Article: Is the Permanent Portfolio Broken?

[Gumby]

The QE enables the government to borrow much cheaper than otherwise and adds to the deficits...There are people here who think QE doesn't do much. Needless to say I disagree. It's a blank check for the government to spend another 85 BN a month without having to tax or legitimately borrow. I know I know....we need the government to spend slips of paper to grease the economic wheels. I forgot I live in a Keynsian fantasy.

That argument doesn't really make any sense when you think about it. Since we have a fiat government, the government already has a "blank check" to spend whatever it wants to (duh). Congress doesn't call up the Fed or Treasury and ask what the interest rates are. They don't call up China and beg them to buy their Bonds. No. Congress just votes on bills and spends the money. When it comes time to pay the bills, the Treasury works with the Fed and Primary Dealers to drain excess reserves into bond auctions and manufacture the dollars needed to pay the bills. Congress doesn't worry about the interest rate. It just spends new fiat debt-based money whenever it wants to — that should be more than obvious since the government has spent trillions of fiat dollars before QE was ever used, and interest rates were way higher in the past. QE doesn't make the government more or less likely to "borrow" money because a fiat government can "afford" any interest rate it wants to set. Congress spends by voting on Bills and spends on whatever they agree on — they don't call up the Fed and ask them if rates are favorable or not for their spending bills.

And secondly, the Fed doesn't lower interest rates to placate the Treasury. The Fed lowers interest rates to influence the ~$100 trillion credit market by swapping a measly $85 billion a month in QE — which is absolutely nothing compared to the private credit market.

The amount the government spends and/or swaps is so tiny — compared to the size of the ~$100 private credit market — I don't know how you can expect us to take comments like that seriously. It's odd that you would focus on a measly $85 billion/month in debt swaps and ~$1 trillion in Congressional net spending when that all pales in comparison to the enormous size of private credit.

The overwhelming majority of new money that's created in our society doesn't come from the government — it comes from private credit issuance.

[Stunt]

Actually Gumby, your argument doesn't make sense...85billion a month is massive.

$85b per month is 1trillion per year provided largely to financial institutions who would have normally held those bonds. They have a reserve ratio of 10% making the total value of QE 10Trillion, plus the inter bank lending multiplier could result in many times that 10trillion. All you need to do is look at the total money supply and how the market reacts to less QE to realize these moves are unprecedented and not a drop in the bucket as you seem to say.

[moda0306]

I guess one could say that an entity that can manipulate its own debt market would be "cheating" and allowing itself to spend more than it otherwise could...

... if we're looking at this in a vacuum...

But our government is actually the ISSUER of currency, so to participate in the debt market at all is artificial. 

It would be like saying that the nuclear technology branch of the defense department is "manipulating" the cost of a nuclear bomb because they only sell to the U.S. government.

The entire government itself is a "manipulation" of whatever the natural order would be without government. 

So the manipulation is a debt-based fiat currency to begin with... to swap one government-issued "manipulatory" fiat asset for another government-issued "manipulatory" fiat asset is NOT fundamentally changing much at all in the economy.

But I wonder whether the model might be temporarily broken, until the Fed backs out of QE.

Why is QE bad for the PP?

QE isn't "bad" for PP but the model is based on diversifying for each economic cycle and QE prevented these cycles from occurring as they would in the past.

I couldn't disagree more.  The PP was established for an environment where the government was very unlikely to default on debt, but that the interest-rate/inflation evironment could be manipulated to our disadvantage.  The nice thing about the PP is that on a nominal basis, T-bills/bonds are all-but risk-free, but to the degree that they're manipulated below giving us real yield, gold will do great to make up for it.

If we had a gold standard or a hard-money economy, the PP would be a very unbalanced idea.  It's a fiat-economy investment strategy.

[buddtholomew]

I wonder how PP investors felt the last time the portfolio returned a nominal loss for the year. Did the group believe that the PP was broken? Real losses, I believe are more prevalent.

[moda0306]

Actually Gumby, your argument doesn't make sense...85billion a month is massive.

$85b per month is 1trillion per year provided largely to financial institutions who would have normally held those bonds. They have a reserve ratio of 10% making the total value of QE 10Trillion, plus the inter bank lending multiplier could result in many times that 10trillion. All you need to do is look at the total money supply and how the market reacts to less QE to realize these moves are unprecedented and not a drop in the bucket as you seem to say.

The money multiplier doesn't work the way it used to.  I'm sure Gumby will destroy my ability to post links.  Simply put, banks aren't reserve-constrained anywhere near to the degree we've been taught.  If one bank becomes "reserve constrained," it borrows them from other banks, and if the fed sees the entire economy is reserve constrained and that there's still slack in the economy, it will provide the reserves.  If the fed sees that the economy is overheating, it will remove reserves.

So even if we were in fact reserve constrained, think of our total reserves in the system as "whatever the fed deems necessary to service the payments system and facilitate lending for real growth in the economy."

[Gumby]

Actually Gumby, your argument doesn't make sense...85billion a month is massive.

I'm sure you think $85 billion sounds like a "massive" number, but in reality it's less than one tenth of 1% of the ~$100 trillion that makes up the private credit market and shadow banking system. And secondly, the money isn't dropped out of a helicopter — it's swapped for financial assets and the POMO transactions do not increase the size of anyone's balance sheet in the private sector. You are trying to make a mountain out of a very tiny mole hill — as many political pundits do.

$85b per month is 1trillion per year provided largely to financial institutions who would have normally held those bonds.

You are misconstruing the role of reserves. A financial institution is no richer or poorer after their Treasury bonds are swapped for cash — their assets are reconfigured, but no greater in value. In fact, the financial institution would rather have the Treasury Bonds over the excess reserves since the excess reserves only earn a tiny FFR/IOR return versus the larger coupon that would have been afforded by the bonds.

They have a reserve ratio of 10% making the total value of QE 10Trillion, plus the inter bank lending multiplier could result in many times that 10trillion.

Sorry, but research from the Federal Reserve refutes the textbook money multiplier effect that we were all taught in elementary school...

“Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.”?

Source: http://www.federalreserve.gov/pubs/feds ... 041pap.pdf

The Fed's own research concludes that the Money Multiplier doesn't exist. And Japan's own experience showed the exact same thing almost a decade earlier. The Fed still attempts to calculate the M1 money multiplier, and here's what it looks like these days...

[align=center][img width=630 height=378]http://research.stlouisfed.org/fredgraph.png?g=n4Q[/img][/align]

Yep. It's dead alright. It's actually less than 1 now. (Any number multiplied times a number less than 1 equals a smaller final number.) Banks aren't reserve constrained and they don't lend out their reserves:

Standard & Poors: Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves

As Standard & Poor's explains:

...The money multiplier has not collapsed because it was never there in a meaningful sense to begin with.


Standard & Poors: Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves

All you need to do is look at the total money supply and how the market reacts to less QE to realize these moves are unprecedented and not a drop in the bucket as you seem to say.

The market reacts because QE inflates the value of financial assets as banks use their excess reserves — which don't earn much income beyond a tiny FFR/IOR — to bid up some financial assets and the market attempts to front-run it. But, let's take a look at the total money supply, shall we?... MZM is widely recognized as one of the broadest published measures of the money supply. I don't see anything extraordinary about the changes in MZM over the past few years.

[align=center][img width=630 height=378]http://research.stlouisfed.org/fredgraph.png?g=qse[/img][/align]

You were saying?...

[Pointedstick]

Sorry, but research from the Federal Reserve refutes the textbook money multiplier effect that we were all taught in elementary school...

Man, we must have gone to really different elementary schools.