Shock and Awwwww

–Gold breached a record $1,400 last night and continued going up!

–Seriously, could The Gold Symposium have come at a better time? With someone as high up as Ben Bernanke practically sponsoring the event, it just had to be a success. But not everyone is convinced of the central banker’s omnipotence. The German Finance Minister called him “clueless” and the Chinese are starting to feel a little queasy about all that Treasury debt.

–One question we still can’t find an answer to is why the Chinese are concerned. They bought all that Treasury debt with printed Chinese money in order to devalue it. Say the Chinese government takes a billion dollar loss on its treasury holdings, what does that matter? Paper came, paper went.

–But don’t go confusing this as an argument for the “neutrality of money”. That ridiculous theory contends that money supply manipulation won’t have a long run effect because prices will simply adjust to the amount of money in the economy. In other words, housing bubbles will correct themselves before they get out of hand.

–On that note, we had an epiphany recently…

–It seems remarkable that Austrian economists used housing in many of their examples for how bubbles form in an economy as a result of poor monetary policy. Those theories were written up decades ago. “What a coincidence” we used to think sarcastically. But the insightful part is that this is the logical asset class to pick for a bubble. Why? Because Austrians believe the interest rate is a key part of why bubbles form, which means highly leveraged asset classes would be most impacted. And there are few things more highly leveraged than housing. (Lehman Brothers comes to mind.)

–The other thing to point out is that as leverage increases due to expectations, prices will rise; the bubble goes exponential because the interest rate effect is even larger.

–So if you accept that interest rate manipulation causes bubbles, you have to wonder what the Federal Reserve is thinking. Like mental health doctors from years gone by, it seems some central bankers still believe in electrocution. “Shock and awe policy,” finance professionals call it. From the market’s perspective, it’s more like “shock and awwwww.”

–Digging down a little further, there seems to be a misconception that the Federal Reserve’s asset purchases are an ineffective stimulus because the new money will simply join the existing reserves on bank’s balance sheets. In other words, it won’t be lent out to revive the economy. It will simply be hoarded.

–The comparison often made is with China’s stimulus, which was roughly the same size. There, the central bank’s new money was used directly in infrastructure spending, spurring growth as far as Australia. But the comparison makes a common mistake. The big hint is that the announced QE2 plus already planned purchases “would be roughly in line with [the US’s] estimated budget deficit ($1.15trn) for fiscal 2011.”

–Here’s the kicker: “So, the Fed would be absorbing virtually all of the net new Treasury issuance as long as it maintained this pace of purchases.” David Greenlaw of Morgan Stanley, who uttered those words, has it figured out. The Fed may not be purchasing the government’s debt directly – note Greenlaw uses the word “absorb”. But the Fed is purchasing the government’s debt, which creates a hole on bank’s balance sheets that can be filled by newly issued government debt.

–The only net difference to having the Federal Reserve purchase the debt directly from the Treasury (the Chinese method) is that banks can make a profit in the meantime. Oh, and the Fed gets to keep its allure of independence to fool people.

–Let’s make this clear. The Federal Reserve is monetising US government debt. It’s doing it in an underhanded way. It’s handing out free profits to banks by letting them borrow at 0% interest and then invest at the government bond rate.

–And it’s got the public fooled – except for Gold Symposium delegates that is!

–But it’s probably too late to join the celebrations there. That doesn’t mean you need to miss out on the torrent of money that will be flooding into world markets. Holding gold has never been more fun, but holding carefully picked small cap stocks in times of monetary madness still trumps it.

Nickolai Hubble.
Markets and Money

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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4 Comments on "Shock and Awwwww"

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“Like mental health doctors from years gone by, it seems some central bankers still believe in electrocution. ”

Hate to burst your bubble ( so to speak ), but electro shock therapy is alive, well and still being used on a daily basis here in Oz.

Apparently it actually works.


@ geo, no wonder prozac is hiding out in the UK! :)


Or elocution, in Ra-l-l-l-ph-h-h-h’s case… .


Geo electroshock therapy is not used unless other forms of treatment fail. It isn’t a go-to remedy. It’s a method of last resort.

And to the point, yeah gold will keep going up.

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