Excerpted from this week’s edition of Notes From the Rabbit Hole, NFTRH 230:
Funny Munny on the Run
US monetary policy makers have enjoyed a Goldilocks environment since
they began the most intense phase of inflationary monetary policy,
which we will define as post-Operation Twist, beginning in January of
2013. Goldilocks held sway because of a lag in inflation’s rising cost effects in the transition from economic contraction to economic expansion.
But the expansion (such as it is) was willed into existence by a Fed
sopping up commercial and government bonds (legacy debt) with newly
printed money. The story goes that this newly printed money will
somehow enter the economy and become accretive to productive economic
activity. But it will not.
The newly created money is entering the financial sphere and seeking assets with which to try to transform itself from printed funny munny to actual value. Actual value could be found in the US stock market in 2012. But typical of funny munny, it may not know when to stop and move on to something else deserving of the ‘value’ bid. That is because it is funny munny and it is all about momentum. It is ‘hot’ money.
Housing, crude oil, uranium, copper, the Chinese stock market, rare earth elements, silver and even gold have all received the ‘funny munny on the run’
bid at various times and to varying degrees in the last decade; so why
not US stocks? Why not for once a Federal Reserve chief able to stand
up and accept the accolades as the great “Hero”?
But economies and financial markets do not work that way. Only
productive economic endeavor can create long-term economic growth. By
relying on its ability to buy massive amounts of debt in a systematic
and open-ended manner, the US Federal Reserve is distorting the signals
traditionally put out by important debt (bond) markets.
This is about the point where I would normally insert the Outer Limits graphic and the funny stuff like “…sit quietly and we will control all that you see and here.”
But instead, this time we’ll play serious newsletter writer and just
get to the facts and ask what happens if the bond markets throw off
predatory policy makers like so many fleas?
Think about all the moving parts to the global picture. China is
having economic and political issues. Japan has committed to the path
of intense inflation. What will that do to its own JGB (bond) market?
Now consider that these are two holders of massive amounts of US
Treasury bonds, the very instruments that “our hero” (the Atlantic’s
words, not mine) at the Fed is using to engineer recovery in the United
States.
Printing new money to buy old debt is inflationary. We see that now in the rising Monetary Base data* [see M2 & MZM discussion at end of report].
If China and Japan begin burping up US T bonds in large volumes in
order to raise capital to attend to their own internal affairs even more
intense operations in the Treasury bond market may be required of our
“hero”.
Or will the inflation regime just end with a nice and tidy exit plan
as the US economy gets the wind in its sails with organic growth and a
clear path to prosperity? With the massive amounts of T bonds held in
potentially unstable hands globally and with the pressure to continue
buying these bonds domestically (QE) it sure does look like ‘inflate or
die’. Would the ‘organic’ economy survive impulsively rising interest
rates?
A symbolic economic death would come by one of two ends. It could
resolve into an inflationary spiral, where scores of asset mongering
frogs will be boiled slowly as they at first come to feel enriched, but
then come to feel threatened by a spiral of prices rising so fast that
the inflation-fueled casino atmosphere begins to feel very out of
control and threatening to every day life.
Or more realistically (in my opinion) the inflationary game will go
on until something breaks once again; some leveraged thing at the heart
of the interconnected global casino just goes dark one day and begins
another domino effect throughout the financial system. This is of
course a deflationary resolution and in my opinion, solution. Much
destruction, with the idea that maybe our children and grandchildren
will be the better for it after a phase of intense adjustment (read:
pain).
A hard drug user experiences pain on the path to recovery. Developed
economies are still in the ‘user’ category and it appears that recovery
is going to have to be imposed, because the addicts are not voluntarily submitting to rehab.
Instead they are pursuing more intense forms of the destructive
behavior that put the system in such a precarious state to begin with.
This is not my opinion; it is fact. The fact is that new money is being
printed to pay for old debt that would not be effectively serviced on
its own, and the proceeds are being employed toward market sustaining
liquidity under the guise of stimulating economic growth. Well yes,
some of that is my opinion. But the fact is that there are positive
economic signs popping up – which we had anticipated – and yet still
they inflate.
On Wednesday the FOMC will conclude a 2-day meeting, followed by a
press conference with Bernanke. If they make stronger sounds about a QE
exit plan (the markets and to a lesser degree the economy are heating
up after all) then we will see if all of the above is just the doomsday
fantasy of a loony letter writer or just maybe a well thought out path
to difficult times ahead. The implication is that the ‘organic’ economy
would be left to fend for itself after all.
They may again note the muted inflation signals in the things most
people look at, which are prices. But the February CPI data was a step
in a mitigating direction for our heroic inflators. This is a notable lagging effect of current inflationary policy to date.
If stock markets continue to rise and if economic activity continues
to grind in a positive direction we will be approaching a policy pivot
point. That would be the point where Joe Public begins to question ‘why on earth are they still printing money in the face of Dow 15,000, improving ‘jobs’ and my own bright and sunny outlook?’
The answer dear public, is the same as it was in 2004, when I wrote my first public article, FrankenMarket Lives http://www.biiwii.com/frankenmarket.htm:
“So where does this leave our poor monster, sloppily
stitched together and meandering aimlessly forward? The market will
look to the economy, and being a forward looking monster, I expect it to
see one of two things; The Fed taking away the punch bowl for real,
deciding too late that the party is over, or more realistically, it will
see a Fed doing all it can to sustain the monster it created. This
market was stitched together with debt, and it will require more of the
same to keep it going. We are knocking on the door of hyperinflation,
and I believe the Fed will choose to open that door, given that it is
too late for our economy to de-leverage in any orderly fashion.”
Opening the door to hyperinflation by the way, does not mean a
hyperinflationary resolution. I prefer the view of a deflationary
unwinding (deleveraging), despite intense inflationary efforts. Now
that we have gone over one writer’s not very happy view of things let’s
proceed to the next part of the analysis, how to play it. [NFTRH
230 then moves on to in depth work on current market situations and the
probabilities for what is ahead and how to approach it].
