Romney and the Market

"An election is coming. Universal peace is declared, and the foxes have a sincere interest in prolonging the lives of the poultry." - George Eliot

"Now, let me be clear. The path I lay out is not one paved with ever increasing government checks and cradle to grave assurance that government will always be the solution. If this election is a bidding war for who can promise the most goodies and the most benefits, I'm not your president. You have that president today." - Mitt Romney

Now I am not a politician.  Never have been and I don't plan on ever being one, it is just not me.  However, this election is going to have a dramatic impact on the market if Mr. Romney is elected AND if he stands by his election campaign rhetoric.  As I have repeatedly mentioned in previous blog posts, the fate of the market is in the hands of the politicians.  Never in my 25 years of trading the markets has it been this skewed towards their policies.

The main reason for this is that over the last few years government has been taking a larger and larger share of the market from buying up Collateral Mortgage Obligations (CMOs) to owning large blocks of GM and other companies to printing money in order to stimulate the market (Bernanke's words not mine).  So the government through the Federal Reserve is trying to manipulate market prices and so far as the stock market is concerned it is working.  But with an election looming what would happen if Romney gets elected?

The first thing he has mentioned is that he will remove the head of the Federal Reserve, Ben Bernanke, and replace him with someone that is of similar mind to his own.  Based on the quote above that would mean cutting the money printing from the Federal Reserve and working towards balancing the budget.  Without the support of the money printing machine the stock market will be destroyed and already it is showing signs of tiring and this is not being helped by poor results from bell weather companies such as IBM, Google, Microsoft and Apple.

So what of the bond market and interest rates?  At present due to the continued economic weakness any elected president requires that interest rates remain subdued.  If interest rates spike any form of recovery will be dismantled and there is no chance of balancing the budget as increased interest payments will offset any cuts in spending.  There is one caveat here though, if the United States is seen to be more austere then there is a fair probability that the reward will be continued low rates.  How low is a big question but I would be surprised to see rates on the 10 year note rise above 2.5% to 3.0% for the simple reason that during a stock market meltdown, demand for safety becomes tantamount and at present the only safety left is either gold or bonds.  Furthermore while rates may start to rise higher, whomever is the Federal Reserve Chairman will have as his or her mandate that rates need to remain low. 

So how can this be done without continued printing of money?  He would have to rely on international buyers of United States debt.  The Germans would argue that being more austere should lead to a dollar rally and this will attract foreign capital keeping interest rates low.  Think about it for a moment, if the United States was seen to be balancing its budget and thereby taking care of its debt issues it would be viewed in a positive light as a good place to invest for safety.  A dollar rally would also take the lid off much of the inflation drivers as oil and other commodity prices would fall.  So if inflation remains muted and the currency remains strong there is every chance that interest rates will remain low for an extended period.  Furthermore I would argue that if interest rates on the 10-year Treasury rose to say 4% that there would be an enormous demand for the product as that rate combined with a strengthening currency cannot be found anywhere.  For a while it was available by investing in Australia and their economy boomed during this period, however it has since faded with the problems in China.  That said it is a model that can be shown to work and one that I would expect Romney to hang his hat on.

So what are the chances that he gets elected?  Well based on some of my sources it seems that the probability is relatively high.  With unemployment stubbornly high and spiralling government debt it appears that most people want a change to see if that helps.  In looking at the market one thing that it does not like is uncertainty and the coming election is creating uncertainty and this is showing up in the slow roll over in the indices.  It is pointing toward a hard hit if Romney is elected but to me the interest factor is to see how interest rates react as if they do not spike on a Romney win then there is a better chance that he can pull off a continued low interest rate environment while implementing his policies.

The last criteria would be the longer term.  I believe that while the market may sell off sharply in the near term on his announcement it is always hard to believe a politician until his actions start to match his words.  Will Romney bow to congress once president and change his policies to suite them and will there be a congress that supports his measures if they get too tough to swallow.  One thing is for sure, creating jobs by cutting the deficit, while it sounds good and will work in the long run, is sure to create short term pain and if I know anything about politicians it is that short term pain always wins over long term gains!

Where Has The Protection Gone?

"The Sharpe ratio measures the excess return (or risk premium) per unit of deviation in an investment asset or a trading strategy, typically referred to as risk, named after William Forsyth Sharpe." - Wikipedia

"If you are not willing to risk the unusual, you will have to settle for the ordinary." - Jim Rohn

"This report, by its very length, defends itself against the risk of being read." - Winston Churchill

In the world of finance the Sharpe ratio is a key aspect of investment.  What you want is a high Sharpe ratio meaning for every unit of risk that you are taking you are receiving more than a fair share of reward in the form of return.  For example, if you invest in a highly speculative stock that has a good chance of providing you with returns of 50% a year for the next five years and only a small chance of a loss, this position would provide you a high Sharpe ratio.  Taking this one step further, funds are measured against an index and those that beat the index with a low level of volatility (risk) provide the investor with a high Sharpe ratio.  They provide the investor with a higher return for the same or lower amount of risk.  As an investor this is what you want!

So how is a high Sharpe ratio achieved?  The easiest way is to find a basket of diverse investments that produce a high rate of return.  This sounds easy and in many instances it is sold as being easy to do, but a recent study showed that not only do most investments have poor Sharpe ratios but that these numbers are dropping.

The first problem is that in the modern world of finance finding or creating a diverse portfolio of investments is almost impossible.  Most people are ignorant to the fact that buying an array of mutual funds does not achieve the diversity that they need.  This is due to the fact that many of the mutual funds hold the same investments even if they call themselves different things.  For example a growth large cap fund and a value large cap fund more than likely have as their largest holding Apple.  Buying both of these means that you are now doubly exposed to a movement in the price of Apple.  This is great while it goes up but it is not a diverse portfolio.

A greater problem for the prudent investor is that the value of diversifying is losing its merit at precisely the time that it is needed most.  The way that a portfolio is created is by finding investments that are not correlated to one another.  As an example if you know that Apple will go up in price if the price of the raw materials of copper and nickel go down because Apple's profits will rise, then it would be said that copper and nickel have a negative correlation to Apple stock.  So by buying all of these you would be protected as if Apple goes up copper and nickel go down.  The one offsets the other.  This reduces the risk of the portfolio but in this example would not provide you any capital gain.

In the real world it is impossible to find a correlation as perfect as this so money managers and investors look for investments that will not move in exactly the same direction or at the same speed at the same time.  The idea is to weight the portfolio to capture some upside while limiting the downside which results in a properly diverse portfolio.  Now if this portfolio beats the index tracked then it would have a high Sharpe ratio as the risk of the overall portfolio is reduced and it is still producing gains in excess of the market.  This is the holy grail of investing but it is seldom if ever achieved.

The reason for this is many fold and I will delve into a few reasons here.  The first reason is that correlation between asset classes are constantly changing.  The trader knows that correlation trades last until they don't, meaning that you should trade the relationship until it breaks.  A classic example of this was that up until recently if the dollar strengthened the market went down and vice versa.  A great trade would therefore be to be long the market and the dollar and pocket the spread, however that correlation has weakened recently breaking the trade.  In a portfolio to properly handle this constant change in correlations you need to constantly change your portfolio allocations.  This comes with the added risk of the cost of moving the investment and the fact that once you have moved you may miss a good run in the position that you just sold.

The second reason is that correlations between all assets are becoming more closely linked.  International stocks used to be a good hedge against movements in the United States back when I got into this game in 1985, but now they all move together.  I also remember a time when commodities were a great hedge but nowadays that is also gone.  Think about copper, it seems to lead the market lower or higher as people use it as a leading indicator rather than as a hedge.

Finally, as we have seen during the recent market melt down, at the exact time that the diversification is needed to protect your portfolio (when the market explodes) is the exact time when correlations move together and everything gets killed at once.  So while countless hours are spent trying to build a perfect portfolio to protect against Armageddon, when that day shows up everything is pounded at once eliminating the desired protection.

So what is one to do?  As with all studies it is far easier to link the main investment opportunities together than to dig for things that lie outside the box.  For one, most people and most studies exclude private equity investments.  This is why these are not typically linked to other investments.  Just because the market is tanking does not mean that your investment in privately held regional Internet or biotech company has been impacted.  Looking further, while local real estate markets are being pounded does not impact the short sellers or the buyers of foreclosures, in fact it benefits their business tremendously.

I remember being an analyst in the early 1990's during that recession and while many of my friends were struggling our business was flourishing.  The reason was we specialized in bankruptcy and commercial litigation, both of which are busiest during recessions.  The key to the story is to look at your portfolio and see what your true weighting is in each asset class and then try to find something that will provide a level of protection if and when the market collapses.

As with everything there are no guarantees but hiding the money under a mattress comes with its own set of risks such as loss to inflation, risk of theft or being lost in a fire.  Look at alternatives to the standard investment portfolio and it should stand you in good stead during these tough times.

The Independence of the Federal Reserve

"The Congress established maximum employment and stable prices as the key macroeconomic objectives for the Federal Reserve in its conduct of monetary policy. The Congress also structured the Federal Reserve to ensure that its monetary policy decisions focus on achieving these long-run goals and do not become subject to political pressures that could lead to undesirable outcomes." - Board of Governors of the Federal Reserve System

The Federal Reserve must be celebrating today as unemployment dropped below 8% for the first time since 2009.  Finally the open ended purchasing of toxic debt and other assets, keeping interest rates at unsustainable low levels, has paid off as we are now trending in the right direction.  A number of interesting things jump out of the page regarding these numbers.

First of all is the fact that the majority, 582,000 of the 873,000 jobs created, were part time.  Now I wonder how many of those part timers were looking for a full time job.  Furthermore it ties in with an article written in the local news paper last week that there are plenty of part time jobs available as stores ramp up for the holiday season.  Is it just me or does this holiday season seem to happen earlier and earlier every year?  It appears that retailers are trying to get a jump on the competition and boost frail sales numbers but either way part time jobs come and go and this is a seasonal adjustment.

The next interesting question is the timing of the release.  It could not have happened at a better time for Obama.  Interesting again is the fact that the Bureau of Labor Statistics had been under reporting the actual employment numbers all year and suddenly found their mistake this month.  I don't know about you but to me the timing is questionable.  Certainly Obama will use this number to show the world how effective his leadership has been and that sticking to his plan will create jobs.  So let's look at the plan. 

More than a trillion dollar a year deficits for as far as the eye can see covered by the printing press that is the Federal Reserve.  The Federal Reserve's purchases of the government's massive trillion plus dollar deficits is what is called "monetizing" the debt.  By monetizing the debt the Federal Reserve is giving Congress a blank check book saying spend as much as you want and we will buy the junk.  Fiscal discipline is out of the window and in its place is a government that is out of control attached firmly to the umbilical chord of the Federal Reserve to preserve their madness.  How anyone in government can look themselves in the mirror and say "It is only a few more trillion of my constituents money but it is well spent" is definitely not in touch with reality.  That is why mirrors are banned in the White House! Only joking of course but how else can you wander around actually believing that what you are doing is solving the problem?

This dysfunctional government is creating a vast wall of debt that is rapidly becoming unmanageable however as long as the Fed keeps interest rates at the lowest level in our recent history the debt service charge is as low as it was $7 trillion dollars ago.  Remember back 10 years ago, everyone was shocked at a $158 billion deficit and $6 trillion in debt.  What would we give for that "little" of a number today?  I bet that you cannot imagine us ever going down to such a low level again, but unless we do trouble lurks ahead.  Just think about it for a minute, 10 years ago a massive deficit of $158 billion and now the deficit is 10 times that amount!  That equates to a growth rate of 22% compounded annually!

So let's look at the results of all of this printing.  Jobless rate of 8% five years after the Recession began and this is supposedly the recovery period.  47 million Americans on food stamps.  Four years of declines in household income to a level equal to that of 1995.  The lowest labor level participation since 1981.  Gasoline prices above $4 a gallon up from $1.50 in 2002.  Is this a recipe that is working?  And yet the Fed continues to believe in printing money to bolster stock prices, housing prices and raise asset values so that the man in the street "feels" more wealthy and then will open their wallet to buy things stimulating the economy.  Now I did not make that last sentence up, it comes directly from the mouth of the Fed Chairman!  So this is how yous timulate an economy, manipulate all asset prices to give everyone the warma nd fuzzies so that tehy can spend money they do not have and get creamed by the next burst bubble.  Nice!

Let's not also forget that they also need to monetize the ludicrous policies of the government and you have a situation where the independence of the Federal Reserve is vaporized.  No longer are their policies to assist employment and keep prices stable for we have just seen that neither of these metrics is happening.  What is happening is that they are manipulating prices and letting the government spending spin out of control with no accountability.  Please do not get sucked into this manipulated market rally, look around you and see what is going on and protect your assets.

Inequality - A Follow Up

“An imbalance between rich and poor is the oldest and most fatal ailment of all republics.” -

Plutarch ancient Greek biographer (c. 46 – 120 CE)

 

Now do not get me wrong, I am all for making money and this blog is not meant to bash on those who are doing well.  Furthermore I am not in the least bit pro-socialism, even after a close friend of mine spent more than a decade of my life trying to convert me from capitalism.  Sadly he died and in large part due to the inadequacies of the social system in which he lived.  No I am pointing out as the above quote states that massive inequality is the undoing of capitalism and that unless there is a change to the structural system in the United States trouble will ensue.  Interesting that the quote dates back to 46AD.  I guess nothing ever changes!

 

What I am referring to specifically is the inequality between the small business entrepreneur and the large multi-national business.  The later has access to massive amounts of cheap capital while the former is unable to raise money and when they can the money is incredibly expensive.  Now I understand that the less risky the loan or investment the lower the interest rate.  This is a natural occurrence and I agree that investors should be rewarded according to the level of risk that they take.  So for example if you plow your life's savings into starting a business and it works, you should be rewarded with large amounts of wealth.

 

On the flip of this, if you invest in a low risk investment such as Treasury bonds that have limited chance of default, then your reward or return on that investment should be minimal.  The dichotomy comes when you have a small profitable company that has a rock solid history and is able to back the investment with collateral that is also rock solid but is penalized as the market shuns that investment class for the large corporation.  Now a normal penalty would be in the range of 2 to 5 percent but currently that spread is anywhere from 10 percent to infinity (the company cannot find funding anywhere). 

 

The reason for this is that the banks and the markets are open to plowing billions of dollars towards the likes of Apple and IBM (considered low risk) but not towards smaller businesses (considered high risk) in order to protect themselves from another financial catastrophe while they get their house in order from the last one.  The amusing part to this is that never in my life has the spread been so wide and unless this spread narrows (money is made available to the small business) soon, the inequality will result in just the financial catastrophe that they are trying to protect against.  It is like playing rugby or football and trying not to get hurt, it is a sure thing that you will get pounded.  A better strategy is to get amped up and drive yourself into the opposition and surprisingly you come off the field intact.

 

As I mentioned in my previous blog on inequality, small business is the driver behind economic growth.  They are also the driver behind employment.  Cutting this class of business off from capital is tantamount to having two sets of rules to the same game.  One set for the favorites and the other, a more onerous and unfair set, for the underdogs.  This creates a false barrier to entry and allows the large corporation to benefit at the expense of the small business.  In order to grow the economy you have to get the money that is being printed by the Federal Reserve into the hands of the small entrepreneur so that they can innovate, hire and grow us out of the malaise that we are in.  Leaving it to the large corporations is not going to provide the growth that we need but that is just what is happening. 

 

I spend my life investing and raising money and right now you can earn an amazing rate of return by doing your homework and investing in these rock solid small businesses.  Typically loans to these businesses can range from 9 to 15 percent and in my view the risk of the investment is more than compensated for when you compare the returns that you can get in the market.  Now to take this one step further if the banks loosened their underwriting criteria slightly and loaned these companies money at say 8%, they could then pass on those rates to their clients (you) in the form of a decent return on your CD, say 4% for a two year note.  Now everyone is a winner.  The sad part is that it is virtually impossible to get these loans from any institution and if they do lend the money they are certainly not passing along the extra income to the CD holder.   

 

To take this one step further, the market is pricing these large corporations based on future earnings.  The thought is that by lowering their borrowing costs their profits will improve.  Furthermore as the economy is being trampled it is a prime time to reduce headcount and work on improved efficiency, so lay off workers and get those that remain to do more for less.  Not a good equation as the result will be that these one off improvements to the bottom line will start to lose their impetus as time goes by.  The result is that the expected profit gains will not be met and the market will suddenly sell off.  Unless you get people hired, growth will stagnate and there is just so much you can do to your balance sheet before the effects are felt on the income statement.  A fundamentally sound market is based on sound economic fundamentals and continued weak employment numbers will eventually undermine everything.

 

P.S. 

Now I don't like to tout myself and my products in this blog (which is why I have put this after the blog post), but the example above is exactly what Fixed Rate Deposits does, issue loans to small low risk businesses so that they can grow, helping them stay afloat and hire people while passing along a good rate of return to the prudent saver so that they can make some money on their deposits.  A win all the way around.  So if you are sitting on some cash and want to earn a good rate of return on your money and reduce your risk to the market let me know and I will send you a brochure to review.

Q&A

I have had a number of questions regarding my last blog "QE3 is Here" so this blog is dedicated to answering some of these so that we can see the differing opinions regarding the money printing press that is the Federal Reserve.

Steve – I’m no economist, but tell me if I am incorrect in dumbing this down – as I understand this.

1)     The banks have been sitting on these toxic, essentially worthless mortgage backed securities.

2)     The Fed says, hey Mr. Bank, we’ll take them off your hands/books at no cost

3)     …and we hope that this will help you feel a little bit better now so you can bloody well start making it easier for your customers and potential customers to take out loans

4)     …which in turn means more spending on business start-up, cars and so forth – from the loans

5)     And the Fed believes that people take out loans not necessarily in good times, but in weak times because in weak economic times people need loans if they want something tangible.

So if I am correct, then no money is being printed and as for the additional debt? Well, it moved from the banks to the Fed. And if the banks make more loans (and more money flows into the economy from the folks who took out these loans) then this begins to offset the mortgage-backed securities (the debt) that the Fed took over from the banks.

Am I off base here?

 

Answer:  This is definitely the theory.  Pass the toxic debt from the banks to the Federal Reserve in the hopes that the banks lend again and the economy recovers.  This presents numerous problems though:

1. The Federal Reserve has as its mantra that it "shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates and provide price stability in the form of inflation control." (from the Federal Reserve Act)  The idea is that with price stability you maintain a healthy economy as businesses are able to plan for the future based on this price stability and this in turn will keep the economy at full productivity and low unemployment levels.  The problem is that their current policies are not creating jobs but are creating a massive wave of debt that will somehow have to be repaid.  As we will see below this has boxed them in!
2. It is one thing to create a loose monetary environment to stimulate the economy, it is an entirely different matter when you are taking on the toxic assets of banks.  This creates morale hazard whereby bankers are rewarded for taking large risks but do not feel the consequences of these risks as they end up being shouldered by the Federal Reserve and by default therefore the tax payer.  I have argued that the Federal Reserve has crossed the line by taking this junk off the banks hands as they are not in the game of saving banks and companies.  The market needs to take care of itself but by coming to the rescue of these companies the Fed has created a morale hazard that is not in line with what they have been established to do.  Transferring the problem to the taxpayer while the bankers walk away from the problems is not their job!  It undermines their credibility and creates a bigger mess later and this is just what is happening.  Let the market wash the slate clean by impacting the banks, the bankers and their investors but not the tax payer.  Transferring toxic debt over to the government who cannot default on this obligation is not what makes capitalism work as the people that took the risks are not taking the pain.
3. If they are trying to stimulate the economy then providing financing for job ready projects would be a far better use of funds than taking toxic debt off the banks hands.  Another potential help would be to cut the student debt load or at least the interest charged on those loans to zero.  The banks pay nothing so why not the students?  The young are the demographic that acquire the most assets and keeping them swimming in debt at high interest rates while providing the bankers with financing at no cost makes no sense. Another idea is to issue more build America type bonds that target projects that hire people to repair the country's infrastructure.  This would get people to work and help the country rebound far quicker.  However now you have to deal with the politicians which is why neither of these will happen in the near future but it is these types of structural changes that need to be made to the political system to stimulate growth rather than blindly pumping more debt into the system.
4. The type of financing provided by the Federal Reserve to the banks is not able to be controlled.  It is given to the banks at no interest and they invest where they see fit.  This is why you see the stock market rising, oil prices shooting higher and other commodities spiraling higher.  The consumer feels the upward movement in these prices and this crimps demand for other goods and services slowing growth further.  Slow consumer spending reduces growth and means companies will cut back further creating a vicious spiral that is not solved this way.
5. The mountain of debt that is being created will crowd out the private sector and will create another drag on growth.  Just as the consumer suffers from too much debt, governments are eventually hamstrung by a mountain of debt and this debt and the cost of servicing the debt slow economic growth creating a drag that lasts for decades, just look at Japan.  This crowding out is already creating a drag on GDP growth and I doubt that the economy will grow faster than 2% per year until this debt burden is under control and to me that is decades away if ever.  Allowing these banks to suffer at the expense of their investors and themselves creates a clean slate and makes it a far easier path to prosperity. 
6. Letting banks fail is part of business.  If bad banks fail this creates a vacuum which is quickly filled by new "good" banks (banks with no toxic debt).  These new banks are keen to lend as they are effectively gaining from the other banks poor investment strategies.  By lending money to consumers at low asset values they ensure that they are stable and are able to function in the normal way regardless of what happens to the other banks.  This is capitalism and is how it should work but by saving these institutions they have created morale hazard.  This has resulted in banks and institutions that are too big to fail which has, in my opinion, been created directly by the Federal Reserve overstepping their bounds and sticking their head into places where they should not.  Certainly at the peak of the crisis it was imperative to save the financial system but since then the market should have taken care of its problems while the Fed concentrated on using the tools at its disposal to create jobs and not support poor businesses.

Steve

Ben has to keep printing money and buying bonds.  If he doesn't, there won't be as much of a market for those bonds and without buyers, the rates go up.  They can't risk that.  With $16 trillion in debt, an unbelievable number, each 1% increase in rate being paid increases the federal deficit by $160b.  That magnifies the deficit and could touch off a debt spiral we cannot get out of.  So, like Japan, the idea is keep rates low or non existent at all costs so the deficit doesn't balloon out of control.

 

Answer: I do not disagree with this comment, in fact I believe like the sender of the comment that the Federal Reserve is completely boxed in.  Without printing more interest rates are sure to rise and this will cause serious damage to the so called economic recovery.  However, more debt will eventually implode on itself and will result in a major financial calamity of the likes we have never seen.  Can they get themselves out of this hole?  My thought is that without structural policy changes it is impossible and looking to the politicians is looking at the problem but it really is up to them to solve this and I have little faith that either candidate will step up to the plate.

For all of these reasons I remain out of the stock market as money prinitng has created a false bull market based not on economic fundamentals but on the fact that there is nowhere to invest that produces a return.  Companies around the globe are ratcheting down their growth forecasts and are continuing to lay people off but the market continues higher.  That is not to say that some companies are not performing well, but it is a manipulated market that will hurt a lot of investors in the long run.  Stay away from trying to make a few dollars in the short run and focus on wealth preservation.

QE3 Is Here!

"All the perplexities, confusions and distresses in America arise not from defects in the constitution or confederation, not from want of honor or virtue, as much as from downright ignorance of the nature of coin, credit and circulation." - John Adams

"The great free nations of the world must take control of our monetary problems if these problems are not to take control of us." - John F. Kennedy
So it is finally here!  Yesterday after months of jawboning the Federal Reserve announced that it would buy $40 Billion of mortgage backed securities.  This is in addition to the $40 billion it is currently reinvesting through its "Operation Twist" program.  So the great balance sheet expansion continues.  The main reason sited for this was the fact that after years of trying, job creation is still languishing so the thought is that printing more money (after printing umpteen trillions already) will start to help the economy grow.

The move was applauded by Wall Street as they have been the direct beneficiaries of all this money printing.  The market rallied over 200 points and the market closed above its 52 week high and within striking distance of its all time high.  The new bond buying program is open-ended, which essentially means the Fed will have carte blanche in terms of how much monetary stimulus it feels is necessary to kick start the economy.  With today's announcement, the Fed finally acknowledged the reality that the unemployment rate will be very slow to come down and will likely not reach 7% until 2014 (this is their estimate and once again it is probably too rosy). In fact, the Fed said that without further stimulation economic growth may not be strong enough for sustained improvement in labor market conditions. Translation: the money printing is necessary to stave off the likelihood of another recession.

Wall Street is of the opinion that at some point in time the increase in asset values being manipulated by the Fed will result magically in lowering unemployment.  I take a quote from Peter Worden to reflect his and other stock traders opinion of the move (I have highlighted the more important pieces to bring them to your attention): "Ben Bernanke feels and logically so, that if the value of personal assets such as homes and stocks continue to show improvement, individual consumers will soon feel confident enough to step-up their spending. And thereby add the quintessential missing ingredient to this recovery."

So by piling more debt onto an already debt burden country the individual consumer will feel confident enough to spend money!  Who are we talking about here, the few thousand on Wall Street or the millions unemployed that have no money to spend either way?!  What a bunch of buffoons!  All the debt spending has not worked to date other than making oil and gasoline prices spiral higher and making stock prices reach for the stars.  Somehow another trillion will magically change everything and we will all have money ready to spend on useless junk to stimulate the economy.  To what end exactly?  So that we can then spend the next few decades of our life paying huge tax bills in order to pay off this massive debt burden.

But wait inflation to the rescue.  It will magically morph the debt into something manageable so that it will not be a problem.  But what if inflation remains muted for an extended period and heaven forbid that deflation occurs as that truly would be the death knell.  So what we now have is more debt and policies that are not producing jobs but if we continue to increase the debt level and remain wedded to the same policies we will somehow come out of this just fine.  Unbelievable!

Even the Fed agreed that we are slipping into a recession.  I believe that more money printing is not going to help us out of that in fact I believe that the drag of more debt will result in more and more regular recessions and slower and slower growth.  So if we are headed for a recession why is the stock market almost at its all time high?  Because the money being printed has to go somewhere and for now it is being pumped into the market as there really is nowhere else to go to earn a return on your investments.  This is a complete set up and will not end well and the more they kick this battered old can down the road the bigger problem they are creating.

Crossing the Line

“Such supplementary interventions [by the State], which are justified by urgent reasons touching the common good, must be as brief as possible, so as to avoid removing permanently from society and business systems the functions which are properly theirs, and so as to avoid enlarging excessively the sphere of State intervention to the detriment of both economic and civil freedom.” – Walter Bagehot

As the quote above mentions very clearly the State intervention is required but it is required for short bursts.  Thinking back to the beginning of the Great Recession, Federal Reserve intervention was needed to prevent a complete collapse of the financial system.  The Federal Reserve acted quickly and effectively and staved off the crisis.  Since that time they have remained involved in the economic “recovery” and it is their belief that unless they remain fully invested that the economy will crater.

The question is have they crossed the line?  The line I refer to is the line between required involvement to rescue the economy for common good or permanently removing systems and functions that are properly seated in the private sector.  This is critical to the long term viability of the general economy and is the reason that I continue to remain skeptical of the current market movements.

The question therefore is whether continued activity will continue to stimulate or whether it is just kicking a tin can up a very steep hill.  Take Greece for example.  They need to borrow money to stave off a default but no-one will lend them any money other than the ECB who ultimately underwrites the debt that Greece owes.  So effectively the ECB who is owed the money is lending more so that the insolvent country can continue to service their debt.  This is unsustainable in the long run unless there is a structural change to either the debt or the Greek government or both.

Looking at the Federal Reserve, saving the financial system was definitely a necessity.  Continuing to pour money into poor investments is not.  The second use of funds was done under the guise of stimulating the economy.  Bernanke who schooled himself on the Great Depression feels that the cause of the Great Depression was in large part due to the Federal Reserve cutting off funding too early.  He is determined not to repeat past mistakes and so has kept the foot hard on the gas-peddle for an extended period.  The result is a now mountain of debt and little in the way of success.  More importantly is that the economy now seems wedded to more money printing to survive and the ills of the past have not been corrected but have been glossed over with more money.

In my view the later portions of the so called quantitative easing have wasted an opportunity.  That opportunity was at their doorstep in the time of severe crisis but was squandered and now we have created a level of debt that has become a burden to the economy and is stripping away market opportunities that should be filled by the private sector. 

Furthermore the market is very fickle and at some point the low level of interest rates could spiral as it has done in Europe.  If this happens our current trillion dollar budget deficits will look small and trying to borrow your way out of that hole will not happen.   As I have argued before I believe that interest rates will remain low for longer than anyone expects but it certainly appears that we are squandering an opportunity to structurally fix the problem while these interest rates remain low by thinking that the only solution to the problem is to print money.  This is not the solution but is going to cause great problems in the future.  However in the meantime Wall Street celebrates any time they hear of more quantitative easing and this is a worry in and of itself as the Federal Reserve pats itself on the back each time the market goes up.

Their thought is that if the rich get richer (through asset appreciation) that the income will trickle down to those that do not have a job (through job creation from the rich) but this is not happening as unemployment remains stubbornly high.  In fact while there is a strong correlation between the stock market and job growth I would argue that job growth creates a strong market and not the other way around, however our leaders in their infinite wisdom believe otherwise.  Hold onto your hats as this will be a bumpy ride.