Quantitative Easing aka. Money Printing

Quantitative Easing aka. money printing is a government sleight of hand that results in an increase in the money supply. According to Wikipedia quantitative easing� is different from the typical method whereby governments buy or sell government bonds on the open market to keep market interest rates at a specified target value. That requires a cooperative market. In unusual times, i.e. when the market is panicked, and banks don’t want to buy bonds, the central bank implements “quantitative easing” by purchasing relatively worthless financial assets from banks and loaning them new electronically created money.  So this is straight forward money printing compared to the more round about tradtional method.

Thus Quantiative Easing increases the excess reserves of the banks creating liquidity for the markets.

Effects of Quantitative Easing

Legendary economist, Milton Friedman once said: “Inflation is always and everywhere a monetary phenomenon.” In other words, inflation is always caused by printing too much money. But the results are seen in prices of commodities like food, clothing and energy after the printed money works its way through the economy.

Generally, after a round of “Quantitative Easing” (aka. Money Printing) it usually takes one to two years for it to show up in popular pricing. The time lag gets smaller as people catch on to the cause and begins to anticipate more inflation. The time lag is also why many people fail to see the correlation between money printing and inflation.

Since the majority of our money these days is not physical paper but simply numbers on a balance sheet, instead of physically cranking up the printing presses these days the way the FED increases the money supply is by buying debt on the open market and replacing it with bank deposits. In other words, it takes liabilities and magically turns them into assets. Theoretically someone owed the banks this money but they may have had to wait 30 years to get it (if they got paid at all). But the FED bought it and so the banks are now liquid (but the FED is holding all the worthless debt).

The first Round of Quantitative Easing (QE1)

In the case of QE1, the US Federal Reserve held $700–$800 billion of Treasury notes (government debt) before the recession began. In November 2008, the Fed began buying $600 billion Mortgage-backed securities (MBS). This is private debt backed by sometimes worthless mortgages. By March 2009, it held $1.75 trillion of bank debt, MBS, and Treasury notes, and reaching $2.1 trillion in June 2010.

So based on the 1 to 2 year time frame you would expect inflation from QE1 to begin between March 2010 and March 2011 and if no more easing occurred, we’d expect the inflationary pressure to end somewhere between June 2011 and June 2012.

QE1 Inflation Begins

As predicted, inflation began well within that target range.  Inflation began in earnest in January of 2011 with a monthly rate of 0.48% (roughly 21 months after QE1 began). It probably started a bit slowly because of the massive deflation that was affecting the world-wide economy. And by mid-2011 the effects of QE1 began to peter out with October, November and December having monthly deflation.

Theoretically, since the QE1 money creation spree lasted 19 months it is quite possible that the inflationary effects will last approximately 19 months. However, the evidence from the end of 2011 seems to be that its effects are primarily spent.  But QE1 was not a steady increase it had its ups and downs so we can expect the inflation rate to fluctuate as well. Although it appears that inflation from QE1 has subsided, as we saw in January 2012, we may still see some effects between now and July of 2012 with some up and down fluctuations. On the other hand January through March could be simply an Oil shock based on the “saber-rattling” between Iran and the U.S.

The Second Round of Quantitative Easing (QE2)

QE2 began in November of 2010 and ended in June of 2011. So we have an additional 8 months or so of monetary increases from that. So if it follows the pattern of QE1 we can expect the effects of QE2 to begin roughly 21 months from November  2010 or around July 2012. But because we aren’t in the throes of a massive deflationary panic  (unlike when QE1 started) it may have begun earlier, pick up quicker and have a greater impact.

So far January and February 2012 each had 0.44% inflation for the month March had a whopping 0.76% and April had 0.30%. This may be the beginning of the effects of QE2 and it could continue through as late as August 2013.  By that time we could see inflation as high as 10-12% if the Euro crisis doesn’t create massive deflationary forces to counteract it.

Theoretically, the rise in the price of Oil in March could be the beginning of the results of QE2 and Oil is just more sensitive to it. However, in an effort to hold the price of oil down the government has threatened to release strategic oil reserves which masks the inflationary effects of quantitative easing.

The other area we may be seeing the results of QE2 is in the stock market as the liquidity flows there. Interestingly, the stock market is one place where people like to see inflation, the other place is in the housing market (even though it tends to price new buyers out of the market).

However, Inflation rates above 5% begin to cripple the economy as we saw with the last Oil spike (July 2008). So as the higher monthly numbers continue to drop out of the equation over the next couple of months we should see the inflation rate continue to fall giving people a false sense of security as they don’t realize the effects of QE2 are still around the corner.

Current Quantitative Easing Moderating Factors

The only reason Inflation isn’t 100 times worse than it is currently is because the Fed is paying banks to hold on to all that money it printed. Basically the FED created money out of thin air and loaned it to the banks at almost zero percent interest. The banks turned around and loaned it back to the government at about 3% interest to finance the public debt. This results in a hidden form of bank bailout as the banks make 3% profit on free money and the government can pretend that it isn’t bankrupt.

China on the other hand is accumulating Gold like crazy in a possible bid to eventually become the World’s reserve currency and avoid the effects of the dollar. This could be the biggest trend of the coming decade and you need to know about it. See:� Why (and How) China is Boosting the Price of Gold also see: Iran Says “Gold Is Money”

See: The Long Road to Inflation Perdition

To see some independent (non-government) inflation numbers see our article:
Can We Trust the Government CPI Numbers?

History shows that once a financial bubble bursts, it can take a long time to bounce back.

Recent history offers an example: Real estate prices topped in 2006-2007 — then came the worst part of the sub-prime mortgage crisis in 2008.

Yet instead of recovering with the passage of time, real estate prices just keep getting worse:

Home prices dropped for the fifth consecutive month in January, reaching their lowest point since the end of 2002.
– CNNMoney, March 27

As values sink and desperation grows, the number of owners giving their timeshares away for $1 — or less — has doubled in the past year, says Brian Rogers, of Timeshare Users Group, an owner advocacy group. “There’s never been a worst time to try to sell a timeshare,” he says.
– SmartMoney, April 4

Observers have called for a bottom numerous times in the five or so years since the bubble burst.

Again, this is what can happen. Recovery can take far longer than many expect.

Real estate is just one sector of the economy. Let’s consider another sector:

According to Citigroup economist Steven Wieting health care is the next big bubble looming in the distance.
And to make matters all the more worrisome, his analysis suggests it’s like nothing we’ve seen before.
– CNBC.com, April 12

Although health care is a huge part of the economy, it’s still just one sector. Let’s consider yet another sector:

The amount Americans owe on student loans is far higher than earlier estimates…Total student debt outstanding appears to have surpassed $1 trillion late last year…That would be roughly 16% higher than an estimate earlier this year by the Federal Reserve Bank of New York.
– Wall Street Journal online, March 22

As big as each of the above sectors are, they are just a fraction of the bigger picture:

…the property market, to me, was a microcosm…of what shape the whole world is in right now — in debt up to its ears and ultimately unable to pay. And that’s what crushed the real estate market and I think it’s going to crush…the entire debt market across the globe…Nobody’s worried…
– Robert Prechter, Financial Sense Newshour interview, March 22

Far from being worried, lenders are once again trying to push credit on risky clients:

[A Brooklyn resident] just emerged from bankruptcy and doesn’t have a job, and her car was repossessed last year. Still, after spending her days job hunting, she returns to her apartment in Brooklyn where, in disbelief, she sorts through the piles of credit card and auto loan offers that have come in the mail.
– New York Times, April 10

As bubbles balloon in individual sectors of the economy, the psychology of the pre-financial crisis days have returned.

That’s why it’s important to remember that hardly anyone was concerned about the real estate market in 2006. Then the whole house of cards fell in.

Now consider the entire global debt market: the biggest bubble of all time.

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How to Speculate your Way to Success

Source: JT Long of The Gold Report (4/20/12)

So far, 2012 has been a banner year for the stock market, which recently closed the books on its best first quarter in 14 years. But Casey Research Chairman Doug Casey insists that time is running out on the ticking time bombs. Next week when Casey Research’s spring summit gets underway, Casey will open the first general session addressing the question of whether the inevitable is now imminent. In another exclusive interview with The Gold Report, Casey tells us that he foresees extreme volatility “as the titanic forces of inflation and deflation fight with each other” and a forced shift to speculation to either protect or build wealth.

The Gold Report: You told us about two ticking time bombs last September, Doug—the trillions of dollars owned outside the U.S. that could be dumped if the holders lose confidence, and the trillions of dollars in the U.S. created to paper over the 2008 liquidity crisis. It’s been six months since then. Have we averted the disaster or are we closer than ever?

Doug Casey: Things are worse now. The way I see it, what’s going to happen is inevitable; it’s just a question of when. We’re rapidly approaching that moment. I suspect it will start in Europe, because so many European governments are bankrupt; Greece isn’t an exception, it’s the norm. So we have bankrupt governments trying to bail out the European banks, which are bankrupt because they’ve loaned money to the bankrupt governments. It’s actually rather funny, in a perverse way.

If it were just the banks and the governments, I wouldn’t care; they’re just getting what they deserve. The problem is that many prudent middle class people are going to be wiped out. These folks have tried to produce more than they consume for their whole lives and save the difference. But their savings are almost all in government currencies, and those currencies are held in banks. However, the banks are unable to give back all the euros that these people have entrusted to them. It’s a very serious thing. So European governments are trying to solve this by creating more euros. Eventually the euro is going to reach its intrinsic value—which is nothing. It’s the same in the U.S. The banks are bankrupt, the government’s bankrupt and creating more dollars so the banks don’t go bust and depositors don’t lose their money.

I’m of the opinion that if it doesn’t blow up this year, the situation is certainly going to blow up next year. We’re very close to the edge of the precipice.

TGR: Is the problem the debt, or all of the currency that has been pumped in?

DC: It’s both. We have to really consider what debt is. It’s the opposite of savings because savings means that you’ve produced more than you’ve consumed and put the difference aside. That’s how you build capital. That’s how you grow in wealth. On the other side of the balance sheet is debt, which means you’ve consumed more than you’ve produced. You’ve mortgaged the future or you’re living out of past capital that somebody else produced. The existence of debt is a very bad thing.

In a classical banking system, loans are made only against 100% security and only on a short-term basis. And only from savings accounts that earn interest, not from money in checking accounts or demand deposits, where the depositor (at least theoretically) pays the banker for safe storage of his funds. These are very important distinctions, but they’ve been completely lost. The entire banking system today is totally corrupt. It’s worse than that. Central banking has taken what was an occasional local problem, a bank failing from fraud or mismanagement, and elevated it to a national level by allowing fractional banking reserves and by creating currency for bailouts. Debt—at least consumer debt—is a bad thing; it’s typically a sign that you’re living above your means. But inflation of the currency is even worse in its consequences, because it can overturn the whole basis of society and destroy the middle class.

TGR: What happens when these time bombs go off?

DC: There are two possibilities. One is that the central banks and the governments stop creating enough currency units to bail out their banks. That could lead to a catastrophic deflation and banks going bankrupt wholesale. When consumer and business loans can’t be repaid, the bank goes bust. The money created by those banks out of nothing, through fractional reserve banking, literally disappears. The dollars die and go to money heaven; the deposits that people put in there can’t be redeemed.

The other possibility is an eventual hyperinflation. Here the central bank steps in and gives the banks new currency units to pay off depositors. It’s just a question of which one happens. Or we can have both in sequence. If there’s a catastrophic deflation, the government will get scared, and feel the need to “do something.” And it will need money, because tax revenues will collapse at exactly the time its expenditures are skyrocketing—so it prints up more, which brings on a hyperinflation.

We could also see deflation in some areas of the economy and inflation in others. For example, the price of beans and rice may fall, relatively speaking, during a boom because everybody’s eating steak and caviar. Then during a subsequent depression, people need more calories for fewer dollars, so prices for caviar and steak drop but beans and rice become more expensive because everybody is eating more of them.

Inflation creates all kinds of distortions in the economy and misallocations of capital. When there’s a real demand for filet mignon, there’s a lot of investment in the filet mignon industry and not enough in the beans and rice industry because nobody is eating them. And vice-versa. And it happens all over the economy, in every area.

How Far to the Wall?

By Terry Coxon, Casey Research

Decades of manipulation by the Federal Reserve (through its creation of paper money) and by Congress (through its taxing and spending) have pushed the US economy into a circumstance that can’t be sustained but from which there is no graceful exit.

With few exceptions, all of the noble souls who chose a career in “public service” and who’ve advanced to be voting members of Congress are committed to chronic deficits, though they deny it. For political purposes, deficits work. The people whose wishes come true through the spending side of the deficit are happy and vote to reelect. The people on the borrowing side of the deficit aren’t complaining, since they willingly buy the Treasury bonds and Treasury bills that fund the deficit. And taxpayers generally tolerate deficits as a lesser evil than a tax hike.

Deficits are politically convenient for a second reason. They can take a little of the sting out of a recession. That effect is transient, and it’s not strong – more like weak tea than Red Bull. But it can be enough to help a struggling politician get past the next election.

Yes, sometimes there’s a big turnover in the personnel, such as with the 2010 election, when a platoon of self-styled anti-deficit commandos parachuted into Congress. As soon as they had taken their seats, they began offering proposals to deal with the government’s trillion-dollar revenue shortfall. But none of the proposals were serious. They were merely tokens intended to make politicians wearing anti-deficit uniforms look less ridiculous. Cut a ginormous $2 billion out of this program and a great big $500 million out of that program. Reduce spending by half a trillion dollars… over ten years. Balance the budget to the penny, but later. No one proposed anything close to dealing with the deficit now.

So stay up as late as you like on election night to see who wins, but the deficits aren’t going to stop anytime soon. The debt mountain will keep growing. The part of it the government acknowledges is now approaching $16 trillion, which is more than the country’s gross domestic product for a year. Obviously, the debt can’t keep growing faster than the economy forever, but the people in charge do seem determined to find out just how far they can push things.

Inflation as Savior

At some point, personal and institutional portfolios will be glutted with Treasury securities, and the government will be forced to pay higher and higher rates to induce investors to take more of the paper – and the accelerating interest cost will make the deficits that much bigger. When that happens, the problem will be feeding on itself. The only way for the politicians to buy time will be through price inflation, to reduce the real burden of the debt, and whether they admit it or not, inflation is what they will be praying for.

The Federal Reserve will hear their prayer. It is 100% committed to protecting the value of the dollar, except when it is debasing the dollar in an effort to cure a recession or prevent a depression. It’s been doing that important work since 1971, when the dollar slipped the leash of the gold standard. With every downturn in the economy, the Fed speeds up the creation of new cash. Each time, the economy does seem to recover, but the economic distortions that caused the recession are allowed to linger to one degree or another. They accumulate like the grotesqueries in the picture of Dorian Gray and predispose the economy to further and deeper slowdowns.

For the last three years, the Fed has been performing an additional service to help keep the system going. Whether or not you believe that suppressing interest rates with newly conjured dollars stimulates the economy in a healthy way, the practice certainly makes it easier for the Treasury to sell bonds to cover its deficit. And as total debt grows, the Fed will be biased more and more toward printing in order to retard any rise in interest rates. In short, the cost of postponing the bankruptcy of a government engaged in nonstop deficit spending will be progressively higher rates of inflation. There is no inherent stopping point in the process short of hyperinflation and the destruction of the currency.

Will it actually go that far? My guess is that it won’t, but that’s a guess about politics, not about economics. At some point, perhaps at an inflation rate of 30% or 40%, the turmoil that comes with runaway inflation will become so painful that the public will accept, and the politicians will find it wise to deliver, a balanced budget and a return to a stable currency. But even a year or two of such high inflation rates, while not a Weimar experience, would be a calamity. Most people’s savings would be destroyed. Most businesses would be badly damaged, and most investment portfolios would be ruined. It would be like the economy hitting a wall.

But when will the economy reach the wall toward which it is headed? Not soon, I believe, but in the meantime there will be plenty of excitement.

The twin motors driving the economy toward the wall are deficits and money printing. Let’s take them in turn and try to foresee their pace.

Danger Zone

When federal debt recently overtook a year’s worth of gross domestic product, the US government crossed over into the zone at which, by historical experience, governments can get caught in a debt trap. High debt raises doubt about creditworthiness; doubt raises borrowing costs; higher borrowing costs add to deficits and day by day to the total debt burden; growing debt increases doubt about credit worthiness. Once in the cycle, it is hard to escape.

But Debt = GDP is not a formula for certain doom. It’s possible to spend some time in a bad neighborhood without getting shot. Japan’s ratio of government debt to GDP, to cite an extreme example, is over 230%. Perhaps the Japanese government is living on borrowed time as well as on borrowed money, but it is still able to find buyers for its debt at low yields.

The US may outdo Japan’s ratio before hitting the wall. The capital markets will tolerate an especially high debt-to-GDP ratio for the US for a simple reason – it’s safer than most other places. It doesn’t get invaded, it doesn’t get blown up in wars, it doesn’t have revolutions and it hasn’t destroyed its currency recently. Still, there is a limit to what the capital markets will tolerate.

How rapidly the US ratio of debt to GDP will grow depends on a list of barely-guessables, including how long the recovery from the recent recession drags on, the time elapsed until the next recession and the level of the public’s actual tolerance for deficits. Assuming that the recent level of deficits continues indefinitely, it would take on the order of ten years for the US debt-to-GDP ratio to get where Japan’s is now, which would bring us near 2022. After that, the safety factor still should buy the government a few years more.

That adds up to a long time to wait for the end of the world. Fortunately for the impatient, there is the Federal Reserve, and what the Fed will be doing, what the effects will be and when they will be felt all can be anticipated with a bit more clarity than the doings of Congress, although it remains guesswork.

Approaching the Wall

The M1 money supply has grown by 52% since the Federal Reserve opened the spigot in October of 2008. That alone is reason to believe that the current recovery, though painfully slow, is real. It has been held to a snail’s pace by the fear of deflation that so many people learned in 2009. Fear of deflation is a reason to hold on to cash, but as 2009 becomes more distant, that fear is waning, and the holders of that 52% are becoming more and more disposed to think of it as excess cash that should be spent on something. That feeds the recovery.

Given the slow pace, it should be perhaps two years until the economy seems more or less normal, but the excess cash will still be at work. Give it one more year, and price inflation will emerge as a noticeable complaint. Then the Federal Reserve will let interest rates rise, but only slowly at first. By the time it tightens in earnest, price inflation will be approaching double-digit rates. It will look like the 1970s. And despite all the statistics it publishes, the Fed will only be feeling its way in the dark, since there is no reliable, real-time indicator of how much excess cash there is in the system. So inflation will keep rising, and the Fed will keep tightening until it produces a rerun of 2008-2009, with crashing investment markets announcing a new recession.

But there will be two important differences vis-à-vis 2008-2009. First, it will be happening with the US government far deeper in debt than it was when the last recession began. In the tightening phase, the government’s interest expense will move above $1 trillion per year, and the budget deficit will jump to new record highs. Second, it will be happening with the rate of price inflation already at a troubling level. Another round of the monetary therapy the Fed applied to cure the last recession would push price inflation to levels beyond those reached in the 1970s. They’ll do it anyway.

This gets us to 2016 or 2017 with the system in turmoil but still functioning. No wall yet, and there will be room for at least one more cycle of reflation. But it will be a fast cycle, since in an environment of already high inflation, people will be quick to spend the newly created cash. That means a quick recovery from the 2017 recession and a catapult into the 20% plus range for price inflation. Then the wall may be in sight.

In the Meantime

Did you hear about the 60-meter-wide rock? Asteroid 2012 DA14, with the kinetic energy of a thermonuclear bomb, is headed toward us. In February of next year, its approach path, as recently estimated, will bring it to within 17,000 miles of the Earth. What I haven’t seen mentioned in any of the reports is that the closer an orbiting body is expected to get to the Earth, the less precise and reliable the estimates of its path become. Its path may veer this way or veer that way. And in astronomical terms, 17,000 miles is very, very close – closer than most man-made satellites. So it’s not just the economy we need to anticipate.

[Anticipating cultural and economic changes can be the difference between outsized profit and staggering loss for an investor. Right now – until midnight EDT tonight – you have an opportunity to put some of the best minds in the business to work for you in a steal of a deal.]

Financial advisors will often tell us of the steady increases available only through the stock market and present us with beautiful charts showing the relentless march of the the stockmarket ever higher and to the right. But what about inflation? How does the stock market perform when inflation is taken into consideration? After we take the loss of purchasing power into account have all the gains disappeared?

When adjusting stock prices for inflation we typically use the US Bureau of Labor Statistics Consumer Price Index CPI-U.  Prices are then calculated in “real” dollars. That means that the price is adjusted so that we can see what it would have cost if prices were what they are today.  Today’s chart is courtesy of our friends at “Chart of the Day” and shows the inflation adjusted stock price using the DOW as the reference. The DOW however has a built in upward bias because it is not made up of the same stocks as it was in 1925. As stocks fall out of favor they are replaced by better performing ones. A better indicator of the overall market is the entire NYSE. In our Inflation Adjusted New York Stock Exchange you can see the trend for the overall stock market.  ~ Tim McMahon, editor

Inflation Adjusted DOW

For some long-term perspective, today’s chart illustrates the Dow adjusted for inflation since 1925. There are several points of interest. For one, when adjusted for inflation, the bear market that concluded in the early 1980s was almost as severe as the one that concluded in the early 1930s. Also, the inflation-adjusted Dow is up 159% since its 1929 peak and trades 84% above its 1966 peak — not that spectacular of a performance considering the time frames involved. It is also interesting to note that the Dow is up 98% from its March 9, 2009 low which is actually slightly more than what the inflation-adjusted Dow gained from its 1966 peak to today.

For more information See: � Chart of the Day

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