QE2: Savior or Suicide

The long awaited decision was announced today by the Fed, $600B in fresh money printing followed by continued reinvestment of proceeds from its first round of easing. This equals about $900B in total QE by our monetary masters. Speculation is rampant in the media about its success or how it will be an epic failure. The funny thing is, no one really knows what will actually happen. Personally, I am still perplexed as to why they are doing it at all, it is stupid.

The Fed is also completely out of ammo which many have stated, myself included, and all they have is the printing press. I want to stress something here and you should pay attention, this whole QE thing is experimental and no country that has ever tried has succeeded. Therefore, I have a predetermined outcome, but at the end of the day you or I have zero idea if it will work. I will lay out a case for its failure based on what I know. I am sure many will disagree and that is fine, but in time one of us will be right.

The economy has a demand problem, not a liquidity problem. Over 2 years ago we had a massive liquidity problem which is why Lehman failed, but now the Fed has dumped trillions into the system along with the federal government. All of that money dumping ended the liquidity crisis and now banks, supposedly, have excess reserves just sitting at the Fed waiting to be loaned out to that sucker who wants to pay 15% interest on money the bank got for free in order to buy that new LED flat screen TV that is just calling his or her name. The problem is the sucker doesn’t want to buy that TV because he doesn’t know if he will have a job next week or is worried about retirement, etc.

We have a demand problem, not a money shortage. I say that with a grain of salt because money velocity is dropping which technically means there are dollar shortages. However, I contend that that dollar shortage is because people are paying off debt to simply saving their money somewhere 9under the mattress??). Regardless of the reason no one wants to buy big ticket items and I do not blame them. After all we got here because of excess debt and no one wants to leverage up to buy senseless items. No amount of QE will change this, sorry, but it won’t. Job security and rising wages will create demand, but that is not happening either. Demand is stuck where it is, weak.

The Fed knows this and they know QE will not change this so why did they do it? I really do not know. Sure, everyone has their own reasons for it, but at the end of the day it is all speculation. I know what they are trying to do, create wage inflation and inflation in general, which they will do eventually, but by their chosen path, QE, they are creating the worst possible outcome, inflation without wage inflation. Stop laughing, it can happen. How you may ask, simple dollar devaluation is inflation, but dollar devaluation does not guarantee wage growth. The only way to get wage growth is through demand with inflation, what the Fed did will not do this. Frankly, everyone should be terrified of Mr. Bernanke and he should be punished for lying to Congress when he said he would not monetize the debt, he is.

I can rattle off all sorts of conspiracy theories as to why the Fed is doing QE, but they are too laughable to mention. I do think one thing makes sense, it is a back door bailout of the banking system, again. There is a little issue I am sure you are familiar with, the foreclosure crisis, and this crisis is a huge, enormous, problem. If you are a bondholder it is one thing to have a borrower default on the debt, the cash flow ends and you get to take the collateral, a home in this case, to recover your capital. However, this whole chain of custody issue, there is no legal remedy for it and all those pundits who claim that this is no big deal are either stupid or scared to admit the truth, means that there is no collateral to collect now. Essentially the borrower can keep the house and screw the lender if the paperwork is messed up, how would you like to own a MBS now? Your bonds are worthless… or are they?

If there was fraud in the loan, as we are now seeing, the bondholder can put back the bond and be repaid their original capital. This is the problem that is starting to rear its ugly head, the put back, and it could be huge. Think about all the paper the banks would have to buy back and now think of all the synthetic derivatives that were written against that bond. What a mess. A big costly web of a mess. I do not know how big the problem can be, but I think part of the QE might help these banks by either allowing the bank to front run the bonds the Fed is buying or by infusing the bank with capital.

It doesn’t matter really, but I think that was one of the reasons for QE2. We have been told for over a year now how great things are now and we are in a recovery so why do QE at all? We have inflation, it is not sky high, but it is there in the PPI and the CPI is still positive. If the CPI were negative I would say we have deflation, but it isn’t and at best we had disinflation which does not justify such a crazy move as monetizing almost a trillion dollars in paper. The Fed sees that no real recovery has happened and maybe that is the reason for the latest round of easing. Regardless, the banks are going to benefit from this, remember the Fed asked them how much they should buy from them.

I stated about a year ago that we can have inflation without wage inflation. We are about to see if that once crazy theory of mine is right. The Fed has now monetized trillion’s in debt and I can say, with history on my side, this has never ended well for any country who has ventured down this path. America is a special place because of our freedoms, but we are not so special that math and history doesn’t pertain to us. All of the people warning about the Fed’s insane moves might be right and the sky very well might be falling. Heck, if things were as great as we have been told over the past few months by the talking heads and our politicians, who no one believes, why are we even having this conversation? Things are not well and I fear we may be in the calm before a very bad storm like we have never seen before.

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Let me be clear, No more bailouts…

The President, Nancy Pelosi, Harry Reid and only God knows how many politicians have all said that the Fin Reg bill ends all taxpayer assisted bailouts for Wall Street. Well, the news lately will put that phrase to the test. To think that all of these foreclosures are not an issue was crazy to begin with, but throw in a little foreclosure fraud and overnight you get a $47B putback from BlackRock and the Fed… go figure.

I believe the putback situation we saw yesterday was merely the beginning and there are many more tens, if not hundreds, of billions of dollars to follow. The banking system cannot handle that type of volume, remember in 2008 it was MBS and derivatives of MBS securities that caused our little problem. There is no easy remedy for this problem, regardless of what JPM or BoA says, since we are talking basic contract law here. Now, Congress did try to sneak through a bill that would have solved the industries problem, H.R. 3808 which would make courts accept all sorts of junk affidavits, but Obama ‘pocket’ vetoed the bill. Do not think that bill went away because it can come back and probably will under a new name, but it will fail in the courts, in my opinion, remember Obama said Congress needed to fix some issues with the bill, a telling statement on his opinion.

Not only does he want Congress to merely make some cosmetic changes to it, but Obama also said that this is just a “minor paperwork snafu.” Oh, how I wish that were true, but it is not a minor snafu. I do not support homeowners who took on irresponsible loans, I have long said they should lose their homes, but I dislike actual fraud even more than irresponsible borrowers. Let’s also not forget that these same lenders often did not verify the borrower’s income either which makes this whole problem a bit ironic as lenders cut corners to give the loan and now they cut corners to foreclose on the collateral. There is a remedy to all of this, as written on Zero Hedge previously, which is a borrower accepts a loan modification which clears the title, guess how successful the HAMP will be now.

If Congress doesn’t create a fix, which they should not, banks will lose foreclosure proceedings to those defendants who decide to fight it. I do not believe anyone really knows how big this problem really is and, frankly, I would not trust anyone who attaches a number to it. After all, these will be the same people who said sub-prime loans were a nonissue a few years ago, the missed that one by a mile, obviously, so they will miss this one as well. Not to mention that this issue will once again be a global issue. Who knows how many of these bonds are sitting on the balance sheet of banks all around the world. Hell, we do not even know what outstanding derivatives are still in play with this paper.

To assume that this will pass with no real material issue to the banks is idiotic. The risk is real and the system is still very, very weak. Perhaps now we know why bank reserves are still so high, did they know this might be an issue? Probably as we know banks do not like to fess up to mistakes until, well, the global financial system is about to implode. The credibility of banks and government has probably never been so low in all of history and that is a problem especially if they need help again. I fully believe another bailout will be needed over this and that means the issues of 2008 will return in 2010 with a vengeance.

Remember, in 2008 it was really the CDO’s and CDS’s on tranches of MBS products that were the problem. We all remember senior and junior tranches that were in the headlines, but back then at least you could get the collateral back to try and sell, albeit at a much lower price. Today if these things are still blowing up and you cannot even get the collateral back that would be a total loss for the investor or bank if it got putback to them. See the problem now? It is just not the banks that have this problem, but the GSE’s as well who may be guaranteeing a lot of this junk now. The GSE’s have $5T in outstanding mortgage guarantees and some say that mortgages as far back as the late 1990’s might not have proper chain of title.

The math is enormous and this should scare people to death. Perhaps it will all go away. Perhaps judges will ignore the 200 year precedents of contract law, they did it with the auto makers, so why not now. However, if this doesn’t go away we are definitely in for a rerun of 2008 again on a much larger scale since even the government is reaching the end of their credit line. Maybe QE2 will buy these securities and that is how the problem will disappear, but if nothing is done the entire mortgage market and perhaps some well known banks are done… again, unless all our politicians lied to us.

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Smoot-Hawley Anyone?

Here we are some 81 years after the Great Crash of 1929 and what turned out to be the beginning of the Great Depression which ushered in unusual monetary policy and solidified Keynesian economics. Part of the reason for the Depression was probably the best intentioned, yet most ridiculous, legislation which placed tariffs on imported goods, Smoot-Hawley. The idea was to protect America and to bring us economic riches, but the exact opposite happened. While not all of the Depression can be blamed on that legislation pretty much everyone agreed that it was a major contributing factor as it triggered trade wars. 81 years later and we are repeating the same mistake, politicians never, ever, learn.

I was shocked when the bill passed committee, well, not shocked, but surprised, but I am dumbstruck by the fact that it went to the House for a vote… and passed! I am referring to the brain child of Lindsey Graham and one Mr. Charles Schumer, 2 peas definitely not alike with the exception of being idiots. The bill I am referring to is Schumer-Graham, the new Smoot-Hawley, which will force Treasury to impose tariffs on countries they feel are manipulating their currency lower, in this case against China. One wonders if the U.S. will feel the wrath of the bill since we are sinking our own currency, but we would never manipulate our dollar lower, yeah, right.

I had spoke about a brewing trade war with China about a year ago as we leveled tariffs on some steel imports and tires. China responded with claims of dumping cars and chicken products and we retaliated, etc., etc. The politicians will not feel, yet, the fallout of this idiotic move, but the people who are struggling sure will. This will essentially guarantee that we will place tariffs on cheap products made in China, I wonder if the iPhone will fall in this category, which impacts the shoppers of Walmart the most, or Target or insert your favorite low cost store here.

I wonder, why does Washington hate the poor? Because that is exactly who they are punishing with this legislation, the poor. They will have to pay higher prices for what used to be low cost goods, money they do not have I might add. While the guise of this bill is to protect American jobs, read protectionism, it will likely do the opposite as China will retaliate in some fashion, I am sure of it. It also makes little sense to give your largest creditor a hard time and to alienate the fastest growing, or one of the fastest growing, economies in the world. Well, Washington is brain dead and probably never thought this far ahead, but still, how could they not?

China already made claims about other chicken products, this is a new claim a couple days ago, which shows that they are willing to do something to return the favor. What that is, who knows, but perhaps they will void more financial contracts with U.S. banks or ban some products. What I am sure of is this will pave the way for more protectionism worldwide and that is not good. You cannot legislate your way to prosperity and punishing a country for keeping their currency cheap is just wrong. I have stated many times before that a major revaluation of the yuan will lead to mass bankruptcies in China, but this is what the U.S. wants, not a strong dollar, but a strong yuan, who cares about the dollar anyhow.

It will not create jobs domestically for one simple reason, Vietnam has favorable currency rates, so does Indian, Indonesia, Peru, Mexico, Malaysia and many other countries. What are we going to do when our corporations move to these other countries? Are we going to tax them or simply place general tariffs on the products manufacturer there? Are you getting the point yet? Capital will flow to the next easier place to do business and Congress can continue to throw up road blocks, but they will fail. Not to mention that we want to double our exports in 5 years, according to Obama, and if we slap China do you really think they will let us have free reign or trade with them? Nope.

This is a job killer and will turn the troubled economy into deeper mud, there is simply no way to deny this. I just cannot believe Congress passed this bill this far, it makes zero sense. I know the Democrats are desperate for votes and this is a populous bill, but most people will see it, if they at least paid attention in high school history class, as a major problem for us. Especially since most Americans know China is our largest lender. Worse is that only 70 or so in the House voted against it… how can there be that many stupid people in Congress?

The bottom line is that our sugar daddy is going to be upset and probably cut us off because of this. We will now have fewer jobs and little financing of our massive deficits. Nice job guys, perhaps you would like to come to each Americans home and kick them in the shin as a follow-up because I do not see how they can top this idiotic move.

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Let’s talk inflation

I have previously laid out my thoughts as to what will eventually happen with the whole inflation-deflation debate, but the issue is still raging full speed ahead. It is interesting that it is hard to find 2 experts that actually agree on what will happen or is happening, deflation or inflation. I think it is obvious that we have disinflationary forces here as producers cannot pass along higher prices or they will lose business. In fact, only food, a basic necessity, has any real pricing power right now.

While I am comfortable claiming we have disinflation right now I do not think it will last for a very long period of time. I believe we will see more easing by the Fed via asset purchases, but that will not create immediate inflation. However, over a longer period of time we will see that inflation pick up and not because of money velocity, but because of straight out dollar devaluation. Let me explain.

We did not experience inflation in the 1930’s because no one spent large sums of money on a regular basis. People actually were starving even as food prices declined, sad really. The thing is that since we were on the gold standard, or a form thereof, it was impossible to have true inflation even though FDR was spending like a madman. The Fed was also not in the practice of buying assets because, well, they followed the rules. Because of the gold standard and there were no asset purchases, government bonds or otherwise, inflation remained tame, deflationary in fact. This is a very 30,000 foot view of the situation, but I think you get the gist of what I am saying.

Now we do not have the gold standard, I am not preaching for a gold standard either, just pointing out the obvious, and we have a completely fiat money supply. The Fed has used its “emergency powers” to do what it would not do in the 1930’s, buy assets. It is clear that the asset purchases are doing nothing for the economy other than keeping rates low on loans, which no one wants or are really willing to make unless you have a perfect credit score. It is not even kicking up much inflation, at all, which is because there is simply zero money velocity. Since there is no money velocity the typical economist will say that inflation is impossible and it can never happen, never say never.

What the heads buried in the sand do not realize, because they are using the Depression as their road map (they always do this at the wrong time I might add), is that the dollar is floating now with nothing backing it. That in itself is not bad, as a matter of general opinion, as long as the printing press is used sparingly and every country prints money at relatively the same pace. The problem is that now, after the crisis supposedly ended, countries are printing money at a slower pace or they stopped printing altogether. Many are certainly not doing asset purchases.

Forgetting the fact that QE will do nothing to ease the pain of the economy being bad, sorry, but it will do nothing whatsoever, what it will do is wreak havoc on the dollar. Since the currency is floating more printing and asset purchases will diminish the value of the currency. This has been Ben’s and Obama’s plan all along since Obama wanted to double exports within 5 years, something that can never be accomplished. We are seeing the impact of what more printing will do to the dollar now, unless you think 1.5 cent moves in the Euro/USD pair is normal, as investors move to a currency that is somewhat more sound, not that the Euro is sound, but perception is half the game.

The citizens, us, will not feel the devaluation right off the bat because we consume 87% of what we produce domestically. However, imported products will cost more and we do import a lot of goods, obviously. As domestic supplies are sucked up by foreign countries, as our dollar is worth less thanks to Ben, we will have to import more from elsewhere. This is how our next bout of inflation will begin, dollar devaluation without an increase of money velocity. If you think about it it will make sense, capital flows to the land with the cheapest goods and a weak dollar means China, Europe or whoever, will find more value, cheaper products, from America.

That actually sounds good, more purchases of American goods means higher production as we have to replace what others are buying, but that may not be the case. Why? Simple, prices domestically will be rising and our government, always trying to do the right thing will institute some sort of protectionist legislation to stop prices from rising as incomes are stagnant. It would be a form of capital controls of sorts, but in reverse. Can’t you see it now? Prices are rising and people are not able to get those big screen TV’s or something less important, food, so the government tries to stop it through making new laws. It sounds counterintuitive, but it would happen, look at what Congress wants to do to China in order to get the yuan to appreciate in value? Actually, if we do more QE Congress will not want that to happen because China will literally own us if or when the dollar is devaluated.

While all of this is happening the treasury market, after an initial huge ramp up in prices, this is what the Fed will be buying, will be in freefall as no one will want to be repaid, without a substantial risk premium, in devalued dollars. This will lead the Fed into more massive buying because even at this stage Americans will not even want to buy our own debt. Also, China will have no need to hold their massive treasury holds so they will be selling like mad. All of this is happening without money velocity picking up. Even if you think I am wrong about the previous paragraph think of it this way, if our production did pick up because of foreign country buying sprees that means we will have the money to buy things, but it will only increase the inflation rate… damned if it does, damned if it doesn’t.

It has nothing to do with actual money velocity anymore, we even have mild inflation with dwindling velocity now, and has everything to do with confidence in the system. More QE will be bad news for global confidence in the USD, it is on shaky ground as is. If we look at today’s market action it proves how the market will react, lower dollar, higher commodity prices and equities stuck because it is good news on one hand and bad news on the other hand. Longer term high inflation is bad news for stocks, in my opinion, and bullish for commodities, obviously. Stocks are horrible inflation hedging instruments, look at the last 10 years for proof, while silver (by far my favorite investment right now), gold and other metals should do very well. Of course, precious metals are not really an inflation hedge, but a currency hedge instead. Since we are looking at a currency issue rather than straight out inflation it makes bullion of any flavor very attractive.

Could anything change my mind about what I think will happen? Sure. If no QE happens it will be great news, but the likelihood of no QE ever happening again are about as long of a shot as you can get. While I am using QE for my defense of my position in this article I believe we can safely assume that budget deficits will not get better so even if no QE happens our spending will accomplish the same thing. I say that knowing that if the deficit does not resolve itself the Fed, to save the US, will still have to do QE eventually on a massive scale no matter what, to keep rates low so the interest doesn’t bust us. However, the Fed cannot suck in all that paper and treasuries will fail eventually.

Outside of no QE I think there is not much that can change my mind about what I think will happen. It is pretty much in stone and will happen either as I laid it out or in a somewhat similar fashion. In the near-term I am still bullish on treasuries, now that we sold off, and on silver, gold too, but I am more partial to silver right now. I am not crazy about stocks and would be very hesitant about committing major capital to any position right now, the market is trading odd to say the least. At this point bullion is your best play, silver looks very promising and a recent Scientific American article points out that there is only 19 years left of easily mined silver, a no brainer to me, buy it.

People always wait to buy metals to “see how it does” and while they are waiting the price goes nuts and then they buy it and wonder why they lost money. Don’t be one of those people, but buy it smart, some every month. Because even if you think the bulk of my argument is wrong, or all of it, we have disinflation and higher bullion prices, what do you think will happen when we do have inflation? Not to mention silver is not only a precious metal, but an industrial metal. So, if you think the world is going to end, buy silver. If you think we are in a real recovery, buy silver.

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Quantitative easing, it’s reality, kind of

When I wrote last week that the Fed would do QE 2 and the trade of the century, granted that was over the top, was leveraged bull 20+ year ETF’s I received some flack, a lot actually. First, let’s talk about the economy and what is going on there. Second, let’s talk about the treasury, gold barbell trade that seems wild and crazy. To clarify something, no, I am not drunk as one commenter asked.

The economy, oh, how this recovery summer is not such a recovery after all. Perhaps Geithner’s op-ed in the Times should have read, “Sorry, we screwed up any chances of a recovery” instead of “Welcome to The Recovery.” Any improvement we have seen within the economy has been purely statistical or for the very wealthy, period. Yes, Saks and Macy’s are indeed having good years, but look at Walmart, not such a blockbuster year. If you strip away the stimulus spending and government transfers you have poor GDP readings, period. I cannot see how anyone would or could really dispute that, but I am sure there are some that will try.

The truest test of any economy is unemployment and I was saying, before it was popular by a certain ‘New Normal’ guy, that unemployment was a leading indicator, not a lagging indicator. Our employment situation is poor at best considering that we are having more and more people leaving the workforce because they are giving up. Imagine just giving up all hope of finding work, not that you don’t want a job, but you just can’t find one, but since you have given up our government says you do not count anymore, nice. Anyhow, if we include all those people who dropped out of the workforce we are up to 10.2-10.5% official unemployment. As far as the U-6 we are still around the 17% area, but I am willing to bet it is much, much higher and who knows, exactly, how many people simple have been unemployed so long they just don’t count anywhere anymore. Regardless, our unemployment issue is the truest test of our economic situation and has indicated for well over a year that the economy is in poor condition.

As far as the other economic data points and indicators, well, show me one that points to an actual positive improvement please. Hint, there is not one that points to a significant improvement in the economic condition in recent months. In fact it is so bad that the Fed is turning to a form of QE which they know will do nothing to boost the economy, but it will look like they are doing something. It is so bad you had Ben Bernanke testify in front of Congress and say; “I don’t know what is going to happen,” basically when he said ‘unusual uncertainty.’ You have the Fed Presidents talking about recessions, QE, Japan scenarios and a host of other issues, but don’t worry because CNBC says no double dip. You know what, they are right. There will not be a double dip because we never made it out of the first depression.

We got the Fed doing this reinvesting of interest and repayment of principal now, to the tune of about $300B or so, into treasuries. What is that going to do for the economy? Nothing. Ben is trying to force banks to lend by doing a bull flattener to the yield curve, good luck Ben. What he doesn’t realize yet is people do not want to borrow. In fact, people want to pay off their debts instead, go figure. Ben cannot boost demand and QE will not do anything at all besides make bond investors very happy. It is a dog and pony show to make everyone feel good and like the Fed has some ammo left, they don’t and the game is over for them. All more QE will do is damage the dollar at some point in the future, that is a certainty. Consumer demand will return only after the deleveraging period is done and that could take 10 more years, who knows. It will be a tough ride, that is for sure.

Now, for those who thought I was nuts for going long a leveraged 20+ treasury ETF and gold, well, you don’t have to say, my account says it for me. UBT was about $85 a share when the article came out and it closed today at about $90.50 and gold was at about $116.50 and it is at $117.73 (I am using GLD as a proxy). I do not believe the trade is done, I wouldn’t enter it here, but I am not exiting it either, especially after CSCO missed their revenue estimates tonight. This was not a crazy trade, it was the most obvious trade in the world. Easy money like this does not happen very often so I am not sure why anyone would think this was ‘high risk’ or abnormal. You can hold leveraged ETF’s, if they go in your favor, over a period of days, just not long-term.

Everyone knew the Fed was going to do something, anything, because the Fed is staunchly independent and not influenced by politics, yeah right. Come on, the Fed knew it had to do something to show it was helping the economy, but not too much because we have an election coming up. What could be safer than maintaining the balance sheet, but reinvesting loose change into treasuries to bring down long-term treasury rates? It does not raise any eyebrows, everyone knew they would do this and it does help borrowers, but it doesn’t help the real economy. Regardless, this was telegraphed and sets up the Fed for real money printing and QE after November.

In the meantime, I plan on locking in profits on my UBT soon and rolling into TLT on weakness. I fully expect that we see the 30 treasury move towards the 3% area, maybe 2.5% as Ben wrote about in the past. That makes longer duration treasuries very attractive still and inflation is not an issue now. However, inflation will be at some time in the future and QE will damage the dollar, hence the gold hedge. I think gold goes back to its high and make a run towards $1,300 an ounce, maybe higher is full blown QE kicks in this fall. Equities are not attractive, in my view, unless they pay an outsized dividend and have a strong balance sheet. Stocks like AAPL, no thanks, they do not work in this environment unless they pull a new killer product out of their back pocket every other month. Good luck.

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