September 20, 2012

September 20, 2012

All That We Can Say is, “Wow!”The European Central Bank (ECB) takes action; Germany’s Constitutional Court approves the bailout fund; and then the biggest of all — open-ended QE from the U.S. Federal Reserve!

These three actions, plus many other stimulating actions by various governments around the globe: infrastructure build-outs (see section below), lower interest rates, lower taxes, other fiscal programs, and initiatives designed to spur exports, when combined create one heck of a global risk asset rally.  Late Note: Japan joined the QE party this week, adding to the trove of liquidity; this confirms our long argued case of QE-E (QE everywhere).  We will discuss Japan further in next week’s letter

In our opinion, the only big problem on the horizon is a war in the Middle East between Iran and others, which would stop the flow of oil to Europe, Japan, and the U.S.  This past weekend featured reports of a massing of British and U.S. warships near the Straits of Hormuz (review our September 6th letter describing the chokepoints for oil transportation) indicating an increase in tensions in the region that could evolve into military action…to read our September 6th commentary go to How To Invest Globally

A Summary of What the Fed Did & What it Means for Citizens and Investors

To us, the key point was as described by the Wall Street Journal in their headline the day after the announcement.  The headline read, “Fed Acts to Fix Jobs Market.”…

Further, the Fed has made these commitments open-ended.  They are planning to buy $40 billion a month of mortgage-backed securities at least through year’s end, and then continue as they deem necessary.  There is no announced time frame.  They will act as is necessary to keep the economy from falling into what they fear could be a major depression.  Fed chairman Bernanke said the Fed is willing to risk higher-than-desired inflation in order to create jobs, as they believe that persistently high unemployment is worse than high inflation.

The Fed, through Operation Twist, is currently buying $45 billion of Treasury bonds per months through the end of 2012.  The two programs combined mean that the Fed will be buying $85 billion per month in bonds and mortgage backed securities… amounting to a $1 trillion-per-year annual rate.  Wow!  They are getting more creative in their stimulus, and will keep using many tools (and new tools) to achieve their goals.  This new program will extend the scope of mortgage-backed and U.S. Treasury securities purchases into 2013 if the jobs outlook does not improve, and does not maintain improvement.

Most astounding of all was that in last week’s Federal Reserve’s Open Market Committee meeting, they had only one dissenting vote.  Even conservative, historically anti-QE members of the committee voted for this program.  We should be reminded that members of the Fed have more data at their disposal and earlier insights into the economy than the public.  They are also a group of highly trained economists.  What must they have seen up ahead?  It was certainly not just the fiscal cliff, with its imminent tax increases and spending cuts.

Think about it: what the Fed has done is nothing short of astounding.  Their actions say three things.

1)  The Fed, with only one dissenter, is afraid that deflationary tendencies are widely afoot in the economy and the federal government’s failure to rein in spending for military and social programs leaves us with deficits that cannot be cured by tax increases alone.  One measure that we are sure they are watching is the overall sum of Americans who are unemployed, underemployed, have fallen out of the workforce, have gone on disability instead to continuing to work, and who are partially employed — all these numbers together reflect that the broader U.S. unemployment rate is over 19 percent.  This is a level that was last seen during the Great Depression of the 1930s.

2)  We believe that regardless of which candidate is elected President, spending must be reined in, and cutting spending will have deflationary consequences.  Thus, more deflationary tendencies will be layered upon existing deflation.

3)  As has happened in Europe, the U.S. public and global investors are not going to buy all of the U.S. debt that needs to be issued to cover the deficits, so the Fed believes that they will have to buy the debt — and to avoid a depression like the Great Depression of the 1930s, more QE and new types of QE are necessary.

The Fed’s new policies are innovative and aggressive in three ways:

1)  They made it clear that unemployment is a big problem in their eyes.  Creating jobs is much more important than their obligation to keep inflation under control.  This is bullish for gold, stocks, real estate, commodities and other hard assets that will rise in value and the U.S. dollar inevitably falls in value.

2)  They made it clear that throughout 2013, and probably longer, the Fed will be active in the securities markets buying bonds to

a) finance the U.S. deficit, and
b) force mortgage rates down thereby incentivizing borrowing to buy homes.

3)  They have made it clear that communications and balance sheet tools will be used to keep confidence high.  We should read this to mean that there will be more actions to provide liquidity, and the Fed will work with other central banks to engage in simultaneous stimulus.  That means more cheerleading, and more simultaneous QE to stimulate confidence and optimism globally…

What This Means for Investors

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Reducing Dependence on Middle-Eastern Oil is a Game Changer (continued)

Earlier this year, we alerted readers to the transformative power of increasing U.S. energy production, and it has been a theme we have touched on frequently in recent months…

The Rest of the World is Watching

…This has not gone unnoticed…

With all this Added Production, Won’t Oil Prices Collapse?

The reasons oil prices won’t capse are…

China: Credit Growth, Stimulus, & Succession

China is in the news for three reasons.  First, it’s a big country, and its GDP (the second largest in the world) is equal to about 63 percent of the US GDP — so it matters what happens in China.  China has been growing at a rate close to 10 percent per annum and the Chinese government has decided that such a high rate of growth is unsustainable.  Not surprisingly, China would like to slow its growth rate to a more stable and consistent 6-7 percent per year.  In our opinion, this is a rational and intelligent behavior.  It is almost impossible for a large economy to continue to grow as rapidly as 10% for a prolonged period.

The second reason for all the news on China is that the country is undergoing a leadership transition as the Politburo is changing…

The final reason is that the world economy is in trouble, and China has by far the strongest growth rate of any major country.  In essence, China’s growth is important to stimulate and accelerate growth in many other regions of the world…stay informed and to learn more about China, upgrade your subscription today, click here

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