The mechanic of government attempts to rescue the economies of the west are not well understood. There aren’t many engineers in this engine room to start with and not all of them certainly understand how it all fits together. That was the case before the system blew up. Now we are dealing with “unorthodox stimulus” which means that even less people know what’s going on and implicit in the phrase, even those people aren’t 100% sure what the outcome will be.
There is yet another layer of difficulty. As a central banker you cannot be transparent, you cannot explain, because if you do explain too clearly, you will be “front-run” by those many who will jump on the trend you are creating or worse still attack the weak points you are highlighting, potentially wrecking your grand design.
You can use this to you favour of course to create a trend you want, like the “Greenspan put” but playing this game is also terribly dangerous as trying to finesse the market is like playing speed chess against a room full of inferior players; it is simply not possible to win every game even though you are mighty.
So you have “work in progress” on a novel gigantic problem, not well understood, where the people in charge are unable to give much clarity to their work.
No wonder most people find themselves in the dark about QE and its ramifications.
What is going on is that government is doing something very clever, innovative and potentially disastrous.
On the surface the US is building up a huge mountain of debt, every year digging a trillion dollar hole.
This is unsustainable.
However the Fed is buying back government bonds and private sector bonds at a furious rate, lets judge it half a trillion dollars.
This is not monetisation, so they say, because bonds are being swapped for bonds, not bonds for cash. This is wrong, because the bonds in the swap given out by the Fed are in effect CASH or will most certainly quickly turn into cash if things go wrong.
The bonds the Fed are swapping for long term treasury debts and your junky mortgage, are short term bonds with zero interest. That’s kind of bond is as good as a dollar bill to you and me. It is just not the kind of bill we see coming out of an ATM but it is near enough the same thing.
So the real loop is this. Borrow a trillion by placing your treasuries; buy them back using your department called “the Fed” of buy them back through fungible proxies for them, buy them with cash-like T-bills. Net result half a trillion of debt. You have printed cash and bought your old paper debt back with new paper cash. This leaves the real new debt at half a trillion in new uncovered liability, which your printing is almost certain to gnaw away at via monetary expansion (inflation).
This is sustainable although not necessarily benignly so.
Why is this sustainable?
It is sustainable because there is no cliff moment. No sharp shocking change brought about by a sudden need to change course dramatically. You can keep doing this till dollars become like Zim dollars a prices have lots and lots of zero on the end like Apple’s market cap.
So how does that pan out.
These are the what ifs.
First lets imagine good news.
The economy recovers, things start to go good. Time to put the breaks on. Fed sells the securities it bought for cash, draining paper money out of the system. Interest rates rise. Dollar strengthens, inflation falls. He heat comes out of the recovery. Government tax take rises, deficit falls to normality. Everyone sings halleluiah.
It could happen.
Now let’s imagine bad news.
Economy dead in the water. The US is over. It simply can’t compete anymore.
Economy continues to nose dive. Fed buys up all outstanding debt for cash, then start monetising new debt. Interest rates stay at zilch, dollar falls, inflation rises. Inflation depletes debt pile, falling currency returns US to competitiveness. Economy rises, off to good news.
So what is the problem?
Well the bad news loop sees the end of the US as the one and only global super-power and sees it no longer the outstanding rich country on the planet It represents a readjustment of the Us to a global economic normality. The US suddenly is just another country amongst many. This process sees the US getting a lot poorer. It doesn’t become as poor as say India, but probably has the sort of economy enjoyed by Spain, Italy or the UK. This isn’t a disaster. It’s just a downsizing.
This downsizing is already sign-posted by US inability to compete in trade, where a single company in China employs a million people produces the lion share of products for Apple and gear for Cisco, Apple, Microsoft, Amazon, Dell, Intel, Motorola etc etc That’s imbalance not sustainable and surely isn’t going to end well. Can America actually make an iPhone in-house anymore? Only by the US getting poorer will it be competitive again.
So there you have it, what happens next with QE.
What about no QE at all.
This is a fascinating question.
There would be a massive collapse without QE, unemployment would likely hit 20-25% Spainish style. Big government would collapse and shrink. Taxes would explode upwards and the US would face PIGS style default and austerity.
Then what?
Economic regeneration or extremist government or both?
“No QE” would be the revolutionary path. It would be the shot at redemption the American right wing crave.
Sadly however these kinds of revolutions normally end very badly.
It is no coincidence the right wing who pray for a return to the days of a “Davy Crockett” rugged individualism are the same people that advocate gold and survivalism.
So what’s not to love about QE3, QE4, QE5?
I for one won’t miss the opportunity to experience the mad-max future of guns and Gold the anti-QE, hard money brigade slaver for.
The alternative pathway with QE as the opiate of Americas retirement as Global Superpower will be as soft and as smooth as the curtain lowering on another US supremacy, the Space Shuttle’s landing at LAX last week. Where once America could land a man on the moon, now it is reduced to sending WallE to Mars.
The Rub.
What is an investor to do when the market starts hitting highs.
Is this time different???
Will it go to new, new highs far beyond the current range?
This has been a bad bet for a decade. The market has been in this channel and when it hits a ceiling it corrects.
From my digging in data, a break out from a channel is at best only a 20% chance, ever.
So here we sit having bagged great long profits, happy, bullish and probably due for a beating.
So what does the bull say?
Well it’s been a long time for the US and Europe to be in a bear market. It is 12 years now. Yes the bear started at the end of the dotcom bubble, not in 07-08 when the credit bubble blew. The bear is half a generation old, it must be over now surely with QE3 etc.
Meanwhile lots of progress has happened.
Surely we are due for a new long term bull.
If we are, you can forget the odd 1000 point rally on the Dow, we are looking at a 30,000 point rally!
If the market went into a long term pull like the one that made us all genius in the 80-90s, you are looking at a Dow at 50,000.
That might seem crazy, but a 25% yearly rise in the market is a 400% increase in 10 years.
It might seem crazy to dream of that, but how crazy would it have seemed to predict in 1999 that the Dow would be only 2-3000 points higher, 12 years later.
What would cause such a rise is a great question, but who cares, when stocks like LinkedIn can have a 600 p/e and Exxon 9.7 p/e, valuations have plenty of room for manoeuvre.
The money train is ready to leave the station! Jump on board, don’t miss all the fun.
So that’s mad bull talk, how about a neutral view.
This bullish position is always the way you feel before the market drops a piano on your head. You have to keep the bull by the nose and not let it blow you up.
The thing is, we haven’t had a bear market, we have had a sideways market. This is not the same. Take a look at the Greek index. Now that is a bear market! It is down 90% there. The last 12 years have seen the end of the “peace dividend” of the US winning the Cold War and the end of Moore’s Law driving productivity. As such where is the growth coming from? No where; there is no real growth only phoney public sector GDP growth stifling real economic progress. As such don’t expect anything but sideways trading.
Sigh… that is no fun.
So lets be down about the market.
Let’s face it we are stuffed. The west is not competitive. The only countries with a hope are suppliers to China, ie Canada, Australia and anyone else serving the growth countries of the BRICs. Those consuming BRICs countries output are toast, read USA and most of Europe.
Europe and the USA are in an end game where they lose their supremacy through low competitiveness. Investing in these countries is just putting your money in currency which will implode. What is the point of an index doubling if the currency halves? That isn’t the ends of the bad news. These countries are going to simply confiscate wealth from companies and individuals. Sooner or later they are going to nationalise wealth just to try to stay afloat. The countries are going to drag there people down with them, its going to get very ugly.
The US and Europe is a slow-motion train wreck. Don’t play in a losing game.
Agh… that tack is even less fun.
So let’s be contrarian.
Don’t trade what you think, trade what you see. I hear gloom, I see rally. Buy the rally. I see QE which most people hate. I must love it, what is QE telling me? Borrow at 0%. Yes please. QE says go take risk. OK I will.
Everyone says we are screwed. So this must be near the bottom.
Everyone says “be scared of the future,” so let’s be greedy.
So the contrarian is a long term bull, which means the short term bull should be indulged.
To buy low and sell high you have to disagree with most people. It is hard on the digestion but it is the only way to go. Buying low and selling high is why the wise man appears the fool and the fool always appears so very wise.
This is of course quite a lot of fun.
So it seems the contrarian bull has all the fun and in the circumstances this seems like the best tack to be on.
Blog.
Im watching the Euro and using it as an indicator of the future. Whatever goes on behind the scenes in Europe today is in the Euro price very quickly. The insider trading on the Euro crisis is staggering, but in the end, who cares? There it is a useful guide.
You can predict what kind of news is due from today’s price. So the last week or so has seen Europe beat up on Greece and Spain behind the scenes and likely a softening in position by the EU has occurred in the last day or two in negotiations. Pretty obvious scenario when you think about it.
My theory is that Europe will print big time and at the same instance do at least a little austerity for show.
The next leg of the crisis will be France, if the Spainish/Italian situation is consolidated. That is probably for next year and if the ECB and its economic limbs get it right, it will be just a ripple of an aftershock.
Then the crisis will be off to the US, where we will see strong inflation and huge printing as the America turns its vast short term ocean of treasuries into cash. The dollar will nose-dive.
Japan is anyone’s guess. The Yen should have dived years ago, but the QE magic trick invented in Japan could hold out a lot longer. When it ruptures it will be the crash of the century and an amazing asset buying opportunity.
Meanwhile Im expecting a pullback in stocks. If this rally continues it might just be the beginning of a new equity cycle. This cycle will start again sometime in the next 3 years and when it does it will be a monster.
Its just a case of waiting and jumping on it when it hits. If you look at emerging market valuations of stocks, your eyes would bug out if you applied them to London or the US equities. There is no reason apart from bitter experience that this couldn’t happen again here.
An old broker said to me during the dotcom crash. The market won’t boom again for a generation. I thought that was a bit unlikely, but here we are, half way there. Perhaps we are closer to the beginning of the new cycle than we can imagine as the bottom of any cycle feels like and is,tom the pits.