Quantitative Easing

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XAU/USD Currency Chart – (Bloomberg)

Gold dipped today despite Wall Street hopes that the US Fed will embark on more QE. As we have said for some time QE3, or a new term for electronic and paper money creation, is a certainty and this will lead to inflation hedging and safe haven demand for gold. 

Ever since the beginning of the year we have been saying that in order for the Fed to unleash QE, stocks have to drop by 20-30% to give political cover to the Fed (and/or ECB) to engage in another round of wanton currency destruction. Because while on one hand the temptation to boost stocks is so very high in an election year, the threat to one's presidential re-election chances that soaring gas prices late into the summer does, is simply far too big to be ignored. Yet here we are: stocks are just 4% off their 2012 highs, even as bonds are near all time low yields, and mortgages are at their all time lows. As such, even with the latest batch of economic data coming in simply atrocious, the Fed finds itself in a Catch 22 - it wants to help the stock market hoping that in itself will boost the "economy", yet it knows what more QE here will do to the priced of gold and inflation expectations: something which as Hilsenrath himself said yesterday does not compute, as it runs against everything "Economic textbooks" teach. What is more important, is that the market, like a true addict, is oblivious to any of these considerations, and has priced in a massive bout of Quantitative Easing to be announced tomorrow at 2:15 pm. There is one problem though: has the market, by pricing in QE on every down day - the only buying catalyst in the past month have been hopes of more QE - made QE impossible? Observe the following chart from SocGen which shows 6 month forward equity vol. What is obvious is that due to precisely being priced in, QE is now virtually unfeasible, irrelevant of what Goldman and its "FLOW QE" model tell us. As SocGen simply states: "More stress is needed to trigger ample policy response."

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Gold took a tumble for the first time in 7 sessions in Asia as Antonis Samaras, leader of the Greece's New Democracy Party (pro-bailout) was victorious.  Today, Samaras plans to form a coalition with other parties backing the bailout – meaning that Greece’s future in the euro is secure – for now.  Gold’s dip in Asia was thought to be due to profit taking and increased risk appetite after the Greek election. However, this increase in risk appetite has been quite short lived with Spanish and Italian 10 year bonds again coming under pressure resulting in record Spanish yields over 7.13% and Italian 10 year over 6% again. Initial gains in equity markets have subsided and the lessening of risk appetite is seeing gold supported. Greece’s exit from the Eurozone is no longer a short term risk however it remains a real risk as does the risk of financial contagion in the Eurozone due to insolvent banks in Spain, Italy and France.

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While the mantra "Don't fight the Fed" seems to ring true with investors, I am little less sanguine than most, and I have a hard time buying the accepted dogma.

Earlier in the week, UBS' Art Cashin noted that some traders were re-reading Bernanke’s speech of November 21, 2002 on countering inflation. Prior re-readings had given clues on things like QE1 and even Operation Twist. The primary theme of the speech was - what can the Fed do to fight deflation (and stimulate the economy) if the Fed Funds rate fell to zero (aah, those simple golden years). Cashin points out that most of the operations, however, tend to be means to make money available or easy. With nearly $2 trillion in excess free reserves that doesn’t seem to be the problem. Inducing spending is the problem. Of all the suggestions, the wider inflation tolerance may be the only one that may do that.

Now that all the rage is now just the NEW QE, but global coordinated NEW QE, it would make sense to observe the impact the last three episodes of quantitative easing, QE1, QE2 and Twist, have had on the market. And more importantly, whether such impact is rising, dropping, or staying the same. Well, as the following chart from BofA shows, we may be lucky if there is any favorable impact on risk assets following the announcement of more easing, and incidentally perhaps global easing is what is necessary (if not sufficient) now that the devaluation of the US dollar has become an exercise in futility. Because it now appears that only an absolute currency devaluation would work, not a relative one. What is another way of saying this: a global devaluation of all currencies relative to some benchmark... say gold. Most importantly, the only question now is how long before the entire "global intervention rumor" is faded, and what happens when the market realizes that suddenly, Syriza not winning the Greek elections is the downside case as it would mean no coordinated central bank intervention. Great job central planners - you have just shot yourself in the foot once again.

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Just as Patton surveyed Rommel's battlefield of Panzers and assumed he knew his plan (since he had 'read the book'), so UBS' Art Cashin reminds us that traders trust implicitly that Bernanke is an assumed tactical genius - capable of deploying his monetary troops at will and in a perfectly timed manner. This trust (and hope) is based on Bernanke's early speeches and one in particular - “Deflation: Making Sure 'It' Doesn’t Happen Here” (here). It was delivered back at the National Economists Club in November 2002 (Before Bernanke became Fed Chair). As Wall Street ponders what form or format the next level of quantitative easing might take, Cashin is taking time off from the fermentation committee to sift through the speech, looking for clues to the next Fed move. The primary complication is the turmoil in the European banking system. That may force Mr. B to include things like currency swap facilities in any new comprehensive easing effort. While QEx is certainly coming, we remain highly cognizant of the reflexive market reaction to any 'decent' dip as hope remaining too alive-and-well that the Bernanke-Put strike is considerably higher than it is in reality.

The financial elite - using academe for intellectual cover - want you to believe that markets are efficient, as defined by the Efficient Market Theory (EMT). Neoliberal economic philosophy is based on the belief that neoclassical economic theory is correct. That is, that “markets are efficient”. Wall Street touts markets as trustworthy and infallible, but that faith is misplaced. Gullible US politicians believe that markets are efficient and defer to them. Therefore, US politicians abdicate their responsibility to manage the overall economy, and happily for them, receive Wall Street money. Mistakenly, the primary focus during the 2008 credit crisis is on fixing the financial markets (Wall Street banks) and not the “real economy.” The financial elite are using this “cover-up and pray” policy—hoping that rekindled “animal spirits” will bring the economy back in time to save the status quo. This is impossible because the trust is gone. The same sociopaths control the economy. A Federal Reserve zero interest rate policy (ZIRP), causing malinvestment, and monetizing the national debt with quantitative easing by the Fed, and austerity for the 99% to repay bad bank loans has not worked—and doing more of the same will not work—and defines insanity.

At the high level, our global economic plight is quite simple to understand says noted Australian deflationist Steve Keen.  Banks began lending money at a faster rate than the global economy grew, and we're now at the turning point where we simply have run out of new borrowers for the ever-growing debt the system has become addicted to. Once borrowers start eschewing rather than seeking debt, asset prices begin to fall -- which in turn makes these same people want to liquidate their holdings, which puts further downward pressure on asset prices.

Gold fell $28 or 1.73% yesterday in New York and closed at $1,591.60/oz.  Gold traded sideways prior to another 1% fall in Asia but has recovered somewhat in early European trading and has made gains in euros and Swiss francs particularly. 

Cross Currency Table – (Bloomberg)

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