Sunday, June 22, 2014

Exit Strategy From QE Remains Elusive

 Exit Strategy From QE Remains Elusive
Regardless of what you name it the "Federal Reserve Nightmare" or the "Yellen conundrum", the box Ben Bernanke made when he painted both himself and the Federal Reserve in a corner remains. Bernanke has by passing the chairmanship to Yellen escaped from the QE trap but left the rest of us fully in its grasp. With a policy of loose and cheap money and an inflation target of just 2%, the Federal Reserve continues to please those gambling that not fighting the Fed guarantees profits. As many Americans are forced to pay higher food, rent, and health insurance premiums, I wish someone would let the Fed know we have already exceeded their target. Any thought that inflation is not higher has come from the false illusion brought from lower payments on things like auto loans and mortgages, this is a one off and will not continue. 

America imports around five hundred billion dollars more from other countries every year than they export. This means we have a giant trade deficit, when we add this to our enormous government deficit it is easy to see that we are living far beyond our means. The Fed has been superbly entrepreneurial when it comes to Ponzi schemes or pseudo-economics hocus-pocus that has allowed the current situation to develop. The Fed must at some point begin to ponder a real exit strategy and end the massive and corrosive stimulus that the economy has come to expect. To make matters worse little has been done to address our structural problems and make America more competitive, this will massively thwart growth going forward.

The Federal Reserve has failed to make any serious efforts in pushing the government to take the necessary reforms needed to move the economy forward. Policy makers aided by the media thrive at presenting simplistic answers that solve both economic and society’s problems with little or no effort required from the masses. What started as a program to support and prop up the economy has morphed into the main driver of economic data. Between the low-interest rates that have propelled investors into high-risk assets in search of a positive return on their money, and money being pumped into the system, the markets have become distorted and disconnected from the economy. The idea that investors will continue to pour money into the sky high equity market is flawed.

Even as many people have grown comfortable with the status quo this does not change the fact the Fed is in a difficult corner. A serious exit strategy from QE  that normalizes interest rates remains elusive. With higher interest rates the cost of mortgages will rise. The low-interest rates that have discouraged savings and encouraged people to take high risks comes at a cost and does not lead to a healthy economy, but rather a story that will end in tears and regrets. When interest rates rise, as they will at some point, the value of these risky investments will decline, and these investors will be hurt. Also, as a double whammy, interest payments on the public debt will rise, increasing the budget deficit, which has averaged well over a trillion dollars a year for the past six years.

If all the money dumped into the economy would suddenly change direction and rush into hard assets, the shift would be devastating to our struggling economy. This thought also raises other questions, what can we define as a hard asset, what is really available, and in what quantities? This may be where inflation raises its ugly head. An unknown and surprising fact about inflation is how fast it can take root. With such a shift, interest rates would move higher and investors would flee government bonds. The crash of the bond market and a popping of what many have called a Bond Bubble will become a reality. It is abundantly clear Janet Yellen has shown no interest in coming up with a plausible exit strategy and even after developing such a scheme making it work will be easier said than done.

Footnote; This post dovetails with many of my recent writings. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged,

Thursday, June 19, 2014

The Economic Efficiency Of Credit Can Collapse

It might soon become apparent the economic efficiency of credit is beginning to collapse and the additional money poured into the system coupled with lower rates can no longer drive the economy forward. When this happens many of our economic policy options will vanish. This interesting concept may be soon put to the test as new problems emerge in China where we are seeing the extra GDP growth generated by each infusion of money drop from 0.85 to 0.15 over the last four years. This might be taken as a sign of exhaustion. The collapse of credit can pose major problems such as what we saw when many sellers were forced to demand payment up front before shipping goods in 2008.

Wei Yao from Societe Generale says the debt service ratio of Chinese companies has reached 30% of GDP the typical threshold for financial crises. This means many companies will not be able to pay interest or repay principal. She warned that the country could be on the verge of a "Minsky Moment" when the debt pyramid collapses under its own weight. "The debt snowball is getting bigger and bigger, without contributing to real activity," she said. The total credit in China's financial system is estimated to be as high as  221% of GDP and has jumped almost eightfold over the last decade. This means companies will have to pay out $1 trillion in interest payments alone this year. Chinese corporate debt burdens are much higher than those of other economies.

Currently, much of the liquidity that exist in China's economy is being used to repay debt and not to finance output. The fact that new investment in factories has slowed drastically is probably a good thing because China is awash in overcapacity. New factories sit idle because of weak demand. This also raises concerns over an exodus of hot money once the US Federal Reserve starts tightening. China might see a large-scale capital outflow if and when there is an exit from quantitative easing and the dollar strengthens. This maybe already starting with recent withdrawals from Chinese equity funds the highest since early 2008 and withdrawals from Hong Kong funds the highest in a decade.

Fortunately, China's Central government carries little debt on its books. This gives the central government the option to step in if a worse case scenario develops and bail companies out or put them on life support as Japan did so many years ago.  Many people think if things get worse China might have to take action to help real estate companies or even worse recapitalize the banking system, but this will not fix all the problems. I'm forced to reflect on how debt is directly affected by interest rates. In Europe, the ECB has stepped in to halt the economic collapse of Spain, Italy and several other countries that were on the brink of collapse by instituting false super low-interest rates. 

What you pay in interest on debt does matter except in the current manipulated land of  Modern Monetary Theory. Often referred to as MMT its believers see it as a way to remove much of the risk ahead and guarantee the economy will always be able to muddle forward by altering and changing the procedures and consequences of using government-issued tokens and our current units of fiat money.  Newly acquired tools like derivatives and currency swaps allow us to print and manipulate away problems. Unfortunately, the part where you collect a debt that you are owed can be similar to a mirage that keeps moving away each time you approach it. Do not forget the small print that governs most contracts often tells us rules can be changed causing many people and companies to become instantly insolvent.

Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? We are abusing the large amount of wiggle room in our economic system and our ability to put off the day of reckoning only proving that we will until we can't! Modern society has become very good at kicking the can down the road and delaying the consequences of bad policy.  This means that at some point the return on loaning money is simply not worth the risk! When this happens the only safe place to store wealth will be in "tangible assets" and the only lenders will be those who print the money that nobody wants.

Footnote; This post dovetails with many of my recent writings, for more I might suggest reading the article below. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged.

Sunday, June 8, 2014

Stock Markets and Girls Gone Wild!

What do stock markets around the world have in common with "girls gone wild" the video of college girls on spring break? The answer is both are crazy out of control. We have grown very complacent as money around the world has continued to flow into intangibles and promises. Currently the market is all a twitter and locked in a "greed and stupidity loop." The loop can be explained as follows, stocks are rising so why get out, not getting out is causing the stocks to rise. When stocks do pullback it is a buying opportunity. Yes, we are indeed experiencing a double down and let it ride mentality. I don't have to explain the greed part.

This market while appearing nowhere over the top when compared to bubbles such as the infamous "tulip bulb mania of 1637" it sports one major difference and that is the element of manipulation. Generally bubbles form organically but this one appears to be the result of an unholy alliance of the Federal Reserve, governments, and the too big to fail. For the big boys insider information and computer trading that exploits where stops are placed improves their ability to wash weak bears out of their positions. The Federal Reserve has made the manipulated and distorted stock market ground zero in the war to convince us all is well. The idea is that a soaring market will bolster pension funds, support housing prices, and generate a wealth effect is flawed, instead it only creates a bubble.

Fact is if QE or the massive government deficit spending that props up our economy is removed it will collapse. The low interest rates of today come at a price, in the long run the benefits they bring will be outweighed by the distortions they cause. The higher market prices mask many of the weaknesses we have created in the system, while keeping intact pension funds and large banks higher prices have addressed none of the real problems, but merely set us up for a bigger fall. The entitlements and promises that have piled up have become overwhelming and the numbers going forward simply do not work. Most people are delusional or too focused on the nearby and fail to look out to 2017 and beyond. That is when the numbers really go to hell.

 I'm reminded of a quote on macroeconomic stabilization and crisis from Nassim Taleb (author of The Black Swan);

"Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite."
This quote suggest an analogy with ideas about what happens when in forest management natural fires are suppressed. If random fires do not periodically clear away forest underbrush, we see a build-up of flammable material sufficient to power a massive conflagration. I certainly think an equivalent truth applies to financial markets. The longer it has been since a painful collapse, the greater the willingness to pile on leverage and complexity, such that the next crisis becomes unmanageably awful. The "Too Big To Fail" and other policies implemented since 2008 have laid the groundwork for "The Big One", or what we will someday look back on as the mother of all sell-offs.

By not taking steps to correct many of our ills in many ways we are making things much worse. We have not made the structural changes necessary for our economy to become sustainable. We have put band-aid upon band-aid, upon band-aid while what was necessary was the amputation of a diseased limb. After all the threats that this market has avoided, and sidestepped, it is possible that many now think of it as invincible. This market has overcome the death of the euro, the financial cliff, and the end of Greece as we knew it. My studies in micro-economics, and observations in the current real-estate market, both as a owner and hands on landlord in middle America allows me to predict, we ain't seen nothing yet!

If you think markets today are distorted, you are right. Distorted by artificially low interest, easy money, currency games, and more. A word to the wise, we have seen in the market a total disconnect from Main Street. At some point the same people who are driving stock prices higher will find that risk outweighs reward on the high-side and that they can make far more crashing the markets. All the highly leveraged financial instruments lurking in the back of the closet and available only to the big boys like derivatives, options, futures, and such have the potential to explode into massive profits and a gigantic transfer of wealth.

This gigantic transfer of wealth has the potential to wreck the system and be our downfall. What I like about numbers is that when they are not jockeyed, jerked around and falsified they tend to tell the truth. Again I repeat, looking down the road the numbers do not work. The bottom-line is that the higher the market goes the more vulnerable it becomes to a major collapse and sudden downward move. Lately we are seeing some large quantities of money flowing across borders and  into crazy investments. With each new rally I feel a bit of deja vu, we have seen this all before. Way back in 2007 we saw all stocks moving in unison, always upward, often ignoring both the news and reality, note, it is happening again. This is a reason for caution! When this market heads south the fall may be a doozy.

Thursday, June 5, 2014

America's Struggle To Stay On Top!

Too many people it appears a struggle is occurring to unseat America as the worlds most dominate nation. For many proud Americans who see the world from the unenlightened and possibly undefendable position of the United States having a right to be in control it is both threatening and frustrating to see control slip away. It is threatening to think the country might quickly fall to the position of a second rate power mired in debt with many of the options we have come to see as our right suddenly ripped away. It is frustrating that in many ways America appears to have become its own worse enemy. The country is guilty of both political inaction and squandering its power through a series of bad choices and missteps.

A major concern has been the shift of power and wealth to the East over the last several decades. Many Americans cringe when they think about the billions of dollars of consumer goods we import from China every month, but what makes it even more bizarre is how China became an export behemoth. We have been instrumental in bringing about the current challenge and possibly our own demise. Decades ago America started down a perilous path to build China into a world power,  a  pathological fear of  Russia and the Kremlin’s atheism caused America to seek a counter balance in the region. The result of our efforts has created modern day China.

Back in the 1970s when MAD (mutual assured destruction) and the communists' stated goal of global domination defined much of international politics the US foreign policy initiative aimed at splitting China from the USSR was an obvious choice. Central to the American effort was offering the prospect of economic incentives to China. Ironically, it was the China’s communist longevity the Washington wise men should have feared more. To separate China from Russia, strengthen our ties with China, and help develop the country made sense. To support China’s economic growth and over 1.3 bill people a export machine was developed that was to both change the  face of China and also how its people viewed freedom and the world.

As a byproduct of our actions we have seen a decline and stagnation not just in America but in many industrialized countries where output has fallen. Because of low production cost, and little regulation, jobs began to be shifted and work "outsourced" to China. Disloyal multinationals are now shipping their products great distances from China to the same infrastructure that they have abandoned and left with excess capacity. For straightforward geopolitical reasons America went down this path, but the path became a slippery slope, a slide greased by greed and short term self interest. Those who let this nightmare get of of hand should have been forewarned, "be careful what you wish for."

A few years ago, Russia, China and the United States appeared to be economic and political allies. Today, those alliances are being quickly scrapped in order to make room for conflict. The false paradigm that the people of these countries can't live together is taking center stage. When countries go to war whether economically or militarily governments demand that individuals relinquish freedom, independence and self-reliance. Sacrifice that “must be made” so that victory can be achieved. In the end, neither nation nor society truly wins, the only winners are the super rich and the oligarchs, who sing words of loyalty to their respective camps. These people never intend to target each other their only target is the people. Again the masses are being bombarded  talk of war.  

In any war each side is led to believe that its position is the good and right position and not asked to question the legitimacy of this because it will lead to ideological weakness and disunity. In the past Americans have shown a tendency to overestimate their enemies and rivals. In what might now be viewed as a state of paranoia during the cold war the Soviet Union was given credit for having far more power than it really possessed. In the early 1980s many Americans lived in fear that the rising economic might of Japan would allow the Japanese to buy all the property in America and make us slaves in our own country. Now as Russia and China grow stronger and closer together also pulling in other countries that are not fond of America we find concern growing that the tide is again turning and America may be unseated as a world leader.

Shift in power can be swift. The fact that the dollar has been the worlds reserve currency for years both empowers America but leaves the country vulnerable to such a shift. Over the last several years many US and European elites have been calling for a centralization of economic power under the control of the International Monetary Fund, as a well as a new global  world wide currency under the guise it would be viewed as more fair and balanced. Note these same elite have a great deal of power and control over the IMF. Not surprisingly, Putin also wants a new world currency under the control of the IMF. During both of his Presidential terms Obama has flooded his cabinet with current and former employees of Goldman Sachs, a longtime proving ground for elitist financiers with globalist aspirations.

Those who cast a critical eye over America see many problems tearing at the very fabric of society. Problems such as inequality, more citizens becoming dependent on the government for their day to day existence, and a dumbing down of the population. Like a cancer cutting through the heart of the country these problems drain away America's strength and resolve with each passing day. Fat and content we live in ignorant bliss and denial of the tough times ahead. When one looks beyond all the theatrical rhetoric being thrown around between Barack Obama and Vladimir Putin, the ultimate reality is that we are being played. The relationship of both governments to the global banking elite is the same and the people are the pawns in a game to enhance the power of those in control. If America wants to stay on top the war it should wage is against its own internal problems, this means it is time we go about setting our own house in order.

 Footnote; While many Americans think China is massively strong reality shows many flaws. The post below delves into some of them. As always your comments are welcome.