Friday, November 11, 2011

QE in EZ: a war of necessity

I was reading an article in the FT this morning as to how the UK government bonds were being rewarded as "safe haven" status with ultra low yield. I kind of lost it in the comment sections out of disgust.

Of course the tone of article and commentary was all self congratulatory, about, really, how the superior management and responsibility paid off.

What a joke.

Ain't nothing going on but QE
All there is to it is a lot of money printing. Buy enough of your own debt (aka monetizing debt, QE, Printing money) and your yields will go dramatically lower. It is not because they are better or better run or safer it is just the mathematics of demand/offer when one of the players has infinite liquidity at his disposal.

QE as a stabilizer
QE1 in the US has backstopped the negative spiral of depression. Let the records show that much. It can be an effective stabilizer. Those that fret about inflation confuse flow and stock. Yes, printing is of course an inflationary contribution but if your background is one of debt deflation (as is going on massively in the western world since 2007) then you are counteracting the main trend. You have a big negative monetary flow (debt deflation) countered by a positive flow (QE) for a net result that may still be negative (stock). QE1 was started in the midst of financial panic in March 08 when the DOW was at 6,666. (yup)

QE2 as a financial weapon
While I can easily rationalize QE1, I must admit I was taken by surprise when Bernanke announced QE2, even though we were in the midst of a summer panik in 2010. I rationalize it as a competitive devaluation of the money vis a vis trading partners and a further stimulus to your economy via depressed yield curves and low cost of financing.

Financial war
I am growing increasingly convinced we are in the midst of an all out financial war, with QE as the main nuclear weapon in use. Naked CDS are weapons of mass destruction (really folks? you want to be paid 10x what a sovereign is defaulting on?). Again low cost of financing for a govt in times of crisis is a god sent (minus the tea-party clownery on the debt ceiling it is all blue sky for the US cost of financing compared to the 7% italy is paying). Devaluing your currency is the simplest way to go back to growth.

Maastricht constraints, German attitudes
By constitution, the ECB cannot, in theory, print all the money it needs to buy a targeted sovereign (no preference clause, no bail out clause). This is partly due the germans ingrained distrust of money printing given their history and partly due to the hawkish stance of Mr Trichet and the technocrats in general.

The QE pedal will be pressed
So Miss Market is throwing her weakly tantrum, getting governments toppled and demanding her pound of flesh in fresh money. The moment a sovereign cannot fund itself in the face of sound fundamentals is when the QE pedal must be pressed. I do not buy for a second that Italy is fundamentally insolvent (and not just in the MMT sense that one can print, but in the accounting sense), this is a liquidity crisis that is quickly turning into a solvency one but with reverse causality.

Mechanisms like the one in the post below with the put/cds EFSF structure also naturally put QE where and when it is needed, not too soon and not too late. The moment it is put in action, the euro will slid which will help everyone including the germans, the euro stocks will rally, competitiveness will be regained using the same weapon the US/UK are using. The cost of funding governments will go down and this whole non-sense driven by hedge funds will evaporate.

Miss Markets gets her way

Of course, the paranoid analysis (which has been profitable for me in the short term) is that there is a concerted attack by hedge funds on sovereign, picking them one by one as if a sniper, all the while harping on the moral defaults of the greeks and Berlusconi. But what Miss Market wants is 1/ volatility 2/ FREE MONEY. It is about to get free money as she has succeeded in bringing about panic dynamics on Italy. The irony of it all.

A best of both worlds?
In fact I am hoping that the germans come to this view but keep a stiff back. This is not a bailout for profligate governments. While I watched in horror the tea-party debt ceiling self inflicted fiasco, and with contempt the self congratulatory comments in the FT about "low cost of funding is a safe haven status" I do think the EZ is overly socialist and that it cannot continue. France is a point in case, I consider france a proto-communist country in terms of the public employment trends, they always go up, never down.

That compromise will restructure of government through austerity, where a little bit goes a long way and too much will kill your economy in in a simple Keynesian way, while at the same time lowering the cost of funding for the remaining streamlined operations.


shtove said...

Hi. Good blog.

Just followed a link from naked capitalism comments.

Do you have a post setting out your position on modern monetary theory?

Would be helpful.

Marcf said...

I have read the book by Wray (the bible of MMT). I found it both exciting and deeply frustrating.

1/ Exciting: it is a clear eyed explanation of how the dark mechanisms of banking and money creation work. Be ready for many 'myths' to be shattered. I think it boils down the following insight: debt is issued first and reserves sought later. in other words, the banks create all the money they want. There is no such thing as the classic equality of investments == savings, or fractional reserve banking as a way to limit debt. The factual part I find VERY educative.

2/ Frustrating;
a/ it is antiquated, does not deal with most of the modern tools like derivatives. So very incomplete. A generalization of MMT should include TRUE monetary levels.
b/ It is EXTREMELY pompous from a writing standpoint. The MMT'ers have a way of wrapping themselves in academic jargon and fake complexity. c/ While, again, I do like the factual presentation on the banking system no matter how incomplete, I find myself shaking my head in disbelief at the ultra-leftist political ramblings that follow the factual presentation. They still call it MMT which to me is a mistake. Half the book is about mechanics of fiat money and the rest is about "let's print as much money as needed to have free everything for the whole wide world". As someone who has saved money and lives on that, I find myself vomiting a bit in my mouth at some passages.
d/ Some of the main guys do post on NC from time to time, I have tried several times to engage in earnest discussion with them on points I see lacking. (for example Foreign Exchange: we see depreciation of currency which voids the effects of printing, so the whole edifice falls apart when your government cannot steal from another government). Like mormons they just ignore you. Comes across as "white tower looking down" when you can just poke holes the size of airports through some of the political reasoning.

All in all I am grateful for the book, would recommend it for those that have time and interest but I do believe it will go down as a marxist fad for the expanded political programs. Note that because of the ultra-left connotations they do have a critical eye on the banking system and that is educative and refreshing. I had been looking for a clear explanation of modern banking and this closest to it.

Chris said...

try this for a money creation primer:

Marcf said...

chris, I don't really welcome blatant spam but did read through the marketing literature that comes with the site. It boils down to banks emit debt and are not constrained by reserves. The banking system can create (and has) created infinite liquidity. IN SHORT ANOTHER BOOK HAMMERING THE FACT THAT BANKS CREATE MONEY ****OUT OF NOTHING****

Of course the discourse after that is straighforward
1/ WHY DO THE BANKS GET INTEREST ON THAT MONEY? they just create it out of thin air and they impose a 5% tax on the real economy? WHY?
2/ Of course the banking theory says that it is because they manage risk (as your book claims). That of course is laughable in the face of CDO structure and the fact that the banking system was a machine incentivized to create volume as it passed on the risk.
3/ Naked CDS make a further joke of that claim (that banks manage risk) as you can make the case that some bankers were in fact creating securities to blow and then papering up in naked CDS in front. Shameful. Borderline illegal (should be). And just a psychopathic behavior posing as "greed is OK no?". Paulson was lionized. To me he is a criminal.
4/ When the debt defaults (which it is bound to do) the BANK GETS TO FORECLOSE THE ASSET. So the banks creates money out of nothing and then GETS THE GOOD (for nothing).

This is why I trust the hard line communist analysis of the banking system, when all is good and nice the defrauding of the real economy by the banking system goes un-noticed, when the shit hits the fan, the true PREDATORY/PARASITIC behavior becomes blatant. Of course the difficulty is WHO GETS TO DO THAT THEN? governments? that would be worse, I think.

shtove said...

Thanks for the rundown on MMT.

The chicken-and-egg position on creation of debt/money may be sound theory.

My objection to it is practical: the printing authority is assumed to be capable of preventing malinvestment in the process. I don't think that factors in human nature!

I wonder if the QE pedal can be pressed in europe. EFSF or ECB balance sheet expansion surely requires commitment from the German taxpayer, and their supreme court has said that commitment can't be made without a referendum.

Maybe there's a fancy way of getting round the electorate, but I haven't seen any real suggestions.

Can't find the link, but der spiegel reports that German politicians are only tinkerin

shtove said...

... tinkering with plans for a referendum.

shtove said...

Sry for tedious posts - der spiegel report here:,1518,797584,00.html