Once You Start Deflating A Bubble…
This is a weekend topic on the effects of Fannie Mae, Freddie Mac, the Federal Reserve’s bond ownership and deflation. From the CBO’s report, WARNING PDF. “Outlays increased for several major categories of spending: Outlays rose for the each of the three largest mandatory programs: Medicare,by $18 billion (or 15 percent), primarily because ofa large payment made to prescription drug plans in November 2014 to account for unanticipated spending increases in calendar year 2014; Medicaid, by $16 billion (or 23 percent), largely because some of the provisions of the Affordable Care Act did not take effect until January 2014; and Social Security benefits,by $9 billion (or 4 percent).”
“Much of the increase in spending occurred because payments to the Treasury from the
government-sponsored enterprises Fannie Mae and Freddie Macwere $32 billion less in December 2014 than they were in December 2013, when Freddie Mac made a one time payment of about $24 billion after a revaluation of certain tax assets significantly increased its net worth. (Those payments are recorded in the budget as offsetting receipts—that is, as negative outlays.)”
“Net Outlays for GSEs: Actual, FY 2014 -39 billions.”
The American Enterprise Institute. “The Fed’s $3.5T QE purchases have generated almost half a trillion dollars for the US Treasury since 2009. On its $4+ trillion portfolio of fixed-income securities, the Fed earned an average interest rate of about 3%, which generated the $116 billion of interest income last year for the Fed. To provide context for that amount of interest income, consider that all nearly 7,000 FDIC-insured US banks together earned only $116 billion in net income during the first three quarters of 2014, and will probably end up with about $155 billion in net income for the whole year.”
“After accounting for operating expenses and other costs (currency issue, interest expenses, dividends, etc.), the Fed paid ‘residual earnings’ to the US Treasury last year of $98.7 billion. That annual Fed distribution to the Treasury was the largest ever, and brings the total amount distributed since QE started in 2008 to almost half a trillion dollars — $469 billion in the six years from 2009 to 2014.”
“That was a point made today by the WSJ in its staff editorial ‘The Fed Cash Machine,’ which pointed out that QE has made the Fed’s annual distribution of ‘residual earnings’ a significant revenue source for the US Treasury: ‘For perspective, the entire federal budget deficit for fiscal 2014, which ended in September, was $483 billion. Without the Fed’s windfall, it would have been nearly $100 billion more. Corporate income tax revenue in 2014 was $321 billion, so the Fed turned over nearly 30% of the amount provided by every American corporation.’”
“Treasury is spending the Fed’s windfall, naturally, which means that when the QE boom ends the country will have to spend that much less or find the revenue somewhere else. The danger is that politicians are getting used to the money, which is one more reason for the Fed to begin winding down its balance sheet sooner rather than later.”
“Bottom Line: While the record transfer of almost $100 billion from the Fed to Treasury last year has gotten some media attention, what hasn’t been reported, except by the WSJ today is this: The monetary expansions known as QE1, QE2, and QE3 ended up being a gigantic transfer of wealth from the private sector to the public sector. By ‘acquiring’ almost $3.5 trillion in assets with a ‘magic checkbook’ that were previously held largely by private investors and the private sector, those trillions of dollars in Treasury and MBS securities, along with the billions of dollars in interest income those securities generate, got transferred to the Fed, which has then transferred almost half a trillion dollars in residual interest earnings to the US Treasury in the last six years.”
“Q: Is that fair/accurate to describe QE1, QE2 and QE3 — as monetary policies that ultimately transferred billions of dollars in private wealth to the US Treasury via the Fed? Or is it more accurate to describe it as printing money to finance the government’s budget deficit disguised to look like monetary policy, since the bond holders got paid for their securities? (Thanks to Jeff Dorfman for help with that second description.)’
“Update 1: Or here’s how Jon Murphy describes it in an email: ‘The Fed is just printing money and giving it to the Treasury but ‘laundering’ it through bonds.’ Update 2: Another way to think of the Fed’s $3.5 trillion acquisition of assets through QE1, QE2 and QE3 is to view the Fed as the ‘world’s largest hedge fund’ — see posts by Scott Grannis here and here for details.”
From Money Week. “Merryn Somerset Webb interviews Paul Hodges about the global economy’s ‘Great Unwinding’, and how Britain’s house prices could halve. Merryn: ‘Paul, when we last spoke you predicted a fall in oil price –you said that you thought the oil price would fall from $80 to $50 by the end of last year, and at the end of last year you were saying you thought it would be down at $50 in the first half of this year, so you’ve already been proven very, very right. Can we just talk briefly about what the basis was for that forecast?’”
“Paul Hodges: ‘Yes, it’s what we call the ‘great unwinding’ of policymaker stimulus that if you look at where we’ve been since our last interview here two years ago, central banks have pumped more and more money into the economy. As a result, we’ve had a sugar high, really, where financial markets just go up in a straight line. In China, people got the idea that somehow suddenly China had become middle class, and so there was this enormous demand and there was free money from the Fed and the Bank of England, so everything looked wonderful.’”
“‘It was a complete and utter charade from beginning to end. There has never been, since 2009, a single moment anywhere in the world where there was a supply shortage, a customer didn’t get the oil, the petrol, or anything else that they wanted, but it was all built on wishful thinking from the central banks. They were saying, ‘We can create demand by printing money.’ The problem is, if you look at the markets, the futures market, where the financial players took the money from the central banks and they went into the… They wanted a store of value, because every pension fund in the world knew that Ben Bernanke and Janet Yellen wanted to devalue the dollar. As a result of wanting to devalue the dollar, pension funds looked for a store of value. That, of course, was oil, because everybody uses it, very large market, and it’s priced in dollars.’”
“‘What you saw, instead of financial players and physical players – the oil companies, people like us who buy to use for transport and for heating and so on – instead of a balance of one-to-one, you’ve suddenly got six times as many financial players going into the market. What happens? Of course, the price rises and goes from $30 at the end of 2008 up to $120, because you can’t print oil in the way that you print money.’”
“Once you start deflating a bubble, it doesn’t go slowly, it bursts. This is what you saw happening in July and August. That was why we made the call in the middle of August, we said, ‘The oil price is now going to collapse, and the obvious logical corollary of that is the dollar is going to go very high indeed,’ and we’ve seen that – the oil price down 50%, the dollar up over 10%. The dollar going up 10% may not immediately, if you’re thinking in pounds and so on, become very important, but it’s absolutely critical because you’ve got $6trn or $7trn of debt in the emerging economies all tied to the dollar, all thinking, ‘We borrowed at 1%. Aren’t we clever?’”
“It was 1% then, but now it’s 1% plus 12% increased value of the dollar, so you’re going to see bankruptcies all over the emerging economies – and, of course, you’re going to see bankruptcies all over the States because people have spent $1trn.”
“It’s terrible, this word ‘trillion’. Before 2009 I didn’t know what the word ‘trillion’ was. I used to think billions were rather a lot.”
“Merryn: ‘So, bankruptcies in the US connected to the huge infrastructure spending in the energy sector?’ Paul Hodges: ‘Yes. The US economy is now riding for a fall. We don’t know how big it is, but if you look at jobs growth since 2009, it’s all – and I mean ALL, with capital letters – being tied into the oil and gas exploration bubble, so all the rest has not moved at all. If you look at the housing recovery, such as it’s been – it’s been 600,000 to one million, which sounds good, but when you’re coming down from two million it’s not so good – that 400,000, most of that new house building has been in Texas in the oil belt, because I was in Houston summer last year; 10,000 people a month were coming into Houston, so you’re building a lot of houses.’”
“Merryn: ‘So, the USA economic recovery has been very heavily leveraged to the shale boom, which in turn was caused by very low interest rates in QE.’ Paul Hodges: ‘Yes.’”
“Merryn: ‘So, as that reverses, we can only expect the US economic recovery to just disappear?’ Paul Hodges: ‘My view of it all is the Fed is actually irrelevant here, that the real action is over in China, that the Fed could do maybe a $10trn final blast, but would the new Congress actually allow that to happen? It’s an interesting question. I don’t know the answer, I just raise the question, but if you look at what’s happening in China, you see that the property market taxes… Property taxes paid last year in China fell 30%. That’s a pretty big downturn in one year.’”
“Merryn: ‘Final question: is it possible for a deflationary environment to persist when central banks can print as much money as they like and shovel it into the economy in a variety of different ways?’ Paul Hodges: ‘People have to want to spend, and if you don’t need to buy anything and if you are fairly cautious about knowing exactly how long you might live, then it’s quite difficult, I think, to encourage people to spend. The central banks, the economists, work on this theory, which was fine at the time – Modigliani’s theory – which said that we all know how long we’re going to live and therefore we consciously make a decision to hold back on consumption today so that we have something left for the future.’”
“‘That was fine if we were all dying at 50 because you weren’t holding back very much, you were just getting more money as you got… But if you’re living to 80 or 90, say, how long are we – you and I – going to live? We don’t know, so probably, if we’re sensible, we’re going to err on the side of caution.’”
“Merryn: ‘This is our worry – that they could. They have the ability to do so; anyone can create inflation if they really want to.’ Paul Hodges: ‘Yes, but what I hope is that common sense prevails and that we abandon these out-dated economic theories. Milton Friedman came along and he said that inflation was ‘Always and everywhere’ – and monetary – but he’s wrong, of course; he’s completely wrong. He was working during the baby boom in the States. The States had a 50% increase in the number of babies being born over an 18-year period. Of course there was massive demand, of course there was no supply…Friedman confused cause and effect.’”
“We’ve had six years, let’s face it, six years of central banks believing that Friedman was right and saying, ‘If we put out enough money, then we will end up with inflation. Sorry about that.’ Could we have some common sense on this which says, ‘If you’ve got an older population, you’re not going to want to spend,’ and could we please, instead of being negative about all these older people, could we not celebrate this and say, ‘Isn’t it wonderful that our society has achieved this?’ Does it really matter if we have GDP? Let’s face it, before 1929, which isn’t very long ago, nobody measured GDP, so for thousands of years people were pretty happy and getting by without thinking about…’”
