Posted by Don Martin on Fri, May 20, 2011 @ 11:02 AM
Effect of QE 2 and technology stocks IPO bubble on real estate
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The effect of QE 2 was to stimulate the stock market and commodity market making wealthy investors feel richer. It has worked for the upper class. Now they may take some of their stock market assets and invest in a house to live in. However the risk is that QE 2 created a false boom or as the Austrian economists describe it a “crack-boom”. QE 2 is ending in a few weeks. The Congressional budget showdown over the debt ceiling may lead to government budget cuts. So a reduction in stimulus is coming.
When QE 2 ends then stocks and commodities will go down. Wealthy people who used a stock margin loan to buy a house without a mortgage may find themselves in a cash flow squeeze. If they were preparing to buy a home then they will have to suddenly cancel the purchase.
I fear that the new Social Media is simply a fad that will end badly as did the tech bubble of 2000 where people thought that if a website can get “eyeballs” then the company can sell ads to its viewers. That turned out to be false.
Tech stock crash coming?
Warren Buffet said in 100 years of aviation the industry’s stocks have merely broken even when all losses and gains are netted. This means investors overpaid to buy into the glamour of owning an airline. It happened with tech stocks in 2000. It probably will happen now. The resulting crash will be deflationary or disinflationary and will make bond prices go up.
Eventually after many years of deficit spending the government many finally succeed in creating substantial inflation, plus “crowding out” of the bond market, resulting in a massive crash in bonds. Since stocks are not a very good pass-through for inflation then investors will need to learn more sophisticated strategies to protect themselves from inflation.
I have written “Real estate deflation continues" and "Housing not comparable to the past".
The Emerging market economies are more fiscally sound than the U.S., so they may be a place to invest for the purpose of reducing the risk of dollar devaluation, or the risk of developed country government insolvency. Important: Get more information in my free Special Report about emerging market currency investing.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 19, 2011 @ 12:32 PM
Effect of disinflation on investing
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People inquire about disinflationary investments, real estate bubble deflation, reducing inflation. The economy is starting to slow down due to anticipation of the end of the Fed’s QE II stimulus. QE II ends June 30 but the funds allocated for it will be exhausted a few weeks earlier than that so it is almost over. State and federal governments are tightening their budgets. 20% of the population has borrowed against their retirement accounts. Private sector borrowing (except for student loans) has continued to decline as those who need a loan can’t get one and those who can qualify don’t want a loan. I am concerned that the Fed will try QE 3 and get a reputation for cheapening the value of the dollar in order to prop up asset prices and then eventually QE4 and QE 5 will be unable to stimulate economic activity because investors will not trust its ability to stimulate the economy.
Is Quantitative Easing full of holes?
As liquidity is withdrawn from the market then investment prices will decline. Add to this the risk that leveraged investors such as hedge funds are supported by the ability to buy reasonably priced Put options on equities and they could suddenly lose this vital support and be forced into margin selling which could trigger more “Flash Crashes” or October, 1987 crashes.
I have written “
QE2 and the Fed losing credibility” and “
Odds of another Oct. 1987 crash”.
The Emerging market economies are more fiscally sound than the U.S., so they may be a place to invest for the purpose of reducing the risk of dollar devaluation, or the risk of developed country government insolvency. Important: Get more information in my free Special Report about emerging market currency investing.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, May 18, 2011 @ 02:31 PM
Effect of QE II on the devaluation of the U.S. dollar
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People inquire about Swiss currency as hedge against declining dollar, 1970’s US$ devaluation, how to hedge against falling dollar, dollar collapse. People ask will QEII devalue the US dollar? (QE II is "Quantitative Easing" or increasing the money supply through bond purchases by the Federal Reserve bank). People want to know: How much did the dollar get devalued by since start of QEII in August 31, 2010?
Some mutual funds that invest in foreign currency could be used to measure the effects of QE II since it was announced August 31, 2010. (These funds are not necessarily recommended for investing. I am merely commenting on the economy and using these funds as a reference point.) “CYB” which invests in Chinese Yuan futures up 2.6%; “PLMIX” Pimco’s Emerging Markets bond fund up 8.7%; “MEAFX” Merk’s Asia currency fund up 2.9%; the NYBOT:DX index showed the dollar went from 82 to 75.45, an 8.7% decline, by contrast it all time low was on 3-17-2008 when Bear Stearns failed, with a reading of 70.7. In 2008 it moved by 10 points (12%) from the high to low, so the 8.7% decline is not a record. A recent low was 73. The DX index is composed of developed countries and is weighted by trade volume. So the dollar declined by a range of 2.6% to 8.7% since QEII, even though other countries tried to devalue their own currencies against the dollar so as to keep the dollar from being devalued.
Money Supply
As I have previously written the dollar has dropped against the developed countries currencies by about 0.8% a year in the 40 years since the dollar was cut loose from the gold standard. Attempts by the U.S. government to devalue have often been offset by competitive devaluations from other developed nations with similar problems which may be worse than our own. However, one must be careful not to rely upon what happened in the past (slow, gradual devaluation) because there is always the chance that a new paradigm shift could occur resulting a new, substantial devaluation. I have written “Investments for a dollar collapse” and “Hedge against a falling dollar”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Apr 15, 2011 @ 04:43 PM
Inflation can be created by three methods:
1. An increase in the money supply combined with tight labor markets and minimal excess capacity
2. Monetization of Treasury debt by the Federal Reserve
3. Quantitative easing, done to devalue the currency
None of these three can happen in the next few years. There is a huge amount of slack and excess labor capacity in the U.S. The only way to reduce unemployment is to increase jobs by 300,000 monthly for several years, a rate that has not happened consistently since the boom years of the 1990’s. This potential type of inflation is what happened in the 1970’s and is the most important type to be alert for.
Monetization of the Treasury debt will only happen if the Treasury can’t sell its debt to anyone. This would only happen if the Congress authorized a huge increase in spending. Huge deficits are forecasted in the distant future, but as we get closer in time to those years there will be more pressure on Congress to refuse to authorize huge deficits. Also there are very special reasons why foreign countries will continue to buy Treasuries.
Quantitative easing has failed. Its goal was to increase the money supply but the bank reserves it created were hoarded as cash by banks; instead bank lending actually shrunk. The velocity of money plummeted by 50% during the 2008 crisis and has remained at a low level. Its goal is also to devalue the currency but foreign countries will try to set an artificial rate for their currency so that they engage in competitive devaluations (currency wars) that prevent the Fed from devaluing the dollar.
I have written about this before “What is the potential source of inflation?”
Ask yourself what if the stock market and China’s economy are a bubble that crashes? What will happen to commodities? Will a “flash crash” cause a wave of selling that results in margin calls which trigger more selling? What about the small investors who write naked Puts to earn some extra money, will they lose their nest egg, and if so will the VIX be a prohibitively high level that would make hedge funds unable to invest with extreme leverage? The market is propped up by a low VIX and low margin rates that fuel asset bubbles. These bubbles are unsustainable and subject to a sudden crash. A risk asset (stocks, real estate, commodities) crash will make investors flee into Treasuries. This is an example of independent financial advice.
Posted by Don Martin on Thu, Mar 10, 2011 @ 11:28 AM
Today’s auction of long term Treasuries went OK with bond prices go up slightly. Yesterday the news had stories of Pimco’s “Bond King” Bill Gross getting completely out of Treasuries. The stereotype of an economic recovery is that after a year or two that jobs return and that increases inflation and also increases the demand for money so that the marketplace reacts by increasing interest rates. So the group-thing consensus has been that a rate increase would occur. However that is wrong because this is no ordinary recession, it is like the “Japanese Soft Depression”.
Jeff Gundlach of Double Line, called the new Bond King by Barron’s, said today that "The markets price in all the facts that are known. The fact that the Fed is going to stop buying Treasuries is known, therefore it's priced into the market. The end of the Federal Reserve's $600 billion program of purchases is already priced into the market and yields will not change "one bit." "It's going to depend upon the fundamentals, not on the stopping and starting of the Fed," he said.
A contrarian bond expert, Lacy Hunt, of Hoisington Investment Management said in the Wall Street Journal, rates might even fall with the end of QE2. He said the QE2 purchases of Treasuries made rates go up in anticipation of inflation, thus when QE2 ends rates will go down and investors will move away from inflation sensitive assets like commodities.
Reasons in favor of lower rates:
• QE2 was counterproductive, ending it will be a reduction of stimulus and is this disinflationary
• The Euro still has unresolved problems. The optimistic scenario depends on Germany with 85 million people being willing to bail out a 500 million population area, and on willing of the ECB to abandon fiscal prudence and engage in loose money policies
• China’s commodity bubble in copper (and in real estate) is looking shaky per the Financial Times
• Employment gains seem to be disproportionally in low wage jobs
• The deep, long recession is more like Japan’s than a typical American recession
Reasons in favor of higher rates:
• The money supply has increased
• Government debt and future liabilities are huge and growing
I don’t agree with the reasons for higher rates. More about that in future and in past postings.
I have written about this here and here. This is an example of independent investment advice.
Posted by Don Martin on Mon, Mar 07, 2011 @ 12:09 PM
Investors have asked about the possibility of the return of inflation because it can severly damage bonds and also hurt stocks.
Inflation is nurtured by an increase in the money supply but can only occur if there are constraints or bottlenecks such as a labor shortage or powerful unions or restrictions on imports. Since these things are not happening then inflation will remain subdued.
The three potential sources of inflation:
- Consumers and corporations borrow more from banks. This is not likely since only healthy people and corporations can qualify for a loan and they don’t want to borrow.
- The Fed monetizes the Treasury’s debt. This needs Congressional approval. With ever increasing deficits projected into the future surely more voters will insist on electing Congress members who would try to reduce the deficit. Do you really think the government will meekly pay all of its contingent liabilities when they come due, assuming these are 500% of GDP? Instead Congress will simply refuse to pay. It would not help the government to create inflation because many of the government’s cost are sensitive to inflation so causing inflation in order to pay for the government’s expenses would quickly be seen as something that does not benefit the government.
- Quantitative easing, done to devalue the currency, will not work because other countries will negate that by doing competitive devaluations. Further, if the U.S. did devalue by 20% that would affect the 17% of goods that are imported, which would be a one-time 3.4% additional increase in inflation. Regarding devaluations, the dollar has dropped 15% in 30 years or half a percent a year, which is less than inflation.
I have written about this here and here. This is an example of independent investment advice.
Posted by Don Martin on Mon, Feb 28, 2011 @ 06:50 PM
QE2 won't work and has not work and its failure will damage the Fed by damaging the Fed's credibility.
When the Fed buys long term debt in an attempt to stimulate the economy who do they buy the debt from? Do they buy it from a working class person who will use the funds to pay for a shopping spree? Do they buy it from a retail stock market investor who rarely owns bonds? Do they buy it from an investor who holds bonds in his taxable account or who holds bonds in his retirement account?
The answer is that most bond investing is done by pensions or buy sophisticated investors who know that bonds should be held in a retirement account for tax reasons. So the sellers of these bonds will view the receipt of cash from the Fed not as a chance to go on an inflationary spending spree but rather as just another dry chapter in their story of investing conservatively by owning and occasionally selling bonds. If the Fed wanted to stimulate consumer behavior they could buy real estate in depressed areas or buy bubbly stocks that are the most talked about in the financial press and most owned by the retail public. My point is that $600 Million QE2 is not only a drop in the bucket of a $36 Trillion U.S. debt market, but the bucket that the drop fell into is in a rich man's IRA or pension and the rich man could care less about the minor increase in wealth that occurred; instead he spends time worrying about a return of 1970's inflation destroying his bond portfolio. So he reacts by exporting his dollars to Emerging Markets and buying stocks and commodities there.
The "real" rate of interest actually went up about a percent since QE2 started. Since that rate is often at 3% then that was a huge increase in proportion to typical real rates. During that time the dollar went down even though yields increased.
The bottom line is that QE does not work as intended but can lead to loss of credibility for the Fed. This loss of credibility may seem trivial, but it is not. The Fed needs to avoid a mass panic out of dollars so it needs every bit of credibility that it can possibly get. The credibility that matters is in terms of making people believe that the Fed is not impotent and the Fed won't hurt the dollar by causing inflation. In a world full of Central banks that are too easy on monetary policy, the future winner will be the country with an honest, reliable, credible Central bank, like Germany, Canada, and Switzerland. If a financial panic starts for whatever reason and the Fed has suffered a loss of credibility then an old-fashioned bank run against the Fed can start but it will occur on a 21st century scale. A fiat money system is all about establishing and maintaining credibility
The solution is for the Fed to follow the lead of Swiss, Canadian and German Central Banks.
Regarding how this affects investors, my first point is that QE2 may have created a stock market bubble. Simply ending the hopes of another QE could be reason for stocks to decline to more reasonable levels of about 900 for the SP. My second point is that since QE2 actually made interest rates higher and damaged the value of the dollar on a "real" interest rate adjusted basis, then once QE has been permanently ended the market will reward the U.S. with better interest rates.
I have discussed QE here and here.
This is an example of independent investment advice.
Posted by Don Martin on Fri, Feb 25, 2011 @ 05:21 PM
In the Wall Street Journal today Fed Vice Chair Yellen said long term bond yields may have risen due to QE2 because the market expected a larger amount of bond purchases. This is startling statement. If the market expected more purchases then the market was saying the economy needed a lot more stimulus in which case rates should be low. So to make rates low the fed will need to buy even more bonds. This implies that the invisible hand of the market is saying that gradually the Fed is losing credibility and that the patient is beginning to fail to respond to the medicine, resulting in a long term soft depression as in Japan. The big risk is that Fed’s actions will increasingly be disregarded by the market and then the government will loose the ability to control monetary policy. It seems that in response to QE which is intended to devalue the dollar that the market raises interest rates to compensate for loss of purchasing power and thus the goal of devaluing the dollar in negated. Thus QE2 or any QE will not work and thus a new recession may occur.
This posting is an example of independent investment advice.
Posted by Don Martin on Tue, Dec 21, 2010 @ 01:52 PM
Originally published Dec. 1, 2010 by Don Martin
QE2 is thought to be propping up the stock market in an attempt to reflate the economy. If the hedge funds that rely on the cheap cost of borrowed money find that their cost to hedge with Put options or their margin requirements have increased then they will be forced to sell assets. Since it is impractical to sell illiquid assets during a crash then to meet margin calls hedge funds will need to sell good investments, thus those assets will go down more than would be expected during a crash, leading to a market panic. Hedge funds do a significant amount of trading of the total market volume and if they were to have a need for a sudden sell off of assets there would not be enough buyers and thus prices would go down. So the effects of QE2 will be negated by a market crash. This would be similar to what has happened in Japan for 20 years where Central Bank easing lead to temporary bear market rallies that eventually collapsed.