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Richard Koo Explains Why An Unwind Of Qe2, With Nothing To Replace It, Could Lead To The Biggest Depression Yet

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Zerohedge

Over the past several days, quite a few readers have been asking us why we are so confident that QE3 (in some format: it does not and likely will not be in the form of the Large Scale Asset Purchases that defined QE1 and 2 - the Fed could easily disclose that it will henceforth sell Treasury puts, a topic discussed previously, or engage any of the other proposals from Vince Reinhart disclosed in June of 2003, or worse yet, do what the BOJ does and buy ETFs, REITs and other outright equities) will eventually be implemented by the Fed. Luckily, instead of engaging in a lengthy explanation of the logical, Nomura's Richard Koo comes to our rescue with his latest research piece. While we disagree with Koo on various interpretations of his about monetary theory (namely that the Fed is not in effect "printing" money and thus creating inflation - this is semantics and leads to a paradoxical binary outcome, whereby if there Fed was successful in boosting the economy, the economy would indeed be flooded with the nearly $2 trillion in excess reserves held with reserve banks. And good luck trying to contain this surge by changing the IOER - if the Fed indeed pushed the IOER to the required 5%+ level it would immediately destroy money markets, leading to the same liquidity freeze that marked the post-Lehman days, confirming the "Catch 22" nature of Quantitative Easing that we have observed since its beginning) we do agree with his analysis of what would happen to the economy if either stocks or commodities are in a bubble (and judging by the violent opinions out there, most investors believe that either one or the other has indeed reached bubble territory), should QE2 end cold turkey: "Viewed objectively, the central banks are trying to push up asset prices using quantitative easing and the portfolio rebalancing effect. The resultant rise in asset prices based on this effect represented a potential bubble—or at least a liquidity-driven event—from the start. The question is whether the real economy can keep pace with asset prices formed in those liquidity-driven markets. If it cannot, higher asset prices will be considered a bubble and will collapse at some point. The resulting situation could be much more severe than if quantitative easing had never been implemented to begin with." Bingo.

"In other words, if stock and commodity prices are in fact in a bubble and if those bubbles were to collapse, the balance sheets of the financial institutions and hedge funds making investments with the expectation of higher asset prices could suffer heavy damage, exacerbating the balance sheet recession in the broader economy. an increase in DCF values, either." And there you have it: Bernanke's all in gamble that QE2 would have been sufficient to restore the virtuous circle of the economy has failed with less than 2 months to go under the QE2 regime. As such, and with fiscal stimulus a dead end, the Fed has two choices: watch as the economy collapses in flames to a state far worse than its pre-QE1 outset, or do more of the same. That's all there is. The rest is irrelevant. And since the Fed will choose the latter option, the market would be wise to start pricing in precisely the same reaction as what happened following the Jackson Hole speech...although to the nth degree.

More at the link.

Full Report

Von Mises anyone?

Bernanke is getting himself into an impossible position, like they did in France and in the Weimar. There is no easy option out, either we accept the pain or have total system collapse.

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Koo is right; a stronger economy results in higher share prices and not the other way round. Bernanke's approach is that we can print our way to prosperity; the only question here is: if it was as simple as that why hasn't it been done before and why aren't we rolling in wealth? The answer is that it has been done before with calamitous results and that a stronger economy is a result of higher productivity not the printing press. These people know it is a house of cards and are terrified it will collapse on their watch.

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QE's goal is to create price inflation. Traditionally price inflation has lead to wage inflation which allows for balance sheet repair by households, businesses and governments.

The miscalculation by monetary authorities globally is that the tradition transfer mechanisms between price inflation and wage inflation have broken down as labour markets have become more global and less local. Simultaneously, unions have lost most of their monopoly powers.

We are going to get bad price inflation without any good (from the policy makers' perspective) wage inflation.

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I don't think Bernanke ever had a choice from the start. Not doing QE 1.0 would have just meant a total melt down of the financial system and reset to 0 of most peoples savings, including pension funds. A few people holding senior bonds would have gotten some of their money out.

Until a self-sustaining private debt expansion is underway they will have to continue with more QE's. Of course this time they will pull off QE 2.0 and then when things go deflationary start up QE 3.0.

And to support Bernanke more while he is in control of the Fed he isn't in charge of the whole US society. There are many reforms America needs but isn't doing. The endgame probably is a hyperinflationary blow-off, total crash and reset if the political system is unable to carry out systemic reforms.

Britain seems to be further down the road, now running inflation over 4% and still unable to raise rates.

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I don't think Bernanke ever had a choice from the start. Not doing QE 1.0 would have just meant a total melt down of the financial system and reset to 0 of most peoples savings, including pension funds. A few people holding senior bonds would have gotten some of their money out.

Until a self-sustaining private debt expansion is underway they will have to continue with more QE's. Of course this time they will pull off QE 2.0 and then when things go deflationary start up QE 3.0.

And to support Bernanke more while he is in control of the Fed he isn't in charge of the whole US society. There are many reforms America needs but isn't doing. The endgame probably is a hyperinflationary blow-off, total crash and reset if the political system is unable to carry out systemic reforms.

Britain seems to be further down the road, now running inflation over 4% and still unable to raise rates.

The problem for Bernanke et al is that many prices have to fall to a level supportable by incomes, which are being pushed lower by the defragmentation of labour markets, before self sustaining private debt expansion can resume.

By trying to force prices higher rather than allowing them to fall to their natural level relative to incomes, they are making the problem even worse.

There is no way that an unnatural equilibrium forced upon the market by QE can be sustained for a long period of time.

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QE's goal is to create price inflation. Traditionally price inflation has lead to wage inflation which allows for balance sheet repair by households, businesses and governments.

The miscalculation by monetary authorities globally is that the tradition transfer mechanisms between price inflation and wage inflation have broken down as labour markets have become more global and less local. Simultaneously, unions have lost most of their monopoly powers.

We are going to get bad price inflation without any good (from the policy makers' perspective) wage inflation.

To make US/UK house prices not look too expensive they have to raise wages. They cannot raise US/UK wages without other countries raising their wages as well or the US/UK becomes even more uncompetitive. QE has flooded the world with money and driven up prices so it's causing problems in other countries and their wages are going up. Then in another year or two they can more openly raise our wages though some are getting rises now.

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The problem for Bernanke et al is that many prices have to fall to a level supportable by incomes, which are being pushed lower by the defragmentation of labour markets, before self sustaining private debt expansion can resume.

By trying to force prices higher rather than allowing them to fall to their natural level relative to incomes, they are making the problem even worse.

There is no way that an unnatural equilibrium forced upon the market by QE can be sustained for a long period of time.

I agree about incomes and prices. And in fairness in a wide swathe of America there has been the reset. In places like Arizona, California, Florida and Nevada homes are nearly free now. You can buy a family house for £50,000 now.

I personally think most of the money has flowed in to shore up the banks. That is what has prevented widescale wipeout of peoples savings at banks.

If you look at the stock market it might be somewhat overvalued but its not bad for long term price earnings averages. And we're in a great global commodity bull market that is way bigger than America.

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Great interview with Jim Rickards on KWN. Hits out at some of the hyperbole surrounding QE3, thinks that the FED will issue greater clarity on the cessation of QE2 soon, thinks that there will be no rush into QE3 because the FED balance sheet is so big. For the time limited listeners, cut to about 11:00 onwards

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To make US/UK house prices not look too expensive they have to raise wages. They cannot raise US/UK wages without other countries raising their wages as well or the US/UK becomes even more uncompetitive. QE has flooded the world with money and driven up prices so it's causing problems in other countries and their wages are going up. Then in another year or two they can more openly raise our wages though some are getting rises now.

You could be right about second round effects in US / UK labour markets. I am not sure about the timeline.

Japan has been indulging itself with QE for up to 10 years (depending on one's definition of when they actually started) with no signs of positive second round effects on wages to date.

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I agree about incomes and prices. And in fairness in a wide swathe of America there has been the reset. In places like Arizona, California, Florida and Nevada homes are nearly free now. You can buy a family house for £50,000 now.

I personally think most of the money has flowed in to shore up the banks. That is what has prevented widescale wipeout of peoples savings at banks.

If you look at the stock market it might be somewhat overvalued but its not bad for long term price earnings averages. And we're in a great global commodity bull market that is way bigger than America.

There are two routes to bankruptcy for banks : illiquidity and insolvency.

As distasteful as I found them, programs like TARP, TALF and the SLS made sense if one thought that banks were illiquid but solvent at the peak of the financial crisis. The programs were necessary to prevent a wipeout of people's savings. This is a rational and often used policy.

Programs like QE appear to me to be an attempt to make insolvent banks solvent again by effectively debasing the currency. This is pure policy experimentation with the risk of massive unintended consequences.

I cannot think of an instance where similar policies have been tried and succeeded. There are examples of where it has been tried and has failed miserably.

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There are two routes to bankruptcy for banks : illiquidity and insolvency.

As distasteful as I found them, programs like TARP, TALF and the SLS made sense if one thought that banks were illiquid but solvent at the peak of the financial crisis. The programs were necessary to prevent a wipeout of people's savings. This is a rational and often used policy.

Programs like QE appear to me to be an attempt to make insolvent banks solvent again by effectively debasing the currency. This is pure policy experimentation with the risk of massive unintended consequences.

I cannot think of an instance where similar policies have been tried and succeeded. There are examples of where it has been tried and has failed miserably.

But this time it's different. :ph34r:

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I don't think Bernanke ever had a choice from the start. Not doing QE 1.0 would have just meant a total melt down of the financial system snip

You see, this is the Lie that the losing bankers propagated...and Bernankes very job is to save bankers.

He may have had no choice as far as his role was concerned, but Governments had the choice of saying no money for you guys.

Not all banks were bust. Debt assets would have been traded, the rubbish defaulted...Chaos for a while, but lets not forget, bankers snap up bargains the moment they appear...they would have done so in the case of closing the big failures.

Lets not forget Barclays vetoed the bail out for Lehmans, and bought their trading desks for a snip the day after.

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There are two routes to bankruptcy for banks : illiquidity and insolvency.

As distasteful as I found them, programs like TARP, TALF and the SLS made sense if one thought that banks were illiquid but solvent at the peak of the financial crisis. The programs were necessary to prevent a wipeout of people's savings. This is a rational and often used policy.

Programs like QE appear to me to be an attempt to make insolvent banks solvent again by effectively debasing the currency. This is pure policy experimentation with the risk of massive unintended consequences.

I cannot think of an instance where similar policies have been tried and succeeded. There are examples of where it has been tried and has failed miserably.

To solve illuidity the Fed can provide liquidity in those securities, which brings the bank back into balance. To counter insolvency the Fed can provide outright capital to the bank.

A tough question is if printing would have to be so vast to provide capital to the banks that it would cause a high rate of inflation. So far the US Federal reserve has not faced that problem. Now the banks have quite a lot of capital buffer, and inflation is still under control.

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I don't think Bernanke ever had a choice from the start. Not doing QE 1.0 would have just meant a total melt down of the financial system and reset to 0 of most peoples savings, including pension funds. A few people holding senior bonds would have gotten some of their money out.

Until a self-sustaining private debt expansion is underway they will have to continue with more QE's. Of course this time they will pull off QE 2.0 and then when things go deflationary start up QE 3.0.

And to support Bernanke more while he is in control of the Fed he isn't in charge of the whole US society. There are many reforms America needs but isn't doing. The endgame probably is a hyperinflationary blow-off, total crash and reset if the political system is unable to carry out systemic reforms.

Britain seems to be further down the road, now running inflation over 4% and still unable to raise rates.

Bernanke thinks he is a Messiah. He spent a lot of his academic life studying The Great Depression and now he is dying to prove his theories correct. Incidentally, Bernanke and King had adjacent rooms when they were teaching at MIT.

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I cannot think of an instance where similar policies have been tried and succeeded. There are examples of where it has been tried and has failed miserably.

It depends on what the long term objectives happen to be, if you mean stablise the economy and keep it ticking over it won't work. Bit like Einstien's insanity of trying the same thing over and over again and expecting different results. Societies have tried this time and again for 1000 years when Chinese folks made paper money.

If you mean total collaspe and a reset, then it will work.... with an unpleasant period in between, pretty much like Russia. Russia had its hyperinflationary period mid 1990s, all the massive entitlements and pensions were wiped out in purchasing power terms. The Russian economy is ticking over OK right now.

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It depends on what the long term objectives happen to be, if you mean stablise the economy and keep it ticking over it won't work. Bit like Einstien's insanity of trying the same thing over and over again and expecting different results. Societies have tried this time and again for 1000 years when Chinese folks made paper money.

If you mean total collaspe and a reset, then it will work.... with an unpleasant period in between, pretty much like Russia. Russia had its hyperinflationary period mid 1990s, all the massive entitlements and pensions were wiped out in purchasing power terms. The Russian economy is ticking over OK right now.

Agreed. The reset will have to happen. QE is unable to prevent it. In fact, it just makes the eventual reset even worse for most people.

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Agreed. The reset will have to happen. QE is unable to prevent it. In fact, it just makes the eventual reset even worse for most people.

What happens after the reset?

I can see how hyperinflation set in in the Weimar Republic, I haven't read anything about the effects on the populace after the reset. I can see how the crisis in Argentina was precipitated and I've read a few articles about the effects on the populace. Japan's problems seem to have been relatively benign for most of the population, the older generation in contrast suffered more.

Russia, everyones' savings wiped out and the rise of the Oligarch.

Are these desirable or worthwhile results?

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What happens after the reset?

I can see how hyperinflation set in in the Weimar Republic, I haven't read anything about the effects on the populace after the reset. I can see how the crisis in Argentina was precipitated and I've read a few articles about the effects on the populace. Japan's problems seem to have been relatively benign for most of the population, the older generation in contrast suffered more.

Russia, everyones' savings wiped out and the rise of the Oligarch.

Are these desirable or worthwhile results?

The larger the imbalances, the larger and less controllable the eventual reset.

In general, the reset seems to result in war or a massive concentration of political and economic power in a very non-democratic form.

The reset happens much more quickly at a given level of imbalance for those with external liabilities and internal assets (Argentina for example) than for those with external assets and internal liabilities (Japan for example).

As you point out, the reset has horrible consequences for most people in most cases. It frustrates me that voters allow their politicians to put their countries at risk of a reset in the first place.

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The larger the imbalances, the larger and less controllable the eventual reset.

In general, the reset seems to result in war or a massive concentration of political and economic power in a very non-democratic form.

The reset happens much more quickly at a given level of imbalance for those with external liabilities and internal assets (Argentina for example) than for those with external assets and internal liabilities (Japan for example).

As you point out, the reset has horrible consequences for most people in most cases. It frustrates me that voters allow their politicians to put their countries at risk of a reset in the first place.

I watched some prog last night about POW camp in the UK...they interviewed an Ex SS Officer who spoke about his experience of 1931-39.

There was vast unemployment in Germany, and The Nazi Party pledged to combat it...they did, they created massive public works ( defence) and created camps to house the workers (later the concentration camps).

Of course, with people working, and the nation moving, they loved their new leaders.

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I watched some prog last night about POW camp in the UK...they interviewed an Ex SS Officer who spoke about his experience of 1931-39.

There was vast unemployment in Germany, and The Nazi Party pledged to combat it...they did, they created massive public works ( defence) and created camps to house the workers (later the concentration camps).

Of course, with people working, and the nation moving, they loved their new leaders.

There are many who believe that the "New Deal" in the US only "worked" because of WWII.

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viewed objectively, the central banks are trying to push up asset prices using quantitative easing and the portfolio rebalancing effect. The resultant rise in asset prices based on this effect represented a potential bubble—or at least a liquidity-driven event—from the start. The question is whether the real economy can keep pace with asset prices formed in those liquidity-driven markets. If it cannot, higher asset prices will be considered a bubble and will collapse at some point. The resulting situation could be much more severe than if quantitative easing had never been implemented to begin with." Bing

Yap. Cold turkey is more painful than if a person never had a drug before...

As this is year 3 of a presidential election cycle and the mirage of prosperity (I mean high stock market) must

be maintained..

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You could be right about second round effects in US / UK labour markets. I am not sure about the timeline.

Japan has been indulging itself with QE for up to 10 years (depending on one's definition of when they actually started) with no signs of positive second round effects on wages to date.

According to the last budget forecast wage increases start rising annually above 5% from 2013/14

Of course that could be just a carrot on a stick for the drones!

wages.jpg

post-15752-0-55161200-1305801811_thumb.jpg

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To make US/UK house prices not look too expensive they have to raise wages. They cannot raise US/UK wages without other countries raising their wages as well or the US/UK becomes even more uncompetitive. QE has flooded the world with money and driven up prices so it's causing problems in other countries and their wages are going up. Then in another year or two they can more openly raise our wages though some are getting rises now.

Yes, that is the plan, IMO.

If we get a big dislocation in the EM/china as many analysts think we will (I for one am not so sure) all the QE money that basically fled our shores and pushed up wages elsewhere will come back and push up wages here.

Regardless of whether this is imminent, it will happen eventually, when the EMs get saturated with sufficient debt to have their own balance sheet recession and equalize with our zirp. They will then do their own QE, and all the original QE money of ours will come back and raise wages back here, quite possibly at a time when labour markets are already tight as a result of population aging. This is when I believe the major inflationary impulse of this crisis will be felt here in the west and it will be extremely powerful.

However we may get a sneak preview of this outcome with Japan well before that.

Edited by scepticus

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the trouble is, most people see bits of paper as wealth.

They are not...they allow the exchange of wealth.

printing more bits of paper does nothing to increase the wealth....just makes the bits of paper exchange for less of the available wealth.

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  • 312 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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