Credit QE

By Jeffrey Snider of Alhambra

Although he didn’t state it specifically in his November 2010 Washington Post op-ed formally justifying QE2, it was very clear that then-Fed Chairman Ben Bernanke intended it to work through lending and especially the bank channel. Though he doesn’t explain, nor has any official ever, why a second one was needed given that the first was “quantitatively” determined, Bernanke was unusually clear about what he expected to happen for it:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth.

If one is of the mood to be hugely charitable toward QE, you can claim that judging from this narrow benchmark it worked. According to the Fed’s Z1 statistics, bank lending resumed steady growth in Q2 2011. Since that quarter, the total of loans on the books of depository institutions has increased by 31%. It is unclear if QE was the motivation for that change, or perhaps it was the 2011 crisis which might have convinced banks to get out of the money dealing business so as to at least get back to the lending business, but again if we are being purposefully favorable we can attribute it to the Fed’s signature monetary policy.

It took a little while longer, and another two QE’s, for the other financial sectors to follow what banks were doing. The non-bank sector, after shrinking precipitously after the panic (Q3 2008), finally resumed positive numbers in the middle of 2013. Like the bank sector, it isn’t clear what motivated the change as that time period like 2011 was characterized by not just additional QE’s but also a great deal of financial turmoil.

The rest of the economy contributed positive loan growth in greater appreciation, though once again the inflection coincides with a prospective QE as well as a great many economic and financial questions (maybe lending doesn’t work the way it is theorized?).

Continue reading Credit QE

The QE Premium

By Michael Lebowitz, CFA

Equity valuations are grossly dislocated from supporting fundamental data

It has been eight years since the great financial crisis of 2008, and the Federal Reserve (Fed) is still maintaining an unprecedented level of accommodation in monetary policy. The Federal Funds rate has been pinned at or near zero since 2008. Recent discussions on raising the rate a mere quarter of a percent are met with a palpable level of angst and incredulity by economists and investors alike. Since the crisis, the Fed quadrupled their balance sheet using printed money to buy U.S. Treasury and mortgage securities. The economic results, supposedly the justification for these aggressive actions, have mostly been disappointing. That said, one can credit Fed policy actions for driving financial asset valuations to historic levels.

Over the last eight years investors have adopted a mindset that Fed intervention is good for asset prices, despite clear evidence that it has contributed little to the fundamental rationale for owning such assets.  Fixed income yields are at or near record lows and stock indices trade at valuations that have only been eclipsed twice in history, just prior to the great depression (1929) and at the height of the technology bubble (2000). High end real-estate and various collectables trade at unparalleled levels. The eye-popping valuations on these less liquid assets further confirm how impactful Fed policy has been on asset prices.

We have written numerous articles highlighting rich valuations and the infectious behavior that can compel investors to make investment decisions that they would not otherwise make.  In this article we employ a cash flow model to quantify the potential ramifications on the equity market. The goal is to provide investors with a simple tool to calculate total return outcomes that could occur if investors were to lose confidence in the Fed and as a result stretched market valuation premiums built up since 2008 diminish or vanish altogether.

Continue reading at TalkMarkets →

Helicopter Money

By Steve Saville

“Helicopter money” is really just Quantitative Easing (QE) by another name

Here is an excerpt from a recent TSI commentary about another absurd course of action now being seriously considered by the monetary maestros.

Once upon a time, the concept of “helicopter money” was something of a joke. It was part of a parable written by Milton Friedman to make a point about how a community would react to a sudden, one-off increase in the money supply. Now, however, “helicopter money” has become a serious policy consideration. So, what exactly is it, how would it affect the economy and what are its chances of actually being implemented?

“Helicopter money” is really just Quantitative Easing (QE) by another name. QE hasn’t done what central bankers expected it to do, so the idea that is now taking root is to do more of it but call it something else. Apparently, calling it something else might help it to work (yes, the people at the upper echelons of central banks really are that stupid). The alternative would be to question the models and theories upon which QE is based, but such questioning of underlying principles must never be done under any circumstances. A Keynesian economist calling into question the principle that an economy can be made stronger via methods that artificially stimulate “aggregate demand” would be akin to the Pope questioning the existence of god.

The only difference between QE as practiced by the Fed and “helicopter money” is the path via which the new money gets injected. Under the Fed’s previous QE programs, new money was created via the monetisation of debt and ended up in the accounts of securities dealers*. Under a “helicopter money” program, new money would still be created via the monetisation of debt. However, in this case the new money would be placed by the government into the accounts of the general public, via, for example, tax cuts and welfare payments (handouts), and/or placed by the government into the accounts of contractors working for the government.

If promoted in the right way, “helicopter money” could have widespread appeal among the general public. Unlike the Fed’s traditional QE, which had the superficial effect of making the infamous top-1% richer and the majority of the population poorer, the average member of the voting public could perceive an advantage for himself/herself in “helicopter money”. Unfortunately, regardless of who gets the new money first there is no way that an economy can be anything other than weakened by the creation of money out of nothing. The reason is that the new money falsifies the price signals upon which economic decisions are made, leading to ill-conceived investments and other spending errors.

Due to the distortions of price signals that they bring about, both traditional QE and “helicopter money” are bad for the economy. However, an argument could be made that “helicopter money” is the lesser of the two evils. The reason is that with “helicopter money” the effects of the monetary inflation will more quickly become apparent in everyday expenses and the popular price indices. That is, “helicopter money” will quickly lead to inflationary effects that are obvious to everyone. This limits the extent to which the policy can be implemented.

Putting it another way, traditional QE had by far its biggest effects on the prices of things that, according to the average economist, central banker and politician, don’t count when assessing “inflation”, whereas the effects of “helicopter money” would soon become obvious in the prices of things that do count. A consequence is that a “helicopter money” program would be reined-in relatively quickly and the long-term damage to the economy would be mitigated.

With regard to the chances of “helicopter money” actually being implemented, we think the chances are very good in Japan, very poor in the euro-zone (due to there being a single central bank ‘serving’ a politically-disparate group of countries) and somewhere in between in the US.

Although it presently seems like the more extreme policy, the US has a better chance of experiencing “helicopter money” than negative interest rates within the next two years. This is because a) the next US president will be an economically-illiterate populist (regardless of who wins in November), b) the average voter will likely perceive a financial advantage from “helicopter money”, and c) hardly anyone outside the halls of Keynesian academia will perceive anything other than a disadvantage from the imposition of negative interest rates.

In summary, then, “helicopter money” is QE by a different name and path. It would inevitably reduce the rate of economic progress, but it has a reasonable chance of being implemented in the US the next time that policy-makers are desperate to do something.

*Every dollar of Fed QE adds one dollar to the commercial bank account of a Primary Dealer (PD) and one dollar to the reserve account at the Fed of the PD’s bank, meaning that every dollar of QE adds one reserve-covered dollar to the economy-wide money supply.

Two Times Was Convincing…

By Jeffrey Snider of Alhambra

Two Times Was Convincing; Five, Maybe Six Times Cannot Be Coincidence

People are often mistaken for thinking the eurodollar is somehow related to the euro, but that is in many ways quite understandable. In reality, the eurodollar system is shorthand for a global, offshore monetary regime that is dominated by “dollars” but includes every major currency. Thus, the participants in these currency markets are usually the same banks, meaning that if there is trouble in Europe and euros (or euroeuros) you can bet (literally) on finding it also in eurodollars. The eurodollar is like dollar, but in many important respects it is inseparable from euro as all of it is cobbled together by bank balance sheets from all parts of the globe.

The Northern Rock Building Society was founded in July 1965 as a merger between two relatively primeval, British financial firms. These are cooperative savings groups that sprung up in the 18th century in England, similar in mission and framework as credit unions or certain S&L’s in the US. Financial growth into the 1960’s had pared back the number of building societies in competition with the (reborn) growing English banking system. Following the merger, the combined firm set about on a buying spree, adding another 53 building societies to its banner over the next few decades.

It was in the later 1990’s, however, that Northern Rock became so distinguished; it was the first UK bank to embrace (enthusiastically) the financial innovation of securitization. By 1997, the company realized that the expansive business model would be better served by converting from a private building society to a public limited company, floating shares and entering the relatively new and exciting world of global money markets. Deposits were and are a serious constraint; wholesale money seemed at the time an invitation toward the infinite.

In 2001, Adam Applegarth took over and began an even more aggressive growth campaign. At its heart, Northern Rock possessed one key advantage – information. The public bank had developed one of the most efficient technology foundations in the business, a vital asset in the wild world of math-as-money. It started closing branches and encouraging its customers to use electronic communications and transactions methods exclusively. The bank used its competitive position to offer consistently lower cost mortgages, which were highly attractive to UK independents who sent the firm about 95% of its volume during the height of the bubble.

By the start of 2007, the former sleepy building society was writing about one-fifth of all new mortgages in the UK. Despite signs of distress in not just mortgages and housing markets but really the global money markets that fed them, Applegarth was still pushing for 20-25% growth in 2007. What had gone unappreciated and almost totally unnoticed was the hubris of “low cost” in wholesale terms; meaning that in addition to streamlining operations and keeping physical costs of Northern Rock low, the bank had also extended this “all or nothing”-like approach to funding. Unlike its UK competitors, the bank’s liability side was proportionally far more exposed to rollover risk.

Continue reading Two Times Was Convincing…

The Evidence be Damned!

By Steve Saville

I was blown away by the following two charts from Jeffrey Snider’s article titled “The European Basis For New Monetary Science“.  [biiwii comment:  Jeffrey Snider’s work is of course available directly, at Alhambra]

As most of you probably know, the Mario Draghi-led ECB embarked on a ‘suped-up’ QE program in March of 2015. The idea behind this program was that by monetising 60B euros of bonds per month the ECB would promote faster credit expansion throughout Europe. The two charts from the aforelinked Snider article show the results to April-2016.

The first chart shows that as at April-2016, 727 billion euros of ECB asset monetisation had been accompanied by an increase in total lending of only 71 billion euros. As neatly summarised by Snider, this means that there was less than one euro in additional lending for every ten in ECB foolishness.

The second chart shows loans to European non-financial corporations, which actually contracted slightly during the first 13 months of the ECB’s suped-up credit-expansion program.



The QE program was therefore a total failure even by the jaundiced standards of the central-banking world, that is, it failed even ignoring the reality that faster credit expansion cannot possibly be good for an economy labouring under the weight of excessive debt. The weirdest thing is, the obvious failure is not viewed by Draghi as evidence that QE doesn’t do what it is supposed to do. Instead, it is viewed as evidence that more of the same is needed. Hence the increase in the pace of asset monetisation from 60B to 80B euros per month announced in March-2016 and implemented this month.

I shudder to think how Draghi’s monetary experiment will end.

The Good, Bad & Ugly?

By Axel Merk

The good, bad and ugly of QE policies

Are we better off with “QE”, the ultra-accommodative monetary policy pursued by major central banks around the world? Is it “mission accomplished” or are we facing a “ticking time bomb”? Are extreme characterizations even warranted to describe the unconventional monetary policy of recent years, and what are implications for investors?

The Good
When interest rates are at or near zero and central bankers want to provide more “monetary accommodation,” it is not clear that negative interest rates are the answer.  The term “quantitative easing” or “QE” was coined to describe the purchases by of government bonds by central banks. It was combined with “forward guidance” which signaled rates would stay low for an extended period; in our assessment the key goal of both policies was to lower long-term rates (historically, central banks control short-term rates, but leave longer term rates up to the market to determine). Doing so, so the logic goes, would provide the desired “accommodation.” There is an index that tries to create a Fed Funds rate incorporating QE:

Note that this index suggests that we have had substantial tightening take place since the ‘end’ of QE.

Continue reading The Good, Bad & Ugly?

ECB QE Doing Opposite of Objective

By Tom McCellan

ECB QE Doing Opposite of Objective

ECB Assets versus DAX Index
June 09, 2016

I like to say that there are only 2 fundamental factors which matter for the overall stock market:

1. How much money is there?

2. How much does that money want to be invested?

Change either of those, and the market will move up or down.  But 2016 is showing us a perverse version of that.  We are in opposite-world now.

The Fed has backed away from the QE game, and is wishing it could find a sufficient excuse to start normalizing interest rates.  But the rest of the world is heading into the world of negative interest rates, such that banks are contemplating expanding their vaults to hold cash in lieu of holding negative-yielding government and corporate bonds.  The idea is that pumping all of that extra money into the banking system should help lift the financial markets, and thus the actual economies of the countries involved.

This presumption of how market physics work persists in spite of the evidence indicating that it actually does the opposite of the intented effect.  This week’s chart shows that the correlation between Germany’s DAX Index and the size of the ECB’s balance sheet is at best non-existent, and perhaps more accurately it is a roughly inverse correlation.

When the ECB started expanding its balance sheet in earnest back in early 2015, Germany’s stock market responded by moving downward.  This makes no sense according to the popular theory that more money means higher stock prices.  But after a while it is time to revise the hypothesis in light of sufficient data.

There is a correlation is between ECB assets and gold, but with a twist.  The size of the ECB balance sheet correlates better with gold as priced in euros.

ECB assets versus gold priced in euros

It is not a perfect correlation, but it is a pretty good one for the overall trend.  The implication is that if Mario Draghi insists on continuing the ECB’s QE program, and running his continent’s banking system into the ground, then gold is likely to be the main beneficiary.  The European economy and stock markets, not so much.

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Quantitative Easing and the Corruption of Corp. America

By Danielle DiMartino Booth


Quantitative Easing and the Corruption of Corporate America

The art of brevity was not lost on Abraham Lincoln. It is that brevity in all its glory that shines through in what endures as one of the most beautiful testaments to the art of oration: The Gettysburg Address rounds out at 272 resounding words. The nation’s 16th President humbly predicted that the world would quickly forget his words of that November day in 1863. Rather, he said, history would solely evoke the valiant acts of men such as those whose blood still soaked the consecrated battleground on which they stood. Of course, Lincoln was both right and wrong. Neither the men who sacrificed their lives nor his words would be forgotten. We remember and know that a terrible and ever mounting price would ultimately be paid, some 623,026 American lives, the steepest in man’s bloody history.

In what can only be described as the pinnacle of prescience, a 28-year old Lincoln foretold of the coming Civil War, which he presaged would come to pass if the scourge of slavery remained unchecked. In an address to the Young Men’s Lyceum of Springfield, Illinois in January 1938, Lincoln spoke these haunting words: “If destruction be our lot, we must ourselves be its author and finisher.” The enemy within.

Since that devastating brother against brother Civil War, so prophetically foreseen by Lincoln, more than 626,000 American soldiers have lost their lives defending the ideals and freedom of our Union. Today that Union stands, but it must now face the threat of an enemy rising within its borders to wage a different kind of war against our hard fought freedom.

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