QE2: Savior or Suicide

Posted by Ray on November 3, 2010 under Main | Be the First to Comment

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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What year is this?

Posted by Ray on April 23, 2010 under Economy, Main | Read the First Comment

Quotes from The Great Depression: A Diary (click to buy). If I left the dates out you might think I am quoting a modern day book, but I am not. Only a fool thinks history does not repeat itself.

“It is also interesting to note that the effort to create credit by having the Federal Reserve Bank buy U.S. bonds in the open market has failed. Huge reservoirs of credit are available but banks won’t make loans because business is too uncertain. It seems to prove that when business starts moving credit will expand automatically but the artificial creation of credit will not expand business.” November 18, 1933

“The U.S. Treasury will face the task in a few weeks of paying out huge amount for bond interest and maturities. Where will the money come from – greenbacks (printing press)?” November 18, 1933

“Industry continues to boom and the entire public seems to be speculating in the stock market. Almost as bad as 1929. Last Friday was a record day of the year with 9 million shares changing hands. The whole recovery has been so spectacular as to almost be unbelievable. Because so much of it is based on inflation theories I have doubted its permanency. The next few months should tell the story. In the meantime lawyers and professional groups have failed so far to share in the boom.” July 3,1933 – sound familiar? The Depression was just getting going and the boom was because of FDR confiscating the gold and adjusting the price, effectively taking U.S. citizens off of the gold standard, but the U.S. still honored international settlements in gold.

“For the 12th consecutive day stocks have been drifting lower. Congress starts an investigation of short selling.” April 13, 1932

“During the boom years it became popular to buy real estate at inflated prices on a shoestring. This was done by encumbering it with a 1st, 2nd and 3rd mortgage. Second mortgage companies were formed to buy 2nd mortgages at a discount of 10% to 25% per year. It has proven to be a bad investment because at each sheriff sale the 2nd is wiped out. Most of these companies have frozen assets and seem to be heading for bankruptcies.” About June 5, 1931

“Magazines and newspapers are full of articles telling people to buy stocks, real estate, etc. at present bargain prices. They say that times are sure to get better and that many fortunes have been built this way. The trouble is that nobody has money.” July 30, 1931 – He further went on to say in 5/16/32; “This advice was premature. Here a year later prices are 1/3 of what they were in 1931.”

The point of this is that we may very well be in one of the peaks and valleys that were fairly common during the 1930’s. If you look at the economic policies of Hoover, which FDR took over and expanded, they are very similar to what we see the present government doing. As it turns out these policies actually extend the problems because banks cannot purge the troubled loans and assets, sound familiar, which created zombie banks. Eventually banks began to get states to pass laws restricting withdrawals, they did this with life insurance loans as well, and that still did not stop banks from failing. Bad mortgage debt is what caused the banks to fail, sound familiar?

The assets of depositors ended up frozen and shareholders were wiped out when a bank closed, they had double liability back then which means shareholders could lose more than they invest in bank stocks if the bank failed, they would get sued basically. Many of these banks did reopen thanks to Hoover’s Reconstruction Finance Corporation, but the savings accounts or passbooks were frozen. These passbooks were used as currency as people would sell them for pennies on the dollar, in hopes the institution would allow withdrawals at full face value. It is interesting to see how this al played out and what the average person was thinking during those times. I have to tell you, this book is all one needs to read about the Depression. I am sure Ben Bernanke learned a lot about the technical’s of the Depression, but unless he read this book he does not know squat.

The real killer, according to Benjamin, was the Smoot-Hawley Act, which placed high tariffs on imports to prevent dumping. Europe had devalued their currency so the tariff was put in place to make sure people bought American. It did not work and made things worse. Does this sound familiar with the rhetoric coming out of Washington about China’s currency value? The interesting thing is that, just like now, all countries were devaluing their currency in order to remain competitive and export in order to improve their own economies, it failed. When every country is devaluing and trying to export, as Benjamin points out, who is left to buy anything?

I will post more quotes from this book, but I urge everyone to read it. The similarity between the 1930’s and today is amazing to say the least. They tried to create inflation and failed, just like Ben is trying, and they tried the NRA, like the stimulus bill but they made the NRA much more strict and imposed higher pay and shorter hours so they had to hire. The NRA put unions in a position of power and several times Benjamin pointed out that labor troubles would come and they did. The current administration also wants more union jobs and activity, I fear that will fail to as unions strike often and are the primary reason the U.S. is not competitive in manufacturing, among other reasons.

History repeats itself and if we forget that basic rule we will always be doomed to repeat it. People who claim this is nothing like the 1930’s are insane. Sure, it is not as severe, maybe it will be if we relapse, but we are showing many of the same symptoms as were present in 1931, 1932 and 1933. Even the market action is somewhat similar. The one difference I foresee in the future is inflation, which only materialized in the 1930’s through price controls and increasing the price of gold, but overall inflation was very tame in the Depression as there was no money velocity, again, sound familiar?

We are slightly more creative in 2010 so I expect money velocity or a full blown currency crisis in the near future. In 1933 we really could not destroy our currency because of the gold standard, we did float the dollar though, but in today’s world we have nothing backing our money so it could really go to zero. It’s scary if you think about it.

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