Tuesday, August 10, 2010

QE2 Will Sink Us

See Update I, below.

Ben Bernanke and the Federal Reserve are preparing for QE2—a second round of Quantitative Easing.

The rationale is that the United States’ economy is circling the deflationary drain—something Bernanke and the Fed are absolutely terrified of. Certainly deflation is hitting the U.S. economy full bore, but it’s yet to be proven that this deflationary trough has twisted itself into a self-reinforcing vicious cycle. I would argue that the chances of the U.S. economy twisting into a deflationary death spiral has yet to be made. But be that as it may, it doesn’t matter if the economy is in a deflationary death spiral—Bernanke and Co. think that that’s the imminent danger. And they're the ones with their finger on The Big Red Money-Making Button.

Some people are claiming that the first version of QE was not enough. Like Paul Krugman whining that the stimulus package wasn’t big enough to restart aggregate demand, the aggregate asset crowd—the monetarists—are bitching that Bernanke didn’t really open the monetary flood gates with the first version of QE.

These people conveniently forget that the Fed more than doubled its balance sheet, in order to carry out QE v.1.0. This interactive chart tells that story better than words can—from less than a trillion dollars, to $2.2 trillion in under 60 days. Clearly, Bernanke now owns the land speed record for monetary expansion. And to any talk that Bernanke is contracting the Fed balance sheet too quickly, let’s just say that a shrinkage of less than $30 billion from a peak of $2.333 trillion is not exactly “drastically reducing” the balance sheet.

Still, with all that liquidity the Fed has been making available, the banks aren’t lending—they’re too weak to lend, their balance sheets too precarious. So banks are hoarding their cash (or carrying out the Treasury’s stealth monetization program). So asset prices are falling (even with over a trillion dollars’ worth of MBS’s shovelled onto the Fed’s balance sheet). So deflation. So monetarists are freaking out: And the Fed is dominated by monetarists.

Hence, QE2—another go-around of massive monetary expansion, to both prop up asset prices, and prevent a (supposed) deflationary death spiral. And Benny’s not gonna screw around: If Bernanke does a for-real QE2—a no-fucking-around, damn-the-torpedoes, full-steam-ahead! quantiative easing—he’ll expand the Fed’s balance sheet from $2.3 trillion to at least $4 trillion, if not $4.5 trillion.

Here is my fearless prediction: If Bernanke does QE2 for-real (which is not a sure thing yet, but likely), then this monetary expansion will become the hyperinflationary kindling—but not the spark.

The spark will come from someone selling a big position in Treasuries. The obvious culprit could be China. China’s economy is tanking—and China has a whole lot of Treasuries, which they will need to dump so that Beijing can prop up its own asset bubble. China’s the likely candidate, but hell, it could be Bill Gross.

Regardless: The Fed has been buying up mortgage backed securities from the Too Big To Fail banks, in order to bail out the banks. The TBTF banks have in turn used the cash to soak up all those Treasuries the U.S. Government has been emitting to finance its stimulus spending. China’s sale of Treasuries—to prop up its homegrown asset bubble—will need to be purchased by someone: The U.S. cannot allow its debt to tank.

Enter QE2, stage right: QE2 will be used to prop up Treasuries—and this will spook the markets. People will realize that Treasuries are as vulnerable as Greek euro-bonds—which they are, of course. So people will want to get out of Treasuries.

So the Fed will be forced to defend Treasuries—with QE2 cash. Instead of buying up mortgage backed securities, they’ll be forced to buy Treasuries. It’ll be 2008, only Treasuries tanking, rather than MBS’s.

This will light the hyperinflationary fire. People will lose faith in the dollar, and try to get out of it—at all costs, all at once. As I've written in other posts, hyperinflation is not the economy overheating, like regular inflation—hyperinflation is when nobody wants to be caught dead with a currency.

This is how deflation will trip over into hyperinflation. And this will happen within 24 months, perhaps as soon as this coming autumn. And even if QE2—by some miracle—does not bring about hyperinflation, then in 18 months or so, Bernanke and the Fed will do QE3: Their rationale will be that they did it “successfully” with QE in 2008 and QE2 in 2010, so why not QE3 in the fall of 2012?

If your only tool is a hammer, then every problem looks like a nail. Bernanke and the Fed will bring about hyperinflation—obviously. They are so irrationally terrified of deflation—and they are so committed to defending aggregate asset prices, regardless of what it takes—and since their only real power is monetary expansion—that they will let loose the QE spigot until they break the back of the Demon Deflation. And in their zeal, they will kill the U.S. economy.

But hey, I’m probably wrong. BTW, that gold necklace you’re wearing—you wouldn’t be interested in selling it, now would you? I got me some freshly minted dollars . . .

Update I (3pm, EST; August 10, 2010)

The Fed’s Open Market Committee met today, to decide what the hell to do.

According to the mainstream media, “The Fed had planned to allow the size of that portfolio [ie., the MBS’s on the Fed’s balance sheet] to shrink gradually over time as the debts matured or were prepaid. Instead, the Fed will reinvest the principal payments in longer-term Treasury securities.” The decision by the Committee was 9-1 in favor of the measure; the lone dissent was Thomas Hoenig, president of the Kansas City Fed.

In other words, the Fed is going to start monetizing the huge Treasury emissions that are coming on deck. It’ll be gradual—little-by-little—just the tip—just to see how it feels . . .


  1. Good summary, very incise............so prophetic.

  2. Sure is nice to here real ideas instead of BS from MSNBC...Thanks Gonzalo

  3. Interesting writing style. Please keep writing....

  4. GL I think you'll dig this movie:

    Time for Change (Bregtje van der Haak, VPRO Backlight 2010)

    I hope progressives and other non-libertarians are realizing that the center of the problem is the currency.

  5. Checked out the video you sent—all of the VPRO Backlight videos are extremely interesting. I highly recommend them—thank you, Brock, for pointing them out to me. GL.

  6. In my gut, I was never sold on the idea that the Fed has ever expected darling Ben's charm for the press/QE to ease anything but time. This real life fantasy has been about buying more time, not more jobs.

    At the very best, a secondary outcome of the charade has been to just pile up more money/debt for bonuses or related scheme of prostitution.

    I am not an economist, or especially well studied in these topics. However, I did pick up a few pointers from Grandma Dunkel. She had 12 children and was pretty darn sharp.

    Writing from Kansas. BTW, I just discovered your writings tonight. Awesome.- Thank you.

  7. Describing QE Light as "Just The Tip" is genius... well done, sir.


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