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David's Macro Blog

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Tag: deflation

If you ever wondered about Quantitative Easing, how it works, and how it affects us, just watch this 7-minute video: Quantitative Easing Explained in under 7 minutes in a way anyone can understand.

My favorite quotes:

“Why do they call it quantitative easing, why don’t they just call it printing money?”
“Because printing money is the last refuge of failed economic empires and Banana Republics, and the Fed doesn’t want to admit this is their only idea.”

“Because they say we have the deflation and the deflation is very bad.”
“What is the deflation?”
“The deflation is when prices of the things we buy go down.”
“Isn’t that good. Doesn’t it mean people can buy more of the stuff?”
“Yes, but the Fed said this is bad!”

“The only thing that I can see that is deflating is the Fed’s credibility.”
“Did they have a lot of credibility to start with?”
“No…”
“Because the Fed has been wrong about every major economic development in the past 20 years.”

“So the Goldman Sachs can front run the Fed and give them the worst possible price on the Treasury Bonds?”
“Yes!”

Classical economics teaches that an economy, if properly managed, will remain in a state of equilibrium. This is because economists assume a perfect market place with rational actors who maximize their returns through their uniform access to all information.

As we know, the REAL world is much different from economic equations.

Instead, the real world economy moves through market cycles. These market cycles fluctuate between boom and bust as the market participants move through cycles of fear and greed and all sentiments in between.

The past 10 years have seen some amazing bubbles which were not sustainable because the asset prices got out of line with the underlying fundamentals supporting the market.

Let’s review the bubbles in our recent memory.

2000 Nasdaq index over 5000 – 9 years later the index is still off 60% from its peak.

2007 Real Estate Bubble – In just 2 years some markets are off 60% and the average is off 30%.

2008 Oil Price – The price per barrel peaked around $150 but then fell to under $40 in less than 2 years.

2009 US Treasuries??? If the future holds inflation then this may be just as large as the 2007 real estate bubble. However, if we continue with deflation, then maybe current yields are the new normal.

So, what bubble are we in now?

Please comment below and let me know what you think.

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How bad is the current deflation?

It is so bad that every tool the Fed has to fight deflation, as listed by Ben Bernanke in 2002, has been used and still hasn’t stopped massive deflation.  Essentially the current economic and financial conditions where not even conceivable just a few years ago.

From Mish: Bernanke’s Deflation Preventing Scorecard

Bernanke’s Scorecard

Here is Bernanke’s roadmap, and a “point-by-point” list from that speech.

1. Reduce nominal interest rate to zero. Check. That didn’t work…

2. Increase the number of dollars in circulation, or credibly threaten to do so. Check. That didn’t work…

3. Expand the scale of asset purchases or, possibly, expand the menu of assets it buys. Check & check. That didn’t work…

4. Make low-interest-rate loans to banks. Check. That didn’t work…

5. Cooperate with fiscal authorities to inject more money. Check. That didn’t work…

6. Lower rates further out along the Treasury term structure. Check. That didn’t work…

7. Commit to holding the overnight rate at zero for some specified period. Check. That didn’t work…

8. Begin announcing explicit ceilings for yields on longer-maturity Treasury debt (bonds maturing within the next two years); enforce interest-rate ceilings by committing to make unlimited purchases of securities at prices consistent with the targeted yields. Check, and check. That didn’t work…

9. If that proves insufficient, cap yields of Treasury securities at still longer maturities, say three to six years. Check (they’re buying out to 7 years right now.) That didn’t work…

10. Use its existing authority to operate in the markets for agency debt. Check (in fact, they “own” the agency debt market!) That didn’t work…

11. Influence yields on privately issued securities. (Note: the Fed used to be restricted in doing that, but not anymore.) Check. That didn’t work…

12. Offer fixed-term loans to banks at low or zero interest, with a wide range of private assets deemed eligible as collateral (…Well, I’m still waiting for them to accept bellybutton lint & Beanie Babies, but I’m sure my patience will be rewarded. Besides their “mark-to-maturity” offers will be more than enticing!) Anyway… Check. That didn’t work…

13. Buy foreign government debt (and although Ben didn’t specifically mention it, let’s not forget those dollar swaps with foreign nations.) Check. That didn’t work…