1. War Room 27 Sept 2012 QE3 : The League of Extraordinary Central Bankers

2. War Room Monthly macro discussion Using tools in context Update on HiddenLevers Features Your feedback welcome

3. QE3: The League of Extraordinary Central Bankers I.How does QE Work? II.Historical – How has past QE fared? III.Threat of Inflation? IV.QE3 Scenarios

4. HiddenLevers HOW DOES QUANTITATIVE EASING WORK?

5. Background: Fed Mandate Fed – 3 part mandate 1.Maximum employment 2.Stable prices 3.Moderate long term interest rates Fed – 3 part mandate 1.Maximum employment 2.Stable prices 3.Moderate long term interest rates Interest Rates Mandate: PCE inflation < CPI This gives Fed wiggle room

6. Background: Fed Mandate Employment Mandate: Above target 6% region Unemployment still ugly 8.1% Interest Rates Mandate: Record low rates No problems here Source: HiddenLevers

7. Fed + Money Supply Conventional Wisdom: Most people believe that printing money leads to inflation

8. Fed + Velocity of Money Money Velocity How often a dollar changes hands (annual) Money moving slower = No inflation from printing Money Velocity How often a dollar changes hands (annual) Money moving slower = No inflation from printing GDP Money supply X Velocity of money GDP Money supply X Velocity of money

9. QE3: Where Does the Money Come From? 1. Fed's balance sheet assets and liabilities:  Assets: US treasuries, mortgage-backed securities, bank loans, TARP investments  Liabilities: Federal Reserve Notes 2. Federal Reserve Note = United States Dollar 3. True Quantitative Easing (not Twist):  Fed buys assets using newly created USD  No borrowing, no increase in US debt

10. HISTORICAL: HOW HAS PAST QE FARED? HiddenLevers

11. Historical QE – Post World War II USA 1941- 1950 Fed + US Treasury collaboration Fed directly purchased treasuries 1.Monetized Debt 2.Directly injected into economy QE did help spark extraordinary growth QE did inject money directly into Treasury QE did NOT contain inflation QE did help spark extraordinary growth QE did inject money directly into Treasury QE did NOT contain inflation GDP up Inflation punishing

12. Historical QE – Japan Lost Decade(s) 1999 - present Close to 0% interest rates since 1999 BOJ tried to promote lending by giving banks excess liquidity 1.Government bond purchases 2.Asset-backed securities + equities purchases 3.Commercial paper purchases QE did prop up Japanese banking system QE did NOT improve economy QE did NOT end deflationary expectations QE did prop up Japanese banking system QE did NOT improve economy QE did NOT end deflationary expectations QE begins WTC attacks Source: HiddenLevers Source: Economist

13. Historical QE – QE1 + QE2 2009-2011 Post US financial crisis Fed purchased the kitchen sink 1.Shot and Long Term Treasuries 2.AIG 3.Fannie + Freddie bailout 4.Bank bailouts - TARP QE did prop up US banking system QE did drive up markets QE did NOT end resolve unemployment QE did prop up US banking system QE did drive up markets QE did NOT end resolve unemployment Both up

14. QE3: THREAT OF INFLATION? HiddenLevers

15. Source: HiddenLevers Inflation Threat – CPI + PPI Not even close

16. Inflation Threat – Oil + Gold since QE End of QE2 QE begins

17. Inflation Threat – Agriculture + Food Agricultural commodities have had extraordinary rise 2009 - 2010: Inflation rising Jul 2012 – present:Droughts in USA breadbasket Fundamentals story

18. QE3: SCENARIOS HiddenLevers

19. QE3: Fed + Critics Views Banks + Financial Institutions Federal Reserve Real Economy Commodities $40B/month Bernanke’s View 1. Fed buys MBS from banks 2. Banks lend to real economy and buy assets 3. Wealth effect + lending combine to help economy Critics’ View 1. Fed buys MBS from banks 2. Banks park money at Fed or buy assets 3. Money ends up in commodities, driving inflation, not growth

20. QE3: So What Do We Got? What it is 1.It is $40 billion per month in mortgage-related securities purchases 2.It is an attempt to inflate asset prices, and induce wealth effect 3.It is one of the few tools Fed has left at 0% interest rates What it is NOT 1.It does NOT add to federal debt 2.It is NOT a direct way to kick start hiring 3.It is NOT a guaranteed way to ignite growth – Fed can give banks and institutions money, but can’t make them lend it or spend it. What it is NOT 1.It does NOT add to federal debt 2.It is NOT a direct way to kick start hiring 3.It is NOT a guaranteed way to ignite growth – Fed can give banks and institutions money, but can’t make them lend it or spend it.

21. QE3: Inflation or Liquidity Trap? Guidance 1.Follow QE1 formula of rapidly rising equity market 2.Wealth effect causes small pop (GDP + employment) 3.Commodities price increases offset most real economic gains 4.Inflation rises as underlying commodity inflation metastasizes Guidance 1.On our way to becoming Japan – zombie banks that cannot + will not lend 2.Velocity of money continues to trend lower 3.QE money sits in banks + corporate balance sheets 4.Stagflation possible if QE funds flow into commodities BOTH SCENARIOS: QE3 cannot boost job growth directly

22. HiddenLevers – Product Update Risk Profile: Multiple Timeframe Correlations Risk Profile: Index Correlations Portfolio Stress Test – Now Customizable Coming soon: embedded app – for lead gen