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Posts Tagged ‘QE2’

David DeGraw
AmpedStatus
08/25/2011 22:39 -0400

There are many factors that clearly demonstrate why it would be disastrous for the Federal Reserve to repeat their vicious Quantitative Easing (QE) policy. If you want to know a significant reason why they cannot get away with another round of QE, here is an equation for you:

(Quantitative Easing + Extreme Weather = Revolution + World War III)

From the very beginning we knew that the Federal Reserve’s QE program was going to cause the cost of food to rise and the dollar to decline in value, and that these intended results would lead to an increase in poverty and civil unrest. Now there is a new study that gives us some more proof of this obvious fact:

Are food prices approaching a violent tipping point?

“A provocative new study suggests the timing of the Arab uprisings is linked to global food price spikes, and that prices will soon permanently be above the level which sparks conflicts….

… there is a specific food price level above which riots and unrest become far more likely. That figure is 210 on the UN FAO’s price index: the index is currently at 234, due to the most recent spike in prices which started in the middle of 2010 [coinciding with QE2].

Lastly, the researchers argue that current underlying food price trends – excluding the spikes – mean the index will be permanently over the 210 threshold within a year or two. The paper concludes: “The current [food price] problem transcends the specific national political crises to represent a global concern about vulnerable populations and social order.” Big trouble, in other words….

The next part of the study identifies that the serious unrest in North Africa and the Middle East also correlates very closely with [the QE2] food price spike. Bar-Yam also notes: “Several of the initial riots in North Africa were identified in news stories as food riots.” From there, the researchers make their prediction of permanently passing the 210 threshold in 12-24 months.”
[read full report]

In other words, if the Fed engages in another round of QE, the global unrest that they have already ignited will go hyperbolic.

Before getting into the details on how the Fed deliberately made these food prices spike, let’s look at another new study, which also helps demonstrate the obvious, extreme weather is linked to war:

Climate cycles linked to civil war, analysis shows

“Changes in the global climate that cut food production triggered one-fifth of civil conflicts between 1950 and 2004

Cyclical climatic changes double the risk of civil wars, with analysis showing that 50 of 250 conflicts between 1950 and 2004 were triggered by the El Niño cycle, according to scientists.

Researchers connected the climate phenomenon known as El Niño, which brings hot and dry conditions to tropical nations and cuts food production, to outbreaks of violence in countries from southern Sudan to Indonesia and Peru.

Solomon Hsiang, who led the research at Columbia University, New York, said: “We can speculate that a long-ago Egyptian dynasty was overthrown during a drought. This study shows a systematic pattern of global climate affecting conflict right now. We are still dependent on climate to a very large extent.”…

Mark Cane, a member of the team, said global warming would have greater climatic impacts than El Niño, making it “hard to imagine” it would not provoke conflicts.”
[read full report]

Put all these factors together and you have, “The Road Through 2012: Revolution [and/or] World War III.”

In summation, Ben Bernanke and the Fed’s economic central planners were clearly aware of the hostile climate and weather patterns when they engaged in QE2. The Fed’s infamous policy, as I said before, “deliberately threw gasoline all over those brush fires. QE2 was another economic napalm bomb from the global banking cartel.” They knew that they were deliberately attacking (sacrificing) tens of millions of people, but that was secondary to keeping their global Ponzi scheme going by pumping another $2.1 trillion into their fraudulent, insolvent banking system through both QE programs. This is why Ben Bernanke is guilty of crimes against humanity.

Now, let’s revisit what I’ve been reporting on for the past year:

I: Centrally Planned Economic Repression

The IMF has a well-worn strategy that they use to conquer national economies. As I warned four months ago, we have now progressed into Step 3.5: World Wide IMF Riots. Back in October, in a TV interview with Max Keiser, we discussed leaked World Bank documents that revealed the IMF’s strategy. I stated the following:

“They have a four-step strategy for destroying national economies…. We are about to enter what they would call Step Three. Step Three is when you’ve looted the economy and now food and basic necessities all of a sudden become more expensive, harder to get to. And then, Step 3.5 is when you get the riots. We are fastly approaching that….

We are headed to, as the IMF said, and as they plan, Step 3.5: IMF Riots. That’s what’s coming…”

Fast-forward four months to today, and now we see country after country rebelling against high food prices. Since our October interview, food prices have spiked 15%. According to new World Bank data, since June 2010, “Rising food have pushed about 44 million people into poverty in developing countries.”

As Federal Reserve Chairman Ben Bernanke announced another round of Quantitative Easing (QE2), those of us paying attention knew that the trigger had been pulled and Step Three had been executed. It was a declaration of economic war, an economic death sentence for tens of millions of people – deliberately devaluing the dollar and sparking inflation in commodities/basic necessities. It was a vicious policy that would impact people from Boston to Cairo.

When QE2 was announced, I warned: “Food and Gas Prices Will Skyrocket, The Federal Reserve Just Dropped An Economic Nuclear Bomb On Us.” I also wrote: “The Federal Reserve is deliberately devaluing the dollar to enrich a small group of a global bankers, which will cause significant harm to the people of the United States and severe ramifications throughout the world…. The Federal Reserve’s actions are already causing the price of food and gas to increase and will cause hyperinflation on most basic necessities.”

To be clear, there are several significant factors contributing to rising food prices, such as extreme weather conditions, biofuel production and Wall Street speculation; but the Federal Reserve’s policies deliberately threw gasoline all over those brush fires. QE2 was another economic napalm bomb from the global banking cartel.

In a recent McClathy news article entitled, “Egypt’s unrest may have roots in food prices, US Fed policy,” Kevin Hall reports:

“‘The truth of the matter is that when the Federal Reserve moved on the quantitative easing, it did export inflation to a lot of these emerging markets…. There’s no doubt that one of the side effects of the weak dollar and quantitative easing has been rising commodity prices. It helped create this bullish environment for commodities. This is a very delicate balancing act.’

It’s a view shared by Ed Yardeni, a veteran financial market analyst, who reached a similar conclusion in a research note to investors…. He joked that Fed Chairman Ben Bernanke should be added to a list of revolutionaries, since his quantitative easing policy, unveiled last year in Wyoming, has provoked unrest and change in the developing world.

‘Since he first indicated his support for such a revolutionary monetary change… the prices of corn, soybeans and wheat have risen 53 percent, 37 percent and 24.4 percent through Friday’s close,’ Yardeni noted. ‘The price of crude oil rose 19.8 percent over this period from $75.17 to $90.09 this (Monday) morning. Soaring food and fuel prices are compounding anger attributable to widespread unemployment in the countries currently experiencing riots.’”

The people throughout the Middle East and Northern Africa, on the fringe of the Neo-Liberal economic empire and most vulnerable to the Fed’s inflationary policies, are the first to rebel.
[read full report]

The conclusion that we reach, the unfortunate reality of our current crisis: the Federal Reserve and global economic central planners have declared war on us. We are under attack.

We must remove Ben Bernanke from power and hold him and the rest of the global banking cartel accountable. We must also break up the “too big to fail” banks. This a message I, along with many others who have analyzed our economic situation, have been repeating over and over for the past three years.

Hopefully, a critical mass of people will soon understand this reality and back it up with non-violent civil disobedience before riots and violence rip our society apart. For these reasons, let’s all go to Wall Street on September 17th and show these tyrants that we’ve had enough.

Read the entire article HERE.

By Greg Robb
June 20, 2011, 10:19 a.m. EDT
MarketWatch

The Federal Open Market Committee, which on Tuesday starts a two-day meeting, is widely expected to make the formal decision to end the current program of buying $600 billion of Treasury securities on June 30. It is also expected to maintain its existing policy to reinvest principal payments from maturing securities to not let its balance sheet shrink, and to keep the target range for the federal funds rate at between 0% and 0.25%.

That decision, due at 12:30 p.m., should hold few surprises, though the accompanying statement will be eyed. But the fireworks will start at 2:15 p.m., when Bernanke holds his second post-rate-decision press conference.

Bernanke’s challenge this week will be to calm financial markets, Corporate America and Main Street, all jittery about what’s in store for the U.S. economy.

A recent soft patch of economic data has only added to existing concerns about the fate of the U.S. once the Fed’s Treasury bond purchase program, frequently called QE2, comes to an end.

A stock market that has slumped for six weeks out of seven, a sky-high unemployment rate of 9.1% and the biggest 12-month inflation rise since Oct. 2008 has provided ammunition of all sorts for the Fed’s many critics.

“What Bernanke needs to do is build confidence in the economy. He has got to be able to step up there and say things are going to get better,” said Robert Brusca, chief economist at FAO Economics.

Bernard Baumohl, managing director of The Economic Outlook Group, said that Bernanke will need solid arguments to convince investors.

“I don’t think he is going to be a cheerleader. I think he’s going to have to be practical and realistic,” Baumohl said.

“He’s got to be straight,” agreed Scott Anderson, senior economist at Wells Fargo.

Baumohl said Bernanke will try to soothe markets by saying there is not going to be any fundamental change to policy in either direction for the foreseeable future.

While the hurdles to a third round of bond purchases are high, the same is true for an exit from the current ultra-low policy stance, Baumohl said.

“He will convey the message that the Fed is going to take a wait-and-see approach, Baumohl said.

But Bernanke will stress that the end of the QE2 program is not the equivalent of pulling the plug on the economy, said Michael Moran, chief economist at Daiwa Securities in New York.

In another step to build confidence, Bernanke will pledge to very closely monitor conditions to see if any of the threats facing the U.S. economy materialize such as a financial crisis in Europe, Baumohl said.

On inflation, Bernanke is likely to be a bit more hawkish than previous meetings, said Maury Harris, chief economist at UBS Securities, in a comment echoed by a number of analysts.

Core consumer price inflation, excluding food and energy prices, rose 0.3% in May, the biggest gain since June 2008. Many see core inflation rising near 2% year-over-year by the end of the year.

“Bernanke will have to acknowledge that,” Harris said.

Mike Englund. chief economist at Action Economics, said the public is so upset about higher energy prices that Bernanke is not likely to “pop the cork” about the recent small drop in gas prices.

“It is hard to be optimistic about $98 per barrel price of oil,” he said.

Ray Stone, economist at the forecasting firm Stone & McCarthy Research Associates, said he was intrigued by some news reports that the Fed might adopt a formal inflation target. Atlanta Fed President Dennis Lockhart this month backed an inflation target, and Bloomberg News reported that Fed officials were seriously discussing it. The Wall Street Journal said action isn’t likely at this meeting.

At the moment, the Fed has an implicit target of roughly 2% inflation.

But with inflation moving higher while Fed policy is accommodative, an inflation target might be one way for the Fed to stress it remains vigilant, said economists at Barclays Capital Research.

Stone said the odds are “less than 50-50” that the Fed would adopt a formal target “but I wouldn’t be knocked out of my chair if they did it,” he said.

The Fed also is expected to cut its economic growth forecast, which currently calls for growth between 3.1% and 3.3% this year.

Read the entire article HERE.

by Tyler Durden
ZeroHedge
04/25/2011

From Peter Tchir of TF Market Advisors

To QE or not to QE, that is the question.

So here is what I expect to happen and why.

The Fed will continue to re-invest proceeds from repayments.

The Fed will use proceeds from pre-payments and redemptions to buy new assets. If they don’t purchase new assets, they are effectively tightening. Any time one of their treasuries matures, they will receive payment from the treasury. This money has to be reinvested or else the Fed will have to remove some 1’s and 0’s from somewhere in the system, effectively, unprinting money. So using the proceeds merely keeps the status quo.
As part of this, they will also announce that they tend to purchase longer dated assets with these redemption proceeds. They will argue that they want to add additional support to the long end of the curve specifically to help the mortgage market. They may even go back to purchasing mortgages and not just treasuries. The rationale of using the money to lend as much support to the mortgage market as possible is the most politically acceptable reason. An unspoken reason for extending maturities will be growing concern within the Fed that this tool will be taken away, so to ensure the most control of their balance sheet they will want to extend their portfolio and reduce roll off going forward.

I believe the market has almost completely priced this in. Any sign that they will not re-invest proceeds would be a negative for the market. I’m not sure the market is pricing in any extension out the curve or into mortgages so those could provide mild upside. I’m a little concerned that much of what I read and hear tends to view re-investment as a continuation of QE2. I don’t see it that way. Any re-investment of proceeds from a treasury redemption is merely keeping the status quo. No new money is being created nor being pumped into the system, its no different than if the Fed had originally purchased this longer dated bond.

QE3 will differ from QE2 and has only a 50/50 probability of being announced

On a basic level, the hawks within the Fed would like to pause the QE program at the end of June. The doves are far more likely to be pushing for another round, but they seem less aggressive right now. The economic data is much stronger than when QE2 was first announced, although it has been weakening of late, and the sovereign debt crisis in Europe has taken another leg down. In an ideal world for the Fed, they would allow QE2 expire in June, but talk up the potential for QE3 in the event it is needed. There are two problems with this approach. One problem is that the Fed is well aware of the growing criticism of the policy. Somewhere in the back of his mind, Ben, must be concerned that if he does not proceed with QE2 now, there will be too much pressure on the voting members to launch QE3 later. If they don’t launch QE3 in June but the data deteriorates to the point they want to launch in September, the outcry might just be too strong. The government as a whole is already against it. Certainly the argument that ‘it worked’ would be difficult to make, the reality would be that just like so many other programs is that it increased current economic activity at the expense of future economic activity. Also, since Ben is constantly trying to manage expectations, what would the market reaction be to a Fed that does not proceed with QE3 in June but tries to do it only a short while later?

So I think they might be pressured into launching a version of QE3 in June, but I think it will look very different from QE2. I expect that it would target longer dated treasuries and possibly even mortgages, in an effort to create the most political support. I also believe it will be more open ended. Rather than saying we will spend $X billion in 6 months and here is our purchase schedule and target portfolio, he will create a ‘war chest’. QE3 will be positioned as we have $X billion that we are prepared to use to purchase longer dated treasuries and mortgages if and when we see the need to add support. This would be a true compromise. It does not force the Fed to create a schedule of auctions like QE2, in fact if the data remains stable they don’t have to do anything. That should appease the hawks. By targeting maturities that directly impact mortgage rates, its more palatable to the average American, and by keeping the activity less obvious they can deflect any links to inflation more easily. It also keeps the purchases open at a time when there must be some real concern that this alternative tool could be restricted in the future.

I believe that the market is set up for some disappointment. It feels like a lot of investors are saying they don’t expect QE3 but deep down think it’s likely and are positioned for the positive surprise. Another group of investors seems convinced that no QE3 is priced in so are comfortable being long since only a positive surprise could happen. In the end, I think a full QE3 announcement is mildly positive, a version of QE3 lite as described above is a minor negative, and no QE3 would be negative for the markets.

What the interested parties are pushing for

Ultimately Ben and the board will determine whether to pursue QE3 based on its merits, but there are a lot of interested parties that are pushing their agenda and likely have some influence on the outcome. In the end, for all these reasons, believe that it is only 50% chance that QE3 is implemented, and if it is implemented it will have more flexibility than QE2 and a more concentrated effort to help mortgage rates.

Wall Street is for QE3

The QE program is great for Wall Street. They will want to see it continue. At the most basic level, the treasury is purchasing about $120 billion a month in treasuries from them. If the street is making 1/8 on each trade with the government, that is $150 million of profit for the street every month. For a product like treasuries, maybe an 1/8 is too much, but since the Fed doesn’t disclose the purchase price, just the quantity, it’s not a horrible assumption. Asides from the direct bid/offer income made from the sale, the Fed is a dream client. They are big, and tell you what they want to do. If the street isn’t able to scrape out another 1/8 or 1/4, I would be surprised. So I think we can assume that the treasury desks make another $200 million a month from trading ahead of the POMO schedule. That is over $1 billion of additional profits for the street every quarter. That is hard to give up. From the earnings announcements so far, most of Wall street had strong revenues in their fixed income departments. A part was certainly coming from corporate new issues, but with secondary volumes light across the board in corporates, it makes sense that a portion of that performance came from treasury trading related to QE2.

That $1 billion a quarter is just an estimate of the direct impact for the banks. The extra $300 billion a quarter in money the Fed is printing has helped increase asset values and likely enhanced trading revenues on other desks as the money had to go somewhere.

So Wall Street would certainly prefer to see a QE3. They would never tell the Fed these are the reasons, but its certainly in their interest to push for more QE.

New York Fed is for QE3

I am going to treat the New York Fed separately from the other Fed members. First, their district benefits the most from QE. Keeping Wall Street happy is particularly important for the New York Fed. But I also believe that they like buying $120 billion of treasuries every month. They are an important player in the market. Wall Street traders who make multiples of what they do are finally at their beck and call. Maybe its all subconscious but its hard not to believe that Dudley enjoys having Wall Street ‘need’ him. The New York Fed gains prestige and the employees enjoy the power of wielding so much money, so they have a strong bias to maintain POMO. They won’t say it, but buying bonds and dealing with the street all day, is a lot more fun than writing two year plans that no one will ever read or follow.

The Average American is against QE3

The average American cares about jobs, mortgage rates, and how much it costs to make it through a day. The ‘success’ of QE2 has always mystified them. They heard about job creation but never really knew anyone who got a job from QE2. They heard it helped mortgage rates, but most had already refinanced, or are so underwater it doesn’t matter, so they assumed it must be working. They have some stocks in their 401k, so that’s been good, but their company is threatening their pensions which is what they were really relying on anyways. Nothing they heard about QE2 seemed to match what they were experiencing, but they let it go. Suddenly the cost of making it through the day has been sky rocketing. Their paycheck is the same, but gas, coffee, and food are all getting more expensive. They are nervous about the prices they are paying for things and are starting to blame this QE thing for it. They are also doubting it really did any of the good things people said it did. This message is becoming louder and congress is hearing it loud and clear.

Foreign Governments are against QE3

Regardless of what Ben says, other countries see QE as inflationary. Regardless of Obama’s contention that speculators are pushing up the price of oil (in dollars) other countries see the QE policy as partly responsible. China and other countries closely tied to the dollar as seeing inflation as a result and are not happy. The U.S. is also not the only country experiencing minimal growth. Other countries are too and the devaluation of the dollar is not helping their recovery. Even strong countries like Germany must occasionally look up from the task of bailing out the PIGS and wonder what the consequences of a strong Euro will have on their economy down the road. We have annoyed the world before, but usually we do that when we feel that we have the moral high ground. With QE, I’m not sure that anyone can really hold their head high and argue with foreign governments that what we are doing isn’t short sighted and selfish. This would be less of a concern if we didn’t need them to buy our debt and weren’t hoping that they won’t retaliate on the trade front.

Corporations are mixed on QE3

The impact to corporations has been mixed.

The immediate impact to any company with overseas income has been positive as they translate those earnings back into weak dollars. This is good so far, but may be temporary as other countries implement policies to fight the weak dollar.

Those that can sell overseas are benefitting from the weakness in the dollar as their products are more competitive. The commodity companies are benefitting directly as prices of their selling prices spike. Companies that have relatively low costs of input (technology) are also doing well; whereas, some manufacturing companies with intensive raw material usage are seeing pressure on margins in spite of increased opportunities overseas.

So in general, corporations are slightly positive on QE as beneficiaries of the weak dollar but are growing concerned as they see margin pressure building.

The Fed is pro QE3

The Fed still feels like it is leaning towards QE3 but is being held back by fear of backlash from the average American, government, and foreign pressure. Maybe they are even a little afraid they have unleashed inflation in spite of their denials that QE2 could in any way cause inflation – it merely caused the expectation of inflation which reduced the risk of deflation and made the whole world better. If they knew for certain that they would be able to launch QE3 anytime they wanted to, they would definitely hold off, but I think they feel it would be prudent to put QE3 in place right now, even if on a limited basis, rather than having to restart the program – which could be very unpopular, and may cause us more harm then good if that flip-flopping behavior spooked the markets.

Read the entire article HERE.

Submitted by THE Tyler Durden
04/11/2011 14:02 -0400

Recently there has been a meme spreading in the internet that the Fed does not really need to do QE3 as the central bank can maintain bid interest at sufficiently high levels by merely rolling and extending maturing debt, a form of QE Lite Version 2, where the Fed’s balance sheet is kept constant even as MBS are prepaid and Treasuries mature. The argument goes that based on some “logic” and lots of estimates it is “reasonable” to assume that $750 billion in MBS prepays and Treasury maturities will depart the Fed’s balance sheet and need to be repurchased in the open market in keeping with a pro forma QE Lite V2.0 mandate. This is false. Here’s why.

First: one does not need to engage in complex calculations of what the maturity profile of the Fed’s holdings are – it is there available for anyone with an internet connection to see for themselves. In each and every H.4.1 update (go ahead, click) the Fed lists the maturity portfolio of its assets. The most interesting for the purposes of this analysis is the securities due in under one year. This includes in addition to Treasurys, MBS and Agencies, also the following items completely irrelevant for this exercise: Reverse Repos , Term Deposits, Liquidity Swaps and Other loans. As the chart below shows, and as anyone with a calculator can estimate, there is $141 billion in Treasury, Agency and MBS maturities in under one year (and just $108 billion in purely Treasury holdings). This number is one tenth of the ongoing monetization of $900 billion in USTs and MBSs in the November-June period, or $1,350 billion annualized. In other words: simply rolling MBS and Treasuries will have one tenth the impact of the ongoing quantitative easing program. Period. End of Story.

(Click Chart for larger view)

So what about MBS prepays? Well, as we had thought we had made abundantly clear, the level of Fed MBS prepays is directly correlated with prevailing mortgage rates: the lower the mortgage rate, the more willing the end consumer is to “put” an existing mortgage to the Fed and open a cheaper one. And vice versa: the higher rates go, the less prepays the Fed experiences. Lo and behold: actually looking at the data, confirms precisely this. As the chart below shows, while in H2 2010, when 10 Year, and thus Mortgage rates, were dropping fast, prepays to the Fed, and thus the rate of QE Lite activity was very high: peaking at $45 billion in December. Alas, since then, due to surging rates, the prepay rates has plunged, and the February and March total of $40 billion is less than all of December. Should rates continue to rise, which they will if fears of no QE3 accelerate, and Bill Gross ends up being right, this number will plummet and could potentially hit zero as nobody has an incentive to prepay a mortgage when the existing one is far more economic.

(Click Chart for a larger view)

So putting it all together: assuming no QE3, and just continued rolling and transforming MBS in UST purchases, means that the Fed will have about $12 billion in average UST purchases per month from maturity extension, and about $20 billion from MBS prepays. This is at best one quarter of the amount the Fed monetizes per month currently and is largely inadequate to continue funding the US deficit. Also, should the 10 Year rate jump to over 5%, QE Lite will halt indefinitely, meaning the only source of dry powder for future monetization will be rolling maturity extensions, which are about one tenth of current monthly funding needs.

Lastly, and people tend to forget this, the primary reason why the Treasury needs the Fed to be the buyer of only resort is that no matter what happens to interest rates, and cash outlay to the Fed ends up being a revenue item for the Treasury! In fact, the higher the rate, the greater the purported revenue from Ben Bernanke, even though in reality it ends up being a wash transaction. For Tim Geithner the ideal situation would be one where the Fed owned all US interest paying instruments, as interest expense would be shortly reclassified as Treasury revenue. Should the Fed not be a key player in monetization, this is money that would ultimately leave the US. And if rates were to jump the annual interest outlays would actually be quite dramatic.

Read the original article HERE.

By Michael Pento
EuroPacific Capital
Monday, April 4, 2011

For years the Federal Reserve has told us that in order to detect inflation in the economy it is important to separate “signal from noise” by focusing on “core” inflation statistics, which exclude changes in food and energy prices. Because food and energy figure so prominently into consumer spending, this maneuver is not without controversy. But the Fed counters the criticism by pointing to the apparent volatility of the broader “headline” inflation figure, which includes food and energy. The Fed tells us that the danger lies in making a monetary policy mistake based on unreliable statistics. Being more stable (they tell us), the core is their preferred guide. Sounds reasonable…but it isn’t.

If it were truly just a question of volatility the Fed may have a point. But for headline inflation to be considered truly volatile, it must be evenly volatile both above and below the core rate of inflation over time. If such were the case, throwing out the high and the low could be a good idea. However, we have found that for more than a decade headline inflation has been consistently higher than core inflation. Once you understand this, it becomes much more plausible to argue that the Fed excludes food and energy not because those prices are volatile, but because they are rising.

If you talk about the grand sweep of Fed policy, it’s fairly easy to fix the onset of our current monetary period with the onset of the dot.com recession of 2000. To prevent the economy from going further into recession at that time, the Fed began cutting interest rates farther and faster than at any other time in our history. During the ensuing 11 years, interest rates have been held consistently below the rate of inflation. Even when the economy was seemingly robust in the mid years of the last decade, monetary policy was widely considered accommodative.

Over that time annual headline Consumer Price Index (CPI) data has been higher than the Core CPI 9 out of 11 years, or 81% of the time. Looking at the data another way, over that time frame, the U.S. dollar has lost 20% of its purchasing power if depreciated year by year using core inflation, and 24% if depreciated annually with headline inflation. The same pattern held during the inflationary period between 1977 thru 1980, when the Fed’s massive money printing sent the headline inflation rate well above the core reading. The empirical evidence is abundantly clear. When the Fed is debasing the dollar, headline inflation rises faster than core. The reason for this is clear. Food and energy prices are closely exposed to commodity prices which have a strong negative correlation to the falling dollar that is created by expansionary policies.

Data we have seen thus far in 2011 underscores the need to focus on headline inflation and to avoid the trap of relying on the relatively benign core. The difference between the core rate and headline rate of inflation was .6 percent in January and a full percentage point in February. If annualized those relatively small monthly disparities will become enormous.

It is shocking how few Americans, even those with economic degrees and press credentials, fully appreciate the Fed’s vested interest in reporting low inflation. With benign data in hand, Fed policy makers are given a free hand in adopting stimulative policies. Central bankers who shower liquidity on the economy earn the gratitude of their peers and the thanks of their political patrons. But once a central bank goes down the expansionary path to fight recession it is much easier to keep pumping money than to reverse course when inflation starts to bite into purchasing power.

The sad truth is that the Fed’s record low interest rates are once again causing food and energy prices to rise much faster than core items. Bernanke is focusing on the core just as we need him to focus on the headline. It’s time for the Fed to stop hiding behind flimsy statistical juggling and to start protecting the value of our dollar, which unfortunately is in free fall no matter what statistics one chooses to use.

Read the original article HERE.

Vice Chair Janet L. Yellen
At the Economic Club of New York
New York, New York
April 11, 2011

Good afternoon. For more than a century, the Economic Club of New York has provided an influential forum for the discussion of social, political and economic challenges facing the nation, and I appreciate very much your inviting me to speak today. My comments will focus on recent increases in commodity prices and the effects of those developments on the outlook for inflation, the economic recovery now under way, and the appropriate stance of monetary policy. Let me emphasize at the outset that these remarks reflect my own views and not those of others in the Federal Reserve System.1

Since early last summer, the prices of oil, agricultural products, and other raw materials have risen significantly. For example, the price of Brent crude oil has risen more than 70 percent and the price of corn has more than doubled; more broadly, the Commodity Research Bureau’s index of non-fuel commodity prices has risen roughly 40 percent. The imprint of these increases has become increasingly visible in overall measures of inflation. For example, inflation as measured by the price index for personal consumption expenditures (PCE) moved up to an annual rate of about 4 percent over the three months ending in February after having averaged less than 1-1/2 percent over the preceding two years. Moreover, survey data suggest that surging prices for gasoline and food have pushed up households’ near-term inflation expectations and are making consumers less confident about their economic circumstances.

Some observers have attributed the recent boom in commodity prices to the highly accommodative stance of U.S. monetary policy, including the marked expansion of the Federal Reserve’s balance sheet and the maintenance of the target federal funds rate at exceptionally low levels. Such an interpretation of recent developments naturally leads to the conclusion that the Federal Open Market Committee (FOMC) should move promptly toward firmer monetary conditions. Indeed, some have even raised the specter of a return to the high inflation of the 1970s in arguing for the urgency of monetary policy tightening.

Increases in energy and food prices are, without doubt, creating significant hardships for many people, both here in the United States and abroad. However, the implications of these increases for how the Federal Reserve should respond in terms of monetary policy must be considered very carefully. In my remarks today, I will make the case that recent developments in commodity prices can be explained largely by rising global demand and disruptions to global supply rather than by Federal Reserve policy. Moreover, empirical analysis suggests that these developments, at least thus far, are unlikely to have persistent effects on consumer inflation or to derail the recovery. Critically, so long as longer-run inflation expectations remain stable, the increases seen thus far in commodity prices and headline consumer inflation are not likely, in my view, to become embedded in the wage and price setting process and therefore are not likely to warrant any substantial shift in the stance of monetary policy. An accommodative monetary policy continues to be appropriate because unemployment remains elevated, and, even now, measures of underlying inflation are somewhat below the levels that FOMC participants judge to be consistent, over the longer run, with our statutory mandate to promote maximum employment and price stability.

While I continue to anticipate a gradual economic recovery in the context of price stability, I do recognize that further large and persistent increases in commodity prices could pose significant risks to both inflation and real activity that could necessitate a policy response. The FOMC is determined to ensure that we never again repeat the experience of the late 1960s and 1970s, when the Federal Reserve did not respond forcefully enough to rising inflation and allowed longer-term inflation expectations to drift upward. Consequently, we are paying close attention to the evolution of inflation and inflation expectations.

Sources of the Recent Rise in Commodity Prices
Let me now turn to a discussion of the sources of the recent increase in commodity prices. In my view, the run-up in the prices of crude oil, food, and other commodities we’ve seen over the past year can best be explained by the fundamentals of global supply and demand rather than by the stance of U.S. monetary policy.

In particular, a rapid pace of expansion of the emerging market economies (EMEs), which played a major role in driving up commodity prices from 2002 to 2008, appears to be the key factor driving the more recent run-up as well. Although real activity in the EMEs slowed appreciably immediately following the financial crisis, those economies resumed expanding briskly by the middle of 2009 after global financial conditions began improving, with China–which has accounted for roughly half of global growth in oil consumption over the past decade–again leading the way. By contrast, demand for commodities by the United States and other developed economies has grown very slowly; for example, in 2010 overall U.S. consumption of crude oil was lower in than in 1999 even though U.S. real gross domestic output (GDP) has risen more than 20 percent since then. On the supply side, heightened concerns about oil production in the Middle East and North Africa have recently put significant upward pressure on oil prices, while droughts in China and Russia and other weather-related supply disruptions have contributed to the jump in global food prices.

In contrast, the arguments linking the run-up in commodity prices to the stance of U.S. monetary policy do not seem to hold up to close scrutiny. In particular, some observers have pointed to dollar depreciation, speculative behavior, and international monetary linkages as key channels through which accommodative U.S. monetary policy might be exacerbating the boom in commodity markets. Let me address each of these possibilities in turn.

First, it does not seem reasonable to attribute much of the rise in commodity prices to movements in the foreign exchange value of the dollar. Since early last summer, the dollar has depreciated about 10 percent against other major currencies, and of that change, my sense is that only a limited portion should be attributed to the Federal Reserve’s initiation of a second round of securities purchases. By comparison, as I noted earlier, crude oil prices have risen more than 70 percent over the same period, and nonfuel commodity prices are up roughly 40 percent. Put another way, commodity prices have risen markedly in all major currencies, not just in terms of U.S. dollars, suggesting that the evolution of the foreign exchange value of the dollar can explain only a small fraction of those increases.

A second potential concern is that U.S. monetary policy is boosting commodity prices by reducing the cost of holding inventories or by fomenting “carry trades” and other forms of speculative behavior. But here, too, the evidence is not compelling. Price increases have been prevalent across a wide range of commodities, even those that are associated with little or no trading in futures markets. Moreover, if speculative transactions were the primary cause of rising commodity prices, we would expect to see mounting inventories of commodities as speculators hoarded such commodities, whereas in fact stocks of crude oil and agricultural products have generally been falling since last summer.2

A third concern expressed by some observers is that the exceptionally low level of U.S. interest rates has translated into excessive monetary stimulus in the EMEs. In particular, even though their economies have been expanding quite rapidly, many EMEs have been reluctant to raise their own interest rates because of concerns that higher rates could lead to further capital inflows and boost the value of their currencies. Some argue that their disinclination to tighten monetary policy has in turn resulted in economic overheating that has generated further upward pressures on commodity prices.

I do not think this explanation accounts for much of the surge in commodity prices, in part because I believe that the bulk of the rapid economic growth in EMEs mainly reflects fundamental improvements in productive capacity, as those countries become integrated into the global economy, rather than loose monetary policies. Irrespective of monetary conditions in the advanced foreign economies, it is clear that the monetary and fiscal authorities in the EMEs have a range of policy tools to address any potential for overheating in their economies if they choose to do so. Indeed, in light of the relatively high levels of resource utilization and inflationary pressures that many EMEs face at present, monetary tightening and currency appreciation might well be appropriate for those economies.

The Outlook for Consumer Prices
Turning now to the outlook for U.S. consumer prices, I anticipate that the recent surge in commodity prices will cause headline inflation to remain elevated over the next few months. However, I expect that consumer inflation will subsequently revert to an underlying trend that remains subdued, so long as increases in commodity prices moderate and longer run inflation expectations remain reasonably well-anchored.

Underlying Inflation Trends
Focusing on inflation prospects over the medium term is essential to the formulation of monetary policy because, due to lags, the medium term is the timeframe over which the FOMC’s actions can influence the economy. For this purpose, economists have constructed a variety of measures to separate underlying persistent movements in inflation from more transitory fluctuations. These measures include “core” inflation, which excludes changes in the prices of food and energy, and “trimmed mean” inflation, which exclude prices exhibiting the largest increases or decreases in any given month.

No single measure of underlying inflation is perfect, but it is notable that these measures have exhibited a remarkably consistent pattern since the onset of the recession: All show the underlying inflation rate declining markedly to a level somewhat below the rate of 2 percent or a bit less that FOMC participants consider to be consistent with the Fed’s dual mandate. For example, core PCE price inflation stood at less than 1 percent over the 12 months ending in February, down from 2-1/2 percent over the year prior to the recession. Trimmed-mean measures of inflation have also trended down over the past couple of years and are now close to 1 percent.

I want to emphasize that this focus on core and other inflation measures that may exclude recent increases in the cost of gasoline and other household essentials is not intended to downplay the importance of these items in the cost of living or to lower the bar on the definition of price stability. The Federal Reserve aims to stabilize inflation across the entire basket of goods and services that households purchase, including energy and food. Rather, we pay attention to core inflation and similar measures because, in light of the volatility of food and energy prices, core inflation has been a better forecaster of overall inflation in the medium term than overall inflation itself has been over the past 25 years.3

In my view, the marked decline in these trend measures of inflation since the intensification of the crisis largely reflects very low rates of resource utilization. Strong productivity gains have also played a role in holding down inflation because, together with low wage inflation, they have markedly restrained the rise in firms’ production costs. With resource slack likely to diminish only gradually over the next few years, it seems reasonable to anticipate that underlying inflation will remain subdued for some time, provided that longer-term inflation expectations remain well contained.

Longer-Run Inflation Expectations
In this regard, surveys and financial market data indicate that longer-run inflation expectations remain reasonably well anchored even though near-term inflation expectations have jumped in the wake of the surge in commodity prices. For example, the Thomson Reuters/ University of Michigan Survey of Consumers indicates that median inflation expectations for the coming year moved up about 1-1/4 percentage points in March, whereas the median expectation for inflation over the next 5 to 10 years increased only 1/4 percentage point. While such movements obviously bear watching, I would note that such a combination–namely, a substantial jump in near-term inflation expectations coupled with a relatively modest uptick in longer-run expectations–has often accompanied previous sharp increases in gasoline prices, and when it did, those movements were largely reversed within a few months.4

Information derived from the Treasury inflation-protected securities (TIPS) market also suggests that financial market participants’ longer-term inflation expectations remain well anchored even as the near-term outlook for inflation has shifted upward. In particular, while the carry-adjusted measure of inflation compensation for the next five years has increased about 1/4 percentage point since earlier this year, forward inflation compensation at longer horizons is roughly unchanged on net. Much of the increase in five-year inflation compensation has been associated with the surge in food and energy prices, and the level of this measure appears consistent with a normal cyclical recovery after adjusting for those effects.

Commodity Prices and Inflation
Now I would like to explain in further detail why I anticipate that recent increases in commodity prices are likely to have only transitory effects on headline inflation. The current configuration of quotes on futures contracts–which can serve as a reasonable benchmark in gauging the outlook for commodity prices–suggests that these prices will roughly stabilize near current levels or even decline in some cases. If that outcome materializes, the prices of gasoline and heating oil are likely to flatten out fairly soon, and retail food prices are likely to continue rising briskly for only a few more months. Consequently, the direct effects of the surge in commodity prices on headline consumer inflation should diminish sharply over coming months.

Over time, I anticipate that the recent surge in commodity prices will also affect the prices of a broader range of consumer goods and services that use these commodities as inputs. Many firms are seeing such costs escalate and will pass along at least part of these increased raw materials costs to their customers. Nevertheless, I expect the overall inflationary consequences of these pass-through effects to be modest and transitory, provided that longer-run inflation expectations remain well anchored. Moreover, labor costs per unit of output–the single largest component of the unit cost of producing goods and services in the business sector–are essentially unchanged since 2007, owing to both moderate wage increases and solid productivity gains. I expect that nominal wage growth and labor costs will continue to be restrained by slack in resource utilization. Indeed, it would be difficult to get a sustained increase in inflation as long as growth in nominal wages remains as low as we have seen recently.

My expectation regarding the transitory effects of commodity price shocks on consumer inflation is supported by simulation results from the FRB/US model–a macroeconometric model developed at the Federal Reserve Board and used extensively for policy analysis. Starting from a situation in which inflation is running at 2 percent and households and firms expect the FOMC to keep it there in the longer run, the model predicts that a persistent increase of $25 per barrel in the price of crude oil–that is, a rise similar to what we’ve experienced since last summer–would cause the PCE price index to rise at an annual rate of nearly 4 percent over the first two quarters following the shock. Beyond that horizon, however, total PCE inflation drops quickly to about 2-1/4 percent and then declines gradually back to its longer-run rate of 2 percent.

These fairly modest and transitory effects of an oil price shock are also consistent with the response of the U.S. economy to the dramatic run-up in commodity prices from 2002 to 2008. Indeed, while oil prices more than quadrupled over that period, measures of underlying inflation remained close to 2 percent. In my view, that outcome was crucially dependent on the stability of longer-run inflation expectations, which in turn limited the pass-through of higher production costs to consumer prices.

Risks to the Inflation Outlook
I have argued that recent commodity price shocks are likely to have only a transitory effect on inflation. But even if such a trajectory for inflation is most likely, some specific risks must be considered. First, while futures markets suggest that commodity prices will stabilize near current levels, these prices cannot be predicted with much confidence. For example, oil prices could move markedly higher or lower as a consequence of geopolitical developments, changes in production capacity, or shifts in the growth outlook of the EMEs.

In addition, the indirect effects of the commodity price surge could be amplified substantially if longer-run inflation expectations started drifting upward or if nominal wages began rising sharply as workers pressed employers to offset realized or prospective declines in their purchasing power.

Indeed, a key lesson from the experience of the late 1960s and 1970s is that the stability of longer-run inflation expectations cannot be taken for granted. At that time, the Federal Reserve’s monetary policy framework was opaque, its measures of resource utilization were flawed, and its policy actions generally followed a stop-start pattern that undermined public confidence in the Federal Reserve’s commitment to keep inflation under control. Consequently, longer-term inflation expectations became unmoored, and nominal wages and prices spiraled upward as workers sought compensation for past price increases and as firms responded to accelerating labor costs with further increases in prices. That wage-price spiral was eventually arrested by the Federal Reserve under Chairman Paul Volcker, but only at the cost of a severe recession in the early 1980s.

Since then, the Federal Reserve has remained determined to avoid those mistakes and to keep inflation low and stable. It will be important to closely monitor the state of longer-term inflation expectations to ensure that the Federal Reserve’s credibility, which has been built up over the past three decades, remains fully intact.

The Outlook for the Real Economy
Turning now to the real economy, real gross domestic product (GDP) has been rising since mid-2009 and now exceeds its level just prior to the onset of the recession. While GDP growth during late 2009 and early 2010 was largely the result of inventory restocking and fiscal stimulus, private final sales growth has picked up over the past six months–an encouraging sign. At the same time, measures of business sentiment have generally returned to pre-recession levels, factory output has been expanding apace, and the unemployment rate has dropped by a percentage point over the past few months.

Real consumer spending–which had been rising at a brisk pace in the fall–slowed somewhat around the turn of the year, and measures of consumer sentiment declined in March. Those developments may partly reflect the extent to which higher food and energy prices have sapped households’ purchasing power. More generally, however, as the improvement in the labor market deepens and broadens, households should regain some of the confidence they lost during the recession, providing an important boost to spending.

Broad Contours of the Outlook
Nonetheless, a sharp rebound in economic activity–like those that often follow deep recessions–does not appear to be in the offing. One key factor restraining the pace of recovery is the construction sector, which continues to be hampered by a considerable overhang of vacant homes and commercial properties and remains in the doldrums. In addition, spending by state and local governments seems likely to remain limited by tight budget conditions.

Moreover, while the labor market has recently shown some signs of life, job opportunities are still relatively scarce. The unemployment rate is down from its peak, but at 8.8 percent, it still remains quite elevated. And even the decline that we’ve seen to date partly reflects a drop in labor force participation, because people are counted as unemployed only if they are actively looking for work.

Some observers have argued that the high unemployment rate primarily reflects structural factors such as a longer duration of unemployment benefits and difficulties in matching available workers with vacant jobs rather than a deficiency of aggregate demand. In my view, however, the preponderance of available evidence and research suggests that these alternative structural explanations cannot account for the bulk of the rise in the unemployment rate during the recession. For example, if mismatches were of central importance, we would not expect to see high rates of unemployment across the vast majority of occupations and industries. Instead, I see weak demand for labor as the predominant explanation of why the rate of unemployment remains elevated and rates of resource utilization more generally are still well below normal levels.

Commodity Prices and the Real Economy
As I have indicated, the recent run-up in commodity prices is likely to weigh somewhat on consumer spending in coming months because it puts a painful squeeze on the pocketbooks of American households.5 In particular, higher oil prices lower American income overall because the United States is a major oil importer and hence much of the proceeds are transferred abroad. Monetary policy cannot directly alter this transfer of income abroad, which primarily reflects a change in relative prices driven by global demand and supply balances, not conditions in the United States. Thus, an increase in the price of crude oil acts like a tax on U.S. households, and like other taxes, tends to have a dampening effect on consumer spending.6

The surge in commodity prices may also dampen business spending. Higher food and energy prices should boost investment in agriculture, drilling, and mining but are likely to weigh on investment spending by firms in other sectors. Assuming these firms are unable to fully pass through higher input costs into prices, they will experience some compression in their profit margins, at least in the short run, thereby causing a decline in the marginal return on investment in most forms of equipment and structures.7 Moreover, to the extent that higher oil prices are associated with greater uncertainty about the economic outlook, businesses may decide to put off key investment decisions until that uncertainty subsides. Finally, with higher oil prices weighing on household income, weaker consumer spending could discourage business capital spending to some degree.

Fortunately, considerable evidence suggests that the effect of energy price shocks on the real economy has decreased substantially over the past several decades. During the period before the creation of the Organization of the Petroleum Exporting Countries (OPEC), cheap oil encouraged households to purchase gas-guzzling cars while firms had incentives to use energy-intensive production techniques. Consequently, when oil prices quadrupled in 1973-74, that degree of energy dependence resulted in substantial adverse effects on real economic activity. Since then, however, energy efficiency in both production and consumption has improved markedly.

Consequently, while the recent run-up in commodity prices is likely to weigh somewhat on consumer and business spending in coming months, I do not anticipate that those developments will greatly impede the economic recovery as long as these trends do not continue much further. For example, the simulation of the FRB/US model that I noted earlier indicates that a persistent increase of $25 per barrel in oil prices would reduce the level of real GDP about 1/2 percent over the first year and a bit more thereafter. The magnitude of that effect seems broadly consistent with the estimates of professional forecasters; for example, the Blue Chip consensus outlook for real GDP growth has edged down only modestly in recent months.

Monetary Policy Considerations
Let me now turn to the stance of monetary policy. As you know, monetary policy has been highly accommodative since the financial crisis intensified. In December 2008, the FOMC lowered the target federal funds rate to near zero and started to provide forward guidance concerning its likely future path. As in its statements since March 2009, the Committee reiterated last month that “economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” In addition, the FOMC has purchased a substantial volume of agency debt, agency mortgage-backed securities, and longer-term Treasury securities. The Committee initiated a second round of Treasury purchases last November and has indicated that it intends to complete those purchases by the end of June. My reading of the evidence is that these securities purchases have proven effective in easing financial conditions, thereby promoting a stronger pace of economic recovery and checking undesirable disinflationary pressures.

I believe this accommodative policy stance is still appropriate because unemployment remains elevated, longer-run inflation expectations remain well anchored, and measures of underlying inflation are somewhat low relative to the rate of 2 percent or a bit less that Committee participants judge to be consistent over the longer term with our statutory mandate. However, there can be no question that sometime down the road, as the recovery gathers steam, it will become necessary for the FOMC to withdraw the monetary policy accommodation we have put in place. That process will involve both raising the target federal funds rate over time and gradually normalizing the size and composition of our security holdings. Importantly, we are confident that we have the tools in place to withdraw monetary stimulus, and we are prepared to use those tools when the right time comes.

Of course, there are risks to the outlook that may affect the timing and pace of monetary policy firming. In my view, however, even additional large and persistent shocks to commodity prices might not call for any substantial change in the course of monetary policy as long as inflation expectations remain well anchored and measures of underlying inflation continue to be subdued. As I noted earlier, a surge in commodity prices unavoidably impairs performance with respect to both aspects of the Federal Reserve’s dual mandate: Such shocks push up unemployment and raise inflation. A policy easing might alleviate the effects on employment but would tend to exacerbate the inflationary effects; conversely, policy firming might mitigate the rise in inflation but would contribute to an even weaker economic recovery. Under such circumstances, an appropriate balance in fulfilling our dual mandate might well call for the FOMC to leave the stance of monetary policy broadly unchanged.

That said, in light of the experience of the 1970s, it is clear that we cannot be complacent about the stability of inflation expectations, and we must be prepared to take decisive action to keep these expectations stable. For example, if a continued run-up in commodity prices appeared to be sparking a wage-price spiral, then underlying inflation could begin trending upward at an unacceptable pace. Such circumstances would clearly call for policy firming to ensure that longer-term inflation expectations remain firmly anchored.

Conclusion
In summary, the surge in commodity prices over the past year appears to be largely attributable to a combination of rising global demand and disruptions in global supply. These developments seem unlikely to have persistent effects on consumer inflation or to derail the economic recovery and hence do not, in my view, warrant any substantial shift in the stance of monetary policy. However, my colleagues and I are paying close attention to the evolution of inflation and inflation expectations, and we are prepared to act as needed to help ensure that inflation, over time, is at levels consistent with our statutory mandate.

Read the original article HERE.

Thursday, March 24, 2011
Gonzalo Lira

So back in September 2008—in the throes of the Global Financial Crisis—the Federal Reserve under its chairman, Ben Bernanke, unleashed what was then known as “Quantitative Easing”.

They basically printed money out of thin air—about $1.25 trillion—and used it to purchase the so-called “toxic assets” from all the banks up and down Wall Street which were about to keel over dead. The reason they were about to keel over dead was because the “toxic assets”—mortgage backed securities and so on—were worth fractions of their nominal value. Very small fractions. All these banks were broke, because of their bad bets on these toxic assets. So in order to keep them from going broke—and thereby wrecking the world economy—the Fed payed 100 cents on the dollar for this crap.

In other words, the Fed saved Wall Street by printing money, and then giving it to them in exchange for bad paper.

Time passes, we move on.

Then, in November 2010, the Federal Reserve—still under Ben Bernanke—unleashed what is colloquially known as QE-2: The Fed announced that it would purchase $600 billion worth of Treasury bonds over the next eight months.

The rationale was so as to stimulate lending. But really, it was so that the Federal government wouldn’t go broke. The Federal government deficit for fiscal year 2011 is $1.6 trillion—the national debt is beyond 100% of GDP, at about $14 trillion. The Federal government issues Treasury bonds in order to fund this deficit. Ergo, by way of QE-2, the Federal Reserve bought roughly 40% of the Federal government deficit for FY 2011. Add on other Treasury bond purchases by the Fed via QE-lite (the reinvestment of the excedents of the toxic assets on the Fed’s books), and the Federal Reserve is buying up half the deficit of the Federal government, as I discussed here in some detail.

In other words, the Fed saved Washington by printing up money, and then giving it to them in exchange for—well, not bad paper, but at least questionable paper.

So! . . . let’s see now . . . Fed money printing—check! Saving someone’s bacon (even though they shoulda known better)—check! Taking on dodgy paper—check!

Did it in 2008 for Wall Street, then did it again in 2010 for Washington.

But the key difference between these two events is, the banks didn’t have any more toxic assets, once they sold them all to the Fed.

But the Federal government will still have more Treasury bonds it will have to sell, once the Federal Reserve ends QE-2 this coming June.

The fiscal year 2012 deficit will be on an order of 10% of GDP—roughly $1.5 trillion. And 2013 and 2014? Around the same range.

Over at Zero Hedge, they are past masters at timing the funding needs of the Federal government. But we don’t need to go into the monthly figures of POMO purchases and Treasury auctions and all the rest of it. All due respect to Tyler and his wonderful team at ZH, all that is merely the mechanics of Federal Reserve monetization.

What we should look at is the simple, macro question: If the Fed ends QE-2 in June as they have said they will, who will take up the slack? Who will purchase between $75 and $100 billion worth of Treasury bonds at yields of 3.5% for the 10-year?

Is there someone?

Anyone?

The answer is, No one will take up the slack.

Who, Japan? They’ve got some well-known troubles of their own—they’re all about selling Treasuries and buying up yens, both now and for the foreseeable future.

The Chinese? They’ve been quietly exiting Treasuries for a couple of years now, and going into every commodity known to man.

Europe? Are you serious—Europe? Please don’t make me laugh that hard—it hurts.

The fact is, there is no one outside the United States that I can think of who would willingly buy Treasury bonds—not to the tune of +$75 billion a month.

Therefore, if no one outside the United States would willingly give money to Washington to fund the deficit, then someone inside the U.S. will have to step up.

The obvious-obvious-obvious solution to this mess is for the Federal government to stop spending its way to oblivion—but does anyone realistically see this happening?

Therefore, as Spock always sez, if you eliminate the impossible, whatever remains, however improbable, must be the truth.

If foreign sources of funding will not cover the Federal government’s deficit after June 2011, and Washington will definitely not cut spending in any sort of realistic sense, then there really are only two—and only two—possibilities:

• The indefinite continuation of QE by the Federal Reserve.

• Or the requisitioning of private retirement accounts and pension funds.

Don’t dismiss the second possibility out of hand—think it over.

What pool of money is just sitting there, not doing much, while being legally barred from its owners? What pool of money is easily accessed, yet is large enough to fund the deficit?

The retirement accounts of the American people: Both individual private accounts, and pension funds.

After all, the total for all pension monies is roughly 100% of GDP (this includes Social Security). And the Federal government has already raided the “Social Security lock box”—that box is stuffed with Treasury IOU’s.

So the Federal government might well turn to the private sector for cash. The Federal government might conceivably claim that ongoing funding needs require that every single 401(k) and IRA divest from its portfolio of stocks and bonds, and be fully invested in Treasuries.

This could be accomplished very easily, from a practical standpoint—just inform banks, and have them turn over to the Federal government all your mutual funds and stocks you agonized over, and get long-term Treasury bonds of nominal equal value in exchange.

401(k)’s and IRA’s would be the first ones the Federal government would go after—for the obvious reason that union pension funds have the union’s political muscle. But individuals? They have no political machine. So they’re screwed.

Anyway, the language used for this maneuver by the Treasury department would make it difficult for a lot of (unaffected) people to get upset over the situation: The Treasury department wouldn’t call this process “retirement account confiscation”. They’d call it something innocuous, like “retirement asset swap”—or better yet, throw in some patriotic bullshit (indeed, the last refuge of the scoundrel) and call it “Americ-Aide Asset Swap”—or even better: Call it “Help America Retirement Treasury Bond Program”—otherwise known as HART-bonds. (Awww!!! Probably maudlin enough to get Geithner an appearance on fucking Oprah.)

There might be short-term political damage, but like losing your virginity or carrying out state-sponsored torture programs, it would be the necessary start for a slide that will never end. After this first “retirement asset swap” carried out on the 401(k)’s and IRA’s, the Treasury department would start doing more of this to ever-bigger pension funds, until eventually all retirement assets would be converted into Treasury bonds.

Hey, they did it in Argentina. And as Yves Smith always sez, America has become Argentina, but with nukes.

Now, this is one possibility, of the only two which I can see.

The other possibility, of course, is that the Federal Reserve will not end Quantitative Easing-2 come June. The Fed will extend the deficit monetization indefinitely. The Fed will be under the mistaken impression that this will somehow save the U.S. economy. (The best metaphor I’ve been able to come up with for this situation is, the Federal government is like a junkie who’s already OD’ed—and the Federal Reserve is trying to “save” him by shooting him up with even more heroin.)

So between these two possibilities—confiscating retirement accounts and forcing some sort of Treasury bond asset swap, or an endless continuation of QE—which is easier?

Obviously QE-three.

Therefore, that’s what I think is going to happen: QE money-printing as far as the eye can see.

Well, look on the bright side: At least you’ll get to keep your ever-shrinking retirement nest egg. Bully for you!

Read the original blog post HERE.

Posted on March 20, 2011
by PaperEmpire

Each time we begin to approach the end of an announced QE period, the nervous jitters of financial markets start to set in. Will Bernanke continue with QE(n+1) or won’t he? Now it’s true that professional traders live and die by their ability to front run rumor and perception, but for long term investors who fret over such decisions, it demonstrates a fundamental lack of understanding of what QE really is. To put it succinctly, QE is an economic deal with the Devil. Once it is begun in earnest there can be no turning back. It must be played to its ultimate conclusion.

In Bernanke’s 2009 interview on 60 Minutes, he suffered a momentary lapse into honesty and stated that Quantitative Easing was effectively money printing. So why then the complicated euphemism of Quantitative Easing? Because that is what modern central banking sponsored economics is all about – the intentional obfuscation of otherwise simple economic principles to cause the eyes of normal people to glaze over. Once accomplished, the central bankers (and their financial community brethren) are able to pursue policies that greatly benefit themselves but are devastating to everyone else. .

Long term investors who worry about whether QE will continue clearly recognize the fact that everything is now correlated to the Fed’s balance sheet. What they don’t understand is how QE is related to the larger economic cycle and its mission of preventing economic recessions.

Keeping the tent inflated

Sometimes physical analogies are the most helpful in understanding complex relationships. Let’s think of the economy as a large inflated tent. The extent of the tent’s inflation is the health of the economy. Under normal economic conditions the tent is fully inflated. In the course of time, events take place that cause the need for a correction to the economic system. New technology can come along which obsoletes old industries, bad investments and debt must be liquidated etc. When this happens a free market economy will correct itself. Capital tied up in failed industries will be reallocated and invested in new businesses. New jobs will ultimately be created and people will go back to work. Of course this reorganization takes place over time and this is what a recession is – a healing process for the economy. In our tent we can think of this as a tear that forms in the fabric. While this hole is being repaired, air escapes and the tent begins to sag a little. The extent of the drooping is the extent of the recession. Once fixed, the tent and the economy go back to normal.

QE is a wholly different method of keeping the tent propped up. It does not repair the hole, but rather attempts to keep the tent inflated by pumping more air in than is escaping through the hole. This is the new money being created and pushed into the economy to offset the credit destruction in the banking system. This is a dynamic process that must be maintained. The catch is that the hole doesn’t just stay a fixed size. The tear begins to lengthen allowing greater amounts of air to escape. The economic tent begins to sag until the volume of air being pumped in is increased to overcome the outflow. This is why QE can never end. To stop now, with such a large hole, would result in a severe and frightening recession. The tent would lose a tremendous amount of air in the time it takes to make such an extensive repair.

This process continues until eventually the hole is so large that the tent collapses around the massive flow of pumping air. This is the ultimate fate of money printing as policy – a currency crisis – the endless flow of new money loses purchasing power faster than it can be created. We are left with an inflationary depression in which savings are decimated and the standard of living of most Americans is dramatically lowered.

QE is economic central planning

When an institution such as the Federal Reserve is allowed to create as much money as it wants and do with it whatever it pleases, without any oversight or transparency, then the free market and its self correcting mechanisms no longer exist. How can capital from failed business and banks be reallocated to more efficient uses when these institutions are bailed out and not allowed to fail? Prices and interest rates are the nervous system of a free market economy. They are the feedback mechanisms that direct all of the individual participants to behave in the most productive and efficient manner. There can no free market when prices and interest rates are de-linked from supply and demand. We are now a centrally planned economy run by our central bank.

But here’s the really insidious part of QE that almost no one in the general public understands: A free society cannot exist independent of free markets. There is a disequilibrium that occurs between the two and over time one will win out over the other. And so here we are, stuck in a decaying economic system that prevents resources from being used in their most efficient manner. We simply can no longer compete with freer markets in other parts of the globe. We are saddled with the weight of central economic planning much like the old Soviet Union was. There will be no recovery and no rush of new jobs created. We will live under the burden of a burgeoning Federal government that operates completely independent of the will of its citizens. It is now beholden only the money manufacturers at the Federal Reserve and will spend money as fast as Bernanke can add zeros to its account.

The problems we are experiencing have been a long time in the making. They began in earnest in 1913 with the formation of the Federal Reserve. It’s taken several generations for the Federal government and its central bank to usurp the world’s monetary system and as such few have noticed. But what’s different now is that we have hit the knee in the curve, the point at which events start to accelerate dramatically as we approach the end of the line. Those who understand QE realize that America as we knew it is already gone. Over the next decade the rest of America will become painfully aware of that fact as well.

Read the entire article HERE.

By Chris Martenson PhD
Financial Sense
03/08/2011

Prepare for Fed-induced turbulence in the markets

There’s a scenario that could play out between May and September in which commodities (including my beloved silver) and the stock and bond markets could all sell off between 20% and 40%. The trigger will be the cessation of QE II and a multi-month pause before QE III.

This is a reversal in my thinking from the outright inflationary ‘buy with both hands’ bent that I have held for the past two years. Even though it’s quite a speculative analysis at this early stage, it is a possibility that we must consider.

Important note: This is a short-term scenario that stems from my trading days, so if you are a long-term holder of a core position in gold and silver, as am I, nothing has changed in my extended outlook for these metals. The fiscal and monetary path we are on has a very high likelihood of failure over the coming decade, and I see nothing that shakes that view.

But over the next 3-6 months, I have a few specific concerns.

It’s time to build on the idea I planted in the Insider article entitled Blame the Victim (February 28, 2011) where I speculated on the idea that the Fed might be forced to end its quantitative easing programs, almost certainly because of behind-the-scenes pressure.

Here’s what I said:

How I read [the Fed's recent propaganda tour] is that the Fed is taking some heat for its inflationary policies, mainly behind closed doors, and it is trying to do what it can — with words — to soothe the situation. Perhaps China is making noises, or perhaps Brazil’s finance minister is making the phone lines feeding the Eccles building smoke ominously, or perhaps it is internal pressure coming from politicians with restless voters. Or all three.

The big risk here is that the Fed will be forced by this rising pressure to discontinue the QE program in June at the normal ending of the QE II efforts. Couple that with a possible federal showdown over the debt ceiling right at the same time, and you have the makings for a massive fireworks display, possibly involving derivative mortars bursting in air.

At the time, I speculated that all of the Fed’s pronouncements about inflation being almost nonexistent were actually signs that the Fed was taking some behind-the-scenes heat for the inflation its policies was creating. And I worried about what would happen if the Fed were to end the QE program in June.

Let’s just say it won’t be pretty.

Everything would tank. Stocks, bonds, and commodities. All of the risk assets that have been unnaturally supported by a flood of liquidity, too-low interest rates, and thin-air base money would give up those ill-gotten gains. Gold might behave a bit differently, because along with these market declines will come an enormous amount of uncertainty about the financial system itself, usually a condition for higher gold prices. So I expect gold to correct somewhat, but not nearly as much as everything else, and it could even gain.

The story is, admittedly, getting more confusing by the week, with some calling for hyperinflation and some calling for massive, outright deflation. I am trying to surf the probabilities and stay one step ahead of whatever curve balls are coming our way.

The basic idea is this: The Fed has been dumping roughly $4 billion of thin-air money into the US markets each trading day since November 2010. The markets, all of them, are higher than they would be without this money. $4 billion per trading day is an enormous amount of money. It’s gigantic by historical standards. As soon as the QE program ends, the markets will have to subsist on a lot less money and liquidity, and the result is almost perfectly predictable.

Hello, downdraft.

The markets are quite substantially elevated due to the efforts of the Fed. T, and then some, is quite likely to be rapidly eliminated as soon as the QE program has ended.

It’s really that simple.

To make the story even more difficult to follow, the Fed has been sending out teams of PR agents in an effort to guide the markets with their words.

First, on March 2, 2011 Bernanke said this:

Bernanke Signals No Rush to Tighten When Asset-Buying Ends

March 2, 2011

Federal Reserve Chairman Ben S. Bernanke signaled he’s in no rush to tighten credit after the Fed finishes an expansion of record monetary stimulus, seeing little inflation risk and still-slow job growth.

A surge in the prices of oil and other commodities probably won’t generate a lasting rise in inflation, Bernanke told lawmakers yesterday in semiannual testimony on monetary policy. A “sustained period of stronger job creation” is needed to ensure a solid recovery, and the Fed’s benchmark rate will stay low for an “extended period,” he said.

The “no rush to tighten credit” statement is a signal that the Fed will neither raise rates at the end of the QE program nor perform reverse POMOs where it reels cash back in and pushes MBS and/or Treasury paper back out.

Upon the cessation of the QE efforts, and the cessation of $4 billion a day in Treasury buying pressure, it’s a safe bet that market interest rates will rise. Bernanke is at least on record as saying that if this happens, it won’t be because the Fed has taken the lead.

Bernanke was being a little bit sloppy in his statements, because stopping QE will serve to tighten credit simply because there will be a lot less liquidity sloshing around the system. It’s a situation where the absence of excess is the same as the presence of tightness, if that makes any sense.

Then on March 5th, a much stronger and clearer signal was given, confirming my worries:

Fed Policy Makers Signal Abrupt End to Bond Purchases in June

March 4, 2011

Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.

“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month.

Whoa. This is important news. Not only a cessation of QE, but the possibility of a sudden stop is being telegraphed. This will change everything.

The old saying ‘sell in May and go away’ might never be truer than this year, although with this sort of a warning, the cautious investor may want to get a head start on things and sell in March or April.

For some time there have been rumors that the Fed has been splitting into factions, with some of the inner team becoming increasingly uncomfortable with the QE program and its effects. But so far they’ve either spoken in code to reveal their displeasure or quietly resigned. So we’re pretty sure there’s an admirable level of support within the Fed for ending QE, and it has now bubbled to the surface and reached the public arena.

Of course, there’s some form of gobbledy-gook reasoning being floated to justify the plan for a sudden stop rather than a gentle wind-down, and it involves the distinction between ‘stocks and flows’ (from the same article as above):

Fed staff members, such as Brian Sack, the New York Fed official in charge of carrying out the bond buying, have argued the total amount, or stock, of securities the Fed has announced it will make has more impact on longer-term interest rates than the timing of those purchases. That’s a view now held by several members on the Federal Open Market Committee, including the chairman.

“We learned in the first quarter of last year, when we ended our previous program, that the markets had anticipated that adequately, and we didn’t see any major impact on interest rates,” Fed Chairman Ben S. Bernanke told the Senate Banking Committee during his March 1 semiannual monetary-policy testimony. “It’s really the total amount of holdings, rather than the flow of new purchases, that affects the level of interest rates.”

Fed Vice Chairman Janet Yellen supported that perspective, saying at a monetary policy forum in New York last week that “the stock view won out over the flow view.”

The idea that Brian Sack, a 40-year-old economist with a PhD from MIT, is winning the day in the argument of “stocks over flows” is somewhat troubling to me. MIT is a quantitative shop, home to some very brilliant people, but how markets will actually respond is another specialty altogether, one that requires a bit of on-the-street experience. Markets have a bad habit of not being logical, not fitting neatly into tidy formulas, and ignoring things like ‘stocks and flows.’

I’ll go even further. I’ll take the other side of that bet and opine that the flows are much more important than the stocks, because it is the flows that support the continued budget deficits of the US government — which, it should be noted, will still be with us each and every month long after June 2011. Those deficits are baked into the cake and will require in excess of $125 billion in new Treasury sales each and every month.

Who will buy all the Treasury bonds after the Fed steps aside? That is unclear. If there are not enough buyers at these artificially inflated prices, then the price will have to fall until sufficient buyers can be found. Falling bond prices are at the other side of the financial see-saw from rising bond yields; one goes down while the other goes up, and the Fed has been pressing firmly down on yields for a while via the QE II program. When that’s over, pressure will be reduced and yields will rise.

Continue reading part II HERE. I subscription to Mr. Martensen’s newsletter is required

By Gary Tanashian
Financial Sense
03/08/2011

While NFTRH was highlighting risk leading into the initial phase of inflationary blow-ups – and surely Egypt, Libya and other strained global situations are symptomatic of chronic and disenfranchising inflation – it is important to understand that headline events do not move markets, beyond the very short term. Indeed, I saw enough last week to nudge the very short-term risk profile toward neutral; and in an age of inflation onDemand one should question a net bearish stance more often than not. Inflation ran the 2003-2007 bull market quite well until ultimately, the soufflé pancaked in 2008.

Bloomberg’s top two headlines at the end of the week: “China’s Wen Targets Inflation as Top Priority to Cut Risk of Social Unrest” and”US Stocks Rise as Economic Optimism Overshadows Increase in Oil Prices”.

I want to spend some time breaking down these headlines, before transitioning to precious metals analysis, where we will take the macro pulse of the sector and review two core gold explorers, from a technical perspective.

Back on message, inflationary policy is what the asset spectrum feeds upon, as the ‘ruling’ class (including you and me ladies and gentlemen, as asset speculators) benefits to the detriment of the non-investor classes, in the US and the world over. People are suffering due to the cheapening of the money used as the medium of exchange for their wages, even as we go forth and speculate on some high potential gold explorers, uranium prospects, emerging, productive and/or resource rich markets, and other areas that offer opportunity in an inflationary world.

Enter, the first Bloomberg headline above. In the article http://tinyurl.com/nftrh126a, [edit: title since changed... hmmm] Premier Wen Jiabao states “We cannot allow price rises to affect the normal lives of low-income people” to which I would answer “Mr. Premier, you have already allowed inflation to affect the normal lives of low income (really low income) people, because you have already promoted and feasted upon an epic and ongoing policy of inflation. You now attempt to stuff the genie back in the bottle because you see some frontier markets blowing up due to global inflation dynamics and perhaps wonder how long it will take for the flames to reach your homeland.”

From my vantage point in the downsized productive (i.e. manufacturing) segment of the US economy, I have watched a myopic and collective greed in the United States work in tacit partnership with China to cheapen the entire concept of free trade. The US, manufacturer of the world’s reserve currency, has been able to leverage and monetize its reputation – built of sweat equity in the earlier parts of the previous century (for ref. see my first ever public article from 2004, Frankemarket Liveshttp://www.biiwii.com/frankenmarket.htm) – in partnership with China, by selling Treasury bonds, printing money and creating a heretofore limitless inflationary drag on the US currency.

Edit: for an unbelievable view of that very different America, see here:http://tinyurl.com/biiwii3811d

China, in pinning its currency to the dollar, and accepting massive volumes of USD denominated instruments in exchange for the work and productivity of its people, has inflated right along with the US. Typical of politicians, the Politburo now tells the people the straight deal after it is too late and presumably upon feeling an implied threat as indicated by the Egypt and Libya uprisings. China’s emerging manufacturing economy has been built by direct, indirect and ongoing inflation.

A robotic talking head sums up the second article http://tinyurl.com/nftrh126b :

“It’s a battle between the negative geopolitical environment versus the very strong economic fundamentals,” said Benjamin Pace, who helps oversee about $420 billion as the New York-based chief investment officer of Deutsche Bank Private Wealth Management. “The economic environment is very equity friendly. The current geopolitical environment and its impact on oil prices, not so much.”

No sir, it is a battle between the geopolitical manifestations of inflation and the seemingly strong economic fundamentals produced by said inflation as grains, clothing materials and energy costs rise right along with precious metals in a not so tacit indictment of these “strong economic fundamentals” that you speak of. During the 2003-2007 cycle, the same thing happened as a result of policy makers’ refusal to allow the economy to purge itself through a hard downturn, which would have eventually set the stage for a new and lasting up cycle. No, in and around 2000, the game became inflation onDemand; inflation as economic stimulant; inflation… it’s what’s for dinner.

Short-term, global and especially US markets are back in the game of blaming oil for the market’s ups and downs. This is similar to the ending stages of the 2003-2007 cycle. Be aware that the majority of ‘Hope 09′ (and ‘Full Hubris 10′, ‘Suck-in 11′, AKA the inflationary cyclical bull born 2008, died… ?) has been attended by a positive correlation to oil, copper, food prices… the stuff that people need; which brings us right back to square one of this segment… the effects of inflation are beginning to erode peoples’ lives and it is becoming obvious. The actual inflation has been ongoing up to now.

Going forward, global policy makers will not be able to merrily inflate their way to bull nirvana. See Wen above; see Trichet last week talking about euro rate hikes. See Ben Bernanke… well, our Fed chief has not quite gotten the memo yet. But even in the US, the winds of change appear to be blowing. Whether our congress puts a stop to it or natural market forces do (I’ll take ‘b’ Alex), the inflation cannot go on uninterrupted forever.

And this, my friends, is where investing and/or speculating becomes tricky. This is where the specter of deflation or more accurately, a deflationary ‘event’ comes into play. At the root of this dynamic is the case for the NFTRH ‘gold stocks above all others’ stance, because it is in gold’s ‘real’ price that the gold mining industry finds its most positive fundamentals, with gold outperforming the things of positive economic correlation, including those that feed into gold mining cost structures.

Read the entire article HERE.