At the rate Obama is spending and with Fed Chair Ben Bernanke buying Obama’s debt (quantitative easing 1,2.3 and now 4), we are screwed and so is the dollar. The Fed will own all of our debt in the next few years or maybe by the end of 2013.
There was a time when it was nothing short of economic blasphemy and statist apostasy to suggest three things: i) that the Fed’s canonic approach to monetary policy, in which Stock not Flow was dominant, is wrong (as we alleged, among many other places, here); ii) that the Fed is monetizing the deficit, thus enabling politicians to conceive any idiotic fiscal policy: the Fed will always fund it no matter how ludicrous, converting the Fed effectively into a political power and destroying any myth of its “independence” (as we alleged, among many other places, most recently here in direct refutation of Bernanke’s sworn testimony); and iii) that by overfunding bank reserves, the same banks are left with one simple trade – to frontrum the Fed in its monetization of the long-end, in the process destroying the bond curve’s relevance as an inflationary discounting signal, with more QE, leading to tighter 10s, flatter 10s30s, even as the propensity for runaway inflation down the road soars, in the process eliminating any need for the massively overhyped, and much needed to rekindle animal spirits “rotation out of bonds and into stocks” trade (as we explained, first, here). Well, that time is now officially over, with that stalwart of statist thinking, JPMorgan, adopting all of the above contrarian views as its own, and admitting that once again, the Fed and conventional wisdom was wrong, and fringe bloggers were right all along.
And while we recreate the piece in its entirety below, here is the punchline:
Since the Lehman crisis, the Fed has been purchasing Treasuries and Agencies at a $500bn per year pace. This flow, which is equivalent to around 3.5% of US GDP, has offset more than a third of the government deficit since the end of 2008. In other words, QE purchases meant that the QE-adjusted government deficit has averaged 5.8% of GDP since the end of 2008 instead of 9.3% for the actual government deficit. This week’s Fed announcement means that this QE flow will double from a $500bn pace currently to $1tr. Coupled with a projection of a lower government deficit next year, to around 6% of GDP, this means that QE will offset almost all of next year’s government deficit.
Who knew that in the internal JPM thesaurus, “offset” was equivalent to “monetize“… But we’ll take it.
From JPM’s Nikolaos Panigirtzoglou:
Flows & Liquidity: QE’s Stock Effect
The Fed announced this week an extension of operation twist bringing the total amount of net bond purchases expected for next year close to $1tr.
The excess reserves are likely to increase by the same amount, from $1.4tr to $2.4tr, adding 70% extra liquidity into the banking system.
This extra liquidity has the potential to suppress bond yields in addition to the traditional demand effect of QE. This demand effect is well documented and understood. As the Fed buys Treasuries and Agencies it offsets government supply, exerting downward pressure on yields.