Yesterday I heard an economist on NPR predict that the Fed would not buy long term bonds because it was “a last ditch stand” ; its potential to explode inflation was so huge. “Like firing an unguided missile”, he said. Today comes news that the Fed is – you guessed it – buying long term bonds. I won’t even pretend to know enough to guess whether the economist is right but it’s been my experience that when something bad can happen, it usually does.
UPDATE: Zimbabwe comes to America? If I understand this thing, and I’m not saying I do, it seems that the Fed is now issuing debt and printing funny money to “buy” it itself. Until today, there was some discipline imposed on our borrowing because if the buyers – Chinese, French, whoever- grew nervous over our spending, they’d quit buying. But now we’re our own buyers. Is this any different than Zimbabwe printing zillion dollar banknotes? If it is, please explain. Mongo have great pain between ears.
UPDATE II: Thanks, Instapundit!
UPDATE: There are some very thoughtful informative comments here and I recommend them highly. Here is the WSJ’s article today (Thursday) on the same subject – I think some of the comments are clearer, but what the heck.
Gold is for optimists. I’m diversifying into canned goods.
Bernimkumpoop is out of control (and out of his league). Not clear to me how much longer this country can survive with the witless financial guidance being delivered by Treasury and Fed.
This is very serious (and an extremely slippery slope) if the FED starts buying US Government debt.
My understanding is that they are printing money (currency) and buying bonds (taking bonds out means you are paying with yet more currency that will go into the economy).
They were not “issuing” debt to any extent greater than they would normally. This is basically a double-dose of printing money and buying bonds, both of which serve to put cash into the system.
Basically, like doing heroin and cocaine at the same time.
Inflation to start in 5…4….3…
At least CF can sell distress-priced houses as eventual inflation hedges for savvy buyers…
I guess I am slow. Could someone explain why they feel they need to take this step; to purchase US Debt with central bank funds?
I would think there is only one good reason, their aren’t enough buyers at the table for all the lucious US debt. But if that were really the case, won’t bond rates be higher yet? Long term rates doen’t seem out of hand to me at nearly 3% prior to today’s announcement.
Oh boy. The real estate schills play Wall Street wizards. THAT is always scary. Let me try and put it in simple terms so you can all understand it. The Fed’s have only 2 ways out of this right now. 1) Default on the debt, and start over. Which they will not do. Stuff like that tends to makes you look bad. Or 2) Inflate your way out of it by printing more money. All those who pick 2 raise your hand!!!
Hey – what was I saying? Nevermind – off to Happy Hour!!
Your Buddy,
Walt
Dang it, Walt, why don’t you consider commuting to Washington from Mustique once a month and replacing Geithner and maybe Bernanke too? They aren’t doing so well and, as they say, you’ve forgotten more than they’ll ever know!
Sorry, Cos Cobber, but I’m referring all further economic questions to Walt.
Oh CF, I’m hardly offended.
Who says we’re are about to default on the debt? I have not read a single story regarding insufficient buyers in the treasury bond market to warrant the fed’s action.
Now Walt, are you saying the Fed’s action is deliberately trying to stimulate inflation?
I’m with Anonymous 3:06pm. The last time we saw serious inflation in the 70′s, the price of hard assets soared. Housing, gold, silver come to mind.
I think housing at the right price is a good inflation hedge, and I think inflation is coming. However, this is a difficult game to play at Greenwich prices in an economy where highly paid locals are losing their jobs.
I have anecdotal (and well placed) info that local nursery schools are being stiffed by laid off parents in financial difficulty. Of course, that would never happen at Brunswick or GA (or maybe they are better business people?).
If they stiff the care givers of their little darlings, imagine how they would feel about paying rent, after being forced to sell their $3 million home they can no longer afford in a short sale. A landlord’s worst nightmare is a tenant who declares bankruptcy. Good luck with an eviction.
I think we are too early for investing in Greenwich real estate, but we may get there. CF, I for one am open to ideas and I am intrigued by your post last week about the savvy investors you know buying property under $2M.
BTW, I walked the land you mentioned at 38 Langhorne last week, since I had to go to Lone Pine Kennel (highly recommend, by the way) on John St. Sheez, I wouldn’t give you half a buck for that land and I think the builder will be very lucky to get his original $1.2M purchase price. But maybe that is because I am not a back country kind of guy.
CF – You made me laugh so hard I spilled my margharita!! YES – they are trying to cause inflation. they have no choice. The Fed made a comment today that deflation is a bigger concern. As it should be. Printing more money causes inflation. But again, they have no choice. Other than to call game over, ask for a redo, and all that other stuff which is way to scary to think about. See my previous post, and RAISE YOUR HAND!!
Hmmm, forgot what I was saying.
Anyway, off to dinner!!
Your Pal,
Walt
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I think it’s a ploy—China et al already have a ton of Fed Bonds—we are now saying that we the Fed Reserve will buy them from the US Treasury as new ones are issued–it’s like lending yourself money & hiding the notes from your friends–basically, yes it will cause inflation.” The Fed will buy the bonds so that the bad guys won’t get them— only
Problem is that the FED WON’T PAY WITH MONEY—JUST CREDIT”
Anonymous, canned food is for optimists….I’ve diversified into REALLY precious metals, lead, brass….
Dog Walker, right now, the best deals, or most tempting, seem to be the big boys – 11 Lindsay Lane, with its asking price of $12.75 and $7.2 million in bad loans on it comes to mind – but smaller houses built be smaller builders should start cropping up. Looking interesting.
I still like that 38 Langhorne property, but that’s what makes a horse race.
“Who says we’re are about to default on the debt? I have not read a single story regarding insufficient buyers in the treasury bond market to warrant the fed’s action.”
You didn’t hear about Hillary begging the Chinese to keep buying bonds?
They can’t buy short term stuff any more to pump out money, because the short term rates are already zero.
The long term rates are enough above zero that they can buy that for additional insertion of money into the economy.
It will lower the long term rates a little, as a first effect.
However, they can’t control the long term rates really, because they’re very sensitive to inflation expectations. The crunch will come if inflation kicks up. It’s hard to guess what will happen if the Fed doesn’t then aggressively soak up all the money it’s been pumping out, because it’s then an irresistable force acting on an immoveable object.
There’s no inflation worry until somebody starts actually spending the money that they’re all sitting on in the meantime, however.
Money that’s out there but not moving has no effect on the economy. In effect it simply disappears, and the Fed is free to print more.
But it had better be really really fast to reverse itself when the time comes.
Walt:
1) In order to buy into your conclusion, we have to buy into the premise the financial institutions were in such peril that it was necessary to bail them out — which caused the need to print the money required to do so;
2) We have recently been treated to the Obama Administrations repetition of the McCain claim that the “fundamentals of the economy are sound.”
3) If McCain was telling the truth (whether he knew it or not) and Obama is telling the truth (whether he believes it or not), then the bailouts were unnecessary. The financial institutions which were in peril could have been allowed to fail. While this would have caused deep short-term pain, it would have allowed for long-term growth of strong financial institutions replacing those which went under.
4) If McCain/Obama is right, then the mid-term elections of 2010 allows us to right the ship and stop the vast bulk of the proposed spending.
5) If we do so, then it wouldn’t have been necessary to either print the money or to buy up our debt.
6) The above would be an example of a third alternative beyond A) Default B) Out of control inflation.
Just sayin…
I’m investing in green ink.
The reason they are comfortable with this scenario is that they’ve seen about 80% of all the liquidity they’ve put into the market over the last six months end right back on deposit at the Fed.
Once the Fed sees the excess reserves being taken up by the economy they can begin to to shrink the balance sheet by selling out the bonds (and pushing rates higher in the process, restraining inflation).
Japan employed “quantitative ease” earlier this decade and had no nasty rebound in inflation.
I think it has fair chance of working. If we’ll all be a billionaires (on a before inflation basis, at least),
The Fed buys and sells Treasury bonds all the time as part of its normal open market operations. Buying assets from banks and “printing” money to pay for them is how the Fed controls the amount of overall liquidity in the system, via the Fed Funds target rate– the rate banks charge one another for overnight loans. When there is a lot of liquidity, the rate falls, and vice versa.
So the overall question is one of degree of the activity (some is important and needed, but a lot is more worrisome), and of the prices being paid. Apparently the current plan is to buy and sell at market prices. This policy can be compared to what was pursued in the past. For instance, before the 1951 Accord (1942-1951), the Fed had agreed to buy government wartime debt at face value, to prop up the government’s borrowing needs. The maximum interest rate on long term Treasuries was thus forced to be 2.5 percent. That express monetization commitment did indeed spark inflation, which hit 14% in 1947 and 8% in 1948 as measured by CPI.
The end result of the new plan will depend upon its ultimate scope (the announced $300 billion size so far is, sadly, peanuts when the Federal budget is 3.6 trillion), and on the end game— what will they eventually do with the bonds. If they were to sell them over time at market prices, the expansionary effect would be gradually undone.
First, Walt is wrong.
The US government will not default on its debt. The risk of default only comes when a country’s debt is denominated in a currency other than their printing press. All the government needs to do is print more money to repay maturing debt.
Now, what will happen in that scenario is the $ will lose its value. In fact, today with the announcement of QE, the dollar lost value against all major currencies (even the Pound which makes no sense given the UK embarked on QE before the US).
Someone asked why is the FED doing this: the obvious answer is they are trying to drive down long term interest rates to aid the recovery and avoid deflation.
What is interesting is they made the announcement on a day when inflation (albeit at a low level) was announced to be still alive and well. Which leads to the not so obvious question/answer… things must be far worse than meets the “public eye” for the FED to have made this announcement.
Either way you cut it, this is not good news.
Thanks FinProf, IB’r and all the rest of you. The neat thing about this blog is I get a bit of education from some very knowledgeable people (and Walt, don’t let their attacks on you dissuade you from posting post-mojito. Monica and the girls love you and so do I!)
Thank you, finprof. Any intro finance textbook will tell you this is standard fed procedure. There are some interesting ramifications, such as lowering interest rates, which will lower bank profit margins a bit…hmmm. It’s also good prep work for the enormous borrowing–which returns all this cash right back to the Fed–the government’s doing and will have to do for the foreseeable future, say till January of 2011. It also will lower rates and increase funds for the private sector to compete against government borrowing. Plus tons more, I’m sure.
Retired IB’er – Good thing you are retired. And good thing I like you peep’s. Of course the gov’t won’t default on the debt. That is my friggin point. Read my previous posts. Or is this a room full of Helen Kellers?
People buy all that “backed by the full faith and trust of the US Gov’t” stuff. They CAN’T default. So choice 1 is not an option and RAISE YOUR HAND!!! They HAVE to print more money. Which will lead to inflation. And someone mentioned Japan, that they didn’t have inflation. And you know where they are? In the toilet. For about 17 years now. You want that?
Deflation is a bigger concern. You don’t think we are experiencing deflation? Read just about any of my condo schilling friends rant’s on Greenwich real estate and tell me we aren’t experiencing deflation? Chris? Chris? You want to weigh in on this buddy?
Deflation is the Fed’s biggest fear and they need to stop it. Printing more money, and having some MODERATE inflation is not a bad thing, and that is what they are doing. Read about Germany after WWl. That you don’t want. Hey, when I have my lucid moments, I think I am old enough to actually remember that!!
In any event, in inflationary times, you need an investment vehicle that out performs the market, which we at FGG are always dedicated to do, and have a long track record of doing. Send the checks to Chris and he can drop them off at Round Hill. He has my address.
Chris – I figure the real estate market back there may be somewhat soft and you can use the K. Standard commission. Not going to play hardball with you Buddy. You can buy me a drink when I get back.
Off to Basils!!
Your Bud,
Walt
bbay, perhaps the Fed is doing this because China and Japan aren’t buying, not because we don’t want them to buy. After all, it seems obvious that the U.S. government plans to repay the T-bills with grossly inflated dollars. Why would anyone want to buy them?
Chris -
I may be old, but I am wirey. Just ask Monica!! And don’t believe all this Jimmy Stewart crap you read. I can get my dander up, gosh darn it. But the fact that people say they have not read the Gov’t won’t default? COME ON. You will NEVER read that. Because they won’t. Answer? Print more money. Now come on guy’s – RAISE YOUR HANDS.
The Fed’s get the importance of image. Full faith and trust and all that crap. Heck, we modeled our marketing materials at FGG after this stuff. These guys are pro’s for Pete’s Sake. I get image, living in Greenwich for Pete’s Sake. And Monica? OY VAY!! Not even going there. Nothing else matters.
Our only problem at FGG was we didn’t have a printing press like the Fed’s do. We counted on Bernie for that. That rat ba#$ard.
Hey – SHOUT is playing!! Gotta go do the worm!!
Your economically connected Buddy,
Walt
I wrote this at the beginning of February at Winds Of Change blog.
Greg F -
Dude – you get it. You have a future at FGG. Do you like horses?
Your Bud,
Walt
Retired IB’er:
Read this and tell me where I am wrong. And I mean no disrespect. As a retired IB’er (and stay retired!!), I would like to speak to you about an alternative investment strategy. We at FGG can help. Chris can hook us up. He needs the commission!! So let’s help him out, dude.
http://www.iht.com/articles/2009/03/18/business/fed.php
Your Pal,
Walt
Jamie gave me the empirical answer I was looking for; that 80% of the liquidity pumped into the system has been returned to the fed. That I get. And yes Walt, of course I understand the deflation is to be avoided and some inflation is good. When you spoke of inflation, I thought you talking something closer to Germany in the 1930s and the run-of-the-mill 3% varietel. It just seems to me that the Fed acquiring US bonds maybe a sign of a deeper problem; an insufficient supply of creditors at the treasury auctions. Is there any tangible evidence this is happening? I guess the bond purchase program has far more to do with stimulating moderate inflation because of all the cash being returned to the fed everynight.
Switching gears and switching sides of an argument; so what if Japan and China curtail their financing of our debt. Since they have some many dollars, won’t they be forced to buy US assets (real estate, companies, etc) or US goods, both of which would help stimulate our economy and help end the completely unbalanced global trade structure (Asia = creditors / US = debtors)?
As you can now see, I’m someone not working in hedgefunds.
Thanks in advance, all the posts have been very insightful…even Walt’s.
Walt, Walt, Walt,
Where have you gone wrong you ask?
Your comments show your superficial understanding of the issues. Demonstrating you have done as much due diligence on this subject as you did on Bernie. And I don’t have to tell you how that turned out for you.
My advice, stick with your comical shtick, it suits your talents. Leave the serious discussion to the adults.
Walt, you wrote:
1) Default on the debt, and start over. Which they will not do. Stuff like that tends to makes you look bad. Or 2) Inflate your way out of it by printing more money. All those who pick 2 raise your hand!!!
Debt HAS to be defaulted, unless you can tell me some way for the total money supply to grow and cause inflation. We’ve already seen the Federal Reserve double base money, but the banks are in no position to extend more loans (without explicit government backstops) and individuals can’t or won’t take on more debt. We’ve reached peak credit, so the base money multiplier will continue to decrease until the debt is written off. The only inflation we’ll see, short of a method to increase the money multiplier, is the inflation you see from a total repudiation of fiat money by the lack of faith in the currency.
Walt,
I realize it was impolite to simply point out your ignorance without at least pointing you in the direction of how to better yourself.
Karl Denninger does a good job of explaining the slippery slope of QE.
http://market-ticker.denninger.net/archives/878-Caution-On-Quantitative-Easing-QE.html
Canned goods? No. Combs and soap. And small hand mirrors. People will always pay to know they look good.
Inflation you say. So, um, buy gold?
problem.
One may buy oil from Venuzuala, Iran, Nigeria, Russia, and the list is growing, with what ever kind of currency one has laying around.
Walty,
Here is another good primer for you. Knock yourself out.
http://www.atimes.com/atimes/Global_Economy/KC14Dj04.html
“Japan employed “quantitative ease” earlier this decade and had no nasty rebound in inflation.”
Yes, but Japan had a massive trade surplus, not a trade deficit (= bleeding hard currency).
And it didn’t work, either.
sometimes economic solutions create more problems than the original issue. Im not saying this is the case here but being an economics major, I did learn that w/ econ, there’s no simple solution.
If hyperinflation does occur, it will negatively effect America’s purchasing.. ppl will be afraid. The average person will begin to panic and buy now but never later.. that will be pretty chaotic.
Why Walt’s Wrong
Walt claims that there are only two ways out of the crisis: 1) “default on the debt”, or 2) “inflate your way out of it”.
Walt makes this argument because he believes that deflation is a bad thing. But the high prices for housing, commodities, education, health care, and other goods in the US economy and world economy in the last five years were partially caused by the our government pumping great amounts of money into these sectors through low Fed interest rates, by government diversion of spending, and also in the case of health care by enormous amounts of perverse government incentives and regulation. The necessary corrective is for relative prices levels to return to normal, i.e., to return to what the consuming public would value them at in the absence of (with housing for example) artificially low-interest rate federal mortgages. Thus, contrary to being harmful, deflation of these prices is beneficial and utterly neceesary. Re-inflating all these prices, i.e., engaging in the ‘moderate inflation’ that Walt talks about, would result in the prices for all these goods continuing to be much more expensive than they need to be, thus robbing Americans of the present and future wealth that they otherwise would have if they could buy these goods more cheaply.
There are two ways one can return the relative price levels to normal: deflation of the abnormally high prices (in housing, the financials, and education, for example), or inflation of the low prices (in the other goods). Trying to prop up prices, of which the tool of ‘moderate inflation’ is one part, is the greater evil because it results in transfering huge amounts of money to the institutions such as banks and finance that are propping up these artificially high prices while at the same time INCREASING our chances of national debt default. In other words, contrary to what Walt claims, all the spending on bailouts and now buying of Treasuries in order to forestall deflation INCREASES our national debt and thus the chances of default. Thus, Walt’s alternatives are actually not alternatives at all, but complementary choices.
Walt is right in one formal respect, however: insofar as Social Security and Medicare, with the improbability that they’ll ever be significantly reformed, will constitute enormous unfunded future obligations, the only likely way that the governemnt will ever pay off these obligations WILL BE through massive inflation. But this of course is exactly that, only a formal solution, since if such a massive inflation occurs the dollars in which Social Security claims and Medicare bills will be paid off will be so worthless that it will be the financial equivalent of default anyway.
In conclusion: there is in fact a third alternative: 1) do nothing and 2) dismantle the institutions which caused the present catastrophe (as they earlier caused the Great Depression). If we do this in time, along with massively trimming government expenditures and getting in the black again, we still have a chance to avoid hyperinflation or default. It’s ironic that the politicians and the Fed claims that they’re ‘willing to do everything necessary’ to aleviate the present crisis. But is Bernanke really willing to dissolve the Fed itself? Are Barney Frank and Chris Dodd really willing to get rid of Fannie Mae, Freddie Mac, and all the other responsible governmental institutions? Let’s ask them, and not accept their false dichotomies, as Walt has done.
Gold is for optimists. I’m diversifying into canned goods.
Canned goods is for optimists. I’m diversifying into ammo.
Retired IB’er:
It’s not clear to me you know how to read, but here you go. Read it a few times and maybe you will get it:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aFrMaHlTmgOY&refer=home
Fondly,
Walt
Il Padrone:
Can I have whatever it is you are smoking? I am not setting policy, just telling you what is going on. They have spent trillions of dollars. In months. So show me some evidence there is a plan to curtail spending. Are you in a friggin comma? Gotta go clip coupons, then off to tennis!!
Your Pal,
Walt
Ok. Even you guys will be able to comprehend this. From todays NYT:
“Although some economists warned that the huge debt purchases could lead to rampant inflation down the road, others hailed the Fed’s move as an aggressive and significant step to address the deepening downturn.”
Off to Tennis!!
Your inflation proof Pal,
Walt
Walter, you’re growing dispeptic – have a drink, perhaps have Monica massage those aching shoulders and relax – enjoy that view from your Mustique deck while you still can.
Why can’t the Fed set a negative discount rate? It would seem that a rate of -1% could provide a trillion dollars of stimulus at the cost of a “mere” 10 billion.
China is asset buying
They are hedging against inflation of the dollar.
When a state spending exceeds revenues + credit (what people are willing to lend it), it has the following choices:
1. Cut spending.
2. Default on at least some of the people it’s supposed to be paying.
3. “Print” money, (i.e., inflate) which is a way of short-changing everyone.
US States can’t create money, so they can only resort to 1 & 2. California is resorting to #2, they’re sending out IOU’s instead of real checks for state tax refunds, for example.
The Chinese have made it clear that they see #3 as a very real possibility, and are acting accordingly.
Just to prove to Walty that I actually do read, and unlike him comprehend the meaning of what I read, I believe, Chris, you meant to write “dyspeptic” with a “y”.
Walt claims he’s ‘not setting policy’; But he stated:
“Deflation is the Fed’s biggest fear and they need to stop it. Printing more money, and having some MODERATE inflation is not a bad thing, and that is what they are doing. ”
The whole point is they DON’T need to stop it and in fact need to allow it to proceed.
He also stated:
“The Feds get the importance of image. Full faith and trust and all that crap. Heck, we modeled our marketing materials at FGG after this stuff. These guys are pro’s for Pete’s Sake. I get image, living in Greenwich for Pete’s Sake”
The Fed, by deluding themselves that this is a crisis of image and confidence and not of substance and their own attempts to indulge in ‘the fatal conceit’ that they can beneficially manipulate the money supply, are focusing on the irrelevant and will only damage the economy further. The more the Fed cons us with their ‘image’ BS, the deeper in the doo-doo we’ll be sinking.
Walt needs to try giving up the margaritas for a day and drinking some Sprite:
“IMAGE IS NOTHING, BABY!”
Default, blah blah blah…. Inflation, blah, blah, blah….
What about the Black Swan?
if you have dollar based assets….get out
I’m with Towny, move out of dollar based assets. Cheese anyone?
Who to believe? My head is spinning try this poll
http://rickywood.wordpress.com/2009/03/19/which-party-lies-more-dems-or-goptake-the-newsvine-poll/
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