Monday, November 8, 2010

a QE2 perspective

as you can see from the above, some in the blogosphere as well as many in the business & financial worlds have had their knickers in knots over the prospect of the Fed's announced quantitative easing this past week; some are even talking like its the end of the world, that tomorrow we'll all wake up in zimbabwe...

let me try to put it in perspective; the announced QE2, which amounts to a total purchase of $600 billion in 2-10 year Treasuries, represents roughly a 25% increase in Fed assets; that's only about a third of the size of the first QE, which came 2 years ago at the height of the crisis, when the Fed almost tripled its balance sheet assets from around $875 billion, to near the current $2.3 trillion (here's a graphic of that)...we went thru all this hyperinflation hype back then, too, and what has materialized so far?  while at $75B a month plus reinvestments they may be covering most of the treasury issue over the planned 8 month effort, they're not hardly monetizing the total publicly held debt, which is $8.6 trillion...

my sense of what might happen is that QE2 will drive a commodities/market bubble and not affect unemployment, the publically stated objective…the fed will be buying medium term treasuries, driving down their yields; in turn, those big bond funds, such as PIMCO (with $1.2 trillion) who are now in treasuries will move their funds to other markets, possibly into corporate debt or emerging market bonds, chasing a higher yield…the liquidity thus produced eventually works its way into equities and commodities; to an extent, its already happening; global stock markets have already hit a 25 month high...and to the degree that commodities play into prices you might see some price increases at the street level…although wheat is up 60%, its down from it’s high following the heat wave & fires in russia; corn is also up, but the ethanol subsidy is partly to blame for that…but even though corn and wheat are both up over 60%, theyre still a minor cost in food; the cost of wheat in a loaf of bread is only a few cents...& although cotton is up 80%, at a record price, that's also largely the impact of bad weather in china, india & pakistan...similar weather related issues are affecting coffee's high...while most of the metals are near year highs, the more serious threat for street level inflation would be if we get a spike in the price of oil, since transport costs affect everything...the dollar weakening attendant with QE, which has already taken place in anticipation, will make imports more expensive; but since china, for the most part, still has it's yuan pegged to the dollar, most of what you buy wont see much price appreciation, unless you're into buying a lot of gold and silver trinkets...

im still thinking a big part of this new round of QE is the ongoing bailing out of the banks, which i detailed here: banks insolvent? extend and pretend…(see the last paragraphs in red), and is still a problem as long as the toxic real estate bonds are still carried on banks books at cost, rather than their market value...as recently as six months ago, all the discussion of monetary policy concerned what would be the exit strategy to unwind the first balance sheet expansion, so despite the public pronouncements of not meeting their targets for inflation and unemployment as the reason, i'd tend to believe the bank balance sheets have probably deteriorated further in the face of deteriorating commercial & residential MBS...thus keeping rates low will continue to allow the banks to recapitalize, but its still a pushing on a string effort for the general economy; just like the first QE was, there will still be no incentive for the public or business to borrow at 1/2% lower rates when the public is overextended already & businesses are still below capacity…so without accompanying fiscal policy there will be no increase in spending, and no boost to the overall economy…and remember, the Fed will have to eventually try to reverse this, and that's where the game really gets real tricky...

the big downside to this QE and low interest policy domestically will be to those living on fixed incomes; according to the census, there are more than 39 million americans over 65; many elderly count on CD or bond interest to live on, and not many have the options to safely take on more risk that a sophisticated investor would have; furthermore, many pension funds have already taken losses on their equity portfolios and have switched into fixed income, even so, the largest of those pension plans are still being funded anticipating a return of 7 1/2% or more...

the reaction overseas to our QE was all bad: german finance minister schauble said it was a horrendous decision, and called the Fed "clueless"; japan's finance minister threatened yen currency intervention in response, brazil's finance minister declared it an acceleration of the ongoing currency war, and the newly elected brazilian president suggested the last time this happened, it led to WW II...amidst other rhetoric, china demanded an explanation for the dollar devaluation, and malaysia and thailand called for a meeting of the ASEAN counties to plan a coordinated response, as capital inflows are feeding bubbles in those emerging markets...a showdown is expected at the G20 this week, where it looks like it will be the G19 vs us

the above is adapted from the weekly comments that accompany my sunday morning links mailing, which in turn is selected from my weekly blog post on the global glass onion; that blog contained over 100 links to news & commentary regarding QE this past week, and you can find those near the beginning of that post, as you typically can for other posts from previous weeks…if you’d be interested in getting my weekly emailing of selected links, mostly from these GGO posts, contact me...

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