Tuesday, July 9, 2013

Here’s Why “QE Isn’t Money Printing and Does Not Cause Inflation” Are Not Only Big Fat Lies, But Red Herrings

By Lee Adler

Here we go again with more self appointed experts repeating the big, pernicious misconceptions about what QE does and does not do. Let me put it bluntly. The ideas that QE does not cause inflation and that it’s not the equivalent of printing money are categorically false, regardless of how many times you see those points made, and on how many websites.  They are not true.

The idea that QE does not stimulate CPI inflation is correct. That is not the same thing as QE does not cause inflation and is not money printing. QE is money printing. It causes some kinds of inflation, but may not cause some types of inflation at a given time. Under other conditions it may. Under current conditions, it does not raise CPI.

QE stimulates inflation, only not the dumbed down definition of inflation encapsulated in CPI or PCE. If you dumb down inflation to exclude all the things that are inflating, then voila, there’s no inflation. However, QE is directly responsible for asset inflation. It was directly responsible for increasing money supply dollar for dollar, but it could not drive CPI inflation. Establishment economists and their supporting cast of lying shills deliberately exclude asset inflation from their definitions of inflation. So it appears that QE does not cause inflation as narrowly defined. If you believe that narrowly defined CPI is the only kind of inflation, then stop reading now. You’re in denial and presentations of fact and logic won’t change that.

Same if you don’t believe that QE is printing money. Prior to the central bank’s purchase of the securities the money did not exist. Subsequent to the purchase it did. Oh sure, the Fed didn’t print the money. It just created an electronic credit in the account of the Primary Dealer at the Fed. The Fed paid for the securities with money that did not exist prior to that moment. Now you don’t see it, now you do. Abracadabra, hocus pocus.

If the Treasury does not issue securities dollar for dollar in the amount of the QE, or if some players are concurrently selling securities and liquidating the margin they used to purchase them, as is currently the case, then it is true that there will be not be a concomitant dollar for dollar increase the money supply. Regardless of that, the Fed still printed the money. It’s just that other forces simultaneously extinguish the money, so that it appears that the Fed’s QE isn’t inflating the money supply.

Absent the simultaneous extinguishment of money, the money supply has inflated at exactly the rate at which the Fed printed the money. That was the case until the end of 2012. US money supply growth stopped in its tracks at that point because big banks and other market participants began liquidating Treasuries, paying off the margin used to purchase them, extinguishing deposits as a result. Prior to that, money supply grew in perfect lockstep with QE. Offsetting forces are now extinguishing money at near the rate which the Fed is adding it to the system.

As Treasury supply diminishes (and counterintuitively, simultaneously has lately become desirable to hold) the recipients of the QE seek other ways to employ the funds. That results in an increase in the prices of other financial assets, whether bonds, equities, or futures. This works every time without fail. When the Fed prints money, asset prices inflate, and if Treasury supply is restricted other asset prices inflate more.

This is basic supply and demand. Effective demand for financial assets is increasing because the Fed is pumping cash into the accounts of trading firms. They look for places to put the cash to work. For a while it was bonds. Bond prices rose and yields fell. Housing prices rose as a corollary of the falling yields. Housing is a perfect example of prices rising 10-15% per year but not being recognized as inflation.

For most of the past 4 years trading firms also bought equities, whose supply was increasing far more slowly than the cash the Fed was pumping into the accounts of these entities. Stock prices have been rising at astronomical rates, but that’s not recognized as inflation.

Why then are Treasury prices falling? The Fed is not the only actor pumping newly printed money into the pool. The BoJ, ECB, and all of the world’s central banks pump and drain funds from the same pond. The PBoC also does so indirectly as some entities to whom the PBoC lends also act in the world liquidity pool.

Lately the ECB has been shrinking its assets at a breakneck pace thanks to the paydowns of the LTRO emergency loans it issued at the end of 2011 and early in 2012. The securities purchased with that leverage are being liquidated. Capital/money is being destroyed. At the same time the PBoC has imposed tightness on its players, forcing liquidation and capital destruction in the world liquidity pool. The BoE has also been tight. These forces have counteracted the Fed’s direct money printing, making it appear this year that money printing does not result in increasing money supply.

One thing that I agree with is “QE does not affect the wider economy in any very helpful way: its effects if anything are contractionary, because of the hit to aggregate demand for some groups caused by the depression of interest rates on savings.”

This is an important point although I would not argue that QE is contractionary. The effects are a matter of transferring wealth. A benefit to one sector is a cost to another in a world that, like it or not, still functions according to the rules of double entry accounting. The accounts of the 7% are benefitting from QE. Everybody else is getting screwed. QE, i.e. money printing, creates massive distortions that eventually result in systemic reset, otherwise known as “collapse” or “crash.”

The conventional inflation/deflation argument is a red herring. It’s irrelevant. It’s the asset inflation, the financial asset bubbles, that are the problem today, just as they were the problem in the middle of the last decade. They’re a problem which few in the establishment, the same establishment that brought us the 2008 “adjustment,” recognize because of the narrow definition of inflation which they promulgate. A repeat performance of the “adjustment”  is coming and will keep coming until the lesson finally sinks in and the system is cleansed once and for all.

I’ve been watching the Fed’s operations every day ever since it started publishing them daily in 2002 along with its balance sheet and the commercial banking system balance sheet. I also closely follow  Treasury operations, revenues, and outlays weekly. As the famous financial philosopher L. Berra wisely said, “You can observe a lot by watching.” I invite you to watch along with me, and observe a lot.

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