So, the spinner heads at the Central banks got together and in dark rooms like an old gangster meeting they lay out a plan. It goes sort of like this…. “Hey fellas, we have a lousy economy. We need to get people spending so maybe companies will make things again. If we can get folks to open their wallets and create some demand, maybe we can keep out of a depression.”
You all know what happened. During a question and answer period a week ago, Bernanke hinted that he wouldn’t mind seeing QE start to taper off later in the year and maybe end in 2014. While he didn’t make a single actual move, the markets all around the world reacted violently. On just Wednesday and Thursday alone, we lost almost 6oo points. Then on this past Monday we opened ugly and within an hour were down another 240. While Monday’s sell off was in response to some ugly noise out of China, we must face the facts. The entire market has been built on Bernanke’s easy money. Just the thought of him pulling it back sends shock waves of terror across the land.
But it is real? I mentioned the other day that I personally do NOT believe QE will end. If just the mere mention of it ending tosses the market around for hundreds of points, and pushes bond yields up so fast we’ve really never seen it before, what happens if they really did end it? The results would be catastrophic. But you have to understand why. The stock market falling for thousands of points is just one aspect of a ripple effect that would turn into tsunami’s crashing into the global markets.
I’m going to say something that is ugly and politically incorrect. But it is indeed fact. For the most part the American public is brainless as a baseball when it comes to what is really going on. I know that’s pretty rough, and I don’t say it to be mean. But consider this. Do you know why they like to boost stocks and housing? It is called the “wealth effect”. When people see their 401k’s rise and the supposed value of their homes rise, they feel better. It’s all about the feelings folks. When they “feel” better they don’t mind spending more money. Does it matter that they shouldn’t’ be spending? Nope. Does it matter that the wealth effect they’re reacting to was artificially stimulated? Nope. Like Pablo’s dogs… when the bell rings, they run out and buy things they don’t need with money they don’t have. They used credit. I’m sorry but that’s just stupid.
So, the spinner heads at the Central banks got together and in dark rooms like an old gangster meeting they lay out a plan. It goes sort of like this…. “Hey fellas, we have a lousy economy. We need to get people spending so maybe companies will make things again. If we can get folks to open their wallets and create some demand, maybe we can keep out of a depression.” So what do they do? They push the buttons and pull the levers that will create a rise in stocks and housing. Sure enough for the most part it worked. The simpletons that listen to their 6 pm newscasts heard daily about how the economy is roaring and stocks are proving it. Housing was recovering they said (over and over and over) so they broke out the credit cards. They ran out and bought cars. “Hey we can afford it, the stock market’s at an all time high!”.
But there’s a few fly’s in the ointment. Since it was simply the Fed money that allowed stocks to rise and housing to stop crashing, with companies now going on year 6 without expanding or growing or hiring…nothing would or will take the place of all those Fed billions if they stop. Thus, the wealth effect dies on the vine, people stop spending again and the gears jam up. If that however was the only ill effect, we’d be okay. People should stop spending in the first place. Unfortunately, losing the wealth effect spending is just one part of a multi pronged fork. There are many other things that we need to consider.
Most fail to grasp the degree to which the "recovery" will stall without the $85 billion per month that the Fed is currently pumping into the economy. Like Peter Schiff said, although Bernanke dodged the question in his press conference, the Fed has broken the normal market for mortgage-backed securities. While it's true that the Fed only owns 14% of all outstanding MBS (the "small fraction" he referred to in the press conference), it is by far the largest purchaser of newly issued mortgage debt. What would happen to the market if the Fed were no longer buying? There are no longer enough private buyers to soak up the issuance. Those who do remain would certainly expect higher yields if the option of selling to the Fed was no longer on the table. Put bluntly, the Fed is the market right now and has been for years.
Interest rates are already rising rapidly based simply on the expectation of tapering. Imagine how high rates would go if the Fed actually tried to sell some of the mortgages it already owns. But the fact is the mere anticipation of such an event has already sent mortgage rates north of 4%, and without a lifeline from the Fed in the form of more QE, those rates will soon exceed 5%. This increase will greatly impact the housing market. Speculative buyers who have lifted the market will become sellers. More foreclosure will hit the market, just as higher home prices and mortgage rates price any remaining legitimate buyers out of the market. Housing prices will fall to new post bubble lows, sinking the phony recovery in the process. The wealth effect will work in reverse: spending and confidence will fall, unemployment will rise, and we will be back in recession even before the Fed begins to taper.
Then of course we have the issue of Treasury debt itself. Bernanke and the Fed heads have told us over and over they’re really not monetizing all that stuff (wink, nod) yet clearly he’s been the buyer of about 70% of ALL Treasuries for a few years now. Why is the Fed buying all the treasuries? Because no one else wants them. Seriously. So, if he were to end all that buying, what would have to happen? Well to get folks to buy them, the yields (interest rates) would have to soar. Well guess what? They’ve soared just on the hint of tapering QE, let alone ending it. The 10-year has jumped from 1.6 to 2.6 in just a few weeks. That’s the fastest jump in 50 years. On a rumor of a taper!
Okay, so what? No so what. If he isn’t buying those 70% of issuance, then they have to try and sell them on the open market. Let’s Call Russia and China and Japan and see what they’ll need to buy up hundreds of billions in Treasury debt. I’m thinking 5, 6% minimum. But of course if rates go to 6% to lure Treasury buyers, companies aren’t going to finance buy backs. Or plant expansions. Or hiring programs. Housing will retreat again. Foreclosures will rise again.
Unfortunately there’s still more. Remember those nagging words “budget deficit?” Well if we’re spending a huge amount each year to service our debts in a “zero interest rate policy” world, how are we going to service them in a more natural order of rates? Our national debt and our deficits per year will soar once again. Can we afford that? Is our tax base growing? Of course not. The only thing growing is permanent disability and food stamps.
So as you can see, the Fed has built an economy based on the Fed. Without their billions, we implode. We crash. We endure giant economic pain. While that is what SHOULD happen, to clear out the whole system and rebuild it correctly, are they really going to let that happen? Remember what I said about Bernanke and his “teaching”. He said over and over that he worked on the Great Depression as his life study. He said he could fix anything like that from ever happening again. Yet if he stops his printing policy, we roll over into a dark depression. Is he willing to be proven wrong and he didn’t have the right medicine to prevent a melt down?? Not likely.
I say this. He talks about tapering. He continues to tell us that they see growth, but it’s just missing the mark. He tells us he wants to taper and cut it completely, but we’re just shy of being there. Over and over he jawbones it. Yet in the end, it doesn’t go away. The only logical way I could see a taper is what I said a few weeks back. Maybe he cuts back from 85 billion to 65 billion at the year end. Then in January he is replaced as he steps down and the new Fed head reacts by jamming even MORE QE in the system. That way the new guy gets to look like a hero right off the bat. I could indeed see that. But to end QE? Not a chance.
Oh and by the way, this monetary experiment in fiat silliness of course hasn’t been confined to the US. China is coming a bit cleaner lately about their policy and basically said that they had misallocated too much money. What they mean is that they too blew a big economic bubble and it isn’t going well. China is on the verge of a “Lehman’s” moment as its shadow banking system implodes. China had pumped roughly $1.6 trillion in new credit (that’s about 21% of GDP) into its economy in the last two quarters… and China GDP growth is in fact slowing. Imagine that.
But here’s where I think it really gets sort of Twilight zone. If I’m right, they’ll talk of taper. They might even give us a couple months of say 65 billion instead of 85 billion. The markets will try and fend it off, an act brave but we’ll be weak. Then the new guy steps into the Fed chairman’s slot and increases QE by MORE than 85 billion. Yet the reaction will be a bit different that time. By then everyone and his brother will be aware that the only reason they’re in stocks at all is because of Fed money, and the stock market won’t run as wild as it did. It might jump big at first, and then maintain a level, but no crazy 3K-point runs. It is at that point where the final chapter might be written and we crash into chaos.
Chaos is coming. It’s coming if the Fed really did quit QE and it’s coming if they don’t and we run over the financial cliff. I’m just thinking that it is in their best interest to run the QE programs and hope beyond hope that one day something good comes of it all. Otherwise, Bernanke is proved to be yet another Keynes fool, and his entire reputation ruined. He’s had 6 years already. He knows he better abandon ship while he can still go to cocktail parties. Let someone else mop up the mess. Oh, and what a mess we’re in for. Stay safe.