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Posts Tagged ‘Monetary Easing’

by Lance Roberts
June 6, 2011
StreetTalkAdvisors

The media has been replete lately with a variety of different government officials saying that there will not be a third round of Quantitative Easing. Even the great Ben Bernanke himself on April 27th spoke against the possibility of QE 3. This isn’t surprising, of course, because in order for something like QE to have the most effect it needs to be, well, a surprise.

However, I am throwing down the gauntlet and making the call – there will be Quantitative Easing, and a big one most likely, by the end of summer. There I said it; of course, I have actually been saying this for the last couple of months and it doesn’t take much of a real genius to figure it out considering that we are heading into a presidential election year. However, it most likely won’t be called QE 3 since the term QE is now politically and socially almost taboo.

The Whitehouse Effect

So why does QE play such an important role for Obama going into an election? No president has ever been reelected to office when unemployment is above 8%, much less 9%. With the unemployed labor pool at very high levels, poor sales being the biggest concern for small business owners (according to the most recent NFIB survey) and wages failing to keep up with a rising cost of living there is no incremental demand on businesses to create new jobs. Since small businesses have 6 applicants for every 1 job opening, are are the primary creators of 70% of the jobs in the country, there is no pressure for wage increases. Without rising incremental demand from consumers, because 1 in 5 are underwater or delinquent on their mortgage, are unemployed or on food stamps, there is no reason for small business to expand production or manufacturing. While the Federal Reserve has been worried lately about commodity price inflation – the real threat to the economy is wage deflation as it bites into the basic economic cycle of a supply/demand economy.

However, it isn’t just the unemployed that will kill Obama at the polls. Without another round of QE, and most likely soon, the economy will be headed for extremely low or potentially even negative growth. When round one of QE finished in the summer of 2010 the economy slid form 3.1% annualized growth to 1.7%. This shock to the system immediately launched the Fed into overdrive to start QE 2. Today we are heading into the summer with a 1.8% annualized growth rate, likely to be revised down a notch, and as QE 2 winds up entirely at the end of June we are likely to see a slide to below 1%. This will most likely get a very late night phone call placed to Mr. Bernanke from the Whitehouse as the average American votes psychological and emotionally.

In the last election the average American overwhelmingly voted an inexperienced and unproven individual with great oratory skills and personality into the highest office in the country on the back of a Pepsi slogan – “Hope and Change”. Unfortunately today, 70% of the population, according to a recent Gallop poll, have lost the “Hope” part of the equation as they still “feel” like we are in a recession or depression. That’s right, they “feel” like things are not good which is an emotional bias; and they will vote the same way.

Furthermore, as the economy slides, so does the stock market as prices are adjusted to reflect what the future profitability of companies may look like. With the market currently expensively valued and analysts still predicting higher profit margins in the coming months – anything that creates stress on corporate profitability, like a weakening economy, will cause a correction in asset prices to reflect new estimations. As always, the market, because it is driven by human psychology (fear and greed) in the short term will overshoot on the upside as well as on the downside. Therefore, another nail in Obama’s reelection coffin will be if the stock market has declined by 20% going into campaign mode. Remember, it was just earlier this year during his State of the Union address that he specifically stated that under his watch the economy had recovered along with the stock market. People are emotionally affected by the value of the stock market – the “wealth effect” is a driver of consumer behavior. When Ben Bernanke launched QE 2 he even added a third mandate to the Fed to include not only full employment and price stability but also asset inflation to create a wealth effect. Without that wealth effect going into the polls – voters are very likely to pull the lever for “Change”.

How To Play It

Beginning back on April 25th we began writing about reducing allocations to risk based assets (read: equities and commodities) going into the summer months and the end of QE 2. As shown in the chart when QE 1 ended last year there was a fairly substantial decline in the markets of almost 20% as the economy began to slow down. Having only that precedent to work off of we should remain cautious and reduce allocations of invested dollars in all risk based categories rather than rotate sectors. I say this because rotating from Technology to Utilities may provide outperformance in the portfolio – during a market correction it will only mean that you will lose less money. Moving into cash and fixed income for the summer months as QE ends has yielded a net positive return to date.

Furthermore, this strategy now sets up the individual investor for part two of the strategy which is having dry powder available to buy back into equity exposure when QE 3 is announced. The market has now been trained, like Pavlov’s dogs, to respond to the QE call. When Ben Bernanke and friends ring the dinner bell the dogs will come running and having cash on the sidelines protected from the summer sell off certainly provides an opportunity to be the “strong hand” buying from “weak hands” at that point.

Remember, being cautious is more important than losing money. The media is constantly telling people to chase stocks which have been one of the, if not the, poorest performing asset class over the last decade. You can always make up a lost opportunity – it is nearly impossible to make up lost capital.

How Much And When?

So, now we know that the Whitehouse needs QE 3 the most right now but how big might it be. QE 1 was $1.25 Trillion coming off the lows of the market in 2009. QE 2 was $600 Billion in the 3rd quarter of 2010 but really had very little effect relative to the effects received from QE 1. I have spoken in the past about the “Diminishing Return” syndrome that would come with each successive QE program. In order for QE to have any real “bang for the buck” this time around it will have to be big, really big, like $2 Trillion in total. However, not only that, but it will also prove ineffective unless it is combined with a serious attempt at mortgage equity write downs, which will have to be combined with guarantees for the second lien holders, mortgage fraud forgiveness for the banks, further tax cuts and credits for small businesses and some real regulation for the banking industry to restore faith in the stability of the financial system. (As a side note – I am really against bailing out homeowners and banks as it is a process fraught with peril and another article for another day.)

This is what it will take to kick start the markets again and boost asset prices, jolt the economy back to 2.5% growth and keep the big “O” in office for another four years – maybe, and that is a big maybe at this point. It will also just “kick the can” down the street for another brief period in time until we all realize that we are in a balance sheet recession and until the total amount of debt, which the majority of it belongs to households, is reduced to a sustainable level, savings rise to historical levels which can sustain growth and the consumer is able to start creating the incremental demand needed for businesses to grow – we are going to be stuck in this cycle for quite a long and frustrating time.

By Doug Casey
Chairman, Casey Research
Monday, April 18, 2011

A meme is now circulating that gold is in a bubble and that it’s time for the wise investor to sell. To me, that’s a ridiculous notion. Certainly a premature one.

As you listen to the current blather from talking heads about where gold is going, keep in mind most of them are just journalists, reporters that are parroting what they heard someone else say. And the “someone else” is usually a political apologist who works for a government. Or a hack economist who works for a bank, the IMF, or a similar institution with an interest in the status quo of the last few generations.

You should treat almost everything you hear about finance or economics in the popular media as no more than entertainment.

So let’s take some recent statements, assertions, and opinions that have been promulgated in the media and analyze them. Many impress me as completely uninformed, even stupid. But since they’re floating around in the infosphere, I suppose they need to be addressed.

“Gold is expensive.”

This objection is worth considering – for any asset. In fact, it’s critical. We can determine the price of almost anything fairly easily today, but figuring out its value is as hard as it’s ever been. From the founding of the U.S. until 1933, the dollar was defined as 1/20th of an ounce of gold. From 1933 it was redefined as 1/35th of an ounce. After the 1971 dollar devaluation, the official price of the metal was raised to $42.22 – but that official number is meaningless, since nobody buys or sells the metal at that price.

(More importantly, people have gotten into the habit of giving the price of gold in dollars, rather than the value of the dollar in gold. But that’s another subject.)

Here’s the crux of the argument. Before the creation of the Federal Reserve in 1913, a $20 bill was just a receipt for the deposit of one ounce of gold with the Treasury. The U.S. official money supply equated more or less with the amount of gold.

Now, however, dollars are being created by the trillion, and nobody really knows how many more of them are going to be shazammed into existence. It is hard to determine the value of anything when the inch marks on your yardstick keep drifting closer and closer together.

“Gold is risky.”

Risk is largely a function of price. And as a general rule, the higher the price, the higher the risk, simply because the supply is likely to go up and the demand to go down – leading to a lower price. So yes, gold is riskier now, at $1,400, than it was at $700 or at $200. But even when it was at $35, there was a well-known financial commentator named Eliot Janeway (I always thought he was a fool and a blowhard) who was crowing that if the U.S. government didn’t support it at $35, it would fall to $8.

In any event, risk is relative. Stocks are very risky today. Bonds are ultra risky. Real estate is in an ongoing bear market. And the dollar is on its way to reaching its intrinsic value.

Yes, gold is risky at $1,400. But it is actually less risky than most alternatives.

“High gold prices will bring on huge new production, which will depress its price.”

This assertion shows a complete misunderstanding of the nature of the gold market. Gold production is now about 82.6 million ounces per year and has been trending slightly down for the last decade. That’s partly because at high prices, miners tend to mine lower-grade ore. And partly because the world has been extensively explored, and most large, high-grade, easily exploited resources have already been put into production.

But new production is trivial relative to the 6 billion ounces now above ground, which only increases by about 1.3% annually. Gold isn’t consumed like wheat or even copper. Its supply keeps slowly rising, like wealth in general. What really controls gold’s price is the desire of people to hold it, or hold other things – new production is a trivial influence.

That’s not to say things can’t change. The asteroids have lots of heavy metals, including gold. Space exploration will make them available. Gigantic amounts of gold are dissolved in seawater and will perhaps someday be economically recoverable with biotech. It’s now possible to transmute metals, fulfilling the alchemists’ dream. Perhaps someday this will be economic for gold. And nanotech may soon allow ultra-low-grade deposits of gold (and every other element) to be recovered profitably. But these things need not concern us as practical matters in the course of this bull market.

“Gold sentiment is at an all-time high.”

Although gold prices are at an all-time high in nominal terms, they are still nowhere near their highs in real terms – of about $2,500 (depending on how much credibility you give the government’s CPI numbers) – reached in 1980. Gold sentiment is still quite subdued among the public. Most of them barely know it even exists.

Some journalists like to point out that since there are a few (five, perhaps) gold dispensing machines in the world, including one in the U.S., there’s a gold mania afoot. That’s ridiculous, although it shows a slowly awakening interest among people with assets.

Journalists also point to the numerous ads on late-night TV offering to buy old gold jewelry (generally at around a 50% discount from its metal value) as a sign of a gold bubble. But this is even more ridiculous, since the ads are inducing the unsophisticated, cash-strapped booboisie to sell the metal, not buy it.

You’ll know sentiment is at a high when major brokerage firms are hyping newly minted gold products, and Slime Magazine (if it still exists) has a cover showing a golden bull tearing apart the New York Stock Exchange. We’re a long way from that point.

***

These are some of the more egregious arguments against gold that are being brought forward today. Most of them are propounded by knaves, fools, or the uninformed.

The bottom line is that gold and its friends are no longer cheap, but they have a long way – in both time and price – to run. Until they’re done, I suggest you be right and sit tight.

Good investing,

Doug Casey

Editor’s note: Doug Casey, chairman of Casey Research, is a best – selling author, international investor, and entrepreneur. He travels the world looking for the best real estate and natural resource investments. His work is required reading here at DailyWealth.

Each month, Doug and his team provide subscribers of The Casey Report with the kind of investment analysis you won’t read anywhere else in the world. We think one good rant from Doug is worth twice the subscription price. Click here to learn more about The Casey Report.

By Jayne O’Donnell
March 31, 2011
USA TODAY

U.S. consumers face “serious” inflation in the months ahead for clothing, food and other products, the head of Wal-Mart’s U.S. operations warned Wednesday.

The world’s largest retailer is working with suppliers to minimize the effect of cost increases and believes its low-cost business model will position it better than its competitors.

Still, inflation is “going to be serious,” Wal-Mart U.S. CEO Bill Simon said during a meeting with USA TODAY’s editorial board. “We’re seeing cost increases starting to come through at a pretty rapid rate.”

Along with steep increases in raw material costs, John Long, a retail strategist at Kurt Salmon, says labor costs in China and fuel costs for transportation are weighing heavily on retailers. He predicts prices will start increasing at all retailers in June.

“Every single retailer has and is paying more for the items they sell, and retailers will be passing some of these costs along,” Long says. “Except for fuel costs, U.S. consumers haven’t seen much in the way of inflation for almost a decade, so a broad-based increase in prices will be unprecedented in recent memory.”

Consumer prices — or the consumer price index — rose 0.5% in February, the most since mid-2009, largely because of surging food and gasoline prices. Core inflation, which excludes volatile food and energy costs, rose a more modest 0.2%, though that still exceeded estimates.

The scenario hits Wal-Mart as it is trying to return to the low across-the-board prices it became famous for. Some prices rose as the company paid for costly store renovations.

“We’re in a position to use scale to hold prices lower longer … even in an inflationary environment,” Simon says. “We will have the lowest prices in the market.”

Major retailers such as Wal-Mart are the best positioned to mitigate some cost increases, Long says. Wal-Mart, for example, could have “access to any factory in any country around the globe” to mitigate the effect of inflation in the U.S., Long says.

Still, “it’s certainly going to have an impact,” Long says. “No retailer is going to be able to wish this new cost reality away. They’re not going to be able to insulate the consumer 100%.”

Read the entire article HERE.

By: Reuters with CNBC.com
Published: Tuesday, 22 Mar 2011 | 3:22 PM ET

The United States is on a fiscal path towards insolvency and policymakers are at a “tipping point,” a Federal Reserve official said on Tuesday.

“If we continue down on the path on which the fiscal authorities put us, we will become insolvent, the question is when,” Dallas Federal Reserve Bank President Richard Fisher said in a question and answer session after delivering a speech at the University of Frankfurt. “The short-term negotiations are very important, I look at this as a tipping point.”

But he added he was confident in the Americans’ ability to take the right decisions and said the country would avoid insolvency.

“I think we are at the beginning of the process and it’s going to be very painful,” he added.

Fisher earlier said the US economic recovery is gathering momentum, adding that he personally was extremely vigilant on inflation pressures.

“We are all mindful of this phenomenon. Speaking personally, I am concerned and I am going to be extremely vigilant on that front,” Fisher said in an interview with CNBC.

Fisher added that the U.S. Federal Reserve had ways to tighten its monetary policy other than interest rates, including by selling Treasurys, changing reserves levels and using time deposits.

He added that he does not support the Fed embarking on an additional round of quantitative easing.

“Barring some extraordinary circumstance I cannot forsee…I would vote against a QE3,” Fisher told CNBC. “I don’t think it’s necessary. Again, we have a self-sustaining recovery.”

Read the entire article HERE.

By Dan Freed
TheStreet.com
03/21/11 – 12:28 PM EDT

NEW YORK (TheStreet) — The Federal Reserve will release data on bank borrowing during the financial crisis of 2008, after the Supreme Court rejected an appeal by the banking industry aimed at preventing the disclosures, Bloomberg News reported Monday.

Bloomberg sued the Federal Reserve to get it to release the data, and a Fed spokesman said the U.S. central bank will comply with the decision and release the records within the next five days.

It will be the first time a court has forced the central bank to disclose borrowing at its discount window, according to the report.

The Clearing House Association, which represents U.S. banking subsidiaries of Bank of America(BAC_), Bank of New York Mellon(BK_), Citigroup(C_), Deutsche Bank(DB_), HSBC(HBC_), JPMorgan Chase(JPM_), U.S. Bancorp(USB_) and Wells Fargo(WFC_) had argued such disclosures would make banks less likely to borrow at the discount window in the future for fear disclosure of those actions would attach a stigma to the institution, the report stated.

By: John Melloy
Executive Producer, Fast Money- CNBC
Published: Thursday, 17 Mar 2011 | 4:09 PM ET

One would think that after the worst financial crisis since the Great Depression, Americans could at least catch a break for a while with deflationary forces keeping the cost of living relatively low. That’s not the case.

A special index created by the Labor Department to measure the actual cost of living for Americans hit a record high in February, according to data released Thursday, surpassing the old high in July 2008. The Chained Consumer Price Index, released along with the more widely-watched CPI, increased 0.5 percent to 127.4, from 126.8 in January. In July 2008, just as the housing crisis was tightening its grip, the Chained Consumer Price Index hit its previous record of 126.9.

“The Federal Reserve continues to focus on the rate of change in inflation,” said Peter Bookvar, equity strategist at Miller Tabak. “Sure, it’s moving at a slower pace, but the absolute cost of living is now back at a record high in a country that has seven million less jobs.”

The regular CPI, which has already been at a record for a while, increased 0.5 percent, the fastest pace in 1-1/2 years. However, the Fed’s preferred measure, CPI excluding food and energy, increased by just 0.2 percent.

“This speaks to the need for the Fed to include food and energy when they look at inflation rather than regard them as transient costs,” said Stephen Weiss of Short Hills Capital. “Perhaps the best way to look at this is to calculate a moving average over a certain period of time in order to smooth out the peaks and valleys.”

The so-called core CPI is used by the central bank because food and energy prices throughout history have proven to be volatile. However, one glance over the last two years at a chart of wheat or corn shows they’ve gone in one direction: up. And many traders say Fed Chairman Bernanke’s misplaced easy money policies are to blame.

Over time, the Bureau of Labor Statistics has made changes to the regular CPI that it feels make it a better measure of inflation and closer to a cost of living index. It improved the way it averages out prices for items in the same category (e.g., apples) and also uses the often-criticized method of hedonic regression (if you’re curious, you can learn more about that here) to account for increases in product quality.

In 2002, the BLS created this often-overlooked cost of living index in order to account for the kinds of substitutions consumers make when times are tough. It is supposed to be even closer to an actual “cost of living” measure than the regular CPI.

“For example, pork and beef are two separate CPI item categories,” according to the BLS web site. “If the price of pork increases while the price of beef does not, consumers might shift away from pork to beef. The C-CPI-U (Chain Consumer Price Index) is designed to account for this type of consumer substitution between CPI item categories. In this example, the C-CPI-U would rise, but not by as much as an index that was based on fixed purchase patterns.”

“As the cost of living increases, we are headed toward a bigger problem with the slowing of housing permits,” said JJ Kinahan, chief derivatives strategist at thinkorswim, a division of TD Ameritrade. “As the staples start to cost more, this could lead to a quick slowdown in the auto and technology sectors as an iPad is an easy thing to pass on if you are paying more for your gas and food and need to cut back somewhere.”

To be sure, it’s nearly impossible to get a perfect “cost of living” measure, and the BLS acknowledges this on their web site: “An unconditional cost-of-living index would go further, and take into account changes in non-market factors, such as the environment, crime, and education.”

Still, states will be cutting back services drastically this year at the very same time they are raising taxes in order to close enormous budget deficits and avoid a muni-bond defaults crisis. So while it may be the missing link to a perfect cost of living measure, one can assume that Americans will be paying more for unquantifiable services such as police enforcement and education, but getting them at a lesser quality.

Bottom line: The cost of living for Americans is now above where it was when housing prices were in a bubble, stock prices at a record, unemployment low and consumer confidence was soaring. Something has gotta give.

Read the entire article HERE.

By Chris Isidore, senior writer
CNNMoney.com
March 7, 2011: 1:53 PM ET

Arlington, Va. (CNNMoney) — If oil prices continue to climb, it could force the Federal Reserve to make a new round of asset purchases, according to Atlanta Fed President Dennis Lockhart.

Appearing at the National Association of Business Economics in Arlington, Va., Lockhart said that while he doesn’t think additional purchases are currently warranted, more stimulus could be needed if oil prices continue to climb.

“If [the rising price of oil] plays through to the broad economy in a way that portends a recession, I would take a position we would respond with more accommodation,” Lockhart said at the conference.

Though he doesn’t think current oil prices around $106 a barrel are a problem, he said the evidence is clear that oil spikes can bring about a recession.

“I think at the $120 range … it’s a manageable level,” he said. “Around $150 it becomes a much more serious concern.”

The Fed announced plans to buy $600 billion in long-term Treasuries last November, a process known as quantitative easing, or QE2 because it is the second round of such purchases. Since then, economic growth has picked up, leading some to call for an early end to QE2.

Lockhart, who is not currently a voting member of the Federal Reserve’s policy making committee, declined to say whether he thought “QE3″ could get past the current committee, which is seen as somewhat more hawkish on inflation.

Dallas Fed President Richard Fisher, who is a voting member of the rotating committee, showed strong opposition to the idea of QE3 in a speech to the Institute of International Bankers meeting Monday morning. In fact, Fisher said he would be open to an early end of QE2.

“I remain doubtful enough as to its efficacy that if at any time between now and June, it should prove demonstrably counterproductive, I will vote to curtail or perhaps discontinue it,” Fisher wrote in prepared remarks.

But there remains a fair amount of disagreement among Fed members over whether the economy still needs help, or inflation is the bigger worry.

In Congressional testimony last week, Fed Chairman Ben Bernanke said he hadn’t closed the door on the possibility of a new round of Treasuries purchases, and largely brushed off concerns about rising prices.

Lockhart said while the Fed needs to keep an eye on inflation expectations, he doesn’t think the labor market has recovered enough for higher wages, a core component of inflation, to take hold.

Read the entire article HERE.

By Daniel R. Amerman, CFA

Overview

The United States government and other nations have increasingly adopted an official economic policy of cheating their own savers, with particular damage inflicted on long-term retirement investors that follow conventional investment practices. This may sound like wild “conspiracy theory” talk, but interestingly enough, the facts involved are not in dispute.  Instead they are the very core of official government policy pronouncements, as well as the financial reporting thereof. Going from lofty principles espoused by public servants to the practical matter of deliberately and massively cheating a nation’s savers and retirees is not a matter of looking at different facts, but of simply changing the “spin” on well established and accepted facts.

The alternative “spin” that we will apply in this article is one of informed common sense from a free-market perspective. This intuitive, free-market “spin” is radical stuff compared to conventional financial and economic analysis, but I think you will find it easy to follow.

Step outside the herd, apply a little common sense, and it is child’s play to convincingly demonstrate that it is official Federal Reserve and Treasury policy to cheat investors in US treasury bonds, notes and bills, as well as in all related categories, such as savings accounts, interest-bearing checking accounts, money market funds, bank certificates of deposit, as well as corporate and municipal debt.

Free Markets Versus Manipulated Markets

Modern portfolio theory is based upon two core assumptions: that investors are rational and that prices are determined by the market. If you remove either one of those assumptions, then the whole edifice of modern financial theory essentially shatters and collapses.

For financial theory to work, investment prices and yields need to be determined by rational buyers and rational sellers finding a place where they can agree upon a price on a particular day or at a particular minute.  Without that free market price to provide discipline – the foundations fall apart.

If you don’t have a free market price, but you instead have a price determined by a force outside of the market, then you have a manipulated price.  If the manipulation is to force prices too low, then the seller is cheated, and if the manipulation is to force prices too high, then the buyer is cheated.  If there is any kind of manipulation, then by definition someone is being cheated when compared to a free market.

The state of many of the investment markets in the United States in 2011 is that nobody is getting a free market price for just about anything.  This is crucially important, because no matter how purportedly laudable the public policy interest goal is (as explained in the media), every time there is an intervention to manipulate prices, then somebody is being cheated to pay for it.  When government policy deliberately forces artificial prices upon a market because politicians don’t want the market price to prevail, then in every transaction in that market one side is either paying too much, or one side is getting paid too little.  This is not the conventional “spin”, but it is an intellectually valid perspective that has powerful real world consequences for the current and future lifestyles of many tens of millions of responsible savers and investors.  This issue also includes stocks, but this article will focus on instruments that pay interest to investors.

Manipulated Interest Rates

Let’s consider the traditional role of the Federal Reserve in trying to determine the federal funds rate, which is how the Fed tries to influence or control all short-term interest rates in the United States. This is not exactly a new or disputed fact, indeed for decades one of the most reliable parts of the business reporting cycle is the media anticipating and then analyzing the results of every committee meeting, trying to see where the Fed is moving interest rates.

This is where the common sense free market “spin” part comes in. In other words, the most heavily covered aspect of Federal Reserve activity on a traditional basis is trying to guess how the Federal Reserve is going to manipulate interest rates. Are they going to attempt to override the market to move interest rates up or override market forces to move them down? After all, that is the whole idea.  If the Federal Reserve accepted the judgment of the market for interest rate levels, there would be no need to intervene.

The overwhelming emphasis of the historically unprecedented Federal Reserve interventions in recent years has been to keep interest rates as low as they can possibly be. Indeed, much lower than they would be in a rational market. What this means is the Federal Reserve has been manipulating short-term interest rates so that purchasers of short-term securities, as well as all savers in general, are being systemically cheated out of the yields they would otherwise get in a free market.

This a fascinating example of how the remarkable becomes the norm almost without comment – when that serves the interests of powerful special interest groups.  It has been a very long time since anyone in the US has been rewarded for responsibly saving their money in savings, money market or interest-bearing checking accounts.  The paltry interest rates have lagged well behind even the official rate of inflation.  For an economically rational person – saving money has been actively discouraged as an incidental by-product of government policy.  While periodically “tsk-tsking” those irresponsible average citizens and saying they really should be saving more, what the government has actually been effectively encouraging is the exact opposite – because artificially low interest rates better serve bank and corporate borrowing needs.

In the 20th Century the Federal Reserve intervened in just one corner of the markets, that of short term interest rates, with a primary focus on interbank lending.  These interventions historically had a powerful influence (albeit not direct control) on short term interest rates of all kinds, but they had a lesser influence on medium term interest rates, and still less of an influence on long term interest rates.  The overall economy and general asset values were also influenced, but the Federal Reserve was only one of numerous influences; it didn’t truly control and manipulate the overall markets.

Now let’s consider our current situation where food prices are spiking, energy prices are soaring, and the Federal Reserve for the first time since the Civil War is engaged in a massive policy of straight up monetization (i.e. creating money out of thin air to directly fund endless federal deficits). This is surely a combination of circumstances that in a free market would lead to soaring interest rates. Inflation is not merely on the horizon, rather it is all around us when we look at food costs, fuel, heating and health care.  The Federal Reserve is basically flicking lit matches at pools of gasoline when it comes to the future value of the dollar with its policy of monetization.  Indeed, the (successful) strategy being pursued by the US in waging currency warfare is to threaten to destroy the value of the dollar through monetary creation.

Arguably, free market interest rates should be soaring, as investors seek protection from inflation.  Yet when we look at short-term interest rates they are some of the lowest in financial history. Because the free market has nothing to do with what we as savers are being paid, this is an entirely manipulated market.

Indeed  the Federal Reserve has been radically increasing market interventions to try to manipulate interest rates in areas where traditionally it has not been able to do so because of previously (but no longer) limited Federal Reserve powers.

One unprecedented intervention was that for over a year, between 2009 and 2010, the Federal Reserve created an almost entirely artificial mortgage market to essentially fund every mortgage being originated in the US, and keep mortgage rates well below what market interest rates would have been.  This manipulation was so overt and massive that not enough buyers could be found, so the Fed had to directly create over $1 trillion in new money to fund the purchase of effectively all new conforming mortgage originations (on a net basis) at far below market yields, as covered in my article “Creating A Trillion From Thin Air”.

http://danielamerman.com/articles/Trillions.htm

While the powerful price and yield distortions drove many buyers away, there was still a continuous and functioning market, meaning every day private buyers were grossly overpaying for mortgage securities.  That is, on a net basis, Federal Reserve monetary creation put enough new money into the market to effectively fund the purchase of all newly created mortgage securities, but it did not comprise the entire trading volume of the market; private parties bought and sold from each other every trading day at the manipulated prices.  Individuals who knew little about the unprecedented Federal Reserve actions, but who were following the traditional strategy of the last several decades of boosting yields above Treasury bonds via buying agency mortgage securities, or who bought into funds following that strategy, were being quite blatantly cheated and were paying much more than they should have had to, because of the artificial market.

The stated purpose of QE2 (the second round of so-called “quantitative easing”, aka running the printing presses) is for the Federal Reserve to directly manipulate medium and long-term treasury bond rates with the idea of encouraging corporate borrowing.   I wrote about this in detail when QE2 was first announced, but despite the Fed openly stating exactly what it planned to do, few financial writers seem to understand exactly what the Fed is in fact doing.

As announced by the Fed, and described in my article “Radical Difference Between Monetization 1 and QE2″ linked below, the Federal Reserve is not actually directly funding the Treasury.  Even though the Federal Reserve is directly creating money out of thin air at a rate approximately equal to the US budget deficit, and using the money to buy Treasury Bonds, the Fed is buying them in the market rather than directly – and they aren’t the same securities.  Part of the reason is that it is illegal for the Fed to directly fund the Treasury (though a simple act of Congress could cure that at any time if need be).   The bigger reason is that the Federal Reserve is attempting to manipulate all interest rates in the US through controlling short, medium and long term Treasury Bond rates, so it is using the money not to directly fund, but to intervene wherever it thinks the market is most in need of intervention.  By controlling the secondary rather than the primary market (my apologies for the jargon), the Fed takes control of all interest rates.

http://danielamerman.com/articles/Monetize1.htm

As discussed in the article above, the Federal Reserve has an unlimited supply of dollars, and is using not just the massive creation of money, but the knowledge of other buyers and sellers that the Fed is in charge, to effectively control the markets in US Treasury securities.  If a financial firm were to risk its capital and take a huge position speculating that interest rates will rise to an impermissible degree, the Fed has unmatched resources to force interest rates down, force a major trading loss, and quash the uncooperative firm in question.  On the other hand, so long as the investment banks follow the lead of the Fed (and they are), then they make “free money” and trading profits without end by following the script fed to them by their cronies at the Fed and the Treasury, profiting from the easiest counterparty in the world to trade against, that being the government.

The ripple effects of this overtly manipulated and rigged insider’s game reach into our day to day lives all across the nation.  That is because Treasury yields are the base from which virtually all other interest rates are determined.  Whether we are talking about certificates of deposit, corporate bonds, municipal bonds, junk bonds, fixed rate annuities, credit cards, prime-based lending, or home equity lines – the base is the Treasury yield for that maturity, and then a spread is added to it.  Control the Treasury yields – and one controls almost everything (other than the spread).

When interest rates in general are manipulated, what does that mean for savers and investors?

When you put your savings into a money market fund, and the policy of the US government is to force interest rates to unnaturally low levels – you are being cheated out of the yield you should be receiving.

When you buy a corporate bond or corporate bond fund – you are being cheated by overt government market interventions that have the explicitly stated purpose of lowering corporate borrowing costs.  This is where that “spin” comes back in.  How does a government lower borrowing costs for multinational corporations, enabling them to take the proceeds and invest them overseas?  (Taking the money and investing it out of country seems to be the most common behavior so far.)

The government does so by manipulating the market so that investors receive much lower interest payments than they would receive in a free market.  In other words, it directly creates benefits for corporations and banks by cheating ordinary investors out of the income they would receive if free market forces governed.  Boil it down to another level, and this is a fairly straight up redistribution of wealth from average citizens to corporate interests.

Wherever the investor goes, whatever interest-bearing investment they look to – there is no escaping the cheating, because there is no escaping the unprecedented direct government control over interest rates.  Even as inflation rises (in the real world rather than the also manipulated world of government statistics), there is nowhere for the fixed-income investor to find compensation for current inflation or inflationary pressures.  Which, in a free market, would likely be the dominant market forces at this point.

Adding to the irony – and the tragic dilemma for us all – is that the market manipulation is being paid for by the Federal Reserve creating brand new money out of the nothingness, so to speak, at the rate of about $1,000 per US household per month.  This is creating perhaps the greatest inflationary pressures of our lifetime.  In other words, government policy is to risk the value of all of our savings in the future, in order to fund a program of cheating us out of market interest rates today. And this thereby ensures that none of us are compensated for the inflationary risks, or are able to prepare for the destruction of the value of our money by way of conventional methods.

It’s all in the “spin”, and this paradigm is not that difficult to see when a common sense and free-market perspective is introduced.

Arbitraging Market Manipulations

At the beginning of this article, I promised to take some well-accepted facts, put a free market “spin” on them, and convincingly demonstrate that tens of millions of investors were being cheated out of their investment returns by their own government.  Are you convinced?  Do you accept the systemic cheating?

If you do, then you have the potential to do something about it.  Maybe even do something extraordinary.  Remember, the whole idea behind manipulating markets is that one set of either buyers or sellers gets cheated, and the other gets an incredibly good deal which they should not otherwise be able to get.

Now the problem for the average investor is that what we are told to do is to be the sucker in each one of these situations. We want to be the ones who put as much as possible of our savings into money market accounts, or into buying the certificates of deposit. Where things grow interesting and challenging – but the rewards can potentially become extraordinary – is when we figure out how to change our financial profile so that we are the beneficiaries of market manipulations rather than being the victim of these manipulations.

It isn’t easy, and there are several hurdles.  The first difficulty is the one that most people will never get past, and that is to truly reject the overwhelming Voice Of Authority when it comes to the conventional financial “wisdom”.  That overwhelming voice that resounds from the universities, from the investment houses, from millions of financial representatives of one kind or another, from the newspapers, magazines and financial websites, and from our friends and relatives.  What was covered in this article could be called no more than common sense in some ways, but it is radical common sense, almost on a different continent from the overwhelming force and authority of the conventional perspective.

This overwhelming Voice of Authority is intellectually bankrupt for the reasons discussed in this and other articles.  It is a voice that systematically cheats tens of millions of responsible savers and investors every year in numerous ways.  It is a voice that we must learn to reject if we are not to be cheated.

For most of us, we are who we are, and are in the position in life that we are in, and there is only so much of our financial profile that can be changed.  I’ve worked on these issues for a long time, and the way I see it – that doesn’t mean that we have to accept victim status.  Instead, it heightens the importance of identifying what we can change, what is within our control.  We can then go ahead and make those changes, because achieving highly positive results in the areas we can control is arguably the only way of protecting ourselves from damage in those areas that we can’t control.

To protect ourselves, we must take what we can control, and position it so that market manipulations redistribute wealth to us rather than away from us.  This is the core of what must be done.  Yet, there is the major difficulty that most of the manipulation profits will go to the government, major banks and corporations, and other powerful insiders.  We can and should scream in moral outrage, but that’s not likely to change the way things are.  Most of the redistributions of wealth are simply inaccessible to the average person.

That said, there are trillions of dollars in manipulations happening on a national and even global scale.  So much is changing so fast that there are also numerous “open doors” in unexpected places.  There are opportunities to reposition ourselves so that wealth is redistributed to us instead of taken from us.  These doors are still open now, but many are starting to close and our time to access them is limited, at least in the US.

Read the entire article HERE.

 
Contact Information:
Daniel R. Amerman, CFA
Website: http://danielamerman.com/
E-mail:  mail@the-great-retirement-experiment.com

By Barry Ritholtz – December 31st, 2010, 10:00AM
The Big Picture

On the last day of the year, I like to think back about the truths I learned this year. Some were revealed accidentally, others were the work of challenging data analysis. We happened upon some Truths during deep contemplation, and occasionally stumbled across them accidentally.

And of course, there was Wikileaks.

Regardless of your method, with a little digging, truth seekers were regularly rewarded. When you find it, often, it is not pretty; the Truth will destroy long held, cherished myths. But if you are an investor, you must go through this process on a regular basis.

If you can identify where the masses’ subjective view of reality is wrong, and then time when they begin to realize this, there are good investment returns to be had. A bonus of this process is some small measure of personal enlightenment.

In 2009 and 2010, I learned that Corporate America took over the political process via their exhaustive lobbying efforts. What was once a Democracy is now a Corporatocracy. Just because I personally despised this result did not prevent me from profiting from it. Hardware, software, and research all cost money. I can promise you it is much easier to fight the powers that be when you have an unlimited Amex card — and cold hard dollars fiat printed Fed money — to help you.

Exactly how far has the takeover gone? The corrupt US Supreme Court provided a sympathetic venue for the creation of corporate rights never envisioned by the Founding Fathers; Congress has become a wholly owned subsidiary of America, Inc. The White House talks a good game of smack, but genuflects in order to beg for job creation.

Politicians do the bidding not for the people, but for the corporate establishment. Those people who want to blame the barking, snarling government for all the woes of the world do not want you to look further up the leash to see who is giving the commands. These corporate apologists pretend to be philosophers, but in reality they are mere Fellatrix, bought and paid for by their lords and masters.

Fearing a corporate takeover of the nation isn’t nearly as radical as it sounds. Thomas Jefferson reviled the idea of big corporations: “I hope we shall…crush in its birth the aristocracy of our moneyed corporations, which dare already to challenge our government to a trial of strength and to bid defiance to the laws of our country.” Jefferson knew the influence bankers could have on a nation’s soul, and he was horrified by it.

No less a figure than Dwight D. Eisenhower — five-star Army general, Supreme Commander of the Allied forces in Europe during World War II, responsible for planning and supervising the successful invasion of France and Germany, who then became the 34th President of the United States from 1953 until 1961 — warned that “we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex.” He knew it was not just the military, but the entire existing corporate structure that sought to take advantage of their influence in order to thwart legitimate competition, skew Federal contracts, and exempt themselves from taxation and regulation.

What might Eisenhower have said about the bailouts, and enormous decrease in banking competition?

The surprising thing about this anomaly is that there are enormous incentives to find the objective truth. Often, it seems like the reality gets buried under a mountain of conflicting interests, with power and money and influence on one side and We, the people on the other.

However, the credit crisis and collapse has taught us one very important lesson: If you continually search for that nugget of reality, if you are willing to roll up your sleeves and sift through the vast mounds of horse shit that Wall Street and Washington regularly serve up, there is indeed, a pony somewhere in there.

That is your job in 2011: Go find the pony . . .

Find the original article HERE.

Nomura Research Institute’s Richard Koo says that what the world is experiencing right now, a “balance sheet recession,” is different from traditional recessions. However, Japan recently experienced a similar type of recession, and Koo says we can learn a lot from that country’s experiences. Interviewed by Daniel Erasmus at King’s College, April 2010.