Quantitative Easing

This is an important update on the U.S. drought of 2012, the combined record-setting July land temperatures, and their impact on food prices, water availability, energy, and even U.S. GDP. Even though the mainstream media seems to have lost some interest in the drought, we should keep it front and center in our minds, as it has already led to sharply higher grain prices, increased gasoline costs (via the pass-through of higher ethanol costs), impeded oil and gas drilling activity in some areas (due to a lack of water), caused the shutdown of a few operating electricity plants, temporarily reduced red meat prices (but will also make them climb sharply later) as cattle are dumped in response to feed- and pasture-management concerns, and blocked and/or reduced shipping on the Mississippi River.  All this and there's also a strong chance that today's drought will negatively impact next year's Winter wheat harvest, unless a lot of rain starts falling soon.

We destroyed the myth that the LTRO would not in fact stigmatize bank balance sheets when it was first introduced as the encumbrance was evident from the start - though took the market a while to comprehend and reprice (exuberant on the new-found liquidity optics). The expectations that the ECB will embark on a new scheme of sovereign debt purchases, implicitly funding governments - no matter how many times they tell us that it is to ensure transmission mechanisms flow, have three objectives or rationales, according to Goldman's Huw Pill: Easing private financing conditions through monetary expansion, Financing governments, and/or Reactivating private markets. However, there is one glaring unintended consequence of this 'aid' - the risk exists that well-intentioned sovereign debt purchases result in perverse incentives and a perpetuation of chronic fiscal and structural problems (much as Bernanke's band-aids have eased the fiscal pressure on our own government and led us further down the rabbit hole). The lack of political legitimacy and blunting of incentives for more fundamental consolidation and reform to take place can only turn the acute pain of the moment in Spain into a truly chronic problem for Europe as a whole - be careful what you wish for.

Over the weekend, we pointed out that the old mechanism for the People’s Bank of China to expand its balance sheet and create base money has been broken by new funds flow pattern, and it will sooner or later require some sort of large scale asset purchases programme a.k.a. quantitative easing to offset the impact of the broken mechanism (after other tools such as cutting RRR reach their limits). However, we also mentioned that as the private sector is currently quite overstretched and will start the deleveraging process (if they have not already started), and that would render traditional monetary tools useless, and quantitative easing ineffective. And that would necessitate deficit spending at both local and central government levels. If we have read the social mood correctly that China might be more pro-austerity than pro-Keynesian, and if policymakers indeed share that view, then the consequence in the near term could be rather grim. The delay in stimulus as well as the small size of it so far has already done damage, if you like. The economy is already on course to a hard landing.

We tried to bite our tongue; we ignored some of the sheer hypocrisy of Cleveland Fed's Sandra' oh Sandy' Pianalto (that QE2 was a definitive success in 2010 but now LSAPs require more analysis of costs and benefits); but when she started down the road of praising the US consumer for deleveraging we had enough. In the immortal words of John Travolta: "Sandy, can't you see, we're in misery" as while she notes consumers cutting back on credit card debt (due to forced bankruptcies we note), Consumer debt has only been higher on one month in history! Soaring auto loans and student debt should just be ignored? There is no deleveraging - Total US Consumer debt is 0.23% from its all-time high in mid-2008, and will with all likelihood break the record at the next data point. Meanwhile her speech, so full of careful-not-to-over-commits can be summed up by the world-cloud that shows the six words most prominent: 'Monetary Policy', 'Financial Conditions', and most importantly 'Credit Economy'. Here's the deal: Consumer Debt is Consumer Debt.

In a little under two-and-a-half minutes, CNBC's Rick Santelli surveys the landscape of just what exactly is Quantitative Easing, why more debt does not solve the problem of too much debt, and why these actions (as even Frau Merkel has ascribed concern) are nothing but counterfeiting. He rhetorically questions how the printing of more money is the way to solve our 'problems', adding via Rick Rule, that "there's been no shortage of cash in the system; but one wonders [given] this economy seems based on liquidity, whether building an economy on what is, in fact, counterfeiting is very good for the economy in the long term?"

While there are many answers to this rhetorical question, a key one is the schism that exists between the two media behemoths when it comes to the topic of the NEW QE, elsewhere incorrectly called QE3. While the now virtually daily missives from Fed mouthpiece Jon Hilsenrath, whom once has to wonder whether he is more of a part time worker at the WSJ or the New York Fed, are there to force markets ever higher each day, with promises that Bernanke will not sit idly by if the S&P were to ever close red (the S&P being a multi-year highs notwithstanding), and that as he stick saved the European close on Friday, the Fed has lots of additional capacity for more QE, Bloomberg actually has the temerity to ask: why do we need any more QE: after all so far all previous iterations have been a disaster. Sure enough, a few hours after Hilsenrath did his latest Fed planted piece in which he amusingly pretended to be objective about more QE and "sized up" costs of more QE, here comes Bloomberg in its daily Brief newsletter, with a far simpler question: why the hell do we keep doing the same idiocy over and over, hoping and praying to generate inflation, knowing full well if we do get inflation, with global central banks soon to hold half of the world's GDP on their books, it will promptly deteriorate to the "hyper" kind.

Although the supply and demand factors do not seem to support the current price levels, there are plenty of other events to sustain and add premium.

What do we call a power center that enables and enforces neofeudal exploitation and predation? We call it evil. The Federal Reserve is a force of evil that should be abolished at once. Its purpose - enabling and enforcing a neofeudal transfer of wealth from the productive many to the unproductive, parasitic few - is evil. Those within it are serving evil. Those who defend it are serving evil. Those who worship its power are serving evil. Those who mask its true nature are also serving evil. In a society and culture that has lost its moral compass, a culture of greed, self-serving lies and corrupt vested interests, the word "evil" has lost its power. It has been reduced to a cartoonish label, a cynic's smarmy joke.

It is one thing for various anti-Central Planning (and thus central bank) outlets to warn, over 3 years ago, that easy monetary policy is merely an enabling substance, and is addictive as any drug to a dysfunctional political establishment which is more than happy to avoid fiscal prudence if monetary policy is readily available to delay the inevitable day of reckoning when monetizing the debt will no longer work. It is a different matter entirely when the head of the world's only solvent central bank -  the German Bundesbank, which happens to be the biggest guarantor of that other mega hedge funds the ECB, and which of all developed economies also happens to have had the closest recent encounter with hyperinflation (unlike all the "other" theoretical experts who enjoy talking extensively about matters they have zero experience with). In an interview with German Spiegel magazine, Buba head Jens Weidmann, once again has loudly warned what as recently as 2009 very few dared to even think: namely that rampant and gratuitous deficit plugging using central bank debt issuance, and thus explicitly monetizing the debt, "can be addictive as a drug." Obviously, like any drug overdose, the aftereffects are always fatal.

The empirical data is in. And it turns out that as we have been suggesting for a very long time — yes, shock horror — helicopter dropping cash onto the financial sector does disproportionately favour the rich. Here are four simple questions to the venerable Bank of England (just as applicable to any and every Central Banker); and sadly, we expect to see the announcement of more quantitative easing to the financial sector long before we expect to see answers to any of these questions.

The odds of Fed easing at the September FOMC meeting seem close to 50-50 (with both sides vehemently talking their books - Fed officials and equity managers alike). Recent data has been a bit better: payrolls, claims, retail sales, and industrial production. As UBS' Drew Matus notes, other factors that will play a role include the ISM report, claims reports, and 'fiscal cliff'-related events. However, the primary determinant will be the upcoming August payroll report. The chart below ignores these other factors and offers up the odds of further easing in September based on the base case that Bernanke’s primary concern is the state of the US labor market. July’s 8.3% unemployment rate and payroll gain of 163k put current odds of further easing at 45%.

There is a frequent tendency to over state the importance of the Fed and its policies and ignore the primary fundamentals driving the gold market which are what we have long termed the ‘MSGM’ fundamentals. As long as the MSGM fundamentals remain sound than there is little risk of gold and silver’s bull markets ending. What we term MSGM stands for macroeconomic, systemic, geopolitical and monetary risks. The precious metals medium and long term fundamentals remain bullish due to still significant macroeconomic, systemic, monetary and geopolitical risks. We caution that gold could see another sharp selloff and again test the support at €1,200/oz and $1,550/oz. If we get a sharp selloff in stock markets in the traditionally weak ‘Fall’ period, gold could also fall in the short term as speculators, hedge funds etc . liquidate positions en masse. To conclude, always keep an eye on the MSGM and fade the day to day noise in the markets.

Buy everything I say without limit. Leverage each purchase to the maximum allowed under the law. The markets will only go up and not down and 100,000 is the next stop for the S&P. It is to be Dow without Jones, assets without liabilities and wealth without poverty. The Middle Class has been evacuated and everyone is wealthy beyond belief. It is just there, of course, that the truth lies in this merry old land, “beyond belief.”

"I like fantasy---it wakes up the brain cells.”

- Dr. Seuss

The deleveraging trap is a catch-22; while debt remains excessive, economic activity remains subdued, and while economic activity remains subdued, generating more production than consumption to pay down debt is extremely difficult. As we have seen in Japan — where the total debt load remains above where it was 1991 — fundamentals can remain depressed for years or even generations. Certainly, the modern debt jubilee isn’t going to cure the culture that led to the excessive debt. Certainly, it won’t wash away the vampiristic TBTF megabanks who caused the GFC and live today on bailouts and ZIRP. Certainly, it won’t fix our broken political or financial systems where whistleblowers like Assange are locked away and fraudsters like Corzine roam free to start hedge funds. And certainly it won’t wash away the huge mountain of derivatives or shadow intermediation that interconnect the economy in a way that amplifies small shocks into greater crises.

Monetary policy typically has little direct impact on the labor market, but Dual Mandate most likely will continue to force Fed's hand into the futile unemployment-QE cycle.