So it was buy the rumor, buy the news, then watch it all fall apart a few days later.

QE was a major international event, with the word being that the ‘money printing’ would not only take down the dollar, but also spread ‘liquidity’ to the rest of the world through the US banking system, via some kind of ‘carry trades’ and who knows what else, or needed to know. It was just obvious…

So the entire world was front running QE in every currency, commodity, and equity market.

And the Fed announcement only brought in more international players, with money printing headlines screaming globally.

Then the ‘risk off’ unwinding phase started, reversing what had been driven by maybe three themes:

1. There were those who knew all along QE probably did not do anything of consequence, but went along for the ‘risk on’ ride believing others believed QE worked and would drive prices accordingly.

2. A group that thought originally QE might do something and piled in, but began having second thoughts about how effective QE might actually be after learning more about it, and decided to get out.

3. A third group who continue to believe QE does work, who got cold feed when they started doubting whether the Fed would actually follow through with enough QE, also for two reasons.
   a. the FOMC itself made it clear opinion was highly polarized, often for contradictory reasons
   b. the economy showed signs of modest growth that cast doubts on whether the Fed might
   think something as ‘powerful and risky’ as QE was still needed.

Reminds me some of the old quip- the food was terrible and the portions were small-
(QE is questionable policy and they aren’t going to do enough of it.)

So risk off continues in what have become fundamentally illiquid markets until some time after the speculative longs have been sold and the shorts covered.

Next question, what about after the smoke clears?

A. The dollar could remain strong even after the initial short covering ends- the modest GDP growth is slowly tightening fiscal, and crude oil prices are falling, both of which make dollars ‘harder to get’

It’s starting a kind of virtuous cycle where the stronger dollar moves crude lower which strengthens the dollar.
Also, the J curve works in reverse with other imports as well. As imports get cheaper, initially
the rest of world gets fewer dollars from exports to the US, until/unless volumes pick up.

The euro zone is again struggling with the idea of the ECB supporting the weaker members with secondary market bond purchases, as ECB imposed austerity measures are showing signs of decreasing revenues of the more troubled members. Seems taxpayers of the core members are resisting allowing the ECB to support the weaker members, and the core leaders are groping for something that works politically and financially. All this adds risk to holding euro financial assets, as even a small threat of a breakup jeopardizes the very existence of the euro.

Japan is on the way to fiscal easing while the US, UK, and euro zone are attempting to tighten fiscal.

Falling commodity prices hurt the commodity currencies.

B. Interest rates are moving higher as spec longs who bought the QE rumor and news are getting out.
But it looks to me like term rates could again move back down after this sell off has run its course.
The Fed still failing on both mandates- real growth is still modest at best, and the 0 rate policy is deflationary/contractionary enough for even a 9% budget deficit not to do much more than support gdp at muddling through levels, with a far too high output gap/unemployment rate.
And falling commodities, weak stocks, and a strong dollar give the Fed that much more reason not to hike.

C. A mixed bag for stocks.
Equity values have fallen after running up on the QE rumor/news, further supported by the dollar weakness that came with the QE rumor news, with the equity sell off now exacerbated by the dollar rally which hurts earnings translations and export prospects.

But a 9% federal deficit is still chugging away, adding to incomes and savings of financial assets, and providing for modest top line growth and ok earnings via cost cutting as well.

Fiscal risks include letting the tax cuts expire and proactive spending cuts by the new Congress which seems committed to austerity type measures.

Low interest rates help valuations but reduce the economy’s interest income.

China acting more like the inflation problem is serious. Hearing talk of price controls, as they struggle to sustain employment and keep a lid on prices, in a nation where inflation or unemployment have meant regime change. Looks to me like a slowdown can’t be avoided with the western educated kids now mostly in charge.

>   (email exchange)
>   On Wed, Nov 17, 2010 at 1:05 AM, Paul wrote:
>   Very interesting — but I have a question:
>   What if the deficit causes “saving” increase in financial assets held by
>   foreigners (via the trade imbalance) rather than US domestic households?

Hi Paul!

That would mean we would get the additional benefit of enjoying a larger trade deficit, which means for a given size govt taxes can be that much lower.

Or, if we get sufficient domestic private sector deficit spending, govt deficit spending can remain the same and we benefit by the enhanced real terms of trade supported by the increased foreign savings desires.

Except of course policy makers don’t get it and squander the benefit of a larger trade deficit/better real terms of trade with a too low federal deficit (taxes too high for the given level of govt) that sadly results in domestic unemployment- currently a real cost beyond imagination.

Fundamentally, exports are real costs and imports real benefits, and net imports are a function of foreign savings desires.

So the higher the foreign savings desires the better the real terms of trade.

Also, with floating exchange rates, the way I see it, it’s always ‘in balance’ as the trade deficit = foreign savings desires.


18 Responses

  1. GM IPO will be interesting to watch as the government tomorrow is going to pull some 23 billion dollars currently in the economy and replace it with some GM stock. Isn’t that deflationary?

    Also wondering how they plan to get the stock from $33 to near $50 in order to break even while they withdraw a total of some $50 billion?

    What about the threat of U.S. banks collapsing in a 2nd financial crisis?

    Fed orders new “stress tests” for banks
    The nation’s largest banks must undergo new stress tests to show they can weather another recession, and the Federal Reserve said those that pass them can boost dividends paid to investors….

    All of the 19 largest banks overseen by the Fed must file the plans — even if they don’t intend to increase their dividend payments. The plans must be filed by Jan. 7, 2011.

    1. Wins, wrt the stress test: Retaliation for all the critcism of the QE2 by the bankers and their minions? This seems to have come out of nowhere after the close. This time it is the Fed, last time Geithner spearheaded these tests from Treasury.

      Maybe Bernanke is pissed and is going to show them who is boss,… or it is another scam to enable the large shareholder insiders to start robbing more money out thru the dividend channel. Flip a coin?

      1. “The results of the upcoming exams, however, won’t be made public, Fed officials said. That’s in line with banking regulators’ long tradition of keeping such information confidential.”

        Given that the results will be private, the only indication of which banks the Fed believes (wants us to believe) are solvent are those that pay dividends.

        The Wray and Black attack makes it apparent BofA is ready to keel over. Things are getting ‘interesting’ again.

        I’d like to know who will replace Larry Summers? That appointment will likely be a better indicator than that coin toss.

    2. the gm ipo is probably not deflationary.

      gm gets the funds, presumably to spend, and they come from investment funds that presumably are ‘savings’ of financial assets, and would not have been spent on goods and services.

      1. “gm gets the funds, presumably to spend”

        On paying back the government, same as taxes right?

      2. winslow,
        I read that Treasury was selling 13B of their shares in this ipo to the public.

        I recall that when the Tresury first purchased these financial assets (the GM stock) the view was it wouldnt add to AD (balances were not used to purchase real assets but financial assets, but it did make the deficit bigger), now when they take it back, this in reverse shouldnt perhaps hurt AD (directly)…its like the govt & non-govt are just trading FAs back and forth. But it should make the fiscal deficit smaller this month (by 13B).

        Im having trouble with this (understanding). I guess my ?: is it the govt’s net provision of NFAs/mo (flow) that is the key thing here that is allowing the economy to muddle thru, or is it the govt sector directly engaging in the real economy and affecting AD? ie is the non-govt sector trying to obtain (currently) about a 110B/mo (flow) of govt provided NFAs, and as long as this is being provided, we muddle thru? And does this ipo interfere with this non-govt sector desire for govt NFAs (Treasuries)? Cuts it (13B) by about 10%+…with perhaps negative effects on demand as non-govt sector cuts spending to compensate. Maybe Im confusing cause and effect.

      3. unlike bank capital purchases under tarp, the gm capital purchase were probably used as operating capital to meet payroll, etc. so in that sense they supported aggregate demand, which would have been a lot lower without those payments to GM.

      4. “. I guess my ?: is it the govt’s net provision of NFAs/mo (flow) that is the key thing here that is allowing the economy to muddle thru, or is it the govt sector directly engaging in the real economy and affecting AD?”

        Right question. When I say deflationary, I mean removing net financial assets from the economy.

        If 110B is from deficit then it adds to NFAs

        If 110B is Fed purchases of U.S. treasuries, it adds nothing to NFAs

        I like your question, Does China/Kuwait’s shift from Treasuries to GM stock reduce demand for net savings of U.S. dollars? I’d guess only as long as the stock market goes up.

      5. Sorry,
        The 110B/mo is what I estimate the monthly deficit (flow) (1.3T divided by 12 months), so approx 110B/mo.

        (This as you point out is also the Feds stated purchase of UST/mo. with the QE2 but that was not what I meant here.)

        Prof Mitchell pointed out that Greece deficit is coming in higher than they estimated due to austerity, so if I look at that, the Greek govt probably at first cut back on certain discretionary Treasury withdrawals , so initially the net flow there to the non-govt sector would fall, then non-govt sector cuts back on expenditures to re-seek the previous flow level of savings desires of NFAs? hence the deficit increases because tax receipts then fall due to non-govt sector pull back in spending?

        My lack of clarity here has been bugging me for a while…

      6. Related to the GM ipo, I guess I assume it is a voluntary exchange between the very few non-govt entities that exchange 13B FAs in the form of res. balances for stock certificates with the govt sector in this ipo. But since this reduces the monthly deficit, does this leave the huge rest of the non-govt sector wanting for govt provided NFAs? (There is 13B less this month to go around) Resp,

      7. “so if I look at that, the Greek govt probably at first cut back on certain discretionary Treasury withdrawals , so initially the net flow there to the non-govt sector would fall,”

        Example of discretionary Treasury withdrawals?

        Not sure of exact sequence, I see the first ‘cuts’ coming in the higher government multiplier activities, libraries, schools, teachers, firefighters. The broad societal beneficial stuff is the first to go. The spending that remains has deeper political ties (corruption, tax cuts for wealthy) and tends to go directly into savings. With a lower multiplier on remaining government spending, GDP falls. Not only does lower government spending reduce GDP, the spending that remains is less productive in producing taxes.

        Eventually things turn get bad enough…..

      8. so there is a multiplier type of effect that depends on what areas the govt sector first decides to cut in an austerity program. Agree that what they typically would cut first would have the greater multiplier as far as collapsing tax taxes collapse more than the spending cuts and hence the deficit increases.

        A payroll tax holiday at this point for the US: This would increase the monthly flow of NFAs from the current 110B/mo (muddle thru) to perhaps 160B/mo thus exceeding current flow of desired savings of 110B/mo by an extra 50B/mo. Workers (those that are left!) would then perhaps spend all of this amount as it looks like it would add income $4$ (sort of by definition) in excess of the non-govt sectors apparent current savings desires which are resulting in an economy that is just treading water. Growth then results, people are hired, etc……external sector also has to be addressed.

      9. yes, pretty much the same.

        good point!

        In the case of the tarp funds to the banks for capital it wasn’t quite like taxes, as receiving the tarp funds didn’t cause spending on goods and services and paying them back didn’t reduce aggregate demand. the funds were just used to ‘qualify’ to be a sound bank, not actually spend directly or indirectly.

  2. Does anyone understand why GM bonds were priced at between 31 and 34 cents on the dollar today?

    I’m hearing small investors are having a tough time accessing the IPO, why not just buy bonds?

    GM bondholders are supposed to 10% of the stock plus a $30 warrant an a $55 dollar warrant based on unsplit prices.

    I calculate that after GM split 3 for 1 the new $33 share price implies bonds are worth 39 cents on the dollar when you include warrants (split at $10 and $18.33). Speculation is the stock will go up 10 to 20% tomorrow, a $39 stock price implies a bond price of 49 cents on the dollar.

    The bond market, with a price of 31 cents on the dollar, is saying the stock will drop to $28.

    Do I have some information wrong?

    1. I think the answer is the unknown amount of debt that is in addition to bondholder debt and declared ‘other debt’. Based on stock price of $35 and bond price of .34/dollar the other debt comes in close to $7.5 billion (not including superfund and asbestos claims) . That or there is a large premium for not getting payout until 2011 first quarter.

  3. China acting more like the inflation problem is serious. Hearing talk of price controls, as they struggle to sustain employment and keep a lid on prices, in a nation where inflation or unemployment have meant regime change.

    Price controls, eh? Abba Lerner and Bill Vickrey are no longer with us, but BOC should get in touch with David Colander.

    It is here that my free-market solution to inflation, later reworked, further developed and, renamed the market anti-inflation plan (MAP) by Abba Lerner and me, came in. Vickrey saw MAP as the institutional change needed to guarantee that a true full employment – roughly 2 to 3 percent unemployment – could be reached in a way that was institutionally compatible with a non-inflationary economy. And it could do so in a way that was fully consistent with existing institutions.;col1

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