Tuesday = Election. Wednesday = Real Policy Makers

[IDBillzFan]

This is NOT I repeat NOT good news for lower to middle income earners. Look for the highest gasoline prices you've seen since 2008 here really really soon.

Given conner's admission that lower- to middle-class people (you know, like Peggy) are "unimportant," I highly doubt he give's a rat's asshair about how this affects the lower- to middle-class earners. The stock market went up 200 today. The GDP went up 2% last quarter. Unemployment could drop all the way to 9.5% tomorrow! The economy is on the rise! We're headed in the right direction!

[Adam]

No doubt, just about everything is going to go up.....

 

For now...

 

Bernankes plan is called the "Wealth effect" strategy, where people see there stock prices go higher, they feel wealthier and then people start spending more which leads to more hiring.

 

The problem is that most of those funds aren't being kept here domestically. The market is going higher not based on solid growth fundamentals but purely because of a liquidity blitz from the Fed which is pushing investors out of longer dated bonds, savings and the dollar into EM and commodity based economies as well as commodities and equities.

 

This carries a large risk. One, Oil is around $87 a barrel right now, food is going through the roof and so are the rest of the commodities. At what point do consumers start changing their consumption patterns based on higher inflationary commodity prices? Which of course punishes lower to middle income earners by reducing their disposable income. Also, many companies depend on tight margins, with higher input costs, they will have to pass this down to the consumer or lower profit margins or a combination of the two.

 

The other risk is what happens if their dual mandate of lowering unemployment doesn't work? Everything that had been going up purely based on QE could be at risk.

 

Basically what we are doing now is flooding EM markets with dollars, manufacturing inflation overseas, and then looking to import it right back.

 

I think this is a terrible idea. It is going to spark as I have noted a global developed world currency devaluation, it will be a race to the bottom. I am now forecasting oil to average over $100 a barrel next year UNLESS central bank policy makers from the developed world reverse course on loose monetary policy.

 

I am just about all in, in the commodity sector and shorting longer-dated US treasury bonds.

While I don't have a full grasp on a lot of the financial stuff, as it isn't anywhere near my area of expertise, that doesn't sound good to idiots like me.

[Magox]

Given conner's admission that lower- to middle-class people (you know, like Peggy) are "unimportant," I highly doubt he give's a rat's asshair about how this affects the lower- to middle-class earners. The stock market went up 200 today. The GDP went up 2% last quarter. Unemployment could drop all the way to 9.5% tomorrow! The economy is on the rise! We're headed in the right direction!

The painful irony of his comment is that he was cheering that the stock market went up today, yet the same people that his masters claim they want to protect are the ones who will get hurt the most out of this and the ones that they demonize, which are the rich are the ones who will benefit the most.

 

I know that I had a great day today, and my clients, well.....Lets just say it was a good day

[Rob's House]

The painful irony of his comment is that he was cheering that the stock market went up today, yet the same people that his masters claim they want to protect are the ones who will get hurt the most out of this and the ones that they demonize, which are the rich are the ones who will benefit the most.

 

I know that I had a great day today, and my clients, well.....Lets just say it was a good day

Conner is also incapable of comprehending the concept that when value remains constant while the currency inflates, it will take more of that currency to represent the same value (hence the stock market hike).

 

This is NOT I repeat NOT good news for lower to middle income earners. Look for the highest gasoline prices you've seen since 2008 here really really soon.

I know, that's what I said.

[bills_fan]

This is NOT I repeat NOT good news for lower to middle income earners. Look for the highest gasoline prices you've seen since 2008 here really really soon.

 

Don't forget heating oil....just in time for winter in the Northeast. Wonderful.

[TPS]

Conner is also incapable of comprehending the concept that when value remains constant while the currency inflates, it will take more of that currency to represent the same value (hence the stock market hike).

 

If you didn't add the parenthetical comment I could understand your point. Your statement implies that stock prices went up without any other change in firm value--is that what you mean? Is QE2 causing the market's P-E ratio to rise because there is more paper floating around?

[Magox]

If you didn't add the parenthetical comment I could understand your point. Your statement implies that stock prices went up without any other change in firm value--is that what you mean? Is QE2 causing the market's P-E ratio to rise because there is more paper floating around?

What would you attribute the market's rise to?

[DC Tom]

Given conner's admission that lower- to middle-class people (you know, like Peggy) are "unimportant," I highly doubt he give's a rat's asshair about how this affects the lower- to middle-class earners. The stock market went up 200 today. The GDP went up 2% last quarter. Unemployment could drop all the way to 9.5% tomorrow! The economy is on the rise! We're headed in the right direction!

 

You just hate facts. There's a consensus!

[TPS]

What would you attribute the market's rise to?

 

Two things drive stock prices higher: expectations of increased future earnings or lower interest rates. It's a little of both. Does anyone seriously think stock prices increased because there is more currency? Inflation's impact on stock prices comes from higher nominal earnings.

[Rob's House]

If you didn't add the parenthetical comment I could understand your point. Your statement implies that stock prices went up without any other change in firm value--is that what you mean? Is QE2 causing the market's P-E ratio to rise because there is more paper floating around?

Obviously attributing the bump in prices solely to the inflationary aspect of this new episode of QE is an oversimplification as there are other factors at play, and I don't put too much into the fluctuations of a single day. However, the broader point still stands and it was a convenient example to illustrate a point.

 

Expectation of future inflation could absolutely lead to higher stock prices as the fluctuation of stock values (not prices) do not necessarily correlate to fluctuations in the value of the dollar.

[Magox]

Two things drive stock prices higher: expectations of increased future earnings or lower interest rates. It's a little of both. Does anyone seriously think stock prices increased because there is more currency? Inflation's impact on stock prices comes from higher nominal earnings.

I disagree.

 

The intended affect is for investors to anticipate higher inflation. They would rather have investors reallocate funds from US treasuries into riskier assets such as stocks, in attempt to provide the "wealth affect", knowing that they will replace or fill in the void of those funds that were moved out of the longer-dated treasuries with newly replaced QE. They basically are replacing the original demand for treasuries from investors (which was induced by fear, poor economic conditions and deflation) and now are in effect monetizing our debt.

 

So what we are seeing here is money moving from US treasuries that were offering insanely low yields, knowing that inflation will crush those longer-dated bonds and moving into riskier assets. They understand that the policy lever they are intending to use induce inflation is by attempting to debase the dollar. How are they going to debase the dollar? Simple, they are going to create more of it through QE. So yes, increasing currency is having an inflation expectation effect of funds moving into stocks, EM economies, commodity based currencies and commodites. Investors would rather hold on to these assets as opposed to a low yielding dollar bond, in anticipation of higher inflation and a falling dollar.

 

This is a simple case of capital flows moving from treasuries to other riskier assets because of anticipation of inflation through dollar/currency devaluation.

 

So again, yes, increasing currency is largely responsible for the markets rally. This is obvious TPS, I don't understand how you are unable to see this.

Edited November 5, 2010 by Magox

[Rob's House]

Two things drive stock prices higher: expectations of increased future earnings or lower interest rates. It's a little of both. Does anyone seriously think stock prices increased because there is more currency? Inflation's impact on stock prices comes from higher nominal earnings.

Yes. More dollars representing the same amount of resources (and stocks are among those resources) means prices go up. Stocks are not an exception to that rule.

[TPS]

I disagree.

 

The intended affect is for investors to anticipate higher inflation. They would rather have investors reallocate funds from US treasuries into riskier assets such as stocks, in attempt to provide the "wealth affect", knowing that they will replace or fill in the void of those funds that were moved out of the longer-dated treasuries with newly replaced QE. They basically are replacing the original demand for treasuries from investors (which was induced by fear, poor economic conditions and deflation) and now are in effect monetizing our debt.

 

So what we are seeing here is money moving from US treasuries that were offering insanely low yields, knowing that inflation will crush those longer-dated bonds and moving into riskier assets. They understand that the policy lever they are intending to use induce inflation is by attempting to debase the dollar. How are they going to debase the dollar? Simple, they are going to create more of it through QE. So yes, increasing currency is having an inflation expectation effect of funds moving into stocks, EM economies, commodity based currencies and commodites. Investors would rather hold on to these assets as opposed to a low yielding dollar bond, in anticipation of higher inflation and a falling dollar.

 

So again, yes, increasing currency is largely responsible for the markets rally. This is obvious TPS, I don't understand how you are unable to see this.

I agree that expectations drove today's rally, as I said. I agree that the lower long term yields generated by the expectation from QE2 also affected stock prices because it pushes up the P-E on the market. I don't disagree with any of the expected effects you mention--I wrote the same elsewhere this week.

I know what Bernanke is trying to do.

What I disagree with is a simple caricature of how more paper raises prices of anything. Sure, someone can give an example of X goods and X pieces of paper means the goods cost X. If I increase paper to 2X, then the cost of each good is now 2X. That's not how things work in the real world though. Yes, the fed is monetizing the debt, but they are buying it in the market, so that means existing debt, not new issues. The question is what will banks, investors, and sovereign funds do with the $s? I agree with you on this. That doesn't mean that stock prices go up in the same proportion as the increase in money. As I said, the impact from inflation on stock prices comes in the form of nominal earnings--if inflation raises EPS (and that's not a given, because of increased commodity prices), then prices will rise for a given P-E ratio.

G'night.

[DC Tom]

Two things drive stock prices higher: expectations of increased future earnings or lower interest rates. It's a little of both. Does anyone seriously think stock prices increased because there is more currency? Inflation's impact on stock prices comes from higher nominal earnings.

 

Think, man...

[TPS]

Think, man...

Then maybe you can all explain why stock prices were essentially flat in the decade of inflation, the 1970s?

[Magox]

Then maybe you can all explain why stock prices were essentially flat in the decade of inflation, the 1970s?

Not the greatest of analogies... Wage inflation was through the roof, while the economy was stagnating. Not only that, the Oil shock had already filtered its way on a more permanent basis into products and consumer behavior.

 

Also, another important factor we have to consider is that there wasn't the major EM engine that is helping provide support the way it is today. Without China and the rest of the EM growing economies, companies like Caterpillar, Deere and other exporting companies wouldn't have nearly the sort of earnings that they do today. I remember seeing a stat about a month ago, that if you took out the exporters from the S&P, the S&P would be down for the year.

 

Another major point that you are not factoring in is the liquidity that is being provided from the Fed. You seem to believe that the money that is being created out of thin air is all remaining in some sort of FED lock box. IT'S NOT! Money is being filtered out into the economy through new super low interest rate home loans and refi's. Also, any government backed loan is being offered at low interest rates, that money is filtering into the economy.

 

Another way that money is moving into the economy through this helicopter money drop strategy is through the purchase of Treasury debt. Think about it for a second. If the fed is buying Treasuries, then expectations for inflation become heightened. So essentially some of this money that was in treasury from the private sector, banks and investors moves away from treasuries and into riskier assets and is now replaced with helicopter dropped money. Now this money that goes into stocks does a few things. Some of it does provide the "wealth effect" factor, which means that some people begin to feel wealthier, which means they spend more, which means money filters into the eocnomy. This money that moves into the economy allows companies to build up their balance sheets. Some of that money goes into new equipment, some of it into new employees. Also, as a result of QE, corporate bond yields are plummeting, which means that corporations are able to borrow at record low yields. Somne of that Money that WAS in treasuries have now moved into corporate debt, which means that some of this money is moving towards corporations. What will these corporations do with these funds, well... they will move into equipment, M&A activity, share buybacks and hiring.

 

So yes, QE does filter into the economy and it doesn't necessarily have to come just through lending.

 

So there are major major differences between what is currently happening and what we saw in the 70's.

Edited November 5, 2010 by Magox

[TPS]

Not the greatest of analogies... Wage inflation was through the roof, while the economy was stagnating. Not only that, the Oil shock had already filtered its way on a more permanent basis into products and consumer behavior.

 

Also, another important factor we have to consider is that there wasn't the major EM engine that is helping provide support the way it is today. Without China and the rest of the EM growing economies, companies like Caterpillar, Deere and other exporting companies wouldn't have nearly the sort of earnings that they do today. I remember seeing a stat about a month ago, that if you took out the exporters from the S&P, the S&P would be down for the year.

Thanks for making my point--yes, stock prices reflect earnings. As you also suppport, stock prices will depend on wether inflation-induced costs can be passed along. If higher wage and oil costs are passed along in higher prices, then nominal earnings will rise based on a given profit mark-up. Your problem is you don't think through all of the effects.

 

Another major point that you are not factoring in is the liquidity that is being provided from the Fed. You seem to believe that the money that is being created out of thin air is all remaining in some sort of FED lock box. IT'S NOT! Money is being filtered out into the economy through new super low interest rate home loans and refi's. Also, any government backed loan is being offered at low interest rates, that money is filtering into the economy.

Simply take a look at the quantity of excess reserves in the banking system from the Fed's data. So, yes, I am saying that QE-ONE's impact was almost nil. The Fed swapped reserves for non-performing assets, and (MOST of) those reserves are sitting on account at the Fed--HENCE THE NEED FOR QE-TWO!!!!

I do agree that low interest rates increase corp earnings after interest paid and refis help households who do refi. It's the big banks who are sitting on reserves because they are still underwater. The fed is paying interest on those reserves, so they exchanged non-performing for an asset that pays a little interest. CHECK THE FED's data!!!

 

Another way that money is moving into the economy through this helicopter money drop strategy is through the purchase of Treasury debt. Think about it for a second. If the fed is buying Treasuries, then expectations for inflation become heightened. So essentially some of this money that was in treasury from the private sector, banks and investors moves away from treasuries and into riskier assets and is now replaced with helicopter dropped money. Now this money that goes into stocks does a few things. Some of it does provide the "wealth effect" factor, which means that some people begin to feel wealthier, which means they spend more, which means money filters into the eocnomy. This money that moves into the economy allows companies to build up their balance sheets. Some of that money goes into new equipment, some of it into new employees. Also, as a result of QE, corporate bond yields are plummeting, which means that corporations are able to borrow at record low yields. Somne of that Money that WAS in treasuries have now moved into corporate debt, which means that some of this money is moving towards corporations. What will these corporations do with these funds, well... they will move into equipment, M&A activity, share buybacks and hiring.

 

So yes, QE does filter into the economy and it doesn't necessarily have to come just through lending.

You are now talking about what the Fed hopes QE2 will do, and I agree with all of those possibilities. The difference between 1 and 2 is that 1 was directed at saving big banks; 2 is buying in the open market from whoever is selling--banks, investors, hedge funds, foreign holders of treasuries. So the big question is what will be done with those funds when one of those entities now has more money in their demand deposit? I think you and I agree here.

Monetary policy can impact the economy in the following ways:

Lower interest rates --> Good:

1. hopefully more borrowing by businesses and consumers.

2. Lower int expense for those with short loans, and increased refis for long loans

3. REduce the value of the $ --> improved net exports

4. increased stock prices as the drop in the long bond yield leads to a higher market P-E, whcich then stimulates consumption by the so-called wealth effect (at least for those with stocks).

The bad:

1. As you've been preaching, expectations of higher inflation can cause investors to use those funds to invest in commodities, precious metals, etc, leading to higher commodity price inflation, higher input costs and higher costs for consumers.

2. The funds get invested overseas instead of US assets (though could have same wealth effect as foreign investments increase as the $ falls).

3. EM sovereign funds react by buying the securities to maintain the value of their currency relative to the $, holding more $ assets in sterile accounts.

 

 

So there are major major differences between what is currently happening and what we saw in the 70's.

Of course there are, but it doesn't change the fact that stock prices (for the most part) are based on future expected earnings...

 

What I disagree with are cavalier statements about how Fed policy impacts spending and inflation in the economy. It's not so simple for someone to say "more money chasing more goods." There is a process of how increased fed intervention influences variables, and most of those processes are indirect.

[Magox]

 

What I disagree with are cavalier statements about how Fed policy impacts spending and inflation in the economy. It's not so simple for someone to say "more money chasing more goods." There is a process of how increased fed intervention influences variables, and most of those processes are indirect.

But that is precisely what it is. That money that is now going into these assets, which wouldn't of happened if the fed didn't create these dollars. That is a fact. Its just a shift of funds, so the money IS being filtered into other areas, therefore creating asset prices to move higher.

 

So when you said, "what do you think it just falls from trees?" YES!! It does, this money would of never of went into these areas if it wasn't for the helicopter drops of money. That is a fact.

 

I have been consistent with my message. You happen to believe that it primarily has to happen through bank lending, I argued that it necessarily didn't have to go through bank lending, that indeed bank lending is the traditional inflationary policy lever, but I argued all along that a reduced dollar is another lever that the Fed can use to induce inflation.

 

Think about it like this, if you are an investor and you were in a 30 year US treasury receiving 3.5% (now its around 4%) and your primary reason for being in that US treasury was because of fear of deflation, uncertainty, safety or any other risk averse reason for being in that treasury, and now the FED is telling you with a bullhorn "LOOK OUT GUYS! HERE WE COME, HELICOPTER DROPS OF TRILLIONS OF DOLLARS ARE COMING YOUR WAY" then this essentially tells longer-dated bond investors to move out of these low yielding bonds which really are yielding less than the interest rate due to dollar devaluation, and is giving the green light for them to move into something else.

 

So where does that money go? Savings or money markets aren't a good option, that is for sure. Domestic stocks? ok U.S exporting stocks? sounds very good. EM stocks? even better. Commodities? makes sense. RE? sounds good. EM currencies? good bet Commodity producing currencies? another good bet

 

We are closer to agreement than what it appears. I think what it comes down to is that you just can't come to grips that inflation can be produced through other means, like the ones I mentioned and NOT JUST through bank lending. This is what I've said, and you have to admit, my scenario is looking more and more likely.

Edited November 5, 2010 by Magox

[TPS]

But that is precisely what it is. That money that is now going into these assets, which wouldn't of happened if the fed didn't create these dollars. That is a fact. Its just a shift of funds, so the money IS being filtered into other areas, therefore creating asset prices to move higher.

Look at what I wrote again. QE1 was a direct exchange with the (wall street) banking system, and it's had little effect because the banks are sitting on the reserves. OK? NOw, QE2 is buying treasuries from the list I mentioned, so it's a portfilio impact. YES, the FED has increased the quantity of money in someone's portfolio in exchange for a treasury, so the impact depends on what bank, investor, HF, sovereign wealth fund does with it--we agree here completely. IT's the first QE that began after Lehman that has not had an effect. Check the fed data.Fed dataThe really interesting stuff is found in the transition, summer of 2008 to the crisis. Click on the "release dates" and go back and look at how excess reserves went from a few billion to a trillion!! in a matter of months, and it's still close to a trillion. This can't be ANY CLEARER!

 

I have been consistent with my message. You happen to believe that it primarily has to happen through bank lending, I argued that it necessarily didn't have to go through bank lending, that indeed bank lending is the traditional inflationary policy lever, but I argued all along that a reduced dollar is another lever that the Fed can use to induce inflation.

That's included in my list on how monetary policy can impact economy.

Think about it like this, if you are an investor and you were in a 30 year US treasury receiving 3.5% (now its around 4%) and your primary reason for being in that US treasury was because of fear of deflation, uncertainty, safety or any other risk averse reason for being in that treasury, and now the FED is telling you with a bullhorn "LOOK OUT GUYS! HERE WE COME, HELICOPTER DROPS OF TRILLIONS OF DOLLARS ARE COMING YOUR WAY" then this essentially tells longer-dated bond investors to move out of these low yielding bonds which really are yielding less than the interest rate due to dollar devaluation, and is giving the green light for them to move into something else.

 

So where does that money go? Savings or money markets aren't a good option, that is for sure. Domestic stocks? ok U.S exporting stocks? sounds very good. EM stocks? even better. Commodities? makes sense. RE? sounds good. EM currencies? good bet Commodity producing currencies? another good bet

Agreed. All on my list.

We are closer to agreement than what it appears. I think what it comes down to is that you just can't come to grips that inflation can be produced through other means, like the ones I mentioned and NOT JUST through bank lending. This is what I've said, and you have to admit, my scenario is looking more and more likely.

I have not disagreed with your scenario on commodities, I disagreed with the extent that EM growth was the main driver vs speculative investment flows--isn't that what you are now saying?

This started because I disagreed with the simplistic notion expressed that stock prices rise because there's more pieces of paper circulating (money printing) relative to shares of stock. That implies investors ignore fundamental valuation principles. Increases in expected earnings make a stock worth more (or a drop in the discount factor--interest rates). It's pretty straight forward, if firms can pass along their higher (inflation-induced) costs into higher prices, then their net income and EPS increases by the rate of inflation, AND therefore stock prices for a given P-E ratio. Unfortunately people choose to believe in a fairy tale explanation, or one that was taught in an elementary school classroom--"if i give all of you more 30 pieces of paper and there are 30 pieces of gum, how much does the gum cost? Now kids, if I give you 60 pieces of paper without increasing the pieces of gum, what's the gum cost? In the real world, the FED doesn't hand out money to all the kids in the room, only to those that have a piece of paper the fed can buy...