Farewell QE, you have been a magnificent success

Farewell QE, you have been a magnificent success - Ambrose Evans-Pritchard → telegraph.co.uk/finance/comm … ccess.html

Then lets stop QE and see what happens ?
75bn of buying power is close to the monthly total after-tax cash flow of the S&P500.
That is how mad QE is and how artificial asset prices are.
There is a reason that QE did not work in Japan and why they gave it up several times (with the same result every time - prices collapsed).

‘Farewell QE’.

Was $85 billion/month - $1,020 billion/year.
Now …
$75 billion/month - $900 billion/year.

An alcoholic drinks 1,020 litres of whiskey a year.
He cuts down to 900.

He’s cured I tells ye !!!

QE was a non event on Japan pre Abe

asset swap; it’s swapping two tens for a twenty;
placebo effect is massive though;

idea that Japan stopping QE caused prices to drop = hilarious (and wrong).

Ah, but that’s not what he’s saying. He’s saying that QE contributed (or caused) deflation. I happen to agree with it. Why bother lending your way out of insolvency when you can just sit tight? Without a return on money, there’s no incentive to invest in loans; you might aswell park it in government bonds knowing you aren’t going to lose money. It’s a defeatist, deflationist impetus.

Agreed. I have been on the “QE possibly deflationary” bandwagon for a while now; it’s been lonely at times :wink:

You are the hilarious one

change in risk asset prices = quantum of marginal net capital into a market (or system)
QE is not an asset swap (that really is hilarious) it is asset backed printing (i.e. you print the money but match with a new asset)
(as opposed to naked printing where you just hand the printed funds at the front door of the central bank to passers by).
QE is marginal new capital into a market (I repeat, it is not a swap)
Imagine the Irish Central Bank prints Euro 100bn (with ECB permission) and buys Irish Real Estate with it.
(but like Bernanke promising to keep the new Real Estate matched off with the newly printed money).
Prices of Irish Real Estate will rise far above what the private markets can manage.

now matter how much QE is done (the stock of new QE capital), once it stops (the flow of new QE capital), risk prices collapse.
The day the Irish Central Bank stops buying Real Estate (having driven yields to 2-3%), and there is no equivalent left, prices fall.
The only way to offset this is to allow an alternate large system take over (i.e. banking is most likely)
US banks were how Greenspan did QE all through the 1990s, allowing Wells Fargo go from 10x assets to 40x assets.
(this could still happen and I am sure the FED is thinking of it).
If the US banks were to reliever to 40x they could keep the margin net new flow of capital going.
Unfortunately, we would be looking at the last bubble we would probably see in our lifetimes as the system would be approaching its limit.
(i.e. when everybody has a 1% tracker and is levered up to the max and all stocks are at p/es of +20x).

Once risk asset prices start to fall (and after some random shock that exposes no buyers - collapse), capital rushes to safety of bonds.
The problem is that there is now new QE capital in the system (i.e. the people who sold 100bn of Real Estate to the Irish CB).
With the same quantum of activities capable of paying interest but a lot more capital chasing them, yields fall.
Every time the FED or BOJ stopped printing, the yield curve hit a new low (as it will do in the US).

The final part of the QE trap is that yields can set the underlying growth rate of an economy (not always the other way around).
The vast bulk of a nations capital base are its deposits and bonds.
A country where they are getting 4% every year produces a much higher rate of natural growth than one where they get 0%.
There is another effect of ultra low yields on cost of capital and Capex spending (i.e. companies stop it) which is also GDP killing.
(this one would merit a whole thread in itself but zerohedge.com has lot on it and the FED’s desperate attempts to start it).
This was the final nail in the Japanese coffin, every time they stopped QE, the yield curve flattened even more, and as did GDP.

… which required the BOJ to re-start and do even more QE

Japan stopping QE caused risk asset prices to drop, which caused bond prices to rise even further.

A final final unusual and unforeseen aspect of lots and and lots of QE is that it can cause the currency to really harden.
This is a surprising consequence of ‘printing’ and it could be just tied to mega-currency blocks.
What happens is that the price of risk assets becomes so compressed, that the currency take up the slack.
(i.e. to ensure that the total stock of capital equals to the markets view of total fair values of all assets in the economy).
I’m still not sure however that I have really got my head around this one ?!

Farewell to QE is about as true as Farewell to the Bailout - we are never leaving either !


Your first paragraph says “imagine Central Bank buys Irish real estate in QE operation” … You are immediately launching with a false canard. One you must create for your argument to have legs. The Fed buys Treasuries, not houses.

Essentially swapping treasuries with reserves.

You don’t believe that banks lend reserves, presumably? So . . . . .

QE, as it is currently enacted, is swapping a $100 for five $20’s and thinking you’re “printing money” … hilarious indeed.

It is an asset swap. And the world is slowly realising it.

I’m using a Real Estate analogy to simplify it
If I need to explain why buying treasuries it almost the same I’ll be here all night.

I don’t know where to begin on the above re ‘asset swap’
Do you accept the QE is net new capital into the system?

They’re not the same at all.
If you have $10bln of T-bonds or $10bln of Reserves – what’s the dramatic difference? The first’s essentially in a savings account (at the Fed) the second’s in a current account (oh, at the Fed).

There are better sites / books that can help you understand this better

… However, you have not answered my question ?

Haha, that’s the best you can do? Other sites?
What are you on about?
Tell me, what is the dramatic difference between 10BB in T-Notes (held at the Fed) and 10BB in Reserves (held at the Fed)?!

Answer the question ?

Don’t understand you?
I asked it, it’s in bold in the quote above?

Well for a start the bank overnighting the reserves with the Fed is not insolvent. In the FDIC sense.

Bank has $10B mark to make believe of ABS. This ABS is embedded in the Tier capital using some creative accounting. Both Basel II and the amended version allow a lot of junk wrapped in shiny wrapping paper to qualify as AAA Tier 1. Using QE this 20c/$ (actual market price) ABS is swapped for $10B of T-Bills at 0% (or close enough). This $10B is overnighted with Feds. Big gaping whole in Tier capital is solved at a cost of $8B net loss (monetary balance sheet) to the Fed.

Whereas if the bank actually had $10B in T Bills in their marketable securities a/c they would have $10B in real assets. And the real (fiscal) economy is $8B richer. Give or take. Because all that has really happened in QE is a transfer of the real loss on the ABS’s, MBS’s etc from the banks balance sheet to the Feds balance sheet.

Think of it as the trillion dollar version of NAMA. But without the NAMA bonds which terminally bankrupted the rest of the Irish banks.

From what I understand Wells Fargo, to name but one, would have been deep in FDIC land if it had not been for QE. Prudent bank me arse.

So it does make a difference.

Daniel - let me answer both questions :smiley:

(a) mine first

QE does provide net new capital into the system (i.e. it is not sterilised). The FED has injected over $4trn into the system to date, which is very close to the amount of capital lost in the system through bank and insurer deleveraging. I used to have an excellent graph of the individual components of US debt to 2012 showing how QE has avoided the total amount of debt to GDP even flattening (hence the critical nature of the ‘flow’ of capital vs. ‘stock’ of capital I mentioned above) but just cant find it. The graph below however is a poorer back up but hopefully makes the case.

(b) your question

If I read you right you are thinking that the FED buys treasuries from people who then deposit the FEDs money back in banks who then deposit it back in the FED. In a way the transaction is self-sterilising and almost a non-event UNLESS other people want to borrow these bank reserves (graphs showing the velocity of money has collapsed to multi-decade lows show this not to be the case). In a ‘normal’ economy where banks just lend money you would be right(er) (although the net new money issue in (a) above would still have an effect), but in modern markets (post Greenspan), and as jmc points out above, large banks (even new Volker rules aside) are more like hedge funds. Modern investment banks (Goldman, JPM etc.) are hedge funds - balls out. $4trn of excess deposits in the top 10 US banks, is an amazing amount of firepower into risk assets. The FED knows this. I don’t know if you follow the ‘POMO days’ of the NY Fed and how the S&P500 ex. POMO days is almost flat for 2013? Mark Carney has spoken openly [citation needed] about the limitations of QE on anything but risk asset prices but how lending is better targeted via specific schemes. This is why the end of QE will have a dramatic effect on risk asset prices UNLESS the FED allows the US banking system to re-lever back to 40x to replace it. Ray Dalio in Bridgewater (who has also written on how ‘deposits’ effect risk assets), has been pointing out recently that risk asset prices are now so fully priced, that it is not a given that banks (and esp. i-banks) will be willing to risk their ‘deposits’ into these markets. He notes the extreme movements in equities and bonds over the summer at even the hint of the word taper. We may have reached the point where marginal additional QE has a lesser and lesser effect on risk asset prices.

Hope this helps Daniel
Sorry for being tetchy last night - it was just too late for me
Happy to debate longer on e-mail

If you have not already read it, I would recommend Richard Koo’s book on Japan lost decade(s). He has put a lot of analysis into it.
I saw him make the points I have ‘robbed’ above in a Q3 2009 presentation on QE. He was almost laughed out of the room (hedge funds) that printing’s effect on risk assets would be temporary, and would be long-term highly deflationary and potentially currency strengthening. He recommended buying 30 year USD bonds (if only …). I have to admit, I was a sceptic myself but did not really understand what he was saying.

If you are willing to wade through a bit of a rant - unfortunately I have never seen a book lift the lid so comprehensively on the manipulations of the FED (especially since Greenspan) - then I would also recommend David Stockman (a lot of the old playbook is being dusted off by the FED). He does not provide much analysis (hardly a single graph in it), but he knows the system backwards.

Fed buys Treasuries and Agency MBS through QE not “mark to make believe ABS” … again, falsehood, which if it were true would be correct. But it’s not, so it isn’t.

Not “thinking”, fact. Fed buys Treasuries (with reserves); Fed extracts T-Note from Private sector, replaces with Reserves. Where do you think the Reserves go when the Fed swaps them for the T-Note with a bank? The reserves sit in the bank’s Reserve a/c … at the Fed.

OK, now I see - you still think Reserves are lent out. Totally incorrect. Read the link in my sig which will explain why this is false -though there are numerous other similar articles. That will likely change your view. Indeed should change your entire understanding of QE.

I know Dalio’s view well, he’s wrong too.

Richard Koo is generally excellent and is very close to being 100% right, but misses when he talks about the JGB default nonsense.

Oh and Stockman is possibly the stupidest ape that currently walks this earth. To quote him, 2010:
“I invest in anything that Bernanke can’t destroy, including gold, canned beans, bottled water and flashlight batteries.” :laughing:

No need to apologise. These threads usually end in four letter words and bans. But the gold bugs haven’t stepped in yet . . .so we might be ok.

My understanding is that pricing of the MBS/ABS component is almost all on model based rather than actuarial based pricing methodologies. And todays divergence in these pricing models is little different from 2007. The various GSE’s like Fannie and Freddie are little more than a bundling mechanism for the immense amount of junk that was issued 2002-2007 by third party institutions, or rolled over since. Its not just the Irish mortgage market that has collapse and gone cash only. In some traditionally high activity real estate areas of the US the cash only component is 40%/50%+ most months (as against historical 10%) on much much lower volumes. So there is no huge volume of new mortgages to hoover up. So its mostly been the old stuff being tarted up, a cheap rouge and lipstick job, and then passed on to the scrapyard.

My example was a greatly simplified example of the bank loss merry go round. But when every step is netted out the result is pretty much as stated. A net transfer of the very large losses from bank balance sheet to Fed balance sheet.

The US banks did not suffer huge losses (directly or indirectly) on ABS/MBS issued during 2002 / 2007 just because they issued them. The lost huge amounts of money because so much of the senior / super senior issue was kept by the banks and often ended up embedded in their Tier capital. Or embedded in products like CDO’s and CDO^2. The true weapons of mass destruction when it came to the non-linear cascade of pain.

QE is little more than a scheme to collect most of the rubble and dump it in a very deep hole. The short T-Bill purchase program is just a very sophisticated (and impressive) way of managing the Feds yield curve to fend off the bond vigilantes. To stop them having any ideas about organizing any (very lucrative) ambushes. Like they did back in the 1970’s.

So the Fed adds a few trillion to the monetary system to soak up the losses in the banking system. And the much much bigger losses in the shadow banking system. Thats why the Federal Gov could spent a couple of trillion in deficits over the last few years and yet have a multiplier of less than 1 during most of the spending. The money was just being poured into the large hole left in the fiscal systems money supply by implosion of the shadow banking system and the loss of a large chunk of the money it had created cumulatively in the various asset bubbles of the last 30 years. In many ways it was just a much much bigger version of the crash of 1893.

And so it goes. The mini housing bubble of earlier on in the year collapsed in April when the taper was first mooted but the very big bubble in car loans, student loans, and CRE loans continue apace. I wonder what the next crash will be. I expect the stock market cheap Fed money bubble (just like 1927-1929) has not long to go.