Virtual money consisting of Paulson, Bair, and Bernanke quarks
Source:
"It's confirmed: Matter is merely vacuum fluctuations"
Stephen Battersby
The New Scientist, 20 November 2008
http://www.newscientist.com/article/dn16095-its-confirmed-matter-is-merely-vacuum-fluctuations.html
an effective policy of aggressive quantitative easing as the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity rather than issuance of public debt. ...
Effectively the Fed Funds rate has been abandoned as a tool of monetary policy
... the Fed is now relying on massive quantitative easing and direct purchases
of private sector short term and long term debts to try to aggressively push
down short term and long term market rates.
Although these moves have reduced ABS and MBS spreads, Roubini believes as others do that there are negative longer-term implications:
... These policies – however partially necessary – will eventually leads to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.
When will this "eventually" occur? In an article titled Ricardian Equivalence, Macro Man commented on the markets' immediate reaction to put the dollar under pressure. To summarize his arguments:
The past few decades, but particularly the past few years, have seem enormous rise in private sector leverage....both through traditional lending and derivatives contracts.
At the end of 2007, Citigroup had more than $2 trillion of assets on their
balance sheet. That number will be a lot lower by the time all is said and done. ...
So in Macro Man's view, any dollars "created" by the Fed to expand its balance sheet (and let's not forget, they have yet to really crack out the printing presses by not sterilizing their asset purchases) will merely partially offset dollars lost through de-leveraging and the implosion of the shadow banking system ...
The impact of these programs will, in Macro Man's view, only submarine the dollar once the crisis is resolved and domestic demand begins growing organically again. That seems likely to be several years away, for there is another kind of Ricardian equivalence at work- the ballooning of the US budget deficit should be offset by a sustained rise in the US private sector savings rate.
This is an important point for investment strategies. If the resolution of the crisis is several years away, perhaps we can expect a relatively stable dollar for some time.
And if the dollar remains stable, and the Fed's actions are offset by private sector deleveraging, perhaps we can expect a deflationary environment to continue for some time.
Sources:
"Ricardian Equivalence"
Macro Man, Nov 26, 2008
http://macro-man.blogspot.com/2008/11/ricardian-equivalence.html
"Desperate Measures by Desperate Policy Makers in Desperate Times: the Fed Moves to Radically Unorthodox Policies as Economy Is in Free Fall and Stag-Deflation Deepens"
Nouriel Roubini's Global EconoMonitor, Nov 26, 2008
http://www.rgemonitor.com/roubini-monitor/254591/desperate_measures_by_desperate_policy_makers_in_desperate_times_the_fed_moves_to_radically_unorthodox_policies_as_economy_is_in_free_fall_and_stag-deflation_deepens
Press Release on MBS
Board of Governors of the Federal Reserve System, Nov 25, 2008
http://www.federalreserve.gov/newsevents/press/monetary/20081125b.htm
Press Release on ABS
Board of Governors of the Federal Reserve System, Nov 25, 2008
http://www.federalreserve.gov/newsevents/press/monetary/20081125a.htm
There is a good article at Naked Capitalism on interest rates and the dollar. Two of the anomalies noted there:
1. Long dated Treasuries rising (a deflation signal) as stocks stage a dramatic rally
2. Dollar weakening while long dated Treasuries rise (the dollar and bonds usually go together)
The first item is actually consistent with many periods of market history when rates fall and stock prices rise. We have, after all, just been through a long period of falling rates and rising stock prices beginning in the early 1980s and continuing until either the dot-com crash of 2000, or perhaps until the present crisis. When long-term rates fall, the present value of corporate earnings streams rises.
The second item occurs in the context of a great variety of contending and fluctuating forces, making currency and Treasury directions very, very hard to call. But this is not inconsistent with some periods of history. If there is some expectation of a collapse under all this debt, there should well be ambivalence about Treasury debt and the dollar.
Others have already commented that long rates will continue to stay low until added money is not consumed in the deleveraging, perhaps not until there is a real economic expansion, which could be a long time off. Or perhaps continued stimulation will make it occur sooner.
Reference: http://www.nakedcapitalism.com/2008/11/some-anomalies.html
At this rate of contraction as revealed by the latest data it would not be surprising if fourth quarter GDP were to fall at an annualized rate of
5-6%.
... the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity rather than issuance of public debt.
Desperate times and desperate economic news require desperate policy actions ... The Treasury will be issuing in the next two years about $2 trillion of additional debt ...
The amounts of money involved are staggering, so is it no surprise that Roubini concludes (emphasis mine):
These policies – however partially necessary – will eventually lead to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.
When and how severely will these injections of liquidity and swelling debt result in higher real interest rates and weaken the US dollar? Roubini is not alone in thinking that we are about at that point, a good example being these snippets from a recent article in the Financial Times:
The banks have been recapitalised. The government has started buying and guaranteeing distressed debt. Finally, the Federal Reserve has begun in earnest to use its balance sheet (in a sterilised manner) to step into the absent shoes of the private sector in the financial system.
A failure of the initial set of policies to reflate the economy is likely to lead to the next, more risky, set of policy choices – those involving unsterilised intervention.
As the US embarks on the next set of policy choices for curing deflation, as outlined by Ben Bernanke, Fed chairman, in his 2002 speech “Deflation – Making Sure it Doesn’t Happen here” – inflationary risks will begin to rise. With that comes the risk of sustained medium term dollar weakness and the risk ultimately of the demise of the dollar as the world’s sole reserve currency.
The Federal Reserve Board on Tuesday announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), a facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).
Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS. The U.S. Treasury Department--under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008--will provide $20 billion of credit protection to the FRBNY in connection with the TALF.More details accompany the announcement, but the impact is clear: The TALF will sustain the consumer credit bubble and blow a bigger bubble, which will pop later and cause even greater pain. The consumer debt load is already too high for many, and there is already too much bad paper in the ABS market. How does the TALF help solve the problem?
Rather then look for a market bottom, look for how the crisis will morph next.
We are witnessing a redefinition of long term market landscape.