Question regarding QE2 and the budget deficit...

MrEureka · February 15, 2011 8:48AM

I don't understand why QE2 matters. The government's financial health doesn't change if it exchanges dollars for treasuries, nor would it change later when the trades are unwound. All they're doing is spinning their wheels. (Yes, I understand that there are times when QE could be a real help, but there's presently so much cash sitting on the sidelines that I don't see now as one of those times.)

On the other hand, I do understand why the budget deficit matters, how it affects the government's finances, and how it's inflationary.

And I don't understand why most people seem to be more worried about QE2 than they are about the budget deficit. Is it simply a matter of them thinking that QE2 is optional and that the budget deficit is not? Or am I completely missing something?

KUCH · February 15, 2011 9:13AM

You don't think the budget matters?????? America can't pay the interest on what it owes? If u had a credit card debt of $1,000 and could not pay the interest on the debt, let alone the principle, what would happen?

cohodk · February 15, 2011 9:17AM

I think people are concerned with QE2 as it may lead to QE3, QE4, QE5, ect.

RedTiger · February 15, 2011 11:10AM

For some QE is equivalent to monetizing the debt. In plain English that means printing money to pay off debts. Would it matter if instead of printing $700 billion they didn't do anything? Or instead they did 10x as much and the quantity printed was $7 trillion? Would it matter if instead of buying bonds and notes they started buying stocks and real estate (like they are doing in Japan)? It is difficult to get a handle on all these games. If it has no effect then why is the Fed doing it? If there is no long term danger, why are so many smart people concerned about it?

Normally, printing money means higher interest rates, as would be lenders want a higher rate. But with QE and QE2 the wrinkle is that they are printing the money to buy bonds and notes. The printing raises rates, but the buying lowers the rates. What has been the unintended (or intended) effect? Interest rates have been edging higher, but most of that newly printed money is flowing in equities and commodities. Crop prices are at record highs. The really poor around the world are starting to literally starve as their $1 a day income no longer in enough to buy food.

Why does the national debt matter at all, if they can just print any amount of money, at any time to pay the whole thing off? Why not print up $14 trillion instead of $700 billion and just say the debt has been paid off? Or as they did with the bailout of some of the major companies, just repudiate the debt and tell the debt holders that they lost, and they won? Well, at some point the game ends, and there is pain, and possibly blood. It is difficult to get clarity when the games become so complicated and so many are so focused on the next quarter, the next election, the next few months.

MrEureka · February 15, 2011 12:46PM

For some QE is equivalent to monetizing the debt. In plain English that means printing money to pay off debts.

The new cash can be used by the recipients (or anyone else down the line) to pay their taxes. In effect, the cash is just as much a claim on the government as as a government-issued bond.

Would it matter if instead of buying bonds and notes they started buying stocks and real estate (like they are doing in Japan)?

I'd guess not, as long as the prices paid were in line with the real market.

calleocho · February 15, 2011 2:55PM

When all you have is "faith" behind a currency, one most be careful not to abuse it otherwise you might see that lack of confidence can be just as destructive as rapid money creation.

The US is running massive deficits which just seem to be getting worse, and the rise of China's worldwide influence is making a lot of new agnostics out here.

The problem with QE2 its not if it works , the problem is what happens if it works really well ...the FED might just believe that they are above free market principles and keep tinkering with new ideas until eventually reality comes crashing down on them.

derryb · February 15, 2011 3:21PM

Think of a coin auction where all the bidders have $100 to spend. What happens to prices if someone walks in and gives all the bidders an extra $100 to spend?

While no new money is actually "printed" with QE2, new money is electronically created. By buying the debt (treasuries) with this new money the Fed is enabling the government to be able to spend more money that it really doesn't have. The result will be more debt and more need for more QE to satisfy interest on that debt.

Treasury bonds are nothing more than I.O.U.s that will keep being put off with more I.O.U.s until nobody wants them. It has gotten to the point that the largest buyer of government debt is the Fed. Remember, the Fed is a group of private bankers (not government agency that many assume it is) and a banker's sole purpose in life is to create debt.

RedTiger · February 15, 2011 3:50PM

<< <i>For some QE is equivalent to monetizing the debt. In plain English that means printing money to pay off debts.

The new cash can be used by the recipients (or anyone else down the line) to pay their taxes. In effect, the cash is just as much a claim on the government as as a government-issued bond.

Would it matter if instead of buying bonds and notes they started buying stocks and real estate (like they are doing in Japan)?

I'd guess not, as long as the prices paid were in line with the real market. >>

How can that be the real market, if it is the government printing money to buy? That makes zero sense. If the government is printing money to prop up prices, by definition those prices aren't real. Imagine if the Fed did it to prop up the prices of 1950 issue baseball cards, or Indian head cents. With that much money flowing in, by definition, it distorts the market.

I can't explain it in simple terms. It is not an easy topic. Intuitively, I know that printing money to buy Treasury bonds is a very dangerous game. It is a complicated game, where the players, don't have a good grasp of what kind of genie they have let loose on the land. I read a New York Times article about the team that does the actual buying and how and when they do it. Would it trouble you to know that the team consists of six 20 somethings? That the oldest person on the desk that does the daily buying of bonds and notes that will eventually total $700 billion is 29 years old? Well, it bothers me.

QE is playing with fire, and there is a chance that the house (the entire financial system) might burn to the ground. Again, one unintended brush fire from the policy is record food and commodity prices as well as recovery highs in the U. S. stock market. Food riots are starting to break out in the poorer countries. Is there cause and effect? Some would say no, but we won't know the history until it is written. If things go badly, historians may look back and blame QE and QE2 as the catalysts to massive starvation of hundreds of millions of poor people all over the world. That's the magnitude of the kind of fire they are playing with. If things go badly, QE might be viewed like the Treaty of Versailles (ending World War I) and the punitive reparations demanded which had a long term cost. When that war ended, very smart people sat down and wrote out the terms. It made logical sense to them.

Humans are capable of incredible financial folly. That you and others don't see a problem doesn't mean there isn't a problem. Quantitative easing is almost certain to have a long term cost. We don't know the price yet. Those in charge don't know the rules of the game. The rules of the game are being made up as we go. I see QE as a genie that has been let loose on the land, and the price wasn't negotiated when he was set free. The genie isn't going back into the bottle until his price is paid, and that price may be high, and there is the chance it may involve blood.

roadrunner · February 15, 2011 10:54PM

I don't understand why QE2 matters. The government's financial health doesn't change if it exchanges dollars for treasuries, nor would it change later when the trades are unwound. All they're doing is spinning their wheels. (Yes, I understand that there are times when QE could be a real help, but there's presently so much cash sitting on the sidelines that I don't see now as one of those times.)

RedTiger has made some posts that can't be improved upon. I don't understand all the undercurrents associated with QE2 and QE2 light. The govt is banking on the fact that 99% of the populace can't understand it either. It's a highly detailed shell game. But I'm fairly confident that creating treasuries and/or bonds out of thin air is monetization, or something for nothing. The govt's health does indeed deteriorate. Our top 5 banks have >$200 TRILL in otc derivatives that they made money on as they created them. Most say that they are all a wash and can be unwound at zero cost. I'm of the opinion that they've permanently destroyed their balance sheets just like the govt has. So here we sit waiting to be told that they don't matter....just like deficits didn't matter.

Dr. Fekete compares QE2 to the 19th century opium trade

roadrunner

PreTurb · February 15, 2011 11:38PM

Again, one unintended brush fire from the policy is record food and commodity prices as well as recovery highs in the U. S. stock market. Food riots are starting to break out in the poorer countries. Is there cause and effect? Some would say no, but we won't know the history until it is written. If things go badly, historians may look back and blame QE and QE2 as the catalysts to massive starvation of hundreds of millions of poor people all over the world.

How long do you guys think the lag time is between a food/commodity futures price going up and the actual food product price going up in these poor countries? If the lag time is pretty long, then things may get MUCH worse for these people than we are observing now. As in, we are now seeing stresses that are a result of a food futures prices X months ago... and now those futures prices are higher currently.

gsa1fan · February 16, 2011 12:38AM

Look at corn price since September 2010. Corn & Wheat go up every thing shall follow.

derryb · February 16, 2011 3:59AM

This chart posted by 57loaded in another thread tells you everything you need to know about QE2 and it's affect on what investors think of the US Government's promise to pay its debts (Treasury Bonds):

jmski52 · February 16, 2011 6:43AM

If I come upon an unconscious individual who is bleeding out from a stab wound, but is still breathing - I will apply pressure and then I will call 911.

What I won't do is to stab him again and create another hemorrage. That is QE2.

derryb · March 19, 2011 8:46PM

The new question with QE2 is what happens when it ends July 1 after the Fed has completed its $600 million purchase of treasuries. Since the Fed has only had one instance of ending quantitative easing (QE1) here's a look at what happened then:

“The S&P 500 sagged from 1,217 to 1,064….
The S&P 600 small caps fell from 394 to 330….
The best performing equity sectors were telecom services, utilities, consumer staples, and health
care. In other words — the defensives. The worst performers were financials, tech, energy, and
consumer discretionary….
Baa spreads widened +56bps from 237bps to 296bps…
CRB futures dropped from 279 to 267….
Oil went from $84.30 a barrel to $75.20….
The VIX index jumped from 16.6 to 24.5….
The trade-weighted dollar index (major currencies) firmed to 76.5 from 75.5….
Gold was the commodity that bucked the trend as it acted as a refuge at a time of intensifying
economic and financial uncertainty — to $1,235 an ounce from $1,140 and even with a more
stable-to-strong U.S. dollar too….
The yield on the 10-year U.S. Treasury note plunged to 2.66% from 3.84%…”

Above facts courtesy of John Mauldin.

As it becomes obvious that the results of QE1 created a need for QE2 why would anyone think that quantative easing can ever end? Another thing to consider is that the Fed is currently the largest purchaser of US Treasuries with China and Japan following at second and third. China is reducing its purchases and Japan is in no shape to continue theirs. Without the Fed, who's gonna buy? The only remaining entity with enough funding is probably American retirement accounts and I look for some effort in Washington to target them with legislation.

Be prepared for QE~ but more importantly, be prepared for the shock to the markets between QE2 and QE3. My particular weapon of choice will be VXX at just the right moment.

gecko109 · March 19, 2011 11:55PM

<< <i>I don't understand why QE2 matters. The government's financial health doesn't change if it exchanges dollars for treasuries, nor would it change later when the trades are unwound. All they're doing is spinning their wheels. (Yes, I understand that there are times when QE could be a real help, but there's presently so much cash sitting on the sidelines that I don't see now as one of those times.)

On the other hand, I do understand why the budget deficit matters, how it affects the government's finances, and how it's inflationary.

And I don't understand why most people seem to be more worried about QE2 than they are about the budget deficit. Is it simply a matter of them thinking that QE2 is optional and that the budget deficit is not? Or am I completely missing something? >>

The trades are not "unwound" at all. When the U.S. sells a treasury for cash already in existence, it does so because it needs that cash immediately for spending.......like for those rare times when they run a budget defecit.

So, the money the U.S. gets in exchange for PRINTED pieces of paper (treasuries) gets spent right away.....enters commerce. 3-6 years later, when the treasury matures, it comes home to roost. But because the U.S. runs persistant budget defecits each year, they have no cash on hand to pay those incoming treasuries. They therefore then have 2 options......either print up the cash, or sell more treasuries. So you see, that exchange does not unwind.....it simply piles up more and more debt or cash. Both outcomes are non desirable.

secondrepublic · March 20, 2011 1:11AM

The OP's question is missing a key point. The Federal Reserve is not exchanging existing dollars for Treasury bonds. If that were happening, it wouldn't be worth discussing. What the Fed is doing is quite different. It's conjuring into existence brand new dollars -- from thin air -- and then using those to buy treasuries. It's the creation of money that's worrying from an inflationary standpoint. It's essentially printing money to pay your bills.

jmski52 · March 20, 2011 1:13AM

nor would it change later when the trades are unwound

The money isn't being loaned, it is being spent. These aren't trades, they are spending programs. Who is supposed to be unwinding these? Only the taxpayer.

CaptHenway · March 20, 2011 1:51AM

Interesting article in the Chicago Tribune today about how prices are going up on just about everything, while the government still insists there is no inflation.

streeter · March 20, 2011 2:55AM

QE2 is going to have a couple of negative long term real & psychological effects that will extend out decades---possibly at least a generation.

1. It is punishing the small incremental saver. People who save a portion of their paycheck are not even keeping up with the devaluation of their dollar. If treasuries were allowed to pay a market rate of return---people might decide to use them to park their cash. I know NO ONE who is using them right now. So much of a lot of peoples side money is buying commodities and in the long run----that is going to punish a lot of people. For people to play the paper commodity game or take possession of small amounts of metal.....does absolutely nothing for the productivity of this country.

2. The govt is getting bolder about doing things---almost abusively bolder. 30 years ago, I wouldn't even have imagined that this QE2 remedy would have been contemplated.
...what's next on the agenda?

3. QE2 and what follows is indeed softening the blow of this recession--and lengthening it for at least another 5 years.

57loaded · March 20, 2011 4:03AM

<< <i>
Be prepared for QE~ but more importantly, be prepared for the shock to the markets between QE2 and QE3. >>

100% agree

there will be some delay, too. i don't know if this (betewwen QEII and QEIII) will be a good buying opportunity for physical or not, though.

my reasoning: i also follow with your VXX play, yet i still think there is good pro$it in the paper metals, of silver and still gold that will be sold during this calm between QE's????

Staircoins · March 21, 2011 2:37AM

This is an excellent thread, gents.

derryb · March 22, 2011 12:58PM

Gonzalo Lira makes a good case of why there will be infinite QE:

Gonzalo Lira

Question regarding QE2 and the budget deficit...

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