What Does $145 Million Per Hour Buy?

 March 11, 2013

If you though the President and Congress were spending a lot of money ($3.6 trillion per year), you may not realize that the Federal Reserve (Chairman Bernanke et. al.) is also printing and distributing $147 million dollars per hour 24/7 to the major banks (including foreign banks with domestic branches).


The banks are using this money to increase assets, reduce reserve requirements and buy assets (including equities, bonds and commodities). This is one way to help the banks and lift the stock market which then reinforces the assumption that we are out of recession and the economy is growing.

This program (increase debt to get out of debt) by the Federal Reserve is being touted by government economists and most of the media as courageous and beneficial. Here is what it brought us in the 4th quarter. Federal Reserve spending over $300 billion, GDP up $5 billion and a growth rate of 0.01%.

Stay on your toes,

More Of The Same

February 13, 2013

Opinion

The President's message last night was, as expected, simply more of the same: More spending and more taxes.

It was expected because the presumptive opinion in America (as defined by politicians, economists and the media) is that the government will find a way to deal with our problems -whatever they are- and that we do not need to worry.

This view, made popular during FDR's reign and reinforced and expanded since by both political parties, believe that the government can and should inject itself into the economy because the economy needs to be managed. That market forces cannot do the job.

The president said we need to do more. I interpret that to mean we need to take more money from the people who earned it, the producers, because the 50-60+% percent being taken now isn't enough or even fair. And besides, the government knows how to spend this money better than the people who earned it.

You may think differently but right now we live, work and invest in this Keynesian world; therefore, going forward we can expect the following:

1. Governments (all levels) will continue to spend excessively and borrow or print more money because there is no incentive to stop (see ZIRP below.) When the States get into trouble, they believe the Federal Government will bail them out.

2. The Federal Reserve will continue their Zero Interest Rate Program (ZIRP) for as long as they can to help banks (it's their job); and to keep interest rates low to "help" people buy/refinance their homes. And maybe one other thing, the Federal Government can't afford to have rates rise because every 1% rise in interest rates will cost the government over $150 billion per year in additional interest.

3. Currently, the Federal Government is running close to $100 billion per month in deficit spending and the Federal Reserve is printing and pumping in another $105 billion per month. The results so far are not too good however. Preliminary Fourth Quarter GDP decreased at an annual rate of -0.1%. But, it's only been four years.

4. Normally, increasing money supply causes inflation. However, even with the trillions of dollars injected into the economy, we do not see inflation as measured by the Consumer Price Index (CPI.) One reason is of course the way CPI is calculated. The other is that the money being injected by the Fed is going directly into the banks. The banks are not lending the money because they can make more money by buying assets (stocks, bonds, currencies, foreign investments, etc.)  

4. Therefore, we have a kind of stealth inflation because real inflation is not visible in the usual places. However, inflation is visible in asset prices (stocks, bonds, metals, etc.) because that is where the banks are "investing" their free or almost free money from the Fed.

5. This kind of malinvestments will eventually cause "cost-push inflation" (increased costs of materials including energy and labor will force prices up and thereby reduce supply.) Reduced supply then causes prices to increase.

6. Today, the government cannot raise rates to combat rising prices (remember Paul Volker) because U.S. debt is too large and interest on the debt would become unaffordable. Nominal rates on the 10-year Treasury of 5% would increase interest payments close to the size of the Defense budget.

So what do we know after the President's speech? The government is going to keep pumping money into the economy raising nominal GDP, asset prices (including the markets) and inflation. We will need to continue investing like a Keynesian whether you believe in this dogma or not, but keep an eye out for the black swan.

Will The Fed Print More Money?

April 12, 2012

This is an important issue right now, especially in this election year. Consensus is mixed, depending on one’s view of the “recovery”, but the market appears to have melted up in anticipation of the Fed injecting more money into the economy. Then, when the minutes of the last Fed meeting were released on March 19th, the consensus of the committee was that the economy was slowly improving but they acknowledged that employment was still a concern. Therefore, additional accommodation (printing money) by the Fed may not be necessary. However, since then, the market has begun to sell off and one reason is its disappointment with the Fed’s position to not inject more money right now. Do you think the Fed really means this? Here are some thoughts from the different sides of this argument.

The Keynesians (mostly Democrats) View

In a recent article in the New York Times, Paul Krugman argued the following:
1. Because the Fed expects low inflation and high unemployment, the Fed should be much more accommodative in order to accelerate the recovery. If we don’t, we will choke off the recovery.
2. The reason we would not be more accommodative is the Republican’s misplaced fear of inflation.
3. But, we can’t worry about inflation; we should be more worried about employment. In fact, inflation of 4-5% would be a good thing. Not a bad thing.

The Keynesian-Lite (mostly Republicans) View

In a recent report written by Brian Wesbury of First Trust, he argued the following:
1. The Fed has finally admitted the economy has improved and took QE3 off the table. There is no need to print additional money.
2. Monetary policy has been accommodative, but monetary policy is not the driving force behind the market, profits are…and profit growth will continue.
3. The Fed will start raising interest rates before its stated date of late 2014. Increasing rates will keep inflation in check.

Capitalists/Austrian Economists View

1. The economy is still in recession as none of our problems have been solved. But, the Fed has already printed too much money and is prolonging the recession with additional injections of money. The only think they have accomplished is unsustainable debt and they are laying a foundation for inflation.
2. We have printed and spent $8.5 trillion dollars in the past four years. This money has raised nominal GDP. That’s because GDP is a mathematical model in which every new dollar created adds (arguably because nominal GDP has risen only $1.4 trillion) a dollar to GDP. But now the money has been spent, we have the debt and real growth has not occurred (8 million jobs lost, 7 million homes in foreclosure, banks under capitalized, interest expenses exceed 10% of income (tax revenues), wages have not kept up with inflation, sovereign, corporate and personal debt, etc.)
3. Now however, the pace of new money creation has slowed for the past two months. Because the money created with credit has been spent, the Fed has to create more money each year than it created in the previous year or the total amount of money supply contracts…. which contracts GDP.
4. Also, Bernanke and the Fed believe we are in a cyclical recession (normal, shallow) versus a systemic recession (major, caused by structural changes.) Therefore, they believe they can fill the spending “gap” with government spending which draws consumers back into the market and ends the recession. This recession is far more serious than a temporary gap in consumer spending.

Conclusion

This recession is far more serious than a temporary gap in consumer spending.
We have below trend growth and stagnant incomes and we have an election year. Do you think the politicians will print more money and kick the can down the road past the election or opt for austerity and a return into recession? I think the answer is they will print more money, but they need “an excuse” to do so (i.e., a bad jobs number or a market sell off or a war or?) because some voters are worried about our ever increasing debt. Therefore, we are now on a path toward more money, more debt or a deeper recession.

Update on Scenario One

July 8, 2011

Scenario One still remains the most probable of my four scenarios. However, if the government or the Central Bank deviates from the “expected” course (from a capitalist point of view) other scenarios might become more probable.

Also, here are some assumptions to consider:

1. The following chart uses the S&P500 index to illustrate this scenario because it is easy to visualize.
2. My assumption is that money supply drives the economy or GDP (and there is a lag time involved here.) Increasing GDP drives business revenues and profits which then drive stock prices.
3. Money supply will slow up beginning in June but will expand when re-election fears really kick in and new “government help” adds stimulus (money creation weather it’s spending or tax reductions unless paid for) to drive up GDP in time to help with re-elections.
4. Serious spending cuts will be postponed until after the election.

Following is a brief description of each point on the chart.


Point 1. Housing bubble bursts and banks become insolvent. The government decides to save the banks by using taxpayer money to “keep them solvent” rather than demanding that the banks try to convert their bonds into equity. Recession is underway.


Point 2. March 2010. The massive increase in money supply which artificially and temporarily increases GDP begins, but results in malinvestments or bubbles. For example:
a. Interest rates reduced to zero and held there
b. Stimulus Programs begin (over $800 billion in stimulus spending and unpaid for tax cuts) plus $1.5 trillion in deficit spending,
c. Mark-to –Market accounting rules revised (allowing banks to increase the ”value” of their mortgage bonds to boost their equity and reserve requirements,
d. Central Bank buys “toxic bonds” from the banks (QE1) increasing ”excess reserves” at banks to $1.1 trillion from $4 billion,
e. November 2010, QE2 begins ($600 billion more pumped into banks but most of it ends up in foreign banks)
f. Money supply increases at double digit rates for 28 of last 29 months (see assumption 2 above.)


Point 3. May 2011. There is a “short-term” stock market top and correction due to anticipated contraction of the pace of money supply and other headwinds including slowing global growth and debt problems. For example:
a. Stimulus ending in June
b. QE2 ending in June (a and b both will contract money supply which will reduce GDP)
c. Debt ceiling “argument” (raise limit by $2-3 trillion and get more fiscal stimulus or austerity) deadline by August 2
d. Reductions in U.S. GDP (Central Bank reduces growth rate in June) and Global GDP rates
e. Increasing inflation rates (headline and core)
f. Housing still a big problem
g. Unemployment slowly getting worse
h. Earnings (Qr 2) in July should be at or near expectations but analysts are already cutting earnings for second half of 2011. It will be a negative for the markets if companies do not confirm current growth rates for second half.

Economy and markets will become more volatile and trend lower until the government “solves” the problems with more money creation, which is what I expect. Or some kind of austerity program including reduced spending is put in place, which I do not expect. However, if austerity happens, my Scenario Two (continued decrease in economy and markets) would come into play.


Point 4. Labor Day or possibly sooner (for example by the August debt ceiling limit) depending on our central planners (government and the Central Bank) the money supply will again increase raising GDP (with a lag) and then revenues, profits and markets. This up turn will last longer (with corrections along the way.)
a. My guess, debt limit increased with promise to cut spending starting in 2013 (after next elections)
b. As economy drifts lower, the pressure will be on government to “do something.” Therefore, I expect a new stimulus program (significant tax cuts because Republicans will have to vote for them and Democrats will get their stimulus because we will borrow the money displaced by the tax cuts)
c. New QE3 program (large) so central bank can continue to buy bonds and keep interest rates low (for housing, employment, etc.) This may be called something else so it can be framed differently for public consumption.
d. Timing of new stimulus for 2012 elections will become important to allow for lag time and momentum prior to elections.

Point 5. Top of Bubble (Sept-Dec 2012 +/-) caused by the huge increase in money supply added over the years and the malinvestments that have occurred as a result of this increased money supply. This bust will cause a very deep recession illustrated by the S&P500 going back down to 600-650 area.

Point 6.January 2015. Long period of stagflation with low, real GDP growth rates of 1-2% and high interest rates due to inflation.

Commodities and the Evil Speculators

When commodity prices rise to the point that constituents start calling their congressperson, something has to be done; and that something is to:

1. Blame someone other than politicians for the problem,
2. Attack the "symptom" (rising prices) rather than the cause and
3. Focus on and talk about the benefits (winners) and ignore the negative consequences (losers.)

That is exactly what the government did last week when they raised margin requirements on silver five times in five days increasing the total margin requirements by 84%; and then raised the margin requirements on oil.

The net result of their "margin increase" policy will be to disrupt the market for a short period of time (creating some winners and some losers,) BUT that short-sighted policy does not change the long-term trend of rising commodity prices because it does not attack the "real cause" of rising commodity prices.

In addition to supply and demand issues, the government and the Federal Reserve are addicted to borrowing and printing money as a way to stay in office. Increasing the money supply (demand) without increasing supply devalues the dollar. This means commodities prices raise to compensate for the devalued dollar. It's pretty simple.

If you are an investor, this correlation is an opportunity to "speculate." But, if the government stopped printing money or contracted the money supply, commodity prices would fall. However, if you think speculation is bad now, wait until people recognize that higher commodity prices are not "transitory." Then, commodity speculation will consume almost everyone like it did housing ("You don't flip") a few years ago.

May 12, 2011