99 Years Of Keynesian-Monetarist "Winning"

99 years ago the Fed was born. Then there was a world war. Two decades later, Keynesian economics (in a somewhat mutated form than that envisioned by the author, much like the Taylor rule) became the gold standard (pardon the pun) of the status quo, as it gave the political establishment a “scientific” justification to spend and accumulate gargantuan debt loads without fear of backlash by the public. Then there was another world war. Then the gold standard was obliterated, allowing the same establishment to dilute the instrument used as money and to cross the “gargantuan” barrier in spending and debt issuance. Then the world came to the verge of complete socio-economic and systemic collapse after a ponzi pyramid of $1 quadrillion in credit money nearly imploded in on itself. Then the final chapter of the corporate takeover of the sovereign model established by the Treaty of Westphalia arrived, as private deleveraging at the terminal expense of public debt took place at a record pace. This is a nutshell is the world history of the past century. And to summarize where we currently stand, we present the chart below. In the entire “developed” world, there is only one country that runs a budget surplus, even as the entire “developed” world is now, according to the Reinhart and Rogoff definition of sustainable public leverage, insolvent.

And that, ladies and gentlemen, is Keynesian-Monetarist #winning!


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P.S. Among the list of key events above, we did not mention the following two other majors one: the creation of the Welfare state by Bismarck in 1870 as a German unification ploy, whereby people were promised virtually anything if only they voluntarily agree to participate in a sovereign ponzi scheme which by definition is unsustainable and cede liberty in order to perpetuate a lie subsequently adopted by all “developed” world governments taking advantage of their mathematically-challenged citizens, nor the 16th Amendment ushering the personal income tax (previously ruled unconstitutional), coincidentally the same year the Fed was born, which in turn enabled the creation of the most bloated apparatus (which as a reminder produces nothing) known to homo sapiens – the US government.

The Fed Is Expected to Launch QE3 Next Week … Which Would Help the Rich and Hurt the Little Guy

Many speculate that the Fed will launch QE3 next week.

But independent economics and financial experts say this would hurt – rather than help – the economy.

Dallas Federal Reserve Bank president Richard Fisher said:

I firmly believe that the Federal Reserve has already pressed the limits of monetary policy. So-called QE2, to my way of thinking, was of doubtful efficacy, which is why I did not support it to begin with. But even if you believe the costs of QE2 were worth its purported benefits, you would be hard pressed to now say that still more liquidity, or more fuel, is called for given the more than $1.5 trillion in excess bank reserves and the substantial liquid holdings above the normal working capital needs of corporate businesses.

William F. Ford – former president of the Federal Reserve Bank of Atlanta – notes:

One of the overlooked consequences of the Federal Reserve’s recent rounds of monetary stimulus is the adverse impact those policies have had on the interest income of savers. The prolonged and abnormally low interest-rate structure put in place by the Fed has made life particularly difficult for retirees and others who depend on conservative interest-sensitive investments. But the negative effects do not stop there. They spillover into the overall performance of the economy.


Our estimates show that these negative effects, resulting from the Fed’s two rounds of quantitative easing (QE1 and QE2), are sizable and may help account for the lackluster character of the current recovery.




By lowering interest rates to historically unprecedented levels, the Fed’s policy deprives savers of interest income they normally would have earned on the interest-sensitive assets they hold. Thus, there is an income channel that no one is talking about, and its negative impact can be powerful.




Table 2 below shows our estimates of the possible losses in spending power, output, and employment generated by the Fed’s artificially low interest rates. Even by our most conservative estimate, which only looks at the $9.9 trillion in assets most directly affected by depressed yields on Treasurys, the losses are impressive. The average yield on Treasurys in June 2010 was 2.14 percent compared to an average of 7.07 percent in the previous nine recoveries, a difference of 4.93 percentage points. The projected annual impact of this loss of interest income on just $9.9 trillion of rate-sensitive assets translates into $256 billion of lost consumption, a 1.75 percent loss of GDP, and about 2.4 million fewer jobs. (Our calculations assume that the recipients of interest income face a 25 percent average income tax rate and consume 70 percent of their after-tax income.)


RR20110704 2 The Fed Is Expected to Launch QE3 Next Week ... Which Would Help the Rich and Hurt the Little Guy


Had these jobs not been lost, the unemployment rate would be 7.5 percent, instead of the current 9.1 percent, and this is the minimal effect we estimate.




As the estimate of the total of affected interest-sensitive assets gets bigger, the negative effects of depressed yields becomes even more striking. Using our mid-point estimate of $14.35 trillion of interest-sensitive assets, a 4.93 percentage point reduction in interest rates annually cost the economy $371 billion in spending, 3.5 million jobs, and 2.53 percent of GDP. This is a sizable effect, given that during this time GDP grew by only 2.33 percent and the economy added only 870,000 jobs.


With the additional jobs that might have been created by higher interest income levels, the unemployment rate could fall to 6.8 percent. And output could grow more than twice as fast as it has. The resulting GDP growth rate of 4.86 percent would then be closer to the average second-year growth rate of the past nine recoveries, and the U.S. economy would be well on its way to a vigorous recovery, rather than struggling as it is now.


This midpoint appraisal is our best estimate of the likely effect of the Fed’s policy. It may still be on the low side.


The numbers do not account for any so-called multiplier effects. Additional spending by recipients of interest income creates revenues for businesses, which in turn increases the income of their owners and employees, who themselves spend more. This, in turn, could boost overall spending and employment by more than the gain in interest income alone would suggest.




The housing market has not even begun to recover since the QE initiatives were created. U.S. auto sales and the stock market also remain well below pre-recession levels. And the sharp decline of the U.S. dollar has not created an export boom. But it has put upward pressure on the cost of our food and energy imports.


And tens of millions of U.S. savers, largely the elderly, still are facing strained circumstances created by Fed-driven abnormally low interest rates across the entire Treasury yield curve.


The negative impacts on output and employment caused by quantitative easing through the interest income effects shown here are large. In fact, they may outweigh the expected, but hard-to-document, positive effects of the QE program.

In fact, it has been thoroughly-documented that quantitative easing is great for the wealthy, but terrible for the little guy.

As the Guardian reported last year, quantitative easing increases inequality:

Quantitative easing (QE) … have contributed to social unrest by exacerbating inequality, according to one City economist.


As the Bank of England considers unleashing a fresh round of QE, Dhaval Joshi, of BCA Research, argues the approach of creating electronic money pushes up share prices and profits without feeding through to wages.

“The evidence suggests that QE cash ends up overwhelmingly in profits, thereby exacerbating already extreme income inequality and the consequent social tensions that arise from it,” Joshi says in a new report.


He points out that real wages – adjusted for inflation – have fallen in both the US and UK, where QE has been a key tool for boosting growth. In Germany, meanwhile, where there has been no quantitative easing, real wages have risen.

The Washington Post reported last month:

How might a third round of quantitative easing (QE3) affect the already-wide levels of inequality in the United States? Across the Atlantic, the Bank of England has come in for some criticism this week after it released a new report showing that its own quantitative easing efforts have disproportionately benefited the wealthiest:

The richest 10% of households in Britain have seen the value of their assets increase by up to £322,000 [$510,000] as a result of the Bank of England‘s attempts to use electronic money creation to lift the economy out of its deepest post-war slump. …


The Bank of England calculated that the value of shares and bonds had risen by 26% – or £600bn – as a result of the policy, equivalent to £10,000 for each household in the UK. It added, however, that 40% of the gains went to the richest 5% of households.

It’s not hard to see why this happens. One way the bank’s quantitative easing program works, in theory, by pushing up asset prices in order to support the broader economy. And, according to the Bank of England, the median British household only holds about $2,370 in financial assets. So the direct benefits largely accrue to wealthier households.


What about the United States? Much like in Britain, the distribution of financial assets are also heavily skewed. As you can see on page 26 of this Fed report (pdf), the median American family in the middle income bracket has about $19,900 in financial wealth. By contrast, the median family in the top income bracket has $423,800 in financial wealth. So any move by the Fed to push up asset prices is likely to increase wealth inequality in the short term.


There are other effects, too. As The Wall Street Journal has reported, the Fed’s efforts to bring down interest rates have mainly helped better-off Americans with good credit scores. For instance, it’s exceedingly cheap to get a mortgage right now — for a small number of people. (The folks at Zero Hedge, who are no fan of Bernanke’s stimulus efforts, have compiled a much longer list of links on how the Fed’s quantitative easing program benefits the wealthy.)

Indeed, Bernanke knew in 1988 that quantitative easing doesn’t work.  But he keeps caving in to the super-elite, and implementing it anyway.

Suddenly, Nobody In Europe Wants The ECB Bailout

It took the ECB a year of endless behind the scenes Machiavellian scheming to restart the SMP program (which was conceived by Jean-Claude Trichet in May 2010, concurrent with the first Greek bailout). The markets soared with euphoria that this time will be different, and that the program which is a masterclass in central planning paradox, as it is “unlimited” yet “sterilized”, while based on “conditions” none of which have been disclosed, and will somehow be pari passu for new bond purchases while it retains seniority for previous purchases of Greek and other PIGS bonds, will work – it won’t, and the third time will not be the charm as we showed before. Yet it has been just 48 hours since the “bailout” announcement and already Europe is being Europe: namely, it turns out that nobody wants the bailout.

On one hand there’s Germany for obvious reasons – not only are they footing the cost, but it is for them that the threat of an inflationary spike as a result of “unlimited” bond buys is most acute. But on the other, just as we predicted all along, are Spain and France, the biggest beneficiaries of the bailout, and whose bonds soared on expectations the ECB may buy them, who overnight have had a change of heart and say they never actually needed the bailout. Why? Because its politicians have suddenly had a change of heart and realize they will be sacked the second they hand over sovereignty over to the Troika or whatever supernational entity is in charge of the country following the submission of the bailout request.

More importantly, and as explained before, as long as the yield on the bonds of insolvent European countries is sub 8%, not one country will demand a bailout. And as long as these countries reap the benefits of cheap rates, the policies of pseudo austerity will continue (as a reminder, nobody in Europe has actually implemented austerity), where nothing changes, where budget deficits continue to pile on, where sovereign debt continues to soar, where politicians continue making the same flawed policy choices, and where the European slow-motion trainwreck continues, only with a brief delay in the final inevitable outcome.

By now everyone knows about the ECB party that sent US stocks to 4 year highs. Now comes the aftermath. From the NYT:

Greeted with initial fanfare by investors and economic officials, the unlimited bond-buying plan that the European Central Bank president, Mario Draghi, announced Thursday ran into immediate political problems in the crucial countries of Germany, Spain and Italy.


In Germany, despite Chancellor Angela Merkel’s support for Mr. Draghi and the independence of the Central Bank, political and news media reaction was scathing, with accusations that the bank, in seeking to stabilize the euro currency union, was subverting its mandate to fight inflation and forcing debt upon euro zone members.


“A Black Day for the Euro,” “Over the Red Line” and “Pandora’s Box Opened Forever” were some of the German headlines, with the normally sympathetic Süddeutsche Zeitung headlining an editorial: “The E.C.B. Rewards Mismanagement.” Even the German Bundesbank, officially part of the European Central Bank, put out a statement commenting acidly that the plan was “financing governments by printing bank notes.”

Here is where it gets funny:

At the same time, the two intended beneficiaries of the Draghi plan — Spain and Italy — expressed reluctance to ask the bank for help, even if both might eventually have little choice but to seek aid. The governments in Madrid and Rome apparently fear the political impact at home of bowing to whatever demands for harsh economic policy changes might come with the aid.

And just as we predicted before…

They seem afraid that the medicine might prove worse than the disease, because Mr. Draghi made it clear that there would be no bottomless well of money made available without a program of greater spending discipline.


Those who did everything to have the E.C.B. help now say they don’t want it,” Ferruccio de Bortoli, editor in chief of the newspaper Corriere della Sera, said in a Twitter message. “Speculation will play on this contradiction.”


The disjunction between how officials seek to placate the lightning-fast markets and the reluctance on the part of the public and politicians to make further sacrifices and move at more than a glacial pace highlight why it has proved so difficult for Europe to overcome the challenges that still threaten to tear apart its 17-nation currency union.

All of this is just as we explained over a month ago: “In Order To Be Saved, Spain And Italy Must First Be Destroyed.” We also explained why this will not happen, and that instead of being saved, Spain and Italy will ultimately be destroyed, by appearing to be saved first: as Mario Draghi kindly obliged us on Thursday. And all with the central-planners’ and stats quo’s blessing.

The simple reality is that already the grand plan is fizzling, which was to be expected. After all politicians are involved. Recall that Goldman, who basically force fed its alum Mario Draghi the play by play (after leaking the ECB playbook hours in advance) now “predicts” (and by predicts, we mean demands) that Spain demand a bailout as soon as next week. Well, Spain PM Mariano Rajoy, who promised Spanish banks will never need a bailout one week ahead of the Spanish bank bailout announcement, already is digging his feet in. As Spanish El Economista write, Rajoy is “tempted” to delay the Spanish bailout request until after the Galician elections, i.e., until October 21. At the earliest. In other words, while the market has already front-ran the Spanish bailout demands, suddenly Spain will conduct at least 6 auctions between now and October 21, during which time bond buyers will be praying that eventually Spain will demand a bailout. Ironically, it is these same “bond buyers” who swallowed hook line and sinker the plan that Draghi et al laid out for them, namely to assume a bailout, and buy bonds, when by doing so, a bailout becomes unnecessary. Did we say bailout? We meant trap.

So what happens in the meantime? Well, Spanish bonds can languish in the 6%, 5%, or even 4% range, which in turn will embolden the insolvent Spanish government to issue even more debt, thus making its fiscal situation even more untenable (recall the Spanish financial system is broke for one simple reason: too many (soaring) bad loans predicated by the endless collapse in the Spanish housing market). And issue bonds it will have to: recall that as we first explained, and as Nomura subsequently understood, Spain is on the verge of running out of cash!

But suddenly now that the market pretends all is well, following the most recent bout of central bank intervention, no Spanish politician feels the urge to sign their own career death warrant and request that the ECB funds these purchases which Spain simply will not have the money for. Instead, the theater that “all is well” will continue until Spain does run out of cash (the record outflow in Spanish bank deposits makes that a certainty) at which point the transition chaos will be unprecedented as instead  of arranging for an orderly transition, the panic in the Spanish government will be epic. Even the NYT now understands this dynamic:

Spain must pay back 20 billion euros, about $25.6 billion, in bond redemptions in October. And some analysts suggest that Mr. Rajoy will need to seek help to satisfy half of Spain’s 180 billion euro financing needs (about $230 billion) over the next year. “The Spanish fear is that they become another Greece — that they will have to chop off their right arm for a blood transfusion,” said Mark Cliffe, chief economist at ING Bank in Amsterdam….Mr. Rajoy is already losing popularity rapidly, and no one wants further political instability in Spain to add to continuing anxieties over Greece.

And this is only Spain. Throw Italy into the mix, which the NYT admits has been even worse at implementing reforms, and one can see why even the once intelligent bond market has demonstrated surprising stupidity with its ramp in peripheral bond prices last week (which really has been just a massive short squeeze).

But the piece de resistance, which readers of Zero Hedge know too well about, is that while jawboning will continue to yield results as long as reality finally demands an intervention, and Spain running out of cash will be just such an jawboning-event horizon, is that once the ECB is forced to begin buying, as up to now nothing has actually been done by the ECB which has merely taken rhetoric, promises and threats to a next level, it is all downhill from there:

There is a further uncertainty about the survival of the euro zone, which the Central Bank is mandated to defend. Once the Central Bank loads up further on Spanish and Italian bonds — it has already bought more than 200 billion euros ($256 billion) of European bonds, including 50 billion euros ($64 billion) from Greece — it will find it very difficult to stop its bond buying even if countries do not keep to their promises of reform. To do so would be a form of suicide, because it could set off market panic and force countries to exit the euro, beginning a process with no clear end.

Yesterday we explained why the Fed will do everything in its power to avoid enacting more LSAP-based QE (it simply does not have the capacity for the kind of massive program that everyone expects, and even an “open-ended” monetization will force everyone to do the math). Today, we learn why it is the ECB that also will do everything it can to not hit the buy button. The biggest paradox is that up to now, the fear of central banks, which is there in part due to their (rapidly dwindling) credibility, is what forced investors to “not fight the Fed/ECB”… and the banks took advantage of this by not doing anything, but merely talking. The time for talk is over, and for one reason or another, the time for action has arrived. Such action will very quickly demonstrate that the central-planning emperor was, indeed, naked all along, and the ramp across all risk assets was for naught.

It also means that the next time when the central banks attempt a comparable jawboning of risk, they will be taken far less seriously, if at all. At that point one may expect the PBOC to finally admit just how much gold it has acquired in the past 4 years, and that anyone who wishes to give a totally new and still quite credible monetary authority the chance, is invited to do so.

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P.S. The initial phrasing of this article’s title was “Suddenly, Nobody Wants The ECB Bailout.” We then added “In Europe” because there is at least one person in the US who is absolutely delighted by the ECB “bailout.” The US president.

On the Fed and WFP

The most disappointing element of Friday's NFP report was the drop in Work Force Participation (WFP). This important measure of the labor force fell to a 31 year low. A look at the details shows things are even worse than the headline report. Consider this chart of WFP for two groups; workers 22-55 (white) and those 55+ (brown). The lines crossed in 2002. The negative gap has widened every year. It's fallen off the chart the past three years.



This chart describes a real crisis for America. The long term consequences to the economic health of the country are tied up in this chart. All long-term macro economic analysis of the USA assumes that the current crop of younger workers will evolve to be a productive group for the rest of their lives.

The hope belief is that the younger members of the sub 55 group will have babies and buy houses. As they prosper, GDP will grow, tax revenues will rise. The younger workers of today have a very big burden on them. In future years they must generate tax revenue for Washington as D.C. has made very big promises on Social Security and Medicare that can't be met unless this crop of workers succeeds.

There is not a chance in hell that younger workers are going to prosper looking at this chart. As a result, future tax revenues will be less than planned. The economy will lag well below potential. Ultimately, the lines will cross; major cutbacks in entitlement spending will have to follow. This outcome is written in stone unless the trajectory of younger employment changes.

What to do about this problem? I don't think there is an easy answer.

One solution to the lack of upward mobility for those 55 and under would be to get more of the 55+ folks out of the workforce. The exact opposite is happening. Older workers are putting off retirement in droves. They have to. Their primary nest egg, their home, has turned into a liability. They are too old to invest all of their money in stocks, and there is no income to be had in a world of perpetual ZIRP. So they continue to work.

Lowering the minimum retirement age from 62 to 60 would change the direction of the lines. I advocate this, but the problem is that early retirement means lower Social Security monthly checks. I doubt that many could afford to retire on the meager income that SS would pay at age 60.

As a policy matter, the country is going in exactly the opposite direction. Republicans, Democrats, the Fiscal Commission and even the AARP have all been pushing for an increase in the retirement age. This may be necessary to "Save SS as We Know It", but more older workers means less opportunity for younger ones.

The only real solution is to magically make the economy grow. The rising tide would lift all the boats. But the country has been pushing the string on efforts to stimulate the economy for the past decade. Those efforts have not worked.

This takes us to Ben Bernanke and what he and his cohorts will decide to do next week. The betting is that Ben is going to act. One thing that Ben is likely to do is extend the ZIRP language for another year or two. Bernanke believes that a promise to keep interest rates pegged at zero until the latter part of the decade is what's needed.

Over the next four years over 10Mn people (and their spouses) will reach retirement age. Many of those people will have this conversation:

Honey, we've saved some money for this day, but sadly we can't get any return on what we saved, so we have to put off retirement, and work for another two years or more. Sorry.

How many people will say this and act accordingly? 20% sound about right? That's two million jobs that the sub 55 group will not get. The lines on the chart will get wider and wider and the future will get dimmer and dimmer.

One could not find an economist (of any stripe) who would not agree that the trends represented in the chart constitute a serious long-term threat.

Over the past few months Bernanke has made comments regarding the risks of sustained ultra-low interest rates. He has done a poor good job of informing us as to what those risks are, and what are their consequences. I've attempted to describe one of those risk here. I'm convinced that the +/- 55 WFP chart will deteriorate further in the next few years. Perpetual ZIRP will contribute to this very negative trend.

Bernanke knows this. I wish he would admit to it.






Guest Post: Analyze This – The Fed Is Not Printing Enough Money!

Submitted by Alexander Gloy of Lighthouse Investment Management

Analyze This – The Fed Is Not Printing Enough Money!

Before you trash me in the comments, hear me out.

It started off with Ray Dalio’s “beautiful deleveraging”, which inspired this post.

Since the financial crisis, the Fed has increased its balance sheet from $900 billion to $2.9 trillion (red line in below chart). The difference is $2 trillion (or 13% of GDP).

When the asset side of the Fed’s balance sheet grows, so must liabilities. The Fed’s liabilities consist mostly of money in circulation. So we can assume that $2 trillion in additional money has been pumped into the economy.

Or has it?

When the Fed buys bonds, it does so from “Primary Dealers” (21 global financial institutions). They hand over the bonds and get a corresponding credit on their account with the Fed. The Primary Dealers might then purchase some other securities with that money (which then gets credited to another bank’s account with the Fed).

And that’s where the buck stops. Three quarters of the money “printed” never make it into the economy. They remain as excess reserves (reserves in excess of banks’ minimum reserve requirements, blue line) in accounts at the Fed.

Hence, of $2 trillion additional money, only $500 billion (yellow line) ended up outside the Fed. Why? Banks could use those reserves for lending, but there is no demand for additional loans (from customers with sufficient debt bearing capabilities).

So if the money can’t find its way out of the Fed – how is money created then? What is money?

To understand, we have to take the example of buying a car.

In the US, literally nobody purchases a car with money form a savings account. The ability to purchase a car depends on the availability of credit. No credit, no car.

Credit availability depends on issuance of debt. Take a look at debt outstanding by ABS (asset-backed securities) issuers over the last 30 years:

ABS Credit market debt outstanding fell from $4.5 trillion at the peak in April 2007 to $2 trillion. That’s a decline of $2.5 trillion. This is money not available for purchases. It dwarfs the $500 billion pumped into the economy by the Fed.

Debt is money. The amount of debt outstanding controls the amount of money available for purchases, and hence for the size of the economy.

In addition ABS issuers there is debt by households, non-financial and financial corporations as well as the government sector. By adding them up you get the big picture: the total credit market debt outstanding (TCMDO):

TCMDO is the blue line, on a log scale. The red line is the change in the annual growth rate of TCMDO, measured from the prior post-recession peak growth rate. You will notice that every recession over the last 60 years, with the exception of 1970, coincides with a slowing of the growth rate by at least 2%-points. The red triangle depicts the 1987 crash, which followed a period of serious slowing in the rate of TCMDO growth.

Up until 2009, total credit market debt outstanding has never declined. The ratio of TCMDO to GDP continued higher and higher, at accelerating speed:

Has debt-to-GDP, or the debt-bearing capability of the US economy, hit a ceiling?

Look at how little additional GDP (blue area, below) we obtained in comparison to ever increasing amounts of additional debt (red area):

The dotted black line is the marginal utility of debt (right-hand scale). Think of it like this: how much additional GDP do you get out of one dollar of additional debt (in %). In 1992, for example, you get $0.30 in additional GDP for every additional dollar of debt.

Problem: this marginal utility of debt has trended lower and lower over the years, and actually reached zero in 2009.

Meaning: you can add as much debt as you want, and it still won’t give you any additional GDP.

To repeat: no amount of additional debt seems to be able to get economic growth going again.

That is a dramatic revelation. We might have reached the maximum debt-bearing capability of the economy. If true, no growth is possible unless debt-to-GDP levels fell back to sustainable levels (in order to restart the debt cycle). This could take years.

At this point, the only way to reset the debt cycle is to get rid of debt.

Ray Dalio correctly describes the three options available:

1. Austerity: this would be painful and take quite some time (the Europeans are going down this path)

2. Restructuring: requires write-downs and losses for bond investors (which are not being allowed to happen for fear of systemic risk)

3. Printing money: Inflation. Better yet: hyper-inflation. You have to destroy the value of debt fast enough before debt service costs, due to rising interest rates, drive the government into insolvency.

In the US, (1) and (2) are not happening. That leaves (3).

As shown above, the amounts needed for the Fed to be able to create inflation are much, much higher than what we have seen so far. And it is not guaranteed to work. Destroying the trust in the value of a fiat currency is a dangerous experiment with mostly adverse consequences.

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