Text of Fed Statement re: QE2

[oldreliable67]

As the economy picks up treasury yields will continue to increase. This is because better returns will be realized in other investment such as stocks.

Yes and no. The key premise is "As the economy picks up." In such circumstances expectations for earnings growth are typically increasing, and then yes, there will be some asset re-allocation from fixed-income into equities. But the more important influence in a recovering economy is renewed growth of credit demands. As the economy expands, so do private sector credit demands (and this is one of the desired outcomes of QE2). Credit demands expand because the new expansion phase of the cycle engenders expectations of increased profitability, hence a desire to participate in same.

It is generally at this point in the cycle when banks begin to reduce their investment portfolios in favor of increasing their loan books. Loans, after all, are much more profitable for banks than treasury or municipal securities. Result: loan-deposit ratios begin to climb back toward more normal levels of about 70%-75% (for mid-size and smaller banks and with lesser dependence on trading than the larger banks).

Therefore, to say that 'better returns will be realized" elsewhere is rather incomplete, and doesn't recognize the interplay of increasing credit demands in an expanding economy resulting in diminished bank buying/liquidation of fixed income securities.

In the current recovery, the extraordinary hoarding of cash and the heightened avoidance of perceived risky counter-parties typical of a balance sheet recession, intertwined with the de-leveraging from extraordinary debt levels, have tended to keep credit demands very subdued. The Fed's quarterly surveys of senior bank lending officers only recently gave a small hint that credit standards may be loosening, if only ever so slightly. Hence, adding to the impetus for QE2.

I'm not sure about this. You may be right about them trying to get banks out of short term treasuries, but typically the money tied up is not a substitute for lending, rather it is collateral for lending as banks can borrow against their assets.

Actually, as I've alluded to above, a banks investment portfolio is something of a substitute for lending. But you are right, the securities in the investment portfolio can be used for collateral to borrow funds with which to fund the loan book. However, doing so increases leverage and there are capital ratios to be considered. The typical first response to a perceived increase in loan demand is, yes, to borrow against the investment portfolio. If the pick-up in credit demands are subsequently perceived as being more than just a temporary blip and more a function of a recovering economy, then the ALM (Asset Liability Management) committee will promulgate guidelines as to managing the provision of funding to meet the expansion of credit demands. This just means that they will estimate how much of an increase in credit demands will be satisfied via borrowing versus drawing down the investment portfolio while keeping within their leverage and capital ratio constraints.

 

[oldreliable67]

OK, but if I understand this correctly, when the Fed starts trying to remove some of the reserves it is adding to the system, it will use reverse repos in order to limit its risk. Presumably, if interest rates rise, the value of the Fed's bond holdings will drop--unless it gets the original sellers of the bonds to buy them back at a price that makes the fed whole, or, at least, close to whole. But if the Fed is limiting its risk, then it's shifting the risk to the banks who originally sold the Fed the bonds. That can't be good for banks, can it?

Reverse repos are one of the tactics the Fed might use to drain reserves, and are a tactic the Fed has never used before. Recent months have seen them exercise the process, but only in a testing mode. Notably, if and when they use reverse repos, they will do so with a broader list of counter-parties, adding large money managers and not relying solely on the 18 primary dealers. Of course, simply selling securities to the primary dealers is the principal and heretofore most often used method of draining reserves on a permanent basis.

Re: risk shifting. Well, no, the Fed is not 'shifting' the risk to the banks, at least not in the sense that it seems like you mean. When the Fed does a go 'round, each contacted primary dealer will have the opportunity to submit bids for the securities that the Fed has said that it wishes to sell. If the dealer is the high bidder, then the dealer owns the securities. So, to the extent that the dealer is now an owner of more securities than it was previously, it has assumed additional risk, thereby putting its capital at risk. But, that is all part of being a primary dealer (as is bidding at auctions, selling securities to the Fed, participating in Fed repo actions, making affirmative markets,etc.).

Once the dealer owns the securities, he has many ways to hedge whatever amount of principal risk he has assumed. Depending on the maturities purchased, the easiest way is usually to short the nearest on-the-run issue in an amount that results in approximately equal yield values of a basis point in the long and short positions, thus assuming a market neutral stance. Shorting futures contracts are another oft-used alternative. Then the positions can be unwound over some amount of time without incurring inordinate market risk. This is a bit simplified description; I've left out some of the details, but hopefully you'll get the gist.

Remember, the Fed's subsequent sale of these securities has no relationship to the original purchase in terms of who bought/sold what at whatever price. They are totally independent trades. Both the purchases and sales will have been thru an auction process consisting of independent competing bids and offers.

 

[oldreliable67]

St Louis Fed Pres Bullard spoke to the NYSSA in New York today, addressing the topic du jour, QE2. His presentation is here.

 

[Missed AB]

I am sorry you took my comments personally or felt offended by them... Don't take me so seriously, my wife sure doesn't

Well if interest rates continue to remain low for an extended period and hyperinflation does occur because of QE2 then apparently you can have a situation of high inflation and low interest rates occurring simultaneously.

That's the thing, you can't have both situations at the same time.

As you know, I don't like Wikipedia, but I did some research on it for you and this point.

"Since the lender is deferring his consumption, he will at a bare minimum, want to recover enough to pay the increased cost of goods due to inflation. Because future inflation is unknown, there are three tactics.
Charge X% interest 'plus inflation'. Many governments issue 'real-return' or 'inflation indexed' bonds. The principal amount or the interest payments are continually increased by the rate of inflation. See the discussion at real interest rate.
Decide on the 'expected' inflation rate. ..."

Interest - Wikipedia, the free encyclopedia

...Inflation rate and interest rates are not the same thing, so why do think they are?

They are not the same thing, but they are linear in relationship and do measures of the same thing - economic health. In my head, I often think of the 2 in the same context, as you saw in my post that I wrote where I misakenly exchanged one for the other. They are tied to each other, and investing in general. The tie is so tight, that interest rates can be boiled down to desire profit + risk + inflation = interest rate

"Inflation Expectations Determine Investors Yield Requirements
Inflation is a bond's worst enemy. Inflation erodes the purchasing power of a bond's future cash flows. Put simply, the higher the current rate of inflation and the higher the (expected) future rates of inflation, the higher the yields will rise across the yield curve, as investors will demand this higher yield to compensate for inflation risk." Understanding Interest Rates, Inflation And The Bond Market

If you really feel that low interest rates and high level of inflations can coexist, can you describe the terms of the loan that you as the lender would agree to. Example, long term expected inflation rate 9%, current inflation 6%. Loan terms 10 years. What would you charge as your interest rate?

I wasn't even debating at that point, let alone resorting to a strawman.

I don't like to use fallacy accusations such as strawman or ad hominem for this reason, it turns off people. I appologize for doing so, and I did use it to show that errors in logic do flow both ways. I am not trying to argue with you here, but I want you to understand why I wrote what I wrote. The strawman was in reference to how you handled my statement about your error with your definition of stagflation. You did not defend your point, or acknowledge that you were lacking inflation in your posted view. Instead you attacked a flaw in my argument to refute my position... That is a strawman.

I said it "looked" like stagflation, I didn't say it was. The reason I said it "looked" like stagflation was because of the high unemployment, low wages, and the stagnating economic growth over the last three years. But note that the Feds aren't raising interest rates in order to increase inflation, instead they are increasing the money supply .

/\ Not a strawman argument. Thank you.

Sorry but I think price levels are the leading indicator of inflation, and not interest rates. Are you sure it's not you who doesn't understand?

Yes, I'm sure. I tried looking up interest rate differentials on wikipedia to prove it to you, but I couldn't find it... Bond Spreads: A Leading Indicator For Forex

Price levels and CPI are not leading indicators, they are lagging indicators. They show you what has already happened and are backwards comparable. Like most mutual funds fine print, past performance is not gauranteed for future returns...

Interest rates and interest rate differentials on things such as loans ie bonds are used to look into the future of where that currency is expected to be. They derived from comparing interest rates of similar investment tools such as bonds spread in one or more currencies. looking into the future to see what the real value of that loaned dollar will be is the most important investment decision to make before clicking the buy or sell button.

If you were to make a loan, wouldn't you want to know how much purchasing power that dollar will have at the end of the terms than before the terms? If you were interested in making real money, wouldn't you then calculate the risks such as expected inflation over the 10 years into that interest rate? If you are calculating future risks, how is that not a leading indicator?

Here are some things you may wish to read and think about before quoting a Webster.com that interest rates are lagging indicators...
Leading economic indicators: new ... - Google Books

Day trading the currency market ... - Google Books

Fundamental Trading Strategy Based on Interest Rate Differentials | Real Estate Articles

Bonds, Interest Rate Differentials And Forex Trading

Alright, I'll give it another look. But you better start being a nice guy or I'm through with you.

Fair enough. Again, I am sorry for upsetting you.

 

[Moot]

That's the thing, you can't have both situations at the same time.

In a conventional sense you would probably be right. But the Feds are using an unconventional policy of quantive easing to target a 2% inflation rate, instead of their conventional policy of lowering interest rates because the interest rates are already at near zero. So the Feds hope QE2 will achieve the same outcome that lowering interest rates would have if they were higher. But there is risk to this method which is that inflation could escape the control of the Feds and create a situation of high inflation and low interest rates occuring simultaneously. Now whether it could be considered stagflation would probably depend on whether unemployment remained high and wages low during that same period. But lets hope it doesn't come to that.

If you really feel that low interest rates and high level of inflations can coexist, can you describe the terms of the loan that you as the lender would agree to. Example, long term expected inflation rate 9%, current inflation 6%. Loan terms 10 years. What would you charge as your interest rate?

As a lender I don't think I would have much control over the interest rate I could charge. But if low interest rates and high inflation did occur and I were a banker then I would probably tighten up my lending standards due to the high uncertainty of runaway inflation and the possibility of bubbles in the market. And if I were a really sauvy banker I"d hedge my way into the bubble and get out before it burst.

Price levels and CPI are not leading indicators, they are lagging indicators. They show you what has already happened and are backwards comparable. Like most mutual funds fine print, past performance is not gauranteed for future returns...

Thank you for pointing that out. I think I understand why you would call price levels and CPI a lagging indicator, but then wouldn't everything, including interest rates be a lagging indicator since the future is always uncertain? So while prices may be lagging, couldn't CPI still be a leading indicator of future inflation? As a consumer, I pay attention to prices. As a borrower, I pay attention to interest rates.

Interest rates and interest rate differentials on things such as loans ie bonds are used to look into the future of where that currency is expected to be. They derived from comparing interest rates of similar investment tools such as bonds spread in one or more currencies. looking into the future to see what the real value of that loaned dollar will be is the most important investment decision to make before clicking the buy or sell button.

They are not the same thing, but they are linear in relationship and do measures of the same thing - economic health. In my head, I often think of the 2 in the same context, as you saw in my post that I wrote where I misakenly exchanged one for the other. They are tied to each other, and investing in general. The tie is so tight, that interest rates can be boiled down to desire profit + risk + inflation = interest rate

Yes, but with interest rates at near zero, the feds can't lower them any lower to raise the inflation rate. So they are trying an unconventional method of using QE to do what lowering interest rates would have done. So in this case shouldn't you be looking at the Feds purchasing of treasury bonds, instead of the Feds interest rates for future investment?

"Inflation Expectations Determine Investors Yield Requirements
Inflation is a bond's worst enemy. Inflation erodes the purchasing power of a bond's future cash flows. Put simply, the higher the current rate of inflation and the higher the (expected) future rates of inflation, the higher the yields will rise across the yield curve, as investors will demand this higher yield to compensate for inflation risk." Understanding Interest Rates, Inflation And The Bond Market

Admittedly bonds still confuse me because they are not as intuitive as stocks. But because I have bought bonds before, the way I try to understand them is as interest rates and/or stocks go up, bond yeilds go down. Simple, but it seems to work for me.

If you were to make a loan, wouldn't you want to know how much purchasing power that dollar will have at the end of the terms than before the terms? If you were interested in making real money, wouldn't you then calculate the risks such as expected inflation over the 10 years into that interest rate? If you are calculating future risks, how is that not a leading indicator?

I'm still too much of a novice to calculate for inflation and have to rely on experts to do it for me. As you read above, I have my simple formula but it probably won't work with quantive easing since it doesn't seem to involve interest rates.

Here are some things you may wish to read and think about before quoting a Webster.com that interest rates are lagging indicators...
Leading economic indicators: new ... - Google Books

Day trading the currency market ... - Google Books

Fundamental Trading Strategy Based on Interest Rate Differentials | Real Estate Articles

Bonds, Interest Rate Differentials And Forex Trading

Thank you I will add them to my list of things to read which btw, is getting quite long.

 

[Missed AB]

Admittedly bonds still confuse me because they are not as intuitive as stocks. But because I have bought bonds before, the way I try to understand them is as interest rates and/or stocks go up, bond yeilds go down. Simple, but it seems to work for me.

Bonds work like this. My company YYY has a 100 dollar bond that I we selling. It is a 5 year bond and we are selling this 100 dollar bond for 90 dollars. The interest or yeild is calculated by the difference of the face value of the bond and the price you paid for the bond. If you are interested in holding the bond to maturity, then you will get the face value. If you are intersted in trading bonds then you will treat the bond like a stock, as the value of that bond goes up, you can sell it for a shorter term proffit... the yeild or interest to the new bond holder then goes down due to a higher premium (price) paid for the right to collect the full face value of the note at the end of the terms.

When you buy the bond from my fake company yyy, you are the lender of record. You are lending me 90 dollars, and I will be paing back the loan plus 10 dollars in interest over the course loan terms. You as the lender do have the power to set the interest rate. If you feel the risk is too high for the returns, then you put in an offer to only loan me 85 dollars in return for 100. The stricter lending standards, reduced risk on the part of the lender, leads to higher interest rates or higher yeilds for said bond.

The stock market and bond market are not polar opposites, but they do balance eachother out. For instance as stocks outpace bond yeilds, people do re-allocate assets to buy stocks. As more bonds are sold than bought, the yeild or interest rates go up as the premium goes down.

It is very critical to note if inflation expectations are elevated, people will pay a lower premium to hold the bond because of the decreased purchasing power that dollar will have at the end of the loan/bond terms. Contrasted to the stock market, P/E may maintain 14:1 but due to inflation the stock price may also increase. For example if tomorrow the FED said every 1 dollar is to be exchanged for the new 10 dollar bill, the bond market would have interest rates sky rocket. That same situation has a stock trading at 10, would suddenly become worth 100 but the PE would remain 14:1. Notice that there was really no gain in the stock price.

Years of research, trial and error... condenced to a few paragraphs. Information was left out, but I hope this helps a bit with the understanding.

In a conventional sense you would probably be right. But the Feds are using an unconventional policy of quantive easing to target a 2% inflation rate, instead of their conventional policy of lowering interest rates because the interest rates are already at near zero.

In real money terms, the fed is pushing interest rates to the negative side which seems unconventional, but it is still how they do business... it is a negative interset rate.

So the Feds hope QE2 will achieve the same outcome that lowering interest rates would have if they were higher. But there is risk to this method which is that inflation could escape the control of the Feds and create a situation of high inflation and low interest rates occuring simultaneously.

Interest rates are more than just what the 20 year Tbill is trading at. Mortgages, car loans, credit cards, savings depositis, student loans... The lender is always looking to get the best return for their money. The GOVERNMENT is not the lender. They are just manipulating the system by acting as the borrower and the market maker. Interest rates across the board need to go up in respect to higher inflation expectations. That is the only way to run a business. It is possible for the Tbill to remain low in higher levels of inflation, but interest rates that are not being manipulated downward must go up or there will be another failure among lending institutions.

As a lender I don't think I would have much control over the interest rate I could charge. But if low interest rates and high inflation did occur and I were a banker then I would probably tighten up my lending standards due to the high uncertainty of runaway inflation and the possibility of bubbles in the market.

As the lender you have absolute control over the interest rates you can charge. What's you Discover card charge 28%? What's your student loan charge 2%? You set the terms. The 5 year US note is selling for $99. If you want put in a limit order for 98, 94, 84, 50... You are the lender. It doesn't mean they will accept your terms, but you set the rate. The system is being manipulated today, so it has a hard floor of how low the price will fall...

but in regards to interest rates in general nothing is stopping you from selling your home, to another person and you assume the mortgage. Your 30y fixed is at 4%. You can sell for current amount plus 5.5% and make money... but if inflation will outpace your collections, the home value today 230K may be worth 650K at the end of the 30 years, but you only collected total of 550K over teh course of the loan.... inflation as seen in house price vs not pricing inflation into loan terms of your asset.

I think I understand why you would call price levels and CPI a lagging indicator, but then wouldn't everything, including interest rates be a lagging indicator since the future is always uncertain? So while prices may be lagging, couldn't CPI still be a leading indicator of future inflation? As a consumer, I pay attention to prices. As a borrower, I pay attention to interest rates.

Lagging indicators do not look into the future. They are helpful in analysis of painting a picture of today, but they use hindsight. There is no uncertainity when saying jun oil was 60 july was 65... It iinflation as measured by the CPI has no way to predict what December oil prices will be.

A borrower has much less for concerns re interest rates. The lender has everything to lose. I am giving you 100K. If you fail to make good on your payments, you can walk away. I am out 100K. If I lend you 100K and it's real value is only 60K at the end of the loan, then I need to have interst charges which counter the decrease in the real value of the lent money and also calculate the chance that I may be stuck with a paper asset with your name attached to it with little else.


More interesting reading for your list:
US stocks fall amid China inflation concerns - International Business Times

"Global stock markets fell, led by declines in commodities shares on speculation that China is preparing to hike the interest rates to cool the inflationary pressure."

Inflation is the effect an expanding economy, not the cause of it. As inflation moves upward, interest rates need to shift that way to prevent an overheated economy... Goldilocks...

 

[oldreliable67]

Interest rates are more than just what the 20 year Tbill is trading at. Mortgages, car loans, credit cards, savings depositis, student loans... The lender is always looking to get the best return for their money. The GOVERNMENT is not the lender. They are just manipulating the system by acting as the borrower and the market maker.

Okay, I'm gonna nitpick here a bit, and provide a bit more in-depth info about who makes markets in treasury securities...

There is no such thing as a 20 year "Tbill." The U.S. government finances itself by selling: bills, which have an original maturity of one year or less; notes, which have an original maturity of one year to ten years; and bonds, which have an original maturity of 10 years to perpetual (though we've never sold any with more than a 30 year maturity).

Bills do not pay periodic interest in the form of a coupon, but are sold at a discount. The difference between the discounted price and the face value when redeemed determines the yield.

Notes and bonds pay periodic interest. This periodic interest is referred to as their coupon rate and is paid twice annually. At maturity, the holder receives face value. An investor's rate of return is thus composed of the sum of the periodic interest payments plus the difference (if any) between the purchase price and face value at maturity (or sale price if sold before maturity). Notes and bonds can be separated into their component parts: the annuity formed by the stream of coupon payments and the present value of the face amount, and traded separately.

The 'GOVERNMENT' is indeed the borrower, but it is not the market-maker. Those dealers designated by the New York Fed as 'primary dealers' are the market-makers. In return for being the counterparty to all Fed open market transactions undertaken in the conduct of monetary policy, the primary dealers (of which there are currently eighteen, but have been as many as forty) are obligated to bid (non-trivially) in all auctions of treasury securities, engage in affirmative market-making (meaning that they must stand ready to provide realistic bids and offers on realistic amounts of the entire list of U.S. Treasury issues at all times), and provide market intelligence to the Fed and the Treasury. Fortunately for the primary dealers, the formal requirement that they conduct end-user customer business at or greater than some non-trivial percentage of volume was relaxed a few years ago.

Being a primary dealer means that you put a significant amount of capital at risk. You hope to earn a suitable rate of return through your distribution efforts, your market-making efforts (buying on the bid side, selling on the offered side), and trading as a principal. The amounts of capital now required to be a primary dealer are significantly larger than heretofore. Indeed, not terribly long ago, most primary dealers were independent, and the lesser capital requirements permitted many to be partnerships. However, over the years, capital requirements have grown tremendously as the amounts to be financed have ballooned and the markets became truly global. Now, primary dealers are all necessarily affiliated with, or are part of much larger organizations with much deeper pockets, all operating on a global scale, around the clock.

Ok, those nits are picked! Hope this helps to understand the basics of how the gov't securities market works.

 

[Missed AB]

Okay, I'm gonna nitpick here a bit, and provide a bit more in-depth info about who makes markets in treasury securities...

Nitpicking allowed. There are a lot of concepts I tried to condense into a readable post, and I am always up for learning too.

There is no such thing as a 20 year "Tbill." The U.S. government finances itself by selling: bills, which have an original maturity of one year or less; notes, which have an original maturity of one year to ten years; and bonds, which have an original maturity of 10 years to perpetual (though we've never sold any with more than a 30 year maturity).

Yes, but the concepts are the same. Maybe you could shed some light for moot on how long term bonds rates are generally used as a proxy for long term inflation projections.

The 'GOVERNMENT' is indeed the borrower, but it is not the market-maker. Those dealers designated by the New York Fed as 'primary dealers' are the market-makers.

I hope you didn't think I was stating the government is NOT the borrower...

True, they are not the market makers in the sense of selling the product, but they will be putting a hard floor in on the sale side and buying up assets preventing the lowering of the asset price. They will be the market maker when it comes to sales, and be the buyer of last resort, just like a good market maker. By stepping in before the market makers have a chance to lower the spread, the government is the market maker for sales. Then if they are able to unload the purchased bonds at higher prices, I have a hard time imagining a situation where the Fed would not unload their cheaper purchased paper from sales for a profit, again stepping in before the dealer has a chance to act as a market maker.

 

[Ahlevah]

(N)ot terribly long ago, most primary dealers were independent, and the lesser capital requirements permitted many to be partnerships. However, over the years, capital requirements have grown tremendously as the amounts to be financed have ballooned and the markets became truly global. Now, primary dealers are all necessarily affiliated with, or are part of much larger organizations with much deeper pockets, all operating on a global scale, around the clock.

When 2008 began, there were five major independent primary dealer U.S. investment banks: Goldman Sachs, Bear Stearns, Merrill Lynch, Lehman Brothers, and Morgan Stanley. When the year ended, we had two. One went bankrupt (Lehman Brothers) while two were absorbed by other banks (Merrill by Bank of America, Bear Stearns by JP Morgan Chase). Even the last two, Goldman and Morgan, while maintaining their primary business in investment banking and finance, converted to commercial bank holding companies.

 

[Ahlevah]

"Global stock markets fell, led by declines in commodities shares on speculation that China is preparing to hike the interest rates to cool the inflationary pressure."

You know, I'm actually gleefully watching the Chinese squirm a bit and have their Fed tantrums. They've basically painted themselves into a corner by having their currency maintain a loose peg to the dollar, so when commodities go up in dollar terms they go up in China as well. But supposedly commodities form a larger component of the cost structure, hence inflation, in China than the U.S. The country was already trying to dampen inflation and property speculation by tightening credit. So we have lots of production in Asia and muted demand in Europe and the U.S. I hope they sell all of their Treasuries so I can reinstall my positions at a bargain price. :mrgreen:

 

[washunut]

You know, I'm actually gleefully watching the Chinese squirm a bit and have their Fed tantrums. They've basically painted themselves into a corner by having their currency maintain a loose peg to the dollar, so when commodities go up in dollar terms they go up in China as well. But supposedly commodities form a larger component of the cost structure, hence inflation, in China than the U.S. The country was already trying to dampen inflation and property speculation by tightening credit. So we have lots of production in Asia and muted demand in Europe and the U.S. I hope they sell all of their Treasuries so I can reinstall my positions at a bargain price. :mrgreen:

I think it is shortsighted to be gleeful that the Fed is devaluing our currency. While it is true that the holders of our debt can do little short term since they have so many dollars this will change over time. Then you will find that the G20 will come up with something to use other than dollars as the reserve currency. Without those foreign dollars to underpin the U.S. trade and government deficits our economy will have problems similar to Greece, Ireland etc.

 

[Moot]

I think it is shortsighted to be gleeful that the Fed is devaluing our currency. While it is true that the holders of our debt can do little short term since they have so many dollars this will change over time. Then you will find that the G20 will come up with something to use other than dollars as the reserve currency. Without those foreign dollars to underpin the U.S. trade and government deficits our economy will have problems similar to Greece, Ireland etc.

There's a lot of pros and cons to QE2 thats for sure. The US dollar has been consider the most stable and one that other countries could have confidence in to peg their own currency to. So the Feds QE2 is shaking their confidence to the core. Another criticism is the US is losing it's credibilty to criticize the Chinese for keeping their currency pegged so low. But, on the other hand, if QE2 helps get the US economy get back on track then that would benefit other countries, too. So the Feds are hoping the benefits out weigh the risk. Besides, it's not like the Feds are pumping the entire $600 billion into the economy all at once. I think small increments was probably the wise thing to do. So imo it's a bit premature to criticize the Feds policy too harshly, since we won't feel or see the effects for quite awhile.

 

[washunut]

There's a lot of pros and cons to QE2 thats for sure. The US dollar has been consider the most stable and one that other countries could have confidence in to peg their own currency to. So the Feds QE2 is shaking their confidence to the core. Another criticism is the US is losing it's credibilty to criticize the Chinese for keeping their currency pegged so low. But, on the other hand, if QE2 helps get the US economy get back on track then that would benefit other countries, too. So the Feds are hoping the benefits out weigh the risk. Besides, it's not like the Feds are pumping the entire $600 billion into the economy all at once. I think small increments was probably the wise thing to do. So imo it's a bit premature to criticize the Feds policy too harshly, since we won't feel or see the effects for quite awhile.

First we have seen some of the effects the fed was trying to attain even before they started QE2, today. The stock market, a stated goal was up about 16%; the U.S. dollar declined vs. most major currencies ( thus the noise at the G20), commodities like gold and oil spiked. We are already awash in cash, other than the wealth effect of driving people into stocks not sure what another $600 billion of cask laying around will do. Taking mortgage costs from 4.3% to 3.8% if it gets that low will not spur a housing boom, or to a surge in home prices with the official unemployment rate at 9.6% and counting part time and discouraged something like 16%.

This problem took a long time to build up ( 20-30 years) and will take a fair amount of time to get fixed. Gimmicks like the stimulus or this QE2 may be like a shot of adrenalin, not it wears off quickly. Better in my view to start thinking and doing the structural things that need to be done.

It may well wind up that the worst thing QE2 does is give ammunition to those that think this Fed is overly political. This will leave it will little to defend itself from the likes of Ron Paul.

 

[Ahlevah]

I think it is shortsighted to be gleeful that the Fed is devaluing our currency. While it is true that the holders of our debt can do little short term since they have so many dollars this will change over time. Then you will find that the G20 will come up with something to use other than dollars as the reserve currency. Without those foreign dollars to underpin the U.S. trade and government deficits our economy will have problems similar to Greece, Ireland etc.

Well, as you know, I don't think the Fed's QE policy will be effective in reflating ("inflating") the American economy. Since banks have largely tied their fate to real estate and real estate is still deflating, they're going to sink with it. (BofA Sells BlackRock at Discount as Capital Deadline Approaches - Bloomberg) I think much of the negative sentiment against the dollar is built on an expectation that the policy will actually work. Once the markets figure out that it won't, the dollar should stabilize and even rise in value. The "glee" I feel is more a sense that China finds its options limited because it tied its fate to the dollar. Maybe that realization is behind China's recent decision to once again let the yuan rise in a slow, ordered fashion against the dollar.

 

[Moot]

First we have seen some of the effects the fed was trying to attain even before they started QE2, today. The stock market, a stated goal was up about 16%; the U.S. dollar declined vs. most major currencies ( thus the noise at the G20), commodities like gold and oil spiked. We are already awash in cash, other than the wealth effect of driving people into stocks not sure what another $600 billion of cask laying around will do. Taking mortgage costs from 4.3% to 3.8% if it gets that low will not spur a housing boom, or to a surge in home prices with the official unemployment rate at 9.6% and counting part time and discouraged something like 16%.

Can't argue with much of what you said so I'll just add my 2 cents. Some of the immediate effects of QE2 we are seeing, like stock prices going up is good imo, because it will help build up those 401ks. The downside is people might feel too confident at seeing their 401ks go up and start spending against it. Mortgage costs going down is good if people can get a loan, but the banks are still playing hardball and a lot of people still can't get a loan even with good credit. The banks are low balling home appraisals on refinances so people who may have had say 30% equity built up in their home, suddenly find their house devalued and anything less than 20% equity will disqualify them for the loan. So imo, it might be awhile for home prices to come back up in the near term. I'm guessing maybe 4-5 years out at least.

As far as the stock market reacting to QE2, I read this the other day....
Does the Stock Market Care if QE2 Doesn't Work? No!!! - MarketBeat - WSJ
I bet the stock market would care if deflation set in.

This problem took a long time to build up ( 20-30 years) and will take a fair amount of time to get fixed. Gimmicks like the stimulus or this QE2 may be like a shot of adrenalin, not it wears off quickly. Better in my view to start thinking and doing the structural things that need to be done.

It may well wind up that the worst thing QE2 does is give ammunition to those that think this Fed is overly political. This will leave it will little to defend itself from the likes of Ron Paul.

Yes, it was a long time in the making, I just hope it doesn't take 20-30 to fix the structural things that took 20-30 years to undo.

Ron Paul will soon be chairman of the House Subcommittee on Domestic Monetary Policy. Luckily, it's a kind of a minor committee without much teeth. But if Paul is successful in getting an audit of the Federal Reserve, would be that be so bad?

 

[Moot]

.....The "glee" I feel is more a sense that China finds its options limited because it tied its fate to the dollar. Maybe that realization is behind China's recent decision to once again let the yuan rise in a slow, ordered fashion against the dollar.

So maybe getting China to raise the value of the yuan was part of the reason for QE2, eh?

 

[washunut]

Well, as you know, I don't think the Fed's QE policy will be effective in reflating ("inflating") the American economy. Since banks have largely tied their fate to real estate and real estate is still deflating, they're going to sink with it. (BofA Sells BlackRock at Discount as Capital Deadline Approaches - Bloomberg) I think much of the negative sentiment against the dollar is built on an expectation that the policy will actually work. Once the markets figure out that it won't, the dollar should stabilize and even rise in value. The "glee" I feel is more a sense that China finds its options limited because it tied its fate to the dollar. Maybe that realization is behind China's recent decision to once again let the yuan rise in a slow, ordered fashion against the dollar.

The extra $600 billion in dollars will have to go somewhere. If we knew where the next bubble they are creating and could short into it I would be rich.

China is starting to diversify their holdings through the purchase of hard assets the last couple of years and my sense is this will continue.

I think the U.S. policy of we will take care of ourselves and not worry if this QE2 creates "hot money" in emerging markets will backfire. I say that because there should be a sense of responsibility for being the reserve currency and get the benefits that has. The U.S. can not expect this action to the rest of the world. They NEED to find a substitute for the dollar. It will take time, just as putting the Euro in place took time but it will happen.

 

[Ahlevah]

So maybe getting China to raise the value of the yuan was part of the reason for QE2, eh?

I'm not convinced the Fed Governors are that smart. :lol: No, I think this is more a byproduct of the policy. I'm going to take the Fed at its word that the idea is to increase reserves, hence lending, at banks. There's also a certain amount of jawboning going on, with the Fed realizing that confidence and inflationary expectations play a significant role in spending decisions. But the problem is not a lack of liquidity. There simply isn't demand to borrow, and there's little desire among bankers to lend to the people who want the credit. With so many real estate loans going south, with real estate prices expected to drop another 10-20%, with about $2 trillion worth of commercial properties needing to be refinanced (at prices above their current worth), with banks still under pressure to delever and shore up capital positions under Basel III and FinReg, I just don't think QE2 will get banks to lend significant amounts of money to people so they can take on more debt. They don't want more debt. They want less debt.

 

[Ahlevah]

The extra $600 billion in dollars will have to go somewhere.

Most of it will go where the first $1.7 trillion went: into Treasuries and reserves on deposit with the Fed.

 

[washunut]

Most of it will go where the first $1.7 trillion went: into Treasuries and reserves on deposit with the Fed.

I do not agree that is the intent. Remember a key difference this time is that all they are buying is treasuries, mostly short term ( up to 5 years). Not sure how you get to improved balance sheet by doing that.

 

[Ahlevah]

I do not agree that is the intent. Remember a key difference this time is that all they are buying is treasuries, mostly short term ( up to 5 years). Not sure how you get to improved balance sheet by doing that.

You lost me here. You said the $600 billion dollars (the money the Fed trades to the banks for their bonds) has to go somewhere. I said, yeah, it will go where the first $1.7 trillion went: into reserves and back into more Treasury debt. Whose balance sheet are you talking about? The Fed will be leveraging its balance sheet to the point that the FDIC should close it for being insolvent if rates spike. The investment/commercial banks will improve their balance sheets by avoiding making any more crummy loans.

 

[washunut]

You lost me here. You said the $600 billion dollars (the money the Fed trades to the banks for their bonds) has to go somewhere. I said, yeah, it will go where the first $1.7 trillion went: into reserves and back into more Treasury debt. Whose balance sheet are you talking about? The Fed will be leveraging its balance sheet to the point that the FDIC should close it for being insolvent if rates spike. The investment/commercial banks will improve their balance sheets by avoiding making any more crummy loans.

What I meant was that in QE1 as I understand it banks got to pass along mortgage and other than treaury debt to the Fed. This time it is treasury debt the Fed is buying with the hope that it gets reinvested in riskier assets. Stocks, commodities,emerging market debt (dollar devaluation). Look at what has happened to these item classes since the Bernanke speech at Jackson Hole in late August.

 

[Ahlevah]

What I meant was that in QE1 as I understand it banks got to pass along mortgage and other than treaury debt to the Fed. This time it is treasury debt the Fed is buying with the hope that it gets reinvested in riskier assets. Stocks, commodities,emerging market debt (dollar devaluation). Look at what has happened to these item classes since the Bernanke speech at Jackson Hole in late August.

A lot of the rise came from expectations built on a hope and a prayer. Then there's reality, which is the country is still undergoing massive deleveraging that will take years to play out. Banks will not want to make a lot of risky loans or assume a lot of risk.

 

[richrf]

Basically whenever Bernanke prints money he is transferring wealth from savers to borrowers. Savers are the ones who are being asked to shell out trillions of dollars just to make the speculators whole so that they can create new bond, currency, and commodity bubbles. No need to get any more technical than this. Savers get devalued dollars as well as 0% interest on their money. The stated policy of the Feds to inflate costs is just an additional kick in the butt. It is pure insanity.

But not all borrowers benefit since most Americans are already too deep in debt to borrow any more. The beneficiaries are the top 1% of economy who are allowed the privilege of borrowing at 0%. They then take this money and invest it overseas while they close down plants in America and layoff Americans as work is outsourced overseas with greater velocity. It has been going on for two decades and it is disgusting as both Republicans and Democrats sell Americans down the river. "Let them Eat Cake" says King Bernanke.

You cannot create wealth by printing money. You can only create wealth with sweat.

 

[Moot]

I'm not convinced the Fed Governors are that smart. :lol: No, I think this is more a byproduct of the policy. I'm going to take the Fed at its word that the idea is to increase reserves, hence lending, at banks. There's also a certain amount of jawboning going on, with the Fed realizing that confidence and inflationary expectations play a significant role in spending decisions. But the problem is not a lack of liquidity. There simply isn't demand to borrow, and there's little desire among bankers to lend to the people who want the credit. With so many real estate loans going south, with real estate prices expected to drop another 10-20%, with about $2 trillion worth of commercial properties needing to be refinanced (at prices above their current worth), with banks still under pressure to delever and shore up capital positions under Basel III and FinReg, I just don't think QE2 will get banks to lend significant amounts of money to people so they can take on more debt. They don't want more debt. They want less debt.

Phew, a housing price drop of another 10-20%, thats going to hurt since 1/5 of homeowners have negative equity in their homes as it is.

During the housing boom people were borrowing against the equity in their homes to buy luxury items, cars, TVs, vacations, and remodel their homes. So if home prices continue to drop, people are not going to borrow to spend like they did over the previous decade. And if they do borrow and spend they're going to be a lot more frugal on what they spend on. But if interest rates stay low and with an above 730 credit score, a job of at least two years, and 20% to put down, and home prices devalued, it's a great time to buy a new home. Unfortunately, I think that probably excludes 75% of the population. No, I think the only way to get people to start borrowing and spending again, whether it's homes or luxury items, is jobs and wage increases. I don't have much hope for a surge in job creation from QE2, but with inflation expectations to rise there might, at the very least be an increase in wages.