... And why does the Fed, with $1.3 trillion in cash parked at foreign commercial banks or more than half of the reserves created under QE1, 2 and 3, continue to bail out non-American banks?
In his parting act, Federal Reserve Chairman Ben Bernanke has decided to continue printing some $85 billion per month (6% of GDP per year) and spend those dollars on government bonds and, in the process, keep interest rates low, stimulate investment, and reduce unemployment. Trouble is, interest rates have generally been rising, investment remains very low, and unemployment remains very high. As Lawrence Kotlikoff points out, echoing our perhaps more vociferous discussions, Bernanke’s dangerous policy hasn’t worked and should be ended. Since 2007 the Fed has increased the economy's basic supply of money (the monetary base) by a factor of four! That's enough to sustain, over a relatively short period of time, a four-fold increase in prices. Having prices rise that much over even three years would spell hyperinflation.
As the S&P 500 continues to push to one new high after the next, the bullish arguments of valuation have quietly given way to "it's all about the Fed." The biggest angst that weighs on professional, and retail investors alike, are not deteriorating economic strength, weak revenue growth or concerns over the next political drama - but rather when will the Fed pull its support from the financial markets. For the Federal Reserve, they are now caught in the same "liquidity trap" that has been the history of Japan for the last three decades. Should we have an expectation that the same monetary policies employed by Japan will have a different outcome in the U.S? More importantly, this is no longer a domestic question - but rather a global one since every major central bank is now engaged in a coordinated infusion of liquidity. Will the Federal Reserve "taper" in December or March - it's possible. However, the revulsion by the markets, combined with the deterioration of economic growth, will likely lead to a quick reversal of any such a decision.
There are three dimensions to the broader investment climate: the trajectory of Fed tapering, the ECB's response to the draining of excess liquidity and threat of deflation, and Chinese reforms to be unveiled at the Third Plenary session of the Central Committee of the Communist Party.
As we enter into the two final months of the year, it is also the beginning of the seasonally strong period for the stock market. It has already been a phenomenal year for asset prices as the Federal Reserve's ongoing liquidity programs have seemingly trumped every potential headwind imaginable from Washington scandals, potential invasions, government shutdowns and threats of default. This leaves us with four things to ponder this weekend revolving around a central question: "Does the Fed's Q.E. programs actually work as intended and what are the potential consequences?"
"A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in the general price levels." Importantly, this evidence is mounting that the Federal Reserve has now become trapped within this dynamic. The important point is that, for the first time that we are aware of, someone (of apparent note to the status quo) has verbally stated that we are indeed caught within a liquidity trap. This has been a point that has been vigorously opposed by supporters of the Federal Reserve actions.
Many have asked us to expand on how the rapid expansion of money supply leads to an effect the opposite of that intended: a fall in economic activity. This effect starts early in the recovery phase of the credit cycle, and is particularly marked today because of the aggressive rate of monetary inflation. The following are the events that lead to this inevitable outcome. And while many central bankers could profit by reading and understanding this article, the truth is they are not appointed to face up to the reality that monetary inflation is economically destructive, and that escalating currency expansion taken to its logical conclusion means the currency itself will eventually become worthless.
"We see upside surprise risks on gold and silver in the years ahead," is how UBS commodity strategy team begins a deep dive into a multi-factor valuation perspective of the precious metals. The key to their expectation, intriguingly, that new regulation will put substantial pressure on banks to deleverage – raising the onus on the Fed to reflate much harder in 2014 than markets are pricing in. In this view UBS commodity team is also more cautious on US macro...
The Fed's capabilities to engineer changes in economic growth and inflation are asymmetric. It has been historically documented that central bank tools are well suited to fight excess demand and rampant inflation; the Fed showed great resolve in containing the fast price increases in the aftermath of World Wars I and II and the Korean War. In the late 1970s and early 1980s, rampant inflation was again brought under control by a determined and persistent Federal Reserve. However, when an economy is excessively over-indebted and disinflationary factors force central banks to cut overnight interest rates to as close to zero as possible, central bank policy is powerless to further move inflation or growth metrics. The periods between 1927 and 1939 in the U.S. (and elsewhere), and from 1989 to the present in Japan, are clear examples of the impotence of central bank policy actions during periods of over-indebtedness. Four considerations suggest the Fed will continue to be unsuccessful in engineering increasing growth and higher inflation with their continuation of the current program of Large Scale Asset Purchases (LSAP)...
Stunning Facts that Your History, Economics and Business Teachers Never Learned ...
If you listen to TV commentators, you’ve been told the worst is behind us. Growth is picking up, and Europe is coming out of its slumber. No one seems to be concerned that this tepid below-2-percent growth is being entirely fed by the central bank’s massive money printing. It’s a “growth at any price” policy. How quickly we forget. We currently fear Fed tapering, as we should. Yet, we should be even more fearful that it doesn’t taper. Today, we really have a dreaded choice of losing an arm now or two arms and a leg tomorrow. Because the price distortions have been massive, the adjustment will be horrendous. Government policy makers and government economists simply do not understand the critical role of prices in helping discovery and coordination.
Almost 3 years ago we noted the oddly hubris-full confidence of Ben Bernanke of his ability to "exit" from the experimental extreme monetary policies:
"You have what degree of confidence in your ability to control this?" Bernanke: One hundred percent.
But last night we got the truth from Fed's Dudley, who more realistically stated:
Dudley: "Exit from these unconventional set of policies is certainly feasible... But we do have to be a bit humble about what we don’t know."
So which is it? Who do you believe?
Much attention has fallen on the Fed's recent announcement that a new fixed-rate, full-allotment overnight reverse repo facility is in the works (so much so that both shadow banking experts Singh and Stella have opined on the issue). It appears that despite the Fed's "best efforts" at communication, not enough clarity has been shed on the topic. So here is Bill Dudley's explanation.
As it turns out, a lot... and also very little.
Even as JPMorgan seems set to put its London Whale troubles behind it with a nearly $1 billion imminent settlement, while at the same time throwing two mid-level traders at NY prosecutors and washing its hands of the whole tempest in a teapot affair, a curious snag has appeared. The CFTC, which in the past has never had a problem with promptly settling any market manipulation abuse with any bank in exchange for a small cash-greased slap on the hand, is suddenly a sticking point in JPM's ability to just walk away from the biggest prop trading Snafu in history. As WSJ reports, "the CFTC is focusing on the bank's increasingly aggressive trades made over several months early last year, when it added tens of billions of dollars to its derivatives positions—contracts tied to investment-grade corporate bonds, these people say. The CFTC is likely to use new powers granted by the Dodd-Frank law that allow it to charge firms for recklessly manipulating markets, say people familiar with the agency's thinking."