Quantitative Easing

While markets await details on the next round of quantitative easing (QE) -- whether refreshed bond buying from the Fed or sovereign debt buying from the European Central Bank (ECB) -- it's important to ask, What can we expect from further heroic attempts to reflate the OECD economies? The 2009 and 2010 QE programs from the Fed, and the 2011 operations from the ECB, were intended as shock treatment to hopefully set economies on a more typical, post-recession, recovery pathway. Here in 2012, QE was supposed to be well behind us. Instead, parts of Southern Europe are in outright depression, the United Kingdom is in double-dip recession, and the US is sweltering through its weakest “recovery” since the Great Depression. QE is a poor transmission mechanism for creating jobs. It wasn’t supposed to be this way.

Another week of central bank watching ahead, and markets will play their customary game of chicken with the U.S. Federal Reserve and the European Central Bank.  Both central banks have policy meetings this week – the Fed’s concludes on Wednesday, the ECB’s on Thursday – and capital markets have been moving higher in recent days on the hope of coordinated action.  For investors and traders, this sets up a classic “Buy the rumor, sell the news” pattern for the week ahead - as the overarching theme is that human history repeats because human nature does not change.  But Nic Colas of ConvergEx asks the deeper question, and the one that will retard any lasting move to the upside, is how much central banks can do without help from fiscal policymakers.

To some, Paul’s stubborn persistence in the campaign has been just that: a stubborn unwillingness to lie down and die despite evidence of sure defeat. But what they have missed is a common misperception of a subtle yet powerful age-old strategy at play - the archetypal shi (pronounced “sure”) strategy expounded and employed by Chinese philosophers and military strategists for thousands of years. More than anything else, we can see Paul’s greatest shi advantage in his outsized support among the young. In this society of immediate gratification and winning right now at all cost we need to ask ourselves: why should future elections and platforms matter so much less than the current ones? There are powerful cognitive biases at work - among them the temporal myopia of hyperbolic discounting, or excessively undervaluing the future, while focusing on the nearer term - which make fuzzy in our minds the importance of victories in the years ahead (a view that is promulgated by the media). The ultimate war is against intrusive, burgeoning government, in the ongoing insurgencies of the battles yet to come—Ron Paul’s grand shi strategy.

While in principle central banks around the world can talk up the market to infinity or until the last short has covered without ever committing to any action (obviously at some point long before that reality will take over and the fact that revenues and earnings are collapsing as stock prices are soaring will finally be grasped by every marginal buyer, but that is irrelevant for this thought experiment) the reality is that absent more unsterilized reserves entering the cash starved banking system, whose earnings absent such accounting gimmicks as loan loss reserve release and DVA, are the worst they have been in years, the banks will wither and die. Recall that the $1.6 trillion or so in excess reserves are currently used by banks mostly as window dressing to cover up capital deficiencies masked in the form of asset purchases, subsequently repoed out. Which is why central banks would certainly prefer to just talk the talk (ref: Draghi et al), private banks demand that they actually walk the walk, and the sooner the better. One such bank, which has the largest legacy liabilities and non-performing loans courtesy of its idiotic purchase of that epic housing scam factory Countrywide, is Bank of America. Which is why it is not at all surprising that just that bank has come out with a report titled "Shipwrecked" in which it says that not only will (or maybe should is the right word) launch QE3 immediately, but the QE will be bigger than expected, but as warned elsewhere, will be "much less effective than QE1/QE2, both in terms of boosting risky assets and stimulating the economy."

Will the Fed then just keep printing forever and ever? As an aside, financial markets are already trained to adjust their expectations regarding central bank policy according to their perceptions about economic conditions. There is a feedback loop between central bank policy and market behavior. This can easily be seen in the behavior of the US stock market: recent evidence of economic conditions worsening at a fairly fast pace has not led to a big decline in stock prices, as people already speculate on the next 'QE' type bailout. This strategy is of course self-defeating, as it is politically difficult for the Fed to justify more money printing while the stock market remains at a lofty level. Of course the stock market's level is officially not part of the Fed's mandate, but the central bank clearly keeps a close eye on market conditions. Besides, the 'success' of 'QE2' according to Ben Bernanke was inter alia proved by a big rally in stocks. But what does printing money do? And how does the self-defeating idea of perpetual QE fit with the Credit Cycle relative to Government Directed Inflation (or inability to direct inflation where they want it in the case of the ECB and BoE)?

Not seeing many fiscal developments that would prompt significant bullish action...

In a recent BBC News article, philosopher John Gray asks the quaint but otherwise vain question of what would John Maynard Keynes do in today’s economic slump.  We call the question vain because practically every Western government has followed Keynes’ prescribed remedy for the so-called Great Recession.  Following the financial crisis of 2008, governments around the world engaged in deficit spending while central banks pushed interest rates to unprecedented lows.  Nearly four years later, unemployment remains stubbornly high in most major countries. Even now in the face of the come-down that inevitably follows any stimulus-induced feelings of euphoria, certain central banks have taken to further monetary easing. The question of interest shouldn’t be “what would Keynes do” but rather “why even listen to someone so pompous and nihilistic to begin with?”  Just as Keynes missed the Great Depression, modern day Keynesians missed the housing bubble and financial crash.  From his contempt for moral principles to his enthusiastic support for eugenics, Keynes saw the world as something separate from the bubble of his fellow elitists. Outside of that we guess he was a great guy!

For some time now we have been warning about the danger to portfolios given the deteriorating fundamental, economic and technical backdrop in the markets.  Our warnings, for the most part, have been ignored as individuals continue to chase stocks in hopes that "this time will be different", and somehow, stocks will continue to ramp higher even though all three support legs are weakening.  Currently, it is the imminent arrival of the next round of Quantitative Easing (QE) that keeps "hope" elevated but further Central Bank intervention is unlikely in the near term leaving the markets at risk of a further correction. The technical and fundamental setup is currently a negatively trending market.  It is very likely that, in the current environment, we will retest the May lows, if not ultimately set new lows, in August.  Those lows will likely coincide with further weakness in the economy which should be the perfect setup for the Fed to launch a third round of Quantitative Easing.

Is it any wonder that Stephen Roach is now ex-Morgan Stanley? Today's brilliant truthiness in his interview on Bloomberg TV is an absolute must-watch as the veteran market practitioner notes that the Fed is forced to act next week and while consumers are telling you that they want to pay down debt - which all the monetray stimulus in the world is not going to change - that QE is nothing but crack to a ridiculously addicted market. With 70% of the US economy in a balance sheet recession, the Fed knows this (which he notes is now run by WSJ's Jon Hilsenrath since what he prints must be adhered to by Ben for fear of market disappointment) and is "dangling QE in front of the markets like raw meat - but it has not worked and it will not work!" But critically, he believes, the euphoric response of markets will be tempered since they have become "used to the fact that all of this unconventional monetary easing by the central bank is just not what it is supposed to be."

Independent from Congress … or from the American People?

Just like last time around when stocks were plunging with no knight in shining armor in sight, until the Fed's faithful mouthpiece-cum-scribe Jon Hilsenrath showed up with a report, subsequently disproven, that more QE is coming minutes before the market close on July 6, so today stocks appeared poised for a precipice until some time after 3 pm it was leaked that none other than Hilseranth once again appeared, at precisely 3:55 pm, with more of the same. Ironically, the market only saw the word Hilsenrath in the headline, and ignored the rest. The irony is that this time around the Fed's scribbler said nothing that we did not know, namely that the Fed can do something in August, or it may do something in September, or it may do nothing, none of which is actually news.

The first is a long-term chart of the Dow Jones Industrial Average (DJIA). The recent price history has traced out a pattern that looks remarkably similar to the one that presaged the crash of 2008, with one difference: massive quantitative easing and Eurozone bailouts pushed the B leg into an overextension. If this pattern is valid, the C leg down could be a real doozy.

So the end stage of neoliberalism threatens a Dark Age of poverty/immiseration – most characteristically, one of debt peonage. ~ Michael Hudson

Two years ago, in January 2010, Zero Hedge wrote "This Is The Government: Your Legal Right To Redeem Your Money Market Account Has Been Denied" which became one of our most read stories of the year. The reason? Perhaps something to do with an implicit attempt at capital controls by the government on one of the primary forms of cash aggregation available: $2.7 trillion in US money market funds. The proximal catalyst back then were new proposed regulations seeking to pull one of these three core pillars (these being no volatility, instantaneous liquidity, and redeemability) from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7. A key proposal would give money market fund managers the option to "suspend redemptions to allow for the orderly liquidation of fund assets." In other words: an attempt to prevent money market runs (the same thing that crushed Lehman when the Reserve Fund broke the buck). This idea, which previously had been implicitly backed by the all important Group of 30 which is basically the shadow central planners of the world (don't believe us? check out the roster of current members), did not get too far, and was quickly forgotten. Until today, when the New York Fed decided to bring it back from the dead by publishing "The Minimum Balance At Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market FUnds". Now it is well known that any attempt to prevent a bank runs achieves nothing but merely accelerating just that (as Europe recently learned). But this coming from central planners - who never can accurately predict a rational response - is not surprising. What is surprising is that this proposal is reincarnated now. The question becomes: why now? What does the Fed know about market liquidity conditions that it does not want to share, and more importantly, is the Fed seeing a rapid deterioration in liquidity conditions in the future, that may and/or will prompt retail investors to pull their money in another Lehman-like bank run repeat?

With Corn hitting its highs again, we are reminded that global food production has been hitting constraints as rising populations and changing diets hit against flattening productivity, water and fertility constraints, and the likely early effects of climate change. As was described in the recent all-encompassing theory of global-collapse, there is general agreement that one of the contributing factors to the rolling revolutions beginning at the end of 2010 was increasing food prices eating into already strained incomes. It is unclear how much impact easing has had on food prices this time, weather has very much made its presence felt (as we noted here). From one omnipotent force (central bankers) to another (hand of god), the fear is that more broadly, food is likely to be a more persistent problem than oil supply. This is because we require almost continual replenishment of food to stay alive and avoid severe social and behavioral stress - food is the most inelastic part of consumption. This says nothing of the pernicious inflationary impact that will likely quell the kind of free-flowing printing so many hope to see from China et al.