Money Supply

It is always amazing to observe how people become less risk averse after risk has markedly increased and more risk averse after it has markedly decreased. The stock market is held to be 'safe' after it has risen for many weeks or months, while it is considered 'risky' after it has declined. The bigger the rally, the safer the waters are deemed to be, and the opposite holds for declines. One term that is associated in peoples' minds with rising prices is 'certainty'. For some reason, rising prices are held to indicate a more 'certain' future, which one can look forward to with more 'confidence'. 'Uncertainty' by contrast is associated with downside volatility in stocks. In reality, the future is always uncertain. Most people seem to regard accidental participation in a bull market cycle with as a kind of guarantee of a bright future, when all that really happened is that they got temporarily lucky. Perma-bullish analysts like Laszlo Birinyi or Abby Joseph Cohen can be sure that they will be right 66% of the time by simply staying bullish no matter what happens. This utter disregard of the risk-reward equation can occasionally lead to costly experiences for their followers when the markets decline.

What Do Economic Indicators Show?  What Do Economists Say?

The great day has come and gone when the Fed would once again ride to the action, not daring to be left behind by the ECB’s perverse vaunting of its new ‘unlimited’ programme of bond purchases. But the few, brief sentences from Bernanke contain such a miasma of error that it is hard to know where to begin if we are to restore a fresh breeze of economic rationale to this swamp of non sequiturs and wilful misunderstandings. It is not enough that crude, Krugmanite Keynesianism clings to the cheap parlour trick of using money illusion to fool unemployed wage-earners into lowering the reservation price of their labour, but now we must battle against banal, Bernankite Bubble-blowing – the hope that money illusion will fool cash-constrained asset owners instead. It is not only that Bernanke’s policies will inevitably assist the zombie companies and the obsolescent industries to absorb scarce resources (not least on bank balance sheets) to a much greater degree than is justified, there is also the danger that lax money misleads even today’s supramarginal businesses into over-estimating the depth and duration of demand for their products, ultimately undermining many otherwise sound undertakings and reducing these, too, when the cycle next turns, to the ranks of the Living Dead.

Going back to the FOMC's own archives reveals some truly stunning disclosures arising from none other than the Federal Reserve on the topics of inflation, currency "debauching", money creation, and what it would take for the Communists and Stalin to win. "I agree with you entirely that the Soviet dictators would like to bring about our economic collapse and, as you know, inflation is perhaps the greatest force for arraying the various sectors of a capitalistic economy against each other. John Maynard Keynes stated in his 'Economic Consequences of the Peace' (1919): 'Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency...Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.'"

Curious why the mere prospect of a gold, or gold-linked "standard" (or any other hard-asset backing for that matter) - a monetary system in which the creation of money units, i.e., literally the creation of money out of thin air, is constrained by some real-world limitation is the scariest thing to the status quo, the following chart courtesy of Grant Williams should explain it all. It shows the expansion of the world's monetary bases coupled with the expansion in the world's gold supply over a comparable period. Needless to say, expanding the money supply at 8% in several years will hardly lead to the massive inflation needed to "inflate away" the roughly $35 trillion in debt overhang by now (vs $21 billion through 2009) that is crushing the entire developed world.

Global gold production remains at its level of the late '90s, even though prices have risen to over $1,700 per ounce from $252 per ounce in 1999 or roughly 16% per annum in dollar terms. Only Rio Tinto and Ivanhoe's Oyu Tolgoi mine in Mongolia stand out as a major new gold mines expected to begin production in the near future. Bulls note that global production has remained impervious to the price of gold. This may continue to be the case due to the increasingly obvious geological constraints being seen in the gold mining sector. Resource nationalism is beginning to become an important factor again. This will also almost certainly affect supply at a time when demand is increasing from people throughout the world and many hedge funds, pension funds and central banks’ due to geopolitical, systemic and monetary risks. The lesson of QE is that fiat currencies increasingly grow on trees. Gold does not.  This is the primary reason that gold will continue to protect investors in the coming months.

Without justice for investors, pension funds and banks defrauded to the tune of hundreds of billions of dollars, there can be no investor confidence to support private finance.  

Pump it up, until you can feel it, Pump it up, when you don't really need it...

From Egan-Jones, which downgraded the US for the first time ever last July, two weeks ahead of S&P: "Up, up, and away - the FED's QE3 will stoke the stock market and commodity prices, but in our opinion will hurt the US economy and, by extension, credit quality. Issuing additional currency and depressing interest rates via the purchasing of MBS does little to raise the real GDP of the US, but does reduce the value of the dollar (because of the increase in money supply), and in turn increase the cost of commodities (see the recent rise in the prices of energy, gold, and other commodities). The increased cost of commodities will pressure profitability of businesses, and increase the costs of consumers thereby reducing consumer purchasing power. Hence, in our opinion QE3 will be detrimental to credit quality for the US."

With the U.S. presidential election right around the corner, Americans are getting themselves all in a tizzy to go to the voting booth and remind the holders of public office who they work for.  Because it’s a presidential election, the stakes are looked to as even higher as the media paints the contest between Barack Obama and Mitt Romney as a conflict with extreme consequence.  The statist tramps known as mainstream journalists are championing the race as a great ideological battle.  The fact that the candidates differ little on policy and vision is purposefully avoided.  To the political and intellectual establishment, the show must go on.  Their way of life depends on it. No matter how hard boobus Americanus is kicked in the teeth with his own inability to have an effect on government, he still feverishly casts his ballot with faith locked into the system. As Gary North puts it, “democracy is window dressing for elite control.” Sadly, unless there is a radical change of thinking, mankind’s intellect will finally begin to resemble that of a dog who after being beaten unmercifully, happily returns to his master’s side ready once more for another round.

The Fed panicked. It is extraordinary that the Fed would announce an open-ended "we'll print as much as it takes, as long as it takes" policy. Chairman Bernanke is sending a signal to the markets and to government that the economy is bad and getting worse and that the Fed will do its part as everyone expects them to do. This is a clear signal to the markets and the world that the Fed stands for monetary inflation. They don't know what else to do. Here is the fallout.

There is one big problem with the Fed's announcement of Open-Ended QE moments ago: it effectively removes all future suspense from FOMC announcements. Why? Because the Fed has as of this moment exposed its cards for all to see from here until the moment it has to start tightening the money supply (which may or may not happen; frankly we don't think the Fed tightens until hyperinflation sets in at which point what the Fed does is meaningless). It means easing is now effectively priced into infinity. Now rewind back to that one certain paper by the New York Fed, which laid it out clear for all to see, that if it wasn't for the expectation of easing in the 24 hour period ahead of the FOMC meeting, the market would be 50% or lower than where it is now, and would have been effectively in negative territory in the aftermath of the Lehman collapse. What Bernanke did is take away this key drive to stock upside over the past 18 years, because going forward there is no surprise factor to any and all future FOMC decisions, as easing the default assumption. It also means that Bernanke may have well fired his last bullet, and it, sadly, is all downhill from here, as soaring input costs crush margins, regardless of what revenues do, and send corporate cash flow to zero. Unfortunately, not even in the New Normal can companies operate without cash flow.

You could be forgiven for believing that the ECB's talk/plans have indeed solved the European problems. The market's reaction appears to confirm all anchoring bias and thanks to overly bearish positioning (and thin summer markets) has sent all but the long-term-est bears scurrying for their rabbit-holes - as once again 'tail-risk has been removed' - just like LTRO, the SGP, and The Grand Plan before it. However, as BofAML notes in this must read note, we do not believe the ECB move will necessarily lead to a permanent stable equilibrium for the euro area for two reasons: 1) a stable equilibrium would require certainty about the ability of countries to restore debt sustainability, i.e. that they will respect an agenda of economic policy reforms and/or; 2) certainty about the ECB course of action, i.e. that the ECB will purchase bonds in such a way that we will not observe renewed financial market stress as we did this summer. Such certainty would require both Spain and Italy to put their faith in the Troika’s hands and the ECB to pre-commit in return, which seems to us very unlikey at this time. The ECB’s conditional backstop is some way from the “bazooka” that many were expecting

Lock Up Your Sacred Cows Before We Find and Slaughter Them!

Earlier this week, former U.S. president Bill Clinton gave the keynote address to the Democractic National Convention in an effort to lend some of his popularity to Barack Obama.  With the unemployment rate still stubbornly high at 8.1%, Obama has lost many of the enthused voters who put him into the Oval Office in 2008.  Clinton was tapped to deliver the speech not only because of his image of a wonkish pragmatist but because of his presiding over the booming economy of the late 1990s.  Like a prized mule, Clinton was dragged out to give Democrats someone to point to and say that his policies were the hallmark of smart governance.  Today, Clinton still takes credit for Greenspan’s manipulated boom.  His supporters on the left love nothing more than to point at his presidency as vindication of the backwards theory that higher taxes equal more growth.  Clinton wasn’t a policy wonk; he was a politician who dipped into the Social Security trust fund to give an appearance of balancing the budget while the national debt still climbed higher. Through all of his financial scandals, womanizing, aggressive foreign policy approaches, and possible cover ups, it is actually fitting that Clinton is still looked to by the political establishment as someone worthy of respect.  He is representative of F.A. Hayek’s timeless lesson: in government the worst rise to the top and state power corrupts.