Debtor's Prison

Greetings fellow inmates,

Seeing as the end of the year approaches, we thought we would revisit an earlier prognostication we made earlier in 2009, shortly after Uncle Benny’s announcement in March of the quantitative easing (QE) program, in which he would purchase $1.75tr of long-term US Treasuries, Agency debt and Agency MBS (at $300bln, $200bln and $1.25tr, respectively).   In spite of its unprecedented size, we predicted it would not be the end of it.   More precisely, we stated that Uncle Benny would commit to purchasing up to $1tr of additional long-term US Treasuries.   Our reasoning behind this belief in further monetary easing was then, as it is now, that the cost associated with the bailouts, existing and upcoming, combined with the enormous reduction in income caused by the economic downturn will require that Uncle Benny purchase more of the debt coming out of the Treasury.   Simple, the US, and other advanced economies, must fund their multi-trillion dollar packages by issuing more debt since they are all running deficits (barring a few), and with China, OPEC, Russia and the rest of the suckers, or rather, prisoners, having much less money to spend on US Treasuries, then Uncle Benny has to step in to support that market.   That is of course the reason why he has already committed to purchasing such a gargantuan amount of MBS debt, $1.25tr, since the Russkies and everyone’s mother started dumping it.   The same will happen with USTs.   The simple fact that there are $2tr of short-term Treasuries (due within a year), means at least that much more debt needs to be issued.   There is just no one with the money to significantly take that down, not even the Chinese.   The natural answer is of course for Uncle Benny to gracefully agree to purchase much-many more of them.    Though there are only two weeks left in the year, we are sticking with our guns.   If not, then we will proceed to make a significant wager that it will definitely happen within the next six months.   We will discuss the gory details in the next couple of weeks, but todays post we will begin with some validation of our views from a “well-respected” and “accomplished” “economist” over at a world-leading and policy-setting think-tank.  

In December, the Peterson Institute for International Economics (PIIE), published a Policy Brief entitled The World Needs Further Monetary Ease, Not an Early Exit, written by Joseph E. Gagnon.      The PIIE is often referred to as the world’s TOP think-thank.  Its policy recommendations are almost always implemented, and it has shaped a significant tract of US policy in the past 3 decades.   Its Board of Directors features some of the top talent in the entire world, to name a few, Stanley Fischer, Jacob Frenkel, Mo Greenberg, Paul O’Neill, David Rockefeller, Lynn Forester de Rothschild, Jean-Claude Trichet, Granpa Volcker and Ernesto Zedillo.  One of its 3 honorary directors is none other that Judy Greenscam herself!  Wow, the whole gang is here!  So nice of you to show up to our little discussion.  We do advise readers to take some time and learn a bit about each of these people, we shall post some bios in The Enforcers soon.   But, in any case, what the PIIE says, the US likely does.   So, not only is this paper a significant leading indicator of what might happen, but it is also more drastic than even our own estimates.    As a very strong side-note, we cannot restrain our utter contempt for this un-digestible garbage, so we thought to give you a factual synopsis of what this “author” recommends, as well as extract some notable garbage for commentary, inspection, ridicule, and all-around humiliation.   Please feel free to peruse the original report yourself, and if you feel so inclined, communicate your thoughts to the “author”, at jgagnon@piie.com.  We will.

Quotes are in bold italics.

THE FACTS

In particular, central banks in the main developed economies should push long-term interest rates 75 basis points below the levels they would otherwise be by purchasing a combined $6 trillion in long-term public and private debt securities.

The Federal Reserve should purchase an additional $2 trillion of longer-term debt securities with an average maturity of around seven years.

The European Central Bank (ECB) should lower its main refinancing rate to 50 basis points, continue to extend unlimited 12-month credit to the banking system at this rate, and purchase €1 trillion of longer-term debt securities.

The Bank of Japan should state more clearly its intention to return inflation to at least 1 percent over the next two years, purchase an additional ¥100 trillion of longer-term debt

The Bank of England should purchase an additional £200billion of longer-term sterling bonds or an equivalent amount of longer-term foreign-currency bonds with the interest and principal hedged using currency swaps.

These purchases would be announced now but could be implemented over the course of 2010.

Clearly, Joseph E. Gagnon (JEG) anticipates a much larger increase in central bank purchases than we do.   He estimates $6tr is needed worldwide ($2tr from Uncle Benny) in order to lower long-term yields, particularly the 10-year UST, by 75bps, hence raising GDP by 3% in two years.    Moreover, he indicates that this could be implemented imminently, to be executed in 2010.   We believe the timeframe JEG, your Masters command it, and so it shall be.   

THE GARBAGE

An Open Letter to JEG:  

In light of high and rising levels of public debt, additional monetary stimulus is preferable to additional fiscal stimulus. Indeed, monetary stimulus reduces the ratio of public debt to GDP by reducing interest expenses, increasing GDP, expanding tax revenues, and enabling an earlier start to fiscal consolidation.  

We strongly contest that “monetary stimulus reduces the ratio of public debt to GDP”.  It can be easily seen that were it not for Uncle Benny’s QE, then the US Treasury would not have been able to issue as much debt.   Let’s get it clear, Uncle Benny bought USTs, because everyone else didn’t have enough willing money to do so.    Hence, it clearly follows that had monetary policy been limited to Fed Funds, then UST issuance would have been lower and/or we would have had to accept higher yields (which is natural anyway). 

Reduces interest expenses how JEG?  By monetizing them?

“Expanding tax revenues”?  Are you joking?  Can you please attempt then to explain the M1 Money Multiplier being below 1.0?   We would all LOVE to hear you try.   Each of those dollars flushed down the monetary black hole has resulted in less than a dollar to the broader economy.  This statement of yours JEG is equivalent to 1 + 1 = 3.

Compared with the status quo, additional monetary stimulus gets the economy back to potential sooner and permanently reduces the national debt by about 3% of GDP.

You are one stubborn little man aren’t JEG?   One day, a few years from now, we will find you and read you this very quote.

Studies typically find that the peak effect of monetary policy on economic growth occurs after one year and the peak effect of monetary policy on inflation occurs after two years.

This VERY notion is what should severely restrain your delusional monetary looseness because there is no evidence whatsoever, nor will there be for another 1.25 years, of the initial inflationary effects, of the earlier round of QE.    In other words, after having deployed a gigantic monetary nuclear experiment with potentially catastrophic inflationary consequences, JEG, you are suggesting that we double it, before any evidence arrives?     Let’s leave alone for once second your blind, misleading, hard-headed and downright stupid adherence to your beloved little Money Multiplier Model.   What happens then 3 years down the line, if let’s say the economy “heats up”, and the initial round of QE did prove to be too inflationary, well, you can’t roll back the second round of QE which you are already suggesting.  Because, remember, JEG:  These are l-o-n-g term bonds, with their inversely correlated prices/yields and all, which are being held on the central bank balance sheet.  “Rolling back” this monetary stimulus is tantamount to selling those bonds, which at the $3.75tr you suggest, would send long-term yields skyrocketing, on everything.   This would not only squash any nascent recovery, but would also compound the inflation problems as people would pile reserve wealth previously stored in government debt into physical assets.   But on NEITHER of these two issues JEG are you even remotely closely to providing an answer or even furnishing a half-intelligible definition.   But, we digress, the point is, if inflation does prove to be too high in 1.25 years, and we have already taken your suggestion JEG, then we will put ourselves over an irreparable edge.  Thanks man.  

Even if it became apparent only after purchase were completed that GDP growth or inflation was considerably stronger than expected, there would be some ability for policy makers to implement a correction through a sharp temporary increase in short-term interest rates.

Just when we thought you couldn’t get any worse JEG.   For starters, let’s remind everyone that you are operating on the premise that inflation will only pick up through a reduction in slack GDP, or in other words, the broad monetary aggregates.   Alright, before you even begin thinking about those things JEG, go read about the M1 money multiplier < 1, inform yourself.  It is highly dubious, if not outright imaginary, that policy makers would be able to implement a correction to such conditions you speak of JEG.  For starters, your Money Multiplier model has been discredited by data, so Uncle Benny’s vestigial Fed Funds, has little or no and lagging effect on broad monetary aggregates.   Moreover, the Fed Funds is even more meaningless now since the massive long-term debt portfolio, which you are suggesting we double, sits there, like an albatross around all your necks.   While those BONDS are there, then bank reserve balances (high-powered money) have to remain greatly elevated, on the liability side of the FedBS.   There is no incentive for banks to keep those reserves there (even at a modicrum of a short-term rate as you suggest), hence they would lend them, greatly increasing inflation.  In other words, Fed Funds, would be meaningless, as long as bank reserves remain elevated, which they must under an inflated balance sheet.   Either that or physically print more dollars.   But that has nothing to do with inflation, nooooo.   They couldn’t teach you that at Stanford, Harvard, the Treasury or the Fed huh JEG.

A bubble occurs only when asset prices significantly exceed their fundamental value. 

We threw this one in for laughs.   “Fundamental value”, hahaha.   Good one JEG, Rumfoltuckerschnitzel!

Finally, we will not quote the four paragraphs of absolute gibberish in your response to any potential Inflation Scare.  Not only is this pitiful section unworthy of lengthy discussion, it is downright gibberish.

Thanks for nothing JEG,

XOXOXO

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In case you have not realized, many of the arguments used against JEG could easily be applied to the whole notion of further QE.   If we are so adamantly opposed to these premises, why are we so adamant about Uncle Benny’s imminent QE increase?  Our conviction in its imperative, given the conditions (engineered and spontaneous), and The Powers That Be (TPTB)’s determination to steer this current financial system into collapse does NOT mean we endorse it.   We simply view it as inevitable.   There is no more money left to buy the gargantuan amount of debt to be issued in 2010.   Uncle Benny and Co will have to buy it, and they are already out of money.   There are TWO WEEKS left, show us your Poker Face Uncle Benny!   Even if our initial timeframe proves incorrect and we have to enshrine our shame in Vomit Cleanup Duty, we are willing to put our penitentiary money where our mouth is.   If Uncle Benny does NOT buy another $1tr of UST by 07.11.10 (roughly six months), then we will fund a $500 community service project.  

May your capital be safe and your investments prosperous,

MAAA