The Bernanke Fed announced a "stunning" plan to save the world from depression on Wednesday.
The numbers were hard to follow, but they were big:
$300 billion, was the number Bloomberg reported
$1 trillion, said the New York Times.
$1.2 trillion, countered the Washington Post.
It turned out that all these numbers were correct. The Fed was going to buy $300 billion of U.S. Treasury bonds...and more of other securities - notably bonds from Fannie and Freddie.
"Quantitative easing," the papers called it.
"What's that?" investors wanted to know.
So, it took them a while to put two and two together. But when they'd done the math they began to see what we've been warning about.
"This is a very powerful and aggressive move," said the chief economist at Bank of New York Mellon Corp., speaking with Bloomberg Television. "One of the reasons I've been arguing we won't have a depression is we've got a Fed chairman who understands the problem and is going to come with the right diagnosis and the right medicine."
Bloomberg continues: "With the purchases of Treasuries and housing debt, Bernanke is effectively using the Fed's powers to print money and aim it where he and other officials believe it will have the greatest impact in lowering borrowing costs."
What do we know? Maybe Ben Bernanke will be able to do what no central banker has ever done before: put in just the right amount of inflation...not too much, not too little. In the past, they tended to overdo it. There are not many examples. France, England and America in the 18th century. Practically no examples we know of in the 19th century (they'd learned their lesson!). And in the 20th century - only marginal countries...or countries with nothing left to lose...engaged in 'quantitative easing.' Germany did it in the 1920s, because her war reparations burden was greater than she could sustain. Argentina did it in the 1980s, because it owed too much money to too many foreigners. And Zimbabwe did it in 2003-2009, for reasons of its own.
There are not many examples because the consequences of over-doing it are so horrible, central bankers have generally not done it at all. Quantitative easing was always a possibility...but it was always a last resort...like blowing up the powder and spiking the guns; it was something you did when you knew you'd lost the battle already.
But here is the world's biggest economy and its oldest (arguably) and most successful government...doing something that used to be done only by desperadoes...
What does it mean? Where does it lead?
We don't know. But we don't think we want to go there.
Investors didn't seem to want to go there either. They sold off top stocks and bought gold.
Gold shot up on Wednesday, after the Fed announcement. Then, it just kept going...adding another $70 yesterday. We wondered why the price hadn't already hit $1,000. It looks like it soon will...this morning it is back over $960 an ounce.
Meanwhile, oil rose above $50, the dollar took a big drop and the Dow finished down 85 points. The greenback slipped to $1.36 per euro.
As to the stock market, whether this is a pause in the rally...or a reversal, caused by the Fed announcement...we don't know. Our guess is that it's just a pause. The rebound is still unfinished business. Besides, investors aren't running scared like they were a few weeks ago. Sentiment seems more relaxed. "We'll muddle through this somehow," investors tell themselves.
And the news appears more positive...at least, if you stand on your head and look up it.
Jobless benefits, for example. They're getting paid out to a record number of recipients. But not as many as economists had expected.
The leading indicators are down 0.4% in February - but not as much as expected.
And consumers are spending less money - but not as much less as expected.
And, of course, there's the money flowing from Washington. The auto suppliers just got $5 billion. Obama's budget will probably reach $2 trillion in deficit this year. And this extra $1.2 trillion from the Fed is not exactly small change. And that's in addition to the $11.7 trillion the feds have already ponied up in their fight against a free market. Investors are going to look at this flood of cash from the Fed and figure that it has to go somewhere. Some of it is bound to go into the stock market.
Now, we turn to our friends in Baltimore to see what the have in store for us...
"The larger [monetary] story," opines Rob Parenteau, lending a The 5 Min. Forecast a hand today, "can be found in the deleveraging effort of households, which accelerated in the fourth quarter of 2008.
"We have never seen such a sustained buildup of credit flows to the U.S. household sector like the one that began in the late '90s. Nor has the U.S. economy experienced such a reversal of household credit flows since the Great Depression.
"Policymakers, investors and entrepreneurs need to grasp this essential piece of the puzzle:
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"There are good reasons why the household sector is are paying down debt in an environment of declining asset prices and personal income. Falling asset prices reduce wealth faster than households can pay down debt.
"We believe this has a number of very important implications, not the least of which is for the restructuring of global growth away from a growing dependence on consumer debt binges in Anglo-American developed nations. Not to mention the policy objective of renewing lending to the private sector... it's misguided."
And yet, it's the very core of the justification for the TARP bailout and the broader Congressional stimulus plan. Rob unpacks this phenomenon in the latest issue of the Richebächer Letter entitled "Deleveraging Demystified". You can learn more on the site.
The 5 Min Forecast is an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less. It's a free service available only to subscribers of Agora Financial's paid publications, such as Breakthrough Technology Report. This publications subscribers have had an interesting couple of weeks, as Obama's pledge to put science on the top of his administration's agenda had them poised to make some pretty major profits. Learn all about it here.
And back to Bill with more thoughts...
"Fed's decision to put more money into the financial system reflects its worry that the U.S. economy is plagued by excess capacity," says the Wall Street Journal.
As we keep saying, the economically correct thing to do would be to let the excess capacity sort itself out. People lose their jobs - and get new ones. Factories close down...and open up again, producing something else. Companies go broke...and new companies spring up to take their places. That's what needs to happen. Then, after this restructuring, the economy can begin rebuilding on a more solid foundation.
But the Fed doesn't listen to us. Ben Bernanke is determined to stop a Japan-style depression from happening in the United States - at all costs. And the only way he can possibly stop it - by his logic - is by increasing demand. Putting more money into circulation gives people more money to spend. It also raises prices - giving them a reason to spend it now.
"Will it work?" was the question put to our little band of analysts this morning.
"It depends on what you mean by 'work'," was the answer.
Bernanke has set the blaze...broken the glass...and pulled the alarm. Now, the sirens whine and the crowds form. He has no choice but to follow through. What that means is that he must continue fanning the flames...inflating the money supply (monetizing the debt)... until consumer prices rise (reflecting an increase in demand).
We don't know how long that will take. But in that sense...it will work...sooner or later. Prices will rise...people will spend.
But what else? Do prices suddenly go wild? Or, do they gently rise...giving the feds time to get out the fire extinguishers before the whole economy burns down?
We don't know. But here is a guess: between the time the flames shoot up out of the roof...and the time the feds have the conflagration under control...you'll see gold over $2,000 an ounce. There's still time to get some of the precious metal to pad your portfolio with...but you have to act fast. See here.
*** Poor Tim. The U.S. Treasury Secretary is "out of the loop," says one source. He's "on thin ice," says a member of Congress.
He appeared on TV and said he couldn't stop the AIG bonuses. Then, the next day, his boss goes on the air: "Yes we can!" says he.
"US moves to take back bonuses," says today's Wall Street Journal headline.
Geithner has only been on the job a couple of months. And he's had to deal with bailouts, meltdowns, regulatory restructuring. It's a "crushing workload," says the New York Times.
But it's the bonus sideshow that gets people's attention. And poor Tim is on the wrong side of the story.
Free market capitalism is the "god that failed," writes Martin Wolf. Thus does Financial Times lead off a feeble chorus of lament in its "Future of Capitalism" series. What do we do now? is the question. Can capitalism be tamed? Can it be harnessed? "Yes we can!" says America's president.
Richard Layard from the London School of Economics, offered a way forward:
"We should stop the worship of money and create a more human society," he writes. "Happiness has not risen since the 1950s in the US or Britain," he points out, despite big increases in wealth. "Modern happiness research can help find answers," he believes.
"Old fashioned socialist planning is the only coherent alternative to a collapsing capitalist economy," an alert FT reader added.
Given the depth of these insights, we decided not to dive into this discussion headfirst. Instead, we will simply mock the swimmers from the bank. Brazil's president, Lula da Silva, for example, could only come up with a campaign slogan: "The future of human beings is what really matters." But who can blame them? They want a capitalism that makes people happy...fairer, gentler, greener... they want to reform it...to housebreak it...to cut its balls off so they can safely put it on a leash and introduce it to their daughters.
But they miss the point of it altogether: we can't reform capitalism; it reforms us. Capitalism punishes mistakes and rewards virtue (or good luck) - not necessarily quickly or gently...but roughly and imperfectly, like a hanging judge in a frontier town. On paper, of course, we can do better. Imagine a world where public employees are saints and geniuses who do such a swell job of allocating capital we want for nothing. But then, when we get a chance to see them in action, we find that they are bigger rascals than the capitalists themselves.
This week, under pressure from its new proprietor - the U.S. government - AIG released a list showing who had gotten more than $100 billion of its bailout money. At the top of the list of recipients was a familiar name - Goldman Sachs. In a truly astonishing co-incidence, Goldman is the firm that had been run by the very person who headed up the AIG rescue - former Treasury Secretary Hank Paulson. And what serendipity! Lloyd Bankfein - Goldman's top man now - was actually in the room with the feds when the AIG rescue plan was put together.
In the room; in the deal. But the big scalawags ducked out of the press almost immediately. Instead, the headlines focused on the small fry. AIG paid bonuses of $450 million - some charged it was $1 billion - to its executives. These guys shouldn't get bonuses, came the popular outcry; they should get a firing squad.
You'll recall the story. The insurance giant AIG lost money on a series of gambles. For example, it gambled that it could insure the mortgage payments of people who couldn't afford to buy a house. During the bubble years, people bought houses at outrageous prices. They could borrow 80% of the purchase price from government-backed debt mongers Fannie Mae and Freddie Mac. Buyers were supposed to put up the other 20% themselves, giving lenders a margin of safety in case the transactions didn't work out as planned. But, if an insurance company would guarantee the other 20%, Fannie could cover 100% of this "enhanced" mortgage loan. AIG found that insuring this part of the loan was profitable - as long as nobody asked questions. But then the market price for the collateral dropped - by as much as 50% in some areas. Suddenly, people were walking away from their houses. Defaults on these "enhanced" loans ran at 5 times the rates on normal Fannie-backed mortgages.
An ordinary person would look at these facts and pronounce the same judgment as the capitalist market: AIG and Fannie both deserve to go broke. But give him enough higher education in the economics department, or a job in government, and the fool rushes in --with someone else's money.
In the theory of bailouts, an ailing firm is given a helping hand when it needs it. This gives it time to get back on its feet, and prevents it from dragging down its employees, lenders, investors and counterparties. But what actually happens is much simpler. Money is goes from the pocket of the person who earned it...to the pocket of someone who didn't...from the innocent bystander to the fellow who caused the accident. Capitalism takes money away from erring capitalists; the capitalism improvers give it back to them.
And who decides who gets the loot? Ah...as soon as you hold them up to the light, the angels' wings fall off. By and large, these are the same cherubim and seraphim - such as Hank Paulson - who were supposed to be leading...regulating...and controlling capitalism when it ran into a ditch. Not a single one raised a warning. Instead, they whooped for the free market and passed the whiskey bottle to the driver! And now, thanks to their bailouts, AIG continues writing insurance against mortgage loans. Seventy-three AIG executives continue getting $1 million bonuses. A long line of reckless counterparties goes unpunished. And Hank Paulson offers advice to Financial Times readers on how to make capitalism work better.
But that is always the problem with improving capitalism...even in the slapstick American way. The reformers promise a 'new deal,' but they've always got an ace up their sleeve somewhere.
Richard Layard from the London School of Economics, offered a way forward:
"We should stop the worship of money and create a more human society," he writes. "Happiness has not risen since the 1950s in the US or Britain," he points out, despite big increases in wealth. "Modern happiness research can help find answers," he believes.
"Old fashioned socialist planning is the only coherent alternative to a collapsing capitalist economy," an alert FT reader added.
Given the depth of these insights, we decided not to dive into this discussion headfirst. Instead, we will simply mock the swimmers from the bank. Brazil's president, Lula da Silva, for example, could only come up with a campaign slogan: "The future of human beings is what really matters." But who can blame them? They want a capitalism that makes people happy...fairer, gentler, greener... they want to reform it...to housebreak it...to cut its balls off so they can safely put it on a leash and introduce it to their daughters.
But they miss the point of it altogether: we can't reform capitalism; it reforms us. Capitalism punishes mistakes and rewards virtue (or good luck) - not necessarily quickly or gently...but roughly and imperfectly, like a hanging judge in a frontier town. On paper, of course, we can do better. Imagine a world where public employees are saints and geniuses who do such a swell job of allocating capital we want for nothing. But then, when we get a chance to see them in action, we find that they are bigger rascals than the capitalists themselves.
This week, under pressure from its new proprietor - the U.S. government - AIG released a list showing who had gotten more than $100 billion of its bailout money. At the top of the list of recipients was a familiar name - Goldman Sachs. In a truly astonishing co-incidence, Goldman is the firm that had been run by the very person who headed up the AIG rescue - former Treasury Secretary Hank Paulson. And what serendipity! Lloyd Bankfein - Goldman's top man now - was actually in the room with the feds when the AIG rescue plan was put together.
In the room; in the deal. But the big scalawags ducked out of the press almost immediately. Instead, the headlines focused on the small fry. AIG paid bonuses of $450 million - some charged it was $1 billion - to its executives. These guys shouldn't get bonuses, came the popular outcry; they should get a firing squad.
You'll recall the story. The insurance giant AIG lost money on a series of gambles. For example, it gambled that it could insure the mortgage payments of people who couldn't afford to buy a house. During the bubble years, people bought houses at outrageous prices. They could borrow 80% of the purchase price from government-backed debt mongers Fannie Mae and Freddie Mac. Buyers were supposed to put up the other 20% themselves, giving lenders a margin of safety in case the transactions didn't work out as planned. But, if an insurance company would guarantee the other 20%, Fannie could cover 100% of this "enhanced" mortgage loan. AIG found that insuring this part of the loan was profitable - as long as nobody asked questions. But then the market price for the collateral dropped - by as much as 50% in some areas. Suddenly, people were walking away from their houses. Defaults on these "enhanced" loans ran at 5 times the rates on normal Fannie-backed mortgages.
An ordinary person would look at these facts and pronounce the same judgment as the capitalist market: AIG and Fannie both deserve to go broke. But give him enough higher education in the economics department, or a job in government, and the fool rushes in --with someone else's money.
In the theory of bailouts, an ailing firm is given a helping hand when it needs it. This gives it time to get back on its feet, and prevents it from dragging down its employees, lenders, investors and counterparties. But what actually happens is much simpler. Money is goes from the pocket of the person who earned it...to the pocket of someone who didn't...from the innocent bystander to the fellow who caused the accident. Capitalism takes money away from erring capitalists; the capitalism improvers give it back to them.
And who decides who gets the loot? Ah...as soon as you hold them up to the light, the angels' wings fall off. By and large, these are the same cherubim and seraphim - such as Hank Paulson - who were supposed to be leading...regulating...and controlling capitalism when it ran into a ditch. Not a single one raised a warning. Instead, they whooped for the free market and passed the whiskey bottle to the driver! And now, thanks to their bailouts, AIG continues writing insurance against mortgage loans. Seventy-three AIG executives continue getting $1 million bonuses. A long line of reckless counterparties goes unpunished. And Hank Paulson offers advice to Financial Times readers on how to make capitalism work better.
But that is always the problem with improving capitalism...even in the slapstick American way. The reformers promise a 'new deal,' but they've always got an ace up their sleeve somewhere.
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