QE 3 – Hoodwinked and Bamboozled
Have you ever been hoodwinked? Bamboozled? Horns waggled? Led astray? Or mislead? Sure you have! The full time occupation of bureaucrats in DC is spinning the facts to ensure sure you remain confused. And sometimes it works. Case in point - QE3. Even for most of us diligent investors and a good number of analysts, QE3 didn't turn out as expected. However, once you realize you've been had, you absorb the lesson, and move on. But the question is have you learned the lesson? If you refuse to understand and acknowledge the lesson, you find that you will continue to repeat the errors of the past. The Fed's third round of QE duped just about everyone! Experts and Joe Public alike. I imagine after it's announcement in September 2012, Bernanke ran behind a curtain, smiled and uttered the words, "Ahhhh psyched! Gotcha's.
The market held a great many assumptions prior to QE3 and they were based upon the notion that adding increased liquidity into the markets would produce inflationary conditions, further debase the dollar, which would be bullish for gold and other non-dollar assets. It's been almost one year since the Fed announced it's third round of quantitative easing, and as Argentus has aptly pointed out, we find ourselves in a a highly repressive stagflationary environment where gold, silver and for that matter, platinum, palladium continue to languish.
I've said before the analogy of helicopter Ben throwing fiat from helicopters, or some guy in the basement of the Fed working overtime like the guy in the Dunkin Donuts commercial that says “Time to make the donuts” is largely a metaphor. The real process behind QE comes through the magic of key strokes. The Fed creates additional dollars that get put into a banks reserves held by the Fed and are not lend into the economy.
This in stark contrast to the 2008 stimulus package and other historic bailouts that went directly into corporate pockets and employees spend those dollars at the local movie theater and ice cream shops. This is one reason the markets rebounded so nicely after 2008. The stimulus actually went directly into corporations or municipalities and was spent into the economy. Those of you who were speculators in gold and silver leveraged equities including the junior mines made out like a bat out of hell.
It's different this time because now the stimulus is sitting as reserves. These new reserves are basically an exchange. The bank gets cash reserves in return for MBS (mortgage backed securities) The reserves sit in the bank and no additional money is put into circulation.
Australian Professor of Economics Steve Keen explains the process:
Reserves are there for settlement of accounts between banks, and for the governments' interface with the private banking sector, but not for lending from. Banks themselves may swap those assets for other forms of assets that are incoming-yielding, but they are not to lend from.
Or as Rick Rule explained to me when I interrogated him on the lack of money velocity, he said “It's simple. Banks get a much better interest rate by lending to Washington than lending to you”
So we have a great paradox on our hands as described by WSJ writer Andy Kessler.
Here is the great economic paradox of our time: Despite the Federal Reserve's vast, 4½-year program of quantitative easing, the economy is still weak, with unemployment still high and labor-force participation down. And with all the money pumped into the economy, why is there no runaway inflation?
So let's look for some answers which can be found in this chart by Richard Koo of Nomura Equity Research comparing M2 (money supply ie money in circulation) vs money base vs bank lending.
We all know that inflation is an increase in the monetary base. So strictly speaking, That is inflation. However, the amount of M2, the amount in circulation has not increased any faster than the previous decade. And as the graph indicates, bank loans are down 22%. This spells low money velocity or deflationary like conditions.
Ellen Brown author of “Web of Debt” writes about the QE phenomena on her blog in her article “Collateral Damage: QE3 and the Shadow Banking System.
Rather than expanding the money supply, quantitative easing (QE) has actually caused it to shrink by sucking up the collateral needed by the shadow banking system to create credit. The “failure” of QE has prompted the Bank for International Settlements to urge the Fed to shirk its mandate to pursue full employment, but the sort of QE that could fulfill that mandate has not yet been tried. http://webofdebt.wordpress.com/2013/07/22/5835/
The essence of her piece is a good one. I highly recommend her book as well as her blog , however, her summary that the money supply has actually shrunk might be better stated as QE3 has caused a fall in money velocity, and a rise in demand for cash exactly opposite to pre-QE3 expectations. There GL goes again spouting off those fancy words like velocity. Yes, it's important and IMO our financial welfare heavily depends on understanding this relatively intangible economic factor. That's why you'll hear me speak of it ad nauseam.
The money supply didn't evaporate. What was happened is that the Fed's purchases has reduced the existing supply of treasuries in exchange for imaginary numbers. Treasuries are considered “safe assets” and these assets are requirement to extend credit into the public domain. What we have is a reduction of safe assets for funny money. Pretty “ponzi-ish” Essentially you are replacing an over rated, inflated asset, a US treasury, considered a safe asset in exchange for thin air.
If the Fed's money “printing” was inflationary, we would have seen a rise in velocity. And again in certain area's, there has been but the condition has mostly been deflationary. Now to exasperate the situation, we have the condition that Argentus is calling “stagflation” or financial repression which is as much a result of political repression as it is financial repression. Money Printing + Reduction of Safe Assets + Sustained low interest rates/bail-ins (political and financial repression) which has created this phenomena of stagflation despite an increase in monetary base. There is no wind blowing the dust through the system.
“Don't Fight The Fed”
Our dear friend, Puck Smith, once posted a comment that is forever etched in my memory. It was about making an argument through the use of quotes, maxims or postulates. Some of our favorites “Don't Fight the Fed” “The Trend is Your Friend” “The Trend is Your Friend, until it isn't “When You Are Crying, I am Buying” “Dance While the music is playing” etc...
They often feel good and sound convincing but a more thorough examination of the facts often show that they are sophisticated form of propaganda. I have not been able to recall the word that Puck used to describe this form of argument for the life of me. If any of you philologist know the word, please share.
I would argue as Rick Santelli at CNBC has many times as well as our friends at ZeroHedge that the economy is a complex system. For that matter, economics is a complex subject and even the talking heads, and the high tower economists struggle to get a handle at all the complex pieces. The fed being the great Keynesian institution that it is thinks that by interfering in one area of the economy, it can predict the outcome. Well, it can't. The fed is constantly fighting itself moping to the left, and jabbing to the right. And as Santelli has pointed out many times in his morning rants, after following the predictions of the FED in their FOMC reports, one would do much better by being a contrarian to FED advice in light of it's record of poor forecasts.
The Fed is either stoking the markets, or dumping fuel out of the markets. Bernanke's May 29th speech or what Ellen Brown calls “taper tantrum” wiped out approximately $3 trillion from the equity markets according to her website. Those aren't markets working on fundamentals, these are markets that are operating on pure psychological endorphins. $85 billion dollars a month are not flowing into the economy for investors to spend on the stock market. They are being fueled by 100% speculative fever and 100% MOPE.
Am I saying that you can't make money in the broader equity markets? NO. Unequivocally No. I am also not suggesting that Pining Armageddon's portfolio is a bad one as I have and will continue to eye some continuing and emerging trends under the right macro conditions. However, people making money off the psychological endorphins while thinking they are making money off of endless QE are deceiving themselves. When markets are out performing while fundamentals are lagging should raise some red flags. Tulips are tulips. It also doesn't mean that sometime in the future the FED will attempt a more direct form of stimulating the economy which flows more directly into the economy. However, they are well aware of the risk of doing that. Wait and watch.
There is certainly no shame in making money from the fumes, however one should do so with the realization that the bubbles which are appearing in the markets and real estate can be removed at will simply by a 10 minute news conference in addition to the real concerns of lingering bank swans which has been the subject of many of our discussions. Managing your risk is ever more important in these markets.
Junior Gold Mining Preview
One of my favorite sectors to watch this dynamic of over inflated expectation playing out is the gold and silver junior mining sector. I will be talking more about the bullish and bearish cases in the mining sector shortly. But as a preview, I wanted to illustrated one dynamic that occurs with junior miners that we are seeing in the broader markets.
For no apparent reason, a junior mine without solid high grade deposits will just spike simply due to speculation not being supported by the fundamentals of the property. AKA Hype!! Some of the most famous mining analysts, newswriters have gotten caught in these whirlpools. If you pretend that you are beyond these subtle influences, that is when you get trapped. An expert mountain climber never takes the next step for granted. The climber remains humble to the mountain and the unpredictable elements.
A stock will simply go up because people think it's good and have been deceived by poor independent assessments and nicely massaged numbers put out by charismatic mining executives . Again, nothing wrong with making money on an illusion. However, smart money retreats before the crowd is able to identify the fatal flaw leaving the rest of the investors without an exit door. Consider this principle in all your investments.
More to come!