Here it is. It’s the video that started a World War last week. Watch it while you still can, before Communications Komissar Stephen Conroy has it banned.
Ben Bernanke’s press conference last week — that’s the incendiary video we’re talking about — doesn’t look and sound like a declaration of war on the Middle Class. But that’s exactly what it is. It’s also the latest campaign in a global currency war that will demand a response from Europe, Japan, China, Russia, and maybe even the Reserve Bank of Australia.
You’ve probably seen all the gory details by now. But if you haven’t, let’s quickly get you caught up on what the Fed said and did, and then what it means. You can bet the markets will rally a bit out of sheer drunken euphoria. But the party atmosphere won’t last.
First off, the Bernanke did not announce Quantitative Easing three, or QE3. It announced open-ended money printing, forever and ever amen! The Fed will purchase US$40 billion a month in mortgage backed securities (MBS) and continue ‘twisting’ its portfolio of US Treasury bonds and notes to longer maturities. All up, you’re looking at around $85 billion a month in bond purchases.
Bond purchases, as you know, are loans. You, the creditor lend money to the borrower. The money has to come from somewhere, unless it isn’t real money. In this case, the Fed will create money to buy MBS from banks and secondary mortgage lenders. Its open-ended purchases of US government debt will also be financed by money that does not yet exist.
It didn’t take markets long to figure out how inflationary the Fed’s new policy may be. Egan Jones, the only truly independent credit rating agency going around, cut the US government’s credit rating from AA to AA-. Earlier in the week, Moody’s warned it could downgrade the US again if the Congress and the President didn’t steer the US away from the looming ‘fiscal cliff,’ where taxes will rise at the end of the year.
A downgraded credit rating works against Ben Bernanke. It pushes interest rates up on US government debt, making it more expensive for the US to finance its world-class deficits. But since the Fed intends to provide all that financing anyway, if it must, then maybe Bernanke doesn’t care what Moody’s or anyone else thinks of the US credit rating.
Bernanke wants a weaker US dollar. He seems to believe that if he drives the dollar down low enough, he’ll make US labour competitive with global labour, leading to a turnaround in the American unemployment rate. In order to save the American economy, it will be necessary to destroy the dollar!
Yes, yes, that sounds crazy. But remember, the Fed also thinks the keys to an American recovery are higher asset prices (stocks and houses) and better communication (telling people rates will stay low until 2015)! Pay special attention to Bernanke’s answer at 17:18 in the video to see what we mean.
Bernanke admitted that monetary policy ‘is not a panacea’. Lower interest rates don’t create jobs any more than ice cream produces weight loss. But he’s committed to this course anyway. And when you remember who he works for, it makes sense.
The Fed is owned by its member banks. The MBS purchases directly support bank balance sheets. And the banks can make money borrowing from the Fed at zero percent and loaning money to the US government. It’s free profit, courtesy of the institution that has monopoly on money printing.
Someone will pay the price, though. Aside from the US middle class, it also puts everyone else in the world on the defensive. A weaker US dollar means a higher Canadian and Aussie dollar. It means exporters in Japan and China will have to match the US dollar weakness to remain competitive. One bad turn deserves another.
Speaking of Japan and China, remember that territorial dispute we mentioned last week? Chinese patriotic anger appeared to increase over the weekend. A Panasonic factory was set on fire in Qingdao and a Toyota dealership was looted during protests in over 50 Chinese cities over the weekend, according to the New York Times. Protestors again gathered outside the Japanese embassy in Beijing and some threw rocks and eggs at it to vent anger at Japan’s move to buy the disputed Senkaku Islands in the East China Sea.
You’d think it’s highly unlikely that Japan and China would resort to armed conflict to settle this dispute. But stranger things have happened. It’s more likely to result in economic warfare, as it did a few years ago when China unceremoniously cut off the export of rare earths to Japanese electronics manufacturers.
Or maybe the whole island dispute is related to the political succession crisis in China. China’s heir-apparent, Xi Jinping, resurfaced last week after a strange public absence. But Agence France-Presse reports that the Senkaku dispute could be a play by the outgoing Hu Jintao to stay in power. Or, it speculates, the crisis could be the Chinese military asserting itself in the absence of a smooth transition in the leadership of the Chinese Communist Party.
It’s all pretty opaque. And from an Australian perspective, it makes it difficult to predict how China’s new leaders (whoever they turn out to be) will respond to Bernanke’s slash and burn dollar warfare. No matter who takes over the leadership, though, they will have trouble matching Bernanke’s money printing without reinflating China’s housing bubble.
The RBA has a part to play in all of this as well. The Aussie dollar went right back up to $1.05 against the USD. The stronger the Aussie is, the more it smashes retailers, tourism, and manufacturing. And with the detritus of the burst mining boom still settling, the bank will start to get more political pressure to intervene in currency markets and weaken the dollar.
Interesting times, aren’t they?
And of course, we haven’t even mentioned the fact that the Arab Spring has turned out far differently than everyone was hoping this time last year. We’ll have more on that tomorrow. It’s a story with investment implications (energy), and political ones too. Stay tuned.
for Markets and Money
From the Archives…
Be Very, Very Scared
14-09-2012 – Greg Canavan
How QE Favours the Rich
13-09-2012 – Bill Bonner
To the Barricades!
12-09-2012 – Dan Denning
The Power of Pork
11-09-2012 – Dan Denning
Waiting on Beijing
10-09-2012 – Dan Denning