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Monday, November 1, 2010

To QE or Not To QE….That Is Not Even the Question Anymore...

Apologies dear readers... due to circumstances beyond my control this post is being submitted now as opposed to late morning or early afternoon. Thank you for your understanding.


Shakespeare penned his now famous quote “To be or not to be that is the question” in his opening soliloquy of the third act in his play “Hamlet”, written around 1600 AD. In this quote Hamlet is contemplating the moral legitimacy of suicide and whether to live or to die. As we approach Election Day tomorrow and the FED meeting on Wednesday this quote sprung to mind.  The country appears to be asking “to be or not to be”; in other words the question is do we attempt to go back toward the America of old or do we continue to the America of present, that is the question.


I want to start with the election because that is the first uncertainty that the markets will have removed. It currently appears as if the Republicans will take the House of Representatives and possibly get control of the Senate too, but I think that is more of a long shot. What does this mean to the markets? Judging by the activity today, the markets are in a holding pattern awaiting results, just like a tired business man traveling on a late winter’s evening trying to land at O’Hare during a blizzard.  The markets are looking to confirm what they believe is true and I have a gut feel that we are in for a sell off once it is confirmed how pervasive the losses are for the Democrats; it will be the old buy the rumor sell the news. I believe that the “Republican wave” scenario has been baked in the cake and the markets will pop first to wait for the FED then reset to reflect the new reality once the uncertainty cloud is lifted. I guess we will find out soon though.


The markets have been anticipating the “gridlock” scenario which has been traditionally a positive as government is too busy fighting itself to act. The markets feel that the houses of congress will take their eye off the ball and not impose more ridiculous and or draconian measures there by removing the jack boot of the partially clad female dressed in the Nazi SS uniform from the throat of the economy, as Woody Allen might envision. While I do believe that we will face gridlock and this will stop the “Obama” agenda in its tracks which on the whole is a positive for the economy, I also feel that you need to be careful what you wish for.


Gridlock worked very well in the past, however, this is a different America then in the past. The last time a power shift like what could be happening tomorrow occurred was back in the days of Newt Gingrich and the “Contract with America”, but the country is in a far worse predicament today then under Clinton. Back in the 1990’s we had a budget situation that was on much more stable ground and we had people in positions of power who could actually take charge. What I see is a “leadership gap” to parphrase Mr. Obama. Today we don’t have real leaders who take charge and work together across the aisles. We do not have politicians that understand what to do but instead their main goal is to wrest power from the opposition and or smear them; which is not exactly a formula for bipartisan compromises.


The danger lies in the fact that today more than ever we need action but that action has to be tempered using the checks and balances of both sides working together. Congress and the President must work together to craft compromises to move us forward not dictate solutions and shove them down our throats.  We need real solutions for the economy and just taxing or just spending which is not going to fix the problem. The markets will in all likelihood get their gridlock fantasy but it will not play well because politics and rhetoric will come before genuine repairs. I believe that the markets will rally in the near future because the FED will have its hand forced by this election and be forced to take additional action since congress cannot.  I stated earlier I believe we get a drop initially after the pop from the election and FOMC meeting, but then the reflation trade will be on again.


The second “to be or not to be” moment this week is brought to you courtesy of the Fed and in essence the FED has telegraphed its intention to bring on line its QE2.As the market sage Richard Russell has been quoted it is “inflate or die” and this is exactly what the FED and “B52 Ben” in particular have been pondering. To QE or not to QE; said a different way do we live through a painful adjustment in our monetary system or do we die in an inflationary supernova; that my dear reader is the question.


I am sure you have heard the expression about dying by a thousand cuts instead our monetary system and way of life is destined to die by 1000 pumps.  Ever since the Jackson Hole meeting where “B52 Ben” stated that the FED found the inflation rate to be to low and unacceptable the markets took off to the upside. I believe that while the FED wanted to goose the markets in an effort to reflate the economy but they did not anticipate the breadth and height of the accompanying rally. Over the past couple weeks the FED has in turn paraded out a variety of officials using MOPE to temper the enthusiasm regarding “B52 Ben’s” level of quantitative easing. The markets are a kin to crack addicts and require ever more of the easy money crack to keep everything rolling to the upside. I believe that QE2 will not do anything except stoke inflation and provide a temporary respite from the market problems of today; it will be necessary to implement QE3 and then QE4 until the world will not tolerate anymore QE aka the day of reckoning. I still maintain that the QE scenario reminds me of the problems with the French Assignat which I detailed in my post “America needs Virtue Not Mr. Soros” .


In an analysis by Eric Sprott of Sprott Asset Management back in May 2010 titled “A Busted Formula” I discovered a tasty nugget that demonstrates why QE fails to do anything for the economy while it stokes inflation. For each dollar of deficit spending, which is what QE essentially is since they print the money to buy treasuries to introduce money in to the system, it only has .09 cents of GDP impact.  The QE money may not do much to bolster the GDP figures but the money does have to find a home and it usually will inflate the markets. The trend of late though has been for the money to find a new home abroad primarily in the emerging markets and you can see this by looking at them. While the US markets have responded to QE, the emerging markets have essentially gone vertical and not just Brazil and China but also Singapore, Taiwan and Malaysia. Interest rates are higher and growth is progressing at a nice pace in the emerging markets of course they are smaller and less developed  markets so the FED’s QE is blowing bubbles but this time outside the US. QE is creating inflation like the FED wants but just not where it wants it, moreover, the governments of the emerging market countries are not happy about it and this is the reason for discord in coming to an agreement on currencies as demonstrated at the last G20.


In the mean time we have a dichotomy in the economy where the ERCI leading indicators have been ticking up for the past couple weeks at the same time there are loads of headwinds in the economy. There is still chronically high unemployment, “Foreclosuregate”, housing overhang, huge budget deficits(federal state and municipal)  as far as the eye can see, Financial entities with fraudulent balance sheets(think banks and Fannie and Freddie) a large tax increase with the roll back of the Bush cuts, health care spending, social security, medicare, 2 hot wars, and various unfunded liabilities to hinder any recovery. The sad thing is I could go on but I could hear you dear reader screaming uncle, uncle already!


So what is the FED to do? Right now the QE inflation is being exported as I mentioned and they don’t want to spark a out of control inflation here so they parade out various FED members to tone down QE expectations. It worked, the contradictory statements caused the markets to put the brakes on before doing a space shot because uncertainty was injected into the market; classic MOPE in action. In the mean time there have been reports that the FED has met with the usual suspects to discuss how big QE should be, which is a bit like the lunatics guarding the asylum. Goldman was out stating that they felt that $4 Trillon was the number needed but they were expecting $2 trillion in QE; to this I say of course Goldman would want that much. Then various FED members alluded to a $500 Billion figure which is more measured and did cause the markets to slowdown.


The bottom line is we know there will be QE2 and in all likelihood when it fails as QE1 did the FED will pursue a QE3 and QE4 if needed, of course the dollar won’t be worth the cotton it is printed on by then.  As the old saying goes If your only tool is a hammer everything looks like a nail and the FED talks a good game but they have done all they can with rates and are left with QE. The FED may adjust what they buy but it will still involve printing money to buy assets to put on their balance sheet.


At this point QE is basically an intravenous line for the economy as without it many things would come apart at the seams from Federal and State budgets to financial entities all of which are held together by bubble gum and scotch tape. There is too much debt that cannot be serviced, too much spending that could not be done and too much smoke and mirrors for “extend and pretend” to work without mainlining QE. The FED knows if it withdraws QE that the system is vulnerable as well as they are all too aware that a shock and awe QE campaign would “jack up” the whole system to ridiculous heights. I believe that Wednesday the FED will come out with a moderate $400 to $500 Billion dollar package but they will use language to keep it open ended. I highly doubt that this will be the last QE as the FED is determined to avoid deflation and the surest way to do that is to debase the currency and over the longer term the Dollar is sure looking more and more like a nail.

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