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All Eyes on the US Federal Reserve

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All Eyes on the US Federal Reserve

Posted on 08 July 2013 by Greg Canavan

Emerging markets have felt the effect of monetary tightening emanating from the world’s largest economy and manager of the global reserve currency.

Since peaking in January this year, the Brazilian market is down a whopping 22% and Mexico’s bourse is off 14%. Asia is not far behind. Chinese stocks are down 13.5% from the peak in February, while Thailand (-10.8%), the Philippines (-15.6%), Indonesia (-8.7%) and India (-6.1%) are all down from their highs in May.

Now this might just be a correction and nothing to worry about. After all, interest rates are still incredibly low from a historical point of view. You could just be seeing a pullback following a central bank induced liquidity melt-up earlier in the year.

But given the inherent instability in the system…and the fact that nothing has changed to correct the problems that brought about the first big credit crisis in 2007, we would be inclined to take the recent market action as a warning sign of trouble to come.


To Understand Why…

You need to understand how the financial system ‘works’. The US is the source of global liquidity. Due to massive US budget and trade deficits, US dollars (in the form of Treasury and mortgage securities) flow out into the world.

Countries that stand to benefit the most from the deficit spending soak up the flow of dollars with, in many cases, newly created domestic money and credit.

This has the effect of both financing over-consumption in the US and building up the foreign exchange reserves of the country in question…reserves which that domestic banking system can then use as a base to expand its own credit creation activities. It’s a liquidity-creating positive feedback loop.

While ever the US, buoyed by cheap money, continues to spew ever increasing amounts of greenbacks into the financial system, and emerging market export-dependent countries continue to mop up those greenbacks and increase their ‘foreign-exchange’ reserves, credit and equity markets will tend to inflate.

But this global dynamic relies on confidence in the ‘system’ to go on creating enough dollars and credit to keep the asset inflation going. And we think that confidence is beginning to wane.

So even though interest rates may still be historically low, it’s the change in rates you should be looking at. And compared to a few months ago, financial conditions are now tighter. And tighter conditions in the US mean tighter conditions around the world. Monetary tightening doesn’t usually inspire confidence amongst financial speculators.

Don’t forget, the US fiscal consolidation plays a large part in this too. For the past five years, the US government has churned out $1 trillion plus budget deficits. But government spending is set to contract sharply following the repeal of the Bush-era tax cuts and some changes to spending.

The Congressional Budget Office (CBO) now projects that the federal budget deficit will total $642 billion in 2013 and $560 billion in 2014. Last year, the CBO estimated that the deficit would remain over $1 trillion in 2013 and reach $924 billion in 2014.

That’s quite a tightening. The supply of new treasuries is still high, but it’s the change that’s important and if the government can hit the CBO forecasts (unlikely) it will represent a significant fiscal contraction over this year and the next.

So you’ve got monetary and fiscal tightening going on behind the scenes, combined with hugely inflated, derivative driven asset market casinos where the players want to keep on rolling the dice.

But maybe not all the players. Perhaps what we’ve seen over the past month or so is the ‘smart money’ taking their chips off the table and exiting the building. When this occurred in past tightening phases, it was a prelude to a crash.

Greg Canavan
Editor, The Daily Reckoning Australia

[Ed note: To read more of Greg's in depth macro-economic analysis, click here to subscribe to the free daily e-letter The Daily Reckoning.]

From the Archives…

The Power of Low Interest Rates Coming to the Aussie Market
5-07-2013 – Kris Sayce

S+P 500 Downtrend Looms? Counting Down The Days…
4-07-2013 – Murray Dawes

Here’s Your Six-Point Stock Buying Checklist
3-07-2013 – Kris Sayce

Are the Credit Rating Agencies at it Again?
2-07-2013 – Kris Sayce

Why This Could be Another Great Year for Australian Stocks…
1-07-2013 – Kris Sayce

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Bernanke’s Excuse for Mass Looting

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Bernanke’s Excuse for Mass Looting

Posted on 22 December 2012 by MoneyMorning

Bernanke said that to remedy the unemployment problem he will continue the Fed’s program of asset purchases. Specifically, the Fed will continue to buy and hold mortgage-backed securities (yes, they are still sloshing around the banking system) and US Treasury securities – $40 billion-plus per month. Plus, he will keep the federal funds rates at near zero.

The great change, he said, is the intense focus on the policy objective of unemployment. The committee sees no inflation threat, so it might as well turn its attention to the labor markets. The Fed loves the unemployed, you see, and wants to help them.

But here’s the disconnect. What the devil does buying bad debt from zombie banks have to do with getting people jobs? The relationship between assets purchases and policy goals is murky at best.

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The Bare, Naked Truth About the US Federal Reserve’s Socialist Agenda

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The Bare, Naked Truth About the US Federal Reserve’s Socialist Agenda

Posted on 15 December 2012 by MoneyMorning

The top line story, according to the FDIC’s latest Quarterly Banking Review, is that the majority of U.S. banks are in better shape today than they have been in years.

The untold story is that when the Federal Reserve is done transitioning the United States from capitalism to socialism, the few dozen banks that remain in America will all be profitable until they need bailing out again, but will never die and live on in infamy.

Is that just hyperbole or some wild conspiracy theory? It’s neither. Unfortunately, it’s the bare, naked truth about the Fed.

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