From China to Argentina, and in every G7 market in the world, 2014’s initial exuberance has now tapered off into steep declines. While the mainstream mumbles incoherently about economic headwinds and reduced expectations for growth, the real culprit is staring us straight in the face: the withdrawal of quantitative easing.
Now at $65 billion a month in the U.S., that represents a $240 billion cut in annual welfare payments to the financial services sector, who has been amplifying the effect on markets through the wonders of fractional banking. If you’re a bank and you hold $100 million in Treasuries or Agency Backed Mortgage Securities – which qualify as ‘Tier 1’ capital in banking parlance – then you can lend out as much as $1..25 billion if you are to observe the Basel II recommended capital to risk-weighted assets ratio of 8%.
So arguably, the withdrawal of $20 billion per month in fabricated-from-thin-air cash equates to the removal of as much as $2.5 trillion per month in potential credit. Obviously thats very back-of-napkin generalizing, but the purpose is to convey the magnitude of the withdrawal on world money supply.
And so, as predicted by a variety of market observers, the first asset class to suffer the effects of withdrawal are the emerging markets, where investors see capital at higher risk than they do in domestic markets in the G7, with the result that that segment of the market is in a state of catatonic despair, and heading lower.
This is/was the danger of quantitative easing warned about when the idea of the magic chequebook first took root, when Bernanke and Co. first conceived of it as the best (only) solution to stem the hemorrhaging back in 2008. It is both ironic and a testament to the delusional stupidity of our so-called leadership that the housing market collapse that catalyzed the crisis, and which was brought about by a limitless supply of capital, credit, and synthetic housing market derivatives to invest in, has resulted in an amplification of the rate at which capital and credit fabrication is undertaken, envisioned as ‘the solution’.
It has always been my position that capital and credit fabrication would only alleviate the symptoms temporarily, while the true root of the problem continued to fester. Now we are going to witness the outcome of the policy. As Bernanke and crew realize, the addition of $4.1 trillion to the balance sheet of the federal reserve has done nothing to stimulate real demand, because all that amplified credit is doing is finding its way into new synthetic derivatives of derivatives, where they are tucked away on balance sheets until they can be coaxed into a profit through complex financial hocus pocus.
Meanwhile, the distortions in asset prices have caused an acute intensification of wealth disparity, as the abundance of capital and credit to the top rung of the economic ladder creates exponential earnings for those participants while the earnings of the lower rungs of the ladder remain flat or deteriorate.
Thus the Fed finds itself in the position it could have foreseen, where it is truly damned if it does and damned if it doesn’t withdraw the source of artificial demand and GDP. The dilemma now morphs to how can confidence in the U.S. dollar be preserved if a large portion of that $4.1 trillion needs to be retired. Who is going to buy that counterfeit dough? Now that they’ve fabricated the monster, it can’t just be rolled up and tucked away for another rainy day.
So there are two things that can happen:
1.) The Fed bites the bullet and continues to move toward zero stimulus, which is the only way we will begin to achieve real visibility into what’s actually happening in the U.S. economy, but which will nonetheless cause market routs to intensify, or
2.) Janet Yellen, who one could argue was selected for the role for her sympathetic disposition toward even greater capital and credit fabrication, might look around at the growing carnage and stop tapering and double down on QE.
If number one is the case, then its time to get out of equities and start to look at precious metals, as the gradual withdrawal to zero is going to make the USD a pariah in the immediate term, and will force the rise of interest rates as investors demand a better return to hold the increasingly fragrant paper.
However, the worst case scenario – and so likely the best choice of the hopelessly reactive Fed – is number 2. If Janet tries to entice the market back into the right direction through a resumption and amplification of asset purchases, there is going to be a premium required to overcome the skittishness the taper-no taper flip flop is going induce in the marketplace. So she might find herself in a position where the number she has to print each month goes up way beyond where she thought it would.
Suffice to say, whereas risk capital has seen its temporal risk exposure horizon reduced to weeks from years, in the weeks and months ahead, we could see that contracting even further, so that investment in business essentially grinds to a halt again.
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