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More on the inability of the Fed to help the economy in this environment, they can only create instability



September 22, 2011 – Comments (4)

A theme in a number of my recent posts has been how monetary policy as spectacularly ineffective in dealing with the current balance sheet recession. QE did not fix anything, it did not print money, all it did was to fuel a mini margin bubble, based on everybody misunderstading the concept of debt monetization. People were 'front running the Fed' in error.

Interest rates are *not the problem*. Even if the Fed could induce a new lending boom (which it can't) that would be precisely the wrong 'fix'. The private domestic sector needs to deleverage. That is the fundamental problem. The only way the real economy is going to be affected in this environment is through fiscal policy (and while austerity is a fiscal policy position, we have more than enough evidence that is precisely the wrong fiscal position to take).


22 September 2011 by Cullen Roche


No story has dominated the market news flow in the last year like QE2.  From its very inception I said the program was a “monetary non-event” and not going to achieve its targets for several reasons (it’s not money printing, it doesn’t alter the amount of outstanding private sector net financial assets, it’s not debt monetization, etc).  But perhaps more importantly, I’ve discussed the potential negative effects the program could have through the channels of misconception.  In other words, the myths of “stimulus”, money printing and debt monetization were all likely to fuel investors with a misguided perception as to how the program would impact the real economy.

I have called this effect an embedded disequilibrium in the market caused directly by the Fed and exacerbated by market participants who quite simply don’t understand what QE is or how it actually works.  From the perspective of the Fed, they thought they could “keep assets higher than they otherwise would be” (infamous last words of Brian Sack of the NY Fed).  But because QE had no transmission mechanism through which it could impact the real economy it in fact only created a disequilibrium between market expectations and the real economy via psychological channels.  And as the real economy has sunk we’ve seen much of this embedded “Bernanke Put” come out of the market in the last few months.

In just the last 24 hours we’ve seen the wheels come off of the “Bernanke Put” bus.  The markets appear to be realizing that the Emperor truly does have no clothes, that QE isn’t all it was cracked up to be and that the Fed can’t save the economy with their magical printing press (don’t worry – the Fed doesn’t print money anyhow, but that’s for another day).

4 Comments – Post Your Own

#1) On September 22, 2011 at 1:41 PM, outoffocus (23.59) wrote:

Hi Binve, My name is OutOfFocus.  Long time reader, long time commenter. 

I wholehearted agree that the Fed's attempts to stimulate the economy are utterly useless and over time as they continue to try to "stimulate", the effects will become more damaging.  I also agree that people need to deleverage in order for us to truly come out of this recession (see today's TMF Post of the Day). 

Alot of that deleveraging has to happen in real estate. Home prices need to be allowed to hit equilibrium before they recover. So what do you say to that housing will "lead us into the recovery".  If it was housing that let to the recession in the first place, is it possible that it will take something else to lead us out?

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#2) On September 22, 2011 at 2:08 PM, binve (< 20) wrote:


Hey outoffocus :)

Alot of that deleveraging has to happen in real estate. Home prices need to be allowed to hit equilibrium before they recover.

100% agreed. I don't think house prices in general have reached a bottom, but I think we are closer to the bottom than we are to the top. I suspect we are in the bottoming process now.

So what do you say to that housing will "lead us into the recovery".

I say that's BS. That doesn't sound right to me at all. Whenever housing prices have increased substantially in the past during previous economic booms (like the 50s and 60s and the mid 80s and 90s) it is because they have been *conicident* with an economic boom (they didn't lead it).

So a statement that fixates on housing 'leading' us out is misplacing cause and effect. The next positive economic cycle will raise economic activity and hence increase housing prices (or at least stabilize them) as people become employed and mobile and sell houses to move to where new employment is located.

Try to generate a housing boom independent of healthy economic activity is putting the cart before the horse.

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#3) On September 22, 2011 at 2:15 PM, outoffocus (23.59) wrote:

Yea I always thought that was a pile of crap. Its good to see I'm not alone in that thought.

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#4) On September 24, 2011 at 4:50 PM, Frankydontfailme (27.20) wrote:

Binve, I pretty much completely agree with this post.

Regarding deficit spending, I still can't wrap my head around the idea of a government (especially ours) effectively running the economy. All of your theories logically add up, but they depend on a somewhat competent government. For example, you've proposed a massive stimulus focused on energy infrastructure. Let's say our government read your posts religiously and agreed. What then?

Would they be realistic and deficit spend towards oil and natural gas infrastructure? What companies' would get the contracts? Instead, might they focus on biofuels and electric cars? How about solar energy (*cough* Solyndra)? Maybe they agree on deficit spending but would rather give the banking system a stimulus and let the banking sector lend to energy companies. Maybe this works maybe most of the stimulus ends up in execs pockets instead.

Maybe we should not have traditional austerity. Instead we get rid of regulations, cut some spending gradually and REDUCE taxes to virtually nothing. Wouldn't this have the same affect as your stimulus spending except it would allow the people to decide where to invest? Frankly I'd prefer a default, balanced budget and gold standard but we can agree to disagree. At least the deficit spending through tax cuts lets people keep/invest what they earn rather than allowing the government to waste it.

I get that I'm being somewhat ideological, but still don't get how you can think stimulus will do anything but continue to distort our economy into a spineless, functionless debt hog.

Can you give me examples in history when governments were able to follow these principles and effectively run an economy?  

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