Sterilised QE Analysis

I write this post rather hesitantly.

From the WSJ:

Federal Reserve officials are considering a new type of bond-buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.

This confirms four important points that relatively few economic commentators have grasped.

First, if QE was intended — as Bernanke always said it was — solely to lower the interest rates on government debt, and force investors into “riskier” assets, rather than to directly stimulate the economy, why were the first two rounds of QE not sterilised? Is Bernanke making it up as he goes along? No — the first two rounds of QE were undoubtedly reflationary:


While the S&P slumped, the monetary base was dramatically increased. This — even as confidence remained weak — allowed the (debt-based) money supply (M2) to keep growing, and thus avoiding Bernanke’s bugbear deflationary spiral.

Second, that Bernanke— unlike Paul Krugman — is concerned about inflation expectations. Given that the money supply could theoretically still triple without any new money printing, I would be too. How might banks respond to an oil shock or some other negative supply shock? We have no real idea. Would all those reserves quickly get lent out, as more and more money chases fewer and fewer goods? We can speculate (I would say this eventuality is quite unlikely) but we just don’t know. Simply, the Fed has created a bed of inflationary dynamite, and we have no real means to predict whether or not it will be set alight, or whether the Fed would be able to temper such an explosion.

Third, that if the Fed is not willing to continue pumping money into the wider economy, the current reinflationary bubble is over. But the money supply has surged ahead of industrial production:


Without a surge in real productivity (I don’t see one coming) price levels will not be sustainable, which may force the Fed back for another round of unsterilised QE.

Fourth, the Fed seems completely and defiantly intent on driving interest rates on Treasury debt into the ground. The supposed justification — that investors are avoiding riskier (but productive) assets seems completely irrelevant. If investors do not want to put their money into equities, they will find a way not to — either by investing in commodities and futures, or in alternative monetary instruments like gold and silver. The real justification — at least for this round of QE — seems to be to cheapen the Treasury’s liabilities, especially in light of the fact that America’s biggest external creditors are getting cold feet. That takes the pressure off the Treasury, but for how long? How much leeway does the Fed have to act as a price ceiling on Treasury debt?

The hope is that the Fed will have much more leeway as a result of sterilised QE. And of course, Bernanke is hoping that there is a real economic recovery down the line so that all these emergency measures can be retired.

The trouble is that the problem in the United States was never that of too little money, but rather that of a broken economy: broken infrastructure, broken energy infrastructure, corporatism, financialisation and diminishing productivity. The Corporatocracy and their cronies in government seem to have no interest in addressing the real problems. That is fundamentally unsustainable — and no amount of QE, or demand for iThingies, NFLX, LULU or corporatist Obamacare will fix it. The real American economy is dependent on foreign goods, foreign energy, foreign components, and foreign resources and there is no guarantee that the free flow of goods and resources will be around forever. In fact, the insistence on not fixing anything — and instead of throwing money at problems — almost guarantees a future breakdown. The era of the American free lunch is over.

What we now know for sure is that the trigger for the coming breakdown is extremely unlikely to be domestic. Bernanke is a can-kicking genius, and will invent new can-kicking apparatuses as they become needed (up to the point of systemic breakdown). America must hope that he — or someone else — has a similar genius for foreign policy, and for negotiating with hostile powers upon which America has rendered herself economically dependent.

17 thoughts on “Sterilised QE Analysis

  1. This is excellent analysis, but it is a little too optimistic. We just hit a credit event that I think will deflate markets worldwide. There will be no sterilised QE. There will just be a crash, followed by more bailouts. After that, who knows?

  2. Is Bernanke really a can-kicking genius? I get the feeling he’s just making it up as it goes along and that the breakdown will really catch him off guard.

  3. Why do people think they can plan the lives of millions and billions of human beings? Especially given that they play around with ‘value’….thinking they can determine the value of something by printing a paper note with digits on it? This breaks all values and makes the whole social system now ‘global’ into a mess. Of course it may appear to work but eventually it breaks, fixing it using the methods of planning only creates bigger distortions for the future when the Big Crash will sweep it all away. They tinker and they ‘do’ giving the appearance of power and knowledge….while their philosophy, methods and actions themselves display their ignorance and stupidity.

  4. Why do people think they can plan the lives of millions and billions of human beings?

    Yeah. We live in the age of hyper-rationalism and hyper-enlightenment. These people do not understand how central planning centralises and magnifies fragility.

  5. Pingback: Sterilised QE Analysis |

  6. John,

    What are your thoughts on the discontinuance of M3. I’ve heard diverse opinions. Some say it was irrelevant others say the Fed is trying to hide something. From what I understand M2 only accounts for deposits up to $100,000. If we have large amounts of endless bail out cash still sitting on the sidelines with large institutions, M3 would be parabolic. How do these larger deposits fit into your view of inflation?

    • I spend a reasonable amount of time on the FRED website comparing various metrics. I filled in their survey the other day. I asked them to bring back M3 three times during that survey, at literally every single opportunity they gave me to write something in. Seriously, tracking shadow banking (or at least trying to) is extremely important. In fact, I think they should track M4, adding in non-financial capital that can be bartered (e.g. farmland, equipment, etc) and M5, adding in gross derivatives exposure. All of these things are pseudo-monetary instruments, and all have an effect on what is broadly known as “money supply”.

      As for this point, you’re kind of wrong and kind of right:

      If we have large amounts of endless bail out cash still sitting on the sidelines with large institutions, M3 would be parabolic.

      This does not show in M3; M3 grows via things like MBS, CDS, CDO, repo, etc.

      What this shows in is excess reserves:

      There’s your bailout cash. And by the way, that spike can fractionally lent out 10x over if needbe, effectively inflating the money supply (M2) by 200%. That is what I am talking about when I use a phrase like “hotbed of inflationary dynamite”.

    • Well, “good Keynesians” would say you should find that chart comforting; that for the first time in a long time banks have excess reserves to cope with balance sheet implosions.

      I’m not convinced.

  7. I still have to get my head around this one. Perhaps Bernanke wants the Nobel in physics for the perpetual motion machine of the Bernanke-kind. Debt doesn’t matter and monetising debt is not a problem because we recall the currency back!

  8. The problem with the idea of getting people into riskier assets, is that the SP500 and Dow Jones use non inflation adjusted data, so the graph will always trend up, and this is deceptive. I think the idea Bernanke is trying to promote is rising equity markets release consumer spirits (Wealth effect), which in turn encourages business to invest, hire and complete the positive feedback loop.

    However I think people are so well informed now, and have seen excessive volatility, computer driven flash crashes, war drumming, to even venture into the markets. This is reflected in larger outflows than inflows into Managed Funds, ETFs etc. It also reflects the lower volume but higher price. With no volume, price is not supported. Effectively the banks are the only buyers, with no Joe Six Pack to offload to.

    PE ratios are still well down, and this implies less exuberance for risk taking. If Japan is still in a deflationary gridlock, then this does not bode well for other deleveraging countries, Germany (An exporter of tangible high quality goods) included.

    Unless the USA relaxes immigration to highly intelligent risk taking, capital positive individuals and families, and has a GDP to energy cost ratio increase (www.westport.com), and diverts spending to the unproductive millitary, government and undeserving welfare sectors, they will grind into poverty much like the Romans did over their last 200 years. But I think it will be over in 10.

  9. Pingback: QE: Past, Present and Future - Alternative News London Ontario - Daily news, sports, entertainment, business, travel, homes and auto sections containing features of interest particularly to any one with half a brain in Southwestern Ontario

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