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QE How Low is Low?

Quantitative Easing lowers the long-term yields of Treasuries below their fair value. But how low can they get?

Goldman Sachs made recent remarks saying that long-term yields have already peaked:

Goldman: Quantitative Easing Is All Priced In And Bonds Are Peaking

Note as a digression that they estimate the fair value of the Yields of 10 Years US Treasury Notes as 2.90%. My personal estimate is more 3.50% which would be more coherent with the historic yields we got since short term yields are at 0%

As I explained Quantitative Easing is bringing the Treasuries yield curve below what would be its fair value with the hope of providing businesses with funds that are below 0% once discounted for interest rate risk. For example the fair rate for 10 years Treasuries would be 3.50% and the fair yield of 30 years treasuries would be around 4.60%. With the present yields on long term treasuries it is akin to set, secretly and unobserved the risk free rate at -1% thus subsidizing the borrowers with the Fed's money.

The Present Yield Curve (Green) and the Normal Yield Curve (Orange)

The Present Yield Curve (Orange) and the Shadow Yield Curve Yield Curve (Green) as Deduced from the Long-Term Yields Engineered by the Fed.

The idea is to jump start the economy and hopefully get it back to a normal regime. That can not be done:

What are the yields that would be supply to the pre-crisis economic development? 

What are the long-term yield that would be needed to return to the pre-crisis level of economic growth and devloppment can be very low.

The ideal interest rate for the US economy in current conditions would be minus 5 per cent, according to internal analysis prepared for the Federal Reserve’s last policy meeting.

The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation.

A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5 per cent.

That would mean that, according to the Fed the ideal rate on the 10 Years US Treasury Notes would be... -1.5% according to my fair valuation of the Yields on 10 Years US Treasury Notes and -2.1% according to  Goldman Sachs valuation.That is impossible to reach given the zero lower limit on interest rates!

There is no theoretical limit above 0% to which the Federal Reserve could bring those yields: the Fed has no theoretical limits to the size of its balance sheet. Remember it is the Fed so it is emitting the money and it can emit as much as it pleases.

A consequence of bring those yields to 0% would be necessarily that the FED would be the proud owner of 100% of the Treasuries with a maturity of more than 2 Years (Probably a little less as with negative yields on the shorter part of the curve financial institutions will be holding part of their funds in longer dated Treasuries)

Even a Pig Can Get Fed Up Eventually...

Efficiency of Doctor Bernanke Fantasy Math So Far:

The only measure of the efficiency of the monetary policy, according to the monetarists, is the M3 component of the money supply. The Fed conveniently decided in March 2006 as they knew that the Liquidity Trap was the inevitable to stop publishing that critical piece of data. However several think tank do compute it following their own formula. One of them is John Williams Shadow Government Statistics.

we see that in order to return to the pre crisis level of economic developpment we should be at +18 unless of course the money has by some magical twist acquired a super sonic velocity which I would strongly dispute. Some of you might take comfort from the slight improvement of the last few month, which nonetheless still exhibit a year on year decrease. The reason is simple: the July August 2008 M3 money growth had just started to decrease so it does not means that M3 is getting better it just started from a lower basis.

According to monetarist theory it means that the economy is still in a deep recession and that governments statistics that tend to exhibit a mild growth are lies. It is well known that promises engage only the one that receives it.


What Goldman Sachs and the Market does is taking in account the fair value of long-term yields. First if those yields were at their fair value we wouldn't be doing Quantitative Easing would we?

What they forget to take into account is the macro economic environment that Quantitative Easing is supposed relieve us from.

The last and not the least of the parameter I have often under estimated is the size, the brutality and social injustice of the implementation of non conventional monetary tools  Doctor Bernanke is ready to implement. I have done it twice that is, at least, one too many. I strongly suggest, and I promised myself, not to do it again.

The Numbers:

German 10 Years Notes are dealing now at 2.29% with approximatively the same interest rate volatility as the US with a 1.00% short-term interest rates that is, at the minimum 0.75% more than the US target discount rate which makes those yields at 0% short-term rate in the vicinity of 1.50%! Much lower than Goldman Sachs minimum.

The Japanese JGB, that I concede must have lower interest rate volatility is at 0.96%.

What is the limit of QE on the 10 Years 2.625% coupon? For obvious reasons the financial math is straightforward: 126.25! Compared to around 103 now. Good journey in the stratosphere!

Just to show how absurd things could get: at these rates an annuity would be worth the infinity and give us a glimpse on the extent of Doctor Bernanke stupidity!


This is why we offer the possibility for anyone to create in parallel to this prevalent economy, incremental jobs, consumption and later and less urgently investments:

Innovative Credit Free, Free Market, Economic Ideology
A Tract on Monetary Reform


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