By Christiaan van Huyssteen (@cvh23)
The Federal Reserve will end its bond buying (money printing) this month, despite the US and world economy still being fundamentally weak.
This is bad for equity investors, particularly in emerging markets such as South Africa. But do not despair, the Fed will soon realise the simple fact that there is no recovery (see here, here and here) and start running those printing presses again. This will be temporarily good for those in the investor class. But common sense will tell you that at some time this will lead to a very serious financial crash.
WITHIN a month, the US Federal Reserve could have succeeded in a high-risk manoeuvre: climbing off the back of the monetary tiger – otherwise know as quantitative easing (QE).
The US Federal Open Market Committee decided in June to end its six-year-long bond-buying spree this month.
Emerging markets, including South Africa, are limping along as currencies fall and growth prospects shrink. And many parts of the world are distinctly unstable – financially and politically.
Ending QE was always going to be tricky because markets soon became addicted to the liquidity it provided. And many economists predicted at the time it was introduced that withdrawing the fix would send the global economy into the second leg of a double dip recession, probably in 2011.
One of the Fed’s mandates is to reach for a certain unemployment target. We hear every month that US unemployment is improving, but the number given is misleading. People who have been discouraged from looking for work are not counted as unemployed. In fact, the labour participation rate is at a 36 year low.
The world economy is addicted to the easy money that is quantitative easing. Quantitative easing is being tapered off at the moment. But I expect it to be restarted sometime in 2015. Perhaps QE4 will start as early as Q1 2015. When this happens, either more confidence will be lost in the dollar, or, more likely, stocks will just rally again.
The chief of the Bank of International Settlements in Basel, Switzerland (the central bank to all central banks) has said that the world economy is very ‘fragile’.
From The Telegraph:
The world economy is just as vulnerable to a financial crisis as it was in 2007, with the added danger that debt ratios are now far higher and emerging markets have been drawn into the fire as well, the Bank for International Settlements has warned.
Jaime Caruana, head of the Swiss-based financial watchdog, said investors were ignoring the risk of monetary tightening in their voracious hunt for yield.
“Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give,” he told The Telegraph.
Mr Caruana said the international system is in many ways more fragile than it was in the build-up to the Lehman crisis. Debt ratios in the developed economies have risen by 20 percentage points to 275pc of GDP since then.
There are so many bubbles in so many markets in so many countries that an unexpected snowflake in some obscure market may cause the next avalanche.
The fact that the US economy is a typical ponzi scheme is now clear for all to see. New debt is having to be issued to pay back old debt.
From Economic Collapse Blog
In fiscal year 2013, redemptions of U.S. Treasury securities totaled $7,546,726,000,000 and new debt totaling $8,323,949,000,000 was issued.
So why does so much government debt come due each year?
Well, in recent years government officials figured out that they could save a lot of money on interest payments by borrowing over shorter time frames. For example, it costs the government far more to borrow money for 10 years than it does for 1 year. So a strategy was hatched to borrow money for very short periods of time and to keep “rolling it over” again and again and again.
This strategy has indeed saved the federal government hundreds of billions of dollars in interest payments, but it has also created a situation where the federal government must borrow about 8 trillion dollars a year just to keep up with the game.
So what happens when the rest of the world decides that it does not want to loan us 8 trillion dollars a year at ultra-low interest rates?
Well, the game will be over and we will be in a massive amount of trouble.
The key thing to watch out for of course are interest rates. Contrary to some reports you my see, the Fed won’t put up interest rates in any significant way in 2015, they can’t. I have covered the effects of low interest rates here. When the market eventually forces interest rates up, there will be a government debt crisis, as governments won’t be able to pay the interest on their national debt. It will cause a problem in the housing market, as buyers will be more hesitant to buy homes with debt. And it will cause a problem for stock markets, as there will be interest bearing alternatives investments. Derivatives linked to interest rates may also blow up.
One thing that you can be sure of is that in the long run the laws of supply and demand (the most powerful force in the known universe) will prevail, and punish those who thought it could escape its grip.
Follow us: @DiagonalViews