Yesterday we left off with the question of what happens to Australian stocks when the Fed ends its Quantitative Easing program later this month. It’s probably not that hard to figure out, once you think about it. The Fed has pumped over a trillion dollars into the mortgage market. Do you reckon some of that found its way into the stock market?
What’s more, if banks could borrow from the Fed at 1% and loan to the Treasury at 3%, that’ a nice little interest rate spread. That money could be dumped right back into the stock market too. It’s not exactly risk-free. But with the Fed on your side, a bank would be in the position of rebuilding its balance sheet slowly.
In any event, we reckon the end of the QE program will lead to falling stock prices. In today’s essay, our colleague Greg Canavan takes up the issue. He reckons the end of QE calls for a two-part strategy: get out of the way of falling asset prices and build a cash position is the first part. That’s where we are now.
The second part is picking through the rubble of an asset price crash for the really good stuff. In order to do this, you have to know how to value stocks. Of course if you get your timing right, you just buy a broad basket of stocks at the exact bottom and ride the elevator up. This is more of a trading strategy, and it’s what Slipstream Trader Murray Dawes is engaged in on a full-time basis
But for our part, we think the days where everyone can passively surf the index to higher and higher share prices are over. You’re better off finding companies that make good use of your capital and deliver higher returns on equity. Greg’s got his take in his article.
China’s Wen Jiabao has told the Americans to stuff it, although not in so many words. At a two-hour news conference in which he warned that removing stimulus too early would lead to second dip in the global recssion, Wen also defended China’s currency manipulation. Defying the global consensus, Wen said, “I don’t think the yuan is undervalued. We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency.”
In a floating-exchange rate world, no one forces a currency to appreciate. If people don’t want to own it for yield or sound monetary and fiscal policies, it’s hard to “force” a currency to rise. You can, however, forcibly depreciate your currency by selling it and buying others. And that’s exactly what China’s been doing for years.
To be fair, China’s currency manipulation is a form of economic stimulus. It’s just less direct than Kevin Rudd’s method of giving people money. By pegging it’s currency to the U.S. dollar, China engages in a kind of perpetual devaluation. It preserves the price competitiveness of Chinese exporters. And more importantly for China’s economy, a humming export engine keeps employment high, achieving the primary goal of political stability.
But there’s no doubt that China’s policy is costing jobs in the Western world. To be fair, the U.S. is also a world-class currency manipulator. The central bank sets the price of money and, from time to time, considers how to keep the gold price from appreciating and exposing its fiat fraud.
And the U.S. is the only country in the world that enjoys the luxury of paying off its debts in the same currency that it alone can print. That is a privilege without peer in the global economy. The U.S. has enjoyed that privilege since 1971 because of its military and economic dominance and, to a lesser degree, because the rest of the world needed to do business in a stable currency and the U.S. dollar (for the most) part, fit the bill.
It doesn’t fit today. And that’s why everything is coming unstuck. As Bill shows below, U.S. tax receipts currently cover the cost of servicing the outstanding debt. But if, as we mentioned yesterday, market-based 10-year yields spike anywhere near where they did in the late 1970s, the cost of servicing the debt would eat up nearly all the current tax receipts.
After that, there’s only so much a government can realistically do. Printing money – radically devaluing the currency – is the only way out (if you’re not going to adopt Greek-like austerity measures on spending, which we don’t expect anyone in America at the government level to willingly do.)
Of course in the meantime, the deleveraging of the household and private sectors (see the 2009 in total credit market debt) is driving current demand for the dollar. That and the weakness of the euro. While these trends can see-saw a bit – don’t be surprised to see a euro rally on some kind of short-term Green band aid – it’s important to see the currency movements for what they are. And what are they?
Chimeras. The super cycle in paper money is blowing up. Currencies are moving relative to one another. But our guess is that relative to gold and tangible things, all of them will lose value. The dollar is bad. But it is less bad than the euro at the moment. And vodka and gold are less bad than the dollar.
But have we unintentionally made the argument for deflation? One reader thinks so.
“Your argument is incredibly difficult to follow because most of it seems to be a damn good argument for deflation. You finally get to the point that because deflation actually is happening, due to the failure of the private sector (the banks) to dole out the credit into the economy, then the government will do it itself. You then expect us to believe that the government will be more successful than the private sector at doing this. This is an extraordinary argument from Markets and Money. Both you and Bill Bonner have been at pains for years to point out that government simply cannot do things as well as the private sector. Now you expect us to believe that they can revive credit markets. Have you gone over to the dark side? Are you now the new marketing arm of government?”
Nick. We don’t work for the Feds. Neither do we think the government will revive the credit markets. We think the government will replace the credit markets. What else are the nationalisations of the auto sector and mortgage markets about if not the elimination of the lender as the middle man.
It’s true that if lenders don’t want to lend and borrowers don’t want to borrow, achieving credit growth would be impossible and asset deflation and deleveraging would rule the land. But we’re advancing the argument that the response of the Feds will be to simply print money and give to people. This destroys the currency, rather than increasing the value of cash and Treasuries, as the deflationists argue.
Yes, we admit this is speculation about future government policy. But Australia previewed this strategy. The difference is that Kevin Rudd gave away money Australia had. Barack Obama is spending money out of an empty pocket. The argument against this is that the bond market would not permit such a policy and would immediately send yields sky high.
We don’t dispute this. But we think the big winner here is gold more than cash. A direct monetisation of the U.S. job market can hardly be the sort of thing that’s bullish for the U.S. dollar. And if the confidence game in the dollar is up, then the moment when people are willing to trade paper money for tangible goods at any price (the Misean “crack up” Greg cites below) can’t be far away.
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