quantitative easing

[TPS]

So there is no justifiable reason for the inverse dollar/commodity relationship? Or that there is no justifiable reason with increased supplies of dollars leading to dollar devaluation?

For both, it depends, and you need to work through the processes to understand under what conditions it does happen. You can't simply say the FED has printed money--there is a process (ok, you will still probably say it...). I've tried to explain to you one of the processes of QE's impact, that of swapping banks' dead assets for reserves (and the FED pays interest on those reserves, which is another reason why banks are content to sit on them).

Other possibilities of QE:

1. Directly funding the US Treasury. As I said, this directly injects spending into the economy, but the FED, for the most part, has stayed away from this.

2. Buy MBS, T-Bonds or other long term assets in the various markets from "investors" to drive down long term rates.

In this case the investor has made a decision to sell because they want to take profits or re-weight their portfolio. In either case the impact depends upon what the investor decides to do with their "cash." Buying more MBS, buying stocks, buying commodity futures, etc. This will drive up prices of those assets. The FED's actions also raise bond prices and lowers yields. With lower rates, those who can afford to, refinance as you indicate. Refinancing substitutes a lower interest rate asset on the bank's balance sheet for a higher one; and raises the discretionary income of the borrower. Households and businesses will have more net income if they refinance. This is one of the transmission mechanisms of monetary policy. However, this mechanism isn't always caused by monetary policy. For example, a recession will reduce long term interest rates without any action by the FED.

 

Your questions:

Commodity prices are currently rising mainly from increased investment funds flowing into these markets and the belief that inflation will come back with a vengeance in the not to distant future because of QE. While there have been some supply issues, most of the price increases have come from these speculative guesses. Right now there is a disconnect between true underlying demand (from industry) for commodities and investor speculation based upon expectations about inflation. Actual inflation will depend on how long it takes for the economy to respond to low interest rates. If we experience a Japan-like decade, then those bets will be wrong. If the FED starts directly financing the Treasury, then they'll be a bit closer. To answer your question: for a given supply, commodity prices can increase by 1) investors allocating more funds--speculating--on comodities; or 2) the actual demand for commodities by industry, which is based upon growth. In case 1, there are no new $s created, there is a re-allocation of investors' funds; in case 2, the money supply increases with economic growth--in the first case you will not find an inverse relation; in the second case you will.

 

#2. The dollar. How do dollars get into the hands of foreigners? They run a trade surplus with the US (our deficits). They then have two choices: China can, for example, 1) sell the accumulated $s from their surplus on the FX market, which would cause the $ to depreciate against the yuan; or 2) if they wanted to maintain an artificially higher $ in order to maintain their export-led growth stratey, then they will use the accumulated $s to buy $ assets. This is what a lot of emerging market economies are doing, and it's what Krugman is talking about. This game has been going on for over 10 years, which is why Japan and China both hold some $3-4 trillion in $ assets. As long as they are willing to keep holding them in order to keep their exchange rates under-valued against the $, then the game continues. So, to answer your question: it depends. As long as those countries want the game to continue, it will continue. Which means they could be holding $5 trillion in a few years, and the $ won't fall against those currencies. On the other hand, if they decide NOT to hold $s, then we'll see your "inverse relation."

 

But, once again, it's a process. You seem to think that money falls from trees, but only in the extreme case of the FED directly financing the Treasury is this the case. The majority of FED actions impact financial markets and asset prices, which in turn implies there is an impact on the portfolios of financial institutions and wealth managers (China's sovereign fund is also one), the impact on the real economy depends on whether banks lend and how the economy respondes to lower rates. This is the part you seem to ignore in your analysis.

[Magox]

 

Other possibilities of QE:

1. Directly funding the US Treasury. As I said, this directly injects spending into the economy, but the FED, for the most part, has stayed away from this.

 

No they haven't. They finished $300B worth of purchases last year and have been rolling over MBS bonds into treasury purchases as of late, maintaining the size of their balance sheet.

 

2. Buy MBS, T-Bonds or other long term assets in the various markets from "investors" to drive down long term rates.

In this case the investor has made a decision to sell because they want to take profits or re-weight their portfolio. In either case the impact depends upon what the investor decides to do with their "cash." Buying more MBS, buying stocks, buying commodity futures, etc. This will drive up prices of those assets. The FED's actions also raise bond prices and lowers yields. With lower rates, those who can afford to, refinance as you indicate. Refinancing substitutes a lower interest rate asset on the bank's balance sheet for a higher one; and raises the discretionary income of the borrower. Households and businesses will have more net income if they refinance. This is one of the transmission mechanisms of monetary policy. However, this mechanism isn't always caused by monetary policy. For example, a recession will reduce long term interest rates without any action by the FED.

 

In which some of this money has already filtered into the economy through new home purchases and refi's.... Also you can't discount the impact of lower interest rates and it's inflationary implications.

 

Your questions:

Commodity prices are currently rising mainly from increased investment funds flowing into these markets and the belief that inflation will come back with a vengeance in the not to distant future because of QE. While there have been some supply issues, most of the price increases have come from these speculative guesses.

 

It's not just "speculative guesses", it's a direct impact caused by a weaker dollar.

 

Right now there is a disconnect between true underlying demand (from industry) for commodities and investor speculation based upon expectations about inflation. Actual inflation will depend on how long it takes for the economy to respond to low interest rates. If we experience a Japan-like decade, then those bets will be wrong.

Wrong! It is not a disconnect, there is strong demand for commodities with currency devaluation policies from the developed world. No disconnect whatsoever.

 

Also, we could go through stagnant growth for many years and we will continue to see commodity prices go higher. Your line of thinking is old-school. Where what happens here in the U.S dominates global activity. Those days are over, we can go through stagnant growth and still experience strong growth in the developing nations. This is where argument fails. However, if we went into a recession then yes, temporarily this would bring everyone else down. The structure is already in place, global growth will continue, but it will uneven. I am 100% sure of it.

 

If the FED starts directly financing the Treasury, then they'll be a bit closer. To answer your question: for a given supply, commodity prices can increase by 1) investors allocating more funds--speculating--on comodities; or 2) the actual demand for commodities by industry, which is based upon growth. In case 1, there are no new $s created, there is a re-allocation of investors' funds; in case 2, the money supply increases with economic growth--in the first case you will not find an inverse relation; in the second case you will.

 

If you have more dollars chasing after the same amount of commodities, then that means the price of those commodities will go up. That is just common sense. QE is occuring in the U.S, Japan, England and with the Euro, the value of paper currencies will continue to be debased and the value of commodities WILL continue to go higher long-term.

 

#2. The dollar. How do dollars get into the hands of foreigners? They run a trade surplus with the US (our deficits). They then have two choices: China can, for example, 1) sell the accumulated $s from their surplus on the FX market, which would cause the $ to depreciate against the yuan; or 2) if they wanted to maintain an artificially higher $ in order to maintain their export-led growth stratey, then they will use the accumulated $s to buy $ assets. This is what a lot of emerging market economies are doing, and it's what Krugman is talking about. This game has been going on for over 10 years, which is why Japan and China both hold some $3-4 trillion in $ assets. As long as they are willing to keep holding them in order to keep their exchange rates under-valued against the $, then the game continues. So, to answer your question: it depends. As long as those countries want the game to continue, it will continue. Which means they could be holding $5 trillion in a few years, and the $ won't fall against those currencies. On the other hand, if they decide NOT to hold $s, then we'll see your "inverse relation."

What do you mean "then" we having been seeing it for close to a decade now .... Krugman is wrong because he never delves into structural issues. We have a consumption problem here in the U.S and his solution is for us spend more as a nation so that we can consume more which of course leads to larger trade deficits. He also wants us to do massive QE, which of course crushes savings rates, which of course leads to more consumption which of course leads to even larger trade deficits. Krugman doesn't have a clue, yet he wants to blame the chinese.

 

But, once again, it's a process. You seem to think that money falls from trees, but only in the extreme case of the FED directly financing the Treasury is this the case. The majority of FED actions impact financial markets and asset prices, which in turn implies there is an impact on the portfolios of financial institutions and wealth managers (China's sovereign fund is also one), the impact on the real economy depends on whether banks lend and how the economy respondes to lower rates. This is the part you seem to ignore in your analysis.

Jesus dude, the money does "fall from a tree", just not at the velocity they had hoped for. It is money created out of thin air that filters into the economy through loans and government spending at ridiculously low rates. Yes, it does figuratively fall from a tree. And you keep mentioning this issue of bank lending. Why is that? Do you really not read what I write? I have told a BAZILLION times that it is largely predicated on filtering into the economy, and bank loans is one of those ways. It is already filtering into the economy, just at a slower pace that they hope for. You just aren't able to comprehend what I am saying. Either way TPS, for over a year now you've been saying that there is a "speculative" bubble with commodities. I can pretty much assure you that you will continue to keep singing that tune for the foreseeable future.

Edited October 14, 2010 by Magox

[TPS]

Jesus dude, the money does "fall from a tree", just not at the velocity they had hoped for. It is money created out of thin air that filters into the economy through loans and government spending at ridiculously low rates. Yes, it does figuratively fall from a tree. And you keep mentioning this issue of bank lending. Why is that? Do you really not read what I write? I have told a BAZILLION times that it is largely predicated on filtering into the economy, and bank loans is one of those ways. It is already filtering into the economy, just at a slower pace that they hope for. You just aren't able to comprehend what I am saying. Either way TPS, for over a year now you've been saying that there is a "speculative" bubble with commodities. I can pretty much assure you that you will continue to keep singing that tune for the foreseeable future.

Cool, we're saying the same thing, we simply use different vocabulary.

 

Everyone understands that commodity prices are based upon global demand. No secret there. We disagree on which factor is currently having the greater impact on prices, global demand or speculative investment flows. I say it's speculators right now; doesn't mean that won't change when globabl growth spreads.

[Magox]

Cool, we're saying the same thing, we simply use different vocabulary.

 

Everyone understands that commodity prices are based upon global demand. No secret there. We disagree on which factor is currently having the greater impact on prices, global demand or speculative investment flows. I say it's speculators right now; doesn't mean that won't change when globabl growth spreads.

You call it speculation, I call it dollar devaluation. EIther way as long as currency depreciation policies are in place this will continue. But the run won't end there, because then inflation will be the primary concern, so commodities have got a long way to go before the run ends.... We are only in the second phase of the commodity bull run, the third will be about inflation and that's when prices will peak and burst and no one will want to own commodities in their portfolio for a very very long time.

 

My calculations tell me that we have 5-8 more years to go....

[TPS]

You call it speculation, I call it dollar devaluation. EIther way as long as currency depreciation policies are in place this will continue. But the run won't end there, because then inflation will be the primary concern, so commodities have got a long way to go before the run ends.... We are only in the second phase of the commodity bull run, the third will be about inflation and that's when prices will peak and burst and no one will want to own commodities in their portfolio for a very very long time.

 

My calculations tell me that we have 5-8 more years to go....

Either way, investors are making bets. This morning's FinTimes has an article which highlights the current environment and the bets that investors are making:

Deflation or Inflation?

 

A quote:

Investors are torn between two extremes. Is the US heading for a decade of Japan-style stagnation characterised by years of falling prices – or will the hundreds of billions of dollars likely to be pumped into the economy by the Federal Reserve lead to the opposite: rising inflation

 

What I wrote yesterday:

Commodity prices are currently rising mainly from increased investment funds flowing into these markets and the belief that inflation will come back with a vengeance in the not to distant future because of QE. While there have been some supply issues, most of the price increases have come from these speculative guesses. Right now there is a disconnect between true underlying demand (from industry) for commodities and investor speculation based upon expectations about inflation. Actual inflation will depend on how long it takes for the economy to respond to low interest rates. If we experience a Japan-like decade, then those bets will be wrong. If the FED starts directly financing the Treasury, then they'll be a bit closer.

[Magox]

Either way, investors are making bets. This morning's FinTimes has an article which highlights the current environment and the bets that investors are making:

Deflation or Inflation?

 

A quote:

 

 

What I wrote yesterday:

The problem as I noted is that this world is much more globalized then what many of the old guards line of thinking is. It doesn't matter, we could have 1.5-2% growth here for a decade and we will still see inflation. Why? Because the growth in this world is uneven and these developing nations have an insatiable appetite for raw materials, so not only is there strong demand for commodities in these countries, but the developed world (U.S, Japan and Europe) will continue to have loose monetary policies in order to attempt to stimulate their economies, which will continue to debase currencies relative to raw materials and will continue to funnel and steer these cheap currencies towards countries that are providing strong growth leading to even higher asset prices (including commodities).

 

Unfortunately this punishes the lower to middle class folks more than anyone, it reduces their disposable income because these commodities are what people consume in their every day lives, meanwhile there incomes are stagnating, and that folks is what we call stagflation.

Edited October 15, 2010 by Magox

[Clip Smith]

It looks like the major factor is a lack of confidence in the currency itself. If a crisis in confidence happens before inflation even has a chance to take hold, it all becomes a sf prophecy. If many others besides the US are in the same boat, then there is nowhere safe to go but hard goods.

 

Ben Bernanke was hired as an expert to prevent a deflationary collapse. Given the balance sheet of the US, what looks to be happening now makes sense.