Floating all boats

Everything is going up. Gold, oil, commodities, stocks, bonds, everything. All at once.

And I suppose it’s no wonder. Central banks are pumping money like there is no tomorrow. Here is how Gavyn Davies framed current central bank intervention yesterday:

The graph uses the size of the central bank balance sheet as a metric to measure the extent of the monetary injection which is occurring now that short term interest rates are at the lower bound. This metric is far from perfect, since different types of QE will certainly have very different impacts on the economy. And some actions by the central banks, such as the Fed’s Operation Twist, have the same effect as QE without changing the size of the balance sheet.

In calculating the figures shown in the graph, I have made a notional upward adjustment of $600m to the size of the Fed’s balance sheet, to represent the impact of Operation Twist and recent changes to communications policy. I have also assumed that QE3 will be launched in April at a size of $100m per month, though the probability that this will occur may be declining. For other central banks, I have assumed that announced policy measures will be followed, and have assumed a size of E400bn for the ECB’s forthcoming LTRO.

Whichever way the numbers are calculated, the overall message is clear. The central banks are engaged in a second burst of QE which will take effect more slowly than the initial round in 2008/09, but which will eventually prove somewhat larger in size. A rough order of magnitude is that QE1 increased balance sheet size by about 5 per cent of GDP, while QE2, spread over a period which will be twice as long, will be around 9 per cent of GDP. This is almost twice as large as QE1, and is far more co-ordinated across the developed world.

Yet, just about everywhere, the mechanisms of transmission to the real economy of all this free dough remain broken. In the US, households either don’t want to borrow or their balance sheets remain under water and can’t. It is striking that the savings rate there continues well above the levels of recent decades despite the appalling returns from bank accounts. The same slack credit demand afflicts Europe, either in the periphery where austerity and falling asset prices has households aiming to rebuild balance sheets, or in the core where nobody ever borrowed much anyway. Then there are the European banks which don’t want to lend when they can make much less risky profits with simple carry trades between their sugar daddies at the ECB and national government bonds. In China we can expect similar dynamics to take a hold of real estate- exposed sectors, irrespective of stimulus, which will be targeted around said market.

But, as we learned through successive episodes of quantitative easing in the US, when the mechanisms of transmission of free dough to the real economy are broken, money seeks out assets. This time the pecuniary gush is coming from all directions, so rather seeing dollar or undollar assets rise or fall, it’s pretty much anything you can lay your hands on anywhere.

Will this restart global growth? Given the broken credit mechanism, the only possible effect of this combined stimulus on growth is the temporary floating of private balance sheets via asset inflation. So yes, it may have some temporary effect on boosting demand.

Will it create a lasting recovery? Sadly no. Asset inflation is already threatening demand in the US with oil at $105 per barrel. A new pulse of production inflation will also arrive as it goes higher.

So, where are we? Somewhere on the way up in another ephemeral round of central bank inspired asset price mayhem with risks of Europe and China temporarily forgotten. China especially remains an unknown.

Keep your finger on the trigger.

David Llewellyn-Smith
Latest posts by David Llewellyn-Smith (see all)


  1. It is still a mixed picture with WTI and Brent rising but natural gas decimated at Henry Hub. Iron ore falling with coking coal. However with the massive QE as Davies points out with QE3 still possible in the near future what chances are there that the major bond markets enter a synchronised bear market due to the money onslaught? Never happened in Japan but maybe Japan is different.

    • Douglas…I’m not understanding your post (sorry I’m a bit thick!) Are you suggesting bonds value for a bear market or bond rates to go down giving what I’d call a bull bond market?

      • flawse What I am saying is that the bond markets act with a mind of their own and bond interest rates go up sharply ie a bond bear market where bond values fall. That is central banks lose control of medium and long term market traded interest rates due to fear of future inflation due to debauchery of the money supplies.

        • Thanks. Yes it will happen…when?
          It’s always been a puzzle to me how, in a world so short of savings, we can persist with zero to negative RAT rates specifically designed to eliminate savings. The wheel turns and certainly at some stage you must be right.
          I’ve learned the hard lesson that being right but wrong on timing is the same effect as being wrong!
          Inflation is coming from everywhere but is being studiously ignored by everyone. Of course everyone sings the same song now “Inflation is good!”
          Hells bells!

    • Yes, there are exceptions, certainly. The signals coming out of China are awful but everyone seems happy to put that down to CNY for now. RRR cut reversed the ore and futures decline yesterday, probably temporarily. Hence my suggestion nobody believe this rally is a new bull market.

      Gas is about the US glut and nice weather.

      As for bonds, I doubt it, even if spreads loosen for a while. Everybody I know thinks the coming bond bear market is the no-brainer trade of the decade ahead. That should tell you something…

      The set-up looks remarkably like 2011. Big free money rally hitting a major roadblock in QE and geopolitical oil spike as well as Asian accident, this time in China…

      • As for bonds, I doubt it, even if spreads loosen for a while. Everybody I know thinks the coming bond bear market is the no-brainer trade of the decade ahead. That should tell you something…

        for clarity are you saying those predictions are a tad overcooked?

        the bear market in bonds meme is already a couple of years old and e.g. cost PIMCO money. One day it might happen but how many bond traders will have their heads handed to them on a plate in the meantime waiting for that day.

          • hang on. I’m pinching myself. You and I are agreeing on things. 🙂

            I better log off and take a break.

          • my understanding of your position on MMT is that you would be more likely to be in the newly formed MMR camp.

            …and you forgot to mention the big difference on SWF but we’re having a nice day so let’s not go there. 🙂

          • As Ballard concluded the ‘output gaps’ are not as large as is assumed.
            Tim Duy was wrong.(as usual)

            Inflation is coming from Government in the developed world but more importantly from the ‘undeveloped world’ (China et al). China undeveloped! Lordy what a concept!

            You don’t see inflation because you assume the model of the last 50 years will stay the same for the coming decades. ALL the evidence tells us this is not going to be the case.

          • “and I am not 100% MMT since I think their position on CADs is nutty.”

            Which pretty much makes the whole thing ‘nutty’. If you take away the Pitchford attitude to CAD then there is nothing new.

    • Different situation now Douglas wrt Japan.
      CB globally are in the game now with QE.
      Bond interest rates have trended down for yonks and no trend lasts forever.
      That spike in rates will be large when it comes and Jpn rates will be swept along too. A tsunami of dough exits bonds and ends up plastered every where.
      Good luck to every one who has to adapt to this.

      • Japan running a trade deficit is a game changer. Their interest rates will have to be higher to reverse their capital account and attract capital back home.
        Ageing population may mean more and more trade deficit.

  2. Good one H&H. I was racking my brain trying to make some logical conclusions from the post. The mind just descends into mayhem which is about where we seem to be heading.
    Not trying to read your mind but the post seems to indicate you were trying to deal with the same effect.

    • As that website is also selling seeds at inflated prices for our ‘survival’, perhaps it doesn’t say it all.

    • We are the only ones not trying to keep our national currency down, so I’d answer yes to your question. More so when the other side of the fx pair is USD, and they definitely want and are getting a cheaper USD.

  3. Janet

    Agree re creditors etc should get a damned good hair cut. At the moment all the rescuemoney is flowing to them.

    Another aspect is who, within the Greek economy, is suffering the most? The Govt employees who have been a significant part of the problem, the tax dodgers, powerful unions or the ordinary Con Stanopolis.
    I don’t know enough about Greece to say but I’d be prepared to wager a small amount.
    It’s the problem we all face in trying to fix this problem. How do we share the necessary pain around? How do we reform the system so we don’t just go back to debt generation as a system?

    • Flawse if the creditors need to take a haircut why do we need to figure out how to share the pain around? Isn’t the pain appropriately allocated by means of creditors losing their hats?

      Not for the first time since getting interested in economics, I’m finding the lack of clarity breathtaking. This whole “socialising losses” concept seems to strike against the heart of capitalist philosophy, am I the only one expecting to see the Wizard Of Oz make an appearance sometime soon?

      • Merk Don’t expect much common sense from modern economics!

        My point is this. Let’s suppose we have a highly indebted nation. Who holds the debt doesn’t matter for the sake of this argument. Suppose we now just wipe out the debt. What we are left with is a debt free nation that still has the same economic, social, and ethical structure that produced eh debt in the first place. So there is a need for widespread reform and the resulting dislocations cause a lot of pain.
        Further the whole economy is running at a faster pace than is sustainable once you take away increasing debt. So by definition there is contractionary pain. In the past this has been borne by just a few while the more powerful and Govt sectors maintained their lifestyle. Everyone has to share the pain….but as usual they won’t. As long as everyone doesn’t then the old debt creating structures are still in place.

    • what’s that you said above about the output gap not being as big as assumed? any link to that opinion?

      • Feb 14 links Tim Duy


        Within it the link to Bullard (apology re name incorrect)

        I thought it was an important debate but no one else seemed to want to enter it. I made a few comments to try to stimulate a bit of discussion on the matter.
        (I don’t mean to ‘bait’ the conversation, and I have been softly castigated by Prince before for this transgression of calling Tim Duy and idiot…but he is!!!

        • The “Output gap” is obviously stuff and nonsense. You may as well extrapolate from 1929.

          But, other than for the impact of currency conversion on imported goods, why would inflation emerge until there were capacity constraints in the real economy?

          It is the underutilisation of virtually all types of productive capacity including labour that prevents inflation from emerging, that and the desire to maximise cash flow to reduce debt during a period of private sector deleveraging.

          • Explorer my opinion FWIW (judge for yourself)In regard to Aus.

            Pull apart the ABS inflation figures. Domestic inflation is currently 5 to 6%. This is predominantly caused by Govt charges and utilities. State and LocalGovts are in so much debt they are now raising charges all over the place. It is still not keeping pace with their expenditure. Debts remain so we can expect these charges to continue to increase at about the current rates.

            Our imported US FOB prices are rising about 15% per year. Again this is supported by the ABS figures where we have a zero imported inflation rate in the face of a 15% increase in the value of the A$.
            Chinese demographics and prosperity mean that imported inflation will get worse. The old padigram of cheaper and cheaper imports from Asia is over.

            Lastly, there is now severe pressure in the retail sector because of low margins. Substantial retailers are starting to fall over. The deflation we have had from squeezed margins in retail will soon enough be thrown into reverse as competition eases and retailers are able to increase margins to stay in business.

            There are just so many imminent inflationary pressures.
            Output gap has little or nothing to do with it.

  4. In the US, households either don’t want to borrow or their balance sheets remain under water and can’t


    Isn’t one of the problems with the official policy responses, a belief that if you create money people (outside of wall street) will demand it. In normal times probably true but surely if your house price has collapsed, i.e. your equity mate has significantly decreased and may be sub zero, and you have either lost your job or know plenty of people who have and therefore feel insecure, then nationally (and this has been a large nationwide phenomena), demand for credit decreases. People want to rebuild their personal balance sheets and many more than before are less credit worthy. In other words a balance sheet recession is a different beast.

    • But YOU don’t want to be the one who misses out on their free loot, do you? If your neighbour is ‘underwater’ and goes on a borrowing spree to buy more ‘renters’ ( what has he got to lose, after all?). Do you want to see him make a capital gain, when you don’t? Who’s the mug there? You, who did ‘the right thing’ and stayed within your means, or your neighbour, who ‘did what he was told to do’ and went a-borrowing?

      • Agree Janet Yes at some stage everything gets inflated. The cost of everything is going up vertically…houses, shares, oil and commodities generally, food, TV’s, ipods, etc etc. The loot is not only free the Govt is paying you to take it. One day everyone will say…screw this I’ve got to take the loot! Then watch the ensuing conflagration.

        • And the really sad thing is….you, me – even David LS- can FEEL it! 4 years of ‘waiting’ for ‘the right thing’ to happen has taken its toll.The Good Guys are giving in; they are tired, and are about to join the inflation-fest, and in so doing destroy the savings and likelihoods of many, many people.

          • Janet You’re exactly right…including me. In the sharemarket I’m invested in companies i think the Chinese are interested in buying.
            After that happens if my timing can be a bit right I’m going to take the money and put it into RE on the Sunshine Coast.
            I’m a bit too old to get into borrowing. However i am thinking of setting in some borrowing at current low fixed rates for my business.

            My super intelligent son always says to me ‘Dad you have to stop investing in what should happen and invest in what is GOING to happen’ I’m learning!

        • Can our house prices really go any higher under our current mountain of debt?

          Inflation would have to run rampant and that would put interest rates through the roof, killing off a huge pile of borrowers living close to the margin of their income before their incomes rose to accommodate, not to mention the negative gearers who can’t find renters to pay their escalating mortgages while apartment la la land is flooded with new builds and vacancy rates are rising.

          And all that in the face of a domestic economy visibly slowing, rising petrol prices, employment hours tanking and China in the brace position with the earth rapidly approaching.

          Seems to me a perfect time to take on more debt to buy real estate…in America where prices have already returned to a semblance of reality and interest rates would not be as high as they are here. Buying here would be double jeopardy on prices and rates.

          Of course we’d all like inflation to disappear our mortgage, provided we always have the high paying jobs left to pay for it…

          • mikey…you may be right about house prices. Other things may inflate and house prices decline. HnH, Janszen et al use the terms ‘inflation in all you use and deflation in everything you own’ or some such!

            Still, I’m 63 years old. I’ve never lived or seen anything like what is coming down the road. I have experience of the high inflation of the 70’s but what I see now is a whole different ball game.
            So i wouldn’t care to predict what or what might not inflate.

            If Aus follows previous patterns most of the population will maintain their lifestyle largely financed by sales of resource assets and other industries (not sure how much we will have left to sell by then). So the majority might well ‘protect’ themselves against inflation with RE.
            For the minority who are forced to bear all the burden the situation will be horrific.

            If we all share the burden RE will be cactus.

            Just thinking out loud!

    • Richard Koo explained the balance sheet recession maybe 3 years ago, but so many people don’t get it.

      Like so many people don;t get the basic economic identity of GDP and think austerity will help Greece while it is trapped in a Monetary Union – although that belief is surely withering now. While restructuring the economy might pay dividends in the long term, reducing G while P is reducing when you have no export base to expand E must mean a fall in GDP, it’s just maths.

    • “Perhaps they’re aiming to inflate away some of the accumulated debt?”

      A big yes on that! But I would suggest inflate away most of the debt. The question is when will we see it? At 2% inflation I think it takes about 70 years , I might be wrong on that time, but it a long time to inflate away the current debt. All the while more debt being accumulated. How long before QE3, or what ever the FED will call it this time, is announced. The market has priced it in at least.

        • Can you offer some support for that opinion?

          You might be in a sector/demographic where your basket has the increasing components of the overall basket whereas I might be in a demographic that has more of the decreasing components of the overall basket.

          Then there are the components that are outside the basket, and to which you or I might be quite differently exposed based on our demographics or even lifestyle.

          Then there is the big one of how best to treat house prices. Its a very different viewpoint from a non-owning 25 year old to a retiree with a fully owned home and investment property of two and a heavily mortgaged thrity something with a couple of kids in pre-scholl and day care a couple of days a week.

          Doug Short presents some good analysis of this effect.



          If you are not buying much education or health care but you’re replacing aging appliances and electronics you can’t believe how cheap everything is!

          Inflation will increase more when the AUD falls as interest rates fall. Costs of cars, electronics, food, petrol, capital equipment for the mining boom will all increase.

          Then everyone will scream about inflation instead of mortgage rates….until rates go up to fight inflation!

          So my question is, “For whom is inflation rising and where is the support for the statement?”

  5. Yep Avid I suspect you are right.
    And the Chinese will just keep buying it ad infinitum? I know we have ‘Prisoner’s dilmena’ operating here but as Herb Stein said “If something cannot go on forever it will stop”

    Talk about playing with a jar of petrol and matches all at the one time! Inflation will have the same effect on debt that water has on a petrol fire!

  6. Doug Noland
    “Yet these types of policy-induced market runs become the devil’s playground for precarious Bubble excess.”

    In a nutshell!

  7. The central banks have learnt from Lehman bro, pump in plenty of liquidty before hand if you think there could be a credit crunch( kicking Greece out of the Euro?)I see this as a preempitive liquidity pump and dump.