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Money Aplenty

October 8, 2012

So how do I write the same thing in a different way? Remember the phrase, “It’s the economy stupid!” I want to say, “It’s the liquidity stupid!” It’s the flood of cash…the meltdown of the printing press…the insane monetary policy…the Federal Reserve on spring break with no inhibitions.

Last month, the Fed did not disappoint the pro-Fed-interventionists when they announced “Q-Infinity” — the purchase of long-term treasuries by the Federal Reserve for an indefinite period of time at the rate of $40 billion a month. If you add this to the Fed’s “Operation Twist” of an additional $40 billion per month, they are now in a position to dominate long-term treasury purchases and continue to pump unprecedented sums of newly created money into the economic machine.

It took the Fed 70 years to grow their balance sheet from zero to $900 billion, but it has taken only a couple of years to more than triple their balance sheet. Add to this the federal government’s tens of trillions of dollars infused through bailouts and taking on more debt — and it creates an astonishing excess supply of money.

An unprecedented supply of money will have far-reaching implications for our nation’s economy. It will also have short-term and long-term consequences. We are already seeing the short-term impact of numerous asset bubbles all at the same time. Past monetary easing generally created bubbles in single-asset classes (e.g. equities, real estate, dot.com, etc.). However, when one implements the “mother of all monetary easing policies,” the result appears to be a developing “mother of all bubbles.” It appears that even housing is beginning to join the party, which is only more evidence that nearly every asset class is experiencing bubble-mania, even though the average small time investor has been severely burned by these bubbles so recently. It makes one wonder how we can return to the scene of the crime and volunteer to be the victim so soon after the original crime was perpetrated against us.

How is it that nearly every investment seems to be a winner, while the economy (particularly for the middle class), seems, at best, to be stuck in neutral? It is, in my opinion, where the new money is getting dumped: into Wall Street and our investment complex. My concern is that our new market highs are a product of high frequency trading, churning and pyramiding casinos all funded by the Fed — certainly not a product of sound fundamental economic growth.

Inflation is defined as “an increase in the supply of currency or credit relative to the availability of goods and services, resulting in higher prices and a decrease in the purchasing power of money.” Or, put another way, too much money chasing too few goods. However, I believe our current stage of “consequence,” is just too much money pumped through too few avenues. It is creating excessive demand for investment products (gimmicks). Trillions of dollars being pumped into the economy combined with a zero interest rate policy drives risk-taking behaviors up and causes even more liquidity.

The investment complex seems to never have too much money; they can always find somewhere to put it. David Stockman, in a presentation before the Mises Institute, made a key observation. When the Federal Reserve did QE3, there were individuals that likely made $50 billion in a single day being on the right side of the QE3 effect, which they knew about beforehand. Stockman notes that betting on what the Fed is going to do, and making a quick profit from their actions, is all that Wall Street is focused on these days.

I have to confess, my past predictions of what would be the next Fed-created bubble did not include all asset classes at the same time. I assumed that those assets, such as equities and real estate, had caused enough pain already for the average investors to be gun shy. But this goes back to my original theory. This total all-out bubble mania is being created purely out of excessive liquidity — no, hugely excessive liquidity. Hence, the “mother of all bubbles” is creating a few extraordinarily rich individuals, while bypassing the rest of us. But those who are bypassed by this current mother of all bubbles won’t escape the negative repercussions of the mother of all explosions. They make all the profits; we pay for all their bets gone bad.

In summary, what I believe we are truly experiencing is Wall Street inflation. Liquidity that has swamped Wall Street has created inflation in nearly every single asset class —so, investment inflation. 

Imagine what the general public’s reaction would have been back in 2008 if our central bankers and elected leaders would have announced that they would have a zero interest rate policy for at least seven years (and counting!), trillions added to the Federal reserve balance sheet, trillions added to the U.S. debt, the outright manipulation of interest rates, the bailout of firms that caused this mess, the purchase (by taxpayers) of toxic assets and many other various gimmicks to keep the economy afloat,  and there would have been an uprising. It seems we have done this so incrementally, yet nonstop, that it is now considered the norm to flood us with liquidity and other ill-conceived stimuli.

We have seen the far-reaching cost of what occurs when individual asset bubbles blow up. At some point in the future we will find out what happens when all assets blow up at the same time. It might be hyperinflation, or a deep recession (one that might make 2008 look like a hiccup), or, and this is what I lean toward, both severe inflation and recession occurring at the same time. We should always remember that unprecedented experiments, such as the one our central banks are currently employing, will likely result in unprecedented outcomes, and I would not bet on the outcome being a pleasant surprise. It sure hasn’t shaped up that way so far!

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One Comment
  1. T Tracy permalink
    October 10, 2012 7:40 am

    Jon,

    Have you seen this article in the Financial Times?

    http://www.ft.com/intl/cms/s/0/005370e2-1137-11e2-8d5f-00144feabdc0.html#axzz28uGkIuux

    Some of the comments following the article are particularly enlightening.

    Keep up the good work. A number of us are paying attention.

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