This is a government’s last resort when it can no longer ease monetary policy by lowering interest rates. And with an official rate of 0%-.25%, there is really no room for the Fed to go lower. In fact, the Fed seems to have an inherent dislike of saying our official rate IS actually 0%. So they keep this charade of a rate “range” in place for a little window dressing… and quickly turn to quantitative easing.

By pouring money directly into the economy, effective rates are supposedly made lower, money is made cheaper and everybody has more of it. That, of course, makes people feel wealthier (whether they are or not), so they spend more money. This creates more sales. More sales create more jobs. More jobs create bigger companies. Bigger companies create bigger profits. Bigger profits make companies less nervous about taking out corporate loans. Corporate loans helps companies expand.

Expansion makes Wall Street think the company will have bigger future profits.  Wall Street’s hopes drive up the company’s stock price, and their bond rating. This helps the company borrow more money at an even better rate, and the expansion cycle continues.

But all of this is contingent on the cheap price of money.

You may have heard the term “cheap money” before. And it’s not easy to wrap your head around the concept. After all, isn’t a dollar always a dollar? Not exactly…

Whether money is “cheap” or “expensive” depends on what it costs to borrow money. When interest rates are high, the cost to borrow is high — and money is said to be expensive. When rates are low, the cost to borrow is low — so money is said to be cheap.

Common monetary theory says that cheap money jumpstarts an economy. People feel like they have more money, so the cycle gets going, just in the way I described earlier.

However, there is a hidden cost to cheap money — and it’s called inflation. When a government pumps too much money into the economy, it will overheat. More money chasing the same amount of products raises prices.

Now, to the first recipients of this new money, it doesn’t matter. When the money first enters the system, prices have not adjusted upward yet. So people have new purchasing power without price increases.

The last people who receive the money (after it trickles down) are the worst off. They have seen prices rise already, but by the time the new money gets to them, it has less purchasing power. So you have some pretty angry folks.

Then a day eventually comes when the government has to turn off the money faucet. Prices continue to rise, but everybody has less cash to buy things with. The masses begin complaining and wanting the government to “do something.”

So the government starts raising rates, and everybody complains some more. But by that time, the pinch is on, and the yeast has started working its way through the bread. It is much easier started than stopped, and everybody hurts until it does. There are no winners in inflationary periods. There are only people who lose less than others because they were better prepared.

The Fed’s quantitative easing will try to lower the cost of money by pushing it through the economy. The question is, how much is too much? At what point do people stop feeling wealthy and only feel the squeeze of higher prices?

The whole circus is beginning to happen now. When the Fed announced its plans, traders, investors, institutions and governments around the world began selling off the dollar. Hard. It fell 6.3% in 24 hours against the euro. Every major currency appreciated against the U.S. dollar. Simply put, traders were saying that the Fed’s actions made the dollar worth less.

But two big concerns remain. First, why did the Fed decide to take this action? As I said, this is usually a tactic of last resort… so what piece of news or indicator mandated this huge policy change?

Perhaps more importantly, how much longer will the Fed take this course? The monetizing (inflating) of trillions of dollars in debt calls into question the safe-haven status of the U.S. currency. Devaluing makes it seem less like a stable reserve currency and a lot more vulnerable.

On a broader view, the European Central Bank may attempt to do the same. They have publicly stated they are nearly at the end of their rate adjustments, although their rate is currently more than a full point higher than the United States. Honestly, it is questionable whether the European Union can perform a Quantitative Easing operation across all 16 member countries. It would be technically difficult to pull off… and next to impossible politically.

But if they do attempt quantitative easing, it will mute the Fed’s actions, blowing through trillions of dollars more with little or nothing to show for it.

So to sum up, if the ECB does not inflate, the dollar looks very bad going forward. If they do, the prospects for an inflationary “recovery” for the United States are slim to none. And slim just left town…
And now we have to add in another piece of the puzzle…the People’s Republic of China.

Red Storm Rising

China has been attempting to flex its newfound economic muscle. Chinese Premier Wen Jiabao’s veiled warning that the United States had better watch its step and keep its promises.

Last Monday, the nation fired another warning shot across the bow. Zhou Xiaochuan, president of China’s central bank, issued a very well-written and forceful essay to the World Bank. Without naming names, he expressed concern about the world’s dependence on just a few reserve currencies. www.pbc.gov.cn/english/detail.asp?col=6500&id=178

He called for the introduction of a world reserve currency, based not on a sovereign country’s currency, but rather on an IMF-based note. He suggested basing it on the IMF’s SDRs, or Special Drawing Rights, a unit of account that the IMF has been using since the 1960s. The proposed currency could also be grounded upon a basket of commodities for the backing of its value, and member countries would make “contributions” to this universal monolith.

Of course, other nations would have to be open to such an arrangement, and even if they were, developing this idea would likely take a long time. But that’s not really the point. The point is, China is expressing its displeasure at what it perceives to be a real inequity between itself and the rest of world. While China is doing its best to weather the downturn, the collapsing demand for its exports has closed many factories and put 20 million people out of work.

What China wants is for its investments to be spared. And for it to be considered above our own national agenda. Because right now our agenda of inflation and their agenda of a stable or appreciating dollar are at odds.

And this provides some of the background for our Australian play. Take a look…

Looking for Thunder from Down Under

I have said before that the likely winners in this worldwide economic crisis will be countries like Canada and Australia. They have an edge because of their commodity-related economies and currencies. Oftentimes you’ll hear them called the CommDolls (commodity dollars) for short.

Of the two, I like Australia better. Canada is inextricably tied to its neighbor to the south (namely, us), and that’s more than just a little problematic. Australia, on the other hand, is not tied to the United States and has many other real positives going for it.

Keep in mind, the U.S. dollar devaluation is under way. And the words of warning from China’s top officials suggest the country is already considering moving its investments to whatever other possibilities exist. Indeed, is has already begun doing so — mainly, into its own economy.

It has produced a stimulus that has been roughly estimated at somewhere just above $550 million, or 14% of the country’s GDP. Its infrastructure expansion is already up 30% from last year, hoping to boost domestic demand. Bank lending is up 24% due to its own monetary easing. Yes, exports are off substantially, and I think will likely continue to drop, but even so, the personal savings rates there are much higher, and China does have the reserves to continue moving things along with little to no borrowing. Plus, they have promised to do more stimulus if it appears to be necessary.

As China attempts to lift itself up by its own bootstraps, Australia comes into the picture. It has been widely understood that Australia is a little China. Not in culture, custom or language, but in economics. A significant part of Australia’s commodities flow into China, and the more the Chinese move ahead, the better it is for Australia.

Also, let’s consider that Australia’s central bank is still holding its interest rates at 3.25%. In a fairly stable country, with a fairly stable currency, that is one heck of an attractive rate. Why, it is downright appealing! It is true that they have followed other developed countries in lowering their national rates. But I think it is the propensity of all central banks to err in their “corrections” of the market. That is, they often lower rates too quickly and too far — as I think is the case here — then they raise them far too slowly to stave off the coming of inflation.

Indeed, Australia may now become the benefiting member of the next carry trade.  After all, if can you borrow money at .25% and invest it at 3.25%, you stand to make a decent haul. And as risk appetite re-enters the market, you can bet your bottom dollar that Australia will likely be a real beneficiary.

More importantly, the continent’s economy has not been too rattled by the worldwide crisis. Wages are up 5.7% by official statistics. That’s great, especially when you consider that full-time employment is up. Now some people may question the importance of Australian employment given that the recent figures showed only a marginal improvement in job numbers. But inside the figure, we have a strong drop in temporary employment, but a surge in full-time filled positions. Going forward, this is good!

Business investment is up 6% over the last quarter — also a sign of good health. As business expands, so does the work force, followed by wages… and next thing you know, interest rates are headed north as well.
Retail sales are up 0.8% this quarter. Even their housing market has only suffered a 3% decline. On top of all that, it has recently run a trade surplus, another sign of a healthy economy.

Now this does not mean it is just smooth sailing ahead, or that there aren’t downside risks. Its central bank could continue to overreact. That would be detrimental. Or commodity prices could take another hit. After all, many producer contracts were locked up last June, and many producers are still protected by them. This June could be an entirely different story. Producers may have to take a big hit compared to last year. That would be detrimental. And the China factor may not pan out as quickly or as well as it appears.

But all things considered, a long position in the Australian dollar doesn’t seem like too bad of a bet.

Regards,
Bill Jenkins

March 30, 2009

Devaluation and a Chinese Warning Shot was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

What do you make of this latest triage of the broken financial system? It keeps things ticking over. But how do you fix a nation that has too much debt by adding more debt? The U.S. government, through its various agency paramedics, is injecting money and buying equity all over the economic shop. But it’s not cheap.

Bloomberg tallied up the various commitments, loans, and guarantees made on behalf of the U.S. taxpayer by various Federal agencies and non-elected officials. It was not a small number. It came to U.S. $7.76 trillion, a vaguely patriotic sum, echoing the year the Declaration of Independence was proclaimed in 1776.

You can read the Bloomberg article as an explication of dependence. Or better yet, a pledge of eternal subservience to the power of debt. The $7 trillion plus figure is nearly half of annual U.S. GDP. Just under half of it — $3.18 trillion — is money tapped by financial firms through various auction facilities. It goes to rebuild balance sheets, rather than building factories, bridges, or new sources of power.

The Federal Reserve is the biggest instrument of this ramp up in commitments. The Fed has pledged $4.74 trillion on behalf of Americans. That’s 61% of the total amount, and $24,000 for every man, woman, and child in America (born free, but now everywhere in debt). More on this in a moment.

Here in Australia, local shares should get a boost from rising commodity prices (provided no more margin loans get called on insiders and short sellers cover). Oil was up $4.50 to $54.43 for a 9% gain on the day. Gold shot up nearly $30 to $821.90 for almost a four percent gain. Copper was up 6%, nickel 7%, zinc 6.4%, and tin 11.3%. And what, pray tell, may have led to that move?

Chinese monthly refined copper imports were up 15% in October, an eight month high. But what China gives it may also take a way. Cochilco, China’s state-run copper outfit, cut is forecast for copper prices in 2009. Where does that leave us with the base metals and with base metal shares? We asked Diggers and Drillers editor Al Robinson.

“China’s resurgent demand for raw materials is already surprising the market,” he wrote to us via e-mail from 2 metres away. “It reverted to ‘net importer’ status in all base metals for October, according to the London Metal Exchange (LME). China already needs more resources than it can get its hands on.”

“It’s buying more rock than it’s selling, in other words. That’s great news for the Australian resource sector in 2009.

“But this story goes further,” he adds. “China isn’t experiencing some sort of meek comeback, following the Olympic slowdown. It actually imported enough copper in October to offset the rest of the LME’s inventory rise. The ‘rest of the world’ may not be setting commodity demand ablaze. But China is already starting to fill in the gaps created by Western recession — on its own.”

While China fills the gaps, you may also start to see some short covering from traders who went short the base metals. That short covering could lead to big one day moves in the shares (which are appallingly over-sold). But it may not quite mark the bottom in metals prices. That’s going to be a function of supply and demand (with supply tightening as projects are shelved and demand idling).

The other thing to look for is bargain hunting. Investors and fund managers who liquidated long positions in the resource sector earlier this year to raise cash may begin nibbling if they find the right share at the right price. Take China for example.

Recently the Australian reported that “Rio may sell stakes to china to reduce debt.” Rio’s Chairman Paul Skinner was in Melbourne to discuss, among other things, the possibility of Rio selling assets or an equity stake to China Inc. in order to help pay off some of Rio’s U.S. $9 billion in debt that matures in 2009. Maybe Rio should first ask the Fed before giving up equity to China. Bernanke can be pretty accommodating, we hear.

And now it is time to bring that U.S. $7.76 trillion back into the picture and put it in the context of Australian resource equities. The Citigroup bailout deal prompted a rally in stocks and a rise in U.S. bond yields on Monday. The yield on two-year U.S. notes rose as the government auctioned another U.S. $36 billion of them into the market.

It’s hard to believe the Citigroup deal unleashed a lot of pent up bullishness on U.S. financial stocks. It’s easier to believe that the ever-increasing supply of U.S. government bonds is prompting investors who’ve rushed into them to look around for other, more desirable assets. Chinese investors, for instance, might decide than an equity stake in Rio Tinto — with its portfolio of iron ore, coal, and other assets — is a better investment than more promises to pay by the U.S. government.

Perhaps we’ve been hasty, though, in calling the pricking of the bond bubble in the past. It could be that the U.S. dollar becomes the clear winner in the global currency wipe out currently taking place. The dollar could end up being the preferred liquid currency in which to ride out the global crisis, despite the inflationary nature of U.S. monetary and fiscal policy.

If that’s the case, then the U.S. Treasury market will continue to suck up the world’s supply of available savings and capital the way a bush fire sucks up oxygen. A fire sucking up all the oxygen in a system leads to a massive destruction of life. Hence the Greek word “holokaustos.”

According to the Merriam-Webster dictionary, a holocaust is a “sacrifice consumed by fire,” or, “a thorough destruction involving extensive loss of life especially through fire.” The holocaust of the Treasuries, then, is what we’re getting at. First crowd all the world’s capital into the U.S. bond market. Then burn it up.

Smart money generally goes where it’s treated best (for yield and capital appreciation). In times of fear, what’s safe is smart. And so now the world’s investors and savers have an interesting choice: is the U.S. bond market safer than cash? Is it smart to play it safe? Or are equities safer than bonds? Or are equity stakes in projects with tangible assets better bets still, even in a world with a shrinking economy?

Our guess is that the printing of the Treasuries (increasing in the supply of U.S. bonds to fund the mega bailout, fuelling the eventual inflationary fire) will gradually spook investors now and into 2009. The leading edge of bargain hunters may already be finding their way into over-sold resource stocks for refuge. And will they find it? Or will their courage end in more losses?

It wouldn’t be surprising to see big one-day gains in over-sold resource stocks in the coming months. But we reckon the real story is that investors are rethinking their long-term asset allocation and will execute a new strategy after reviewing their 2009 performance.

More cash, fewer shares. And of the money that remains in shares, it will probably be parked in long-term positions that are selling at cheap valuations, perhaps with a nice yield. Expectations will be lowered and time horizons-for equities anyway-will be lengthened. You’ll have to expect less and be willing to wait longer.

Not that being in the equity market during the most serious financial crisis since 1929 is a sure thing. We live in dangerous times. Not much is certain. But for investors, the actions taken by U.S. monetary officials are starting to lead to movements in global capital. This could signal the beginning of the bottom in commodity prices, and the beginning of bargain hunting in resource shares.

Regards,
Dan Denning

Parting Shot: Well, you can’t say you haven’t been warned. You know full well that the fed is gathering wood and squirting accelerant all over the place. They are going to make sure this currency burns till there is nothing left.

Possible Holocaust in U.S. Bonds was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Don’t like slavery? Let’s fight a war, even though slavery was disappearing rapidly and it had been illegal for 55 years to import more slaves. Let’s call the power grab “Saving the Union.” That sounds good, doesn’t it? (When dishonest Abe got elected, as the first Republican, six states instantly seceded, as they knew what was coming). Don’t like roads? Let’s build an interstate highway system at taxpayer expense, charge no tolls, and kill tens of thousands of businesses, kill railroads, escalate the price of fuel to pay for them forever, and change the cities, face, air, and oil consumption of America. Want to give a lot of power to big shots? Let’s form the Federal Reserve, which isn’t federal, and has no reserves. Let it print money created out of thin air, loan it to the taxpayers at interest, and make them pay through the gills with inflation.

Yes, I can literally go on and on. They write an infinite number of bureaucratic prescriptions, which are all force fed to the citizenry, who, in the main, seem to think that it is all so wonderful, while the nation is flooded with trash, lazy, non-productive people, living off the thousands of welfare schemes. The masses become so drugged with fake hopes, fake money, empty promises, and non-education that they finally actually voted in Adolph Hitler, FDR, LBJ, and now Obama. The drugs and prescriptions of government and bureaucracy, have worked well by making D.C. the absolutely most stupid, power mad, idiotic, corrupt city in the world. And we all anxiously awaited the outcome of the elections. I did, and so did you, even though one was about as bad as the other, and the Congress is hopeless, no matter who gets elected…except Ron Paul possibly.

What is now happening happened in the 1930s, and is absolutely like a carbon copy. The Fed floods the market with tons of cash, which makes the stock market and real estate bloom like flowers in spring, with banks loaning on slim or no margin, thereby creating a huge bubble, which has to eventually bust. It did then, and has currently burst. Then they tried to “fix” the broken economy, like they are trying to do now, only at the expense of the taxpayer. Didn’t work then, and old FDR finally got us out of it by means of WWII. The morons of D.C. are literally printing $2.7 TRILLION un-backed pieces of paper, to “fix” the economy, and it won’t work. FDR’s dollars had to be backed by gold, so he told everyone to turn in their gold so he could print more dollars, which didn’t solve the depression, but robbed the populace of hundreds of billions of bucks, when he raised the price of gold from $20.67 to $35, overnight. Today, there’s no backing, they need no gold to back dollars, so they merrily will print and print and print till who knows when? Will the buck collapse, thanks to printing? I don’t think so, because everyone’s doing it!

If something works well for politicians, other politicians will glom onto it, and do it also, which they are. The world’s a big printing press. All governments are printing their respective currencies like there is no tomorrow…except there is. Hyper-inflation is what it is called, even though the time delay between printing and hyper-inflation fools most. It will come. How to fix the current situation? Not easy, because as each depression comes along, they might get worse, thanks to government. The way to fix this, is to simply let the cards fall where they may. No interference of any kind. No bailouts, no subsidies, and no ‘help’ from governments anywhere. Failures? Lots of them, but they probably should have failed anyway. Broke people and corporations? Can’t be helped. They have done it to themselves or are caught in a bad place. Everyone has to help themselves, no matter the cost.

Cruel? Yes, but when government ‘helps,’ in any situation, the ‘help’ instantly turns to ‘hurt’ of the productive class, whose taxes pay for government, which is hurting them. Obama has promised to ‘help’ the poor, at the expense of the producers who pay his salary. This is known as biting the hand that feeds you. When government endlessly subsidizes, ‘helps,’ and hires tens of thousands of money-ingesting bureaucrats to regulate the producers and hand out scrip to the non-producers, calamity is the obvious result.

The nations of Earth, with America being no exception, are flooded with trash, non-productive people, who have no real reason to exist, other than to suck the very life’s blood out of the productive class. The entire continent of Africa, to make a generalization, is classic. Ask the Germans about the Turks. How about North Philly, East St. Louis, Detroit, or South Central LA? How to get rid of them? Other than letting them self-destruct, I have no idea, but at least I know the problem. Government handouts gave us the underclass, and now we have to put up with them, while they continue to suck at the government teat. Suppose all ‘help’ ceased? Suppose 85% of federal bureaucrats were fired, the IRS eliminated, and their offices sold to productive businesses? Suppose 85% of all federal government were disbanded, and D.C. was turned into a virtual, temporary, ghost town, till producers could come in? But then, I speak of a Constitutional government, and that is old-fashioned, I realize.

The Constitution tells government what it can do, and that range of permissions has been so totally ignored and violated, that it is no wonder we are where we are now. What to do? There is no better place on earth to live, so we must stay here, preferably in small towns with sound banks, small governments, and no severe weather. And of course, we must protect ourselves. I can offer no other solutions, because the decay has so thoroughly infected the patient, that more prescriptions will only harm us more.

Regards,
Don Stott

November 25, 2008

Stop Fixing It was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.