When the Fed prints money it makes the price of gold go higher, and it
makes the stock market go higher. Many Fed watchers had expected the US
central bank to announce a new round of paper money creation, the third
round of Quantitative Easing, or QE 3, at its FOMC meeting on August
1st. But it didn’t. In the following paragraphs, I will share my views
on why it didn’t. I will also discuss the four developments that would
force the Fed to push the print button. This is important because the
chances are relatively high that the price of gold, the stock market and
the economy in general will weaken until the Fed prints again (unless
the European Central Bank, the ECB, jumps in with another big round of
Euro printing, which certainly cannot be ruled out).
The economy is weak and getting weaker. US GDP grew by only 1.5% in
the second quarter. Unemployment is high and getting higher, 8.2%. So
why didn’t the Fed launch QE 3 this week to rev up the economy? I think
there are two main reasons. The first is that printing money does more
than push up the price of gold and stocks; it also pushes up the price
of food. During the second round of QE, global food prices rose 60%,
causing a humanitarian disaster for the two billion people on earth who
live on less than $2 per day. After QE 2 ended in mid-2011, food prices
gradually declined – until a severe drought struck the United States
and drove corn prices back near record highs in recent months. That
drought-provoked spike in the price of corn may have been the main
reason the Fed did not act this week. They did not dare push global
food prices higher still. The last thing they want is for the
hunger-inspired Arab Spring revolutions to go global.
The second reason that held the Fed back this time could have been that interest rates are already too low.
When the Fed prints money and buys bonds, it pushes up their price and
that pushes down their yields, i.e. the amount of interest bond buyers
receive. The yield on ten year US government bonds fell below 1.4% last
month. They have never – I repeat NEVER – been lower. With the yield
on government bonds so low, it will be very difficult for pension funds
and insurance companies to earn enough money from their investments in
bonds to pay their obligations to pensioners and policy holders. The
Fed must fear that yields have already fallen to dangerously low
levels. Therefore Chairman Bernanke and his colleagues are reluctant to
print more money and cause bond yields to fall further still.
So, what would force the Fed to fire up the printing press? I believe
there are four potential triggers that would force the Fed to print
again.
The first would be a significant decline in the stock market. If stock
prices began to plummet, (paper) wealth would be destroyed, consumer
confidence would drop and consumer spending would fall. As a result,
the economy would begin to contract and deflation would take hold. That
is not a worry right now, however. The stock market is pretty strong.
If the S&P Index dips below 1250 (from 1370 now), Fed action would
become more likely. If the S&P begins to approach 1100, look for
helicopter money to begin raining down from the sky.
The second trigger would be a spike in government bond yields. The US
government must finance a very large budget deficit every year. The
budget deficit has averaged about $1.3 trillion a year for the last four
years. If the private sector won’t buy the government’s debt at low
interest rates, the Fed would print money and buy the debt itself.
Right now, as discussed above, that is not an issue either. Yields are
very low. However, should the yield on ten year bonds rise above 3.5%,
then it would become an issue and the Fed would consider printing.
A third factor that would push the Fed toward printing again is the
threat of deflation – and this is once again becoming a real concern.
With the US economy and the global economy weakening rapidly, the level
of consumer price inflation (CPI) has started coming down fast. Now,
however, the drought in the United States is likely to cause prices to
rise again quite quickly, making near term Fed action less likely. It
is certain the Fed is monitoring prices very closely because it is
terrified of deflation. If rapid disinflation resumes, the Fed will
print.
The final factor is the unemployment rate. If it moves up to 8.5%, the
Fed will probably print more money. With the global economy weakening
so quickly, that is a real possibility. If the Congress does not avert
the “Fiscal Cliff” at the end of this year (when government spending is
due to be capped and taxes are due to surge), it is an absolute
certainty that unemployment will soar and the Fed will print.
So, in conclusion, keep an eye on the inflation rate and the
unemployment rate. They are likely to determine when the Fed launches QE
3. And, until then be cautious. The price of stocks, gold and other
commodities (not affected by the drought) are likely to fall – unless
the ECB turns on its printing press and pushes them back up.
On a personal note, I spent the week of July 16th promoting my book, The New Depression, in London. The week began at 7:30 am Monday on CNBC Squawk Box Europe. Please find here the link to that interview: http://www.cnbc.com/id/48193471/How_Close_Are_We_to_New_Great_Depression
No comments:
Post a Comment