Diary of a Financier

More on Inflation/Deflation & QE3

In Economics on Thu 31 Mar 2011 at 08:36
  • Regardless of QE2’s true cause & effect, the US would excuse itself for the socioeconomic waste it lay internationally via USD devaluation, because China (and other emerging markets) has the autonomy to break free of their USD peg to combat inflation.
  • The broad strokes of US stimulus aren’t largely responsible for food & energy inflation, because stimulus lay with the banks (i.e. the carry trade), not in the real economy (i.e. loans, wages, or dividends).
  • As confiscatory as food & energy inflation are, housing costs are the greater share of consumers’ expenditures and therefore the first priority.
  • The psychology would dictate that US authorities continue to act for egocentrism, putting domestic needs ahead of international wants in policy-making.

I wanted to quickly pile on top of my prior comments regarding the inflation/deflation debate, the end of QE2, the [inevitable] next government intervention, and housing.

To wit, I’ll start with a fairly obvious observation of our state.  From my most recent entry on the matters du jour:

Monetary expansion by the Federal Reserve has collaterally damaged international socioeconomics.

My official stance on this subject sounds a bit callous when I re-read it, but here goes nothing.  The US Treasury can just sit and snicker at the global inflation story.  The aim of the latest government stimuli could have been to inflate away our federal debt, help mortgagees, mend banks, stimulate domestic borrowing, and/or shake China off its US Dollar peg. Yet, if ever interrogated for the waste they lay upon the globe, Tim Geithner & Ben Bernanke will always cite their favorite parlay: China [and other emerging markets] had the autonomy to fight inflation by breaking its USD peg. It’s like double jeopardy, “Autrefois acquit,” and they’re relieved of their sins. As the bearers of the global reserve currency, that’s flat irresponsible, because there exists real inflation in many emerging markets, so messing with the dollar to combat the Chinese Yuan (CNY) is like Quantitative Easing to fight housing deflation.  Broad strokes have unintended consequences.

So what am I trying to say?  Well, Quantitative Easing has not been responsible for domestic inflation–that 2.16% headline number reared in the divergence between housing and food & energy price levels–because the monetary stimulus created by QE hasn’t found its way into the real economy.  It has repaired bank balance sheets while remaining in bank vaults, just funding a carry trade.  How do I know it’s not leaking into the real economy?  First, bank loan activity is still falling:

Gross Bank Assets (Loans & Leases)- Loan activity still falling, and when looking at the QE2 period since November 2010 compared to the Summer 2010, there's still a fall in loan activity.

Bank Assets (Loans & Leases)- y/y % change

So the banks aren’t parting with the stimulus via loans.  Another outlet into the real economy would be Private wages & earnings, which just aren’t taking the handoff either:

Private Wages & Earnings

…or, finally, dividends to shareholders can catch the pass of stimulus from the banks to the real economy via the “wealth effect.”  But, dividends have only recently been approved for “strong” banks.

That’s why I arrive at the conclusion:

The commodity boom has been one part drought, two parts the debasement of fiat, two parts speculation.  With the relevance of China’s rising middle class and a proliferating world population, investors ploughed money into commodities to get in on some hot investment themes like the global Agricultural boom.  Problem is, these themes take 15 years to develop, but inflows pulled-forward the performance.

End QE2.  That ends the risk-free carry trade, which preoccupies bank capital right now.  That stokes the outlook for loan activity and real economic activity.  Most commodity prices will wane as speculative capital is reallocated toward other return vehicles.

The risk of discontinuing stimulus is deflation, for which housing holds the ripcord.  As an investor acknowledging Mr. Bernanke’s sensitivity to a 1937-style double-dip, I’m fighting any semblance of a general QE3, in favor of a specific HAMP 2 (if anything):

Come June, “HAMP 2″ will be the artist formerly known as “QE3”… With mortgages & housing being the real aims of stimulus, future stimulus needs to directly impact mortgages & housing… without any residual effect upon food & energy. HAMP 1 was wrought with corruption and idiocy, so I hope Washington takes a few months to carefully plan an effective sequel.

Yes, it’s more government spending, but the New York Times reminds us:

Congress set aside $50 billion for foreclosure prevention, amid administration projections that three million to four million homeowners would benefit from modifications. So far, the Treasury Department, which oversees the program, has spent slightly more than $1 billion, and just 607,000 homeowners have received permanent loan modifications.

Even if I’m wrong about the relationship among stimulus> inflation> commodities,  policymakers will continue to argue for housing stimulus, because they’ve only deployed 2% of their foreclosure prevention allowance.  (Mostly due to the fact that HAMP was implemented hastily, proving itself an operational nightmare.) Not to mention deflation in housing is truthfully a greater risk than inflation in consumer staples:

Consumer Expenditures as a percent of Income- Housing (35%), Food (13%), Gas/Motor Oil (4%).

If ever we wake from this bad economic dream, we need to individually reconsider our priorities in the above graphic.  If the government’s intervention to keep interest rates low happened to increase your price at the pump, you price at the market, or your price at Starbucks (see this Gallon to Gallon infographic), imagine what the reciprocal would feel like.  Imagine rising rates inflating your mortgage, whence your NINJA option ARM goes kung-fu on your disposable income.  Are we willing to sacrifice all to heed to housing’s 35% claim on our income?  (In case you were wondering how widespread the effect, the homeownership rate in America is about 70%.)  You can’t quantify the intangible qualities of a home.  You can weigh them against the utility of other spending nodes.  Quantitatively, I’m comfortable calling the “home as an investment” theme imprudent, albeit quixotic:

Real v Nominal Housing Prices- Yves Smith agrees, "from a policy standpoint, housing is best regarded as a forced savings vehicle or a store of value rather than an investment."

If I’m wrong about the non-causal relationship among today’s stimulus> inflation> commodities, there’s a price-to-pay [literally] for global consumers.  I would hope that emerging markets would move to revalue their currencies, because further exacerbation of socioeconomic tensions would trigger a modern World War.

Again, it’s a bad standard for US diplomats to act with egocentrism given their responsibility as the custodian of the world’s reserve currency, but international wants are at odds with domestic needs.  Is the Fed’s priority not the American populace?  Does the Treasury not act in the better interests of US citizens first & foremost?  I feel selfish even suggesting that this is the psychology behind what’s about to unfold.  But that’s just it: I’m not in support of such egocentrism.

I believe in the chief responsibility of Americans to their brethren around the world, the responsibility to humanity.  That’s what I’m preaching… but it’s not what’s in store.  Unsure of the global inflationary impact (food & energy) from more easing, the US will react to the coos of its domestic economy in isolation.  Conveniently for foreign nations, food & price inflation are US political nuisances for policy-makers.  Congress will rebuff any broad-stroke successor to TARP & QEs, but housing is still the irritant, and a housing-specific ointment is the only tenable cure.

–Romeo (hattip AWF & Richard Smith)

  1. A well-timed note from my friend Hugh Hendry this morning:
    “…monetary easing represents an enormous change to the benign policy which has driven global growth for the past 15 years. I equate the easing program with Roosevelt’s devaluation of the dollar in 1931 (that year keeps reappearing). By this I mean it could mark the moment when modern American policy makers rejected globalisation. It is a direct attempt to address and remove the free rider (or mercantilist) problem associated with managing the dollar as a public international good.”


  2. […] The fundamentals behind ADM are attractive to the point of not presenting much risk.  The valuation doesn’t make it a stock I’d hold long-term, because it’s just not that mispriced, plus I keep harping on the proximate unwind of the commodity cycle. […]

  3. […] keep harping on this: “The broad strokes of US [QE2] aren’t largely responsible for food & energy […]

  4. ..And last but not least, MarketWatch also agrees:
    “Reading the inflation data, Fed doves strike back.”

  5. […] So, I’m hoping that the retirement of QE2 in June will be succeeded by some type of housing support from the Treasury.  I’m just pleading for support to prevent a deflationary relapse–not for stimulus to inflate another bubble–and I think policymakers will arrive at the same conclusion I have, based on my analysis. […]

  6. […] that sentiment is derived from media or the constituency.  Inflation I fear not… but I’m curious what data expectations the Fed’s watching.  Is there something […]

  7. […] is Coming, It’s Just a Matter of Time,” the article is reminiscent of my own repeated insistence, as follows: Come June, “HAMP 2″ will be the artist formerly known as “QE3”… With […]

  8. […] rally, the fundamentals have really changed.  Deflation was the threat throughout because of housing’s disproportionate share of the economy.  The Fed/Treasury were there throughout to offset that threat. But deflation still remains, and […]

  9. […] in March, I evaluated a thesis about a weak dollar policy as (more than anything else) a means for the US to shake the Chinese Yuan […]

  10. […] wit, revisit my entry from March 2011: Come June, “HAMP 2″ will be the artist formerly known as “QE3”… With […]

  11. […] economies don’t operate in vacuums. Back in March, I opined: The aim of the latest government stimuli could have been to inflate away our federal debt, help […]

  12. […] discussed reasonable, empirical, long-term housing growth expectations back in March 2011: [Housing has a] 35% […]

  13. […] I discussed reasonable, empirical, long-term housing growth expectations back in March 2011: […]

  14. […] maturities from POMOs) is increasing via Operation Twist. So far, there’s little but expectations to materially push commodity prices higher; it’s certainly not justified by the […]

  15. […] maturities from POMOs) is increasing via Operation Twist. So far, there’s little but expectations to materially push commodity prices higher; it’s certainly not justified by the […]


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