FED and the 0ishrate policy +QE; Its the velocity-stupid!

Leverage
This reminds me of the PLN corporates I mentioned yesterday. They were hungry to reduce corporate hedging costs in a very low vol environment via taking on leverage and optionality short exposure. This leverage has now put them into severe difficulties, to the extent that the risk is affecting the country´s GDP.

This is the US version of it. In its quest for restarting growth and stopping deflation and debt spiral, they have now borrowed 2 TRN USD in 2009, cut rates to zero ish and introduced quantative easing.
(US Equities are still down 40ish% Y/Y, US 10 YR yield is 2.25ish%, US 30 YR yield is 2.75ish% with US core inflation at 2.0% and US O/N lending rates at 0ish%.
The Usd/Jpy carrytrade these days is to sell Usd/Jpy!)

It will generate massive riskmanagement issues for the US economy going forward. Having said that, relatively speaking, I believe they will be better off than regions such as Europe.

Admittedly, US will start 2009 on the verge of recession. Everything looks very gloomy. Leading indicators, production and orders have collapsed, unleashing deflationary pressures. Liquidity is hence provided a la helicopter Ben. It is being spewed out in desperation of getting that availability of credit going again.


The velocity of money is what counts
Without velocity of money, just pumping in liquidity without any other measures, will have as much effect on getting the economy going as pushing on a piece of string.
Once the US economy do gain traction, the mighty power of velocity of money in the monetary base will be felt in the form of very quick acceleration in inflation. The extent of that inflation increase will be strongly correlated with the amount of money that have been pumped into the monetary base. Stagflation will intially be a significant risk with this kind of debt leverage.

For now, the measures taken in the US is most likely overkill from a pure liquidity point of view. Having said that, US will probably be the first one out of the jaws of deflation. Compared to Europe, US is the best in class. Europe will, relatively speaking, be frothing with slowness and/or inability to act, political bickering and policymistakes. The overwhelming risk in Europe is that they will do too much, too late. Fiscal authorities and the ECB seems to ignore that Eastern Europe is about to fall apart.


This is a process,effect is lagging
Just as a driver, skidding on a snowy road in an "old school car" (no ESP etc) can only turn the wheels to a suitable angle and wait for friction to return and then adjust again, monetary policy authorities will have to have some patience for the process to work through.
This timespan can be used to launch smart infrastructure projects.

The driver will only put himself in a worse situation by turning the wheels too much, while awaiting friction to return.
From an economic point of view monetary policy authorities run a similar risk. Unfortunately, noone knows what the right angle on the wheels should be when friction and monetary velocity comes back.

This time span could be wisely spent launching infrastructure projects. This would help getting the monetary base moving and increase the velocity of money, without the negative effects of pumping up the monetary base to extreme levels. This is what I want to see from here.
I expect US to be first, and Europe to be a very distant second or third.

How will this affect the USD?
More on that in a piece later.






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