Looking Forward to QEIII? Don't!
Once upon a time, believe it or not, this nation instituted the occasional “tight money” policy. By that I mean that the Federal Reserve, in an effort to rein in spending in an over-heated, dare we say “bubbly,” economy and to curb inflation, would raise short-term interest rates (also called Fed funds or the discount rate.) This increased the cost of borrowing for member banks, who passed along the increase to their borrowers, so companies and consumers decided to borrow less. If that wasn’t enough to shut down the drunken partying, the Fed might also take it a step further and sell Treasury bonds to absorb even more of the capital available for investment in the markets.
But that was back in the days when the Fed remembered that its charter, defined by Congress in writing, was to seek maximum employment, stable prices, and moderate long-term interest rates; in other words, to control inflation but ensure enough capital for businesses to hire and expand. The idea was, when the economy was sputtering, to provide easy money by lowering short-term interest rates and buying Treasuries, as they are doing today, making sure banks have plenty of money to lend to businesses. Conversely, if things got a little too bubbly, they would revert to a tight money policy.
So what went wrong? Well, the Fed’s job is to fill the punch bowl when times are tough and to stop filling it when there are too many drunks surrounding the trough. But it must have just felt so good pontificating weekly on the stock market shows and being lionized for keeping the good times rolling, somebody just couldn’t help filling the punch bowl over the brim until every drunk in the place was lapping it up as it overflowed and getting drunker and drunker and stupider and stupider.
Want more bubbly? The Fed is here! So we transitioned not from easy money to tight money, as is the natural order of things, but from easy money (which funded the any-idiot-can-IPO-with-no-earnings Internet tech boom,) to easy money (which funded the great real estate bubble of 2006 to 2008,) to easy money (the if-you’re-deemed-too-big-to-fail here’s more money credit bubble that we are currently reeling from.)
Now, after three episodes of easy money, the Fed cannot institute tight money without risking depression. So interest rates remain low and the Fed is buying long Treasuries, both of which bespeak more easy money. And their solution to remove their posteriors from the horns of the dilemma they find themselves on? Why, more easy money, of course! Instead of whisking the punch bowl away, the Fed is ignoring all those who left the party in disgust – a huge and growing number – and instead keep re-filling it for the remaining hard-core drunks like the institutional trading desks. After all, these comprise the Fed’s “member banks.”
Who gains and who loses? Any individual or institution that can borrow cheap and lend dear benefits from low interest rates. But here’s the problem: instead of bankers lending their easy money to entrepreneurs and businesses, which in the econometric model (and previous history) would jump-start the economy, this time they aren’t lending. Why? Are they in worse shape than we imagine and need to build their own capital? Maybe. And certainly the banks and banksters (brokers who became “banks” in name only in order to get their share of the goodies from American taxpayers) have found they can do better by taking the money they borrow at a very low discount rate and re-invest in 100% secure Treasuries, which only continues the easy money spiral -- and keeps interest rates lower because of their demand.
The whole idea of easy money is to create growth. But along with that, of course, the cost of any commodity denominated in dollars, will rise, adding to inflationary pressure. Those yearning for QEIII (more easy money) don’t seem to understand that with one hand the Fed is giving a boost to the markets but with the other, inevitably giving a boost to the price of oil, copper, corn, wheat, gas, etc.
The winners are the banksters who have only to collect the float between the discount rate and their no-risk investments. Other winners are central government which, in this administration, has already hired more central government employees in three years than any other in history, all the while pontificating that “the private sector is doing fine” and telling those of us who worked 14 hours a day to build our businesses and paid the taxes to fund roads, bridges and all those new bureaucrats, “you didn’t build it yourself.”
The losers are states and municipalities that cannot simply print money at will. They are laying off workers just as the central government is hiring them. The biggest losers, of course, are you and me and our fellow citizens who must buy food for their table or gas for their car. The hardest hit are those living on fixed income who have seen their investment returns descend to levels below the level of inflation and taxes.
Let the Markets Correct!
By that I mean all the markets: the housing market, the auto market, the oil market, the coffee market, the stock market, whatever. Since the Fed doesn’t have the spine to challenge the drunks now guarding their private punch bowl, let economic nature take its course. Will there be dislocation and hardship for some of us? Of course. I am underwater in my house right now. It might get worse. But it won’t decline to zero. If we let the markets sort it out in the sober light of day rather than continuing to stumble about in a drunken haze, we’ll reach a point where houses, or cars, or coffee or the stock market will represent true value that will attract sober citizens.
Of course there will be those who say, “Oh, no, the government can’t let that happen!” I say it’s a case of pay it now or pay it later. Would we rather have a hangover based on what has already been consumed or keep on drinking until we fade into unconsciousness?
If we accept that bubbles deflate, we take our licks in stages. If we wait until the bubble blows apart, there will be another crash. The Fed won’t be able to stop it; they will be out of ideas. As previous Fed chairman Alan Greenspan said to Congress after the first Fed-induced bacchanalia (in a rare attack of candor), “I really didn’t get it until very late.”
The drunks themselves certainly won’t sober up on their own. Wall Street went back to business as usual after the 2008 crash. There are now five financial industry lobbyists for each and every member of Congress; their job is to fight any reform to the way they do “business.” Do we really want to pay the price to get these guys clean after we let them imbibe again? That’s what QEIII will do at its best. From easy money to easy money to easy money to easy money one more round! For the sake of the American economy, citizens, taxpayers, investors, consumers and retirees, stop the madness! Let a little air out of the balloon now rather than celebrating the fact that it gets so big it’s bound to pop. And when it does, who do you think will have Congress’ ear? You and me – or the 2,500 lobbyists of the financial industry begging Congress for yet another bailout?
I understand the Fed is in a difficult position. So what? Who placed them there – you and me, or the banksters and the Fed's desire to please their primary constituents, the member banks? Besides, that’s what we pay them for – to deal with difficult decisions. They’re the ones who claim to be the “experts.”
Our strategy will be to keep our clients hedged for now. We must be willing to cover the short side of our hedges the moment it looks likely that the Fed will cave in. And we expect Wall Street to issue daily or weekly rumors that “today’s the day” or “this week’s the week” the Fed will announce QEIII. After all, we’re getting close to the next FOMC meeting so anything is possible.
I just hope that some adult leadership somewhere within those hushed halls understands, going forward, that every time a K Street bank lobbyist slurs “I wanna ‘nother dr...dr...drink!” it does not require them to fill the punch bowl yet again. And if they do, our clients will be among those selling our long positions to those clamoring to buy now that happy days are promised yet again. When we sell our longs, we’ll be hunkering down on the short side for a dreaded investing winter that never had to be.
Disclosure: We remain hedged in this volatile market.
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