After last week’s Jackson Hole speech, expect to see Ben Bernanke sporting a sling the next time you see him. There is simply no way he could spend that long patting himself on the back and not suffer at least a sprain. The monetary yoga master asserted that the Fed’s non traditional monetary policies were responsible for creating 2 million jobs and raising output by 3% despite the US economy remaining in the downward facing dog position 4 years after the onset of the crisis. Of course, those numbers are based on simulations run through the same economic models that produced a stock bubble backed up by a housing bubble and a financial crash so you’ll have to excuse me while I hunt for a large enough grain of salt to make that analysis palatable.
Helicopter Ben offered up a cost benefit analysis of Large Scale Asset Purchases – quantitative easing or money printing in the popular lexicon – that – unsurprisingly – found the benefits large and the costs manageable. I suppose if one has a government car and gas card at one’s disposal, a stock portfolio, a derivatives trading department, access to the discount window or happen to be sitting on some oil reserves, it would be easy to come to that conclusion. For most Americans, who have none of those things, the benefits of Fed money printing have proven a tad more elusive. Based on Bernanke’s spirited defense of his tenure as Captain of the good ship QE over the last 4 years, it seems likely that the monetary beatings will continue until morale improves.
It also seems increasingly likely that future versions of QE will take the open ended path. Bernanke has not been as clear about this as other members of the Fed but a consensus seems to be emerging that asset purchases should continue with no set limit until economic conditions improve. I guess the thinking is that if the number of lashes is known in advance the beatings won’t be as effective in altering the behavior of the lashee. To my knowledge, none of the recent remarks about this policy option has included the possibility that further Fed asset purchases might in fact make things worse. I would merely note that just hinting at further easing – as the speech was widely interpreted – was accompanied by a rise in commodity prices. With oil already at $100, gas prices at their highest level ever on Labor Day and food prices rising with the thermometer, I am of the opinion that another round of dollar debasement is unlikely to be the panacea hoped for by central bankers and politicians alike.
Stocks also moved higher but as I said last week, I’ve become more worried about the potential downside recently and despite the hints at QE3, I haven’t changed my mind. In fact, more easing at this point is likely to increase my concerns rather than alleviate them. The US economy is not in recession yet but rising commodity prices could change that and anyone who believes that easy monetary policy has no effect on commodity prices hasn’t been paying attention. With Europe in recession, China and the other emerging markets slowing and the US plodding along at 1.7% growth it is hard to make the argument that oil is at $100 based on growth expectations.
Further evidence of the potential effects of more QE can be found in the gold market which is rallying once again after hibernating through the Operation Twist phase of non traditional monetary policy. That isn’t surprising since Twist had no effect on the size of the Fed’s balance sheet but the hint of more asset purchases has lit a fire under the gold market. If economic recovery is the goal, a rising gold price is the last thing we would want to see. Capital flowing into the gold market is not a sign of a return of animal spirits and the desire to take risk. It is the opposite, a sign of fear that locks capital into a non productive asset. It is the ultimate malinvestment.
Uncle Ben’s Monetary Elixir was a necessary antidote at the height of the financial crisis to avoid a 1930s style deflation but it has reached the limit of its effectiveness. More doses at this point are likely to do more harm than good since it was always a palliative rather than a cure. The problems facing our economy are on the supply side of the equation and have more to do with fiscal and regulatory policy than any perceived lack of money or demand. I didn’t see Clint Eastwood’s speech at the Republican Convention but the use of an empty chair as a metaphor for the actions of our politicians over the last decade could not be more accurate. I would only quibble with the number of chairs.
I believe we are entering a very dangerous period for economic policy. We have become too reliant on the central banks of the world to solve problems for which they are ill suited. With an election in the near future and little hope for action from the political class, I believe Bernanke and his money printing pals are about to over reach with potentially disastrous consequences. We have endured an anemic recovery so far and it hasn’t been fun but adding inflation to the puzzle will make it much worse. I know there are many out there who believe that inflation isn’t possible right now but there is a tipping point somewhere and I believe we are rapidly approaching it. It is not an economic model that tells us that high inflation and high unemployment are possible; it is hard earned, real world experience. We traveled this path in the 1970s and Bernanke, the intellectual love child of Arthur Burns and Milton Friedman, seems intent on taking the fork in the road that leads us back to stagflation.
The next few weeks will be critical ones for investors. This week we have a number of important US economic releases including both ISM reports and an employment report. If more QE is not already a settled question at the FOMC, these reports may prove pivotal. Further weakness will likely seal the deal and possibly our fate. We also have an ECB meeting this week and a ruling next week from the German court on the legality of the financing mechanisms being considered for further bond purchases. And then of course, the FOMC meeting. Our portfolios are overweighted – as they have been for a while – toward commodities, including gold. We are also hedged against rising volatility and are maintaining a cash cushion. It is my hope that the economic data obviates the need for further Fed action but I am far from confident that will be the case. Based on his speech it appears Bernanke feels the same way.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: email@example.com or 786-249-3773.
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