Okay, the Fed's recent decision to boost its
monetary stimulus (a.k.a. "money printing," "quantitative
easing," or simply "QE") by another $45 billion a month to a
combined $85 billion per month demonstrates an almost complete departure from
what a normal person might consider sensible.
To borrow a phrase from Joel Salatin: Folks, this ain't
normal. To this I will add ...and it will end badly.
If you had stopped me on the street a few
years ago and asked me what I thought would have happened in the stock, bond,
foreign currency, and commodity markets on the day the Fed announced an $85
billion per month thin-air money printing program directed at government bonds,
I never would have predicted what has actually come to pass.
I would have predicted soaring stock prices on
the expectation that all this money would have to end up in the stock market
eventually. I would have predicted the dollar to fall because who in their
right mind would want to hold the currency of a country that is borrowing 46
cents (!) out of every dollar that it is spending while its central bank
monetizes 100% of that craziness?
Further, I would have expected additional
strength in the government bond market, because $85 billion pretty much
covers all of the expected new issuance going forward, plus many entities
still need to buy U.S. bonds for a variety of fiduciary reasons. With little
product for sale and lots of bids by various players, one of which –
the Fed – has a magic printing press and is not just price insensitive
but actually seeking to drive prices higher (and yields lower), that's a
recipe for rising prices.
Then I would have called for sharply rising
commodity markets because nothing correlates quite so well with thin-air
money printing as commodities.
That's what should have happened. But it's not
what we're seeing.
Instead, stocks initially climbed but then
closed red. Gold was mysteriously sold in the thinly-traded overnight markets
and again right after the announcement in large, rapid HFT blocks that
swamped the bids. U.S. Treasury bonds actually sold off on the news. The
dollar hardly budged. Commodities were mixed across the board but more or
less flat on the day, with the exception of the metals, and especially the
precious metals, which were sold vigorously.
The markets are now well and truly broken. Not
because they don't conform to my predictions, but because they are no longer
sending useful price signals. Instead, my hypothesis here is that the markets
are now just a giant and rigged casino, where a relative handful of big firms
and other tightly coupled players are gaming their
orders to take advantage of this flood of money.
When your central bank badly misprices money
and then bids up everything related to bonds, nothing can be reasonably
priced. Risk is mispriced; the few remaining investors (as distinct from speculators,
which are now the majority) are forced to accept both poor yields and higher
risk – so we know the price of everything, but the value of nothing.
So what exactly is this new thin-air money
printing program all about? Well, unlike any prior Quantitative Easing (QE)
announcement, this one was tied to a fuzzy and quirky government statistic:
the unemployment rate.
Dec 13, 2012
We got the most thunderous Just-In-Time
monetary policy today that is a substitute for the absence of any degree of stimulative fiscal policy.
You might say that QE4 is now going to act as
both monetary and fiscal stimulus– another $85 billion worth of Fed accumulations of Treasury
bonds and mortgages- that is meant to keep stock prices moving higher
and residential home sales climbing briskly.
The goal is to drive economic activity,
especially residential home building, so that unemployment drops from 7.7% to
6.5%. The surprise move is
meant to signal the Fed’s awareness of the softening economy; it sees
the gritty numbers before we do.
Getting unemployment down to 6.5% without
inflation rising to a level higher than 2.5% is not expected to happen until
2014 at the earliest. And it could go longer if there is no deal and we go
over the cliff.
But, you should know that the only reason
unemployment is 7.7% is because hundreds of thousands of males have dropped
out of the search for regular work. A very depressing tale.
The key point here is that the Fed is now
actively running both monetary and fiscal policy because it will now be in
the business of funding nearly 100% of all the new government
deficit spending in 2013. And it is pumping a bit more than
$1 trillion of hot, thin-air money into the economy as it does so.
The odd thing here is that by tying their
policy to the unemployment rate, we could be in for a very long wait for the
stimulus to end. The reason is that the unemployment rate has a couple of
moving pieces, one being the number of people who are unemployed, and the
second consisting of people who have given up looking for work, which is
tracked in something called the 'participation rate.'
As more people leave the labor force and the
participation rate goes down, the unemployment rate goes down, too. Somewhat
confusingly, as more jobs are created, the unemployment rate goes down, too.
As you can see, these numbers work in opposition to each other because as
more jobs become available, more people re-enter the work force.
Before the crisis struck, the participation
rate was around 66.5%. But now it sits at just 63.6%, meaning that, at
roughly 1.4 million jobs for each percent, a bit more than 4 million jobs
would have to be created just to absorb the folks who left the labor force
but presumably would like to work again. As those 4 million folks come back
to work, the unemployment rate will not budge at all.
It will require two full years of 150,000 jobs
per month just to absorb the 4 million missing workers, which means that this
QE effort will be with us for a very long time. Three to four years is my best guess, and that's
only if the economy magically recovers. And I have very strong doubts about
This means that the Fed is
most likely on track to increase its balance sheet by another $3-4 trillion.
Ugh. That's 300% to 400% more money created in the next year than was created
than during the entire 200 years following the signing of the Declaration of
The other part of this new QE policy is that
they will continue this as long as inflation remains below 2.5%. Again, this
is a very fuzzy government statistic subject compared to the usual massaging
and political biases, but it has top billing as the one that is most likely
to force an early termination of the thin-air money printing efforts.
However, I remain convinced that the Fed will
change any rules and move any goalposts it needs to in order to continue its
mad money printing experiment. Because there really isn't any other
alternative at this point.
Secretly in the Open
Once upon a time, it would have been
considered in bad taste to suggest that the world was being centrally managed
in secret by a small-ish cabal of bankers whose
actions served to either prop up the excessive spending habits of the very
governments that conferred upon them the power to print money, or to bolster
the health and profits of the banks they mainly serve.
That was then. Today you can just read about
it in the Wall Street Journal:
Dec 12, 2012
BASEL, Switzerland—Every two
months, more than a dozen bankers meet here on Sunday
evenings to talk and dine on the 18th floor of a cylindrical building looking
out on the Rhine.
The dinner discussions on money and economics
are more than academic. At the table are the chiefs of the world's biggest
central banks, representing countries that annually produce more than $51
trillion of gross domestic product, three-quarters of the world's economic
Of late, these secret talks have focused on
global economic troubles and the aggressive measures by central banks to
manage their national economies. Since 2007, central banks have flooded the world financial system
with more than $11 trillion. Faced with weak recoveries and Europe's churning
economic problems, the effort has accelerated. The biggest central banks plan
to pump billions more into government bonds, mortgages and business loans.
Their monetary strategy isn't found in
standard textbooks. The central bankers are, in effect, conducting a
high-stakes experiment, drawing in part on academic work by
some of the men who studied and taught at the Massachusetts Institute of
Technology in the 1970s and 1980s.
While many national governments, including the
U.S., have failed to agree on fiscal policy—how best to balance tax
revenues with spending during slow growth—the central bankers have
forged their own path, independent of voters and politicians, bound by
frequent conversations and relationships stretching back to university days.
If the central bankers are correct, they will
help the world economy avoid prolonged stagnation and a repeat of central
banking mistakes in the 1930s. If they are wrong, they could kindle inflation or
sow the seeds of another financial crisis.
If it feels like you are part of a very grand,
high-stakes experiment, congratulations! You're exactly right. We are all
collectively prisoner to whatever outcomes are in store.
The rather politely ignored truth right now,
at least by most news outlets and politicians, is that the world's central
banks have wandered very far off the reservation and are running an
experiment that really has only two possible outcomes. One is a return to
what we all might call 'normal and stable' economic growth. The second is the
complete collapse of the fiat money and their attendant financial systems and
While it is technically possible to achieve
some other middling outcome, that possibility has
been receding to ever more remote territory with every passing month and new
round of money printing.
The basic predicament here is that more and
more money is being printed while the world economy, predictably for those
who follow the net energy story, has been entirely stagnant and constantly
threatening to slip back into economic retreat. Of course, more money + the
same amount of (or even less) hard assets = the perfect recipe for inflation.
So the rise of inflation will signal the
beginning of the end of this slow-motion tragedy. I use the term 'tragedy'
here because it doesn't have to end this way. We have other options; we could
make other choices and use our time and resources to try and do something
other than maintain a broken financial system that desperately needs to be
In Part II:
It's Better to Be a Year Early Than a Day Late, I explain the facts behind why I am more convinced than ever that
this all ends in one of the most disruptive financial and currency events
ever seen on this planet. And while the repercussions will be felt by all,
taking prudent action while there is still time can greatly improve our
individual odds of weathering them safely.
to read Part II of this report (free
executive summary; enrollment required for full access).