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The Fed’s QE 3 Program: Short Term Thinking For Long-Term Pain
Yesterday the Fed announced QE 3: an open ended program through which the Fed will purchase $40 billion worth of Mortgage Backed Securities every month until it decides that the world is right again.
The implications of this are severe. However, the first question we have to ask is, “why now?”
After all, stocks were already at 4-year highs, food and energy prices were soaring, interest rates were at record lows, etc. On top of this, the Fed failed to announce QE 3 for over a year (QE 2 ended June 2011). Why announce it now?
There are only two reasons:
1) Things are in fact far worse behind the scenes than we know (the Fed HAD to do something to get more money into the system)
2) Politics
Regarding item #1, I want to be very clear here. The fact that my timing was off on predicting a European collapse doesn’t mean Europe will not collapse. Instead it simply means that my timing was off.
With that in mind, we have to look at the Fed’s move from an EU perspective. We know that Obama literally pleaded with Angela Merkel to keep the EU together until the election was over.
Moreover, we know that Europe is in a very bad place. Here’s a quick 30,000 foot view of Europe in bullet point form. I’m focusing on the country that’s in the most trouble (Spain) and the country that is the backstop for the EU (Germany).
All of the following are facts:
Spain:
1) Spain’s banking system saw a bank run to the tune of €70 billion in August. The market cap for all of Spain’s banks is just €114 billion. So Spanish banks need to raise at least €20+ billion or so per month in the coming months to stay afloat. This is without depositors pulling additional funds in September onwards. That’s really bad news.
2) Spain’s now nationalized Bankia just took another €5.4 billion from Spain’s in-country rescue fund. This indicates that once nationalized, problem banks DO NOT cease to be problems.
3) The region of Andalusia is requesting a bailout from the Spanish Federal Government. This comes on the heels of bailout requests from the regions of Valencia, Murcia and Catalonia (none of which want any “conditions” on the funds).
4) Spain has set aside €18 billion to bailout its regions. The current bailout requests already amount to €10.8 billion. That’s just from this year alone.
Simply put, Spain has MAJOR problems. And this is after the ECB put over €1 trillion in liquidity into the EU banking system to cover three year funding gaps for EU banks.
Despite these measures, Spain has already asked for a €100 billion bailout for its banks from the EU. However, it’s yet to request a formal sovereign bailout.
The reason for this is Spain doesn’t want the EU or IMF to impose conditions on its already troubled economy (youth unemployment at 50% and total unemployment at 25%).
Also, Spain doesn’t want IMF and EU bean counters to sift through its book. Case in point, the country just discovered another €28 billion in debt on its books. One wonders what else is hidden in the darkness of Spain’s officials “numbers.”
Germany:
1) The country is now sporting a Debt to GDP of 90% courtesy of its EU bailouts.
2) Germany has committed over €2.1 trillion in backdoor bailouts to the EU.
3) German Chancellor Angela Merkel is up for re-election next year. The EU bailouts will be THE election topic. And she is facing backlash from members in her own party as well as opposition leaders concerning her actions in helping the EU.
So, we see a problem country (Spain) facing a severe bank run, regional bailouts, and more at the precise time that its ultimate backstop (Germany) has put its own solvency into question due to various EU bailout schemes.
I believe that the Fed’s decision to announce QE 3 now was in part due to the severity of these issues. One has to remember that a significant number of the Fed’s Primary Dealers are based in Europe. The Fed will be feeding them liquidity via QE 3.
Remember, the ECB’s recent open-ended bond program requires countries to meet “conditions.” The Fed’s QE 3 doesn’t. So this can be seen in some ways as a potential back-door bailout to Europe in that it will get liquidity into European banks.
Again, I firmly believe that one of the primary reasons the Fed did this was to deal with liquidity issues that are occurring “behind the scenes.” The fact the Fed piggy-backed this announcement after the ECB’s announcement of its open-ended bond purchasing program makes this a coordinated central bank intervention.
Why would the Fed and ECB do this? Because they’re scared stiff of what’s happening and are trying to shock and awe the markets into submission with terms like “open ended” and “unlimited.”
There is only one reason to do this: things are in fact much worse than anyone has admitted.
In this regard the announcement of QE 3 should in fact be cause for serious concern about the stability of the financial system. Again, there is no logical reason for QE 3 now. Food and energy prices are high as are stocks. Interest rates are low. US unemployment (based on the official numbers) is not that bad.
So we have to see this QE 3 announcement as a kind of desperate move to support the ECB in its attempt to rein in a European Crisis that is rapidly spinning out of control.
As I’ve noted in earlier articles to you, the EFSF bailout fund has only €65 billion left in funding. And the ESM (which Germany has ratified) is meant to receive 30% of its funding from Spain and Italy. So Europe was about out of options as far as bailouts go. QE 3 is meant to help Europe get through the US Presidential election at which point a larger program might be announced.
Now on to the second reason for QE 3: politics.
I have to say, the Fed’s decision to announce QE 3 now was a real gamble. Mitt Romney has stated several times that he would replace Bernanke if elected. So the fact the Fed decided to announce QE 3 now as opposed to any time in the last year should be perceived as a very political move.
In plain terms, this is Bernanke trying to juice the stock market (and perhaps the US economy) for all its worth to help Obama’s re-election chances. There is simply no other way to perceive this move. Bernanke is doing a “Hail Mary” pass to try and keep his job.
The consequences of this will be complicated. For one thing, with food and energy prices already high (Oil just cleared $100 again). So the Fed is running the risk of increasing the cost of living to the point that voters potentially turn on Obama. The economy is already entering another recession (the recent ISM reading was sub-50 which is recessionary territory). To pile even inflation of top of this is not a wise move.
We also have to consider China and the Middle East.
China’s economy is entering a hard landing. With food prices already high, the Chinese Government is desperate to channel the country’s frustrations towards an external problem rather than face rampant civil unrest.
Thus far the focus of this has been Japan (the long-standing dispute over who actually owns the Senkaku islands). But with the Fed now announcing QE 3 (which will push food prices even higher), we will see a resurgence in the US/ China conflict: more accusations of currency manipulation, trade wars, and other political issues.
In plain terms, the Fed just handed China another problem (even higher food prices). Don’t expect China to ignore this. That’s unintended consequence #1.
As for the Middle East, we need to remember that the entire Arab Spring was started when QE 2 pushed food prices to record highs. With anti-Americanism on the rise in the Middle East (see the numerous embassy attacks), the consequences of more food inflation in the Middle East courtesy of QE 3 will NOT be pleasant.
That’s unintended consequence #2.
Finally, the Fed’s QE 3 program will result in higher operating costs for US companies. Higher operating costs mean lower profits. With companies already lowering their earnings forecasts (in the last month we’ve seen Fed Ex, Bed Bath and Beyond, Proctor and Gamble, Adobe, Starbucks, and McDonald’s do this), the Fed just greatly increased the potential for even more earnings surprises to the downside.
The Fed has also increased the likelihood of more layoffs in the private sector. When operating costs rise, corporations will cut whatever other costs they can. This means firing people. So look for unemployment to actually rise based on QE 3.
So, to recap all of this, the key takeaway items from the Fed’s QE 3 announcement are the following:
1) This should be seen as a tag-team effort between the ECB and the Fed to try and rein in the European Crisis
2) It’s also a clear and obvious political move to attempt to boost the Obama re-election campaign (and save Bernanke’s job)
Both of these issues indicate that the Fed is very concerned about issues in the short-term (Europe and the US Presidential election). This should be a big red flag to all of us that things are very likely far worse than we realize.
On top of this, the Fed’s move will have severe consequences for the US’s foreign relations as food prices add fuel to the fire for conflicts in China and the Middle East.
How precisely these issues will play out remains to be seen, but it’s clear none of the consequences will be good (what are the odds the Middle East or China end up grateful to the US/Fed for this?)
So the Fed’s decision to announce QE 3 should be seen as a very big negative if anything. True, stock prices will soar. But:
1) Profit margins will shrink resulting in lower profits (which will likely lead companies to lay-off workers to cut their costs).
2) The cost of living will increase globally as well as in the US.
None of these are items to celebrate. If anything the Fed has just added fuel to the fire. The fire was bad enough to begin with (Europe, the US, and China were entering recession). Adding higher inflation to this mess isn’t going to do any of us a lick of good.
I’m currently working on a new portfolio of investments that will profit from this new investment landscape. I do not think it’s wise to buy anything today as risk-on assets are sharply overbought and should stage a pullback.
Moreover, it’s never a wise idea to load up on new investments before a weekend, especially when so many major issues are moving forward. There are too many surprises that can occur while the markets are closed.
So I’ll have another update to you next week concerning which investments to focus on. For now, the most obvious items to look into are Gold and Silver bullion. But I’ll have more for you on Monday.
Until then…
Best Regards,
Graham Summers
PS. I’m going to be posting this update to my full client list. However, the next update featuring specific investment ideas will only be available to paid clients (Private Wealth Advisory and The Perfect Trade).
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This is one of your better pieces Graham. Thanks for posting it.
It is, and does connect the dots.
Go one step further into the natal charts of the USA, China, & the EU.
Things get really hinky next year with Pluto in the 2nd House of China & the US; NYC chart starts getting hammered by the same effects.
The rest of the decade is not going to be fun.
"So we have to see this QE 3 announcement as a kind of desperate move to support the ECB in its attempt to rein in a European Crisis that is rapidly spinning out of control."
That makes sense to me. Also, GS's point that things are worse behind the scenes than they seem.
Another thought: Suppose the Fed Reserve fears a collapse is in the offing in Europe. If that were to happen, the Fed would be blamed, especially by Keynesians, for not having been pro-active. So this move could be seen as an attempt to deflect blame, even if it won't actually do much good, or will just kick the can down the road.
The default cascades will occur no matter where it goes big first, nor what the CBs do. Every time they ease they will just reduce its effect and the duration of effect, so the next time has to be bigger and sooner to prop the banks, until it's continuous. The banking system will come down hard, they just held it off in 2008 with $23 trillion in secret FED loans.
The 1929 crash ended in total banking system meltdown in 1933. But there were high levels of US bank failures occurring each year from 1925 on. The banking system was already is serious trouble long before the 1929 market crash. So there's no telling when the mass default cascade will accelerate this time.
One look at the PIIGS deposit outflows though and you can see the system is fast settling in the water by the bow.
Wish I knew 2 years ago what I know now about the Fed corruption of purpose by politics. Id be richer.
Dup. Fuck soft keyboards.
No comment.
I'm glad I was'nt one of the "paying clients" who followed his advice on the "No QE" call. Not for the first time have I felt this relief.
I suspected Ben's QE bazooka yesterday had a lot to do with Europe. After all, his Wall St. masters would keel over from cascading cross defaults in the European banking system. Who says he won't be taking MBS off the hands of European banks as well?
Anyone seen Graham Summers?
GS. JUST WALK AWAY FROM THE TRADING SCREEN and get into a 12 step program
Graham when are you going to realize that this financial chaos is planned? These people do know what they are doing and are exeercising their power. It causes chaos the the masses but it increases thier POWER. That is what this is all about, consolidation of power. Money is nothing. Power over the masses is everything to these people. They will crash this thing (thru hyperinflation) and have a new currency and power consolidation(new world order) preped and ready to go once they push the button.
If the international bankers use the US or Israel to start a war with Iran, oil prices will go up and fast. In countries that produce a lot of the worlds grains, this will mean farmers may look at the current grain prices, versus the cost to put in crops - and decide not to plant. In western countries, which produce a great deal of the worlds grains - agriculture is very energy intensive.
The following year is when all hell will break loose. The military aggression towards Iran is incredibly dangerous for many reasons, but a world in which grain prices skyrocket will not be a very nice place.
"So the Fed’s decision to announce QE 3 should be seen as a very big negative if anything. True, stock prices will soar."
I feel a stock market crash coming real soon for some reason.
If Graham had indeed thrown in the towel then I think we could be certain of a crash coming. Now I am not so sure because he has hope again.
OH wow ! What great insight! You "feel" a crash coming, like an idiot using your emotions instead of reason and logic
Whoosh...right over your head, you dumbass.
Maybe his sphincter is puckering. You can feel that.
Guess it all depends where the QE ends up huh? PMs look like a good bet, most likely other real assets too.
Maybe Big Ben is padding the market to make some headroom for US to go over fiscal cliff. Seems to me TPTB would love to see higher taxes. Could be the plan.
Ahhhh sorry middle class, the Dems and Repubs just can't get along enough to extend the credits so guess what??? You get bent over once more.
I think that Spain should have left the Eurozone 2 years ago. Everybody in Europe would have been better off if that had happened. Except those who want a more closely integrated Europe at any cost.
I dunno... I followed your advice last time...
Anybody wanna buy some Netflix stock?
why now ...
to protect the banks graham /
the fed is not for the american people , but a criminal l entreprize set up to protect the banking syndicate . when the folks begin to realize this then the real story will unfold \
sorry ...the author is 100% wrong about point2. qe might be political but it isnt to 'help the economy'. did the economy get better with qe1/2/twist...? THE FED CAN NOT CREATE DEMAND. how many times..how many examples do we need to show they are pushing on a string.
what is the real political reason behind the move...?
Come on hannah ... to stave-off a precipitous banking system meltdown ... which is going to happen anyway.
The two most recent US examples are 1923 to 1933, and the S&L crisis from about 1982 to 1992. Each of these bank failure processes ended in an exponentially accelerating meltdown of failed zombie-banks, that just couldn't be propped up any longer.
Since Jan 1st 2008, 464 US banks have failed so far.
We are four years into this, and when it finally ramps exponentially nothing will stop the default cascades, it'll bring the entire financial system down like the World Trade Center, which is an apt visual analogy and also title. There's no chance QE is going to stop before that crescendo, QE is going to accelerate as well.
This has almost nothing to do with the real-economy, or with deleveraging, as all the deleveraging is going to occur as the banks fail. Banks go broke because their customers went broke. So propping the banks won't work, when the real-economy is getting fried anyway.
(it won't matter who's elected)
This is actually very good analysis. Graham's problem is his continuous definitive predictions in the face of unlimited central bank intervention and manipulation. But I guess one has to sell a newsletter somehow.
Very good analysis? In case you missed it, here's Graham's post on his blog yesterday:
"For months I’ve predicted we wouldn’t see QE 3. It’s now clear I was wrong. The Fed just announced QE 3. And while the implications of this will not be positive for the cost of living in the US, or ultimately the markets (inflation will eat away profit margins), the fact of the matter is that on this forecast I was totally and completely wrong."
Source: http://gainspainscapital.com/2012/09/13/graham-eats-humble-pie/
Phoenix, I would have preferred, instead of this long-winded diatribe of the obvious, if you'd simply post an apology to ZH for your continual dead-wrong call that QE3 wasn't going to happen, and that the EU wasn't going to get their bailout done. you were incredibly wrong on both counts, and anyone who actually allocated capital based on your advice got KILLED in the last few months.
So before you try to pawn your cruddy service on ZH's readers, as a cloaked advertising medium, I suggest you just write a very brief apology for your bad calls, they are building up to reduce your readership of your paid-service-hawking infomercials you call 'writing'.
ZH, you should be ashamed of yourself for helping this man hawk his doom and gloom subscription business under the guise of writing an informative article.
He already posted an apology asswipe.
EXACTLY. This moron has been dead wrong, day after day, for MONTHS. Same claptrap every time. This is borderline offensive to the intelligence of ZH readers. WHY THE FUCK IS THIS GUY'S UNINFORMED OPINION ALWAYS AT THE TOP OF ZH? Does ZH endorse Phoenix Capital?
He already has posted an apology in the last couple of days- look in the archives (grrm impatient ingrates). Anyway, the fundamentals of the analysis are perfect. I suppose we could do with a bit more digging into details- the especially interesting question is how they are keeping the trainwreck that is Spain on the rails and within the Euro. There's so much to look at in Spain- The Bank of Spain's 'dynamic provisioning' and whether it has hidden asset depreciation- and especially if it has hidden GDP decline? Who pays for the unemployed? What's the cost of it and how long can it be sustained? What about the Cajas? Problem solved, deferred or covered up? How sound is Santander, Spain's biggest bank? What about the regions- will one or more try for independence? Catalonia I believe has a 22% budget deficit and claims that it gives way too much to the central Govt. Personally i think Spain is the complex breakdown that will see the Euro begin disintegrating, but when I can't say, just that the fundamentals are all downward in Spain, and probably worse than they appear. Oh, and Rajoy will insist till he's blue in the face that Spain's ok- until one weekend they just leave, quietly, out the back door. I hope for their sakes that they do, and soon.
Judging from your use of the word "fundamentals" and misunderstanding of the concept of "reflation" it is clear that A) You have no clue what the fuck you are talking about, and B) You are a keyboard jockey with no real capital deployed in the markets, which is actually good for your sake, because of reason A
i disagree. if people didnt allocate any of their wealth into the 'markets' at least they didnt lose anything (other than to inflation). not all stocks went up over the last 6 months....
Thanks for the tip on gold and silver, Graham. Cheers.
Good News for People who Love Bad News!
It's actually the snake oil "science" of the far left.
You're blaming the Republican Bernanke for actions that are "far left"? Hilarious.
Ha ha, nominal GDP targeting. And they say he saved the economy?