More Funny-Money From the Fed?

Includes: GS, JPM
by: Avery Goodman

No nation, in all of recorded history, has ever managed to print its way into prosperity. If it were possible to do that, Zimbabwe would be the most prosperous nation on the planet. Indeed, the temporary "benefits" of the American printing orgy of 2009/2010 are already disappearing merely a few months after the counterfeiting process ended in late April, 2010.

Zero percent interest rates and free printed money combined with allowing banks to sell worthless debt instruments to the central bank for cash, has merely enriched speculators and caused a massive misallocation of resources. This misallocation, in turn, is actively preventing any possibility of real recovery of a permanent nature. Unfortunately, this has not stopped certain dimwits at the Federal Reserve, along with their supporters in the financial world, from promoting the idea of printing more counterfeit money.

Reports in the Wall Street Journal, and a deepy flawed article penned by regional Fed bank President James Bullard, as well as predictions from major investment banks, most notably Goldman Sachs (NYSE:GS), certain individuals working at JP Morgan Chase (NYSE:JPM), and others, have caused a lot of speculation that the Fed may restart its dollar printing program (aka "quantitative easing") on August 10, 2010.

Supporters of the concept of conjuring money out of thin air say that "more stimulus" is "needed". Then they try to make it more palatable to those who see the concept as outrageous by claiming that the Fed should engage in an abbreviated version of quantitative easing. Let's give the "abbreviated" printing process they are advocating a name. Let's call it "QE-Lite".

Basically, QE-Lite involves maintaining the bloated Federal Reserve balance sheet at the same level at which it now stands. This will be accomplished by rolling over maturing mortgage bonds into Treasuries using the cash that comes in as the notes come due. That will allow the United States government to engage in more so-called "stimulus", in addition to maintaining current levels of bloated liquidity within the financial markets. In other words, U.S. national debt is to be monetized and Uncle Sam is to be given an opportunity, via the printing press, to continue to spend reams of dollars he doesn't have. Continue to spend reams of dollars, that is, until everything collapses around him...

QE-Lite would prove Ben Bernanke and his minions to be inveterate liars. Bernanke has spent many a speech insisting that the Federal Reserve will not monetize debt and assuring the public that the currently bloated Fed balance sheet would be reduced in size. He and the members of the FOMC promised a public that was worried about eventual hyperinflation that the bloated balance sheet would be reduced both actively, and by the natural maturity of the bonds. They even talked about doing reverse repo operations to sell the bonds into the marketplace. If the pundits are correct, however, all those promises were nothing more than a sham, with the true purpose being to mislead investors into continuing to buy dollar denominated debt instruments.

If started, QE-Lite will cause the Fed to lose whatever credibility it has left. And, it doesn't have much credibiity left. We have already seen a deep drop in the U.S. dollar, over the past few weeks, just upon the mere contemplation of this new iteration of quantitative easing. The idea raises the spector of quantitative easing into infinity in the minds of investors. That, in turn, means the compete collapse of the American currency within a few months or years.

Some believe that this would be good for the stock market and such folks tend to be willing to do just about anything to insure higher stock prices, erroneously believing that it equals economic recovery. They are very wrong. You can get away with something once, even if it is outrageous, because perceived credibility, built over many decades, is hard to break. The truth is that you can, indeed, fool all of the people some of the time as the Fed and its primary dealers managed to do over the past year. But, you cannot fool all of the people all of the time, and a new program of QE-Lite would be an attempt to do just that.

There are trillions of dollars that are on the edge of fleeing the American currency. The fight away from America will cripple the U.S. economy. QE-Lite, if enacted, or even if the Fed talks seriously about doing it, so close in time to the last quantitative easing, is going to panic the market. People will sell the dollar en masse, expecting endless additional episodes of Fed counterfeiting. We will end up with Zimbabwe on the Potomac.

In the face of a mass exit from the dollar, the Fed's primary dealers probably think they will solve the problem using one of their financial "models", by just issuing a torrent of countering derivatives to calm the market, and then unwinding them later. Such a defense, however, is doomed to failure and would eventually bankrupt the dealers, because, when they tried to unwind, there would be no willing counter parties, and not even the Fed could save them. This again is because its monetary diarrhea, by that time, would be viewed as worth exactly the same as the type of manure that we use to fertilize our farms.

While it is true that there is still a somewhat elevated demand for dollars because of the level of bad debts in this depression, and the natural process of credit money destruction, this demand will be overwhelmed by the mass exit from the dollar. With the dollar collapsing, the stock market may seem to soar, at least in nominal dollar terms. However, the truth will be that it will be collapsing, just slower than the dollar and the bond market.

More talk of quantitative easing, in any form, at this time, when the outlook for the economy and the dollar is so uncertain, and when sentiment about the dollar is so fragile, coming so soon after the last episode of counterfeiting, will surely be the straw that breaks the camel's back. It will greatly speed the flow of capital away from the U.S. It will mark the beginning of a currency collapse.

What many policy makers, unfortunately, do not realize, is that hyperinflation is not a matter of supply or demand. It always happens as a result of a loss in confidence in the currency as a means of value storage. Using currency debasement to steal the value of Grandma's CDs and transferring the money to high frequency traders, primary dealers and other speculators does not create confidence.

Most of the actions of the U.S. Treasury, Congress, and the quasi-governmental Federal Reserve, have been dead-wrong from the very beginning of this Financial Crisis. Chairman Ben Bernanke and most of his committee members are not wise men. Yet, they are not stupid enough to induce a currency collapse, where that outcome has a fairly certain "cause and effect" relationship to their actions.

Although I have fewer connections to the FOMC,
I disagree with the view of Goldman Sachs and the Wall Street Journal. If the FOMC approves QE-Lite, or any other form of funny-money printing for that matter, at this particular time, the dollar will not recover from the blow. The members of the FOMC are not so stupid that they do not realize this. I am confident, therefore, that no additional quantitative easing measures will be announced on August 10th, 2010.

us hope beyond hope that the Federal Reserve's FOMC does not only not start up the funny-money printing presses again, but doesn't even mention one word about the possibility of doing so. Indeed, even the perception that they are seriously considering the idea may be enough, even in the absence of any action, to collapse the U.S. dollar. By collapsing the dollar, they will also be torpedoing the U.S. economy. Thankfully, James Bullard, who is in the habit of opening his mouth when it should properly stay closed, will no longer be a voting member of the FOMC next year.

Disclosure: No positions in any company discussed.

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