Everything in the financial world just keeps getting stranger and stranger. The sea of credit that floated the world’s asset markets for the last twenty years is evaporating and receding. It’s leaving some assets high and dry. And it’s causing investors to herd themselves into a narrow isthmus of bonds that are perceived as “safe.”
But let’s not be so cryptic. Let’s deal with the Federal Reserve’s announcement today that it would sort of extend its quantitative easing program; the one begun last year. It wasn’t exactly QEII, and for that reason the market didn’t quite know what to make of it. Is it time to flee risk assets and pile into bonds? Or is this more free money to change your life?
What the Fed said in its statement is this:
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.
What does that mean? Well, that means the Fed is going to “roll over” its existing holdings of Treasury, Agency, and mortgage backed securities, and, for now, keep the asset side of its balance sheet north of US$2 trillion. The anti-deflationists at the Fed (pro-inflationists) believe that not rolling over the debt will lead to a further contraction in credit and the U.S. money supply, which would lead to contracting GDP too.
Of course, when households and businesses pay off their debts and borrow less based on their unease about the future, of course it’s going to lead to lower growth (and probably higher unemployment). This is what happens on the downside of the business cycle and in a balance sheet Great Correction. You put your financial house in order.
But the Fed doesn’t want prudence. It subscribes to the blinkered Keynesian worldview that if households and businesses aren’t buying, the government must stimulate demand. It presumes that buying Treasury bonds from banks and institutions will force cash into the economy and that cash will go forth and multiply. The cash is being stubborn though, and is desperately clinging to short-term government debt.
So here we are treading water stagflationally. There’s not much more to add to our core argument that, absent some unexpected surge in US growth, the Fed is going to have to go unconventional on the economy and find a way to monetise debts and/or lend directly to households. But in the meantime, the very sad fact for U.S. savers is that they are getting smashed because of low yields.
The even sadder fact is that the giant risk-aversion that’s implied by the Fed’s negative outlook on the U.S. economy attracts an ever larger number of investors into the death-trap that is the U.S. bond market. Of course if you believe that deflation is inevitable, then short-term bonds and cash are the goer. As we explained in last week’s e-mail update to Australian Wealth Gameplan readers, deflation is not politically acceptable. Money will be created by the Fed and spent by politicians, whether it exists or not.
A good example of this is the $26 billion emergency blah blah blah package passed by the U.S. House yesterday and signed by the man presiding aloofly over America’s fiscal decline, President Obama. The emergency bill forked over $11 billion to U.S. States to pay teachers. Another $16 billion increased Medicaid payments to U.S. States so the States can pay other people, like fireman, police officers, and valuable public workers sitting at desks.
The States are the Federal government as Greece is to the European Union. In fact, America’s sovereign debt crisis maybe a trickle-up affair, as States and municipalities pass the buck on up the ladder to Uncle Sam. This is why, deep down in our contrarian bones, we know the U.S. dollar is doomed as a store of value.
What about here in Australia, though? The amount of money being lent for housing fell by 3.9% in June according to the Australian Bureau of Statistics. It was the lowest amount for housing finance since February of 2001, which was over nine years ago. What does that tell you?
It tells you that the largest factor on “underlying demand” for Australian housing is the price of money. When the price of money is cheap, the demand for housing goes up. When the price of money goes up, the demand for housing goes down. This insistence that there is a structural shortage of housing in Australia is the rubbish you get from spruikers at the height of a credit-fuelled bull market. Spruik on!
for Markets and Money