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“Imagination is more important than knowledge,” the
brilliant Albert Einstein used to say. Imagine for just a moment that the Dow
Jones Industrials has become a key instrument of national economic policy,
and that by “actively managing” its direction, the Federal
Reserve could impact the wealth of tens of millions of US households, and by
extension, influence consumer confidence and spending. By ramping up the
money supply, and slashing interest rates to zero percent, in order to
inflate stock market bubbles, the Fed could in theory, fuel an economic
rebound.
Former Fed chief “Easy” Al Greenspan used to pursue
an “asymmetric” monetary policy, - that is to say, - always quick
on the trigger to slash interest rates whenever the stock market was melting
down, but very slow to lift interest rates, when stock markets were booming.
Traders coined the term – the “Greenspan Put,” to describe
the Fed’s propensity to rescue the markets with huge injections of
liquidity.
Under Fed chief Ben “Helicopter” Bernanke,
speculators have celebrated the easiest monetary policy in history, which
earned Mr Bernanke the designation of Time magazine’s “Man of the
Year,” in 2009, because of his love affair with running the printing
press at maximum speed. After the Fed slashed the federal funds rate to
zero-percent in December 2008, the Fed unveiled its nuclear weapon,
“quantitative easing,” (QE), in order to jig the stock markets
higher.
Conspiracy theorists have long talked about the clandestine
activities of the “Plunge Protection Team,” (PPT), - a shadowy
group of agents, acting at the direction of the Fed and US-Treasury, that
coordinates the targeted buying of billions of dollars in stocks and stock
index futures to cushion the stock-market during sell-off’s, and to
prevent outright meltdowns. The PPT operates 24-hours per day, and often,
buying spree kicks in during the last hour of NYSE trading, and thinly traded
Asian hours, creating a short squeeze on bearish speculators.
But now, with the implicit guarantee of the “Bernanke
Put,” backed by the promise of zero-percent borrowing costs for years
to come, it’s increasingly apparent that the Fed is in the business of
rigging the stock market. It’s simply not wise to “Fight the
Fed.” The conspiracy theories about the mythical PPT, were given an
added degree of credibility on Nov 3rd, when Bernanke wrote in the Washington
Post, that jigging-up the stock market, was in fact, the Fed’s key
mechanism for bringing down the jobless rate, and spurring an economic
recovery.
“Easier financial conditions will promote economic
growth. Lower corporate bond rates will encourage investment. And higher
stock prices will boost consumer wealth and help increase confidence, which
can also spur spending,” Bernanke wrote, describing the “wealth
effect.” Absent an economic recovery by early next year, bond dealers
are already forecasting $400-billion for QE-3.
On Nov 5th, Professor Bernanke traveled to Jacksonville
University in Florida. He tried to explain to a class of students, the basic
principles of “Bubble” Economics. “We see an economy which
has a very high level of under-utilization of resources and a relatively slow
growth rate. The standard considerations suggest we should be using
expansionary monetary policy, and that’s the purpose of QE-2. This
sense out there, that QE is some completely far removed, strange kind of
thing, and we have no idea what the hell is going to happen, and it’s
just an unanticipated, unpredictable policy, quite the contrary. This is just
monetary policy,” he said.
Recounting his famous “Helicopter” speech in Nov
2002, Bernanke explained, “If pernicious deflation does take hold in
the economy, there is a way out of the trap. You see, US-dollars have value
only to the extent that they are strictly limited in supply. And the
US-government has a technology, called a printing press that allows it to
produce as many US-dollars as it wishes at essentially no cost. By increasing
the number of US-dollars in circulation, or even by credibly threatening to
do so, the Fed can also reduce the value of a dollar in terms of goods and
services, which is equivalent to raising the prices in dollars of those goods
and services.”
“If we do fall into deflation, we can take comfort that
the logic of the printing press must assert itself, and sufficient injections
of money will ultimately always reverse a deflation. Under a paper-money
system, a determined government can always generate higher spending and hence
positive inflation. A principal message of my talk today is that a central
bank whose accustomed policy rate has been forced down to zero has most
definitely not run out of ammunition,” Bernanke concluded.
Eight-years since Bernanke delivered his trademark
“Helicopter” speech – his theories are being put into
action. QE-1 and future QE-2 have lifted the Dow Jones Industrials above the
11,400-level, recouping all of its losses, following the default of Lehman
Brothers. Likewise, the US-dollar has tumbled to below parity with the
Australian and Canadian dollars and sunk to a 15-year low of 80-yen. Gold
soared above $1,400 /oz, and silver hit $29.25 /oz, its highest in 30-years.
While the Fed can unleash a tsunami of liquidity, it can’t always
direct where the money flows.
One of the students at Jacksonville, commented that even before
the radical QE-2 experiment officially begins, there’s already been an
upward explosion in the prices of a wide array of commodities, including
crude oil, corn, cotton, copper, cattle, gold, heating oil, gasoline, rubber,
nickel, tin, palladium, silver, soybeans, rice, and wheat. The Continuous
Commodity Index (CCI) is skyrocketing in a V-shaped parabolic rally and is
+84% above its Dec 2008 low. Perhaps, these forward looking market signals
could become a harbinger of an outbreak of virulent inflation?
Bernanke replied that fast growing economies, such as China and
India’s, are behind the strong demand for commodities, and pushing-up
prices, but the Fed thinks most of the increases would not be passed on to
US-consumers. Making an exception for energy costs, Bernanke said, “Our
research and our experience suggest that, broadly speaking, when you have a
situation like we have today, where there’s a lot of slack in the
economy, a lot of excess supply, that it’s very, very, difficult for
producers to push through those costs to the final consumer,” he said.
The students were reminded that the Fed’s preferred
indicator of inflation doesn’t include volatile food and energy costs.
Yet it would be naïve to ignore the fact that the sharp drop in the
value of the US-dollar is contributing to the sharp upward trajectories of
many commodities. It’s also fueling a “carry trade” that is
attracting “hot money” flows into emerging stock markets. Traders
are borrowing US$’s at near zero-percent, and re-investing the funds in
higher yielding currencies, emerging stocks, gold, and commodities. In fact,
much of the liquidity from QE-2 might simply find its way into foreign
economies, - and not America’s.
Gold Climbs above $1400 /oz, US-Treasury’s Yield Curve
widens, There are other key indicators in the marketplace that are
flashing yellow lights, warning that a major outbreak of inflation looms on
the horizon. The yield spread between the 10-year US-Treasury note and
30-year bond has widened 55-basis points (bps) to an all-time high of
+160-bps, amid fears of accelerating inflation.
Recently, the price of Gold has closely tracked the twists and
turns in the Treasury’s yield curve, on its journey to $1,400 /oz.
Clearly, QE-2 has dealt a severe blow to the long end of the Treasury yield
curve, especially for maturities beyond 10-years. Given the
hyper-inflationary implications of the Fed’s QE-2 scheme, investors
prefer wealth preserving assets, such as gold and silver, rather than holding
long-term US-Treasury bonds, that could eventually begin to resemble
Zimbabwe’s debt.
On Nov 9th, Tea Party favorite Sarah Palin lashed out at Fed
chief Bernanke and his radical band of inflationists, - calling upon them to
“cease and desist,” from monetizing the national debt. “We
shouldn’t be playing around with inflation. We don’t want
temporary, artificial economic growth bought at the expense of permanently
higher inflation which will erode the value of our incomes and our savings.
We want a stable dollar combined with real economic reform. It’s the
only way we can get our economy back on the right track,” Palin said.
Ron Paul, R-Texas, said on Nov 8th, the Fed will eventually
destroy the US-dollar’s value around the world. “Bernanke is very
clear at what he’s going to do. He’s going to create money until
he gets economic growth, but there’s no evidence creating money creates
economic growth.” Asked about Bernanke’s statement that
he’s aiming for 2% inflation, Paul said: “When he gets to four
percent, he’ll decide to go to eight, and there’s no way they can
stop it. If they withdraw, it might make things worse. They think they have
control. They don’t,” he warned.
“The German finance minister called the Fed’s
proposals clueless. When Germany, a country that knows a thing or two about
the dangers of inflation, warns us to think again, maybe it’s time for
Chairman Bernanke to cease and desist,” Palin said. Paul Ryan, the next
likely chairman of the House budget committee starting in January, said,
“I think it’s going to give us a big inflation problem down the
road.”
At a Nov 6th meeting on Jekyll Island, Georgia, Bernanke tried
to deflect mounting criticism over QE-2. “We’re not in the
business of trying to create inflation. I reject any notion that we are going
to try to raise inflation to a super-normal level in order to have effects on
the economy.” However, St Louis Fed chief James Bullard said his best
guess is that the full amount of QE-2, - $600-billion of fresh cash, would be
injected into the markets by mid-2011. “Given the outlook now, it looks
like we will follow through on that and reassess at that point,” he
said.
So far, QE-1 combined with expectations of QE-2, have
successfully enabled the Dow Jones Industrials to recoup its post Lehman
Brothers’ losses. How can anyone doubt the power of the Fed’s
printing presses? However, there are definite risks that go along with the
magic elixir of Zimbabwe-type QE, such as the outbreak of virulent inflation,
and capital flight from the local bond market, when the central bank states
its goal of monetizing $1-trillion plus budget deficits.
Although a widening yield curve, alongside a booming stock
market, might be viewed as a harbinger of a stronger economy, - there are
dangers lurking beneath the surface. The US Treasury’s 30-year bond
yield has risen 75-basis points to 4.25%, since the Fed started telegraphing
QE-2. Also, over the past three-weeks, the yield on Ireland’s 10-year
bond has soared 312-bps to 9.12% today. In a replay of the Greek debt crisis,
the Euro is tumbling sharply lower, and rattling S&P-500 multinationals.
As the Fed crosses the Rubicon into the world of QE-2, one has to wonder if
the US-T-bond market could be the next target of the infamous bond vigilantes
that are bludgeoning the Greek and Irish bond markets this week.
Commodity Inflation Sweeps across China
On Nov 9th, Chinese Vice-Premier Wang Qishan warned that because
of the Fed’s QE-2 scheme, “emerging economies are seeing large capital
inflows and face mounting inflationary risks. There is excessive liquidity in
the world and fluctuations in international financial markets.” The
Shanghai stock index has gained 18% since the start of September, and prices
for grains, cotton, rice, rubber, copper, sugar, and steel on China’s
futures exchanges are soaring into the stratosphere.
China’s voracious appetite for raw-materials now accounts
for 35% of global demand for base metals and 40% for cotton. China will
probably buy about one-third of the US-soybean crop this year, whittling down
US-inventories of corn and soybeans to dangerously low levels. And as
China’s demand continues to expand, trade volumes on the Shanghai and
Dalian commodity exchanges will increase, and would greatly influence prices
on Western markets, including the London Metal Exchange.
China and India are the world’s top consumers of natural
rubber, with demand driven by the auto industry. Rubber futures in Shanghai
rose above 38,400-yuan /ton this week, up from 23,000 –yuan just
three-months ago. In the 1980’s, China had a marginal influence on the
copper market, accounting for only 10% of the global demand. Now, China is
buying 35% of the world’s copper output. Copper jumped above $4 /lb in
New York, up sharply from a low of $1.250 two-years ago.
China is also the world’s largest consumer of rice, and
prices of the world’s top staple food are up 35% from four months ago.
Half of China’s rice ends up being traded on grain markets, rather than
consumed locally. China is the fourth country to launch grain futures
trading. The United States, Thailand (the world’s #1 rice exporter) and
India (the #2 rice producer) also have rice futures contracts.
The price of cotton has reached the highest levels since the
American Civil War. At the nadir of the Global Recession, cotton futures
dipped below 40-cents a pound in New York. This week, they were selling for
$1.46 a pound. In a normal year, cotton sells for 50-cents to 80-cents a
pound. But now, the center of gravity in cotton has shifted to China, - the
biggest producer, the biggest processor, and the biggest importer, and the
biggest factor in the jump in cotton’s price.
Global cotton supplies were reduced this year by
Pakistan’s massive floods and by India's decision to restrict cotton
exports. China maintains strategic stockpiles of many commodities, including
cotton. To meet demand from textile companies, the Beijing has auctioned
16-million bales of cotton from its strategic stockpiles, since May 2009.
That’s close to what US farmers grow in a year. As those stocks
deplete, China has been willing to buy cotton at any price. Clothing
manufacturers and retailers are going to have to raise prices.
Chinese citizens are buying more clothing as they increase their
wealth. The average consumer in China now buys 4.4-pounds of cotton a year.
The average American purchases 33-pounds. If Chinese consumption rises to
US-levels, it would require growing an extra 80-million bales of cotton each
year somewhere in the world, while global production is about 117-million
bales.
The Continuous Commodity Index (CCI) index has rallied for 11
straight weeks, its longest streak since 1977. In the US, traders have plowed
$320-billion into commodities and related ETF’s banking on the
inflationary power of the Fed’s QE-2 scheme. Soaring commodity prices
have pushed China’s annualized inflation rate, to +4.4% in October,
well above Beijing’s annual target of 3% for 2010. More recently,
prices of China’s farm produce have jumped 5% since mid-October, and
China’s M2 money supply is +19.3% higher than a year ago.
A top Chinese central banker, Ma Delun, warned the
People’s Bank of China (PBoC) will not leave inflation unchecked. On
Nov 10th, the PBoC ordered the country’s biggest banks, banks to set
aside an additional 1% of their customer deposits with the central bank,
in order to shrink the pool of yuan available for lending. The extra
tightening step takes the required reserve ratio (RRR) to a record 18.5%,
and would drain a massive 600-billion yuan ($90-billion) out of circulation.
On October 20th, the PBoC hiked bank deposit rates by 25-bps to
2.50%, the first interest rates hike in three years, and began to guide
longer term bond yields higher, to discourage traders from speculating in
commodities and Shanghai red-chips. China’s benchmark 7-year bond yield
jumped to 3.75% this week, but still remains far below the inflation rate,
making gold, commodities, and natural resource shares more attractive to stay
ahead of the rising cost of living.
Crude Oil Zeroes in on $90 /barrel, Since Bernanke and former
Goldman Sachs partner William Dudley telegraphed their support for QE-2, the
price of crude oil has rallied $12 /barrel to over $88 /barrel today.
Likewise, the price of wholesale unleaded gasoline has increased by 40-cents
/gallon. Recognizing the Fed’s intention to devalue the dollar, the
OPEC hawks convinced Saudi Arabia to raise the upper target ceiling for crude
oil by $10 to $90 /barrel.
“An oil price between $70 and $90 a barrel is a
comfortable range for consumers, said Saudi Oil Minister Ali al-Naimi on Nov
1st, marking a step up from OPEC’s previous target zone of $70-$80
/barrel. Oil prices are going up, even though OPEC is producing 1.9-million
barrels per day of extra supply beyond its stated quotas. But OPEC
isn’t worried about its members’ compliance with its quotas right
now.
Instead, it’s all about the Fed’s QE-2-scheme,
because as the US-dollar weakens, oil prices go up. “The real price of
oil should be about $20 less than current levels,” said Venezuelan
Energy and Oil Minister Rafael Ramirez. OPEC’s Abdullah al-Badri added,
“Even if the oil price reaches $90, it will not hinder world
growth.” If the rest of the G-20 central banks were to engage in money
printing, to counter the Fed’s QE-2, oil prices could climb above $100
/barrel, even if the US-economy stays weak.
Thus, while QE-1 rescued the US-economy from a Great Depression,
and restored tranquility to the credit markets, the Fed’s decision to
cross the Rubicon into the world of QE-2, might leave the economy worse off,
- stuck in the “Stagflation” trap. Among the possible outcomes of
QE-2 are a global “Oil Shock” lifting crude oil above $100
/barrel, and sharply higher 30-year T-bond yields. As rapidly rising consumer
prices outstrip wages, thus shrinking disposable income, while Wall Street
basks in the glow of QE-2, and banks gets another clandestine bailout,
there’ll be another public uprising, and this time, - it might not be
confined to the voting booth.
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