In September 2008 the US came to a fork in the road. The Public Policy decision to not seize the banks, to not place them in bankruptcy court with the government acting as the Debtor-in-Possession (DIP), to not split them up by selling off the assets to successful and solvent entities, set the world on the path to global currency wars. By lowering interest rates and effectively guaranteeing a weak dollar through undisciplined fiscal policy, the US ignited an almost riskless global US$ Carry Trade and triggered an uncontrolled Currency War with the mercantilist, export driven Asian economies. We are now debasing the US dollar with reckless spending and money printing with the policies of Quantitative Easing (QE) and the expectations of QE II. Both are nothing more than effectively defaulting on our obligations to sound money policy and a “strong US$”. Meanwhile with a straight face we deny that this is our intention. It’s called debase, default and deny.
With just over a week left to the QE2 announcement, discussion over the amount, implications and effectiveness of QE2 are almost as prevalent (and moot) as those over the imminent collapse of the MBS system. Although whereas the latter is exclusively the provenance of legal interpretation of various contractual terms, and as such most who opine either way will soon be proven wrong to quite wrong, as in America contracts no longer are enforced (did nobody learn anything from the GM/Chrysler fiasco for pete's sake), when it comes to printing money the ultimate outcome will certainly have an impact. And the more the printing, the better. One of the amusing debates on the topic has been how much debt will the Fed print. Those who continue to refuse to acknowledge that the economy is in a near-comatose state, of course, hold on to the hope that the amount will be negligible: something like $500 billion (there was a time when half a trillion was a lot of money). A month ago we stated that the full amount will be much larger, and that the Fed will be a marginal buyer of up to $3 trillion. Turns out, even we were optimistic. A brand new analysis by Jan Hatzius, which performs a top down look at how much monetary stimulus is needed to fill the estimated 300 bps hole between the -7% Taylor Implied Funds Rate (of which, Hatzius believes, various other Federal interventions have already filled roughly 400 bps of differential) and the existing 0.2% FF rate. Using some back of the envelope math, the Goldman strategist concludes that every $1 trillion in new LSAP (large scale asset purchases) is the equivalent of a 75 bps rate cut (much less than comparable estimates by Dudley, 100-150bps, and Rudebusch, 130bps). In other words: the Fed will need to print $4 trillion in new money to close the Taylor gap. And here we were thinking the economy is in shambles. Incidentally, $4 trillion in crisp new dollar bills (stored in bank excess reserve vaults) will create just a tad of buying interest in commodities such as gold and oil...
We highlighted the following report from St. Louis Fed's Daniel Thornton in today's Frontrunning, but it may bear repeating as it is the first written salvo in the internal Fed trench warfare over QE2. The report is no surprise: as St Louis is the bastion of Daniel Bullard, one of the biggest non-voting hawks at the Fed, a group which is increasingly getting more vocal with such others as Philly's Plosser and Dallas' Fisher, not to mention Atlanta's Hoenig, the paper titled "Would QE2 Have a Significant Effect on Economic Growth, Employment, or Inflation?" is merely an attempt by the sensible undercurrent at the Fed to distance itself from the policies enacted by the supreme madman in charge of it all. While the report says nothing notably new, it does repeat what all QE2 skeptics know all too well: "It is possible – perhaps even likely – that almost all of any increase in the supply of credit associated with QE2 simply would be held by banks as excess reserves. If so, the effect of QE2 on interest rates could be small and limited to an announcement effect – the effect associated with the FOMC’s announcement – independent of the effect of the FOMC’s actions on the credit supply." Which begs the question - why is this report coming out now? Is this the red herring to the lack of a QE2 announcement on November 3? With everyone certain monetization is imminent and inevitable, is everyone about to end up on the wrong side of the trade? And if so, just how far will the market crash, now that at least 150 S&P points worth of QE2 are priced in...
Jan Hatzius pretty much slams the door on any possibility for a liquidity moderation (let alone exit): "We found that under our own economic forecasts it might take until 2015 or longer before a rate hike became appropriate." In other words, the US economy will very likely just go down in flames, as the Fed makes sure that each and every American is infinitely "rich" courtesy of zero cost debt denominated in worthless dollars. The only salvation from this outcome is for the rest of the world to stage a Fed intervention before it all burns down.
From the Fed's Evans: "If we were to do more large scale asset purchases, namely Treasurys, that would have a beneficial effect. There would be some reduction in long-term yields. That would be of some help. But given the nature of the outlook, much more accommodation than that is probably what’s called for. We have to think a little more carefully about the potential tools that we have available to us."
$10 gallon gas is one step ever so closer. The administration is committing suicide by pursuing a hyperinflationary path. Never too late to the party, spot gold just passed $1,340 for the first time ever.
From Tungstenman Sachs: "Our view remains that the Federal Open Market Committee (FOMC) will once again ease monetary policy via unconventional measures in late 2010 or early 2011. Our views have not changed, and today’s comment discusses them in Q&A form. We believe that purchases of US Treasury securities cumulating to $1 trillion or more are the most likely cornerstone of the program; that the September 21 FOMC meeting is probably too early for a big announcement, but that November 2-3 is a possibility; and that it would likely “work” to a limited degree, perhaps boosting real GDP growth by a little under ½ percentage point per $1 trillion in purchases."
More Decoupling: Goldman Continues Bashing The USD, Sees Short-Term Dollar Strength Followed By QE And A PlungeSubmitted by Tyler Durden on 09/08/2010 15:53 -0500
Goldman's Tom Stolper, in the firm's monthly FX Global Viewpoint, is once again bringing up the theme of a biphasic future in the FX world (and thus, in macro in general), which will see an initial bout of strength for the dollar, which would result in a EURUSD all the way down to 1.22 in 3 months, followed by domestic QE and accentuation of US weakness, which would in turn jettison the dollar, and spike the EURUSD to 1.35 and 1.38 in 6 and 12 months. More importantly, the overarching theme of increasing pessimism and general dread in the writings of Goldman research analysts is becoming ever more palpable, having first originated in the works of the firm's economists, and now shifting to salespeople and product strategists. This in itself would be sufficient to make people believe that Goldman has truly turned bearish, although numerous reports out of the open outcry pit that Goldman's rep repeatedly kept forcing shorts at 1,100 to cover their positions during the day, seems to detract from this particular theory... At least in the short-term.
What made America great was her unsurpassed ability to innovate. Equally important was also her ability to rapidly adapt to the change that this innovation fostered. For decades the combination has been a self reinforcing growth dynamic with innovation offering a continuously improving standard of living and higher corporate productivity levels, which the US quickly embraced and adapted to. This in turn financed further innovation. No country in the world could match the American culture that flourished on technology advancements in all areas of human endeavor. However, something serious and major has changed across America. Daily, more and more are becoming acutely aware of this, but few grasp exactly what it is. It is called Creative Destruction. It turns out that what made America great is now killing her!
Following up on Friday's economic forecast reduction, Goldman's economic team provides an extended analysis validating its dramatic cut to 2011 GDP from 2.5% to 1.9%, and its increase to the unemployment rate from 9.7% to 10.0%. It does so not without a decent bit of gloating: "Our forecast for a significant slowing in the second half of 2010, widely seen as implausible three months ago, is now increasingly accepted." Of course, those reading this blog are fully aware that the fake economic sugar high achieved over the entire past 2 year period is what accountants would consider a non-recurring, one-time item achieved in the face of a deflationary tide, interspersed with ever more desperate attempts by the Fed to stimulate (hyper)inflation. And the closer we get to the imminent realization that as tens of trillions of debt need to be eliminated (and guess what that means for a like amount in underwater equity value) before any form of self-sustaining growth can be achieved, the more likely it becomes that the Fed will commit to the nuclear launch codes which will eventually destroy the US currency, in what many have pegged as hyperinflation for the items we need, and hyperdeflation for the items that nobody really cares about: an outcome which will make the Schrodinger Cat nature of our economy apparent in its final wave function collapse, with the only difference that the US economy is dead in both worlds.
Goldman Capitulates: Lowers GDP Forecast, Increases Unemployment And Inflation Outlook, Sees Imminent QE "Lite"Submitted by Tyler Durden on 08/06/2010 11:41 -0500
It's official: the double dip is here. Goldman's Jan Hatzius just lowered his GDP forecast for 2011 from 2.5% to 1.9% (kiss goodbye all those 93 EPS estimates on the S&P), increased his unemployment forecast from 9.8% to 10.0%, boosted his inflation expectation from 0.4% to 1.0%, and said that QE lite is now on the table, as he expects that "the FOMC to announce that they will reinvest the paydown of mortgage-backed securities in the bond market at next Tuesday’s meeting." Look for all other sell-side "strategists" (here's looking at you Neil Dutta) to lower their economic outlook in kind, and the 2011 S&P consensus to decline accordingly.
The International Monetary Fund (IMF) stress tested 53 large banking holding companies, and concluded that despite restoration of some stability, there remain certain important risks to the U.S. financial system and economy mainly coming from the real estate sectors.
In the first quarter, the US economy grew by 3.7%, revised up from an originally reported 2.7% increase. But growth estimates all the way back to the start of 2007 were revised lower. Moreover, the level of real GDP in Q1 was revised down by $100 billion. Does this mean the secular bull market in bonds will continue? And are Treasuries the "last diversifier left"?
A useful presentation for all those who continue to be bullish despite that fact that the double dip has officially begun. In one of the better compendiums of bearish data, oddly enough coming from Goldman's Jan Hatzius, the chief economist summarizes all the adverse trends that continue to not be priced into stocks. He notes that while the inventory cycle has boosted growth, this artificial rise is now losing steam. Key headwinds facing the economy are that fiscal policy, which has been expansionary, has now become to restrictive; that there has been no overshoot in layoffs for a mean reversion expectation; that the labor market multiplier is very much limited; that while capital spending is just modestly above replacement levels, the large output gap suggests spending should be subdued; the housing overhang is still huge and house prices have further to fall; that there are risks to US from European crisis; that inflation is dropping (and non-existent) even as utilization is low everywhere, which creates a major deflation risk; that the scary budget deficit will destroy any hope for future fiscal stimulus as public debt is surging out of control; lastly, with Taylor-implied Fed rates expected to be negative, the Fed's monetary policy arsenal is non-existent. All this in 18 pretty charts.
The WSJ's Greg Zuckerman has published a Q&A with one of the world's biggest deflationists (who nonetheless admits that once QE 2 begins all bets are off): David Rosenberg. Here is how Rosie sees the world of finance over next 2 years, and provdes more color on his currently favorite investment strategy (aside from bonds): SIRP (Safety and Income at a Reasonable Price... and in keeping with acronyms RIP GARP).
As the whole world prepares for years of austerity, now that virtually everyone is aware that sovereign debt levels are unsustainable and the drive to push public sector deficits down has reached a crescendo, one question remains open: what will happen to the private sector deleveraging commenced the world over in the aftermath of the Lehman bankruptcy. Goldman's Jan Hatzius takes a look at this question, and reaches some very unpleasant conclusions. Looking at the closed system of the financial balances of the private sector, the public sector and the rest of the world (i.e., private balance + public balance = current account balance), in which the push for deleveraging in the private sector, the rush to ramp up exports, and the imminent Age of Austerity all signal an upcoming unprecedented "demand shortfall for the economy as a whole", Hatzius concludes gloomily that "given the forces of retrenchment and balance sheet repair, the risks to the growth of aggregate demand?as well as risk-free interest rates?over the medium term are tilted to the downside. Policymakers can provide some relief, but realistically will find it hard to neutralize the headwinds altogether" The economist also looks at what realist fiscal and monetary rabbits are left in the hat of the administration/Fed, and realizes that there is little that can be done to prevent what he dubs a "slowdown" and what everyone else whose bonus isn't tied in with perpetual growth assumptions, a new wave of the Second Great Depression.