Catch QE-22

We can see Joseph Heller having a quiet chuckle about this. In order to keep on ascending, global markets need another dose of ‘Quantitative Easing‘ – QE Mark III. But for the Feds to justify another round of QE or debt monetisation, they need to see the market fall considerably, perhaps by 20 per cent or more.

So we’ll get QEIII. Which will help to push the market higher. But only after the market thinks QEIII is off the table…and falls substantially.

It’s not quite the classic case of Catch-22 that Heller outlined in his brilliant book, but it’s pretty close. In the book, US air force pilots in Italy in WWII didn’t have to fly more missions if the authorities thought they had gone ‘crazy’. To get out of a mission, all you had to do was say you were crazy and ask to be grounded. But the army considered such a request the thought process of a rational mind. Therefore, if you asked, you were not crazy…and had to fly more missions.

So are we seeing the start of another substantial equity market decline – one that will eventually ‘justify’ another round of QE? Or is this just another ‘buy the dip’ correction? If you’re a trader, the question is an important one. If you’re an investor, you shouldn’t really care. You should’ve been largely out of this market a while ago.

We’ve been saying this rally is nothing more than a liquidity-driven, fingers-crossed hope fest for a while now. Whether it peaked this week or has another leg up is of no concern.

What matters are the fundamentals. And from an investment point of view, what price you’re willing to pay for shares based on the fundamental outlook. Right now, markets are pricing in some sort of recovery and a return to normalcy. That’s idiotic. We’re so far from having a normally functioning economy that calling the current state of affairs simply ‘abnormal’ downplays the problems.

Take Europe as an example. The Europeans persist with a currency union that is clearly not working. Sovereigns around the Mediterranean are broke. Because domestic banks fund the sovereigns, the banks are broke too.

So what does the ECB do? It allows the banks to hand over their sovereign bonds as ‘collateral’ for a loan. The banks then use the ECB’s newly created cash to buy more sovereign bonds…because under bureaucratic logic, issuing more bonds will maintain the value of existing bonds.

Put in a non-bureaucratic way, Europe has dug a hole for itself. In order to get out, the authorities’ solution is…continue digging. European bond yields are rising again in Portugal, Spain and Italy. The only thing that will drag these countries out of their spiralling debt dynamics is growth. And growth is nearly impossible to generate when governments are all of a sudden asked to tighten their belts after a decade of propping up the economy with their free spending ways.

Yet the markets are pricing in some sort of recovery! If you believe the recovery is real we suggest you’re simply forming an opinion from the price action. ‘The market is up, things must be improving.’

In a centrally planned world, this is a fatal interpretation. When central banks manipulate prices and try to control outcomes, you cannot rely on price signals. That’s because the price signals are usually false and fleeting.

That’s the whole point of money printing. It’s designed to momentarily push up the price of assets in the hope of conning everyone into believing things are improving. This generates ‘confidence’…and maybe people will go out and borrow some money to buy a house or a car.

In the upside down world of a central banker, wealth generation starts with a rising asset price. That is, manipulate a price signal. Make people feel wealthy. And then hope those people go out and borrow and spend.

Yes, that’s how an economy generates wealth. Not with an idea, the creation of a product and the hard work of getting that product to market. That’s the old-fashioned way.

In our ‘everything-on-demand’ world, it’s much easier to just create wealth via money printing and let animal spirits do the rest. Because, apparently, more borrowing = more spending = a healthy and growing economy.

We’re not sure what’s more depressing. That people in a position of power think this is a viable economic structure or that those in the financial media and industry don’t question its logic.

But it’s worse than that. The central bankers’ attempts to implement their crackpot economic ideas to get money into the economy are not even working. Fed money goes to the banks and the banks deposit the funds back at the Fed.

The money transmission mechanism ceased working with the onset of the credit crisis back in 2008. Banks have trillions in ‘excess reserves’. In a normally functioning credit system, excess reserves don’t exist beyond a very short timeframe.

The fact is supply of credit is plentiful but private demand is weak. This lack of demand means banks turn to speculation to generate profits. So the financial markets become a casino.

The liquidity provided by the Fed remains inside the financial system for financial insiders to play with. The benefits don’t (and won’t) filter through to the wider economy.

In Europe, the recent torrent of money created by the ECB has gone back to sovereign governments. From there, the money goes to paying off maturing bonds with the residual funds used to maintain the broken welfare model.

And once private sector investors (like pension funds) receive their proceeds from the maturing bonds, they reinvest in German or US bonds. Once again, the money stays ‘inside the system’. That’s how the game works. Central banks create money for the benefit of governments and the banking cartel.

How do you survive such a rigged ‘system’? You can choose not to play…but that means keeping your money in the bank…which is a part of the system. You can invest in quality businesses at a good price…but prices are not exactly cheap at the moment. Australia’s economy is slowing (even if the RBA can only see it in the rear-view mirror) and China’s slowdown has yet to really hit our shores.

Or you can own the ultimate anti-system asset – gold. You may be tired of the gold talk. After all, what has gold done lately? If you bought in the last eight months you’re probably underwater. It’s fallen heavily in just the past few days.

But think about what we said earlier. In a centrally planned world, relying on price signals is fatal. The central planners like the message a falling gold price sends. And they get that message out as often as they can.

Remember back on 29 February when the gold price collapsed by around $100? That was the day the ECB announced its second long-term refinancing operation. So gold collapses as Europe prints…right.

Then, a few weeks ago, gold fell when Bernanke held out the prospect of more money printing. And just two days ago the gold price dived when the Fed indicated there would be no more money printing.

If you think that’s the free market price of gold responding in exactly the same way to different monetary signals then the central planners are doing their job.

The fact is gold is anti-system, anti-establishment and anti-central planning. The king of central planners, Vladimir Lenin, hated gold so much he wanted to build a toilet out of gold.

So the central planners manipulate the price of gold at opportune times to throw people off the scent. They can’t stop the long-term trend, but they can create confusion and doubt among gold investors.

Don’t be put off by these false signals. If you’re a gold investor, realise you’re up against the ‘system’. It’s going to get dirty. But the only way of beating the system is to hold on.

So grip tight and good luck. The gold bull market is going to be a wild ride.

On that note, have a happy and safe Easter long weekend.


Greg Canavan
for Markets and Money

From the Archives…

Why BHP Should Be Bracing Itself For a China Slowdown
2012-03-30 – Greg Canavan

What Does “the Market” Mean to You?
2012-03-29 – Joel Bowman

Why Australian House Prices Are Set to Crash
2012-03-28 – Dan Denning

Why US Manufacturing Could Be Made in America…Again!
2012-03-27 – Chris Mayer

The Best Real Estate Bets
2012-03-26 – Eric Fry

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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Do you see silver as a viable option as well greg?

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