Qualitative Easing from Jackson Hole

Once again, everything is backwards. The worse news gets, the higher markets go. That’s because it brings government meddlers with their wacky ‘solutions’ back into the fray. (The irony here is that the rallying markets, anticipating the wacky solutions, make those solutions seem less necessary to those that might choose to implement them. Hence the bipolar nature of markets these past two weeks.)

Mr Market is under siege from all the institutions and authorities created by men. They lob their legislation over the walls, set off money bombs under the walls and try to bribe the gatekeeper with something they call stimulus.

But Mr Market doesn’t eat, drink or sleep – and he has one hell of a life expectancy. So you know he will be the last one standing. It’s just a matter of time before the rest of us give up on telling him what to do. That doesn’t make what goes on in the meantime less interesting. So let’s take a look…

Credit default swaps on many bank bonds around the world, known to you and me as insurance against their default, are priced higher than they were in 2008. That implies the likelihood of their default is at its highest yet.

The Telegraph gives a big hint as to why things are worse this time around: ‘The cost of insuring [Royal Bank of Scotland] bonds is now higher than before the taxpayer was forced to step in and rescue the bank in October 2008.‘ That’s because, this time, there may be no money for bailouts.

Over in Germany, it’s the politics that is causing the issues. One German minister called for Greece to put up gold as collateral for any more German bailout lending. She was promptly shushed up by her parliamentary colleagues. But Germany’s renowned politicians of the past – and some who hold largely symbolic office only – are taking Chancellor Merkel’s government to task. Their theme is ‘don’t spend it all at once,’ or as a gambler would translate it, ‘don’t go all in.‘ The gamble they are referring to is saving the rest of the EU.

Then there is the German Constitutional Court, which is still deliberating on the legality of all this bailing out in the first place.

Remember, without an ironclad commitment from Germany, Europe is in trouble. Well, more trouble than it would be in with German backing.

One brief respite from the world’s woes came when an earthquake hit Washington D.C. As staff from the Pentagon and the White House were evacuated, the Libyan campaign was victorious and the stock market rallied massively for the day. We’ll leave you to draw your own conclusions.

Looking back to more serious economics, the list of maladies continues. Economic indicators, which have all sorts of strange names that make your eyes glaze over, like Empire State Index, are pointing down. Many quite firmly indicate a recession is in the US’s near future. Remember, it took the US nine months to realise it was in recession from December 2007. So they may already be in a recession. One that is beginning with debt levels that make fiscal stimulus and bailouts questionable.

But as you read this, Federal Reserve chairman Ben Bernanke will be practising his Jackson Hole speech. Or washing the dishes, which he claims to do regularly.

The world will be awaiting his decision on whether or not to increase monetary stimulus efforts to the world economy. (The US dollar is the world’s reserve currency and banks from around the world, including Australian ones, enjoy emergency lending facilities at the US Fed. So, any decision there affects us all.)

The irony in this is that the Fed and its fellow conspirators, including the European Central Bank, the Reserve Bank of Australia and the pioneering Reserve Bank of Zimbabwe, are supposed to promote stability. Price stability, output stability, employment stability and so on.

But when Bernanke gives his Jackson Hole speech, markets will either jump or tank depending on Bernanke’s decision (or indecision). Call that stability?

Not that anyone knows what will happen if Bernanke decides to stimulate or not, or continues with ambiguity. The previous two Quantitative Easings ended up having the opposite effect to their intended purposes. QE1 was about suppressing interest rates, but they rose. QE2 was about the wealth effect, where rising stock prices encourage spending. The market is below the level it was at when QE2 was announced.

Of course, that didn’t stop central bank apologists from justifying the sequence of events in their favour. Usually they come out with the old ‘it would have been worse if we didn’t do it‘ chestnut. The fact that the counterfactual is never known in economics is a perfectly good point. But it invalidates the mathematical models the intervention was justified upon.

When the free market reigned over the interest rate, at least to a greater extent than it does now, economic events were not determined by men who do the dishes. In fact, not by men at all. Instead, the market determined the price of money. Supply (the savers of money) met demand (the borrowers of money). There was no central bank to fiddle around with the supply and demand, so the interest rate simply balanced the two.

Of course, it wasn’t only supply and demand. The weather was important too. Most borrowing, for much of Britain’s most prosperous era, was done by merchants. And so when the flag outside the Bank of England was pointing downstream on the river Thames, people knew that a lot of borrowing and lending was about to take place, as money was needed to fill up departing ships with merchandise. Then, when the flag turned to point upriver, a lot of repayments would be flooding in to repay loans after ships returned from successful commercial ventures.

Everyone could tell, based on the direction of the flag, what the nature of the day’s business would be. Today, nobody has a clue what Bernanke will come up with.

Our guess is that it will involve the banks. That’s because they have been in trouble lately. (As discussed above.)

So how might the Federal Reserve help out the struggling banks without inciting more public rage? (Presidential candidate Rick Perry threatened Bernanke with physical violence if he prints more money a few weeks ago, which is an entirely new tactic.) The best way to snuggle up to its owners (yes, private banks own the Federal Reserve) would be to do what economist Philipp Bagus calls ‘Qualitative Easing’. That’s when the central bank swaps high quality assets for the banks’ poor quality assets. That improves the position of the banks.

Not necessarily in the way you would expect. Here is how it works: Central banks can hand out cash to banks if banks lodge collateral with them. That collateral has to be of a certain quality, based on the ratings agencies’ ratings. So what the central banks do is swap high quality assets on their own balance sheets for low quality assets on the private banks’ balance sheets and then use those high quality assets as collateral in lending agreements. This leaves the central banks holding the low quality assets and the banks holding the cash, with the high quality assets posted with the central bank as collateral. All without violating the rules of how central banks are allowed to operate.

This is already taking place in Europe with Greek bonds, where the bailouts are not simply handing out money, but handing out assets that can be posted as collateral with the ECB, which then hands out the money.

If you’re confused then you’ve discovered why they do it all so complexly.

Most likely, this sort of thing is going on in the US already.

But rather than berating the Fed for the terrible nature of all its intervention, we’ll accentuate the positives.

Blogger Bruce Krasting explains how some Fed economists have made themselves useful:

The San Francisco Fed has come out with a research paper connecting the dots between the retiring baby boomers and stock prices. The thinking is that the boomers will divest themselves of stocks as they retire and eat into their savings.

[Their] conclusions are just horrendous! The suggestion is that there is a 15-year bear market in front of us. [Price to earnings] multiples will fall by 50%.’

Our guess is that much of the same will apply here in Australia. From memory, the US’s demographics aren’t as bad as our own. Nor were Americans forced into superannuation-type investing to the same extent.

Oops. We’re not supposed to mention super.

Usually, licences allow you to do something. Driving licences allow you to drive. Gun licences allow you to shoot. But Australian Financial Services Licences do the opposite. They prevent you from doing things. If our publishing firm, Port Phillip Publishing, didn’t have an AFSL, we’d be able to write about superannuation all we liked. But because we have one, we can’t.

We can however, write about retirement savings. But that’s toeing the line a little too close for a goody two shoes like us.

So here goes:

Isn’t it rather telling that the most marketable benefit fund management companies can come up with regarding your government-mandated retirement savings is that they can find them?

Seriously, take a good look at your TV screens, advertising mail and tram stop billboards. Everywhere you look, the biggest Aussie funds management companies are advertising their ability to find your lost super, erm… retirement savings.

Our fingers are tied with red tape on this topic, so we will finish with a ‘happy birthday’ to Slipstream Trader Murray Dawes, whose subscribers are in several risk-free positions, awaiting Bernanke’s speech. That means they have taken enough profit on their trades so far that the overall position cannot lose money, but is poised to make a packet if the markets moves as Murray expects.

To find out what Murray expects will happen next, check out his YouTube channel here.

Until next week,

Nickolai Hubble.
Markets and Money Weekend Edition

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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2 Comments on "Qualitative Easing from Jackson Hole"

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Australian demographics actually look quite good compared to China and Japan.

Alexander Malejew

Well, yes our top heavy ‘Baby Boomer’ demographics are indeed slightly better than Japan and the PR China, but those are horses in the glue factory!
Better to compare ourelves with other countries, say Canada for example.

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