Juggling Dynamite

No thinking person can feel good about the insane surge in asset prices over the past two months. Actually it is horrifying. The US Federal Reserve is flooding capital around world markets with a fire hose. And the content of their spray is not water, it is kerosene and it is igniting a firestorm of risk around the globe. Yesterday I was trying to describe the situation to my 11 and 12 year old kids. Growing up around a couple of analysts makes them unusually aware of world events, but I realized in trying to explain this most recent wave of whacko that we have now reached a whole new dimension of dark and sinister. The mess is now so big and far-reaching it is increasingly unclear how it will finally get sorted out, and which people will have the leadership and fortitude to get the money-gushing harpies back into the bottle.
There is no good that can come of forcing interest rates to virtually nothing and funnelling capital into wild speculation in everything from oil to food. It is penalizing the prudent people in the world who have carefully amassed some savings. It is undermining the solvency of all the institutions that a civil society depends upon for stability. Insurance companies, pensions, social agencies, and savers all depend upon guaranteed deposit rates to control risk and fulfill crucial funding obligations.
Worse still, it is ballooning commodity prices in basic necessities for people who are already under-employed and barely making ends meet. Basic materials and oil are all now back at prices seen before the credit crisis collapsed. Oil is above its 2008 level at a time when world oil demand has fallen by more than 10%! There is no logic to any of this. Thoughtful people can’t be fooled. We know we are not wealthier from fleeting bubble gains on paper assets. We have seen this film several times already. Each bubble bursts in carnage more damaging than the last.
See an excellent summary of the knock-on effects in the real economy here: Bernanke's folly: the end game.

“The implied tax that has been imposed on the economy thus far since QE1 was put in place is a stunning $250 billion annually due to oil's price increase alone, or nearly four times the so-called “Bush Tax Cuts” for the rich. QE2 will add another $1/gallon (roughly) to gasoline which is another $140 billion, for a total of almost $400 billion each and every year.
And that's just in oil prices – then you have to add in all the other input cost-push problems, from corn to wheat to oats to cotton to wood pulp. The total effective tax increase from QE2 is in fact the entire $600 billion QE package, plus whatever the market anticipates Ben will do as a follow-on!
What is being done here, if it is not stopped by Congress and/or the people, will destroy the economy. There is no ability to withdraw the QE-anything without causing all of the previously-hidden costs to immediately assert themselves in the economy. This is not speculative – it is factual. We cannot get wage inflation due to the lack of pricing power by labour in a market with 17% of the people either out of work or underemployed and another 7 million who are not counted as they are not part of the labour participation rate, which has declined by 5% in the last two years. The true unemployment rate is thus closer to 25%.”

Moral hazard has been writ large on the face of global stability because the financial harlots who drove the economy into the swamp were all bailed-out and promoted over the past couple of years by the politicians they helped to appoint. Meanwhile real people have been left to pay the price and suffer hard lessons that will last for years to come.
The economy is incredibly weak so yes there is an argument in favour of government stimulus plans aimed at supporting employment now in projects that will benefit the country and its citizens for decades to come. Spend 350 billion refurbishing schools. Rebuild antiquated water and sewage treatment systems. Develop clean domestic energy sources. But stop funnelling tax payer dollars into financial bubbles to goose the short term profits of a few traders and bankers. The real economy, one that is actually worthy of investment, is crumbling before our eyes.
Let’s hope that Ron Paul can start to turn the tide back to sanity and reign in the run away Federal Reserve. See: Ron Paul is about to totally revolutionize the House Monetary Policy Panel.For anyone who saw it David Stockman, former budget director in the Reagan administration, gave a remarkably candid and important interview on Bloomberg Television yesterday November 4 at 3:30 pm ET on the outrageous nature of QE spending. Unfortunately so far Bloomberg has not made the clip available. I have asked them to reconsider. Hopefully they will and I will be able to post a link shortly.
Meanwhile real people should continue to be extremely defensive of their capital in these crazy market conditions.

Today we are living in the moment with stock and commodities roaring ahead on promise of more government stimulus and rumours that the battered democrats may now agree to extending the Bush tax cuts (set to expire this January) for another year or so. So more government spending and less revenue than projected– all looking good to risk markets today!
Meanwhile economists are now busily lowering their growth estimates for most countries looking through 2011 and 2012. This morning independent macro-econimc group Capital Economics issued this update:
“The world economy is set to slow as the fading of the policy stimulus again exposes the underlying fragilities left by the recession. During this period of transition, growth in external demand for Canadian goods and services is already weakening. We expect this to contribute to a sub-par economic performance over the next two years, and have cut our GDP forecasts accordingly. We now anticipate growth of 2.2% in 2011, down from a previous forecast of 2.7%, and just 2.0% in 2012, down from 3.0%.”
Growth of 2% for the next couple of years means no meaningful job growth and probably more job losses as over-capacity in the world economy continues to downsize.
Bulls may say it is good that the future looks weak as that means the Fed will continue to pump world markets. But as the Wall Street Journal points out this morning Captain Ben charts a treacherous course:

“There is no guarantee the U.S. economy will be in markedly better shape by June, even with a stimulus of this size. In fact, the Fed's loose-money policy has driven down the U.S. dollar and pushed up not just stock prices but commodities too. That risks undermining the purchasing power of U.S. consumers—particularly lower-income households that can't compensate for higher costs by bidding up wages and miss out on the free lunch of asset appreciation.
While there are plenty of reasons to believe the Fed will keep pulling the monetary lever and pushing up assets, there is little historical evidence that QE really can generate a stable, self-sustaining recovery. Investors, in their euphoria, may want to pause for thought as the Fed heads further off the map.”

Risk markets are all booming this morning with the next 600 billion instalment of the Bernanke put meeting its stated aim to “buoy animal spirits”.
It's every person for themselves. Whether and how much caution to throw to the wind here is a personal choice. Market prices were historically expensive and over bought leading into yesterday's fed magic, the higher prices go in the next little while, the higher the risk to capital; that's just the way it is. For some the thought of missing out on interim rallies is agony. I understand the temptation. In the end though, the test is not an interim ride, all's only well that end's well, and this latest government-goosed bubble is destined to end just as badly as the last several they have engineered. Extreme care is warranted.
The US is following the same path as Japan. The facts speak for themselves as pointed out by Japanese economist Richard Koo in this presentation he gave in April 2010. Here are the charts he references in this clip.

The bottom line is that debt-aversion today is a societal shift that will be with us for another 10 years at least. Asset bubbles driven by credit bubbles end in balance sheet recessions and massively deflated asset prices that grind down over a period of many years. This has been the aftermath of Japan since 1989. It was also the aftermath of the land and stock bubbles that burst in 1929. A similar cycle to these is playing out on a global basis today across all asset classes from stocks, real estate, commodities, gold and bonds.
A key difference for Japan was that Japanese people and institutions held the bulk of their debt coming into the bust domestically. Foreigners hold the bulk of US debt. This means that although the US would prefer to inflate their way out of debt and debase the dollar to do so, they actually cannot afford to heavily debase the dollar without prompting a rebellion in their foreign lenders that would force up US interest rates at a time when the government and economy have no ability to pay higher rates. This is why I think the US dollar may prove more resilient than many predict in the end.
As for all the China bulls drooling over insatiable demand stories there, see this excellent presentation by Vitaliy Katsenelson: China- the mother of all grey swans and Japan- past the point of no return.