Friday, September 14, 2012

QE-Infinity: Poking Holes in Bernanke's Logic

I'll start off by saying: I was dead wrong about "no QE3" this time.  With the dollar in crash mode and equities trading at multi-year highs, I did not expect the Fed to do anything more than continue their "Virtual QE3" talking-points program. 

With that bit of crow-eating out of the way, it's time to adjust to the new realities and discuss what the program means for the market and the economy; additionally, one simply cannot avoid some discussion on the moral hazard and the politics of it.

Let's start off with what the program entails.  Quantitative Easing is government-speak for "printing more money" (although, in today's world, this is less about the physical printing press and more about digital transfers).  The Fed has been reduced to printing because their usual go-to monetary tool, which is lowering interest rates, has long been maxed-out and ineffective.  Fed fund rates are already effectively negative; thus there's nothing more to be done in that regard.

The Fed has departed somewhat radically even from previous QE programs, as this is the first program with no fixed end-date.  Therefore, instead of calling it "QE3," it seems more appropriate to name the new program "QE-Infinity" (I would simply use a lemniscate after "QE," but my font doesn't allow it).  On Thursday, the Fed committed to buying $40 billion worth of Mortgage Backed Securities (MBS) every month in an ongoing open-ended program, which, for those keeping tabs, equals a total commitment of $85 billion a month when combined with existing programs.  This will cease when the Fed "sees substantial improvement in the labor market."

Of course, this immediately begs the question, "What will the Fed view as 'substantial improvement?'  What are the qualifiers, and where will it end?" 

The answer is a resounding: "Nobody knows."  In Bernanke's own words: "We haven't yet come to a set of numbers, but we're guaranteeing that we won't tighten too soon."  That statement alone should create some discomfort with American taxpayers, as the unaccountable (to voters) Fed is admittedly setting a far-reaching policy with no qualifiers.  But naysayers are glibly refuted, as Bernanke demonstrates in a statement discussed later.

Printing money floods the market with more dollars, which makes dollars worth less (supply and demand: more supply equals lower value), which means that tangible assets priced in dollars -- such as oil and food -- end up costing more. This is euphemistically referred to as "inflation."

One of the arguments against prolonged low interest rates and flooding the money supply is that these actions punish savers in two ways: artificially low interest rates hit savers' accounts directly; and printing money hits them a second time and forces them into high-risk assets as they try to keep up with inflation.

In a weak attempt to address the fact that his policies punish savers, Bernanke responded with this glib straw-man argument: "You can't save without a job." 

Yes, that's a true statement.  But it's not a legitimate argument.  Even in this depressed labor market, there are still far more Americans with jobs than without them; and there are more and more retirees struggling to survive on savings being held in accounts that currently yield virtually no return. 

Bernanke's argument that trying to add a few percentage points to the employment rate justifies punishing everyone else because "you can't save without a job" is akin to the automotive industry announcing that, henceforth, they're only going to produce super-cheap cars that have no seatbelts, no bumpers, and no other safety features -- on the justification that these dirt-cheap cars will allow more people to afford cars.  Ben's simplistic logic is essentially: "You can't die in a car wreck if you don't have a car!"  Can't argue with that statement.  But it doesn't address the real issue at all; it merely reframes it into terms where he can seemingly win the argument.

His statement also assumes the underlying presupposition that an ongoing QE program will actually improve the labor market -- and that assumption is not a given.  There is an ongoing debate over how much influence the Fed actually holds over the labor market, and the question was asked of Bernanke yesterday:  "How does boosting assets really help the real economy?"  Bernanke replied, "There are a number of different channels: Mortgage rates, corporate bond rates, and increase in home prices and stock prices."

This is another non-answer that avoids the real question.  Bernanke responds that there are "different channels," but he does not establish that these channels have any direct causation in creating more jobs (he also argued this earlier, but again in a cursory manner based on unproven presuppositions). 

Nor does Bernanke establish how these "channels" materially differ from what's already been tried.  In fact, Esther George, president of the Federal Reserve bank in Kansas City, recently asked this rhetorical question: “Is there anyone not borrowing today or purchasing a house because interest rates aren’t low enough?  Do we expect that businesses will hire if their long-term rates are lower?”

The follow-up question that needed to be asked was, "I understand that, Mr. Bernanke; allow me to rephrase:  How do these 'different channels' actually help the labor market?"

QE1 and QE2 did not appreciably help the labor market, as shown on the employment chart below.  But, hey, this time will be different, right?

While the QE programs haven't helped the labor market, they have pushed up the stock market and commodities through inflation, as shown on the chart below:

As the chart suggests, a disappointment from Bernanke here would likely have had ramifications for the stock market -- but one might ask why this would matter to Bernanke when the market is trading at multi-year highs.  I know politics is always a heated venue, but in an attempt to answer that question, let's briefly talk reality in a neutral manner.

It's no secret that Bernanke's term ends in 2014 -- and Mitt Romney has stated that, if elected, he would not reappoint Bernanke. This is not "supposed" to influence an alleged independent entity like the Fed; but the Fed is made up of humans, not emotionless robots. If you knew with certainty that your boss losing his job meant you would lose your job too, would you not work extra hard to keep your boss employed? If Obama loses the election, Ben will have to start shopping his resume. I don't care who you are or where you fall in the political spectrum: that type of perceived threat influences human action, and Bernanke is human (I'm 80% certain he is, anyway). 

Finally, for the sake of argument, let's assume the best possible outcome: success of QE-Infinity! The Fed prints boatloads of money and successfully drives up housing and stock prices, which is Bernanke's stated goal. Great work, Ben! I'm buying drinks!

Whoa, not so fast...let's take this train to its logical conclusion.

Didn't we all agree (in the very recent past) that the last housing market mania was a bubble?  Even if these policies are successful, how is reflating that bubble any kind of meaningful solution?  What about stocks -- can't the same be said there?  These "different channels" Bernanke speaks of just don't sound any different; instead it appears we're actively trying to repeat the exact same mistakes all over again.  Are our leaders' memories really that short?

What do we do when these newly-reflated bubbles pop next time, somewhere down the road?  What "tools" will the Fed still have left at its disposal, after all these bullets have already been fired just to get us back to the same situation we're trying to recover from in the first place

As the old saying goes: "Rome wasn't built in a day" -- and neither was its economy. It would seem wiser to finish taking our bitter medicine now and let the market recover more naturally over time.  But we don't and we won't, because our leaders have become addicted to a false sense of prosperity.  We all know "there ain't no such thing as a free lunch" -- but printing money from thin air gives us the illusion that there is; and, unfortunately, the prevailing mentality at the Fed seems to be that the bubbles must be reflated at any cost. 
"We can't solve problems by using the same type of thinking we used when we created them." 
-- Albert Einstein 


Market update

This article took a lot longer than I anticipated (I basically spent the entire day and night on it), so the market update will be brief and I'll get more into the nitty gritty of the charts over the weekend. 

The market finally reached, and over-shot, my 1440-1460 target.  This was not entirely unexpected, but given the present realities, the market may be in the process of declaring a new path.  With the Fed and the ECB in full-bore printing mode, I would not suggest any bearish front running by any but the nimblest of traders.  This is the type of move that can just keep melting up, and it might be wise to await some type of confirmation from the market before turning overly bearish.

For the past several weeks, I have been discussing the potential of a bearish ending diagonal -- but I did not anticipate a new QE program, and it remains to be seen how the market will respond.  So far, the response has been bullish, and it was bullish the last two times, so this isn't exactly uncharted territory. 

That said, we are roughly at the spot where the ending diagonal, if it holds any water, would complete -- but the first step for bears would be a whipsaw of the upper trendline.  Until that happens, bulls should be given the benefit of the doubt, as the market may be in the process of announcing new intentions to match Fed response.

The first chart shows the S&P 500 (SPX) and the upper diagonal boundary.  As I've stated previously, this is my adjustment point from bear to bull, and while this overthrow could still fit the pattern, the bears first need to whipsaw the market back below support to have any shot at getting things going.

Next, a chart of the CRB Commodity Index, which also looks very bullish at present, and just completed a "golden cross" of the 50 day moving average above the 200-day moving average.  Note there's a typo on the chart, and the measured target is 344, not 350.

In conclusion, the bear case isn't completely dead yet -- but the Fed just drove several nails into its coffin.  The next few sessions will be critical to bears' intermediate hopes, and they need to find some selling pressure that currently appears absent.  As I've stated for several weeks, if the market sustains this breakout, I will throw in the towel on the intermediate bear case until further notice, and await some type of confirming move before turning bearish again. 

It is worth noting that the Nasdaq Composite hasn't yet cleared long-term resistance, so there's still a watch-and-wait going on in several markets.  For the time being, the trend remains up.  Trade safe.

  Reprinted by permission; copyright 2012 Minyanville Media, Inc.


  1. Pretzel- Not trying to brag, but I've been commenting for some time on my site and in other venues that this is a Presidential election year and that the powers that be will do everything possible to help their re-election chances.  So QE3 should be no surprise.  Also, and probably cynically, the QE3 effort does not have a long term goal in mind - in 60 days it's purpose will either have been achieved or will have failed.  As you point out, Bernanke's explanations are weak at best - he's too smart to not know the long term implications of this inflationary measure - so it seems pretty certain that there is another agenda at work.

  2. I still don't really understand the reason behind QE: It propels commodity prices, production costs for companies will increase. They will need cost cutting, not hiring, or product price increase. On the other side: For ordinary people, the cost of living will go up (food, gasoline, etc.), so they won't be able to buy those products manufactured by companies, especially not on higher prices.
    Is this a good script for a bull market?

  3. FWIW I own a busniess - I am floored by how ignorant people like Bernanke and gang are. Heres what is going on in my business. My cost are going up - and now alot. I put on a hiring freeze because of that and in fact may have to lay off 2 people because of higher costs lower cash flow. I gotta believe alot of business's are doing this. My customers are spending less and really being hurt by fuel costs - they are holding back on purchases until further notice.
    This policy will lead to lower consumption by people, higher costs and lower profits by business's. Hold on hiring and probably more layoffs to lower controllable costs.
    The exact opposite of what we need.
    How does someone with a Princeton diploma miss it so bad -
    Things are going to get real bad IMO

  4. I just read your note after I posted mine above - Your spot on - The stock market will eventually catch on -   A few more profit and sales warnings and a bad job report and adios

    Eagan Jones is spot on in their analysis - just what you and I are saying

  5. well, Pretzel, if you made a prediction that was wrong ... it means you had the courage to make a prediction that could be proven wrong.  many analysts, reporters, bloggers, etc. won't make a bold prediction because they need to leave themselves room for deniability. 

  6. Great comments.  Appreciate the time it took for you to write it.

  7. All excellent comments, you guys should sign up and join the daily discussion.  and PL, as the dc said, nothing wrong with the prediction you made, we have all been confounded by this continuous money printing to prove an argument that should have stayed in the faculty lounge.