Monetary Pumpers Speak Up Again
If you wonder why 'risk assets' were bouncing strongly on a day when the one year Greek government note yield closed at 97% (this is not a typo – you actually would get a yield of 97% if Greece were not to default long before the year is out…), look no further than the recent stream of fresh speculation on more monetary easing. Now we're not certain whether the central banks will actually comply…in fact, should stocks keep going up for a while, the pressure to 'do something', however futile a gesture it would be, would likely abate.
Alas, Wednesday was chock-full with news about more monetary pumping and the prospect of more deficit spending.
Über-dove Charles Evans of the Chicago Fed at the European Economics and Financial Center, where he noted:
“The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.”
He then went through the whole rigmarole of why a 'little bit of inflation isn't so bad', and that 'there is no inflation anyway' (let's not mention that the true money supply is up by 50% in less than three years) and even threw some mathematics at his listeners, and then – quite hilariously – concluded:
“Last year about this time economic conditions deteriorated to the point that we undertook discussions on how to provide further monetary accommodation—and we ended up with our second round of large scale asset purchases. Now, one year later, we again find ourselves with a weakened economic outlook and again trying to decide what further accommodation to provide. I’m sure everyone will agree that we seriously don’t want to be in this position again at this time next year. I believe that means we need to take strong action now.”
So let's get this straight: according to Evans, last year the economy was in a bad spot and therefore the Fed decided to print a lot of money. One year later, it has turned out that this has not helped at all, since the economy is back in the very same bad spot. His conclusion: in order to avert a repeat one year from now, the Fed must do the same thing all over again. We wonder if anyone started laughing at that point (possibly many had fallen asleep before the speech was finished, but what about those still awake?). Anyway, Evans seems not in the least bothered by Einstein's famous definition of insanity: Insanity is doing the same thing over and over again and expecting a different result.
His colleague at the San Francisco dependance of the Fed, John Williams, chimed in with similar thoughts. First he listed the Fed's efforts (pushing a few keys on a computer that mark up a few numbers on someone else's computer are the modern version of a 'heroic effort' as some observers have called it) to keep the economy from…from doing what, actually? Falling into the ocean? We're not sure, but these interventionists apparently really do believe that without them, we'd have been in a constant panic since at least 1638 or so (when Holland's Tulip craze failed). Then he went on to describe the economy in terms of a sick patient (well, not a bad analogy actually. He didn't mention the sickness though – it's the equivalent of a heroin addiction, and he and his pals are the smack dealers).
“Today’s economy is like a patient who has suffered a number of injuries and needs time to heal. For the healing process to succeed, it is essential that the bleeding be stopped, the patient be properly hydrated, blood pressure and temperature properly regulated, and secondary infections avoided and treated. These treatments don’t cure the injuries directly, but they reduce the risk of the patient getting worse and allow the natural healing process to take hold.
The monetary policy situation is similar. Like the hospital patient, the economy took a turn for the worse and faces heightened risks. In addition, inflation is expected to drift down. These circumstances called for additional monetary easing. At our August meeting, the FOMC took a step in that direction, issuing a statement that we are likely to keep the federal funds rate at exceptionally low levels at least through mid-2013. In one respect, this wasn’t such big news. Even before the announcement, financial market participants generally didn’t expect the Fed to raise rates much earlier than mid-2013. But it was news in the sense that it removed uncertainty and helped financial markets better understand our intentions. In response to the FOMC statement, financial market expectations of future interest rates and U.S. Treasury yields fell. Note also that we are not tying our hands by making this announcement. We haven’t made a guarantee. We will alter our policy as appropriate if circumstances change.
Right now, though, the real threat is an economy that is at risk of stalling and the prospect of many years of very high unemployment, with potentially long-run negative consequences for our economy. There are a number of potential steps the Fed could take to ease financial conditions further and move us closer to our mandated goals of maximum employment and price stability. 3 Of course, these “treatments” won’t make our economic problems go away and their costs and benefits must be carefully balanced. But they could offer a measure of protection against further deterioration in the patient’s condition and perhaps help him get back on his feet.”
Actually, no, you can't heal a heroin addict by giving him more of the stuff – although it is true that it will get him temporarily 'back on his feet'. Since we are already in the realm of this analogy, there is a real risk that the ministrations the poor patient has been subjected to thus far have in fact killed him and that they're trying to pump the stuff into a corpse.
In other words, all the monetary pumping to date may in fact have pushed the economy's pool of real funding over the edge, the point at which more wealth is in fact consumed than is created. A note to our readers: we have talked about the phenomenon of capital consumption in the past, but newer readers may not be aware of the posts in which the topic was discussed in detail. Since we have recently published a little article on the production structure, we will endeavor to soon do a follow-up post where this idea is brought into context with that article.
In any case, one thing should be clear: printing money can not create a single iota of wealth, and it can therefore also not create a single job. The 'dual mandate' that the Fed is legally bound by is simply put economic nonsense.
Obama Set to Produce Luxury Miracles
A similar nonsense is propagated by the deficit spenders. It is held that the government can 'create jobs' by spending more money than it takes in. However, where is that money coming from? The fact is, every cent the government spends must come from the private sector. It matters little if the money is raised by taxation or borrowing – if the government employs it, the private sector can no longer employ it to the exact same extent. Inflation is of course an even worse and even more insidious process, but generally speaking, government spending can only allocate scarce resources according to bureaucratic fiat or political favoritism (usually a combination of the two) and only if one believes that bureaucrats are better at allocating scarce resources than the free market can one possibly be in favor of it. It is not only the case that this can be shown to be true theoretically, it is also a fact of experience. In this context consider the recent bankruptcy of a 'green energy firm' that was apparently run by 'friends of the president', since he paid it a personal visit and sang its praises, before stuffing it with government subsidies to the tune of $535 million in loan guarantees. As Mish reports here, this means that the government spent about $486,000 per job in this company for a period of 18 months – and then the jobs were gone again. Calling this a disaster may actually understate the case somewhat. It is of course symptomatic of government-subsidized economic activity: by definition, such activity can not be profitable, otherwise it wouldn't require a subsidy. If it is not profitable, it wastes scarce resources that could have been profitably employed elsewhere.
This latter point is extremely important in this context, because it counters the well-worn Keynesian 'ditch digging' and 'pyramid building' arguments. In reality, the argument that government spending on jobs that are clearly wasteful activities is better than doing nothing at all is entirely wrong. It espouses a variation of the 'broken window fallacy'. It is not enough to consider what can be seen on the surface ('hurrah, 1,100 people had a job for 18 months'). The cost of $535 million is not irrelevant to the economy at large. Whatever real resources where appropriated by this business and ultimately wasted were and are no longer available to those in the economy who actually generate wealth.
This doesn't keep the president from wanting to once again do – you guessed it – what hasn't worked the first time around. What is especially humorous about this is that financial markets seem to love this stuff (they always do actually, until it turns out that economic laws have not been miraculously suspended).
As Bloomberg informs us, “Obama Said to Seek $300 Billion Jobs Package”. This from the man whose administration has thrown such a plethora of in the way of businesses that some people have actually already decided to 'go Galt' as we noted on a previous occasion.
“President Barack Obama plans to propose sparking job growth by injecting more than $300 billion into the economy next year, mostly through tax cuts, infrastructure spending and direct aid to state and local governments.
Obama will call on Congress to offset the cost of the short-term jobs measures by raising tax revenue in later years. This would be part of a long-term deficit reduction package, including spending and entitlement cuts as well as revenue increases, that he will present next week to the congressional panel charged with finding ways to reduce the nation’s debt.
Almost half the stimulus would come from tax cuts, which include an extension of a two-percentage-point reduction in the payroll tax paid by workers due to expire Dec. 31 and a new decrease in the portion of the tax paid by employers.”
We are generally all for tax cuts, but we would note that these governmental calculations never really turn out the way they are presented. What's more, the sentences we highlighted above show what the problem with the idea is. If he proposed tax cuts in parallel with a commensurate decrease in government spending, then we would expect the measures to have a positive effect. But that is not what he wants to do – in reality the tax cut portion probably amounts to throwing a sop to the Republican Congress to get it to agree to more spending.
The important point is that he is saying out loud that the tax cuts will only be temporary, and be made up be raising taxation later. You can not get entrepreneurs to invest by telling them they get temporary tax breaks but will be asked to pay up anyway 'sometime later'. People are generally a lot less stupid than politicians seem to assume; they know that more deficit spending in the here and now means nothing but deferred taxation, even if it weren't actually said out loud.
Besides, what he really wants to do is tax and spend – and of course he wants to win the upcoming election. Temporarily goosing the economy with deficit spending and easy money is a well-worn tactic before elections, but as we noted above, in terms of monetary pumping, whether such a ploy seemingly 'works', really depends on the state of the pool of real savings. With regards to deficit spending, the actual size of the already existing deficit plays an important role – the bigger it already is, the more likely it becomes that the 'Ricardo effect' (deficit spending has the same effect as higher taxation) overrules the expected boons from such a policy very quickly.
Concerted Pump Priming?
Meanwhile there are also rumors of impending concerted action by G7 central banks to increase monetary pumping. Pound Sterling has lately been soggy because the expectation of even more 'QE' from the Bank of England is rising. As we have pointed out before, the BoE has evidently gone off the rails completely, as it has already a clear case of stagflation at its hands.
Nevertheless, there are now growing expectations that the BoE will print even more money, as Bloomberg reports:
“Sterling slipped against a broadly stronger euro on Wednesday, and hovered near a seven-week trough against the dollar on speculation that recent soft UK data may eventually lead the Bank of England to resort to more monetary stimulus.
The BoE is expected to hold interest rates at a record low 0.5 percent and refrain from adding to its bond buying programme when it ends its policy meeting on Thursday.
A Reuters poll shows economists expect the UK central bank will hold rates through late 2012, while there is a 35 percent chance the BoE will resort to another bout of asset purchases to support the flagging economy.
However, London traders said some in the market were positioning for the possibility the BoE may announce more stimulus on Thursday, given persistent signs of a slowing economy in the past month.”
“Traders said some in the market were positioning for even the slightest chance the BoE could add to its 200 billion pound asset-buying programme on Thursday.
"Some will be going into the BoE announcement short (on sterling). I think it will be a market mover," said a trader in London. He added that the pound stood to lose 2 cents against the dollar if the BoE to expand its asset purchases by 100 billion pounds, while a 50 billion pound addition could knock it 1 cent lower.
If no stimulus is announced, sterling could rally 1 cent, he said. Some traders said the possibility of more UK quantitative easing in the future would remain high even if the BoE sits tight on Thursday.
"QE seems to get more likely with each week and set of data that passes," said a London-based spot trader. "Even if the BOE does not announce any fresh measures tomorrow, sterling could see a knee-jerk reaction higher, before sellers reappear and reality dawns."
Oh well, if that's the case then Mervyn King can use the same old excuse again when he pens his next 'dear chancellor' letter to explain to the chancellor of the exchequer why the UK's CPI inflation rate is ten times higher than the BoE's administered interest rate. 'It's not our fault', he will say, 'it's the weak pound'. As if the pound's external value were some independent variable of the natural catastrophe sort, an act of God not in the least connected to what the central bank is doing.
Meanwhile, Morgan Stanley went out on a limb and predicted 'concerted action':
“A fiscal response to economic weakness in the US and the euro area may be desirable but is unavailable, at least in the short run. The burden of propping up markets and the economy for the next few months thus falls on central banks. The negative feedback loop between weak growth and soggy asset markets makes a coordinated monetary policy easing move more likely – perhaps as early as the G7 meeting this weekend. The Fed, the ECB, the BoJ and the BoE could all participate in a coordinated move with a mix of rate cuts and quantitative easing. Strategic complementarity – the willingness and ability to ease if others are doing the same – makes it easier for banks to act jointly rather than unilaterally. Such strategic complementarity also exists for EM central banks. The recent pre- emptive (and perhaps prescient) rate cuts by the central banks of Turkey and Brazil make monetary easing by other EM central banks less surprising and thus that much easier to implement.”
Marketwatch meanwhile reports that 'Bernanke gets another shot to lay out QE3 options' on occasion of a speech he is to deliver in Minnesota on Thursday. Apparently there isn't even the slightest doubt anymore that he will engage in fresh monetary pumping, only the precise form it will take is still to be discussed. This assumption is likely correct, but still – the fact that this is now evidently already taken for granted is still slightly terrifying.
Meanwhile the always reliable Martin Wolf at the Financial Times (who probably has never met an intervention he didn't like) has also just penned another jeremiad bemoaning the fact that there is not enough deficit spending in his opinion. Like a good Keynesian, he hits us over the head with a few simple equations that purportedly prove his case (no human beings are required for these. It's all 'sectors' and tautologies adding up fiat money sums. The economy is a machine, don'tcha know). His latest argument: low government bond yields (wherever they still are low now, because investors are fleeing in terror from insolvent sovereigns to the ones they still consider solvent) are a 'signal that we need more deficit spending'.
As the Seeking Alpha news editor remarked drily (paraphrasing): 'So, what did bond yields tell us half a year ago when they were at almost 4%? That it was time to run surplus?'
Wolf seemingly forgets that he has been crying for more deficit spending for years now – and guess what? He got it! In spades! And to what end? Today countries in the euro area periphery are facing national bankruptcy, and if the core actually decided to go 'all in' and really bail everybody out with the sums often bandied about ('the EFSF needs at least € 2 trillion to be effective' is a phrase that we come across quite often, it has become like a mantra), then it would soon be facing the same fate. Meanwhile, the public debt of the US has now grown by almost $ 5.5 trillion since early 2008 alone….and that was somehow not enough? Why the hell not?
The total public debt of the US. According to Martin Wolf this recent parabolic bulge in the numbers wasn't enough spending just yet. We must not 'make the mistake of premature tightening'. Just keep spending and let the good Lord sort out the rest – click for higher resolution.
Wolf approvingly cites Richard Koo, and even drags up the old canard – and this one really shows you the chutzpa of the people who so liberally advocate the wasting of other people's money by the State – of 'Japan's mistake of premature tightening'. Japan, readers may recall, has built up the by far biggest public debt mountain relative to economic output of the entire industrial world – indeed, one of the biggest such debt mountains in all of human history, definitely the biggest ever in peace time – with absolutely nothing to show for it.
'Premature tightening'? Hello? Allegedly, a single brief episode of Japan raising a sales tax by one or two percentage points in 1996 – soon taken back as it were – has wrecked the entire two decades long Keynesian experiment there! Sometimes we're wondering if the people spouting such nonsense have simply all gone crazy when we nobody was looking.
In fact, they probably have (see Evan's bizarre insistence that more of the same is guaranteed to bring about different results).
In view of all this, better hold on to your gold , although of course the 'gold bubble' has just popped – again (it seemingly happens two or three times every year). This brings us to something else…
There is an immense fixation by countless market commentators on declaring gold's ascent a 'bubble'. Todd Harrison at Minyanville is actually one of the good guys, so please don't think that we want to pick on him – and he was fair enough to admit (in the comments section of his article) that the chart he picked for his latest 'bubble comparison' was, well a bit arbitrary. Besides, Todd Harrison (probably) couldn't care less about gold bug concerns. He is a trader, and by all accounts a good one; when he sees an interesting chart he shows it on Minyanville and comments on it.
Here is what he wrote on Wednesday – entitled 'Is the Gold Bubble About to Pop?' This is the scary chart that went with the article:
Gold bugs, you're done for … – click for higher resolution – click for higher resolution.
Now look at what he wrote less than a year ago, in October 2010- entitled 'How Big Can the Gold Bubble Get?' (apparently it was a bubble in 2010 already – or was it? Gold was trading at or close to $1400 at the time).
Here is the somewhat less scary chart that went with that article:
Gold bugs, things are not as bad as they at first appeared….phew! – click for higher resolution.
So what's the problem? It is all about the scales on such a 'five in one' chart from Bloomberg. That is why we always point out to readers that our CDS charts are 'color-coded' – both prices and price scales are identified that way. It looks e.g. on the 'PIGS' CDS chart superficially as though Greek and Italian CDS were at the same height, but a look at the legend reveals that nearly 2,000 basis points lie between them. Essentially, one can make such a chart look any way one wants. Simply aligning the peaks of prices tells one very little if the price scales differ.
For instance, the Nikkei index was trading at a mere 1,000 points in 1969 – in 1989, at the peak of the bubble, it had reached nearly 39,000 points. If gold were to imitate the Nikkei, it would have to rise to $9,750 by 2019 (39 times the 1999 low of $250). Crude oil was a little over $8/barrel at its 1998 low and reached $145 in 2008. Gold would have to go to $4,530 to produce a similar percentage rise. You get the drift – gold's ascent to date still pales compared to these bubbles of the past. In fact, if gold were to merely imitate itself – this is to say the percentage gain it managed to garner from 1971-1980 – it would have to rise to $6,400.
Note also Bill Fleckenstein's interesting comments on the 'bubble question'. Fleckenstein explains the reasons why he thinks gold is not a bubble (or at least not yet), noting inter alia that
“[…] part of what drives the creation and growth of bubbles is the belief that you are not in one. Instead of being suspect, parabolic price appreciation gets rationalized away with statements like, "new economy," "this time, it's different" or "housing prices never go down."
Conversely, a widespread belief that steep price appreciation is unsustainable is a good sign that you are not in the midst of a bubble, since it is an argument against joining the action. Whereas during a bubble all you hear — in the media, at parties or even from the bagger at the grocery store — are the reasons you should jump in before it's too late.
The reason I bring all this up is because inane commentary about the gold market being a bubble continues almost daily […]”
What's really noteworthy is the amount of hostility this article has provoked in the comments section. Admittedly, people really like to go on the barricades on these mainstream sites for some reason (for instance, Mark Hulbert regularly gets castigated by commentators regardless of whether he espouses a bullish or a bearish view on various markets in his articles – somehow there's always a flood of criticism). Still, we found this remarkable because normally it's the gold bugs that are one of the more vocal groups.
Stocks Like Easing Talk
Finally, as we noted at the beginning, stock markets around the world evidently liked all this recent talk about more monetary easing and deficit spending, but curiously, gold was somewhat less enamored of it. This tells us that there is a fair amount of trading going on that is based on recent inter-market correlations. In other words, it doesn't really mean much at this stage.
There are of course some arguments in favor of a continued short term bounce in stocks, such as the recent oversold conditions and relatively high put-call ratios, as well as the divergences we pointed out yesterday. Specifically we noted that:
“The SPX diverges from the European markets by putting in a higher low. Whether this divergence will be meaningful remains to be seen, but it is certainly something worth paying attention to.”
However, be aware that long term sentiment indicators continue to be stuck in 'red alert' territory, with the mutual fund cash-to-assets ratio firmly planted at an all time low and margin debt still at one of its highest levels ever, in both relative (relative to market capitalization) and absolute terms.
Moreover, the euro area crisis remains unresolved. We will discuss the latest developments in the euro area on Friday – we would however mention here that Finland is apparently considering pulling out of the Greek bailout if it fails to get any collateral. This would likely make the bailout impossible, as to our knowledge unanimity is required for its implementation (i.e, all 17 euro area nations must agree to go forward with the bailout).
The SPX rises amid talk of more monetary easing and deficit spending – but it does so once again on declining trading volume – click for higher resolution.
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8 Responses to “A Barrage of Calls For More Interventionism”
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