Comments on: Bernanke explains QE2 A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: TFF Thu, 04 Nov 2010 17:54:05 +0000 Exactly, DanHess. Debtors could barely repay creditors when times were good. Now that the economy has retrenched a bit, they are in over their heads.

We’re seeing moderate but sustainable levels of default, dragged out over a few years. This is a “fair” way of destroying debt because it directly impacts only the creditor and the debtor, however if the rate of defaults rises too high then it can bring down the whole system. Meanwhile, NOTHING HAPPENS in the economy until the imbalance has cleared (and at this rate it will take a while).

Quick defaults = (a)
Slow defaults over a long period of time = (b)

The Fed is trying for (c), which is the best bet to destroy wealth quickly without bringing down the whole house of cards.

By: DanHess Thu, 04 Nov 2010 15:56:25 +0000 A terrific, thought-provoking post!

I have to disagree sharply with DeLong that the Fed’s actions made little difference. DeLong argues that because the 5 year is at 1.17, the Fed’s actions do not matter. I would argue instead that the 5 year was at 1.17 because the Fed was loudly announcing its plans to buy and everyone had front-run the Fed already. If the Fed suddenly changed course and refused to buy, interest rates would shoot upward.

“Brad DeLong says, the only way that QE is going to work is if it results in higher inflation expectations. ”

I agree with Brad. But I also think this will be self-fulfilling. How?

(1) The Fed buys bonds at very low rates with ‘new’ money. Check.
(2) The Fed holds these bonds long term (so far so good).
(3) Eventually, while inflation expectations raise interest rates rise, causing real, permanent losses on the part of the Fed.
(4) This Fed loss shows as a gain on balance sheets all over the world. This is brand-new money, that the Fed printed, spent, and that it will never recoup.

In fact the Fed has already injected brand new money into the real economy in the form of bond gains that have already been booked by many funds which sold to the Fed.

I am seeing the point of Ray Dalio at Bridgewater. He argues (my understanding) that we are in a ‘D-process’ where creditors must sustain losses because debtors can’t pay it all back. This can happen by (a) massive defaults and deflation (Great Depression) or (b) prolonged low returns on debt or (c) inflation, or some combination of the above.

The Fed is successfully avoiding (a). That much is very clear to me.

By: Woltmann Thu, 04 Nov 2010 15:52:25 +0000 The Fed is trickling down on us, flooding our economy with liquidity, the farm is saved!

By: Gotthardbahn Thu, 04 Nov 2010 15:06:57 +0000 Well argued, Felix. WaPo should print this blog as a counterpoint.

By: djiddish98 Thu, 04 Nov 2010 14:58:49 +0000 I second the reaction here – as a consumer, I don’t see the benefit of lower rates now that I didn’t already see a year ago. I’m also not sure what businesses would be more willing to invest in idle production now as opposed to 6 months ago.

If the Fed’s history over the past 20 years is any indication, this is not going to end as planned.

By: yr2009 Thu, 04 Nov 2010 14:38:13 +0000 Felix,
You got all points right, and Bernanke is flat wrong.
A brave new era of stagflation is dawning. In other words, the underlying weakness in the US economic machine is morphing into something new.
Never a dull moment…