This is the most normal, healthy thing. Interests rates have been unnaturally low. Now they are starting to rise and seem likely to rise. The ability to get a higher return on bonds will put negative pressure on stock prices, sending P/E rations towards their historical averages. And that is OK!
I'm wondering what "unnatural" means when it comes to a mostly-arbitrary human game like the economy? Seems like it's all artificial, and interest rates in particular are especially artificial (controlled by central banks).
Long-term interest rates are controlled by the auction the US Treasury holds: aka the free market.
Only short-term interest rates are controlled by the central bank. And that's mostly because the central banks own something like a $$$TRILLION in short-term debt and raw cash, so they simply have enough money to shift the market direction.
In essence: short-term interest rates are still determined by auction, just like any other debt from the US treasury. But when a trillionare is sitting there with ideas about how the market should look like, the trillionare has real power to manipulate the market. Note that these trillions of dollars are money from private banks. Under a "true free market" situation, the Trillionare would still exist! The pile of $TRILLIONS is the money that's been collected by all of the banks in the USA.
In theory, if the central banks ran out of money, they would lose their power to manipulate the markets. But otherwise, the central bank is simply the largest "consumer" on the market. That's the extent of their control. Much like how Apple can buy out the entire 10nm or 7nm production chain for months at a time (preventing Apple's competitors from using TSMC's or GloFo's advanced nodes whenever Apple starts to prepare an iPhone).
Entities with lots of money exert power over the entire market. That's the free market.
Perhaps a better example would be the GDAX Bitcoin exchange. It only will take $25 Million to increase BTC's price to $9000 right now on GDAX: https://www.gdax.com/trade/BTC-USD. It will only take 3000 BTC to drop BTC's price down to $7000, over the short term at least.
Good point on long-term rates, but on short-term rates, this seems like a distinction without a difference?
The Fed can create unlimited amounts of money so at least in theory, they're always going to be able to prop up demand for treasuries in dollar terms. (Possibly at the expense of inflation.) If the short-term interest rate rises, it's because they want to let it rise. And they can always change their mind.
What the Fed can do with QE is create new accounts. And as I described to another poster, the concept is very similar to how a credit card can "create" money out of thin-air by creating a $5000 credit card for you.
Does the money really exist? Not really. Its just a number, and the reason why it works is because you, the credit card holder, will do your best to return the money at a future date.
Similarly, QE is fine as long as the Fed draws it down and sells the bonds back into the market (or alternatively, lets them mature and doesn't buy any back). Which it has begun to do.
Sure. I wouldn't put "create" in scare quotes, though. Money created this way exists just as much as other money. Just like Bitcoin or credits in some online game or Hacker News comments exist.
I put it in scare quotes because of the important difference. When most people talk about "printing money" or "creating money out of thin air", they are talking about:
1. Create money
2. Spend Money
And this is bad. Very, very, very bad.
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In contrast, the credit cycle is:
1. Create Credit
2. Spend Credit
3. Pay back credit. <--- Most important step!!
Step 3 is incredibly important to making sure it all works out at the end. In essence, "printing money" is scary because it skips step 3. (See Venezuela for details).
So as you can see, "Create Credit" is quite different from the colloquial use of "Create Money". People have every right to be scare of "creating money" or "printing money". Because that's the sort of stuff that destroys economies.
The creation of credit is only a problem if it can't be paid back.
This cannot happen. The Federal Reserve can issue digital U.S. dollars. (Through a quirk of history, only the U.S. mint can print or coin physical dollars. But those are a minority of money, negligibly so in financial markets.)
There's a big difference in issuing new credit and issuing new dollars.
Printing Money (aka: New US Dollars) means you have no intent on paying the money back or closing the account.
QE was the creation of a credit-line. Just like how a credit-card eventually needs to become $0, the US Fed is winding down QE and reducing its account back to zero.
Reversal of QE is accomplished through the inverse of its actions. Instead of buying bonds, the Fed will sell bonds (causing interest rates to rise WHILE closing out the QE credit). The Fed will NOT receive money (ie: M0) for those bonds, it will instead pay off the QE Credit Card account.
There's a HUGE difference between QE and Printing Money. And this difference (paying it back, which negates the effects of QE over the long term) is why QE is okay.
I don't see any reason why QE couldn't continue forever? The reason the Fed doesn't buy unlimited amounts of whatever it likes and grow its balance sheet forever is that this isn't consistent with its mission to fight inflation. But as a matter of game mechanics, it could do this. The Fed never has to pay anything back because people are very happy when you pay them for stuff using U.S. dollars.
It could also create as much M0 as it wants by buying it from the U.S. Mint. This is pointless, though, because there's no real difference, and guarding mountains of cash would be more expensive.
We talk about M0 versus M1, but it's not like the U.S. has two different currencies. They are both equally money.
I think its actually "MB" you're talking about, not M1. M0 for coins + physical bills. "MB" would include Federal Reserve deposits. For whatever reason, its different than M1...
They are considered "equally money" because its "Equally trusted". Banks can turn Federal Reserve deposits into Cash, and vice versa. Your savings account, checking account, and so forth is similarly "equally money" because you trust the bank to give you the cash when you need it.
And once again: the Fed can't create M0. So that right there is a major disconnect between M0 and MB / Federal Reserve Deposits.
But Federal Reserve Deposits are not money. Like a savings account, it generates an interest rate. In effect, Federal Reserve Deposits are "like money" because everyone trusts them very much.
If the Federal Reserve plays too many games with its Federal Reserve Deposits, there may become a mismatch in the trust of MB and M0. A dangerous game for sure, so its a good thing that QE has stopped.
> The reason the Fed doesn't buy unlimited amounts of whatever it likes and grow its balance sheet forever is that this isn't consistent with its mission to fight inflation.
Bingo.
Because the Fed as an entity believes inflation should be at a certain level. Not too high, and not too low (aka: negative or deflation).
> The Fed never has to pay anything back because people are very happy when you pay them for stuff using U.S. dollars.
On the contrary. Inflation is precisely when people aren't happy for being paid in US dollars. Things cost 10% more because people trust the dollar 10% less.
If the Fed never pays anything back, inflation will grow (aka: people trust the dollar less and less). The reason why inflationary monetary policy was fine in 2011 through 2014 was because DEFLATION was the main worry.
re: "But Federal Reserve Deposits are not money. Like a savings account, it generates an interest rate."
I don't see how that follows? Before, the Fed didn't pay banks any interest and now it does, and that's not going to change what most people think of as money. Money in the bank is still money as far as most people are concerned.
re: "there may become a mismatch in the trust of MB and M0"
This seems like a fancy way of saying the exchange rate might not be 1:1 but there's no way for that to happen. An account holder with the Fed could withdraw all their money as cash, and they could deposit any amount of cash in their account. Cash and money in a federal deposit account are always 1:1 and there's no way to "break the peg" because they can always print more money or increase the number in the bank account. People do prefer more or less cash at different times of the year, so adjustments are being made all the time.
re: "the Fed can't create M0"
This doesn't matter because the Treasury prints however much they ask for. Sure it's outsourced, but so what?
As far as I know the risk of QE has nothing to do with that. It's just ordinary inflation risk through increasing the money supply if the Fed buys too much stuff. It's not anything special.
When inflation happens, all accounts measured in U.S. dollars are affected equally. There's not a special kind of inflation for each kind of money.
> This doesn't matter because the Treasury prints however much they ask for. Sure it's outsourced, but so what?
Whenever the Treasury prints M0 money, the Federal Reserve Banks have to hold securities as collateral. Its not like the Fed Reserve gets the physical money "for free". All of the M0 money is effectively "paid" for through held collateral.
The Fed is an independent, technically public company. They are at best quasi-government. They do NOT have the power to print money. Only the US Government proper (US Mint) can do so. And when the Fed asks for more M0 physical money, it has to pay up.
> Cash and money in a federal deposit account are always 1:1 and there's no way to "break the peg" because they can always print more money or increase the number in the bank account. [snip]
> When inflation happens, all accounts measured in U.S. dollars are affected equally. There's not a special kind of inflation for each kind of money.
Dollar Accounts in savings accounts are safer than Money Market accounts, but a savings account could "break the buck" if the commercial banks fail. At least, for the uninsured amounts above $200k or so.
The Central Federal Reserve Bank can theoretically fail, but if it ever happened the US would be in a lot of trouble. But Federal Reserve Deposits are just a number. Its really just a bit bank, and I'm fairly certain that if there was a $100+ Trillion run on money for some reason, the central bank would fail.
Again, the Fed cannot order the Treasury to print money without offering collateral. That's the law. The Fed can create Federal Reserve Deposits arbitrarily, because that's what is within its power.
And that's why "Federal Reserve Notes" are different than "Federal Reserve Deposits", even if the bank on the outside is exchanging them. "Deposits" are the number the Fed Reserve can make up, while "Notes" can only be made by the US Treasury.
Paper money is a voucher - it is credit "I owe you X weight of silver and promise to pay it on demand" in the case of older U.S. bills. Digital "credit" same sorta promise or lack of same. So this is really a distinction without a difference. Nobody likes the term "printing money", is all.
Way back when I advocated QE (before the term existed, and perhaps the concept, but probably not) I talked about it in terms of printing money.
Move your mouse around the order book (the "bottom" chart). It indicates the current order book. There's some dude selling 0.0406 BTC at $8380. But then there's another dude selling 1.467 BTC at $8385.
If you wanted to buy ~2 BTC, you'd "run out" of BTC to buy at $8380.0. So you also buy the BTC up to $8381, $8382... etc. etc. until you get all the BTC you need. This increases the price to $8385.
Obviously, the numbers will be different by the time you see my post, but you get the idea. In essence, if you buy out the supply of BTC on the market, you increase the price. Even at ~$100 to $1000, you are already moving the market up and down a little bit, and when you get into the $millions, you start to really affect the market by a significant amount. If you watch the BTC charts long enough, you'll see some $5 Million+ orders come by and swing the price of BTC by $500 or so.
Note that this information is also available for the Stock Market. Its why people pay attention to a number called "volume", the more trades that happen, the less your particular trade affects the market.
No different than the $5000 credit line from your credit card "created money".
The Fed creates money supply by manipulating accounts. But it never prints a physical bill. But this practice is almost the same as how your credit card can have $5000, $10,000, or $20,000 credit line created out of thin air.
Regular consumers and millionaires and billionaires have limits on how much they can borrow. This special trillionaire doesn't (for all practical purposes).
My point here is that I don't think your characterization of the FED as just a market participant is very useful, nothing more.
The special trillionare has a limit. It can borrow up to the point where people lose confidence.
Because the special trillionare's goal is to ensure the stability of the US Monetary system. As soon as they start to threaten the stability of the US Monetary system, then they'd have failed their job.
Ultimately, QE is safer than just "printing money", because at the end of the day, the Fed's QE program kept track of every single dollar in the QE account. And it is in the process of paying that money back and ending QE.
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Consider the "free-market" alternative to this situation. Tether-coin. Its literally an account made up by some dude that claims to be "similar to USD".
The "legitimacy" of QE (and Tether) is in the strength and confidence in the promise to pay back the money. If Tether pays all of the USD back for all of the USDT they issue, then there's nothing wrong with what they did.
Similarly, as long as QE is properly paid for over time, then it's not "money created out of thin air". It more accurate to state it as "credit created out of thin air", and "credit that eventually was paid back".
There's little reason to trust Tether in their ability to pay things back. (They're failing the sniff test at the moment). But QE is legitimately being paid back by the Fed. And that's the difference.
> My point here is that I don't think your characterization of the FED as just a market participant is very useful, nothing more.
Under normal circumstances (ignoring QE), the Fed acts just as a normal market participant. But QE hasn't been done for years now. QE is a special case, but it is also a tool that is rarely used.
The fractional reserve banking system has inherent limits as the bank must keep enough reserves in case of a run. But the fed has no inherent limit. Root access to the USD.
Unnatural would be prices not supported by future cash flows, or prices that are not typical of historic norms based on concrete measurements such as profit, revenue, or growth. I take your point that pricing is arbitrary, particularly moment to moment. But economics theory dictates that all the arbitraryness resloves or cancels out into an efficient finding of price.
Recessions are also normal, healthy things. Until the business cycle stops being a cycle, and debt cycles stop being cycles...people should expect....cycles. Its ok. With the fed not renewing QE, and unemployment and private debt where it is....expect a recession to come in the relatively near future. It has to happen, as sure as we need seasons.
Interest rates have been rising since January at least, and there's an expectation that the good economic news we got will encourage the Fed to raise interest rates in March.
I'm thinking that the authors of the article just needed "something to say" about why people are selling stocks today. But I don't think its interest rates, mostly because interest rates haven't really been "moving quickly" or unexpectedly.
I think recent volatility, especially the destruction of XIV (inverse volatility index tracking ETF) has caused some people to flee the market. Its been years since the stock market fell a bit, and people have forgotten what it feels like to lose money. Scared people contribute to the sell-off. Basically, your standard market correction.
There might be some other explanations out there: but attributing it to the long-expected interest rate hike seems weird. The 30-year Treasury went +0.02% today. Its not moving very quickly.
It's amusing how there is a tendency in the media to attribute changes in the market to recent events when more often than not there is little evidence of correlation.
This reminds me of mid-2015 and early 2016. I believe it's a normal healthy correction and not the ominous beginning of something bigger. It feels like the economy has at least enough gas to keep moving to the end of 2018, but I'd be surprised if Trump completes his term without a market downturn.
I really wonder how the Bay Area housing market is going to fare when borrowing money becomes a lot more expensive than it is now. Right now the low interest rates are baked into the prices — Piled onto the lowered deductions in the new tax bill, and something's gotta give.
Interest rates are only part of the problem. The real culprit is a weak dollar. Hard for foreign buyers to stay invested in the US and make a profit. Also hard for exporters to make a profit outside the US. We are a net importer as a nation so a weak dollar will hit us with more expensive goods. We'll be seeing it soon.Thank Trump and his treasury secretary.
The weak dollar is not Good even if we suddenly start to export.
>> The weak dollar is not Good even if we suddenly start to export.
That's assuming that a decline in the value of investments is better than the increase in jobs due to more exports. For most people on this forum, I think that is true. For most people in the US, a decline in a portfolio of equities (that they don't generally hold) is a great trade off for jobs (through export).
