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Of Keynesian Cul-De-Sacs And The Fed Creating More Financial Market Uncertainty

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Submitted by John Browne of Euro Pacific Capital,

Although the U.S. stock market continues to hit new nominal highs on a nearly daily basis, the U.S. economy bumps along at a lackluster pace. This disconnect has been achieved by a massive Fed experiment in monetary stimulation. Through the combination of seemingly endless maintenance of zero interest rates and the injection of some $1trillion a year of synthetic money into fixed-income markets, the Fed is hoping that the boom it is creating on Wall Street will lead to a boom on Main Street. In reality, this a very dangerous economic gamble of enormously high stakes.  As we have seen in the recent past, financial bubbles can leave catastrophe in their wake.

In October 2013, Professor Robert Schiller, the renowned Yale economist, was awarded a Nobel Prize together with two others for research into asset bubbles and resulting values. In a recent interview in the German newspaper, Der Spiegel, he said, "I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets. That could end badly. I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable."

However, there are many in the financial establishment who disagree with the professor, including, most interestingly, Professor Karl Case, the co-creator of the famous Case-Shiller Home Price Index. Most market participants either believe that current share prices are fully justified by corporate metrics or they believe the Fed has expertise, and the ability, to prevent an ugly sell-off if things turn out badly. This debate has become the defining conversation as we head into the end of the year.

However, those who believe that QE will produce positive results to compensate for the risks are finding their position to be increasingly difficult to defend. At the International Monetary Fund's November annual conference in Washington, Mr. David Wilcox, reputed to be one of the Fed's most important economic advisors, offered insight into some problems facing QE. In essence, he maintained that the Fed's QE-3 program is producing only very limited results in terms of U.S. economic growth. At the same time, he seemed to hint that unlimited QE could create serious financial market distortions.

Many market observers, including myself, think that the Fed's open-ended QE program has been a massively expensive failure. As a result, market watchers have become increasingly eager for the program to be wound down, and many do not understand the Fed's reluctance to taper its monthly bond purchases.

Although many of the more open-minded members of the Fed's Open Market Committee may have lost faith in the ability of QE to deliver tangible gains in the real economy, they have also shown some concern that a diminishing of QE could trigger stock and bond market turmoil. There can be little doubt that such an outcome could usher in a new round of recession. In other words the "good" that the Fed sees in QE may merely be the prevention of a potentially worse reality.

A majority of investors have seemed to convince themselves that QE has become an unneeded crutch that the Fed will be more than happy to abandon by the end of next year. Many believe that such an outcome will place limited downward pressure on stocks, bonds and real estate. These views are Pollyannish in the extreme. The recent sell-off in the bond market should attest to that. On the other hand, some investors, including some aggressive hedge funds, seem to be operating under the belief that QE will not be ended any time soon, if ever. They have even borrowed massively to invest on booming financial markets that stand already at record highs. Today, total New York Stock Exchange margin debt stands at $412 billion, an all-time record.

The disagreements of the investing public are of little weight in comparison to the opinions of the FOMC members themselves (such is the world we have created). The key point for 2014 is how many voting members of the new Yellen-led FOMC will follow her down the Keynesian cul-de-sac. Should a majority of the FOMC feel forced, in the national interest, to vote against an expansion of the Bernanke-era stimulus policies (which we believe Ms. Yellen is sure to propose), financial markets could be in for a severe shock.

Those who wish to continue equity investing in face of this risk might be well-advised to ensure they have adequate hedging policies in place. Investors in both equities and bonds must question how the Fed can coax a market into a continued boom in a manner disconnected from economic reality.

 


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Mon, 12/09/2013 - 20:53 | Link to Comment unrulian
unrulian's picture

Gold Bitchez

Mon, 12/09/2013 - 23:34 | Link to Comment ZH Snob
ZH Snob's picture

by any scientific standard this little experiment of theirs keeps showing the same results. 

these are highly educated people who know exactly what they are doing, so the only logical conclusion is that they are not being entirely honest.  to think they are foolish or out of control is to play right into their hands.  that kind of thinking just gives them more license.  we must instead conclude that for whatever reason they are purposely scuttling the entire worldwide economy.

Tue, 12/10/2013 - 07:55 | Link to Comment new game
new game's picture

since they get first crack at the qe/pomo money creation(debt); they know exactly what they are doing. to even question that remains a glarring sign of your ability to reason. these fuckers are oprn notorious and very dangereous people/subhuman organisms. the results will be a magnitude 10 of human suffering. that is what they are doing by not letting the markets eb and flo and determine winners and losers.  violence will be the outcome...oh, and they know that too (war, they win again-financing both sides). until we france/heads removed- them -1700 circa, we are doomed to repeat and remain debt servatude!

Mon, 12/09/2013 - 21:00 | Link to Comment ejmoosa
ejmoosa's picture

It's more than synthetic money.  It's synthetic profits.  Because that's where the dollars would have to come from to purchase all that the QE has been buying the last 13 months.

Assume an average 10% profit margin,and it's like a $10,000,000,000,000 economy that simply does not exist.

Mon, 12/09/2013 - 21:03 | Link to Comment 10mm
10mm's picture

And the Sony and Cher song comes to mind "And The Beat Go's On,And The Beat Go's On.

Mon, 12/09/2013 - 21:08 | Link to Comment Grande Tetons
Grande Tetons's picture

I think the Fed chair should wear a funny hat like the Pope.  

Some sort of dunce cap...or what Mickey Mouse wore in Fanatasia. 

Mon, 12/09/2013 - 21:28 | Link to Comment WhyDoesItHurtWh...
WhyDoesItHurtWhen iPee's picture

You are on to something.  A "Cheese Pope Hat".

Mon, 12/09/2013 - 21:29 | Link to Comment mess nonster
mess nonster's picture

It will end badly, now or later. The banks won't cough up the QE dough. They plow it back into treasuries or into the market. The actual widget-makers make more in paper profits than they do on widgets no-one can really buy because no-one really has any real money. 

What I wonder is, isn't this analogous to buying the market on margin? I mean, even though there is really only one lender, the Fed, all the money in the market is loaned money. Instead of the traders borrowing, its us who are borrowing. If the market crumbles, traders get to walk away. There won't be any leaps out of windows this time. Somehow, I get to pay for someone else's stock market highs. If I jump out of my window, I'll just land in the flower bed three feet below my ranch-style window. 

Mon, 12/09/2013 - 21:54 | Link to Comment Son of Captain Nemo
Son of Captain Nemo's picture

"If I jump out of my window, I'll just land in the flower bed three feet below my ranch-style window."...

Where the people who tried to borrow but couldn't (finished it) will push you off your ranch-style window onto the cement 5 stories below!

Mon, 12/09/2013 - 21:33 | Link to Comment K-Dog
K-Dog's picture

A system that attempts to stimulate the economy by enriching those who have more at the expense of those who have less can't possibly work.  Getting people back to work is the only thing that can stimulate the economy.  Everything else is just irresponsible and waiting for miracles to happen.  It seems the FED is waiting for miracles and the second coming of Christ to fix things forgetting what he did to the money changers in the Holy Temple.  I'm enjoying mentioning Christ this Christmas since nobody else is.  Perhaps a rename to Consumemas would be appropriate.  But it would take away my fun.  QE is a trickle down formula but nothing trickles down.

Mon, 12/09/2013 - 22:00 | Link to Comment TNTARG
TNTARG's picture

"Cul de sac", I love it!

That's style, folks.

Mon, 12/09/2013 - 22:04 | Link to Comment Harbanger
Harbanger's picture

"Cul de sac", means go out the same way you came in.  No other Exit.

Mon, 12/09/2013 - 22:09 | Link to Comment lasvegaspersona
lasvegaspersona's picture

I'm just a doctor. Three years ago I didn't know monetary from financial. I did not know what the Fed did. Why do I have to be the one to ask if there is a hidden derivative market time bomb that will explode if the Fed ends QE?

If Bernacke could end QE why didn't he do it in September?

Why don't all these geniuses wonder out loud about all the angles instead of just the ones that leave a ray of hope...cuz I ain't seein it.

Mon, 12/09/2013 - 22:15 | Link to Comment ebworthen
ebworthen's picture

Meahwhile, 10 Year T rate at 2.85%.

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