Clar­ium Cap­i­tal, Peter Thiel's hedge fund, has released its quar­terly let­ter to share­hold­ers which includes a lucid assess­ment of the econ­omy, credit mar­ket, and a elo­quent expla­na­tion of what exactly Quan­ti­ta­tive Eas­ing is and how it dif­fers from credit eas­ing, as well as whether or not this move is inflationary.

The let­ter effec­tively pro­vides a key to under­stand­ing how the U.S. of 2009 resem­bles the U.S. of 1900, and it is not only edu­ca­tional, it is enlight­en­ing, and one of the best explain­ings that we have seen of Quan­ti­ta­tive Eas­ing yet in the last year. We urge you to put this on top of your must read pile.

Ordi­nar­ily, eco­nomic read­ing is quite oner­ous, and gen­er­ally bor­ing. Not this time though.

Here is one excerpt:

Since both Credit Eas­ing and Quan­ti­ta­tive Eas­ing increase the mon­e­tary base, why don't they both cre­ate infla­tion? To answer this ques­tion one must under­stand how these oper­a­tions work. In both Credit Eas­ing and Quan­ti­ta­tive Eas­ing, the cen­tral bank pur­chases secu­ri­ties from banks and then cred­its them with reserves; the increase in reserves is the expan­sion in the mon­e­tary base. In order for this expan­sion of the mon­e­tary base to be infla­tion­ary it must make its way into the econ­omy, and the mech­a­nism for doing this is for banks to make more loans against the increased reserves. But in con­di­tions where bank lend­ing is weak, merely increas­ing the mon­e­tary base will not increase lend­ing; hence it is ques­tion­able whether a straight­for­ward Quan­ti­ta­tive Eas­ing pol­icy would have any effect at all today in the US. (And there is con­sid­er­able debate whether Japan's pol­icy had any effect dur­ing the time it oper­ated.) Even fur­ther, the Fed is pay­ing an inter­est rate on excess reserves equal to what banks could expect to make on them by lend­ing them overnight, which explic­itly moti­vates the banks to leave the reserves on deposit with the Fed. As long as those reserves sim­ply sit with the Fed, their mere increase has no infla­tion­ary effect on the economy.

This com­pre­hen­sive analy­sis writ­ten by Patrick Wolff, CFA, Man­ag­ing Direc­tor, Clar­ium Cap­i­tal, leaves few stones unturned. You may down­load the com­plete let­ter here, or you may view it below, via scribd (click on full screen view but­ton on the top right).

Source: MarketFolly.com, Peter Thiel's Clar­ium Cap­i­tal Investor Let­ter (Mar­ket Commentary)

Down­load: Clar­ium April 2009 Let­ter to Partners

Read more from the author/contributor here.

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