Gyroscopic Investing

Pointedstick wrote: You're talking past each other. Kshartle, you're talking micro but Gumby and others are talking macro. If you want to discuss macro things like QE, you can't rely on micro.

I was talking about the Government being more irresponsible with people's money than they would be in loaning it out. Moda brought up banks and courts. I indudged the diversion.

Ohhh you mean about savings and where they come from. Gotcha, the idea that savings come from government not actual production that is saved. This requires a better understanding of what a dollar is. It represents a claim on goods and services. Without the latter the former is nothing. We don't need more of the former for more savings, that just results in prices going up. We need more of the latter. We can save and improve our standard of living even without dollars. So we certainly don't need anyone creating more.

Is that clear enough or too vague?

Lowe wrote:

Gumby wrote:He said it in other threads. He thinks that QE will result in the collapse of the dollar or hyperinflation if it is continued.

I can't disagree that QE is unlikely, if not totally unable, to result in hyperinflation.

QE in itself can't produce any inflation.  Only increased lending of the reserves could do that.

If the central bank printed 500 trillion tomorrow and bought every asset it legally could what do you think would happen?

What do you think the banks that just got all those dollars would do with them? Might they buy other assets?

Kshartle wrote:We had far and away the highest living standard in the world and the fastest growing economy and fastest growing standard of living...You can't print a higher standard of living and the banks can't loan us one.

And yet, our standing of living has increased significantly ever since we became a trade deficit nation. I wish I could believe you, KShartle, but — as with everything you say — you offer no evidence to back up what you are saying.

Kshartle wrote: If the central bank printed 500 trillion tomorrow and bought every asset it legally could what do you think would happen?

That would probably lead to some inflation.

Thankfully this is totally unlike QE, which is limited to non-circulating assets held by banks and the cash exchanged for those assets also does not directly circulate in the economy.

Lowe wrote: And yet, he believes that is somehow highly inflationary — despite the fact that there is no evidence to support that theory.

A word of advice Lowe....buy a cornfield. You'll need a home for a lot of strawmen.

Kshartle wrote:Since interest rates are heavily influenced by the FED to say the least, I'm saying they are a major cause of the cycles if not the greatest cause.

They are unquestionably wasteful. They drive people to borrow when absent manipulation they would prefer to save. They distort behavior. We know people act in their own self-interest already. If people aren't doing something (borrowing) there is a reason. They either prefer to not borrow or lenders (people with the money) prefer to not lend.

Do you think there's some way to show this is distortion-ary?  I think I agree with the notion that Fed control over long time periods leads to distortions and the irretrievable loss of capital.  I tend to agree with it because the Fed's controls/influence is analogous to price controls, which are known to cause shortage or over-supply.

Kshartle wrote:The clearest example of their interference causing a bubble is the last housing bubble. Artificially low rates and government gauranteed loans sucked people into buying that otherwise would have not and bid up housing prices causing people to get into the home-buying business when they should have been doing something else. It could only be sustained with cheap money. The cheap money can't go on forever without inflation getting out of control (anyone remember $150 a barrel oil)?

I think this is the same example I referred to as Greenspan in the 2000s.  However, has it been shown that the Fed exacerbated things?  That is, that they were holding down interest rates in the face of an over-heating economy?

I think you will have to admit, regardless, that QE was not going on at the time.

Gumby wrote:

Kshartle wrote:We had far and away the highest living standard in the world and the fastest growing economy and fastest growing standard of living...You can't print a higher standard of living and the banks can't loan us one.

And yet, our standing of living has increased significantly ever since we became a trade deficit nation. I wish I could believe you, KShartle, but — as with everything you say — you offer no evidence to back up what you are saying.

This is like me saying smoking damages lungs but you have evidence of of someone who runs faster now as a smoker than he did prior to smoking without mentioning any other variables (like the fact he lost 50 lbs. or the economy now has computers and other countries are more productive lowering our costs ect.).  Based on your evidence smoking must be good for lungs.

It is ridiculous way to debate/discuss. I've pointed out how ridiculous it is over and over.

I don't need to show a guy who can't run after becoming a smoker to prove that smoking is bad. Give me a break. If that's what you require to believe something that's your issue with understanding concepts.

Lowe wrote:However increased lending is the purpose of QE, whether it occurs immediately over an extended period.

The problem is that the Fed's own research refutes that...

Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. wrote:“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 suggests that the Money Multiplier doesn't exist. And Japan's own experience and research showed the exact same thing almost a decade earlier.

Lowe wrote:Therefore the money should enter circulation, in that it is loaned to people.

Reserves never leave a bank's account at the Federal Reserve. Consumers never touch those dollars. Banks never "loan" reserves (i.e. base money) to customers. The reserves are pretty much just used for interbank transfers at the end of every business day.

Lowe wrote:If it doesn't then QE fails, and price deflation continues until it bottoms out of its own accord.

QE bids up financial assets (as Dalio explained). It seems to have some psychological effects as well.

Lowe wrote:So it is accurate to say successful QE is inflationary (since increased private credit will lead to price inflation, at least to the point of recovery from price deflation)

As Dalio explained, the reflation of private credit really comes from Treasury (fiscal) spending. He implies that the Fed funds that Treasury spending, but MR also points out that the Primary Dealers would happily (and contractually) buy the bonds and fund that fiscal spending rather than keep their money as excess reserves and earn a measly IOR/FFR.

Lowe wrote:Alternatively QE is not inflationary in the short term, but should be in the long term.

There's no evidence to support that. It's mostly supposed to be based on the money multiplier effect, and the research from the US and Japan shows that it appears to be a myth. Again, MR explains it by pointing out that banks never loan reserves. QE has some other inflationary effects on financial assets (i.e. banks using excess reserves to bid up assets).

I could keep explaining it, but you'd probably find it more interesting to just read the paper

http://pragcap.com/understanding-the-mo ... m-part-1-2

Lowe wrote:Another way for QE to fail is for too much lending to occur, resulting in inflation beyond price-recovery.  This situation is less likely than the other mode of failure because private banks are careful about whom they lend to, and not many people look credit-worthy during deflation and consequent recession.

Exactly, but, again, banks are never reserve constrained when the reserve requirement is zero. They wouldn't ever turn a credit-worthy borrower away. They would make the loan and then go find any needed reserves for interbank transfers (asking the Fed if necessary).

Lowe wrote:Some argue an analogous failure is what occurs with fiat money over a long time period, exacerbating the next debt cycle.  That is difficult to know, but I can't definitively say it is false.  Citing increasing living standards is not a rebuttal, because there is nothing to say living standards might not have been higher, given this or that.

He claims that all government money printing is destroying our living standards, but he offers no evidence of that and the past century says otherwise — despite all the money printing that went on. If he wants to say that living standards could have been even better, that's fine, but he'd never be able to prove it and it seems to fly in the face that the last half-century was the greatest increase in living standards the world has ever seen.

He is certainly entitled to his theories, but he never offers any evidence to support them.

Kshartle wrote:This is like me saying smoking damages lungs but you have evidence of of someone who runs faster now as a smoker than he did prior to smoking without mentioning any other variables

Well, now you're being ridiculous. There is evidence that smoking damages lungs. You, on the other hand, have never offered any evidence to support anything you've ever said!

Honestly, KShartle. I would love to believe what you are saying, but you never offer any evidence to support your statements, so you're just not that convincing. I truly wish you could do better.

Gumby, I am not saying that increased cash reserves is what motivates the banks to lend more, under QE.  I understand they were never reserve-constrained to begin with.

I am saying they lend more because they don't have the alternative of buying and holding Treasurys, nearly as available to them.  This causes them to make as many good loans as they can, fully using whatever credit-worthy borrowers are available.  This causes an increase in private credit.

I had thought this was the primary purpose of QE.  Is that not true?

Likewise I had assumed the bidding up of equity would be due to fewer Treasury available to potential buyers.

Kshartle wrote:

Lowe wrote:

Gumby wrote:He said it in other threads. He thinks that QE will result in the collapse of the dollar or hyperinflation if it is continued.

I can't disagree that QE is unlikely, if not totally unable, to result in hyperinflation.

QE in itself can't produce any inflation.  Only increased lending of the reserves could do that.

If the central bank printed 500 trillion tomorrow and bought every asset it legally could what do you think would happen?

What do you think the banks that just got all those dollars would do with them? Might they buy other assets?

Kshartle,

Don't you see the fundamental difference between trading reserves for another government financial asset called t-bills, both of which are just financial assets on a bank balance sheet, and the fed trying to buy homes, cars, businesses, land, etc?

These are fundamentally different.  Think of any time the fed buys something that it's actually disabling it for use in the broader economy.  A treasury bond is fundamentally not much different from cash in terms of its use on our balance sheet and in our lives (and this is especially true for banks).  If the fed starts taking factories, farms, homes, cars and land out of commission, you have HUGE economic impact.

I actually disagree with Pointed Stick... I think we could actually see hyperinflation if the fed started buying up tangible productive assets to the tune of $500 trillion.

What we're saying is that for us as consumers, and especially for the banking system, there's very little difference between dollars and T-bills when we understand how both are used in the treasury, bank, fed circle-jerk.

Lowe wrote:I am saying they lend more because they don't have the alternative of buying and holding Treasurys, nearly as available to them.  This causes them to make as many good loans as they can, fully using whatever credit-worthy borrowers are available.  This causes an increase in private credit.

I've highlighted what I believe is the key phrase. During a credit crunch, it can be difficult to find such borrowers.

Lowe wrote:I had thought this was the primary purpose of QE.  Is that not true?

Potentially. I think that QE is misunderstood even by the people who are implementing it. Nobody really knows if its intention is to stimulate loans, bid up assets, or just look like they are doing something. In every case, it doesn't appear to do as much as most people imagine it does.

Lowe wrote:Likewise I had assumed the bidding up of equity would be due to fewer Treasury available to potential buyers.

Correct. If you're only getting a measly IOR/FFR (thanks to Treasuries not being available) and your Christmas bonus depends on you making X-billion dollars for your bank from trading Treasuries, my guess is you take those excess reserves and give it to the HFT guys and bid up some assets.

moda0306 wrote:I actually disagree with Pointed Stick... I think we could actually see hyperinflation if the fed started buying up tangible productive assets to the tune of $500 trillion.

I think PS was correct in his interpretation of KShartle's statement. KShartle said, "bought every asset it legally could" — and that wouldn't include tangible assets.

On a side note, there isn't even anything close to $500 trillion of legal financial assets in the private sector, so his question is just another fantasyland example that doesn't apply to reality. The Fed can really only buy Treasuries and a few other financial assets that Congress has approved. So, even in an extreme example, we are really only talking about ~$20 trillion or so. It still kind of pales in comparison to the size of private credit, which is closer to ~$56 Trillion (some research suggests that Shadow Banking is now in the neighborhood of ~$100 trillion).

Lowe wrote: Gumby, I am not saying that increased cash reserves is what motivates the banks to lend more, under QE.  I understand they were never reserve-constrained to begin with.

I am saying they lend more because they don't have the alternative of buying and holding Treasurys, nearly as available to them.  This causes them to make as many good loans as they can, fully using whatever credit-worthy borrowers are available.  This causes an increase in private credit.

I had thought this was the primary purpose of QE.  Is that not true?

Likewise I had assumed the bidding up of equity would be due to fewer Treasury available to potential buyers.

Lowe,

This is good stuff... I think what your saying would be absolutely true if 1) we weren't pushing on a string where people don't wan to borrow even at near-zero interest rates, and 2) the fed didn't pay interest on reserves.

This is an odd world, because if I'm not mistaken, if the banks hold reserves instead of short treasuries, they get a higher interest rate.

Combine no real "reserve ratio" with interest on reserves, and you literally have almost zero, nada, zilch, nil, nonexistent fundamental difference between short-term treasuries and reserves/cash.

I'm not trying to "yell" or talk down... just think this is one of the most important things to grasp in this debate.  It takes a while for it to click, but when it did for me, EVERYTHING made more sense.  Before then I was like Neo in the Matrix, knowing something just didn't make sense.  After, I felt like I could jump from one building to the next and dodge bullets.

I read Roche's paper on MR, and I have a few questions for you guys.



1)  Do banks ever mix their outside money (Fed reserves) with their inside money (credit-created money, outside Fed)?  Or is the outside money only ever used in transactions with other banks with reserves, and with the Fed?



2)  To what extent can banks negotiate for better terms, when they are compelled legally to act as a partner in transactions with the Fed?

For example, if I am a bond trader at a bank, and a Fed bond trader expresses his desire to buy some of my bank's T-bills, how much can I bid the price of those bonds up, from whatever the market price is?

From what I understand the typical open market operations of the Fed result in Treasury prices being bid up/down.  Up if the Fed is buying, down if the Fed is selling.  This assumes the Fed is the biggest influence upon the Treasury market, which I think is fair.  This should be true because the Fed is in the open market, and must be competitive in its bids.

From what I have heard, QE is different, in that it is not open market.  The law compels the banks' bond traders to participate, since they probably would not, otherwise.  Is that correct?  If so, the extent to which they can negotiate for prices above market value, should be the extent the market price of bonds rises.



3)  This question is related to the second, but is more foundational.  I read on Wikipedia that historically the main objective of the Fed has been to use open market operations to reach a target Federal Funds Rate (FFR).

This does not say if the FFR has causal important to interest rates, or if it is only an indicator of rates.

However, the subsequent explanation implies that the FFR does have causal importance to to interest rates.  Lenders add their expenses to FFR, to figure out rates.  The assumption is that inter-bank reserve loans are the alternative to other lending (1).  The Wikipedia description of events also seems to assume that is the scarcity of the reserves that guides banks to bid FFR up or down (2).  Here is a flow of events, with the two assumptions cited.

Flow A:

Fed buys Treasurys / reduces liquidity (reserves)  -->  Reserves scarcer  --(2)-->  Reserve-lending banks bid up FFR  --(1)-->  FFR guides lenders rates up

Fed sells Treasurys / increases liquidity (reserves)  -->  Reserves less scarce  --(2)-->  Reserve-borrowing banks bid down FFR  --(1)-->  FFR guides lenders rates down


From what I understand, MR supports neither (2) nor (1).  Someone recently asked me how the Fed controls rates, and I described a different flow to them.  Afterward I began reading the Wikipedia description, and found no mention of these events.

Flow B:

Fed buys Treasurys  -->  Treasury sellers bid price up  -->  Treasury auctioneers offer lower yields (3)  -->  All bond auctioneers offer lower yields (4)  -->  FFR bid down

Fed sells Treasurys  -->  Treasury buyers bid price down  -->  Treasury auction-ees bid up yields (3)  -->  All bond auction-ees bid up yields (4)  -->  FFR bid up


In Step 4 bond auctioneers could be replaced with borrowers, and bond auction-ees with lenders.  In practice steps 3 and 4 occur at the same time, because all parties know that when Treasury prices rise/fall, Treasury auctioneers are watching those prices and will offer rates inversely related.  This flow of events assumes that loaning to the Treasury is the alternative to other lending.

In this flow FFR is an indicator of rates, but not a cause for them.  If Treasury auctioneers are offering lower rates, then reserve-lending banks competitively bid down the FFR to about the same as T-bills.  Likewise is Treasury auction-ees are bidding up yields, then reserve-borrowing banks competitively bid up FFR, to about the same.


My question is, does Flow A occur, or is it incorrect?  Is Flow B what occurs, or something else?

Lowe wrote: I read Roche's paper on MR, and I have a few questions for you guys.

I'm getting ready for a trip and don't have much time. If you want to ask Cullen yourself, you can do it here:

http://ask-cullen.com

You'll probably get better answers directly from him, or from one of his more knowledgeable readers.

Lowe wrote:1)  Do banks ever mix their outside money (Fed reserves) with their inside money (credit-created money, outside Fed)?  Or is the outside money only ever used in transactions with other banks with reserves, and with the Fed?

Electronic base money, or "high powered" money never leaves the Federal Reserve. Credit-created money is nothing more than an entry on a statement. In essence, the credit on your statement gives you the ability to transfer the bank's high powered money (or withdraw notes from an ATM).

Lowe wrote:2)  To what extent can banks negotiate for better terms, when they are compelled legally to act as a partner in transactions with the Fed?

For example, if I am a bond trader at a bank, and a Fed bond trader expresses his desire to buy some of my bank's T-bills, how much can I bid the price of those bonds up, from whatever the market price is?

The Fed doesn't really call up your bank and have a conversation with you. It's all done on the secondary market. The New York Times did a piece on the QE trades awhile back...

NYTimes: An Inside View of QE2

The New York Times wrote: Mr. Frost and his team work out of a small, beige corner office with arched windows that used to be a library. There, at about 10:15 most workday mornings, one of them pushes a button on a computer. Across Wall Street, three musical notes -- an F, an E and a D -- sound on trading terminals, alerting traders that the Fed is in the market.

On one recent Tuesday morning, what Mr. Frost and his five young colleagues did over a 45-minute period might have unsettled even a seasoned Wall Street hand: they bought $7.8 billion of Treasuries.

Mr. Frost and his team drew up the daily schedule for what the Fed calls its Large-Scale Asset Purchase program. And that program is, by any measure, large scale: through next June, these traders will buy roughly $75 billion of Treasuries a month -- on top of another $30 billion it is reinvesting in Treasuries from its mortgage-related holdings.

But depending on daily market conditions, Mr. Frost can decide not to buy certain bonds if they are already in short supply.

As offers to sell Treasuries flash on a bank of trading screens, a computer algorithm works out which ones to accept. The computer compares the offers from Wall Street against market prices and the Fed's own calculation of what constitutes a ''fair value'' price.

The real work is done by three traders who sit at a long table against the wall, tapping at seven screens.

The lead trader one recent morning was Tiffany Wilding, 26. While she reviewed the offers accepted by the algorithm, a second trader, Blake Gwinn, 29, double-checked her decisions and a third, James White, 29, made a duplicate of everything in case the computers crashed.

Mr. Frost stood behind his colleagues, ready to intervene -- even cancel the Fed's purchases -- at any sign of trouble.

They have their work cut out, trying to outwit the 18 investment firms that deal directly with the Fed. These so-called primary dealers -- the Goldmans and Morgans of the world -- employ some of the sharpest minds on Wall Street.

Source: NYTimes: An Inside View of QE2

It is literally people tapping keyboards — trading bits of data. Not all that exciting.

Lowe wrote:From what I understand the typical open market operations of the Fed result in Treasury prices being bid up/down.  Up if the Fed is buying, down if the Fed is selling.  This assumes the Fed is the biggest influence upon the Treasury market, which I think is fair.  This should be true because the Fed is in the open market, and must be competitive in its bids.

Generally speaking, yes. That's the idea.

Lowe wrote:From what I have heard, QE is different, in that it is not open market.  The law compels the banks' bond traders to participate, since they probably would not, otherwise.  Is that correct?  If so, the extent to which they can negotiate for prices above market value, should be the extent the market price of bonds rises.

Well, it's not so much "the law" as it is a contractual obligation. A Primary Dealer isn't forced to be a Primary Dealer. They sign up willingly and can opt-out if they want to (though it's a big deal to be a "Primary Dealer" so nobody would really "opt-out" of being a Primary Dealer). As you'll see from the NYT article, sometimes QE doesn't have the effect that they want it to have on interest rates.

Lowe wrote:Flow A:

Fed buys Treasurys / reduces liquidity (reserves)  -->  Reserves scarcer  --(2)-->  Reserve-lending banks bid up FFR  --(1)-->  FFR guides lenders rates up

Fed sells Treasurys / increases liquidity (reserves)  -->  Reserves less scarce  --(2)-->  Reserve-borrowing banks bid down FFR  --(1)-->  FFR guides lenders rates down

Sorry, but I must be misunderstanding you. If the Fed buys Treasuries from Primary Dealers, that would increase the liquidity and the reserves of Primary Dealers, right? And if the Fed were to sell Treasuries, to Primary Dealers, wouldn't that decrease their liquidity and reserves? After all the QE, there are too many reserves right now.

Lowe wrote:FFR

The problem with FFR right now is that we live in a world with IOR. IOR is now the de facto FFR because there are too many reserves.

See:

http://pragcap.com/will-the-fed-end-up- ... e-programs

http://pragcap.com/interest-on-excess-r ... lation-low

You are asking excellent questions. The nice thing about Cullen and his site is that he (or his readers) is more than happy to answer these kinds of highly technical questions. They enjoy these kinds of questions because it allows them to refine their understanding of the monetary system and that potentially enables them to invest better. They aren't in it to convince people of good/bad fiscal policies.

So, I would pose the question to http://ask-cullen.com and see what you get back! Sorry I can't be of more help.

Yes, the first one was supposed to say "sells," not "buys," and the second was supposed to say "buys," not "sells."  Here it is corrected, also with Flow B in matching order.


Flow A:

Fed sells Treasurys / reduces liquidity (reserves)  -->  Reserves scarcer  --(2)-->  Reserve-lending banks bid up FFR  --(1)-->  FFR guides lenders rates up

Fed buys Treasurys / increases liquidity (reserves)  -->  Reserves less scarce  --(2)-->  Reserve-borrowing banks bid down FFR  --(1)-->  FFR guides lenders rates down


Flow B:

Fed sells Treasurys  -->  Treasury buyers bid price down  -->  Treasury auction-ees bid up yields (3)  -->  All bond auction-ees bid up yields (4)  -->  FFR bid up

Fed buys Treasurys  -->  Treasury sellers bid price up  -->  Treasury auctioneers offer lower yields (3)  -->  All bond auctioneers offer lower yields (4)  -->  FFR bid down


I am interested to know which one of these reflects reality, more or less.



EDIT:  Yes, I read that the Fed had begun paying interest on reserves since 2008, and that this determines what FFR is.  I do not totally understand that, but I was asking about the Fed's historical operation, more than its current operation.

Lowe wrote:EDIT:  Yes, I read that the Fed had begun paying interest on reserves since 2008, and that this determines what FFR is.  I do not totally understand that, but I was asking about the Fed's historical operation, more than its current operation.

Right... so that's part of the wokish debate that's been going on between Krugman and Cullen Roche.

http://pragcap.com/banks-and-the-moneta ... ul-krugman

Most economists are still using the old flow (which I'm honestly not as familiar with). Now that the Fed pays IOR it fundamentally changes everything. Unless Moda, or someone else, knows the answer, I would ask-cullen.

But, if I had to guess, I would say "A". My impression is that in historical times, when the reserves were scarcer, some banks needed to find reserves when they expected to make interbank transfers and were willing to bid on other banks' excess reserves accordingly (with the Fed literally controlling the amount of reserves, via POMO, to hit a target FFR).

Okay, thanks.  That sounds like a good guess, but I will hopefully ask about it on Roche's site as well.

It seems like Flow B must have been occurring, even before IOR was paid.  But maybe it was not as important as Flow A, because scarcity of reserves truly was an important consideration, as you say.  There may be papers out there on the subject.

I just read some about IOR in a paper linked on one of the articles you listed.  I think I understand it, as it removes the opportunity cost of a bank having excess reserves (more than its needs to conduct its transactions with other banks or with the Fed).

In an age of excess reserves, I can't see Flow A mattering as much as Flow B, however I don't know what the effect of a floor on FFR (that is, paying IOR) has on this.



EDIT:  By the way, by historically I meant recent history.  As in 80s and on till 2008.  I don't really care about pre-80s, since that was when dinosaurs roamed the earth and ran the central banks.  Also there was a fixed exchange rate between the dollar and gold.

I don't know much about FFR and IOR, other than if you work those basic elements into a few other fundamental truths about our banking system, it becomes real obvious real quick that trading reserves for bonds accomplishes almost nothing.

I can't talk about it like those MR guys, though.  I'm literally not that smart.  I just think about things until they start to make sense in some sort of very simple logical framework.

Hah. You're smart enough, Moda.

dualstow,

Literally though, I try like hell to simplify things that can be broken down using the following tools:

- Venn Diagram

- Decision Tree

- Financial Calculator

If it's too complex for those, I whip open an excel document for help.

Still no answer?  Google & Wikipedia.


My common sense leaves a bit to be desired, but my ability to waste hours pontificating on meaningless subjects is second to none.

moda0306 wrote: My common sense leaves a bit to be desired, but my ability to waste hours pontificating on meaningless subjects is second to none.

In that case, you might want to consider a career in politics!