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Today, the January Jobs Report indicated that the economy created 243,000 jobs in January and the unemployment rate dropped to 8.3%. That sounds good and most of the “experts” were screaming that this more proof that the economy has turned around and job growth will continue. What they didn’t do is look beyond the headline.
First, I was startled when I heard the headline numbers. Here is the context behind the numbers. Last week, Chairman Bernanke said the economy was soft and lowered his GDP growth estimate, extended the zero interest rate program through 2014 and implied that he was ready to intervene with more money creation if necessary. That doesn’t sound like the environment for “surging” new job growth.
So here is some information behind the headline.
1.A record 1.2 million people fall out of the labor force (these are people who are no longer looking for a job.)
2.This means that the percent of the population that would like to work dropped to 63.7%. The long-term, historic percent is 65.8%. This is important because this is the number they use to determine the unemployment rate. This is 5 million people less looking for work than is normal; and with 5 million less people you get a much lower unemployment rate. And baby boomers are not retiring like many assume, In fact, their participation rate in increasing.
3.Part-time workers increased by 699,000 and full time jobs increased by 80,000 jobs. So about 10 percent of jobs were full time.
I am not saying there is a conspiracy to improve the numbers. It is the way the math model works. But it does demonstrate that you must look beyond the headlines to get the real story.
Friday, February 3, 2012
Thursday, January 26, 2012
Why Is The Market So Optimistic? What’s Changed?
It’s not the economy. Not much has changed there except for a few of the many antidotal data points that are published each month. The expert’s points to three or four of the 30 reports published every month and conclude that they signal that the economy is recovering. Most don’t look at the context surrounding the data point so they don’t know what it means (do you think the guy writing headlines knows how the CPI index is adjusted for quality improvements verses price increases) or even if ”that data point” can be used to forecast the future.
There are two things that have changed. One, we continue to pile up debt (now exceeding 5 times our revenues) at a rate of $4 billion per day increasing the probability that we will have to eventually default on our sovereign debt. Two, the Federal Reserve continues to print money in increasing amounts and in many different ways like helping the European Central Banks with liquidity, or running a “Twist” program here to bring down long term rates, or the Zero Interest Rate Program (ZIRP) to help the banks and hurt savers (and force them into higher risk investment to earn any return on their investment.)
Then, yesterday, Chairman Bernanke announced that he intends to keep ZIRP in place through most if not all of 2014. Remember, both political parties were angry with Chairman Greenspan for the housing bubble because he held interest rates at one percent for a year. Bernanke intends to hold rates at zero for four years! And then, just to make things worse, he said he would be willing to “be more accommodative or in English, print more money) if the economy gets worse. Oh, by the way, he revised his estimate of GDP growth down another quarter percent.
Money supply data shows that the Federal Reserve has continued to increase the money supply and has increased the pace in the past month. In spite of what Bernanke says, this is money printing (QE3) pure and simple. Since we know that increasing money supply is how you increase GDP, the markets are pricing in the increased money supply.
There are two things that have changed. One, we continue to pile up debt (now exceeding 5 times our revenues) at a rate of $4 billion per day increasing the probability that we will have to eventually default on our sovereign debt. Two, the Federal Reserve continues to print money in increasing amounts and in many different ways like helping the European Central Banks with liquidity, or running a “Twist” program here to bring down long term rates, or the Zero Interest Rate Program (ZIRP) to help the banks and hurt savers (and force them into higher risk investment to earn any return on their investment.)
Then, yesterday, Chairman Bernanke announced that he intends to keep ZIRP in place through most if not all of 2014. Remember, both political parties were angry with Chairman Greenspan for the housing bubble because he held interest rates at one percent for a year. Bernanke intends to hold rates at zero for four years! And then, just to make things worse, he said he would be willing to “be more accommodative or in English, print more money) if the economy gets worse. Oh, by the way, he revised his estimate of GDP growth down another quarter percent.
Money supply data shows that the Federal Reserve has continued to increase the money supply and has increased the pace in the past month. In spite of what Bernanke says, this is money printing (QE3) pure and simple. Since we know that increasing money supply is how you increase GDP, the markets are pricing in the increased money supply.
Monday, January 16, 2012
We Must Change The Way We Look At The Economy
Until WWI, America was a booming Free Market economy. By 1890, American manufacturing output surpassed that of Great Britain. In 1913, Henry Ford paid his employees $5 per day which equates to $10,000 per month in today’s inflated money.
America thrived because Free Markets are driven by entrepreneurs making decisions based on the knowledge they have, how they viewed the future and their willingness to take risk. Unavoidably however, not every economic decision can be correct; therefore Free Market business cycles are prone to some excesses and recessions. Without government interference, these shallow business cycles were generally short-lived and produced tremendous economic growth.
Today’s economy and markets are fundamentally different than those of the past. Expanding government interference in the economy has slowly changed our economy from a market based, entrepreneurial economy to one that is Centrally Planned. America’s current economy is driven by politicians and their friends: favored corporations and their lobbyists who are often referred to as “capitalists.” One result of this transformation from a Free Economy to a Centrally Planned economy is that short, self-correcting cycles have evolved into volatile bubbles and busts.
The individual, economic decisions of 320 million citizens that drove the Free Market economy has been supplanted by an elite gang of politicians and their favored corporations. The economic “experts, ” the pundits and the media prove this every day with their constant calls for the government “to do something” - to solve the debt crisis, to create jobs, to invest in green energy, to fix the housing problem. The American economy is being transformed from an entrepreneurial-based, manufacturing economy to a financially based services economy dominated by the political class and their favored, financial institutions.
Central Planning is bringing our economy to the edge of disaster
Markets are no longer focused on companies and their future prospects, but on media headlines made by our Central Planners. Yet it has been proved over and over that central planning does not work no matter how much the politicians want to help. It is impossible for a few elite politicians to know the wants, needs and preferences of 320 million people, let alone the complexities of a $60 trillion dollar global economic system.
Central planners make decisions based on political concerns and personal agendas. As a result, they interfere with the economy based upon political expediency, not fundamental economic reasoning. Their political concerns create a paradigm of decisions that are naturally shortsighted, and they generally get fiscal and monetary policy wrong. The hubris and power of the Central planners means they can never admit they were wrong, which leads to more interference, more short-sighted decisions and more damaging fiscal and monetary policy decisions. The Central planners are leading us to the edge of disaster.
The Yellowstone National Park fire
The Yellowstone fire of 1988 provides an excellent analogy of what has been going on since WWI. Yellowstone National Park was created in 1882 and is managed by The National Park Service in Washington, D.C. There are about 35 forest fires each year caused by lighting and about 6-10 fires caused by man.
Until the mid-1960’s, any fire was thought to be detrimental to the park and forests. Fire Management Policy was to suppress all fires as quickly as possible. The beneficial, ecological role of fires was ignored (fires cleaned out the understory and dead plant matter, helped fertilize the soil and allowed new tree species and plants to grow.) Doesn’t this sound like the role of recessions?
In the late 1960’s, Washington D.C. slowly began to see the benefits of the fires and began to change its policy to allow some fires to burn out. But, by this time, the forest was very mature and a significant fire hazard. A crisis was imminent.
In 1988, lightning started a fire on a very dry June day. It quickly grew out of control and soon the wind spread to different parts of the forest. The fire burned for months even though 9,000 fire fighters and 4,000 military personal were used. The fire was eventually extinguished in late fall by rains and snow. About 73,000 acres or 36% of the park was affected and fighting it cost $220 million in today’s dollars.
Our centrally planned economy may be headed for the same kind of fate.
A few central planners can never replace the value of millions of entrepreneurs. Government’s “management plan” of trying to stimulate every little dip in consumer spending with borrowed money has led us to an unsustainable debt level and pending crisis. Yet, the government refuses to face this issue and others.
Studies have shown that when sovereign debt exceeds 5x revenues or when interest payments exceed 10% of revenues, repayment of the debt goes from almost no risk to risk. Once there is a perception of risk, it becomes more difficult to raise additional money. Generally, deficit spending continues, debt mounts and interest rates begin to rise. For example, U.S. 10-year bonds carry an interest rate of 1.98% - at this time, Italy’s 10-year bond as an interest rate of 7% (and the rate increased from 4% to 7% in just a few days), Greece’s 10-year bonds have an interest rate of 37%. Untreated, interest expenses will eventually consumes all revenues. Then, the sovereign is left with three choices: severe austerity, default on the debt or default by inflation.
America thrived because Free Markets are driven by entrepreneurs making decisions based on the knowledge they have, how they viewed the future and their willingness to take risk. Unavoidably however, not every economic decision can be correct; therefore Free Market business cycles are prone to some excesses and recessions. Without government interference, these shallow business cycles were generally short-lived and produced tremendous economic growth.
Today’s economy and markets are fundamentally different than those of the past. Expanding government interference in the economy has slowly changed our economy from a market based, entrepreneurial economy to one that is Centrally Planned. America’s current economy is driven by politicians and their friends: favored corporations and their lobbyists who are often referred to as “capitalists.” One result of this transformation from a Free Economy to a Centrally Planned economy is that short, self-correcting cycles have evolved into volatile bubbles and busts.
The individual, economic decisions of 320 million citizens that drove the Free Market economy has been supplanted by an elite gang of politicians and their favored corporations. The economic “experts, ” the pundits and the media prove this every day with their constant calls for the government “to do something” - to solve the debt crisis, to create jobs, to invest in green energy, to fix the housing problem. The American economy is being transformed from an entrepreneurial-based, manufacturing economy to a financially based services economy dominated by the political class and their favored, financial institutions.
Central Planning is bringing our economy to the edge of disaster
Markets are no longer focused on companies and their future prospects, but on media headlines made by our Central Planners. Yet it has been proved over and over that central planning does not work no matter how much the politicians want to help. It is impossible for a few elite politicians to know the wants, needs and preferences of 320 million people, let alone the complexities of a $60 trillion dollar global economic system.
Central planners make decisions based on political concerns and personal agendas. As a result, they interfere with the economy based upon political expediency, not fundamental economic reasoning. Their political concerns create a paradigm of decisions that are naturally shortsighted, and they generally get fiscal and monetary policy wrong. The hubris and power of the Central planners means they can never admit they were wrong, which leads to more interference, more short-sighted decisions and more damaging fiscal and monetary policy decisions. The Central planners are leading us to the edge of disaster.
The Yellowstone National Park fire
The Yellowstone fire of 1988 provides an excellent analogy of what has been going on since WWI. Yellowstone National Park was created in 1882 and is managed by The National Park Service in Washington, D.C. There are about 35 forest fires each year caused by lighting and about 6-10 fires caused by man.
Until the mid-1960’s, any fire was thought to be detrimental to the park and forests. Fire Management Policy was to suppress all fires as quickly as possible. The beneficial, ecological role of fires was ignored (fires cleaned out the understory and dead plant matter, helped fertilize the soil and allowed new tree species and plants to grow.) Doesn’t this sound like the role of recessions?
In the late 1960’s, Washington D.C. slowly began to see the benefits of the fires and began to change its policy to allow some fires to burn out. But, by this time, the forest was very mature and a significant fire hazard. A crisis was imminent.
In 1988, lightning started a fire on a very dry June day. It quickly grew out of control and soon the wind spread to different parts of the forest. The fire burned for months even though 9,000 fire fighters and 4,000 military personal were used. The fire was eventually extinguished in late fall by rains and snow. About 73,000 acres or 36% of the park was affected and fighting it cost $220 million in today’s dollars.
Our centrally planned economy may be headed for the same kind of fate.
A few central planners can never replace the value of millions of entrepreneurs. Government’s “management plan” of trying to stimulate every little dip in consumer spending with borrowed money has led us to an unsustainable debt level and pending crisis. Yet, the government refuses to face this issue and others.
Studies have shown that when sovereign debt exceeds 5x revenues or when interest payments exceed 10% of revenues, repayment of the debt goes from almost no risk to risk. Once there is a perception of risk, it becomes more difficult to raise additional money. Generally, deficit spending continues, debt mounts and interest rates begin to rise. For example, U.S. 10-year bonds carry an interest rate of 1.98% - at this time, Italy’s 10-year bond as an interest rate of 7% (and the rate increased from 4% to 7% in just a few days), Greece’s 10-year bonds have an interest rate of 37%. Untreated, interest expenses will eventually consumes all revenues. Then, the sovereign is left with three choices: severe austerity, default on the debt or default by inflation.
Friday, December 9, 2011
New European Agreement Needs Reality Check
Here is the headline from an Associated Press story earlier this morning:
“US stocks rise after new European budgetary pact
U.S. stock indexes rose in early trading Friday after 26 European nations agreed to consider tying their economies together more closely in hopes of preventing another debt crisis.”
Here is a reality check:
1. This agreement has to be ratified by each country before they have anything.
2. A closer fiscal union (with sanctions) means each country will have to give up its sovereignty to whom (Germany, The Central Bank, or?)
3. Based on their current financial situation, who will lend them the money at an interest rate they could afford with the Euro zone sliding into recession.
4. They need $3 trillion or more not the less than one trillion they hope to raise over the next three years.
5. Their Sovereign Credit ratings are likely to be downgraded soon by S&P resulting in even higher interest rates.
6. Their banks have not been recapitalized (unlike U.S. banks) and consequently have leverage ratios three times higher than U.S. banks.
Net: This new credit line on top of their old credit lines doesn’t make sense. But, using hopium might get them a few yards down the road to an even bigger crisis. And no, the IMF (International Monetary Fund) will not bail them out either. They do not have the money and to get it, they would have to get an appropriations bill through our congress as we would be liable for about 27% of the total funds raised.
Wait. I wonder, could Bernanke just give them the money with a couple of keystrokes with out telling us?
“US stocks rise after new European budgetary pact
U.S. stock indexes rose in early trading Friday after 26 European nations agreed to consider tying their economies together more closely in hopes of preventing another debt crisis.”
Here is a reality check:
1. This agreement has to be ratified by each country before they have anything.
2. A closer fiscal union (with sanctions) means each country will have to give up its sovereignty to whom (Germany, The Central Bank, or?)
3. Based on their current financial situation, who will lend them the money at an interest rate they could afford with the Euro zone sliding into recession.
4. They need $3 trillion or more not the less than one trillion they hope to raise over the next three years.
5. Their Sovereign Credit ratings are likely to be downgraded soon by S&P resulting in even higher interest rates.
6. Their banks have not been recapitalized (unlike U.S. banks) and consequently have leverage ratios three times higher than U.S. banks.
Net: This new credit line on top of their old credit lines doesn’t make sense. But, using hopium might get them a few yards down the road to an even bigger crisis. And no, the IMF (International Monetary Fund) will not bail them out either. They do not have the money and to get it, they would have to get an appropriations bill through our congress as we would be liable for about 27% of the total funds raised.
Wait. I wonder, could Bernanke just give them the money with a couple of keystrokes with out telling us?
Monday, November 21, 2011
What Is The End Game For The European Debt Crisis?
Can Europe get out of its sovereign debt crisis by adding more debt? No. Can Europe grow its way out of its current debt problem? No. It will have a difficult time growing its economy at all next year.
To make matters worse, they have a banking system that is leveraged three times higher than the U. S. banking system. But, we’re not sure because of the lack of transparency in the banking system. For example, they do not have to mark their “toxic” bonds to actual, current market prices. They can price them just about where they want. The rules were changed to keep the banks from becoming insolvent. Just like the U.S.
But unlike the U.S., they cannot do what we did to keep the banks solvent. Their government structure and the limited power of their central banking system prohibit it. This could change with new legislation but it would take time and they would have to overcome the opposition from Germany. Germany has already experienced hyperinflation caused by runaway money printing (i.e., in 1923, Germany’s inflation rate was running at 10,000% per year.)
We all know what happened to Greece recently and the moral hazard of that “agreement.” If Greece could get a 50% reduction on $200 billion of debt and additional money to spend, why wouldn’t every other country be entitled to the same?
The result of that agreement has institutional investors selling European debt as fast as they can and are now coming after Italy; next will be Spain, then France.
Italy has $2.7 trillion dollars of debt and they and must rollover $300 billion of it within the next year. They do not have the money to finance this, if they could find buyers, at an interest rate over 5.5%. Last week they sold $3 billion with an interest rate of 6.1%.
As this unfolds, major banks will have to take enormous losses. Estimates are that U.S. banks have a $600 to $750 billion dollar exposure to European banks. This could cause serious problems for American banks.
I do not know exactly how this “debt crisis scenario” will unfold over the next two weeks, two months or two years. Will the ECB get the authority to print money so they can kick the can down the road a bit longer? There is, also, severe pressure on Germany to go along and let the ECB print. Germany will have to foot much of the bill.
Therefore, the end game it seems is either default or inflate their way out of this debt crisis.
Regardless of exactly how it unfolds, I think the banks are due for a serious correction. What is in question is the timing. We may be unable to prevent this European debt crisis from happening, but there are ways to preserve your capital or profit if you know what’s likely to happen ahead of time and can position investments appropriately.
To make matters worse, they have a banking system that is leveraged three times higher than the U. S. banking system. But, we’re not sure because of the lack of transparency in the banking system. For example, they do not have to mark their “toxic” bonds to actual, current market prices. They can price them just about where they want. The rules were changed to keep the banks from becoming insolvent. Just like the U.S.
But unlike the U.S., they cannot do what we did to keep the banks solvent. Their government structure and the limited power of their central banking system prohibit it. This could change with new legislation but it would take time and they would have to overcome the opposition from Germany. Germany has already experienced hyperinflation caused by runaway money printing (i.e., in 1923, Germany’s inflation rate was running at 10,000% per year.)
We all know what happened to Greece recently and the moral hazard of that “agreement.” If Greece could get a 50% reduction on $200 billion of debt and additional money to spend, why wouldn’t every other country be entitled to the same?
The result of that agreement has institutional investors selling European debt as fast as they can and are now coming after Italy; next will be Spain, then France.
Italy has $2.7 trillion dollars of debt and they and must rollover $300 billion of it within the next year. They do not have the money to finance this, if they could find buyers, at an interest rate over 5.5%. Last week they sold $3 billion with an interest rate of 6.1%.
As this unfolds, major banks will have to take enormous losses. Estimates are that U.S. banks have a $600 to $750 billion dollar exposure to European banks. This could cause serious problems for American banks.
I do not know exactly how this “debt crisis scenario” will unfold over the next two weeks, two months or two years. Will the ECB get the authority to print money so they can kick the can down the road a bit longer? There is, also, severe pressure on Germany to go along and let the ECB print. Germany will have to foot much of the bill.
Therefore, the end game it seems is either default or inflate their way out of this debt crisis.
Regardless of exactly how it unfolds, I think the banks are due for a serious correction. What is in question is the timing. We may be unable to prevent this European debt crisis from happening, but there are ways to preserve your capital or profit if you know what’s likely to happen ahead of time and can position investments appropriately.
Thursday, November 3, 2011
The Zero Interest Program Is Doing Great Damage To Our Economy
Today, The Federal Reserve Indicated they would extend Zero Interest Rates beyond Mid-2013. This Zero Interest Rate Policy (ZIRP) is doing great damage to our economy. Here are a few reasons why:
1. ZIRP punishes savers and forces people to take on additional risk in order to earn needed income. Also, we need savings in order to get investment capital
2. ZRP hurts pension funds and insurance companies who depend on interest income to pay pensioners and cover insurance losses
3. ZIRP distorts prices and encourages malinvestments and new bubbles
4. ZIRP allows banks to make money from the carry-trade (by borrowing from the Federal Reserve at zero and then buying long-term Treasury bonds and capturing the difference in interest) basically risk free. We know the banks need the money.
5. ZIRP is not the way to get consumer spending back to bubble levels because the consumer credit cards are maxed out.
Also, the Federal Reserve is making things even worse with their latest “Twist” program.
This program has the Fed selling its short-term bonds (because demand is high due to world turmoil) and buying long-term bonds (10-30 years in maturity.) This is their attempt to drive down long-term interest rates to “help” the housing industry through lower mortgage rates. Someone should tell them that mortgage rates have been low for several years.
An even bigger problem is inflation. America’s $15 trillion in debt is currently financed at very low rates with an average maturity of less than five years. What happens when inflation hits and drives interest rates to the point where we cannot afford to refinance the debt we currently have? Look at the interest rates Europe is paying to get an idea (Greece two year bonds at 200% and Italy’s 10 year bonds at 8%.) Multiply that by $15 on our way to $20 trillion dollars.
What do you think is going to happen when the Federal Reserve stops buying Treasuries (the way they keep the rates down) and lets the market set interest rates based on time preference (how much interest one is willing to pay to buy the product now versus sometime in the future) and risk.
Be aware of what you can do in the current environment and prepare for higher interest rates in the future.
1. ZIRP punishes savers and forces people to take on additional risk in order to earn needed income. Also, we need savings in order to get investment capital
2. ZRP hurts pension funds and insurance companies who depend on interest income to pay pensioners and cover insurance losses
3. ZIRP distorts prices and encourages malinvestments and new bubbles
4. ZIRP allows banks to make money from the carry-trade (by borrowing from the Federal Reserve at zero and then buying long-term Treasury bonds and capturing the difference in interest) basically risk free. We know the banks need the money.
5. ZIRP is not the way to get consumer spending back to bubble levels because the consumer credit cards are maxed out.
Also, the Federal Reserve is making things even worse with their latest “Twist” program.
This program has the Fed selling its short-term bonds (because demand is high due to world turmoil) and buying long-term bonds (10-30 years in maturity.) This is their attempt to drive down long-term interest rates to “help” the housing industry through lower mortgage rates. Someone should tell them that mortgage rates have been low for several years.
An even bigger problem is inflation. America’s $15 trillion in debt is currently financed at very low rates with an average maturity of less than five years. What happens when inflation hits and drives interest rates to the point where we cannot afford to refinance the debt we currently have? Look at the interest rates Europe is paying to get an idea (Greece two year bonds at 200% and Italy’s 10 year bonds at 8%.) Multiply that by $15 on our way to $20 trillion dollars.
What do you think is going to happen when the Federal Reserve stops buying Treasuries (the way they keep the rates down) and lets the market set interest rates based on time preference (how much interest one is willing to pay to buy the product now versus sometime in the future) and risk.
Be aware of what you can do in the current environment and prepare for higher interest rates in the future.
Friday, September 23, 2011
“Print ‘Till You Drop” Update
In Scenario One: “Print ‘Till You Drop” I estimated the market would continue to drop until monetary policy (the Federal Reserve printing money) or fiscal policy (Government spending and borrowing money) began to re-inflate the economy and consequently the markets. The timing of the turnaround would be dependent on the “pain” felt by investors and politicians. My estimate was +/- Labor Day because it takes time to implement these programs and the election cycle begins to heat up.
Also, my assumption was a new stimulus program would be initiated (and one was introduced by President Obama as a “Jobs Program” for $445 billion) and a new Quantitative Easing (QE3) program from the Federal Reserve. The political mood is against more stimuli at the moment, but the Republicans can’t resist tax cuts so I assumed about $300 or $350 billion would get through the Congress. Net/Net: we basically have two options: Re-inflate the economy and markets (print ‘till you drop) or revert to a capitalist system (small government and a privately run economy.)
Since there is little chance we will go back to a capitalist system, my assumption was that the government would be “accommodative.” This assumption appeared to be correct when the debt ceiling was raised with almost no cut in spending until 2013. Then, a month ago, Fed Chairman Bernanke extended the zero interest rate policy (ZIRP) through at least mid-2013 and a statement that the Fed would remain “accommodative.” He re-iterated that statement when he was in Minneapolis a few weeks ago.
In the meantime, it was leaked that the Fed would, at minimum, initiate a “Twist” program. This program would sell about $400 billion of short-term treasuries and buy $400 billion of long-term treasuries in order to drive down long-term interest rates and help the housing industry refinance. This program would not increase the money supply (sell 400, buy 400) so it would not help re-inflate GDP or the markets. In fact, Since QE2 ended, money supply would actually contract because he did not replace the $600 billion in new money he printed for QE2. As you know, contraction takes away from GDP and thus the markets.
By the way, by itself, “Twist” will not help the housing situation either. It will also cause the yield curve to flatten (not much difference in interest rates between two year bonds and 30 year bonds) which takes the profits out of lending.
Many thought, me included, that the Fed would “surprise” the markets with additional easing or money printing. For example, stop paying banks interest for excess reserves held at the Fed which would force the banks back into the lending business. Also, to push additional money into the financial system to cause inflation (help GDP, help the markets, reduce value of the dollar to help with exports.)
On Wednesday, the surprise was that the Fed did not agree to create more money. Evidently, we have not reached their pain threshold yet. However, within hours of the Fed announcement, European markets began to fall apart again. World GDP growth rates were reduced, including the U.S. So, the question becomes: is this enough pain or do we have to wait until the next Fed meeting in November? Or is the political will to spend more money just not there?
Also, my assumption was a new stimulus program would be initiated (and one was introduced by President Obama as a “Jobs Program” for $445 billion) and a new Quantitative Easing (QE3) program from the Federal Reserve. The political mood is against more stimuli at the moment, but the Republicans can’t resist tax cuts so I assumed about $300 or $350 billion would get through the Congress. Net/Net: we basically have two options: Re-inflate the economy and markets (print ‘till you drop) or revert to a capitalist system (small government and a privately run economy.)
Since there is little chance we will go back to a capitalist system, my assumption was that the government would be “accommodative.” This assumption appeared to be correct when the debt ceiling was raised with almost no cut in spending until 2013. Then, a month ago, Fed Chairman Bernanke extended the zero interest rate policy (ZIRP) through at least mid-2013 and a statement that the Fed would remain “accommodative.” He re-iterated that statement when he was in Minneapolis a few weeks ago.
In the meantime, it was leaked that the Fed would, at minimum, initiate a “Twist” program. This program would sell about $400 billion of short-term treasuries and buy $400 billion of long-term treasuries in order to drive down long-term interest rates and help the housing industry refinance. This program would not increase the money supply (sell 400, buy 400) so it would not help re-inflate GDP or the markets. In fact, Since QE2 ended, money supply would actually contract because he did not replace the $600 billion in new money he printed for QE2. As you know, contraction takes away from GDP and thus the markets.
By the way, by itself, “Twist” will not help the housing situation either. It will also cause the yield curve to flatten (not much difference in interest rates between two year bonds and 30 year bonds) which takes the profits out of lending.
Many thought, me included, that the Fed would “surprise” the markets with additional easing or money printing. For example, stop paying banks interest for excess reserves held at the Fed which would force the banks back into the lending business. Also, to push additional money into the financial system to cause inflation (help GDP, help the markets, reduce value of the dollar to help with exports.)
On Wednesday, the surprise was that the Fed did not agree to create more money. Evidently, we have not reached their pain threshold yet. However, within hours of the Fed announcement, European markets began to fall apart again. World GDP growth rates were reduced, including the U.S. So, the question becomes: is this enough pain or do we have to wait until the next Fed meeting in November? Or is the political will to spend more money just not there?
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