Remember our old “Cash for Clunkers” QE II model? I said that everyone who wanted to sell bonds at all for the next few months would do so before QE II ended. This would result in a natural vacuum of sellers after QE II ended.
I also said there would be the “Godzilla of all bond rallies” post QE II. This is a chart of 30 year yields. Yields are opposite of price. Lower yields mean higher prices.
See that huge red bar at the end? That means a huge rally in bond prices.
Lots of people think the world is ending right now. It looks bad out there, but there should be some appreciation of the fact that the most willing sellers of U.S. Treasuries sold them during the actual time of QE II.
The actual GDP numbers – while anemic – aren’t falling at anywhere near late 2008 levels.
Question: How much of this panic is due to a completely wrong interpration of what’s happening in the oil markets?
People say that lower oil prices means that the economy is tanking, but it’s more likely that the speculative bid under oil just shifted out of oil.
Lower oil prices are great for the real economy, not bad.
Just an FYI – we’re getting terrifying action in the interest rate markets.
In other cases, gains like this have meant there is a huge, worrisome problem in the world. Right now, Europe is on the verge of blowing out, but will this mean a run in the european shadow banking system? I don’t know.
The european leadership has been able to calm things down over and over again, but it’s pretty clear by now that the only solution is for the European Central bank to buy huge quantities of sovereign bonds.
Of course, this is political nitroglycerin. Macro Man will probably have some good insights if he will share them Also, we shouldn’t discount his idea that currency interventions seem to solve the problem.
*This is a massive simplification, but good enough for non-pro’s, of course.
Scott Sumner isn’t a bad guy. He’s a good guy. He’s smart. He’s creative. He’s forceful. His ideas about NGDP aren’t all wrong.
But someone needs to tell him that monetary policy sucks even during the good times. It sucks because it uses real estate as the primary vehicle for economic stimulation, which causes all sorts of bad outcomes for our economy.
And someone needs to tell him that right now, monetary policy is particularly bad. While it sucks even in the good times, right now monetary policy is nearly impotent.
The U.S. real estate market is in the middle what will be a legendary bust. Real estate prices are going down more than in the great depression. Nobody wants to borrow money to buy real estate.
But that’s the channel that monetary policy uses. That’s the part of the economy that monetary policy stimulates.
What monetary policy does is stimulate the economy by inducing people to borrow or not borrow money for real estate deals. That’s why it works well at all.
So how cheap would money need to be to induce people to buy real estate that’s going down 5% per year?
We can talk about monetary vs. fiscal policy all we want, but until at least one person who is advocating monetary policy identifies the exact group of people who are going to start borrowing enough money to stimulate the economy, why should we bother to respond?
Corporations don’t need to borrow – they are sitting on a record horde of cash (they have more today). So the only channel left for monetary policy to work is through real estate.
Tell me, advocates of monetary policy, how is this supposed to work?
And why would you want it to work? There is a good chance real estate will drop another 20% or more in price. Do you want to saddle more people with houses they cannot sell, and mortgages that are too big?
Great news! TC is now on the first page of Google results for “shadow government statistics”! for the post Why Shadow Government Statistics is very, very, very Wrong. One of the major ways people reach this blog is through a variety of searches for “shadow stats”, “shadow statistics” and such. It is great to see this on the first page of results.
We do not have hyperinflation. People that say we do have Hyperinflation are either deluded, or not being truthful with you. Hyperinflation in the U.S. on May 9th, 2011, is a cruel hoax. Inflation is about 2-3% at this time.
Remember that post about the futility of using monetary policy to impact the price of oil? It turns out that the elasticity of oil is even lower than I thought! The IMF – ok, no jokes – came out with a report showing the short term price elasticity is nearly irrelevant, while the long term price elasticity is freakishly tiny. The Blog world is a-titter about this.
The IMF says that a 10% increase in the price of oil results in 0.007% less demand in the short term.
The U.S. uses about 15 million barrels a day. A 10% increase in the price of oil results in – wait for it – a decrease of 1050 barrels of oil per day. Increasing the price of oil from $90 to $99 results in 1000 less barrels of oil demanded. That is 1 futures contract at the CME/NYMEX. A 1 lot. To put this in perspective, 319,000 contracts traded yesterday.
What level of interest rates – in the standard model- could be high enough to push down oil prices 20% or so, back to$90 a barrel? The demand for oil will not change in the slightest even if rates were increased to 5% tomorrow. People won’t say “Oh, this quarter point increase in the Fed Funds rate makes me want to use less gasoline – or at least pay a lower price for it.” A 10% increase in the actual price impacts demand by an amount so small it is a rounding error. Tiny movements in interest rates will have zero observable impact on the price we are willing to pay for gasoline.
A self-inflicted cure of higher rates in response to high oil prices would be far worse than the disease. We know what it takes to get the price of oil down to $40 a barrel. It takes a global depression. It takes losing 500,000+ jobs a month in the U.S.
This is another reason to fight the Hyperinflation Hoax.
[Update: I made a mistake in oil demand. The actual numbers are a 10% increase in the price of oil causes a drop of .2% in demand after 20 years.
This translates to a decrease of demand of about 30,000 barrels a day. It does take 20 years for this to happen. So if we assume a linear drop, then it's a drop of about 125 barrels/day a month, every month for 20 years. This is still very small. I wonder how this number is significantly different than zero - it seems impossible that such a small effect would have an error term that's even smaller, considering the data used. ]
The post, “ShadowStats: Still Very, Very, Very Wrong” has been receiving consistent hits from the search “Shadowstats”. A quick investigation shows- We’ve made the front page of searches for “Shadowstats”!
That means some random people are clicking to find out that our inflation rate is only 2-3%, and are getting disabused of the 10% hyperinflation hoax.
Bonus: They get an exposure to Functional Finance and MMT.
We could probably get higher in the rankings – hint, hint, hint… :)
Shadow Government Statistics just does not match reality.
[Update: It turns out that a search for "shadowstats 10% inflation", Traders Crucible is 2 and 3 in Googles search. This "10% Inflation!" was a big story a few days ago, and gets repeated endlessly on places like zerohedge and other bond vigilante wanna-be places. Fighting the good fight here at TC.]
Shadow Stats is frackin’ wrong. No doubt about it. Shadow stats is wrong, even if Zero Hedge thinks they might be right. And yet gullible John Malloy sees fit to report this crappy data on CNBC.
1 +U.S. Treasury Rates = (1 + inflation) * ( 1 + real rates)
We know what the Treasury Rate is with a high degree of certainty for points on the Yield Curve for the next 5 years, because they are traded in a highly liquid market. The real rate is what investors really make after you take into account inflation.
So rearrange this equation to find out how much investors are really making by investing in U.S. Debt:
(1 + U.S. Treasury rates )/ (1 + Inflation) = ( 1+ real rates)
If we use 10% inflation and plug in the latest 6 month T-Bill Rate, we can see how much investors are making.
The 6 month T-Bill rate is 0.11% Shadow Stats says we have 10% inflation. So using grade school math, investors in 6 month T-Bills are losing 8.99% per year due to inflation!
Wow – those investors are really stupid or really worried! Or maybe, just maybe, John Williams is wrong. Which one could it possibly be? Who can know?
Can you believe that this BS gets reported in the major media, by a guy who works for CNBC and used to work for Bloomberg? He must be a smart guy – every Bloomberg guy I’ve ever talked too has been whipsmart, and to go on CNBC is another huge step. So how can he not know this?
[Update: Here it is on the Front page of CNBC. We're getting less informed by this "news."]
[Update 2: Google "Shadowstats is wrong", and TC comes up #3. Slowly, we're getting traction.]
[Update 3 4/19/2011 Getting even more traction debunking Shadow Government Statistics. We've made the front page on the simple search term Shadowstats. For a complete roundup on why Shadowstats is wrong, and who is silly enough to promote this nonsense, see here, here, and here. ]
Matt Yglesias is tackling the “Big Idea“. Once you realize that U.S. insolvency isn’t possible, a bunch of assumptions about the behavior of governments and the private sector need to go away too.
One of the biggest implications: The meaning of the yield curve is vastly simplified. Since default is impossible, default risk is zero. The yield curve is more transparent in meaning.
Over to Warren:
“Let me add that the govt. has full and direct control over the term structure of govt rates, but has elected not to act in that regard, instead only setting the fed funds rate, which means the rest of the term structure is determined by anticipated future fed funds settings (plus or minus a few technicals of supply and demand of the institutional structure)
So, for example, if ‘the market’ thinks QE causes inflation, it can’t change the fed funds rate, but it can change longer term rates as market participants make the (incorrect) assumption that the coming inflation will cause the Fed to hike rates.”
Matt Yglesias channels Warren Mosler:
One thing I’d say about the potential implications of a government shutdown on the bond market is that I think it’s probably a mistake to see Treasury interest rates as primarily driven by default risk. If the government of El Salvador or Illinois borrows dollars, it might in the future run out of dollars and not repay its loan. But there’s no reason the government of the United States should ever run out of dollars. It makes the dollars.
An increase in Treasury borrowing costs could be driven by hope or by fear. In the “hope” scenario, if investors increase their view of the growth outlook they’ll become more willing to invest funds in things other than bonds and thus bond interest rates will have to go up. There’s also a fear scenario, which would probably be about the value of the dollar. If you lend the US government some dollars, you’re definitely going to get back the number of dollars that the US government promised you. But right now a dollar buys you about 0.70 euros and maybe five years from now it’ll only buy you 0.65 euros, in which case lending euros to the Dutch government might look like a better bet than lending dollars to the USA. That would drive interest rates up, but it still wouldn’t be default risk.
We can directly observe the cause of the “fear” – it is called inflation. In a free floating currency regime, we cannot control the value of the currency relative to other currencies. However, that isn’t the mandate of the Fed, or the worry of most citizens. The Fed’s mandate is price stability, and people fear inflation. We have tools and policies that can impact inflation.
Determining the exact rate of inflation is very hard. But we have good ballpark estimates, and every reasonable observer agrees that inflation is under 4% in the U.S.
Still, it is far more difficult to determine the willingness of the bond market to fund perpetual deficits. It turns out we don’t have to determine this willingness. Note this should help to reduce business community uncertainty – the first step to confronting a fear is to identify it.
I wrote a post on the head and shoulderish formations in the long bonds and 10 year. This was now noticed by dshort and Chris Kimble. The bonds are very close to breaking out higher during risky times – this could be a huge “risk off” trade.
But given this potential rally in U.S. Treasuries, what is going on in the Euro today? It is strong even in the world wide “Japan will repatriate money” trade-o-the-day. How does this match with U.S. bonds completing this potential head and shoulders?
Curiouser and Curiouser…
One of the core premises of MMT is that the funds to purchase government debt is created through the deficit spending of the debt. In other words, the there is 1:1 relationship (or very close to 1:1) between the amount of debt issued and the money available to purchase that debt.
The MMT premise is that the base money supply is defined by the amount of deficit spending, and not by deposits in banks. Of course, the amount of deficit spending usually matches up quite well with the amount of debt issued.
So when Bill Gross decides to ask “who is going to buy all of this debt that the U.S. Treasury will issue?”, he is missing something so huge about government deficits, bonds, and savings that it boggles the mind. The money will be there – it must be there – by the accounting identity we know and love: Public Deficit = Private Savings + Currency Account Surplus
He certainly knows about the Widow Maker trade – Japan’s experience with Quantitative Easing. Why would he think the experience of the U.S. will be any different?
Japan did QE back in the early 2000′s – and look at their bond yields and inflation rates over the last decade. The “Widow Maker” trade – where the BV’s have been calling for massive increases in Japanese government bond yields for as long as I’ve been following the markets – has been making Widows for going on 20 years now. Bill Gross knows this very, very well…why is he wading into the same situation in the U.S and not looking at the historical record of Japan?
From a conventional standpoint, Bond Vigilantes are theoretically correct – so why have they been wrong for 20 years in the case of Japan? Why didn’t QE I cause vast amounts of inflation? QE I has already been in effect for over 2 years! $1.75 Trillion by March 2009. It’s March 2011, folks. 24 months. And again, $1,750,000,000,000. Where is the 10% core inflation rate?
Let’s look at the Japan experience with government debt in view of the MMT statement – really Mosler’s statement – about the funds available to purchase government debt being created by the deficit spending. Read this Pimco (!) interview about Japans experience with QE – it’s like a Onion article on Quantitative easing.
In March 2001, the Bank of Japan (BoJ) began an historic new monetary policy known as “quantitative easing” in an effort to revive Japan’s economy and end the deflationary decline in consumer prices. Five years later, on March 9, the BoJ ended the quantitative easing policy, satisfied that the Japanese economy was on the path to stable, reflationary growth.
Q: Why did the BoJ decide at the March 8-9 meeting to end the quantitative easing policy?Masanao: Quantitative easing worked; the Japanese economy is recovering and core consumer prices are rising. Before the BoJ’s March meeting, the year-on-year change in Japan’s core CPI had been positive for three consecutive months, and the core CPI has now increased for four consecutive months. Most importantly, BoJ policymakers expect a sustained recovery and continued increases in core consumer prices, fulfilling the conditions laid out in the commitment to maintain quantitative easing.
In 2011, these quotes read like an alternative history of Japan that never happened. Japan didn’t have significant inflation at any point in the 00′s. We know that even in 2006 Inflation in Japan was very low. We know that even 5 years after QE was tried by Japan, they had deflation for months on end.
Where can you store an Ocean?
One distinguishing factor with very, very popular currencies like the Euro, Yen, and USD is that there is so much of it floating around. We know this from the amount of trade and economic activity, from the number of assets and investments in those currencies, and from the amount of trading that happens in these currencies. You could say there are oceans of these currencies out there.
So where can you put an ocean? Where can you store this much of something? You don’t have many choices. You need a place big enough to store ocean sized volumes. For the U.S. Dollar, there needs to be an asset class that can absorb $14,000,000,000,000 notional value of U.S. Dollars. I have a suggestion – the U.S. Government Debt market is a good fit.