed it.
Moreover, your hyperinflation concerns amount mostly to conspiracy theory. Hyperinflation occurs generally after very specific and exogenous shocks, such as a collapse in productivity or huge amounts of debt denominated in a foreign currency.
Demand-driven inflation occurs when the supply of money in the system outstrips the economys productive capacity to absorb it. Given that we are in a situation of huge slack capacity utilization and 8% unemployment, demand side inflation ranks just about last on the list of pressing economic concerns.
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What's a Laffer curve?
How much will you work if the tax rate is 100%. If you're not working, how much tax will be collected from you?
> They can tax the rich at 100%
Actually, you can't. If you confiscate assets, you've got assets, not money. And there's no one to buy.
I think you were more asking "if something bad happens, but law and order remain, how do I protect my purchasing power."
Short answer: hard assets.
Medium answer: As a business, you want to be out of cash and into inventory. This is because you can always increase the price of the hard goods you have that others want, so you can always receive true value. However, once you have traded the goods for cash, that cash immediately begins loosing value.
Longer answer:
You want physical, tangible goods that you can barter for other goods or whatever is locally being used as currency.
Think about what money looks like in shape and form. Light, a little thing can represent a lot of value, has a long shelf life, is widely accepted and equally valued.
Think about what people want to have or need to have even when money is tight. Cross off that list anything with a shelf life or that is so hard to transport and trade that it wouldn't be worth doing. Have a good amount of what remains on your list, stored in a place you can secure.
That is kind of vague, so here's a list of things to consider:
* Preserved Food (beprepared.com)
* Gold and Silver (apmex.com)
* Hard Liquor
* Cigarettes
* Ammo
* Firearms
* Farm Animals
* Farm Land
All of the things on my list have increased in value during our current debt crisis.
A government that controls its own currency and does not keep any exchange peg is not revenue constrained. The only real constraint on gov't spending is inflation (that we match our deficit spending $ for $ with bond issuance is mostly an institutional legacy from the gold standard/ fixed exchange rate era, as well as performing certain key functions in stabilizing our payments system).
I challenge you to identify a point in history when we had to raise taxes in order to pay off retiring debt. Debt is paid by shuffling numbers in a xls at the Federal reserve. That's probably the best way to look at government spending in general--as ex nihilo. Spending creates money, and taxation destroys it. So think of taxation not as raising money per se but as the government draining enough aggregate demand from the system so as to enable it to spend sufficiently to achieve its goals without causing undue inflation.
Moreover, there is nothing a priori good about a balanced budget or a surplus. A surplus means the government is draining more income from the private sector than its adding in. In general, because household savings and a current account deficit represent a leakage of demand/income, the US should and does run a deficit most years (otherwise there wouldn't be enough available income in the system to purchase our output every year). Right now especially, with depressed household consumption due to the debt overhang and massive excess productive capactiy, the government should be running huge deficits in order to support private sector incomes.
I love thinking about our money supply like that. I'm stealing your quote.
Since the Federal Reserve now is the largest single owner of US government bonds[1] and since it has come close to purchasing all available bonds at the long end of the spectrum[2], it is doing the last thing it can think of: an open-ended, unlimited purchase of Mortgage-Backed Securities. This is the terminal end-game of central banking.
This won't end well.
[1] See http://cnsnews.com/news/article/fed-now-largest-owner-us-gov... (2011), updated data here http://www.federalreserve.gov/monetarypolicy/files/quarterly... and here http://www.treasury.gov/resource-center/data-chart-center/ti....
[2] http://www.zerohedge.com/news/scary-math-behind-mechanics-qe...
A good example is Obama's "stimulus" which was a big old pork package, underwritten by the Fed that he got to pretend was "taking action" to "improve the economy" / "create jobs".
It was a complete failure by even its own promises, but that has not hurt Obama's re-election chances, because people don't hold politicians accountable for damaging the economy.
And this goes for Bush, Clinton, Bush 1 and Reagan -- all of whom took at least some actions that damaged the economy.
I just don't get what keeps most people complaining about one or two narrow pieces of the puzzle, but yet completely accepting of the entire perverted ball of wax of over-abstracted, hollowed out, and corrupt institutions. This mild dissent is then amazingly converted into support every time an election roles around, where the socially acceptable thing is to cheer on your chosen republocrat, pretending that electing new faces will change anything (not that a third party would magically fix things either, it's just a minimum viable dissent). Is it just straightforward cognitive dissonance because of how painful it would be to admit most things you take for granted are simply not there? Is it that most people smart enough to actually see how rigged the game are still able to achieve an "above average" place in society and thus aren't interested in meta questions ? I suppose anything is easier than developing an adversarial individualist perspective which can't be unseen.
.. looks like gold spiked up 2% on the news.
I don't think you can do it, which is why I don't have an opinion about its intrinsic value.
But if you look at the price of gold as actually the price of dollars measured in gold, then things look much different.
By that measure, taking monetary inflation into account over the past 100 years, gold is historically cheap.
Gold has "two values" (and one sale price)
It can be a "money substitute"
But it is also a mineral, with an extraction cost, and usage in the industry
Now let's compare to oil
Oil is very liquid (pun intended), it can almost anytime be converted into money. And then, used, converted into products or services.
Gold has no such property.
Yes, seeing "the price of dollar in gold" is certainly eye opening, still, the US has enough gold (and other resources) to keep the price of dollar (compared to gold) high enough.
Here's something a little better: http://en.wikipedia.org/wiki/Quantitative_easing
</conspiracy-theory>
It's incredibly hard to predict how these massive macro changes affect us on an individual or company level.
Not necessarily. If he'd done it in June/July, we could look at the results, which might not be good.
Doing it now, Obama can continue to argue "things are going to get better real soon now".
QE3 is pretty much already priced into the market.
However, the stock market won't help Obama. He needs employment.
The median income has gone down more during the "recovery" than it did during the recession. The only reason why unemployment is stable/creeping down is that folks are dropping out of the workforce; workforce participation is dropping.
Heck - compare the number of folks going on disability to the number finding work.
The most significant thing this signals, in my opinion, is the expectation that the economy will continue to do poorly in the short and medium term. People have equated these policies to pushing on a rope, the Fed can lower the rates but it can not force companies to take loans and higher risks.
As an individual you may be able to refinance your debt at a lower rate. As a company you may be able to borrow money at a lower rate. In the real world however (as someone involved in a business who just got a bank loan for 6%) this doesn't always work.
The stock market may go higher because lower rates make bonds a less attractive investment. The only problem is the bond market isn't as impacted because some people feel the Fed will not be able to continue maintaining lower yields due to inflation.
(EDITed with some more thoughts)
Edit: consumer-level or corporate level credit won't be any cheaper - only a very specific type of credit, ie mortgages, would become cheaper still.
As you've rightly pointed out, the Fed is targeting mortgage rates, and thus, home affordability. This is to support house prices and encourage construction-based spending in the economy.
House-buying and construction have the biggest multipliers in terms of their knock-on effect on the economy. That's why the recession was so deep - and that's why a recovery can only truly be kick-started by making mortgages affordable.
However, some big downside risks here:
(a) The European crisis, obviously - although the politicians now seem to have come to their senses a little bit.
(b) The credit burden on the US consumer - consumers are still quite leveraged and spending is still financed heavily by credit than by pure income. That will always cause blips to the economy (like oil-price induced inflation) to be magnified and will defeat what the Fed is trying to achieve.
(c) Short-term commodity inflation risks - but given that WTI light crude is almost $20 below Brent crude, there already is a North American supply glut.
If funding of mortgages is cheaper for banks and agencies, then they become cheaper for the borrowers as well. Even if you aren't buying a new home, you can refinance your existing mortgage at a lower rate.
Isn't this what caused the 2008 crisis in the first place?
This is a method under the guise of helping the housing market to inject billions (if not trillions) of extra liquidity. Eventually, that leads to higher inflation, which devalues the currency.
So any good arguments against the inflation view (except the obvious: the market is not expecting it) would be welcome.
But may I recommend the EconTalk podcast. http://www.econtalk.org/archives.html#category
In particular, Barofsky on Bailouts (http://www.econtalk.org/archives/2012/09/barofsky_on_bai.htm...), Johnson on the Financial Crisis (http://www.econtalk.org/archives/2011/11/simon_johnson_o.htm...), and Wapshot on Keynes and Hayek (http://www.econtalk.org/archives/2011/10/wapshott_on_key.htm...).
Hell, the entire EconTalk podcast series is full of so much braininess.
This is a pretty complex subject and there is more to it than just printing money and buying up T-Bills.
The downside is that this hurts savers, particularly small time savers who aren't investor class people. And is still not guaranteed to work. So you get the worst of both worlds, a higher inflation rate and still not enough jobs.
For example, I could say that it was the best of both worlds: more jobs, and the inflation rate won't be bad.
I just looked back at the first sentences of that paragraph, and they're just as interesting. Both parts of the observation are binary (hurt/unhurt vs. guaranteed/not guaranteed), but the one that you want to imply is more important, you judge on a positive margin, and the one you want to imply is less important, you judge on a negative margin, i.e. if a "small time saver" loses a single dollar more under Q.E.3 than if it hadn't happened, that "small time saver" was clearly hurt; if there is any confluence of future possibilities that could cause Q.E.3 to not achieve the Fed's goals, it is clearly not guaranteed.
People are so interesting in so few words.
The reason for this is because the fed's 'dual mandate' to keep inflation low and unemployment low. The big theory behind this is the so-called Phillips Curve, which states that there's an inverse relationship between unemployment and inflation. The reasoning here is threefold:
1. It's believed that inflation 'lights a fire' under capital (i.e. it's expensive to hold cash), which spurs people to invest, which in turn creates jobs.
2. Wages are sticky -- after losing a job, people tend to be reluctant to take a big pay cut when accepting new job and so tend to wait for something better to come along. Paradoxically, people are more willing to take a REAL pay cut when the NOMINAL pay cut is smaller, as would happen in an inflationary environment (note: there's no change in actual spending power).
3. Higher inflation acts as a transfer to borrowers from lenders. Any debt currently issued before a change in inflation will have been valued in light of lower epected rates of return. A change in inflation expectations effectively decreases the debt burden on any debt held before the change. This improves firm's balance sheets by decreasing the value of debt on their balance sheets, making them more able to invest.
As an individual, there's not much to guard against here. We should expect this to have a slightly positive impact on jobs and asset prices. We should also expect inflation to run a little higher, but there's little risk of any sort of run-away, or "hyper," inflation because of this -- the fed can stop inflation as easily as it can start it by
[Edit: Corrected Taylor Rule to Phillips Curve]
The most sophisticated community I know of is the board at Wilmott.com. And I saw that someone tried a nice HN clone at quantly.com, but it sadly never took off.
My personal approach is to build out (and regularly cull) an RSS folder with financial analysis, quant methods and economics blogs. The newsletter from AbnormalReturns.com is a great starting point. Also, ritholtz.com, A Dash of Insight (http://oldprof.typepad.com/) and marginalrevolution.com might be good starters.
Step 1, bring short-term rates to zero (end of 2008)
Step 2, (2010) announce that you're going to keep rates near zero for an extended period, and make it increasingly specific (currently through 2015). Since today's 2-year rate is the current 3-month rate compounded with the forward 3-month rates out to 2 years, that has the effect of pushing the yield curve down to near zero out to 2 years.
Step 3, (2011) 'Operation Twist', announce that you're buying long-term bonds and selling short-term bonds. That pushes low low rates even further out the yield curve.
Step 4 (today) buy mortgages via MBS, directly pushing down mortgage rates relative to Treasurys. Means lower rates for borrowers who can qualify for mortgages/refis. Also lowers credit spreads by taking away an option for people who want to get high rates by taking on credit risk such as mortgages/corporates, pushing lower rates up the credit spectrum.
bottom line... low low rates. Europe, China, Japan not doing too well these days, Fed trying desperately to avoid similar fate for US. Generally good for stock markets/startups, if investors can't make high returns in deposits/bonds they're more likely to try to find them in stocks/startups.
*http://www.treasury.gov/resource-center/data-chart-center/in...
Neverthless, as a first order approximation I would stand by the notion that buying bonds makes their prices go up, rates go down.
But yeah, if the policy is successful it will steepen the yield curve.