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Assflation and Fed Derangement Syndrome

Cullen,

In your blog about assflation, you mentioned that it is an advanced form of Fed Derangement Syndrome and point out that it infects people who are biased in how they think money is created. Do you assert that Richard Werner and Steve Keen fall into those category? I would consider both of them, as well as you, Post-Keynesians. They seem to believe that assflation is happening as a cause of different mechanisms than what you are assuming in your blog post.

Hi @nguyend, honestly, I am not that familiar with their specific views on this matter. It seems to be a widely held belief though that QE boosted asset prices significantly. I just don’t see how this is possible. Equity prices aren’t efficient, but investors also don’t just buy them without considering fundamentals. If it was all a scammy liquidity driven bull market I suspect prices would be much lower than they are if there wasn’t real fundamental improvement to support prices. And that’s the kicker - we know for a fact that corporate profits have surged and that EPS has hit all time highs. There is real fundamental evidence for the improvement in corporations.

On the interest rate front, there is also a disconnect. Interest rates are low because inflation is low. The Fed’s goal was to boost inflation and wages. They’ve largely failed. So rates didn’t follow. If QE impacted rates it should have caused rates to RISE by making inflation rise and growth increase.

So, this all looks like a case of conspiracy theorists making up stories to explain why they were wrong about the impact of QE....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

I think I shared this before, but Frances Coppola's piece on inflation is interesting:

http://www.coppolacomment.com/2019/03/inflation-is-always-and-everywhere.html

Thanks! I took the time to take a deeper look at their positions and I actually think I misrepresented Richard Werner's position, so I apologize. I think your point about real fundamentals is fair. But the Fed's goal was to expand the money supply and increase lending from the banks to the economy, not boost inflation from what I understand. Irregardless of their goal, wouldn't QE by buying bonds in the open market have an impact by creating more demand for bonds, forcing prices to go up, thus bringing rates down?

That's the theory. But I don't think it works that way. Bonds are priced based on fundamentals, of which supply and demand is just one component. For instance, when a firm buys back stock that does not necessarily make the stock price go up. After all, would Enron stock have gone to zero if they were doing a buyback? Yes. Absolutely. Think the same basic thing with bonds. If inflation is rising then yields on bonds will rise. It doesn't matter so much what the supply is because bonds are fundamentally priced as a function of inflation. So, the reason yields fell is quite simply because inflation fell, not because supply changed.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Aren't you also implying that the central banks never have any control over interest rates with that statement? Since QE in most cases are just an extension of the open market operations that they are regularly engaged in, saying QE doesn't work implies that the Fed have no effect on interest rates at other times also.

I am not disagreeing that the interest rates are mainly affected by inflation and interest rates do not drive inflation. But I can't see how your analogy with Enron holds up since cash is being decreased at the same time as the buying of the stock. Consider corporate bonds instead - the credit risk/default risk premium is fundamentally determined by each investor. Each investor can assess the credit risk as low or high and that can be seen as the demand curve for the bond. If a new buyer enters the market, they must buy it at a price higher than at least one person thinks its worth (the person who evaluates the credit risk higher than all the other owners). You can say that the fundamentals didn't change, or you can say that the new buyer represents fundamentals; either way, the corporate bond prices go up. Of course inflation will determine yields more than credit risk, but I wouldn't say bonds are priced as a function of inflation.

No. See the attached piece on how rates are set.

Basically, the Fed has complete control over short rates and sets them based on what they believe inflation will look like and they let the long end float which is set by bond traders based on inflation plus a risk premium.

https://www.pragcap.com/who-determines-interest-rates/

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Thanks for the link. I have also read your article https://www.pragcap.com/the-biggest-myth-about-quantitative-easing/ and understand your analogy to stock buybacks. I guess I still have a couple questions to reconcile this framework. What effects does open market operations have on the economy? Quantitative easing has had an impact on asset prices, how did QE effect this - do you just attribute it to restoring market confidence?

That’s a very hard question to answer. My view is not that there’s zero impact, but that it’s probably much smaller than most people assume. 2009 was probably a unique environment because the Fed was basically guaranteeing assets that might have otherwise failed. So the balance sheets of banks ended up MUCH healthier because of QE in that specific instance.

But in a healthy Econ environment I don’t see much of a transmission mechanism. The Fed can induce confidence and try to lower rates, but rates are mainly a function of inflation so if QE “works” it should drive rates up. And while the Fed can induce confidence I don’t think the market is so inefficient that they can virtually trick people into buying stocks that aren’t supported by more fundamental underpinnings.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche