Will Fed Tapering Actually Work?

There is still continuous talk about the Fed withdrawing stimulus from the markets. The assumptions made are that the U.S. economy is recovering and can absorb the withdrawal of stimulus. There is no mention of raising interest rates, but the implication is that if you shrink the amount of money that is out there, or buy back outstanding bonds, you will decrease the supply of debt, and the price (or the interest rate) will rise by economic law. This is being reflected in bond yields of late. (5) This is the same law that drove down interest rates when more bonds were issued into the economy, i.e. money printing.

Can Fed tapering actually work? The short answer is: nobody knows. A flooding of money into the economy worldwide has never been tried before. Following are some points to consider.

The U.S. “recovery” is weak at best. (7)(8)(9) There has been low interest rates since 2008 worldwide, and there has not been a huge boom in GDP, work shortages, or rampant inflation. These are signs of an actual recovery and boom. There is no very low GDP (7), low inflation (7) and high unemployment (7). The current figures are based on the past performance, which is not accounting for higher interest rates. When interest rates rise, what happens to all of these factors? Inflation will rise, because costs of everything will go up. Interest is embedded in the production of anything that uses leverage (borrowing) somewhere in its production cycle. This would include almost all corporations and governments. Higher costs mean less spending and less demand for everything. Higher interest rates also make borrowing more expensive, which means less demand from the consumers as well. The assumption being made here is that the “recovery” can be sustained despite the fact that it is weak, and also sustain more headwinds.

The rest of the world is not helping with this recovery. Take note that German GDP is shrinking (2) and unemployment is rising. The rest of Europe is expected to do worse next year. (1) China GDP is also slowing. (3) Japan has many problems in its economy. (4) India is also slowing. (6) So, who is going to buy the goods that the U.S. is producing? With higher interest rates, Americans will not be able to buy them, and other countries would not be able to either.

So where does this leave us? It is a matter of bad timing for tapering to take place, or is this just not a feasible exit plan at this time? Perhaps it is both.

Sources:

1)      http://www.bbc.co.uk/news/business-22700029

2)      http://www.bbc.co.uk/news/business-22810772

3)      http://www.bbc.co.uk/news/business-22883830

4)      http://dealbook.nytimes.com/2013/06/13/when-bernanke-confounds-wall-street-reaches-for-theories/

5)      http://dealbook.nytimes.com/2013/06/11/in-a-shift-interest-rates-are-rising/

6)      http://www.forbes.com/sites/kenrapoza/2013/06/12/india-on-painfully-slow-path-to-recovery/

7)      http://www.bea.gov/national/index.htm

8)      http://www.cfr.org/geoeconomics/quarterly-update-us-economic-recovery-historical-context/p25774

9)      http://www.theglobeandmail.com/report-on-business/economy/a-star-spangled-recovery/article12579981/?page=all

 

To What Extent Does Perception Move the Market?

The perception of market participants influences market prices. As an example of how this is true, there were higher jobless claims and lower GDP data reported on May 31, 2013. (1) You would expect that the markets would go lower as the economy is not doing so well. The corollary to this statement is that the markets would actually rise because softer numbers means more likelihood of money printing, which generally makes stocks rise. This is assuming that this was the only news on the day.

At the same time, another news report came out stating that the economy is poised for growth and that consumer confidence is at 5 year highs and the housing market is doing well. (2) These are two contradictory news items at the same time. It can be argued that these news reports should be combined together to give a better view of the economy, because the markets discount all information as it comes out. If that were the case, the markets would likely see the two reports together as neutral. What did the markets do? They went down. What does this tell you? It is not the news itself but how it is interpreted that will determine what happens. This is like a person receiving good news and bad news about the same thing. Are they happy? Are they sad? Do they assume that the two pieces of news cancel each other out? If they become sad, is their sentiment biased toward the negative outcome?

Another interesting thing is that consumer confidence and economic projections are also based on what the stock market does (1), which means that the perception is a reinforcing feedback loop. What can be learned from this? All of the news, economic indicators, statistics and methods are variations on the perception theme. This is not a new concept, but the conflicting news at essentially the same time makes this concept more obvious than usual.

 

Sources:

1)                  http://www.bloomberg.com/news/2013-05-30/u-s-stock-futures-remain-higher-after-gdp-jobless-claims-data.html

http://www.bloomberg.com/news/2013-06-03/bernanke-economy-in-fed-centennial-poised-for-gdp-growth.html

To Taper or Not To Taper, Or To Expand?

The latest Federal Reserve meeting on May 22, 2013 has provided some very conflicting signals (2). On the one hand, Federal Reserve Chairman Ben Bernanke states that “A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,”(2). This is interpreted to mean that Quantitative Easing is necessary for the recovery to continue. Without Quantitative Easing, the recovery has a “substantial risk” of failure. Looking at this more closely, the economy is really on monetary life support and is not running on its own steam. Once the life support is removed, the economy will suffer. Since this Quantitative Easing has been going on for over 5 years, do we really have a recovery?

On the other hand, there was another statement that Bernanke made which is: ‘the Fed could “take a step down in our pace of purchases” in the “next few meetings.”’(2).  Even though the recovery is on life support and has been there for years, there is a willingness to take the risk of slowing Quantitative Easing anyway. The criteria used to determine whether tapering should take place or not is a consistently better labour market and inflation changes. Yes, the official unemployment number is down to 7.5%. Is this good? Is it consistent? If it is, the tapering of the QE program would have started already. Inflation has been dropping lately and the official numbers remain low. Recoveries are usually accompanied by higher prices. (3)

Do these two statements mean that the Federal Reserve is not sure what to do? Does it mean that the Fed wants one outcome, but the economy is not co-operating so another outcome is emerging? The two sets of statements appear to be completely opposed to each other, but this could be a sign of indecision more than anything else. Which one do you believe?

Sources:

1)      http://www.cnbc.com/id/100352475

2)      http://www.bloomberg.com/news/2013-05-22/bernanke-says-premature-fed-tightening-would-endanger-recovery.html

3)      http://www.usinflationcalculator.com/inflation/current-inflation-rates/

What Do You Think “Government Spending” Is?

There are different interpretations to many expressions that you see in the media. An example of this is government spending. If someone asks you: “Do you agree with cuts in government spending?”, how do you respond? This will depend on your interpretation. Some people think of government spending as spending on public welfare, health care and unemployment insurance benefits. Other people think of government spending as wasteful projects, bureaucracy and regulation. Did you know that government spending also means subsidies to corporations and defence spending? (1)(2)(3)(4) (5) (6)(7) It is also money used to pay interest on the national debt. (8)(9) All of these categories are government spending, but this is not discussed in the typical debate on balancing budgets or reducing costs.

 

This debate has been raging for the last few years as government budgets have become harder and harder to balance. When the word austerity came into being as a common expression, which government spending was being referred to? It appears as if expenditures had to do with pensions, wages, health benefits and public services. What about the other areas where money is being allocated? The government is involved in most industries, sometimes at multiple levels.

 

Why does this matter? People are being asked to cast an opinion on something without having all of the information. They are also being asked to make tough decisions without exploring all of the options. People are paying for all of this spending through taxes. Should spending be reduced on pensions instead of interest on the national debt or defence? These questions have no doubt been asked in the past, but these topics should be debated so that everyone involved can have the information to make proper decisions.

 

Sources:

 

1)      http://www.fraserinstitute.org/publicationdisplay.aspx?id=12386&terms=Corporate+welfare++Milke

2)      http://www.financialpost.com/opinion/story.html?id=7ba13b37-8cb8-4a7a-9601-da38e5c67698

3)      http://www.filmsforaction.org/news/government_spends_more_on_corporate_welfare_subsidies_than_social_welfare_programs/

4)      http://www.cato.org/publications/policy-analysis/corporate-welfare-state-how-federal-government-subsidizes-us-businesses

5)      http://www.nytimes.com/interactive/2012/12/01/us/government-incentives.html?_r=0

6)      http://www.globalresearch.ca/more-than-50-of-us-government-spending-goes-to-the-military/18852

7)      http://www.globalissues.org/article/75/world-military-spending

8)      https://en.wikipedia.org/wiki/Government_debt

9)      http://www.usnews.com/news/articles/2012/11/19/how-the-nations-interest-spending-stacks-up

Are the Physical and Futures Markets for Gold Still Linked?

The theory of financial futures markets links a physical market (or commodity bought today), with the futures market (or commodity bought in the future) via the idea that the cost of something today will equate to the cost of that same thing tomorrow, plus the cost of financing the wait, paying dividends and storing and insuring the commodity. Since the quality and size of the commodity are the same over time, there is no physical deterioration to speak of when it comes to gold.

Is this link still valid? The gold futures market took a large drop and the best reason cited was that there were large institutions who were selling gold futures. (11) The reason why is not that clear. The economic and fundamental reasons had not changed, and in fact had gotten more compelling to buy gold. The economic numbers from the U.S. were weaker. (7)(8) Economic numbers from Asia were weaker and stimulus from Japan was higher. (9)(10) There was news of Cyprus selling its gold, but this amount is tiny compared to the rest of the world. The idea that other European countries may be forced to sell their gold may explain some of the drop, but it remains to be seen. (6)

Days after gold hit 2 year lows, physical demand got much stronger in Asia as well as Europe and the U.S. (4)(5) Physical demand had been climbing steadily as coin and bar sales have been robust in the last 6 months. (4)(5) The question is: Why is there such a dichotomy between physical prices and futures prices? How can futures prices drive so much of the gold price when the physical demand is consistently strong? If the futures market starts settling in cash instead of actual metal delivery – has this in fact created 2 markets, with a large disconnect between them? (1)(2)(3) This seems to be happening in the silver market as premiums on physical silver bullion are going up. A secondary set of prices is being generated for physical silver that is diverging from the futures price (1). Logic would lead you to believe that if physical demand has been strong for months, why is the gold price not strong for months as well? Futures prices can lag up to 9 months out versus the spot prices, so it may be a matter of time. What seems to be happening is that there are now two markets for gold and silver – the futures market and the physical market.

Sources:

1)      http://www.kitco.com/ind/Hamlin/20130418.html

2)      http://asiaetrading.com/smx-to-launch-cash-settled-gold-silver-and-copper-futures-contracts/

3)      http://www.rts.ru/s725

4)      http://www.prweb.com/releases/gold-coin-2013/american-eagle-gold-coin/prweb10505855.htm

5)      http://online.wsj.com/article/SB10001424127887324493704578428332095974800.html

6)      http://www.guardian.co.uk/business/2013/apr/12/gold-selloff-cyprus-eurozone-crisis

7)      http://www.cnbc.com/id/100637164

8)      http://www.bls.gov/bls/newsrels.htm#latest-releases

9)      http://finance.yahoo.com/news/chinas-economic-growth-slows-first-quarter-021541443–finance.html

10)  http://www.reuters.com/article/2013/04/04/us-japan-economy-boj-idUSBRE93216U20130404

11)  http://www.zerohedge.com/contributed/2013-04-15/why-gold-crashing

QE Is Not Likely To End in 2013

There have been many hints over the last several months (3)(4) that the Quantitative Easing (QE) program may end in 2013. There have been repeated statements by Ben Bernanke that QE will end when the labour market substantially improves. (1) Yes, this statement can change at any time, but there are a number of reasons why QE will not end any time soon, in spite of what people are saying.

The first reason is the U.S. payroll tax. Since that has been enacted, the number of jobs has been declining (5). When people’s wages are reduced, they spend less. You can’t spend what you don’t have, especially when there is no more credit available, and no hope of a future job.

The second reason is President Obama’s latest budget. There are cuts to Medicaid and Social Security being contemplated. If no cuts arrive in this budget, there would be a sequester instead – which has the same effect.(2) If cuts occur anywhere, money would be taken away from people, and they would be forced to spend more on basic needs. The job market would suffer. These effects would come through in the next 3 to 6 months, and the employment numbers will get worse.

The third reason is that the participation rate is at a multiple year low. (1) This means that even if many new jobs are created, the influx of new job seekers will drive up the unemployment rate, making that number look a lot worse. More job seekers also create the semblance of more competition, which will drive down wages and benefits. There is simply a large pool of unemployed people, and until that pool is used up, the present malaise will continue and the job market will languish.

Unless Ben Bernanke changes his mind or his policy using the labour market as an indicator to end the QE program – it will likely go on much longer than expected. The longer it goes on, the longer the higher interest accumulated on the debt will necessitate further spending cuts, and the cycle continues. How much faith do you have in QE ending in 2013?

Sources:

1)      http://www.bloomberg.com/news/2013-04-05/bernake-s-caution-on-jobs-vindicated-by-payrolls-slump.html

2)      http://www.keyt.com/news/politics/Obama-to-reach-out-to-Republicans-in-budget/-/17989322/19630988/-/2kjh0f/-/index.html

3)      http://www.bloomberg.com/news/2013-02-27/fed-s-fisher-calls-for-cuttting-qe-to-avoid-overkill-.html

4)      http://www.cnbc.com/id/100352475

5)      http://www.bls.gov/news.release/empsit.t10.htm

What Impact Will the Cyprus Deal Have?

The government of Cyprus had initially voted against a bailout from the European Central Bank, European Commission and the International Monetary Fund (1) due to public outcry against a depositor tax.  The decision was then reversed and the tax was reinstated with deposits higher than 100,000 Euros. (1)(2) What could have generated such a quick reversal in the decision? One can speculate that the possible bankruptcy of the Cyprus banks would have caused a greater catastrophe. There is speculation that the Russians could have bailed out Cyprus but decided not to. (1)(3)(4)(5) Does it matter? It likely does not matter – but the fallout of this decision is very important. Bank withdrawals are being severely limited to 100 Euros per day in spite of the deal being passed.(2) Banks have also been closed for over a week due to threat of bank runs. (2)(7)

This is the first time that taxes are being made on existing bank deposits. Aside from the fact that these deposits have already been taxed, there is the notion that these depositors are partly to blame for not keeping the banks afloat. (7) The depositors are being labeled as money launderers and tax evaders.(7) Even if this is partially true, shouldn’t such money be targeted at the source rather than trying to tax everyone? Deposits are supposed to be stewarded by the banks, and profits made over and above these amounts are subject to creditor seizure. The banks don’t “own” your money, they are using it and are obligated to return all of it to you on demand. How banks invest your money is where the profit comes from. This seizure is treating deposits like assets, and they are not.

Will this happen in the future? The odds are that it will, and it was even alluded to in a recent comment which was then retracted. (6) If there is a possibility of taking people’s deposits, it will be done in spite of what is stated, not stated or modified in a statement. It is actions and past history of trust that will allow you to determine if trust has been violated or not.

Sources:

1)                  http://www.bloomberg.com/news/2013-03-25/cyprus-to-chop-banking-system-to-win-aid-avoid-default.html

2)                  http://www.reuters.com/article/2013/03/24/us-eurozone-cyprus-withdrawals-idUSBRE92N0E320130324

3)                  http://www.reuters.com/article/2013/03/22/us-cyprus-parliament-idUSBRE92G03I20130322

4)                  http://www.dailymail.co.uk/news/article-2298337/Cyprus-Russia-savages-EU-island-gets-8-5billion-bailout-deal-richest-investors-losing-40-savings.html

5)                  http://www.reuters.com/article/2013/03/22/us-cyprus-russia-money-idUSBRE92L0PI20130322

6)                  http://www.reuters.com/article/2013/03/25/us-markets-stocks-idUSBRE92A07T20130325

7)                  http://www.spiegel.de/international/germany/cyprus-bailout-highlights-deep-mistrust-in-europe-and-euro-zone-a-890745-2.html