People will get used to almost anything if it goes on for
long enough. And the getting-used-to-it process doesn't take long at all if
it's something that people don't understand well and that they can't experience
directly. They hear about Quantitative Easing and money printing and government
deficits, but they never see those things happening in plain view, unlike a car
wreck or burnt toast, and they never feel it happening to themselves.
QE has become just a story, and it's been going on for so
long that it has no scare value left. That's why so few investors notice that
the present situation of the US economy and world investment markets is beyond
unusual. The situation is weird, and dangerously so. But we've all gotten used
to it.
Here are the four main points of weirdness:
- The Federal Reserve is still fleeing the ghost of the dot-com bubble. It was so worried that the collapse of the dot-com bubble (beginning in March 2000) would damage the economy that it stepped hard on the monetary accelerator. The growth rate of the M1 money supply jumped from near 0% to near 10%. This had the hoped-for result of making the recession that began the following year brief and mild.
- A nice result, if that had been all. But there was more. Injecting a big dose of money to inoculate the economy against recession set off a bubble in the housing market. Starting in 2003, the Fed began gradually lowering the growth rate of the money supply to cool the rise in housing prices. That, too, produced the intended result; in 2006, housing prices began drifting lower.
But again, there was a further consequence—the financial
collapse that began in 2008. This time, the Federal Reserve stomped on the
monetary accelerator with both feet, and the growth of the money supply hit a
year-over-year rate of 21%. It's still growing rapidly, at an annual rate of
9%.
see graphic by clicking: http://www.zerohedge.com/news/2014-04-11/meltdown-america-movie
- The nonstop expansion of the money supply since 2008 has kept money market interest close to zero. Rates on longer-term debt aren't zero but are extraordinarily low. The ten-year Treasury bond currently yields just 2.7%; that's up from a low of 1.7%.
The flow of new money has been irrigating all financial
markets. In the US, stocks and bonds tremble at each hint the Fed is going to
turn the faucet down just a little. And it's not just US markets that are affected.
When credit in the US is ultra-cheap, billions are borrowed here and invested
elsewhere, all around the world, which pushes up investment prices almost
everywhere.
- US federal debt management is living on borrowed time. The deficit for 2013 was only $600 billion, down from trillion-dollar-plus levels of recent years. But this less-terrible-than-before figure was achieved only by the grace of extraordinarily low interest rates, which limit the cost of servicing existing government debt. Should interest rates rise, less-than-terrible will seem like happy times.
Almost no one imagines that the current situation can
continue indefinitely. But is there a way for it to end nicely?
Let's look at the puzzle the best minds now face.
If the Federal Reserve were simply to continue on with the
money printing that began in 2008, the economy would continue its slow
recovery, with unemployment drifting lower and lower. Then the accumulated
increase in the money supply would start pushing up the rate of price
inflation, and it would push hard. Only a sharp and prolonged slowdown in
monetary growth would rein in price inflation. But that would be reflected in
much higher interest rates, which would push the federal deficit back above the
trillion-dollar mark and also push the economy back into recession.
So the Fed is trying something else. They’ve begun the
so-called taper, which is a slowing of the growth of the money supply. Their
hope is that if they go about it with sufficient precision and delicacy, they
can head off catastrophic price inflation without undoing the recovery. What is
their chance of success?
My unhappy answer is "very low." The reason is
that they aren't dealing with a linear system. It's not like trying to squeeze
just the right amount of lemon juice into your iced tea. With that task, even
if you don't get a perfect result, being a drop or two off the ideal won't
produce a bad result. Tinkering with the money supply, on the other hand, is
more like disarming a bomb—and going about it according to the current theory
as to whether it's the blue wire or the red wire that needs to be cut means a
small failure isn’t possible.
Adjusting the growth of the money supply sets off multiple
reactions, some of which can come back to bite. Suppose, for example, that the
taper proceeds with such a light touch that the US economy doesn't tank. But
that won't be the end of the story. Stock and bond markets in most countries
have been living on the Fed's money printing. The touch that's light enough for
the US markets might pull the props out from under foreign markets—which would
have consequences for foreign economies that would feed back into the US
through investment losses by US investors, loan defaults against US lenders,
and damage to US export markets. With that feedback, even the light touch could
turn out not to have been light enough.
To see what the consequences of economic mismanagement can
be, and how stealthily disaster can creep up on you, watch the 30-minute
documentary, Meltdown America. Witness the harrowing tales of
three ordinary people who lived through a crisis, and how their experiences
warn of the turmoil that could soon reach the US. Click here
to watch it now.
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