Almost one year ago (Nov. 3, 2011), I published a piece entitled Hangover From Hell that was highly critical of the approach to economic policy being applied around the world. Sadly, the policies have not changed since that article. Nor have these policies revived economies. Indeed things have gotten worse! Both the US and Europe have administered more alcohol to the alcoholic in an effort to prevent the the pain and suffering necessary for a cure and recovery.
In the US the Fed announced Q-Eternity, a $40 billion per month injection of funds with no end date other than “as long as it takes.” If economic recovery is meant by “as long as it takes” there will be no ending because no economic recovery is possible from such policies. Very high inflation will eventually stop the Fed, although it will further impoverish the middle class. If they wait until hyperinflation, the economy will collapse and fixed incomes and savings will be wiped out.
The Fed committed to further suppression of interest rates through either 2014 or 2014 (I have no incentive to look up the exact date because the promise is meaningless and likely impossible to maintain). This manipulation of interest rates (“price fixing” is the proper term) is responsible for much of the distortion we face. This policy will create more mal-investment as a result of sending false signals conveyed to consumers/investors.
Politicians (and Bernanke is controlled by them) have chosen to continue to kick the can down the road. Each kick moves us further away from a recovery and makes the road back longer and more painful. Each kick also moves us closer to hyperinflation. How different are we than how Art Cashin describes what occurred in Weimar Germany?
Originally, on this day in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to “jump start” a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental “more is better” theory they simply created more and more money. But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then,suddenly prices began to explode unbelievably (but, perversely, not business activity).
To better comprehend what happened in Germany and how that is happening here, I recommend Cashin’s entire piece.
In my comments from a year ago I predicted that QE3 would be $750 billion to $1 trillion dollars. That is exactly what Bernanke has committed to with his $40 billion per month augmented by another $40 billion reinvested from the from the debt and interest repayments the Fed is receiving from past loans. The two together amount to $1 trillion a year, most of which will go toward buying Treasuries so that the government does not have to stop paying social security and other obligations. (Yes, I know he is buying MBS’s from the banks, but the banks will be instructed to buy and hold Treasuries with the proceeds.) Virtually all of this activity is being done to hide the fact that the government is no longer able to finance itself.
Here are the comments from a year ago:
The talking heads on CNBC this morning are excited about the ECB rate cut. I assume it is because they are paid to generate viewership, although ignorance and/or stupidity should never be ruled out as an alternative or joint hypothesis.
Jim Cramer is one of several who believes this rate reduction improves the outlook. Soaring markets seem to agree with his position. But nothing of substance has changed. The underlying economic problems of Greece, the other PIIGS, Europe or the US for that matter have not been addressed. Today’s market euphoria is akin to celebrating the provision of more alcohol to an alcoholic. Temporary pleasure has been purchased at the cost of worse suffering ahead. The hangover from hell has been deferred, not avoided.
Michael Krieger interpreted the action properly:
Nothing has changed and absolutely nothing has been accomplished. There is no “solution” to the crisis that will not result in massive pain, confusion and wealth decimation. The reason is patently obvious. At least half the continent is completely and helplessly bankrupt. There are only two outcomes to the entire situation. Either the sovereign debts are written off aggressively and the banking system declared insolvent and restructured or the ECB decides to turn on those printing presses to the tune of trillions and destroys the purchasing power of the union in Zimbabwe-like fashion.
The belief that more credit will solve problems created by too much credit qualifies as insanity, at least as described by Albert Einstein (doing more of the same and expecting a different result). Government economists seem to be oblivious to Einstein’s definition. Larry Summers, learned Keynesian economist and former Treasury Secretary, recently commented:
“The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending. Most policy failures in the United States stem from a failure to appreciate this truism…”
This quote describes government economic policy for the last several decades. It is precisely these policies that have crippled the economy, destroyed the financial system and placed us in an inextricable hole. Government is responsible for the problems, and it will be responsible for the collapse.
What we see now is European politicians trying to buy time. What they are doing is the economic equivalent of re-arranging the deck chairs on the Titanic. The loose confederation of nations and their banking systems have no hope of surviving. There is no solution to the problems because they have been practicing this type of can-kicking for the past several decades. Problems in the past were not insurmountable and could have been solved had they been addressed then. Now the problems are too big to be solved.
The United States is in the same condition. Our financial system is deeply intertwined with that of Europe. No one can calculate the potential problems associated with derivatives and what will happen when they begin to default. A financial collapse in Europe will trigger a collapse here. Perhaps that is why markets here reacted so well today.
Yet we will have our own collapse with or without Europe. The US is little more than another Greece. The primary difference is that we have a big printing press.
No economy can be managed via a centrally-directed plan. An economy is not a big machine that can be manipulated by speeding up or slowing down various fiscal and monetary policies. An economy is a complex system made up of millions of people and millions of prices and other incentives and disincentives. It cannot be managed or corrected by focusing on a couple of variables from the top.
Years of distortions have developed as a result of trying to manage the economy. These distortions are now so great as to be uncorrectable other than by a great cleansing which is a euphemism for a Great Depression. There is no other way to regain growth and prosperity. No pain, no gain is particularly applicable to the condition we are in.
The irony of Keynesian economics is that it could not work even if it were a correct economic paradigm. In a political setting, central planners never see the need to slow an economy down. Political considerations make that virtually impossible. Unfortunately, modern economies have suffered from two defects — a false economic paradigm and a political class more interested in their own well-being than that of their constituents.
Now we near the end of the road. People surely will soon realize that there is no hope for Europe or the US. Oh, the political charade will go on for as long as it is allowed. But subsequent crises in Europe will occur rather quickly. Additional G-20 and ECB maneuvers will be forthcoming to mitigate the inevitable, but credibility is waning. Soon, there will be nothing that can be done to pretend and extend. Markets will take control.
In the US Ben Bernanke announced recently that the economy is not getting better any time soon. Nor will it be until after the coming collapse (which Bernanke cannot talk about, at least publicly). Something like QE3 will be coming and will amount to $750 billion to 1 trillion dollars of money creation. That is an estimate based solely on the rate of deficit creation. We will spend about $1.5 trillion more this year than revenues will cover. Soon no one will be buying US treasuries. When that happens, printing is the only alternative to government termination of major spending programs.
The result in both Europe and the US will be massive money creation in order to keep the system going. Money creation is harmful. In the context of what is about to happen, it can produce two outcomes. If the rate of money creation is too slow, de-leveraging will plunge the world into a Great Depression despite the best efforts of central banks. If it is too fast, massive inflation will occur (likely hyperinflation in parts of the world). Unfortunately there is no “just right.” If we don’t go directly into a Great Depression, markets will cease to accept fiat currencies. A barter economy would arise, but be unable to support the amount of transactions to sustain a modern economy. Depression will ensue even in that case.
We are in dangerous times for investors. Should investors take their money out of financial markets in anticipation of a crash? Or should they leave funds in, in the hope that stocks will rise enough to cover part of the purchasing power losses that will result from inflation? There is no simple answer to these questions. One frustrated investor described the situation as follows:
One can kneejerk every headline coming out of Europe, or one can buy gold, which has finally had enough with this endless BS and has realized that no matter what the ECB will have to print, followed by everyone else.
Richard Russell, revered investment advisor, noted in his newsletter:
The key to the world picture is the most unattractive of all avenues. That avenue is contraction, pain, and a return to the time-tested formula. That painful formula is 2 + 2 = 4, or, live within your means. The simplicity of this formula is frightening. The frightening part of it lies ahead. There is only one foolproof investment – we call it gold.
Both of these gentlemen suggest gold as a panacea. Unfortunately there is no guarantee that either are correct with respect to their gold affinities.
It is soon to become tough for non-investors as well. The definition of luxuries is about to be defined downward.