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With
yesterday's Fed decision and press conference, Chairman Ben Bernanke finally
and decisively laid his cards on the table. And confirming what I have been
saying for many years, all he was holding was more of the same snake oil and
bluster. Going further than he has ever gone before, he made it clear that he
will be permanently binding the American economy to a losing strategy. As a
result, September 13, 2012 may one day be regarded as the day America finally
threw in the economic towel.
Here is the
outline of the Fed's plan: buy hundreds of billions of home mortgages
annually in order to push down mortgage rates and push up home prices,
thereby encouraging people to build and buy homes and spend the extracted
equity on consumer goods. Furthermore, the Fed hopes that ultra-cheap money
will push up stock prices so that Wall Street and stock investors feel
wealthier and begin to spend more freely. He won't admit this directly, but
rather than building an economy on increased productivity, production, and
wealth accumulation, he is trying to build one on confidence, increased leverage,
and rising asset prices. In other words, the Fed prefers the illusion of
growth to the restructuring needed to allow for real growth.
The problem
that went unnoticed by the reporters at the Fed's press conference (and those
who have written about it subsequently) is that we already tried this
strategy and it ended in disaster. Loose monetary policy created the housing
and stock bubbles of the last decade, the bursting of which almost blew up
the economy. Apparently for Bernanke and his cohorts, almost isn't good
enough. They are coming back to finish the job. But this time, they are
packing weaponry of a much higher caliber. Not only are they pushing mortgage
rates down to historical lows but now they are buying all the loans!
Last year,
the Fed launched the so-called "Operation Twist," which was
designed to lower long-term interest rates and flatten the yield curve.
Without creating any real benefits for the economy, the move exposed US
taxpayers and holders of dollar-based assets to the dangers of shortening the
maturity on $16 trillion of outstanding government debt. Such a repositioning
exposes the Treasury to much faster and more painful consequences if interest
rates rise. Still, the set of policies announced yesterday will do so much
more damage than "Operation Twist," they should be dubbed
"Operation Screw." Because make no mistake, anyone holding US
dollars, Treasury bonds, or living on a fixed income will have their
purchasing power stolen by these actions.
Prior
injections of quantitative easing have done little to revive our economy or
set us on a path for real recovery. We are now in more debt, have more people
out of work, and have deeper fiscal problems than we had before the Fed began
down this path. All the supporters can say is things would have been worse
absent the stimulus. While counterfactual arguments are hard to prove, I do
not doubt that things would have been worse in the short-term if we had
simply allowed the imbalances of the old economy to work themselves
out. But in exchange for that pain, I believe that we would be on the road to
a real recovery. Instead, we have artificially sustained a borrow-and-spend
model that puts us farther away from solid ground.
Because the
initials of quantitative easing - QE - have brought to mind the famous Queen
Elizabeth cruise ships, many have likened these Fed moves as giant vessels
that are loaded up and sent out to sea. But based on their newly announced
plans, the analogy no longer applies. As the new commitments are open-ended,
quantitative easing will now be delivered via a non-stop conveyor belt that
dumps cheap money on the economy. The only variable is how fast the belt
moves.
Fortunately,
the crude limitations of the Fed's only policy tool have become more apparent
to the markets. If you must stick with the nautical metaphors, QE3 has sunk
before it has even left port. The move was explicitly designed to push down
long-term interest rates, but interest rates spiked significantly in the
immediate aftermath of the announcement. Traders realize that an open-ended
commitment to buying bonds means that inflation and dollar weakness will
likely destroy any nominal gains in the bonds themselves. To underscore this
point, the Fed announcement also caused a sharp selloff in Treasuries and the
dollar and a strong rally in commodities, especially precious metals.
Given that
30-year fixed mortgages are already at historic lows, there can be little
confidence that the new plan will succeed in pushing them much lower,
especially given the upward spike that occurred in the immediate aftermath of
the announcement. Instead, Bernanke is likely trying to provide the
confidence home owners need to exchange fixed-rate mortgages for lower
adjustable rate loans - which would free up more cash for current consumer spending.
He is looking for homeowners to do their own twist. If he succeeds, more
homeowners will be vulnerable to increasing rates, which will further limit
the Fed's future ability to increase rates to fight rising prices.
The goal of
the plan is to create consumer purchasing power by raising home and stock
prices. No one seems to be considering the likelihood that unending QE will
fail to lift bond, stock, or home prices, but will instead bleed straight
through to higher prices for food, energy, and other consumer staples. If
that occurs, consumers will have less purchasing power as a result of
Bernanke's efforts, not more.
The Fed
decision comes at the same time as the situation in Europe is finally moving
out of urgent crisis mode. While I do not think the ECB's decision to
underwrite more sovereign debt from troubled EU members will work out well in
the long term, at least those moves have come with some German strings
attached [For more on this, see
John Browne's article from earlier this week]. As a result, I feel that
the attention of currency traders may now shift to the poor fundamentals of
the US dollar, rather than the potential for a breakup of the euro.
In the
meantime, the implications for American investors should be clear. The Fed
will try to conjure a recovery on the backs of currency debasement. It will
not stop or alter from this course. If the economy fails to respond to the
drugs, Bernanke will simply up the dosage. In fact, he is so convinced we
will remain dependent on quantitative easing that he explicitly said he won't
turn off the spigots even if things noticeably improve. In other words, the
dollar is screwed.
Peter Schiff is CEO of Euro Pacific
Precious Metals, a gold and silver dealer selling
reputable, well-known bullion coins and bars at competitive prices.
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