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
