Roughly five years ago, when we first started warning that the Fed's QE program, which we predicted will never end (five years later this is as true as ever), instead of leading to a virtuous economic cycle would result in a world where the labor force is increasingly converted from full-time workers to part-time labor, in which spending on growth capital is entirely replaced with such short-term shareholder friendly actions as dividends and buybacks, where the government is more broken than ever and where, courtesy of monetary policy, Congress can just tell the Chairman to "get to work" any time there is a crisis, and in which the record wealth disparity between the wealthiest few (0.6% control 40% of the world's wealth) and the poorest 99% (now that the middle class is on the path to extinction) will inevitably lead to a 18th century French outcome complete with guillotines, or worse, one of the more traditional financial pundits, John Maudlin, espoused the "Muddle Through" theory - in a nutshell, that all, even if at a far lowered output and standard of living, would be well, one which we (much to the chagrin of Cypriot - to start - depositors) refuted.
Some five years later, now that the prevailing mainstream media consensus has finally caught up with our "tinfoil" view, which for years was mocked by the same media, usually on an ad hominem basis, and even the Fed has realized (confirmed by the latest Jackson Hole symposium) it is in a trap as it understands it has to end the market's dependency on monetary heroin but has no idea how to do it without in the process undoing five years of central planning, we have seen some spectacular opinion flip flops take place. Which aside from the occasional headscratcher such as David Rosenberg going bull-retard (we once again wonder: just what does Ray Dalio serve in his cafeteria?) have been almost exclusively from optimistic to pessimistic, or as we call it, realistic. And as the case may be, such as with John Mauldin and his latest missive to potential clients, A Code Red World, a very deep and red shade of pessimistic.
Some extracts from the man whose Muddle Through has now become the Fumble Through and Through:
The arsonists are now running the fire brigade. Central bankers contributed to the economic crisis the world now faces. They kept interest rates too low for too long. They fixated on controlling inflation, even as they stood by and watched investment banks party in an orgy of credit. Central bankers were completely incompetent and failed to see the Great Financial Crisis coming. They couldn't spot housing bubbles, and even when the crisis had started and banks were failing, they insisted that the banks they supervised were well regulated and healthy. They failed at their job and should have been fired. Yet governments now need central banks to erode the mountain of debt by printing money and creating inflation.
Investors should ask themselves: if central bankers couldn't manage conventional monetary policy well in the good times, what makes us think that they will be able to manage unconventional monetary policies in the bad times?
And if they don't do a perfect job of winding down condition Code Red, what will be the consequences?
Economists know that there are no free lunches. Creating tons of new money and credit out of thin air is not without cost. Massively increasing the size of a central bank's balance sheet is risky and stores up extremely difficult problems for the future. Central bank policies may succeed in creating growth, or they may fail. It is too soon to call the outcome, but what is clear (at least to us) is that the experiment is unlikely to end well.
The endgame for the current crisis is not difficult to foresee; in fact, it's already underway. Central banks think they can swell the size of their balance sheet, print money to finance government deficits, and keep rates at zero with no consequences. Bernanke and other bankers think they have the foresight to reverse their unconventional policies at the right time. They've been wrong in the past, and they will get the timing wrong in the future. They will keep interest rates too low for too long and cause inflation and bubbles in real estate, stock markets, and bonds. What they are doing will destroy savers who rely on interest payments and fixed coupons from their bonds. They will also harm lenders who have lent money and will never be repaid in devalued dollars, if they are repaid at all.
We are already seeing the unintended consequences of this Great Monetary Experiment. Many emerging market stock markets have skyrocketed, only to fall back to earth at the hint of an end to Code Red policies. Junk bonds and risky commercial mortgage-backed securities are offering investors the lowest rates they have ever seen. Investors are reaching for riskier and riskier investments to get some small return. They're picking up dimes in front of a steamroller. It is fun for a while, but the end is always ugly. Older people who are relying on pension funds to pay for their retirement are getting screwed (that is a technical economic term that we will define in detail later). In normal times, retirees could buy bonds and live on the coupons. Not anymore. Government bond yields are now trading below the level of inflation, guaranteeing that any investor who holds the bonds until maturity will lose money in real terms.
We live in extraordinary times.
When investors convince themselves central bankers have their backs, they feel encouraged to bid up prices for everything, accepting more risk with less return. Excesses and bubbles are not a mere side effect. As crazy as it seems, reckless investor behavior is, in fact, the planned objective. William McChesney Martin, one of the great heads of the Federal Reserve, said the job of a central banker was to take away the punch bowl before the party gets started. Now, central bankers are spiking the punch bowl with triple sec and absinthe and egging on the revelers to jump in the pool. One day the party of low rates and money printing will come to an end, and investors will make their way home from the party in the early hours of sunlight half dressed, with hangovers and thumping headaches.
The coming upheaval will affect everyone. No one will be spared the consequences – from savers who are planning for retirement to professional traders looking for opportunities to profit in financial markets. Inflation will eat away at savings; government bonds will be destroyed as a supposedly safe asset class; and assets that benefit from inflation and money printing will do well.
Such fire and brimstone , such a dramatic shift in perception? Well, better late then never, right... But one wonders - why now?
This book will provide a roadmap and a playbook for retail savers and professional traders alike. This book will shine a light on the path ahead. Code Red will explain in plain English complicated things like zero interest rate policies (ZIRP), nominal GDP targeting, quantitative easing, money printing, and currency wars. But much more importantly, it will explain how what is in store will affect your savings and offer insights on how to protect your wealth. Code Red will be an invaluable guide for the road ahead.
Code Red will be available on Amazon on Monday, Oct. 28.
... and suddenly it all makes sense.