19 December 2008

Beware - "Quantitative Easing" is Hallucinogenic

The Bernanke Fed can’t wait to experiment with QE, by printing unlimited amounts of US-dollars out of thin air, and monetizing the US Treasury’s debt. On Dec 16th, the Fed shocked the market by adopting a target for the fed funds rate, within a range of zero to 0.25%, an all-time low, and said it would employ “all available tools” to dispel a year-long recession. “The Fed is sending a message that it will print money to an unlimited extent until it starts to see the economy expanding,” remarked William Poole, former president of the St. Louis Fed.

However, “Quantitative Easing” is a very dangerous hallucinogenic drug, and quoting Santayana again, “Those who do not learn from history are doomed to repeat it.” Fed chief Ben “Bubbles” Bernanke, who strongly endorsed “Easy” Al Greenspan’s ultra-low interest rate policy earlier this decade, which was designed to inflate the commodity, housing, and sub-prime debt bubbles, is now fueling a massive Treasury market bubble, and legions of speculators are taking collective leave of their senses and succumbing to delusions of zero-percent 10-year yields.

If left unchecked, “Bubble-mania” engenders a massive, largely uncorrected rise in valuations that discounts not just the present and near-future, but also a distorted view of the far-horizon. The Fed’s bold shift to QE seems designed to head-off the possibility of a deflationary depression. However, “if inflation targeting creates the presumption that the central bank can look at consumer price inflation alone, then it might have the unintended effect of creating a bubble,” warned BoJ chief Shirakawa.

Japanese bond traders still carry the scars from the bursting of the JGB bubble in 2003, and so, far haven’t gotten caught-up in “irrational exuberance” of the US Treasury bond market. “Wisdom comes by disillusionment,” said Santayana. JGB traders are anxiously waiting to see how the BoJ’s reacts to the Fed’s dangerous experiment with QE, and whether it will boost its purchases of long-term JGB’s from the current 1.2-trillion yen ($13.2-billion) per month.

The BoJ has put a floor under the 10-year JGB yield at 1.25% for the past five-years, but BoJ chief Shirakawa is under heavy pressure from Tokyo warlords, to resume full-scale QE.“We acknowledge the Bank of Japan’s independence. But as stipulated under law, the BoJ and the government keep in close contact with each other in guiding economic policy,” said Finance chief Shoichi Nakagawa on Dec 16th. “I hope the BoJ reaches an appropriate conclusion, bearing in mind Japan’s economic and liquidity conditions,” he warned.

The yield on the US Treasury’s 2-year note has collapsed to 20-basis points above Japanese yields, the smallest gap since 1992, which in turn, has crushed the US$ versus the Japanese yen, to a 13-year low of 88-yen. Japan is heavily dependent on exports, particularly to the US and Europe, and a major factor sinking Japan’s Nikkei-225 index is the strength of the yen against all major currencies including the Euro and US-dollar. Falling exports have already led to a contraction in the Japanese economy in the second a third quarter, and the worst is yet to come.

On Dec 16th, BoJ chief Shirakawa said he is “examining quantitative easing,” and is increasingly concerned about a deepening recession. “In addition to falling exports due to a slowdown in overseas economies, corporate profits, household finances and job conditions are worsening, and it is taking a toll on domestic private demand. Output, employment and consumption data were all severe,” Shirakawa told parliament, sending JGB futures higher.

As the Fed floods the global money markets with another big tidal wave of US-dollars in the months ahead, the BoJ might return to QE, to cushion the slide of the dollar. The BoJ might buy commercial paper, increase its monthly purchases of Japanese government bonds, or expand the types of collateral it accepts when making loans, the Nikkei business newspaper reported on Dec 15th.

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