The Dubious Monetizing Efforts Of The Fed

Posted: August 15 2009

Fed plans to monetize and cause inflation, Writing off debt no easy task, the big institutions should have been allowed to fail, unemployment and other metrics to move only sideways, trade friction between US and China

The 10-year note auction yielded 3.73%. The bid to cover was 2.49 to 1 versus the average of the last ten auctions of 2.48 to 1. Indirect participation was 45.7% versus an average of 30%; we believe this is because foreign central banks are buying in behalf of the Fed via money they swapped with them.

As we discussed previously we expect this second half of 2009 to improve slightly. 2010 should pick up more about mid-year. We believe second quarter GDP figures were not minus 1.5%, but closer to minus 4%. We see real GDP at even by the end of the year and into the first half of the year with a plus 2% in the second half of 2010. If another stimulus package of $2 trillion is not passed and banks continue to reduce lending, the economy will begin to slide again. Our guess is if the stimulus package is not increased the Fed will instruct the banks to increase lending, which will monetize money and start higher inflation. It is really a tragedy for the American people and particularly business interest to have to deal with bogus government figures and continued lies. If neither events occur then the economy will resume degeneration and that will force the Fed to further monetize fund injections into the economy to avoid being overwhelmed by deflation. If economic and financial stability is to be maintained over the next ten years trillions of dollars will have to be injected and monetized into the economy and no lasting growth will be achieved.

In the meantime de-leveraging will have to be dealt with, especially among the banks and Wall Street; coupled with their terrible losses on their balance sheets. This will be a mean feat. As this transpires we will experience chronically rising unemployment. No economy can intrinsically grow under such conditions and it can only end in stagflation indefinitely. As we move along over the next five years people will finally discover that free trade, globalization, offshoring and outsourcing have robbed them of their once vibrant economy. The public will finally demand tariffs on goods and services in order to save what is left of their economic structure. In time world economic weakness will be reflected in commodity prices, which will slowly retreat. All of the above will advance government intrusion into the economy via regulation, as consolidation of monopolizations takes place. This will lead to increased corporatist fascism and America will slip deeper into socialism.

It will take three more years for residential real estate to bottom out and then we’ll have seven to 20 years of bumping along the bottom. That is if the derivative market and the financial system don’t implode. The fall in housing, the market and bonds will pauperize many who do not hide in gold and silver related assets. For those who survive net worth will have been decimated. As we have said previously things will be like they were in the 1950s and 60s.

All those who see recovery are the same group that saw recovery 1-1/2 years ago. It is just more propaganda and misdirection. Even if a recovery took place it would barely take growth to more than even and it would take years to recover. Writing off debt will be no easy task.

In the commercial real estate sector, the victim of over building, falling demand and unbelievable financing, which was the fault of the lenders, over the next three years sees $150 billion in properties up for refinancing. Sixty-three percent will not qualify for refinancing due to a 40% fall in value that will be followed by another 30% drop. In all about $500 billion in mortgages will have to be dealt with of which 50% won’t be refinanced. That means the banks’ balance sheets will be further clogged with properties with 70% losses. If you think the banks are buried now, three years from now most all of them will be insolvent. What else would be expected when they were lending 50 times their deposits when 8 to 10 times was normal? The Federal Reserve knew this was going on and they encouraged it.

At best the North American and European economies will move sideways over the next year as unemployment grows, but at a slower pace. The course from then will depend on whether there will be another stimulus package or a large increase in loans by banks. Either way there will be serious inflation and government cannot avoid engaging in monetization, because they cannot allow continual massive unemployment. Such conditions will continue to entice workers to save and reduce debt, which is not inductive to grow an economy. In order to augment employment, government, which makes up about 50% of spending and employment, will have to increase that year after year. That means more debt and higher taxes. This is not a very positive future, but that is the way it is.

The signals are being run up for the second stimulus package for this administration. The one under Bush did not work and the one started this year hasn’t worked as yet either. The bulk of this stimulus package in fairness doesn’t hit until next year, an election year.

The feedback we are now getting is that the Keynesian solution really hasn’t been tried yet, and it is time for that $2 trillion we predicted would be demanded in January, to be passed. How else can Keynesianism survive?

As we pointed out earlier if the relief is not forthcoming then the banks will have to start lending and monetizing. We are told the true measure of the success of the stimulus is not the actual level of unemployment, but what unemployment would have been without the stimulus. Talk about double talk. These great thinkers should reflect back to the fact that they caused this monster. Here they are telling us we are lucky it is not worse, and only the same old Keynesian nostrums can save us. These are the same policies that buried us.

For political reasons 75% of the stimulus will be spent in 2010, an election year, and some in 2011. Politics screwed up the package and we will never know if it would have been successful. The one-third devoted to tax cuts has been a loser just as the checks to citizens was. Banks seeing what is going on won’t lend easily in a depression. At the same time consumers are reluctant to borrow. Only business is in the mood to borrow and that is just to keep things going.

If you step back and look at what the Fed and government has done you will see they have spent trillions bailing out Wall Street, banking and insurance, as well as the auto sector. This is called corporate welfare. The recipients contend if they go down the system goes down and they are right. We believe they should have been allowed to fail. They were the ones lending 50 times assets while playing in a grand casino. Taxpayers will never get that money back and they will be forced to pay that principal and interest to foreign lenders over many years. You might also notice that only a few crumbs were thrown to the public.

Even if there is a second stimulus plan it won’t work. All it will do is buy more time, just as increased bank lending will. The victim is the dollar. It simply has to fall and as it does real interest rates will rise and the market will fall. Monetization will create more inflation and lending by foreigners will dry up forcing further monetization. A vicious circle that will end in hyperinflation. No one is willing to bite the bullet and that is what it takes to solve this problem. Even Joe Stiglitz wants the Keynesian solution, which will be much worse than it has to be.

As the financial “expertsâ€