Quantitative Easing

Swiss banks, UBS and Credit Suisse, have moved to offer allocated gold and silver accounts to their clients – including high net worth, hedge funds, other banks and institutions.  The move allows these entities to take direct ownership of their bullion in allocated accounts. According to the Financial Times, the banks say that they are making the move in order to reduce exposure and risks on balance sheets and in an effort to be more transparent.  “Under more common "unallocated" gold accounts, depositors' bullion appears on the banks' balance sheets, forcing them to increase their capital reserves. Like their global peers, UBS and Credit Suisse are under pressure from regulators to reduce capital-intensive activities ahead of the introduction of new Basel III global banking rules.” It is more likely that the banks made the move to allocated storage due to an increased preference from their investors who are weary of continuing systemic risk.

How long will the other Central Banks tolerate this before they initiate a currency war? Both Germany and China have fired warning shots at the Fed. And we all know that just beneath the veneer of goodwill, tensions are building between the primary players of the global financial system.

While the overnight session has been relatively quiet, the overarching theme has been a simple one: currency warfare, as more of the world wakes up to what the BOJ is doing and doesn't like it. The latest entrants in global warfare: Taiwan, whose central bank overnight said it would step in the FX market if needed, then Thailand, whose currency was weakened on market adjustment according to Prasarn, and of course South Korea, where the BOK said that global currency war spreads protectionism. Last but not least was China which brought out the big guns after the PBOC deputy governor Yi Gang "warned on currency wars." To wit: "Quantitative easing for developed economies is generating some uncertainties in financial markets in terms of capital flows,” Yi, who is also head of China’s foreign-exchange regulator, told reporters. “Competitive devaluation is one aspect of it. If everyone is doing super QE, which currency will depreciate?” “A currency war, a series of tit-for-tat competitive devaluations, would trigger trade protection measures that would damage global trade and therefore growth globally,” said Louis Kuijs, chief China economist at Royal Bank of Scotland Plc in Hong Kong, who previously worked for the World Bank. “That would not be good for any country with a stake in the global economy.” Which brings us to the fundamental question - if everyone eases, has anyone eased? And is there such a thing as a free lunch when central banks simply finance global deficits while eating their soaring stock market cake too? The answer, of course, is no, but we will cross that bridge soon enough.

The purpose of asset purchases by the Fed might no longer be improvements in the real economy, but rather a more subtle financing of U.S. government deficits. However, in the long run, expanding the money supply inevitably leads to inflationary pressures. Luckily for the Fed and the U.S. government, there is so much slack in the labour market that inflation might be years away. And, if we are right about the long run unemployment rate being structurally higher, then the Fed has all the room it needs to continue Quantitative Easing (QE) to infinity. This might allow them to continue to hide the true financial position of the government for many years to come. Nonetheless, the rising GAAP deficit and the sheer size of the U.S. Federal Government’s liabilities to its citizens makes it clear that one day or another, services (health care, social security) will have to be cut. Financial alchemy can hide reality, but it does not provide any tangible services. Europe’s (unresolved) experience with its debt crisis provides an insightful window into the future. Austerity measures in Ireland, Portugal, Spain and Greece have caused tremendous pain to their citizens (25% unemployment rates) and wreaked havoc in their economies (double digit retail sales declines). Are we going to ignore the obvious?

There has been an burst of exuberance as of late as the market, after four arduous years, got back to its pre-crisis levels.  Much has been attributed to the recent burst of optimism in the financial markets from: better than expected earnings, stronger economic growth ahead, the end of the bond bubble is near, the long term outlook is getting better, valuations are cheap, and the great rotation is here - all of which have egregious holes. However, with the markets fully inflated, we have reached the point that where even a small exogenous shock will likely have an exaggerated effect on the markets.  There are times that investors can safely "buy and hold" investments - this likely isn't one of them.

In a quiet corner of Davos this week, Davide Serra (hedge fund manager) and Nouriel Roubini (doom-monger) laid out to the great and good attending just exactly what their puppet central-banking transmission channels were doing to our world. As The Telegraph reports, "Money printing is theft from our children and may merely be storing up problems for an even bigger crisis." QE has led to gross mis-allocation of capital, the two gentlemen go on to note, adding that they comprehend the reasoning why Bernanke's Put has replaced Greenspan's but add that in doing this money-printing-by-another-name, they have "made it difficult for bond vigilantes to do their job - force fiscal reform." QE just buys time - but the time must be used wisely. Roubini warned that central bankers need to think about turning off the cheap money tap or risk creating another, possibly even worse, bubble.

Forget the Housing, Bond or Derivatives Bubbles ... Fraud Is the Biggest Bubble of All Time

Since Alan Greenspan became the Fed chairman in 1987, there has been a policy consensus on the primary role and effectiveness of monetary policy in cushioning an economic downturn and kicking it back to growth. Fiscal policy, due to the political difficulties in making meaningful changes, was relegated to a minor role in economic management. Staving off crisis and reviving growth still dominate today's conversation. The prima facie evidence is that the experiment has failed. The dominant voice in policy discussions is advocating more of the same. When a medicine isn't working, it could be the wrong one or the dosage isn't sufficient. The world is trying the latter. But, if the medicine is really wrong, more and more of the same will kill the patient one day. The global economy was a debt bubble, functioning on China over-borrowing and investing and the West over-borrowing and consuming. The dynamic came to an end when the debt crises exposed debt levels in the West as too high. The last source of debt growth, the U.S. government, is coming to an end, too, as politics forces it to reduce the deficit. Trying to bring back yesterday through monetary growth will eventually bring inflation, not growth.

The day Lehman failed saw the launch of the most epic central bank intervention in history with the Fed guaranteeing and funding trillions worth of suddenly underwater capital. However, what Bernanke realized quickly, is that the "emergency, temporary" loans and backstops that made up the alphabet soup universe of rescue operations had one major flaw: they were "temporary" and "emergency", and as long as they remained it would be impossible to even attempt pretending that the economy was normalizing, and thus selling the illusion of recovery so needed for a "virtuous cycle" to reappear. Which is why on November 25, 2008, Bernanke announced something that he had only hinted at three months prior at that year's Jackson Hole conference: a plan to monetize $100 billion in GSE obligations and some $500 billion in Agency MBS "over several quarters." This was the beginning of what is now known as quantitative easing: a program which as we have shown bypasses the traditional fractional reserve banking monetary mechanism, and instead provides commercial banks with risk-asset buying power in the form of infinitely fungible reserves... So how does all this look on paper? We have compiled the data: of the 1519 total days since that fateful Tuesday in November 2008, the Fed has intervened in the stock market for a grand total of 1230 days, or a whopping 81% of the time!

There are two main drivers in the foreign exchange market today: the much anticipated BOJ meeting and the much stronger than expected German ZEW survey. Anticipation of aggressive easing by the BOJ today has kept the yen on the defensive. However, the combination of "sell the rumor and buy the fact" activity and, arguably, some disappointment, saw dollar turned back from the JPY90 level, which it has test during the three prior sessions without a convincing break and fall to near JPY88.35 before finding a bid. Similarly the euro, which had been flirting with the JPY120 area, was sold down to almost JPY117.30 before finding a solid

If governments or central banks really can create wealth simply by creating money, why does poverty exist anywhere on earth?  Why haven’t successive rounds of quantitative easing by the US Fed solved our economic recession?  And if Fed money creation really works, and doesn’t create inflation, why haven’t Americans gotten richer as the money supply has grown? The truth is obvious to everyone.  Fiat currency is not wealth, and the creation of more fiat dollars does not mean that more rice, steel, soybeans, Ipads, or Honda Accords suddenly come into existence. The creation of new fiat currency simply strengthens a fantasy balance sheet, either by adding to cash reserves or servicing debt.  But this balance sheet wealth is an illusion, just as the notion we can continue to raise the debt limit and borrow money forever is an illusion. 

According to “Economics 101”, quantitative easing, on the heroic scale we have witnessed thus far, should already have led to rampant if not hyper inflation. That it hasn’t is down to the continuing decline in the velocity of circulation of money. In simple terms the banks aren’t lending (compared with the amount of money available to them), but instead are punting on financial assets, which is where “inflation” is ending up and benefitting their balance sheets. Markets generally front run the economy, but if, as many folk believe, including our commentator above, that quantitative easing has been a failure from the start, then why are equity markets indicating an upturn in economic activity? At the end of the day, if the central banks continue to believe they have no other option than money printing and you can put up with the volatility, it’s all aboard the equity train. Bond yields won’t rise much either; if at all. The gold price should give some indication of whether this strategy is working or not, but that is a market that is far easier to rig than sovereign debt – the Germans seem to think so as they contemplate repatriating some of their bullion held by other central banks.

“Here we go again”

Demand for gold is likely to rise as the world heads towards a multi-currency reserve system under the impact of uncertainty about the stability of the dollar and the euro, the main official assets held by central banks and sovereign funds. This is the conclusion of a wide-ranging analysis of the world monetary system by Official Monetary and Financial Institutions Forum, (OMFIF), the global monetary think-tank, in a report commissioned by the World Gold Council, the gold industry’s market development body. The report warns of “twin shocks” to the dollar and the euro and of a “coming dollar shock” and points out how gold would be a safe haven in a dollar crisis. “Gold has a lot going for it; it correlates negatively with the greenback, and no other reserve asset seems safe from the coming dollar shock.” “The world is preparing for possible twin shocks from the parlous. position of the two main reserve currencies, the dollar and the euro... The OMFIF offers a confidential, convenient and discreet forum to a unique membership of central banks, sovereign funds, financial policy-makers and market participants who interact with them. They note that “western economies have attempted to dismantle gold's monetary role. This has failed.”

The newly elected Japanese Prime Minister, Shinz? Abe, has caused quite a stir. The leader of the Liberal Democratic Party, which scored a landslide victory in 2012’s election, he’s promised to restart the Japanese economy, whatever it takes. How will he do this? By “bold monetary policy”, what he means—and what he has said—is to end the independence of the Bank of Japan, and have the government dictate monetary policy directly. The perception is, the Bank of Japan will not only print yens and buy government bonds à la Quantitative Easing of old - it is also generally thought that Mr. Abe and the incoming Japanese government fully intend to target the yen against foreign currencies, like Switzerland has been doing with the euro. This perception is what has been driving the Nikkei 225 index higher, and driven the yen lower. But why was this decision triggered?