On the weekends when I have time I like to sit and listen to my classic vinyl collection on my mid 1970’s stereo and relax and think. I know you are probably thinking mid 70’s stereo? Yes, really they don’t build them like that anymore. I have a Sansui G7500 direct DC output amp with 90 watts per channel “old school” which is probably comparable to 300 watts in today’s lightweight equipment. Just like so many other things these days the yardstick used to measure anything makes it like comparing apples to pineapples. So anyway I put on a classic album that brings me back to high school, which by all accounts was a much more stable and optimistic time then the world of today. By my sophomore year Ronald Reagan had become President and the country was throwing off the shackles of the 1970’s with its horrible fashions and terrible inflation, there was a sense that America could do anything. The US hockey team defied the odds in the winter Olympics beating the Russians, the hostages were released from their captivity in Iran and the sense that the long nightmare of the 1970’s was over; brighter days lay ahead for “the shining city on the hill” as Reagan called it. So I guess subconsciously I wanted to drift back to that era while I pondered the issues of today. I chose a favorite record of mine that I listened to in the time period and allowed my “wayback” machine to do it’s thing. I sat back with some coffee and listened to Rush “2112” and the last song on the second side just got me thinking because of its title “Something For Nothing”.
“Waiting for the winds of change
To sweep the clouds away
Waiting for the rainbow's end
To cast its gold your way
You pass the days
Waiting for someone to call
And turn your world around
Looking for an answer
To the question you have found
An open door
You don't get something for nothing
You can't have freedom for free
You won't get wise
With the sleep still in your eyes
No matter what your dreams might be”
Something For Nothing - Rush 2112 – September 1976
As Geddy Lee the bassist and lead singer sang out the lyrics in his distinctive yet nasally voice the words struck me that we are all waiting for the winds of change to sweep the clouds away. However, in thinking of the week that was, what really popped out at me was “you don’t get something for nothing, you can’t have freedom for free”. It seems that right now the FED seems to feel that the US can get everything for free with free money and we won’t have to give up any freedom to get it. Issac Newton who penned what are now known as Newton’s Laws of Motion stated that “for every action there is an equal and opposite reaction”.
Interestingly enough Newton himself was no stranger to investments as he invested in the South Sea company and initially made 7000 pounds a fairly substantial sum for the time and pulled out. Newton then went on to reinvest in the South Sea bubble and ended up losing most of his fortune, 20,000 pounds, when the mania crashed. He has a famous quote regarding investing “I can calculate the motions of heavenly bodies, but not the madness of people”. To me it appears that the “B52 Ben” and the rest of the FED are playing with fire here trying to get something, economic growth, for nothing dollars conjured from thin air. The problem is that something has to give and the opposite reaction will be the US dollar. Sure the dollar is once again bouncing along its recent low and it could get a bounce here because so many people are negative, however, the more money conjured the more justifiable the negative sentiment becomes. What I am trying to say is that as the FED debases the dollar they are expanding pool of sellers and traditional sentiment numbers could be useless just like an oversold indicator in a primary bear market.
As for not being able to have freedom for free I believe that applies as well. By debasing our currency we are essentially giving up our economic freedom for cheap money. As the rest of the world continually owns our debt and as our dollar becomes less valuable it has an impact on our economy and deprives us of the economic freedom we have enjoyed up until recently. Even Lenin understood "The best way to destroy the capitalist system is to debase the currency”, yet it appears that Bernanke has no clue and is doing to us what our enemies could only have dreamed about.
Looking at the Fed Statement that was released on November 3rd there were many things I found interesting upon reflection after rereading it over the weekend. To start with leading up to the announcement the media made it seem as if several of the FED governors had suddenly turned hawkish and there was a possibility of a split vote. According to the press release all those in question voted for the action “B52 Ben” had suggested in his now well known Jackson Hole speech, save the outspoken Hoenig. Hoenig made his position clear that he felt that the risks engendered by the purchases (“printing of money”) outweigh the benefits as well as could cause inflation. He even went further to state that the policy could eventually destabilize the system. Hoenig did not mince words here and I tend to agree with his assessment of the situation.
The statement also gives some detail on the QE2 package with in the typical FED boilerplate language trying to doublespeak and justify why they are perpetrating this crime on the American people.
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”
So dear reader you can see in the above paragraph that the FED is telegraphing what its intentions are regarding QE2 as well as the supposed reasons. It stated that they will expand their balance sheet by some $600 Billion are a rate of $75 Billion or so a month. Dear reader do you notice what is missing from the statement? First off at $75 Billion a month it would take 8 months to acquire $600 Billion and the second quarter end is 6 months. Moreover they are going to review the pace and adjust the size based upon incoming information. In other words the FED left things open ended as to the size and the end date if there is one of QE2. Furthermore, it does not take a rocket scientist to extrapolate if the FED does $75 Billion a month open ended that is a $900 Billion a year pace. The FED has left enough wiggle room in the statement that you could fly a “B52” through. I believe that the FED will ultimately end up printing more money than they are letting on. Moreover, as I had stated in a prior missive the FED is targeting the 5, 7 and 10 year notes as indicated by stating the intent to purchase “longer term Treasury Securities”.
Obviously the FED feels that if they can make mortgages cheaper or at least keep them from rising then their action will have the effect of kick starting the housing market. The FED is behind the curve and driving in the rear view mirror as they believe that an inflated and over saturated market like housing can be sprung back to life when vast swaths of the economy are unemployed or under-employed.
The FED is obviously basing their assumption on the post WWII experience in our economy where housing, autos and retail tended to lead us out of recessions. In the current situation housing is in a post bubble environment and the excess capacity and lack of strong demand due to the unemployment levels is not going to be helped by just lowering rates, prices have to fall further to get the sector moving. The current U6 numbers which unlike the headline U3 number paint the broadest picture of the health of the employment market show that seasonally adjusted 17% of the potential labor force falls in to this category and non seasonally adjusted the figure is 15.9%.
While both U6 figures are down slightly from the month before the numbers are skewed because there are a great number of people no longer counted as they have exhausted the 99 weeks of unemployment granted by Congress, at which point the BLS just magically removes them from the count. In this manner we do not get the true picture of unemployment even though the markets trade off this erroneous data. The website Shadowstats.com tracks the unemployment data as well as other now bastardized government statistics using the “old school” methods to give its subscribers a clear picture and according to them the U6 number is actually hovering around the 22 mark.
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
The statement goes on to state that the FED stands ready to keep in place the current policies that are essentially providing for negative real interest rates. The FED justifies this by stating that there is low resource utilization and subdued inflation trends, hello? Earth to Bernanke have you been shopping lately or looked at a financial channel? We do have inflation here and now food prices up, grains up, precious metals up, oil up, and the list goes on as all the cheap money is finding a home in a multitude of markets. Of course we are exporting a tremendous amount of that inflation abroad to emerging markets as well, which is why we are hearing pontifications from China, Brazil and even Germany. Apparently every one but the FED can see the inflation and the markets are roaring based on inflation expectations which the FED doesn’t see according to their statement. The FED still lives by Allan “Mr. Magoo” Greenspan’s declaration of how it is impossible to see a bubble when you are in it only afterwards is it obvious. Not everyone can see it but the bubble is in the Dollar, US housing debt and US Government debt.
The FED has not changed its solution one bit as they still believe that the best method to get the debt under control is to issue more debt and pay for it by printing money. It is a crazy solution, just like you don’t cure a heroin addict by continuously giving them more heroin, this only leads to death. It would appear that in order to save the patient that being the US economy we must kill the Dollar. Albert Einstien once said “the definition of insanity is doing the same thing over and over all the while expecting a different result”. The FED and its many supporters have so deluded themselves by putting stock in their gerrymandered models and statistics that they cannot see the forest for the trees and can’t figure out what will really work anymore so they have fallen in to the insanity trap.
As long as the FED keeps printing money and pegs rates so artificially low that we have negative real rates “things” have nowhere to go but up. Which brings me to an article I saw over the weekend that made me chuckle on the Motely Fool website. The author of the article proclaims that gold will go to $500 an ounce because it has to fall back toward a reversion to the mean price which according to the authors’ convincing statistics is $500. The article is well written and the author makes some fine points but I disagree with his conclusions and I would be much more worried about the price of gold if articles like this one were not appearing and instead the mainstream media was proclaiming that gold and or silver were the ultimate assets going to outrageous prices. As of the moment we are very far from the precious metals or even “things” being widely coveted regardless of how much or little they have risen. Yes there is more press regarding investing in precious metals and things but the reality is that as a percentage of investible assets these areas are barely a blip on the radar screen at the moment.
The trade may be more crowded than a couple years ago but it is hardly crowded enough to be discussed in polite company, when it is will be the time to look for the exits. Even with all the great analysis in the article the author misses the one point of why gold is doing what it does so well store value. All you have to do dear reader is look at this chart that I got from the Von Mises website put together by Sean Malone and you can see that the author of the article talks about gold value in dollars but dollars are not constant and gold reflects the strength or weakness of the dollar as well as confidence in it. This picture is worth $200 Trillion words.
“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. “
The FED goes on to basically give a disclaimer that they will be watching the situation and will take action as they see fit using tools they see fit without committing to a timeframe. Open ended statements like these from the FED are nothing new. They are being deliberately vague as this way they can justify any situation and implement either QE 2.5 or QE 3 once the current program fails just like QE 1.0.
I have heard the argument that the Republicans will impose discipline or that President Obama has gotten the message and will instruct Bernanke to cut out the money printing. I just don’t buy this as I don’t believe the Republicans who just got out of the dog house will make the unpopular giant deep cuts needed and will push to keep or even increase tax cuts. As I had stated prior the figure on cuts being bandied about by the cost cutting Republicans is $100 Billion which is but a drop in the bucket. On the flipside the odds that Obama has truly gotten religion and would instruct the FED to reduce its operations I believe is farfetched. First I don’t believe that Obama sees what Bernanke is doing as a bad thing since he is crediting the policies for “pulling us back from the brink” and second while the President appoints the FED chair for a 4 year term (Bernanke’s term ends in 2014) the FED operates independently and the government has little control over their decisions. FED policies and decisions do not have to be ratified by the President, legislature or legislative branch of the government so they can act to impose the policy they believe is needed whether popular or not; just think back to Paul Volcker in the early 1980's and his rasing of interest rates to the double digits . It is true that the FED derives its authority form the congress and is subject to congressional oversight with a divided congress it is doubtful that any binding action would be passed to stop any of the FED’s plans. Basically it appears to me that Bernanke has the green light to continue on with the great financial experiment otherwise known as the US economy.
I have more thoughts and observations of QE2 and I am sure dear reader that you are tired of hearing about QE in general, but it is vitally important for our collective financial well being to understand the implications. In financial markets knowledge is power but applying the knowledge correctly converts that power to success. Tonight or tomorrow I will put up the second half of this missive…until then happy investing!
Tomorrow's Post (11/9/2010) "The New Alchemists"