QE, S&P & History

BarroMetrics Views:  QE, S&P & History

This is the last in the present series of answering reader questions.

In Behavioural Changes, Bob Mitchell asked four (4) questions. The questions are too long to post here, so I have attached them as a Word doc.

Bob says in part: ” The problem I have is that the history that predicts this is based on a history without ever having QE, especially on this scale and with these methods.”

In part I agree with Bob:

  1. The mechanism for QE is new and
  2. Its the first time I have seen where funds created, by the Central Bank, have remained, for the most part, in the Central Bank. In what appears to be an effort to repair the banks’ balance sheets, the FED has been paying interest on the deposits (see attached PDF). Figure 1 shows how the deposits in the St Louis Fed have exploded exponentially since the sub-prime crisis.

Where I disagree is the assumption we have never this sort of deficit spending. In my view, all boom bust-cycles can from the expansion of the monthly supply over productivity i.e. actual goods and services created.

Rather than answer Bob’s questions point by point, I think, in this case, a better approach is to provide a succinct but comprehensive explanation. I’ll separate the explanation in four areas economic, historical, social, technical.


I believe boom-bust cycles are created by the excessive expansion of the money supply:

  1. The boom happens because the additional funds in excess of productivity create either inflation and/or an asset class boom. What was unique in the 1992 to 2000 was the fact that we a boom in all assets classes.
  2. The bust is the correction of the booms’ malinvestments.

The reason why we have not seen inflation in this cycle is because the majority of excess funds have not hit Main Street. Instead, we have have seen stock market asset inflation. We only have to look at the stock market response to Bernanke’s suggestion of  the possible end of QE to see the truth of the supposition.

The locking in of QE funds has kept inflation at bay. But, at a cost. That cost is the damage done to middle America. In effect, we have a Government whose policies are  adversely affecting the middle class. The most visible effect is the state of jobs.

Jobs? Isn’t that improving? That brings me to my pet complaint with the US BLS. Every government distorts figures to some extent. But, US stats are starting be on par with the Chinese – headline numbers cannot be believed.

FIGURE 2 is  taken from ShadowStats.

You’ll see that the data from ShadowStats is a leading indicator, it tends to turn before the other data. But, at this juncture, the most important thing is the divergence. It’s the first time I have seen this. It suggests that the BLS has distorted the data more so than  in the past. At some point either the data will have to catch up with reality or social action (street demonstrations etc) will force the Government to take action on the employment front.

If the data is to catch up with reality, then an obvious solution to the problem is for the St Louis FED to stop paying interest. This will force the banks to lend out the funds i.e. QE will flow to Main Street. Once that happens, we’ll see the inflation rate rise and rise strongly. That will mark the end of QE.

Tomorrow I’ll look at some historical aspects.




FIGURE 2  ShadowStats Employment


BOB’s Questions


Fed Paying Interest

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