Two decades of monetary easing since 2000 explains why core Personal Consumption Expenditure (CPE) and inflation has remained low and why it will go down further. The ramification for when it happens is a financial crisis like no others.
It all started in 2000 when Federal Reserve chairman Alan Greenspan; faced four challenges that caused near deflation.
1-Bursting .com bubble in March 2000
2-Cyclical recession in March 2001
3- 9/11 Attacks that generated 40 billion in insurance losses and 7.5% stock decline in one day and closure of the stock market
4- China membership to WTO in Dec 2001 that opened the market to the cheap labor that put downward pressure on prices ever since
The customer CPI in 2001 was 1.5%, the lowest since 1986. The CPI rosed to 2.83% in 2002 but dipped again to 1.88% in 2003. In response, the annualized effective Fed fund rate declined from 6% in Jan 2001 to 1.8%.
Greenspan kept fund rate below 2% till Feb 2004 to stop the deflation.
Deflation is the Central bank’s most significant nightmare that increases the real value of debt, which would lead to default and jeopardize bank solvency and makes hoarding cash more valuable than consumption.
Greenspan succeeded in bringing inflation back to 3.42% before his four years ended in 2005. However, the three years stretch of sub 2% Fed funds 2001-2004 was too low too long. Cheap money flowed into the housing market and resulted in the housing bubble and subprime mortgage crises that exploded in 2007.
Fast forward to 2008, and the world saw the near-destruction of the banking system and the international monetary policy. The CPI dropped to 0.09% in 2008, even lower than 1.8% that prompted Greenspan to embark on four years of monetary easing.
In 2008 Ben Bernake responded similarly, taking the Fed fund rate to 0% in Dec 2008 until the next Fed Janet Yellen raised the rate to 0.25% in Dec 2015.
Bernake started QE in three rounds purchasing long term security form the bank primary dealers. The purchases were paid for with money from thin air that resulted in Base money supply MO to increase from $820 billion to $4.1 Trillion.
First-Nov 2008 – June 2010
Second-Nov 2010 – June 2011
Third-Sept 2012 – Oct 2014
Critics of QE argued this would result in higher inflation. However, inflation never came as it has little to do with the money supply. Inflation is a psychological phenomenon that needs a catalyst. Inflation never came because people were saving and paying debts.
Bernake used the theory of portfolio balance channel, stating the money has to go somewhere. By purchasing the long term treasury security, the Fed lowered the total return making it less attractive to investors and in turn, making stocks more attractive on a relative basis. As money flowed to equity and houses, these assets would be worth more. The asset value provides more collateral for borrowing. The higher asset value also provides a wealth effect that would encourage consumption. In combination, more wealth and more borrowing would push inflation to the Feds 2% target and drive natural GDP growth sustaining a trend above 3%.
None of these results emerged, core CPE or consumption rate remained below 2% for six years till 2017. The Fed fund rate was still at 2.5% till mid-2018 well below the 3% fund rate. Real GDP growth from 2009 till mid-2018 was less than 2.2% materially below the long term trend.
The inflation never arrived, the natural cycle of the stimulus never arrived.
QE had one affect the asset bubble. The difference was in 2008; the Buble was confined in housing with an impact on the equity.
In contrast, in 2019, the bubbles are everywhere, stocks, bonds, real high-end state, emerging market, and Chinese credit.
The US Fed has two choices, stop QE and let the stock market to drop 50-60% or continue with monetary easing and QE and wait for global financial armageddon.
It all started in 2000 when Federal Reserve chairman Alan Greenspan; faced four challenges that caused near deflation.
1-Bursting .com bubble in March 2000
2-Cyclical recession in March 2001
3- 9/11 Attacks that generated 40 billion in insurance losses and 7.5% stock decline in one day and closure of the stock market
4- China membership to WTO in Dec 2001 that opened the market to the cheap labor that put downward pressure on prices ever since
The customer CPI in 2001 was 1.5%, the lowest since 1986. The CPI rosed to 2.83% in 2002 but dipped again to 1.88% in 2003. In response, the annualized effective Fed fund rate declined from 6% in Jan 2001 to 1.8%.
Greenspan kept fund rate below 2% till Feb 2004 to stop the deflation.
Deflation is the Central bank’s most significant nightmare that increases the real value of debt, which would lead to default and jeopardize bank solvency and makes hoarding cash more valuable than consumption.
Greenspan succeeded in bringing inflation back to 3.42% before his four years ended in 2005. However, the three years stretch of sub 2% Fed funds 2001-2004 was too low too long. Cheap money flowed into the housing market and resulted in the housing bubble and subprime mortgage crises that exploded in 2007.
Fast forward to 2008, and the world saw the near-destruction of the banking system and the international monetary policy. The CPI dropped to 0.09% in 2008, even lower than 1.8% that prompted Greenspan to embark on four years of monetary easing.
In 2008 Ben Bernake responded similarly, taking the Fed fund rate to 0% in Dec 2008 until the next Fed Janet Yellen raised the rate to 0.25% in Dec 2015.
Bernake started QE in three rounds purchasing long term security form the bank primary dealers. The purchases were paid for with money from thin air that resulted in Base money supply MO to increase from $820 billion to $4.1 Trillion.
First-Nov 2008 – June 2010
Second-Nov 2010 – June 2011
Third-Sept 2012 – Oct 2014
Critics of QE argued this would result in higher inflation. However, inflation never came as it has little to do with the money supply. Inflation is a psychological phenomenon that needs a catalyst. Inflation never came because people were saving and paying debts.
Bernake used the theory of portfolio balance channel, stating the money has to go somewhere. By purchasing the long term treasury security, the Fed lowered the total return making it less attractive to investors and in turn, making stocks more attractive on a relative basis. As money flowed to equity and houses, these assets would be worth more. The asset value provides more collateral for borrowing. The higher asset value also provides a wealth effect that would encourage consumption. In combination, more wealth and more borrowing would push inflation to the Feds 2% target and drive natural GDP growth sustaining a trend above 3%.
None of these results emerged, core CPE or consumption rate remained below 2% for six years till 2017. The Fed fund rate was still at 2.5% till mid-2018 well below the 3% fund rate. Real GDP growth from 2009 till mid-2018 was less than 2.2% materially below the long term trend.
The inflation never arrived, the natural cycle of the stimulus never arrived.
QE had one affect the asset bubble. The difference was in 2008; the Buble was confined in housing with an impact on the equity.
In contrast, in 2019, the bubbles are everywhere, stocks, bonds, real high-end state, emerging market, and Chinese credit.
The US Fed has two choices, stop QE and let the stock market to drop 50-60% or continue with monetary easing and QE and wait for global financial armageddon.
