If you are a policymaker, there is one good thing about crises -- they allow you to implement policies that, were there no crisis, would be deemed ludicrous. If the Fed and the ECB have their way, the world will witness the inception of limitless money printing in less than a month's time. The public has been conditioned to believe that the only way out of the financial quagmire into which the United States and Europe have been thrust, is through the benevolence of supposedly omnipresent central bankers. Of course, it wasn't hard to talk the public into placing their trust with Bernanke and Draghi, after all, to do otherwise would mean admitting that the lifestyle we currently enjoy is a charade made possible by the perpetual extension of counterfeit credit.
Both Americans and Europeans tried living in the real world and it turned out to be quite a bitter pill. In Europe, austerity protests clearly demonstrate the citizenry's unwillingness to sacrifice present comfort for long-term sustainability. As for the U.S., for a brief period following the financial crisis, Americans were saving again. The personal savings rate in America hit 6.2% in the second quarter of 2009 and has been on the decline ever since, hitting 3.6% in the first quarter of 2012 and rising only slightly to around 4.4% at the end of June.
Indeed, the temptation to reinflate the credit bubble proved too great as the Fed chose to cut interest rates and inject cash into the system instead of allowing the deleveraging to run its course. As David Stockman (former Director of the Office of Management and Budget, and the man whose questions formed the basis of Congressman Issa's letter to Bernanke) puts it, "Quantitative easing is..facilitating more public-sector borrowing and preventing debt liquidation in the private sector."
Similarly, Marc Faber noted (in a presentation given in Dubai earlier this year) that when credit contracted for a brief period in 2008 as fearful Americans squirreled away money and banks tightened lending standards, the Fed and the Treasury panicked "because they realized that the U.S. was a credit-addicted economy." Knowing that like any addict, the U.S. economy would collapse without getting its fix, the Fed and the Treasury moved to offset the private contraction in credit with fiscal deficits and monetization. Once government credit expansion exceeded private credit contraction, "asset prices went ballistic" and have continued to do so to this "very day". Back to Stockman:
The Fed balance sheet was $900 billion when Lehman crashed in September 2008. It took 93 years to build it to that level...Today it is nearly $3 trillion, [and as a result] everything in the world is overvalued-stocks, bonds, commodities, currencies. Too much money printing and debt expansion drove the prices of all asset classes to artificial, non-economic levels.
Of course reality has a pesky habit of perpetually trying to reassert itself, and the further one's policies diverge from it, the stronger it pushes back, hence the diminishing returns on central banks' interventions over the past several years, and hence the current tug-of-war between the ECB and sovereign spreads and between the Fed and the unemployment rate. This has led to a scenario wherein incremental interventions are no longer sufficient to offset reality, and indeed why should they be? Reality is attempting to bring the market back to equilibrium continually, so attempts to offset this must also be undertaken in perpetuity. Goldman Sach's recent research on the necessity for a perpetual 'flow' of QE speaks to this analysis.
All of this has culminated in a situation wherein central banks are 'pot-committed', to borrow a poker analogy. The game is up and everyone seems to know it given the media's incessant focus on QE3 and ECB periphery bond purchases. The only way to placate the market and keep the music from stopping is to take accommodative policy to its logical extreme and commit to open-ended balance sheet expansion. Note that this is equivalent to the sanctioning of unlimited money printing and it is exactly what is now under discussion at both the Fed and the ECB.
Boston Fed Chief Eric Rosengren has recommended that the Fed pursue a policy of asset purchases unconstrained by limits as to their scope and duration. PIMCO's Bill Gross now sees this as the most likely course of action regarding QE3. Similarly, the ECB appears set to implement some form of implicit or explicit caps on sovereign spreads which, for all intents and purposes, means there will be no limit to the amount of periphery debt the central bank is willing to buy to defend the caps.
This means that far from learning from the past, we are entering an era in which unlimited asset purchases by central banks will become the norm as the world has apparently sworn to never again do without for the sake of returning to the path of sustainability. In this new world, investors would be wise to remember that should reality have its day, inflation will rear its ugly head. Remember that one way central banks fight inflation is by selling assets to soak up cash. There will certainly be a lot of assets to sell, but the question is will there be enough buyers.
Furthermore, in the case of the ECB, it may find that there are no buyers for its soured sovereign debt at any price and similarly, the Fed may find that as interest rates rise, its book of long-dated Treasury bonds is worth far less than the face value of its liabilities (remember, the longer the average duration of one's bond portfolio, the more dramatic the negative effect on price a given rise in yields will be). In light of these considerations, investors should be cautious about investing in inflated assets propped up by bogus credit expansion and should instead place at least 20% of their portfolios in gold (GLD) and other hard assets.