I am going to make a confession here: I don’t believe in the mainstream monetary theory. What do I mean by “mainstream monetary theory”? I refer to the thesis that we should not see inflation, because the velocity of money circulation is low, even though the money supply continues to increase exponentially. If you want to believe in this theory, you have to believe in the idea of neutrality of money. the announcement of the Fed’s $300BN purchase of Treasuries implies that Treasuries owners (who in reality are owners of a claim against a technically insolvent debtor) are being paid out at the expense of those who do not own Treasuries, including anyone living outside the U.S., but holding US dollars.
Perhaps an even more subtle but very relevant way to show the non-neutrality of money is to observe the latest trend in the credit markets. I am referring to debt restructurings we’re seeing…
Good morning,
Let’s go to the point: What did the Fed buy yesterday? $1.5BN (9.6% of $15.6BN offered) in TIPS (Treasury’s Inflation Protected Securities) in an outright purchase, and (net) $21.75BN in Agency mortgage-backed securities. Oh, but format matters too, because the Fed avoided the 5 or 10-year points in TIPS. This inevitably caused some dissapointment. After this first purchase, we started to see some action in the market, with the S&P500 starting to catch a bid and finishing +1.55%, at 865 (See chart below). All this happened with the VIX dropping to Sep-08 (pre-Lehman) levels: 36 (-1%).
Data on the U.S. economy continued to be deflationary, but of little relevance to the market: Housing starts down to 510,000 and the Philadelphia Fed’s Business Activity Index at -24.4. Along the same line, there were a few defaults yesterday. General Growth Properties was one of them, and surprised investors as regional shopping centers and other subsidiaries also filed for protection. Abitibi-Consolidated and Noble International filed for Chapter 11 too. RH Donnelley, Six Flags, Georgia Gulf, and
Energy Partners missed payments. On the positive side, JPM was able to place $3BN of 10-year non-US govt. backed debt (350bps over Tsy). In summary, as I have been saying since March 19th, as long as the Fed and all the other central banks keep pouring liquidity and feed us with daily announcements, we can see stock prices NOT falling. Economic data does not AND SHOULD not matter….Should we be worried then? Absolutely! Why? Over the next weeks, the Fed purchases of Treasuries will slow down. There are only four rounds of buying scheduled.
On another note, I am going to make a confession here: I don’t believe in the mainstream monetary theory. And if you liked the waterfall graph I included on the April 14th letter you should side with me and not believe in that theory either…
What do I mean by “mainstream monetary theory”? I refer to the thesis that we should not see inflation, because the velocity of money circulation is low, even though the money supply continues to increase exponentially. If you want to believe in this theory, you have to believe in the idea of neutrality of money. You have to believe that there exists something called the “general level of prices” and that such level rises or falls proportionately with the increase or decrease in the quantity of money in circulation. But again, if you agree with the flow of funds in the inflationary waterfall graph, you will realize that as liquidity is injected into a market first, the price of the goods exchanged in that favoured market will necessarily increase vs. those goods exchanged outside the favoured market. There is really no point in trying to “average” such changes in relative prices, to come up with a “price level”. And if there was a point to be made, it would be to prove that there is a massive transfer of wealth forced by the monetary authority (the Fed) from the owners of the not-favoured goods to those of favoured goods. Such transfer is a taxation that was not discussed by Congressmen or Members of a Parliament, let alone voted by taxpayers.
But, what am I talking about? Well, so far only the announcement of the Fed’s $300BN purchase of Treasuries implies that Treasuries owners (who in reality are owners of a claim against a technically insolvent debtor) are being paid out at the expense of those who do not own Treasuries, including anyone living outside the U.S., but holding US dollars.
Perhaps an even more subtle but very relevant way to show the non-neutrality of money is to observe the latest trend in the credit markets. I am referring to debt restructurings we’re seeing, where borrowers that are “too big to fail” in the eyes of their banks, obtain favourable amendments to their credit agreements, that later enables them to access the public debt markets and refinance their liabilities. Is this not a transfer of wealth from the bank shareholders or loan investors to the holders of public debt? Yes, but at the end of the line, the taxpayer pays for it as well, because banks can afford to bear such transfers thanks to the central banks that protect them…with taxpayer money. In the eyes of the trader, these movements look technical. In the eyes of the economist (on the other hand), these movements are a piece of a more fundamental ongoing process.
