Everything changed on September 13. It’s the day Ben Bernanke promised not to take away the punch bowl.
Last Thursday, Helicopter Ben announced that the Fed would start buying $40 billion in mortgage-backed securities – for as long as it takes. He also announced the Fed will keep rates between 0-0.25%, until mid-2015.
The goal is to keep supporting the mortgage bond market until the employment level improves ‘sufficiently.’
But given that the last several rounds of multi-hundred billion dollar stimulus didn’t accomplish that goal, it’s hard to see why they’d expect this time to be any different.
Maybe it’s just because Paul Krugman was right: They didn’t spend enough the first two times (sarcasm intended). Or then again, maybe that’s not really their goal…
Consider this: At Jackson Hole just a few weeks ago Bernanke said that, historically, there has only been limited experience with quantitative easing. Therefore central banks, including the Fed, ‘have been in the process of learning by doing.’
Excuse me, but are you freaking kidding me?
Did Ben skip all his history classes? Has he ever heard of the demise of Rome or Weimar Germany?
More recently, even Argentina and Zimbabwe have had plenty of experience with quantitative easing. Their zealous over-printing led to major devaluation and/or outright currency collapse.
Couldn’t Bernanke have checked in with Cristina Kirchner or Robert Mugabe?
The only real difference, and I’ll admit it’s a substantial one, is that the U.S. dollar is the reserve currency for the world’s central banks. But that won’t change the outcome.
Instead it may just delay the day of reckoning. In the meantime, it’s very likely going to make the situation much, much worse.
So What’s the Fed Really Up To?
Well, here’s what I think…
Keeping interest rates way below market rates has the following effects:
- It discourages savings and encourages consumption. Actually it’s a slap in the face for anyone holding onto cash, especially retirees who depend on fixed returns for income.
- Investors will also be “forced out” of bonds, because they provide a negative yield after you factor in true inflation (which is certainly in the neighborhood of 6%-8% annually, no matter what the Fed says). The 10-year bond has been trending lower for the past five years, currently yielding near record lows at 1.8%.
- That in turn encourages investors to pursue higher-risk investments, effectively supporting and pushing stocks higher.
Printing massive amounts of new dollars has the following effects:
- It debases the currency, meaning holders of U.S. dollars have continually decreasing purchasing power.
- It seriously annoys other nations who suddenly find their exports to the U.S. shrinking (as they become more costly to Americans), leading to “me too” policies from them, otherwise known as “currency wars.” (Europe confirmed this a couple of weeks ago, and Japan announced new easing measures).
- This, too, supports and pushes stocks higher.
- Asset bubbles develop in areas that are especially inflation-sensitive, like precious metals and commodities of all sorts, and even select real estate.
- This in turn causes inflation to increase for all kinds of basic goods, like food, raw materials, and energy (sound familiar?).
And so the vicious cycle of higher input costs, leading to still higher prices, becomes entrenched.
The risk is that once serious inflation, or even the fear of it, takes hold, it will probably already be too late for the Fed to address in any substantial way.
So if there’s so much risk, and so little to show for the recent bailout/stimulus campaigns and extended low rates, why pursue more?
For the answer, we need to look at who the Fed really serves: the [US] federal government and the large banks.
Bank of America just last week said it expects the Fed to almost double its balance sheet, running it up from its current $2.8 trillion to $5 trillion in the next two years alone.
Extended artificially low rates are good for debtors. So it will help mortgage holders and homebuyers somewhat, but the federal government is by far the largest debtor. And low rates are a disincentive for the government to actually rein in spending to get its fiscal house in order, as they make the debt burden relatively more manageable.
The [US] national debt will likely rise to $20 trillion by 2016 from $16 trillion today. Even at a reasonable 5% interest rate, debt servicing alone will cost $1 trillion per year, eating up a whopping 40% of government tax revenues.
When rates do return to “normal” market levels and probably much higher – à la the levels of the late 70s to early 80s – look out, as it could get really ugly. If rates went to 12%, all tax revenues would go to service the national debt!
Keep in mind that the effect of higher stock prices also makes both the Fed and government “look good” in the eyes of the populace.
As for the large banks, incessant money printing adds to their cash balance. And since they’re barely lending, much of that cash earns a risk-free return on deposit at the Fed. Not a bad deal, for the banks.
The new cash repairs their balance sheets and improves their capital asset ratios. The banks slowly return to relative health and profitability, and the taxpayer foots the bill through higher taxes and inflation.
But let’s face it, it’s a lousy deal for Joe Main Street.
How to Game the Fed
While QE1 and QE2 clearly did little to help the unemployed, their effects on the markets were undeniable.
Since March 2009, gold is up 97%, silver is up 162%, oil is up 122%, and the Continuous Commodity Index (CCI) is up 55%. The S&P 500 is up 114%, and is at spitting distance from its 2007 all-time highs.
Those who didn’t participate, typically lower income earners and most of the middle class, are certainly the poorer for it.
In the four weeks preceding Bernanke’s September 13 QE-Infinity announcement, inflation-sensitive hard assets sensed that something was afoot.
Over that one month alone, gold gained 10.8%, silver gained 26.5%, oil was up 5.4%, copper gained 13.4%, and the CCI was up 8.2%.
Meanwhile the U.S. Dollar Index lost almost 7%, a huge amount for any major currency, in the six weeks leading up to the recent QE announcement.
So what’s an investor to do? Well, what works, of course.
My advice is simple. Thanks to the Fed, this trend has just been rebooted. Maintain exposure to inflation-sensitive assets, like precious metals and commodities. They will continue to do as well or better than they did during QE1 and QE2.
Look, the only difference with this round of QE is that it’s going to be much bigger and go on much, much longer.
So the effects of the first two rounds of QE are really just being extended, and the gains will multiply from here.
So while posterity may not be kind to Bernanke’s legacy, you have the knowledge to protect yours.
Contributing Editor, Money Morning
Publisher’s Note: This is an edited version of an article that originally appeared in Money Morning (USA)
From the Archives…
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