Michael B. Krause's  Instablog

 Just a concrete summary of what the respective banks have done to money base in the last 3 decades.

For the past several years, I have monitored treasuries against the dollar to confirm whether bearish dollar moves were sustainable. The treasury market foretold the lack of sustainability of the 2008 commodity boom; And it foretold the same impermanence when the Canadian dollar flew past parity. I have found no more fascinating and useful an economic indicator than the price of the 30 year treasury bond against the US dollar.

For the first time in recent years, universal dollar weakness, including weakness versus the Yen, is being confirmed by a little mini-flight on long maturity treasuries. This is worrisome as it obviously does not bode well for treasury bulls, and ultimately the Fed is placed into a little tighter corner than it has had to deal with recently. Either it turns the on faucet to increase the rate of debt monetization (as latest minutes reveal) via outright treasury purchases, accelerating dollar overshoot, or it shows restraint, letting the free market decide where the long term yield shall be. My flip flop between being a treasury bull and assumption of the more consensus reflationary scenario has come full circle.

The little bit of irony is that more the Fed targets longer rates, the more control it forgoes of future monetary tightening with disastrous consequences. This bodes poorly for the dollar, and serves as an effective devaluation by proxy. Investors may require a greater risk premium than before to buy treasury assets even in the face of a guaranteed treasury bid, as dollar exchange rates fall. This points to an environment where amidst Fed price supports and interest rate targeting, they end up being the only holder of long maturity treasuries. Upon commencement of monetary tightening policy, we will see sudden sharp moves on the long end. At that point, a mere removal of the Fed bid will see a several hundred basis point move on the long end. Central bank asset liquidation will be another story. For this reason, it will be a terribly politically difficult effort for the Fed to actually tighten this time around. It points to a replay of the Volcker scenario.

In the end, this (increasing QE) is unbelievably the right thing for the Fed to do if it is to successfully prevent liquidationists from taking assets from the current generation of capital holders. The dollar needs to be weaker to stimulate our export economy, end dollar hoarding and resume investment appetite. Inflation is a gift to the debt holders, and will stop bank insolvency in its tracks. The long run circumstances are an obvious one-off inflationary move the Fed is unable to neutralize unless it is willing to sell its agency MBS assets into an open market, once again shooting the mortgage market in the head. To me, this points to a permanent move to a higher price level.

The contrary argument of course is that no matter how much the Fed prints (within the under 10 trillion dollar range, of course) that it will be impotent against the wealth destruction we've already seen, itself in the many trillions. I find it easy to challenge that assumption, especially now that the Fed has so flexibly responded in its program creation. In this week's most important unnoticed headline, the Fed has finally activated the TALF, making the Fed's trillion dollar pledge actually useful to enable banks to offload old CMBS assets. PPIP is coming. And all of this several trillion dollars of treasury supply that is driving yields up will be spending into the economy that would not have otherwise happened so quickly. Government spending is directly augmented into GDP 1:1.

The multiplier effect of the impending monetary flood we are about to see in the next 6 months has a great chance of successfully offsetting the wealth destruction of the late crash of 08. Unlike the six hundred billion of monetary base currently sitting in excess reserves not being multiplied into the money supply, TALF, PPIP, QE, and treasury supply (stimulus) will be another story. That money will be multiplied, in a way Americans have never seen before.