The Fed's Bond Bubble Doomsday Machine

[JimmieD]

A key component of inflation that is almost always overlooked is something called "the velocity of money"....Just so since the crash of 2008. The velocity of money slowed considerably. Which is precisely why the Fed has been printing so much more of it. The Fed is attempting to get more cash out there to increase the sluggish movement of money.

Put more money into more hands and some of it is going to move around.

The traditional measures of velocity of money are outdated in that they are too narrow. When we talk about "money" now we must consider things like collateral and collateral chains.

OK, the big problem here is that the basic monetary identity PY=MV (where P is a price vector, Y is an output vector, M is a scalar measure of money supply, and V is a scalar "velocity of money")is an accounting identity and not a function. If you treat all four variables as dependent variables, the system is overdetermined. You set three as dependent variables to be explained with a function and the fourth (V) automatically comes out in the wash. You don't need a "theory" for the velocity of money. If you have one, you need to identify which other part of the identity has become the residual (price level? output? money supply?). The options don't look very attractive.

This is why a lot of monetary theory texts express the identity as V=(PY)/M, which makes clear that V is arrived at as a definition, not a function.

The statement that increases in the money supply cause prices to rise (inflation) is just another restatement of this monetary identity with the added assumption that increases in the money supply have no direct effect on output or velocity. This is where an explanatory "theory of velocity of money" might come in, but it would be a theory derived from a theory of prices and output.

Also note that if we are in a Keynesian liquidity trap, increases in the money supply are not inflationary because the velocity of money changes (through hoarding) to offset the increases in monetary base. Almost every conservative (or monetarist) economist in 2009 predicted rapid inflation which did not occur. This "natural experiment" should have been the definitive proof that we were in a liquidity trap and that the macro dynamics were very close to the 1928--1933 experience. It's a measure of the collective denial of much of the profession that five years out almost all of these false predictors stand by there model and persist in recommending ruinous policies based on wishful thinking and economic theory that comes out of a CrackerJack box.

So I take it you disagree with my point that what counts as money is too narrowly defined?

 

[EdwardBaiamonte]

Excellent posts, but I am interested in your projected timelines for inflation, etc. The semi-independent variable in these equations is an international race to the bottom, i.e., many countries are devaluing their currencies, thereby propping up US investments as relative safe havens.

Inflation...why not stagflation?
I think we are on the precipice of stagflation, especially when you factor in the level of underemployment, not just unemployment.
Stubborn unemployment/underemployment.....check.
High inflation....check. (ignoring the bullsh*t CPI)
Slow economic growth....double check.

good argument except its hard to have stagflation without inflation!!
You can get inflation easily though, just ignore the CPI and pretend as you have done!

If you want growth just make the liberal agenda illegal: inflation, deficits, debt, unions, welfare programs, regulation of health care, and big government should all be illegal as the Constitution intended. We'd have 5% a year for 10 years!!

 

[SteadyMercury]

If you want growth just make the liberal agenda illegal: inflation, deficits, debt, unions, welfare programs, regulation of health care, and big government should all be illegal as the Constitution intended. We'd have 5% a year for 10 years!!

Make inflation illegal?

My Name is EdwardBiamonte, and I think what we should have is world peace.

 

[Paulie]

When the Fed buys a bond, it is putting more money into circulation. This makes people who hate the Fed crazy. "They are debasing the currency!!!"

However, the Fed sells its bonds, too. And when it sells the US Treasuries it owns, it takes the principal it receives from those sales and...destroys it! But you never hear the people who hate the Fed crying, "They are strengthening the currency!!!"

Most of the profits from the interest earned on the assets it owns go to the US Treasury. That's right, to the federal government.

By buying and selling Treasuries, the Fed maintains an inflation rate of about two percent. That two percent is to accomodate economic growth.

As I mentioned in my last post, the Fed holds about $3 trillion in assets. That's an extra $3 trillion of money that would not ordinarily be in our economy.

That extra liquidity is not causing any inflationary problems right now. In fact, it prevented runaway deflation.

We can debate all day long over whether we should have allowed that deflation to occur, but that's another topic.

Anyway, as I said, the velocity of money is sluggish, and so inflation is not getting away from us...yet.

But what happens when the economy begins warming up again? What happens when people start digging up that $3 trillion from their backyards and begin spending it, increasing the velocity of money in our economy?

Inflation happens, that's what.

And that is when the Fed would start selling its assets and soaking up all that cash flying around and destroying it.

But...we have a problem.

More to come...

The reason asset sales are not cheered as strengthening the currency is because the Fed has never historically exited from its asset holdings in an efficient enough manner to avoid a deflationary spiral. It has caused several of those in its history.

They have no idea what they're doing. They literally sit around and come up with hypotheses and hope to god that they work, and they usually don't.

 

[Paulie]

When you buy a bond, you are making a loan to the issuer. That bond is money owed to the buyer, making it an asset.

When the Federal Reserve buys a US Treasury bill, note, or bond, it is making a loan to the federal government because the federal government has appropriated more spending than it has received in revenues.

The Fed doesn't purchase from the Treasury. The Fed buys Treasuries from dealer banks.

Yes, they buy it from the market like everyone else. I was just keeping it simple. The end result is the same. Monetizing the debt.





That was actually the whole purpose of purchasing the MBS. To get banks to increase lending because lending had ground to a halt.

The whole intent was to get banks to stop hoarding cash and get it out there. That is why the Fed keeps talking about lowering the interest rate it pays on Reserves.

When the economy heats up, the Fed will raise the interest it pays on Reserves to cause the price of borrowing from banks to rise.

A key component of inflation that is almost always overlooked is something called "the velocity of money".

If the Fed gave you a trillion dollars, and you buried it in your backyard, then that trillion dollars will have absolutely no effect on the value of the money in circulation. The velocity of that trillion dollars is zero.

Just so since the crash of 2008. The velocity of money slowed considerably. Which is precisely why the Fed has been printing so much more of it. The Fed is attempting to get more cash out there to increase the sluggish movement of money.

Put more money into more hands and some of it is going to move around.

The traditional measures of velocity of money are outdated in that they are too narrow. When we talk about "money" now we must consider things like collateral and collateral chains.

Good luck measuring collateral chains. There is a lot of cheating going on with collateral, with some collateral being double or triple pledged, or God knows how many times.

It's only debt monetization if the treasury purchases aren't offset by either previously held bonds maturing, other assets sold in conjunction (sterilization), or if it was a repo agreement.

That being said, there's been no sterilization since 2008.

 

[Toro]

I'm all in favour of QE.

I've made a boatload of money trading gold.

Now I'm long stocks.

Go Bernank! Go!

 

[oldfart]

Excellent posts, but I am interested in your projected timelines for inflation, etc. The semi-independent variable in these equations is an international race to the bottom, i.e., many countries are devaluing their currencies, thereby propping up US investments as relative safe havens.

There is a difference between late and never. People who predict inflation or growth as a result of monetary policy are generally expecting to see something within six to twelve months. How long did we expect the stimulus to take? The guys who predicted hyperinflation were the same ones bitching that the stimulus was ineffective. But five years out the bogeyman hyperinflation is still "just around the corner".

You are right to note that international trade aspects and monetary policies have an effect on this and creating doubt about the monetary system is a big one. This is readily measured by the interest rate spread on various sovereign debt. If Germany pays 2% on its debt and Portugal has to pay 18%, nothing is going to work for Portugal. The Germans are just beginning to realize that their trade balances are heading south because their policies and the austerity "recommendations" are drastically decreasing demand in countries like Portugal who incidentally buy German exports. I think Homer Simpson caught ontl this problem before Angela Merkel.

 

[oldfart]

So I take it you disagree with my point that what counts as money is too narrowly defined?

I generally agree with you. There are several different measures of the money supply. and no one measures seems to work well for all purposes. It really boils down to how institutions are changing, what instruments they use, and what behaves like "money". Short-term commercial paper? 30-day T-bills? 52-week T-bills? 30-day CD's?

 

[editec]

When you buy a bond, you are making a loan to the issuer. That bond is money owed to the buyer, making it an asset.

When the Federal Reserve buys a US Treasury bill, note, or bond, it is making a loan to the federal government because the federal government has appropriated more spending than it has received in revenues.

This is called "monetizing the debt". Putting more money into circulation.

Because of the crash resulting from the global derivatives bubble, the Federal Reserve has also been buying Mortgage Backed Securities (MBS) from Wall Street. Yeah, the Fed owns mortgages. Maybe even your house. This is also printing money and putting it into circulation.

So how much money has the Fed printed? What is the book value of its assets?

3 trillion dollars.

I think Bloomberg has it at $4, but what's a mere Trillion between friends?

Even more frightening is, the PROMISE to MAKE GOOD if those NGO "bonds" the banks are counting as assets turn out to have even less value that we think.

The estimate for how much the federal government is guaranteeing (not monetarizing, simply promising to if it comes to that) is OVER $20 Trillion (nobody can really put a price on it since they won't mark-to-market)

With that much extra cash in circulation, inflation is a real concern. There are those who claim inflation is the reason the price of gas or stock prices are so high, but they are making a common mistake, confusing rising relative prices with inflation.

The price of oil has always been volatile, but we rarely hear anyone making panicked cries of doom over "rapid deflation" when the price of oil plummets. Instead, there is dead silence when it does. We only hear panicked cries of doom when the price of oil jumps. A simple observation of the price of oil over long periods of time reveals there is obviously something greater than inflation at work there.

Amen, brother.

A key component of inflation that is almost always overlooked is something called "the velocity of money".

If the Fed gave you a trillion dollars, and you buried it in your backyard, then that trillion dollars will have absolutely no effect on the value of the money in circulation. The velocity of that trillion dollars is zero.

Just so since the crash of 2008. The velocity of money slowed considerably. Which is precisely why the Fed has been printing so much more of it. The Fed is attempting to get more cash out there to increase the sluggish movement of money.

Put more money into more hands and some of it is going to move around.

A great deal is being hoarded, though. Just as though it was buried in someone's back yard.

More to come...

G500, I admire your efforts to educate this board in a subject which is so damned confusing.

Of course if Congress wasn't the lapdog of the BANKSTERS, when they saved their asses back in 2007-2008, and when they started infusing the faltering banks with basically FREE MONEY, they COULD HAVE insisted that the banks start loaning it out again.

But the BANKSTERS knew something they don't want to admit.

They're broke and they can't even tell us how broke.

After 100 years of FED reserve monopoly on money, their insane greed got so out of hand (since about 1980 or so) that they do NOT even trust each other.

I suspect we're looking at the END game of the fractal banking monopoly as we knew it.

When I see what the EU mafia has done in Cyprus, I shudder to think how bad it truly must be.

 

[EdwardBaiamonte]

I suspect we're looking at the END game of the fractal banking monopoly as we knew it.

dear, according to the markets we're looking at economic recovery, not your idiotic conspiracy theories~!!!

When I see what the EU mafia has done in Cyprus, I shudder to think how bad it truly must be.

actually, dear, Russians put their money in Cyprus whereupon it was loaned to Greece! Now the EU is heroically trying to save the bank and Cyprus. Is that really over your head? Sorry, didn't mean to interrupt your nut job conspiracy convention.

See why we are positive a liberal will be slow?

 

[waltky]

Dat's right - dey gonna be the central bank for the new world order...

IMF says monetary easing could drive asset bubble
10 May`13 — International Monetary Fund officials say they are watching carefully for signs that massive flows of cash unleashed in world markets by unprecedented monetary easing might lead to asset bubbles, or to overheating in some emerging markets.

"There is a risk of overheating of domestic economies, so we have to pay close attention to this risk," said IMF Deputy Managing Director Naoyuki Shinohara. "There are some warning signals, but it is not up to the level to ring alarm bells," he said. Cash added to the global economy from monetary easing in the U.S., Japan and Europe is affecting currency values and fueling investments in commodities, property and other assets. On Friday, the Japanese yen fell to its lowest level against the U.S. dollar in over four years, passing 100 yen to the dollar. The Japanese currency is bound to weaken given the aggressive monetary policies Tokyo is using to try and break free of years of debilitating deflation, he said. But the resulting rise in other currencies could be disruptive.

In China, a continued reliance on government-backed investment in construction, despite its pledges to shift to consumer-driven spending to fuel growth, remains a concern, Shinohara said. "If you look at the statistics, China has not converted to becoming a consumption-oriented economy yet," he said, noting that such heavy spending increasingly likely will go to inefficient projects. Meanwhile, heavy borrowing by local governments poses a risk in the medium to long-term, especially given the size and lack of transparency in the country's huge informal lending sector, he said. The key, IMF officials said, is to ensure that resources help to drive real economic growth.

In Japan, for example, share prices have surged, with the benchmark Nikkei 225 stock average jumping 2.9 percent Friday to 14,607.54, its highest close since January 2008. Other share markets have also rallied in recent months. But data on growth, prices and investment do not reflect that degree of ebullience. "There have been sharp improvements in world markets but they have not been matched by improvements in the world economy," Shinohara said.

Yuko Kinoshita, assistant to the director of the IMF's regional office for Asia and the Pacific, warned of a potential spike or "bubble trend" in asset prices. "If these are not controlled, there could be a serious boom and bust cycle," she said. Even if the current government's economic policies succeed in spurring demand, the fund's forecasts for Japan's real growth were a modest 1.6 percent in 2013 and 1.4 percent in 2014, partly due to expected sales tax increases that are expected to slow consumer demand.

IMF says monetary easing could drive asset bubble

 

[oldfart]

May`13 — International Monetary Fund officials say they are watching carefully for signs that massive flows of cash unleashed in world markets by unprecedented monetary easing might lead to asset bubbles, or to overheating in some emerging markets.

"There is a risk of overheating of domestic economies, so we have to pay close attention to this risk," said IMF Deputy Managing Director Naoyuki Shinohara. "There are some warning signals, but it is not up to the level to ring alarm bells," he said. Cash added to the global economy from monetary easing in the U.S., Japan and Europe is affecting currency values and fueling investments in commodities, property and other assets. On Friday, the Japanese yen fell to its lowest level against the U.S. dollar in over four years, passing 100 yen to the dollar. The Japanese currency is bound to weaken given the aggressive monetary policies Tokyo is using to try and break free of years of debilitating deflation, he said. But the resulting rise in other currencies could be disrupted.

Yawn. Somebody should try keeping up with the news. Shinohara must have missed the memo on "Abenomics". The Japanese are TRYING to increase the expected inflation rate. It's a way to fight deflation which has been the bane of the Japanese economy for the last twenty plus years.

Hello? The yen has fallen 17% against the dollar so far this year. That's why Japanese exports are doing well and the reason for the Japanese market reaction.

Now if someone would like to explain to me what economic theory predicts asset bubbles in the mother of all liquidity traps, I'd like to hear it. Notice I said "economic theory" not "political tripe" or "economics is a morality play" nonsense.

 

[itfitzme]

This is called "monetizing the debt". Putting more money into circulation.

Incorrect.

Simply put, if the debt were monetized, their would be no debt.

You seem to be misunderstanding some critical details.

 

[g5000]

This is called "monetizing the debt". Putting more money into circulation.

Incorrect.

Simply put, if the debt were monetized, their would be no debt.

You seem to be misunderstanding some critical details.

I'm afraid you are the one who is wrong.

Monetizing debt is thus a two-step process where the government issues debt to finance its spending and the central bank purchases the debt, holding it until it comes due, and leaving the system with an increased supply of money.

Monetization

For example, the U.S. Federal Reserve can monetize the nation's debt; this involves the process of purchasing debt (treasuries) which in turn increases the money supply. This essentially turns the debt into money (monetization).

Monetize Definition | Investopedia

 

[g5000]

I came back to this topic because it appears the Bank of Japan's bond bubble is about to pop. The scenario I outlined at the top of this topic is about to play out in Japan first.

 

[g5000]

Japan panel eyes shift to riskier assets for GPIF

A panel of experts advising Prime Minister Shinzo Abe's government has set Japan's $1.2 trillion Government Pension Investment Fund on course for riskier waters, with potential rewards for the Japanese economy and managers of active investment strategies.

The GPIF is probably the biggest asset manager on the planet, and they have decided the negative returns on Japanese monetized debt, along with Abe's plan to increase inflation, call for them to start dumping the BOJ's bonds. They are the biggest BOJ bond buyer.

The bubble is starting to collapse.

 

[RKMBrown]

This is called "monetizing the debt". Putting more money into circulation.

Incorrect.

Simply put, if the debt were monetized, their would be no debt.

You seem to be misunderstanding some critical details.

I'm afraid you are the one who is wrong.

Monetizing debt is thus a two-step process where the government issues debt to finance its spending and the central bank purchases the debt, holding it until it comes due, and leaving the system with an increased supply of money.

Monetization

For example, the U.S. Federal Reserve can monetize the nation's debt; this involves the process of purchasing debt (treasuries) which in turn increases the money supply. This essentially turns the debt into money (monetization).

Monetize Definition | Investopedia

Your making a couple incorrect assumptions, or rather leaving out some import stuff.

1) We are not the only country doing this, are we?
2) The fed can continue this process indefinitely there's no limit to the number of zeroes the fed can make up.
3) Bonds/stocks/CDs/Realestate/matress... all investments carry risk.

 

[RKMBrown]

I came back to this topic because it appears the Bank of Japan's bond bubble is about to pop. The scenario I outlined at the top of this topic is about to play out in Japan first.

Wish I had a dollar for every prognostication of a bond or stock crash. Seems to me most of the time folks are saying it's about to crash that's when you need to be investing. It's usually when folks say don't sell yet that you need to get out

Money has to go somewhere. If not bonds where? Stocks? Yeah all time high .. hmm. If not bonds or stocks, where? Realestate? Look how that worked out, and the feds have changed nothing right? And the fed won't start dump their holdings right?

 

[SteadyMercury]

I came back to this topic because it appears the Bank of Japan's bond bubble is about to pop. The scenario I outlined at the top of this topic is about to play out in Japan first.

So you came back to a prediction about the US you made over a year ago that didn't happen, to pat yourself on the back by making another prediction?

Will you be back in a year if Japan doesn't have a bond market collapse, maybe with a prediction about another country?

I'll make my standard prediction whenever I see someone predicting a collapse with an open-ended timeframe so nobody can hold them to it: the Phoenix Suns will win the NBA championship!

 

[Kimura]

This is called "monetizing the debt". Putting more money into circulation.

Incorrect.

Simply put, if the debt were monetized, their would be no debt.

You seem to be misunderstanding some critical details.

I'm afraid you are the one who is wrong.

Monetizing debt is thus a two-step process where the government issues debt to finance its spending and the central bank purchases the debt, holding it until it comes due, and leaving the system with an increased supply of money.

Monetization

For example, the U.S. Federal Reserve can monetize the nation's debt; this involves the process of purchasing debt (treasuries) which in turn increases the money supply. This essentially turns the debt into money (monetization).

Monetize Definition | Investopedia

The term monetization is out out paradigm. We're no longer on a gold standard.