Tuesday, October 5, 2010

Quantitative easing is working

The steepness of the long end of the Treasury yield curve reached another all-time high today of 126 bps. 10-yr Treasury yields have fallen to their lows for the year, but investors in longer maturities are balking—the steepening of the curve is coming mainly from rising yields on 30-yr Treasury bonds, which are up 20 bps since the end of August. That's a sign that the Fed's quantitative easing program is working.

The Fed can pin the 10-yr Treasury yield at artificially low levels, but easy money can't make an economy grow, except to the extent that the prospect of inflation causes people to invest money they would rather just keep in cash. Shoveling money into the economy mostly results in higher prices, and there is growing evidence that this is occurring.

Against a basket of major currencies, the dollar is down 12% from its June highs, and down 6.5% from its late August level, when the Fed first started to float its QE2 program. Measured against a broad basket of currencies and adjusted for inflation, the dollar is once again at its all-time low level by my estimation (above chart). A weaker dollar, of course, means that prices outside the U.S. are rising. Pinning interest rates at an artificially low level is akin to supplying dollars that no one wants, and so we see that the dollar's value is declining.

Gold is up $25/oz. today, reaching another all-time high and also confirming that the world is awash in dollars. Most commodity prices are rising as well, and oil today is up to $83/bbl.

If there is anything good about these signs of reflation, it's this: rising prices throw very cold water on the notion that the U.S. economy is at risk of deflation. And if you can dismiss the risk of deflation, then the future brightens considerably, and risk-aversion makes much less sense. Investors who are parking cash in zero-interest accounts are forced to reevaluate their convictions and concerns. The calculus increasingly favors taking on some risk, and this is one of the things the Fed is hoping for. As a result, we're getting a modest boost to growth, and increasing signs that inflation may perk up in the future.

The next shoe to drop will be the realization that an improving economy with rising prices means that more quantitative easing is not really necessary. This may short-circuit the Fed's widely telegraphed plan to launch QE2 a month from now, but that would hardly be bad news.


David Wozney said...

Re: “...the dollar's value is declining.

If the stated value, of “Federal” Reserve notes, declines enough with respect to copper and nickel, the 1946-2010 U.S. Mint nickels, composed of cupronickel alloy, could become somewhat rare in mass circulation.

The October 5th metal value of these nickels is “$0.0612951” or 122.59% of face value, according to the “United States Circulating Coinage Intrinsic Value Table” at Coinflation.com.

septizoniom said...

excellent post.

Benjamin Cole said...

I don't know what to say. The title of the post has me stunned. I am not going to read any further.

Benjamin Cole said...

I have recovered enough to raise a point: Gold is not at an all-time high, or even close ot it, except in nominal terms.

I forget the math, but adjusted for inflastion gold hit $2k or more back in the 1980s.

A long, long and still fruitless wait for "investors" who bought gold in the last fever.

Cavier Empty.

Benjamin Cole said...

I like today's rally. Who doesn't?

Man, oh man, I hope central banks start to think big. None of this usual central bank namby-pambyism. Pour it on, and when you run out of ammo, go back and get some more. Keep blasting away until you have blown the blight of deflation to Kingdom Come, and property values are rising, and equities are dancing high on Wall Street.

When I start seeing "Help Wanted" ads pasted on the doors of Los Angeles restaurants, then I know good times are back.

Please Bernanke, don't let up until I see those signs again.

PS on gold:

Well, gold goes where it will, but think about this: If stocks and property rally, money will move into those asset classes, hurting gold.

If property and equity does not rally, then it means we are in deflation. Without inflation, whither gold?

True, gold has been rallying last couple of years with zero inflation in Japan and USA. That may continue, but it may not.

Interesting times.

Daniel said...

interesting times indeed. enjoy this cartoon, Benjamin. gave me a good chuckle.


Mr. Kowalski said...

You'll be happy Scott.. Big Ben will be unleashed on 11/3 yet again. But beware of currency wars and soaring commodity prices. I do see equities running up as well; SPX to 1250 anyone ?

Benjamin Cole said...


Great cartoon--but remember, Japan tried some QE 2001-2006, and they are still in deflation. When they tried it, their economy improved, but the prim BoJ started to pettifog about inflation, and they stopped QE, and they went back into deflation.

So a round of QE need not cause hyper-inflastion.