Saturday, October 30, 2010

Riddle me this

The big debate in the financial world right now is "how large will next week's second round of American Quantative Easing be?"

it's the wrong question for a variety of reasons and I hope to touch on them at some point during the week.

The mantra being repeated over and over is the looming threat of deflation. The supposed intent of QE 2 is to lower interest rates to promote job growth and avoid the apparently growing threat of deflation. But the very idea that the economy is weak because interest rates are too high is laughable.

One of the greatest elements that threatens deflation, as the US Federal Reserve is quick to point to, is falling real estate prices.

But here's a question for you.

Why, when real estate prices were rising, didn't the Federal Reserve (or our own Bank of Canada) raise interest rates to bring them down?

Now that they are falling, the US central bank (as well as the BOC) feels compelled to lower rates to prop them up.

If falling real estate prices threaten deflation, why was there not concern about an inflation threat when real estate prices were rising?

Under the new way CPI is calculated, housing is neither inflationary or deflationary.

In his weekly Op Ed column, Peter Schiff has a theory. He thinks the spectre of deflation is a red herring;

  • "All this deflation talk is a red herring. The true purpose of QE 2 is to disguise the decreasing ability of the Treasury to finance its debts. As global demand for dollar-denominated debt falls, the Fed is looking for an excuse to pick up the slack. By announcing QE 2, it can monetize government debt without the markets perceiving a funding problem. If the truth were known, a real panic would ensue. So, the Fed pretends buying treasuries is simply part of its master plan to boost the economy, even though, in reality, it is simply acting as the buyer of last resort."

Monetization of the debt under the guise of economic stimulus. More on this as the week goes on.



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  1. What we are witnessing is an event that you can tell your grandchildren. The US knows it cannot rely on imported finished goods to supply its economy for the simple fact that not enough jobs are in place to stimulate demand. What demand has been based on is credit and that bubble has burst. Deflation has taken hold and people do not spend when they are worried about their jobs.

    You cannot get that demand back until unemployment drops and the only way now is manufacturing. Construction and finance cannot serve as the fuel anymore. China knew this years ago and has been in a desperate race to stimulate domestic demand so that their economy does not collapse.

    Watch and see how QE2 effects inflation and then watch for protectionism to kick in slowly. Interest rates will be held down for as long as possible but will go up. Housing in Canada is still in denial but with increasing rates-- reality will sink in.

    Hopefully this works but if you have a mortgage you better think hard and act soon .

  2. Once again I would love to believe that higher interest rate are around the corner. But what of the near record bid-to-cover ratios on virtually all bond offerings? I think Peter Schiff is the man, but I don't quite buy that there is no demand for treasuries. All evidence seems to be to the contrary. And POMO activities account for only a small portion of total bond sales.

    You could argue that the Fed is somehow acting is bidder through some off shore agency, but that gets a bit too conspiracy theory for me.

    You're also dealing with a massive secular shift in asset allocations. $81 billion have been pulled out of domestic equity funds in the US just this year. Where perhaps might that money end up? Probably as bids on treasuries.

    Ultimately I agree that everything you say will happen, but I don't think the timeline of imminent hyperinflation and default quite aligns with the data.


  3. If the US is monetizing the debt, the 'timeline' will collapse as confidence is lost.

  4. QE2 makes no sense at all. There are clearly other motives at play.

    - Robert