Yesterday was Hallowe’en. We saw hobgoblins … scarecrows … six-foot-tall rodents … and at least one crow that weighed 200 lbs.
We also saw the Dow fall 71 points and gold lose $25 an ounce.
A few days ago, investors were sure it was “QE from Here to Eternity.” Now, they’re not so sure. The Fed seemed to leave some uncertainty on the matter when it made its remarks on Wednesday.
But we have little doubt. The Fed won’t be tapering in any serious way anytime soon. It is determined to increase “demand,” and the only kind of demand it knows is the kind you get from more cash and credit.
As to real demand – what you get from increases in real wealth and real prosperity – the Fed knows nothing… except that it can’t help.
The Fed is not stimulating a recovery. But it is simulating one – with phony demand coming from phony asset prices based on phony low interest rates. And now it can’t take off the mask.
Because then all the disguises, false beards, and fraudulent get-ups would have to come off too – like the day after Hallowe’en. Then we’d see things for what they really are.
Then we would realize that much of our stock values, our standards of living, our earnings and our balance sheets are all based on a lie – the lie of constantly expanding credit.
Since the early 1980s, credit growth has been increasing roughly twice as fast as US economic growth in real (inflation-adjusted) terms. That’s when everyone came to believe that “deficits don’t matter.”
But deficits do matter.
Because when you increase your debt faster than your income for 30 years, you end up with a lot more debt than income. You also find yourself at a dead end.
Your economy has come to depend on something that can’t continue. You can’t run up your debt levels forever. Eventually, forever comes. And then the masks drop … the beards fall to the ground … and the costumes come off.
In short, our economy is living on borrowed money and borrowed time. When the Fed stops suppressing interest rates, its time will be up.
So, let’s turn to another matter…
A Bugged Life
On the front page of yesterday’s Financial Times was a photo of a woman on her way to jail. Poor Rebekah Brooks. It will be a shame to send her to jail. She has such pretty hair.
Instead, send NSA spy chief Gen. Keith Alexander to jail. He has little hair at all.
But our judgment on jail time is not purely based on this pair’s hair, but on their crimes. Brooks – a former editor of British tabloid newspaper the News of the World – is alleged to have hacked phone lines (including those of the British royal family!) to break big stories. That is to say she acted with a noble motive – to make money!
Alexander, on the other hand, seems to have hacked half the world’s phones – including those of foreign heads of state.
And for what reason? Nobody knows. Alexander says the NSA was protecting the world from terrorism. But surely German chancellor Angela Merkel is no terrorist!
The latest twist to the NSA story is that the agency says Europeans handed over their own phone records so the NSA could snoop on their conversations. The French flatly refused the general’s explanation, saying it was “not plausible.”
Readers must be getting as tired of the spying story as we are. Besides, where’s the surprise?
Give America’s spooks billions of dollars, the latest technology, about 40,000 employees (the actual number is classified) and permission to do whatever the hell they want courtesy of the Patriot Act … and what do you think they will do? Still, we slap the story onto the page to introduce a broader theme.
The theme is a familiar one. But this time we approach it from a new angle.
We’re talking about civilization …
Barbarians at the Gates?
President Obama and Gen. Alexander believe they are protecting the civilised world from barbarians. They are not the first to think so.
“Three times have Italians saved civilization from barbarians,” said Benito Mussolini.
The most recent time was in World War II, when the Bolsheviks menaced all we hold dear. At least Benito thought so. And he believed it up to the moment when he stopped believing anything. That is the moment in April 1945 when partisans found him in a German armored car, headed for the Swiss border, with a Hallowe’en disguise of his own… six months too late.
Mussolini – the defender of Western civilization – was dressed as a soldier of the Wehrmacht. Too bad for him that Communist partisans recognized him. Soon, he was hanging upside down on a meathooks from the roof of a gas station along with his mistress, Claretta Petacci.
Typical of both the enemies of civilization and its defenders, the partisans made no distinction between a real enemy and his paramour. Although poor Claretta wasn’t guilty of anything more than being in love with the wrong man at the wrong time.
US Navy SEALs made the same judgment in their assassination of Osama bin Laden. They killed an unarmed woman on the scene. What was her crime?
And the troops of General Juan Manuel de Rosas, in 19th century Argentina, decided to protect European civilization, too. They did so by sweeping the Pampas… in the Desert Campaign… of its native tribes. Once they were virtually annihilated, the natives posed no further threat to civilization.
But can you really protect civilization by snooping, stationing troops all over the world sending out drones and assassinating people?
More to come…
Can the Fed Afford to Taper?
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
This week, the Fed decided once again not to taper its bond-buying program – QE.
But it spooked markets with a more upbeat view of the US economy. Investors are interpreting this as a hint that tapering may come sooner rather than later.
From this week’s post-FOMC meeting press release (emphasis mine):
Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.
But can the Fed afford to taper?
QE may not be particularly good at raising consumer price levels (at least not on the evidence so far). But it seems to do a good job of raising asset price levels.
And rising asset prices – particularly rising stock prices – is the prerequisite in incoming Fed boss Janet Yellen’s mind for the so-called “wealth effect.” (Folks, seeing paper profits in their stock market portfolios, are supposed to run out and start buying flat-screen TVs, new cars and the like.)
One particular area of concern for Yellen is record US corporate net profit margins.
As you can see from the chart below from Citi Research, corporate America’s operating profit margins – earnings before interest expenses and taxes (also known as EBIT) – have been flat to negative over the last six months or so.
It’s only when you look at net profit margins – which take into account reduced interest expenses on corporate debt – that margins look rosy.
As you can see from this next chart, showing quarterly interest expenses as a percentage of sales, it’s not that CEOs have been incredibly efficient at running their businesses. It’s that the companies they run have been the beneficiaries of ultra-low interest rates, which pushes up their net profit margins.
If the Fed starts to taper, interest expenses will start to rise… and corporate America’s net profit margins will start to collapse.
This is bad news for US stocks… and a big threat to the Fed’s attempt to conjure up the illusive “wealth effect.”
Will the Fed dare remove this important support?
We doubt it.