Fed vs History

The Age reports on the downside of a soaring Aussie dollar. Apparently, it will be putting a damper on profit results of exporters. But what is the RBA to do? With the economy performing well, there is little room for the money printing that other central bankers are enjoying.

This is quite an interesting dilemma and we can’t see any policy solutions. Then again, the issue is likely to “solve” itself according to this statistic:

Based on the net speculative positions in the USD there is a 100% chance (based on past occurrences) that the dollar will rally from here. According to a report today from Credit Suisse the US dollar has rallied 100% of the time from these levels on a 3 month basis. On a 1, 2 and 6 month basis it has rallied 80% of the time.

That lends support to an epiphany we had in the Supreme Court of Victoria: Nothing has changed!

Three years after the crisis began hotting up, we face exactly the same issues. Mortgage issues in the US are the big hint. And Australia is plodding along nicely, as it was leading up to the hullabaloo of 2008.

This time is different (wince) because central bankers had their dress rehearsal and now know exactly how to go about their business during a crisis. Their business is, of course, money printing.

CNBC reports “Fed Undaunted by Uncertain Prospects for Money Printing,” with Thomas Hoenig, the president of the Federal Reserve Bank of Kansas, whinging more than ever about how this will end in tears. And we will whinge with him, because we agree that QE is not going to do any good.

Word is that the markets have already priced in some QE anyway. But “if financial markets have already priced in several trillion dollars worth of quantitative easing from around the world, where can markets realistically go from here,” Dan asked on Tuesday.

Oh and by the way, QE has snuck in the back door already, reports Reuters. But let’s gloss over that.

Wait. Something more sinister is afoot. If you have heart problems, skip the next paragraph.

“The Fed also said for the first time that it was considering targeting a path for the level of nominal gross domestic product as a way to increase price expectations.”


Some of you may not be familiar with nominal and real measures. Think of it this way: Nominal = real + inflation. It works for GDP and interest rates. For example, with a real interest rate of 3% and inflation at 2%, you get a nominal rate of 5%. That 5% is what you will see quoted in the paper.

The importance of this is as follows. If you have nominal interest rates at 1% and inflation at 2%, you get a -1% real interest rate. So, you can borrow at 1%, buy stuff, which will increase in price at 2% and you make a 1% profit by simply waiting! This is the state most of the economies of the world are in. Free profits! At least for the bankers, who have access to the 1% rate.

Going back to GDP, targeting a nominal rate of GDP growth means that inflation will make up the difference of any amount that real economic growth can’t measure up to. If the economy is shrinking by 1% and the Fed’s nominal GDP target is at 3%, they would aim at creating 4% inflation! The worse things get, the higher the Fed will push prices – just what you don’t want during a contraction!

This isn’t just stupid. It’s ridiculous. Art Cashing from UBS points out where this sort of policy ends:

Originally, on this day in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to “jump start” a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental “more is better” theory they simply created more and more money.

But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity).”

That’s why the head of the German Bundesbank is trying to inject some sanity into the QE debate. Axel Weber said the risk of “exiting too late” is greater than the danger of “exiting too early.” Weber is a known inflation hawk and ECB President hopeful. This won’t get him votes with the governments struggling to fund their deficits at current rates.

But the point is that both the Fed and the ECB have known inflation hawks who could restore sanity. Singapore’s central bank is a current example of being willing to lower inflation despite economic contraction. The problem is that central banks are inherently insane, so the world’s respite from the money printers would only be temporary. There will always be another Greenspan in the ranks, just waiting for a chance to be credited with brilliant monetary management, which turns out to be a bubble.

Legendary investor Jim Rodgers reckons he knows how it will end for the Fed. He pointed out that both of the US’s previous central banks disappeared and the Fed would go the same way. Why stop there? “Rogers also called for an audit of Fort Knox and raised questions as to the quantity and quality of the gold there.”

But why mention gold? Well firstly, thanks to the readers who answered a couple of ignorant comments about gold on our published article last week. You were spot on. Gold isn’t an investment we spruik. Its insurance we suggest. It’s not something we want to profit from. It’s something we want to keep to sleep deeper at night. You see, gold is money. It has certain qualities that make it ideal for this purpose. Check your economics textbook and you will find them in the first chapter. Something like divisibility, homogeneity, store of value, …

The point being that, in times of crisis, gold derives its value from its characteristic as being good for use as money. It is held to offset falls in everything else. It’s like holding cash, except safer. Price fluctuations have little to do with whether gold was a successful addition to your portfolio. This is because you would only sell it at a time when the price is high because of a crisis. It will, by definition, perform exactly when you want it to. Like in the past decade, when stocks have gone all over the place. And Gold? Need we mention the record high?

And if you’re not convinced, you can examine a long time gold investor’s reasoning here. Moses, Incas, angel’s wings, and three wise men are just some of the reasons gold bug Mr T mentioned on Bloomberg.


The foreclosure madness continues in the US. Foreclosuregate has everyone looking over their shoulder, unlike subprime, where you had to look under your rug. Basically, the story is that the banks have been using “robo-signers” to complete foreclosures. That led to mistakes, including foreclosures on houses that weren’t delinquent. The mainstream has been covering it all pretty well and not many revelations to add from our end. But the implications of it all are the muddled part.

You see, much like subprime, this mess has tentacles extending to the entire economy. It’s going to go systemic… if government abides by its own laws. But that’s not likely, so expect some political interference. Dan discussed the whole debacle on Wednesday.

Only a politician…

The NY Times reports that “Mr. Obama and the Democrats escalated their efforts to present the Republicans as captive to moneyed interests.” Now this seems a rather odd time to be doing so. Here is why:

  1. Obama is expected to sign into law bill HR3808. Tyler Durden of Zero Hedge reports that the legislation will let banks off the hook for fraudulent foreclosure practices which could cost them billions in legal costs and damages.
  2. 30 big corporations, including McDonalds, are expected to be granted a form of exemption from Obama’s piece de resistance, his healthcare bill. All they had to do was ask nicely.

Now let’s be clear. Like the American public, we have about equal feelings towards Bush and Obama. So don’t go accusing us of taking sides against Obama and his hope(less) message. But clearly Obama has pulled ahead on the hypocrisy count.

Risk free

A fundamental concept of the academic world of finance is the risk free rate. You will see it in most equations. And the convention is to use a US treasury security as a proxy for what interest rates on a “risk free” security would yield. That could be changing. Bloomberg reports that the US has a rival for the risk free proxy. Guess who…

“At a time when governments around the world are facing growing debt, China’s bonds are becoming almost as safe as U.S. Treasuries in the market for insuring against defaults.”

This may seem “academic”, but the implications of having a reserve currency without the risk free proxy rate denominated in that currency are rather intriguing. This could be the signal that Bretton Woods is coming to an end.

Go stand in the corner… with the cash!

Last week we reported that the European Commission laid bare Greece’s true debt and deficit figures, sans Enron practices. As a disciplinary measure for their misleading reporting, “The International Monetary Fund may transform its loan to Greece into a longer-term repayment plan, a move that would allow the country to pay its loan back later without restructuring, European Central Bank Executive Board member Lorenzo Bini Smaghi said.”

Ok, ok, so maybe the Greeks just need a hand up. It is a loan after all, not a gift. Fool me once, shame on you, and all that. But hold on: “Greek markets have been battered since the end of last year when the newly elected government led by Prime Minister George Papandreou said the budget deficit was twice as big as the previous administration indicated.”

How does it go? Fool me twice…?


Check out this link for a map of the world in debt terms. You will notice that Australia is the same colour as PIIGS member Spain and basket case Hungary. That’s supposed to indicate we are just as bad in terms of public debt.

Not that the Economist’s oddly named Intelligence Unit is terribly good with these types of animations. Recently they suggested rearranging Europe so that similarly indebted nations could be close together…


We may have a new favourite central banker. Not sure who the old one was, but Janet Yellen, Vice-Chairperson of the Federal Reserve, came up with some cracking admissions in her first speech after taking up her role. Last week served as an expose on how central bankers speak. This week is no different, so we will provide the English translation alongside the Fed-speak.

Janet Yellen’s Fed-speak Markets and Money Translation
It is conceivable that accommodative monetary policy could provide tinder for a buildup of leverage and excessive risk-taking in the financial system. Alan Greenspan made a huge mess of the global economy leading up to 2007 by keeping interest rates too low. The crash was his fault. The Austrian School economists were right. On behalf of central bankers around the world, I apologise.
We need macroprudential policy makers ready to take away the punch bowl when the party is getting out of hand. But we’re not finished yet! Give us more power!
Monetary policy cannot be a primary instrument for systemic risk management. But don’t hold us accountable when we do stuff up again.
A first-order priority must be to engineer a stronger, more robust system of financial Despite what those who predicted the crisis say, we need more regulation. Having been proven
regulation and supervision, one capable of identifying and managing excesses before they lead to crises. wrong on all other counts, we can’t change our mind on this, or we would end up losing our job and purpose in life.
We know that market participants won’t take kindly when limits are set precisely in those markets that are most exuberant, the ones in which they are making big money Having acknowledged we caused the crisis, we would like to punish someone else.

Anarchy vs Billing

During the week, we attended the admission ceremony of the latest batch of lawyers to haunt the state of Victoria, in our capacity as handbag minder of one of the budding lawyers. We had the privilege of hearing the Chief Justice Warren outline the importance of lawyers to the rule of law. Not too many objections there.

But then the Chief Justice got herself a bit lost. “Without lawyers, there would be anarchy” was the gist of her speech. Hmm.

Not long ago, a friend and French law student explained that even anarchists have strict laws and rules that must be abided by. They just don’t believe those laws need meddling with by politicians. And they don’t think laws should be so complicated that you need lawyers to interpret them. That makes a state of anarchy look a lot less miserable than one where you need a lawyer to do anything legally.

As we watched the lawyers swear themselves in for a career of service to the court and their clients, we couldn’t help but imagine what all those lawyers could achieve if they didn’t spend their time following the directions of those who got themselves into a muddle. Imagine the diseases they could cure if they didn’t spend their time suing pharmaceutical companies for the side effects of a life saving drug. Or the music they could write instead of prosecuting online peer to peer distributors.

Then again, it seems lawyers have a tendency to end up as politicians if they give up the legal profession, so maybe we should keep them where they are.

But we can’t whinge too much, or Saturday afternoon could be a tense one. Besides, our colleagues down the hall are helping those who find the law a burden by creating guides and updates on changes to the law.

Until next week,

Nickolai Hubble.
Markets and Money Week in Review

Nick Hubble
Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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Neal Vanderstelt
Hello Australia. Very good article. If you get a chance come by and see my blog. I have the latest charts on the Dow Jones. “That’s why the head of the German Bundesbank is trying to inject some sanity into the QE debate” Unfortunatly there is no sanity to the debate. They have 2 choices: 1 correct things now and the big banks will go belly up and other undesirable things will happen economically. This is the result of pushing the buck too far. Eventually things will level out with reasonable policies put in place but as it stands it’s… Read more »
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