QE2: Captblogain, your ship is sinking

By Warren Mosler

So imagine the corn crop report comes out and it surprises on the upside at up 30%.

  • What happens? The price of corn probably starts to fall. Commercial buyers back off, farmers rush to hedge, and, overall, players of all ilks try to reduce positions, get short, etc.
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A few weeks later it’s further confirmed that the farmers are producing a massive bumper crop.

  • What happens? The same adjustments continue.
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But what if that crop report was wrong? What if, in actual fact, there had been a crop failure? And market participants never do get that information?

  • What happens? Prices go down for a while as described above, but at some point they reverse, as sellers dry up, and as consumption overtakes actual supply price work their way higher, and then accelerate higher, even if no one ever actually figures out there was a crop failure.

QE is, in fact, a ‘crop failure’ for the dollar. The Fed’s shifting of securities out of the economy and replacing them with clearing balances removes interest income. And the lower rates from Fed policy also reduces interest paid to the economy by the US Treasury, which is a net payer of interest.

But the global markets mistakenly believed QE was producing a bumper crop for the dollar. They all believed, and some to the of panic, that the Fed was ‘printing money’ and flooding the world with dollars.

  • So what happened? They tripped over themselves to rid them selves of dollars in every possible manner. Buying gold, silver, and the other commodities, buying stocks, selling dollars for most every other currency, selling treasury securities, etc. etc. etc. in what was, in most ways, all the same trade.

    This went on for months, continually reinforced by the pervasive rhetoric that QE was ‘money printing’, and that the Fed was playing with fire and risking hyperinflation, with the US on the verge of suddenly/instantly becoming the next Greece and getting its funding cut off.

    Not to mention Congress with it’s deficit reduction phobia.

  • So what’s happening now? While everyone still believes QE is a bumper crop phenomena, QE (and 0 rate policy in general) is none the less an ongoing crop failure, continuously removing $US net financial assets from the economy.

    And so now that the speculators and portfolio shifters have run up prices of all they tripped over each other to buy, the anticipated growth in spending power-underlying aggregate demand growth needed to support those prices- isn’t there. And, to throw more water on the fire, the higher prices triggered supply side response that have increased net supply along with a bit of ‘demand destruction’ as well.

Last week I suggested that higher crude prices were the last thing holding down the dollar, and that as crude started to fall I suggested it was all starting to reverse.

It’s now looking like it’s underway in earnest.

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3 Comments
  1. James Dollinger says

    Really interesting take on QE2. I’m inclined to agree, but isn’t the trade off for the dollar going to be interest lost vs amount of new loans made due to having additional reserve balances? Or am I misunderstanding the argument.

  2. James Dollinger says

    Really interesting take on QE2. I’m inclined to agree, but isn’t the trade off for the dollar going to be interest lost vs amount of new loans made due to having additional reserve balances? Or am I misunderstanding the argument.

  3. Edward Harrison says

    @twitter-72658346:disqus this is what Warren Mosler e-mailed me about QE: ”
    the causation runs from loans to deposits and reserves. reserves aren’t ‘used’ to make loans, they are a residual. lending doesn’t ‘use up’ reserves- only the fed can alter net reserve balances. hope that helps.

  4. Edward Harrison says

    @twitter-72658346:disqus this is what Warren Mosler e-mailed me about QE: ”
    the causation runs from loans to deposits and reserves. reserves aren’t ‘used’ to make loans, they are a residual. lending doesn’t ‘use up’ reserves- only the fed can alter net reserve balances. hope that helps.

  5. Anonymous says

    I agree the mass-movement part, but I cannot help myself here:

    “So imagine the corn crop report comes out and it surprises on the upside at up 30%. What happens?”

    Answer: you start lobbying it to e.g. German people as new fuel. Nevermind it stresses the engine more, you need it more to travel same distance compared to oil-based fuel. Nevermind it may cause your car burn and torch you into flames, because the fuel injection tubes get corroded and may leak the liquid all over the engine. Nevermind it costs more, because gas stations need to reorganize the tanks.

    For some reason we can expect free market in action here, again. The customers don’t like it and are ready to pay for the previous labels. Gas stations are trying to cope, but then the government strikes back and tells the free market enterpreneurs to put the ethanol back into the tanks and sell it, by force if nothing else helps. If they do not oblige they will be fined and perhaps been driven out of business.

  6. Anonymous says

    I agree the mass-movement part, but I cannot help myself here:

    “So imagine the corn crop report comes out and it surprises on the upside at up 30%. What happens?”

    Answer: you start lobbying it to e.g. German people as new fuel. Nevermind it stresses the engine more, you need it more to travel same distance compared to oil-based fuel. Nevermind it may cause your car burn and torch you into flames, because the fuel injection tubes get corroded and may leak the liquid all over the engine. Nevermind it costs more, because gas stations need to reorganize the tanks.

    For some reason we can expect free market in action here, again. The customers don’t like it and are ready to pay for the previous labels. Gas stations are trying to cope, but then the government strikes back and tells the free market enterpreneurs to put the ethanol back into the tanks and sell it, by force if nothing else helps. If they do not oblige they will be fined and perhaps been driven out of business.

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