Does the Stock Market have a QE Addiction It Can’t Quit?

I just saw a slideshow that shows countries with the highest external debt to GDP ratio, and the US was number 20, at just over 100%. So 19 countries were worse off, many way worse off, with Ireland being the worst. Their percentage was astronomical, and their per capita debt was over $500k! That's right, more than 10 times that of the US. Greece was about number 15 or so, so why is it that they're going to be the first to default? And since the US is so much better off than so many other countries, does this strengthen the view of our politicians and the general public that maybe things aren't so bad? Plus of course, we can always print more money.

I agree with you that Q3 is in the making. I believe that the Bernanke will wait until early next year for it's launch. If Bernanke were to launch QE3 now, then that would mean it's expiration around summertime (assuming the typical QE duration cycle), during the heat of Obama's re-election campaign. Do you really think Obama is going to sign off on that? Anothere market selloff during the summer -- I personally think not. IMHO, the Bernanke will be steady on the trigger until the $ gains more momentum to the upside while pushing down commodity prices/inflation, then watch out for a massive stimulus program. I will be all in, and pulling out before the election.

Wash, rinse and repeat. I loved your book!

Thanks for the forum,
Andrew

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The Fed will not print money if Inflation starts to pick up(inflation is picking up!)if they were-it would have happened at last meeting-market had been crashing, europe was on the brink, there are no jobs to speak of out there.Fed is not an bunch of idiots as so many people try to portray them as and they see the same figures/risks we all do.they know they cannot get inflation or it will be game over.If market crashes so be it - Congress will have to take the blame on that for their terrible decision on debt ceiling. Bottom line Fed will not print again,there will be year end rally when Europe gets its TARP-Congress will make make changes to spending (they understand risk as well) and that will be the match that ignites a huge market rally.all the people sitting in cash or shorting the market will get their heads handed to them and teach them a lesson about timing the beast.Ms. Market never lets anyone time her and she punishes those who do.

Thanks Cindy for including 401(k) holders in your discussions. Great article!

Great question, Steve. Debt-to-GDP is a useful statistic, but it doesn't necessarily tell you when a government will be forced to default. Remember, the government isn't paying its debts using the country's GDP. A better way of looking at it is debt-to-income ratio, just like you would with an individual. The government's income is tax revenue. Greece fares much worse when measuring debt-to-revenue.

You're right that the relative wealth of the US makes it hard for many to believe that we could ever truly face disaster. But while our wealth will make the landing a little softer (relative to other countries), it won't save us from the fall.

Thanks for your comments Andrew. Remember though that while the White House and Congress have some limited influence over the Federal Reserve, monetary policy decisions do not have to be approved by anyone outside the Fed.

Interesting points, John. The problem is that the Fed likely won't see inflation – even in the 4 or 5 percent range – as dangerous, but rather as a sign of recovery, as it has been in the past. The theory behind QE is that it will stimulate the economy, and once that happens, the money that was put into circulation can be gradually pulled back in, preventing any meteoric rise in inflation.

But, as we see it, the economy is not recovering and money printing is just reinflating the bubbles. And all bubbles eventually pop.

Most of us looking forward are forced to deal with the market. Faced with this and the almost inevitable Aftershock why hasn't anyone mentioned the newest bubble appearing? The College Debt Bubble and how that will influence future personal productivity which in turn drives the market?

The book suggests that inflation is one way that governments "solve" their national debt crisis. Could someone elaborate on this? I'm not sure that I understand how we emerge on "the other side" of a period of high inflation with the debt crisis behind us?

Len,
You're absolutely right about the college debt bubble. We just include it as part of the larger private debt bubble. The real problem comes when the government can no longer guarantee those loans (likely in the next few years).

Tim,
"Solve" is perhaps a misleading term. But when a government faces a debt crisis, there are three ways it can raise money to pay its debts and avoid default: A) raise taxes, B) cut spending, or C) print currency. Politically, printing currency is the easiest to do. Unfortunately, while the debt may be paid down, the upshot is a strongly devalued currency. (The more currency in circulation, the less value it has.)

One thing I noticed from the book that diverges from other organizations warning of similar aftershock is the outlook for the Euro. It seems you believe that the Euro will survive in the long term. However others believe the Euro's demise is not only inevitable but even imminent. With all the recent developments in Europe with Greece, Italy, Spain and Ireland, why do you feel the US is in more trouble? Just the sheer size of the debt?

Good question, Brett. The US dollar bubble is only partially tied to the national debt. The real problem is the expansion of the money supply – now more than three times what it was in 2008 with more expansion likely on the way. In the Eurozone, we've seen some devaluing of the currency in order to deal with the debt crises of Greece, Italy, and others, but it's insignificant compared to the devaluing of the dollar. In the long term, the euro's strength is that it is not at the whim of any one country's response to crisis. We can expect a lot of volatility and even significant inflation to come for the euro, but we think it will survive and hold up better than the dollar in the end.

Today the Fed "came to rescue" of the EURO and the DOW again soared in response to what seems to be QE by a different name. It does seem, however, that this ever tightening relationship between world banks can only mean that they are all headed down together.

I know that after WW-I Germany tried to print more money to "inflate itself" out of debt, but that got totally out of control and completely ruined the country. In the sixties and seventies the U.K. tried to deal with it's debt similarly, but with more control. They went through some serious infrastructure issues when the pound was devalued, but they survived. How do the U.S. debt and money supply issues compare to those and how much infrastructure disruption do you foresee when the Dollar and Debt bubbles pop?

Earlier this year (2011) records of the Federal Reserve from the early stages of the credit crisis were made available to the public. It is now very clear that the Fed has loaned trillions to European banks hold off a collapse.
How does this "external" quantitative easing affect the money supply?
Would an earlier collapse of a major European bank accelerate the pop of the Dollar and U.S. Debt bubbles?

Paul,
There are many differences between our current situation and those in the past, most notably the whole series of bubbles we're dealing with (not just the public debt and dollar bubbles). The real danger of inflation comes from the sheer volume of monetary expansion we've seen, which has only served to reinflate the other bubbles, meaning we can expect even more quantitative easing to come (by that name or another).

We'd still put the dollar bubble burst a couple years away. The actions of the Fed toward Europe have a major effect, but we had already anticipated much of this in our predictions.

I just found a 2009 paper by Fed staff explaining the effects of implementing the policy of paying interest on excess reserves. The title is "Why Are Banks Holding So Many Excess Reserves?" by Todd Keister and James McAndrews, listed as Staff Report no. 380, July 2009.

It shows the banks holding excess reserves close to a trillion dollars as of 1 Jul 2009 and credits this for controlling inflation while keeping the banks liquid. It is not helping ease the credit crunch on small business and is not actually in the circulation accounts. I see this as a money bomb with increasing potention to cause explosive inflation.

I found this article while following up on a reading of Aftershock v. 2, especially p. 84ff.

When the final bubbles pop and the banks fail, what will happen to stocks that we own if our brokerage goes under or for that matter if we own a gold ETF like CEF, will that gold still be availble to us and how will we retrieve it or cash out of it?

Dear Aftershock Team,

I just read an article which indicated that the Money Supply in Europe has doubled in the last two years. Has this been included in your predictions? How large an effect is this likely to have on U.S. stock markets? How much is this likely to increase the magnitude or the duration of the U.S. Dollar Bubble? How much is this likely to increase the magnitude or the duration of the Gold Bubble? Thank you for your responses.

Sean,
Generally speaking, securities should be safe to the extent that they have value. Liquidity could become an issue with gold ETFs, but at least at the moment we don't see a problem with them.

Paul,
Yes, the money supply in Europe has fallen in line pretty well with our predictions. To the effect that money printing in Europe will have an effect on US stock markets, it will likely be somewhat positive in the short term as it is stabilizing the financial system there. Of course, in the long term, it only contributes to the problem. To some extent, it prolongs the dollar bubble because the dollar is still seen as a safe haven by those who are fleeing European instability.

The gold bubble has a very long way to go. It hasn't even really gotten started, and probably won't for another couple years.

Sean,

I would like to add to the reply of the Aftershock Team. (I am a licensed Broker Dealer Rep.)

If you hold actual stock certificates, and your Broker goes under, there will be little effect.

However, if your stocks, ETFs, bonds, etc. are held "in street name", the broker actually owns the shares or bonds for the benefit of your account. In this case, if the broker truly fails (i.e. no bailout and not bought by another entity) your accounts with that broker are insured by the S.I.P.C. up to a limit of $500k.

Hi Paul,
thanks for the info but if several or most banks/brokerages fail will S.I.P.C be able to cover the losses? what happened to Lehman Bros. did they get bought out by another brokerage or just go away?

Sean,
The process may get more complicated that what we've seen in the past, but for the most part, we'd expect securities from bankrupted financial firms to end up at other firms intact (again, to the extent that they have any value left). Expect to see a lot of government intervention in this process.

The situation gets trickier with CDs, savings accounts, and any debt instruments. Eventually, it will be impossible for the government to guarantee these accounts, and many will likely be wiped out.

Is there a way small investors can get some of our assets out of the country legally to get it away from the reach of an repressive gov.?

I just read an article on what a second Obama term could bring in the way of financial oppression, very unsettling.

Sean, I hear a lot of this it it also keeps me up at night.

I do however agree with the Aftershock team that the USA will weather the storm better then other countries (except for expensive energy).

Since so many nations need to export their stuff to us they will be hurting far more for certain once their largest customer goes bankrupt.

I am not happy with Obama or almost any other one that's running for "King", but I would hate to see China, Germany and Japan once we are finished buying their stuff.

As for the expensive energy disaster which we can see happening now those countries will survive better then us.

The American suburbs were designed around cheap energy.

Whether it being peak oil or the Aftershock the suburbs will be hit with a sledge hammer in a world of expensive energy.

The suburbs will be the new slums while the projects maybe desirable since it's occupants use less energy.

Anyone else out there that sees Wall St. as, structured for traders, not investors? Of the billions, yes billions of shares traded daily. Just what percent of these do you think are for investment? As in buy a stock for long term and maybe a bit of dividend to boot. I believe it to be a tiny fraction. IE Wall St. exists mainly for Wall St.

Not content to sell real investment on a commision basis. The "Street" itself trades by the billions. Not content with that. They have created all sorts of exotics and derivitives. No wonder the little guy, gets drained. And has for most left the market.

Guess the only thing left to go after is the Tax payer. Oh wait that has already happend. Who is responsible for the "structure" of Wall St.? That seems to be off limits to all, even the "Pundits".

Dear Aftershock Team,

I read in the Wall Street Journal yesterday, 03/28/2012, that in 2011, the Federal Reserve purchased 61% of all treasury bonds sold at auction. This means that they put in the highest bids and paid a premium (i.e. more than the face value of the bonds) in order to keep the yields artificially low. When large investors could not by treasuries at a reasonable yield they were forde to look elsewhere for investments with a higher potential return.

This is what has kept the stock market from falling last year and what kept yields on treasuries so low.

> A curious question occurred to me. If the Fed can create money to loan to the government, what would keep the Fed from quietly forgiving that debt later (at or even before the bonds maturity)? Would that, in effect, reduce or increase the money supply? Also might that forestall or reduce the impact of the debt bubble when it pops?

Great question Paul. I always wondered about this too.

I think the dollar bubble would burst so big it would blow a hole through the universe.

If the fed were to keep monetizing the debt this way then we will see hyperinflation for sure.

The debt would no longer exist but as the fed buys 100 trillion in debts (which is what it will be when we add the unfunded liabilities) then the economy will be totally destroyed.

I feel that the fed will create as much inflation as they possibly can until they realize they have no choice but to stop and let the markets finally take over.

Sean,
Moving funds out of the country is a somewhat difficult process, and we wouldn't necessarily call it advisable now. Possibly down the road.

Greg,
We expect to see many reforms after the crash hits that will help get us on more fair and solid ground. It is one of the silver linings of the Aftershock.

Paul,
The problem is that the Fed's quantitative easing program of buying huge amounts of Treasury debt is all predicated on the idea that they can sell it back down the road when the economy recovers, and thus avoid inflation. We don't think that will happen — aside from jeopardizing any economic gains, it would also spell big trouble for the bond market — but it's a big part of the Fed's justification for QE and banks holding excess reserves.

The Fed can buy as much government debt as it wants and minimize the Treasury's obligation, but it just creates more and more inflation in the process. If this could be done without consequence, every government would do it 100 percent of the time.

When the Fed buys back US Bonds and Notes, does that lower the amount of total debt versus the congressional debt limit? In other words, is that a way to sidestep the debt limit?

Jim,
The Fed's share of Treasury debt is included in the debt total. The Fed is actually the Treasury's largest single lender, ahead of China, Japan, and the usual suspects you typically hear about.

What would make gold ETF's less liquid? I get the challenges that the financial institutions will face but since the demand for gold should increase wouldn't the demand for gold ETF's increase as much if not more because they are easier and more accessible to the general population? Seems to me there should be ample demand for gold ETF's as poeple lok for stock/bond replacements with their portfolio's. Where's the liquidity problem?

Sorry, as an astrophysicist I am a little in the dark on finance. I thought that by issuing money the treasury did not incur debt and thus the net debt would decrease when the newly minted money was used to buy back government notes and bonds.

Ben,
Let's be clear first that we don't see any problems right now with PHYS or GLD, in that they both appear to be well-managed and 100 percent backed by physical gold with no liens on it. The potential issue with ETFs is that they might have more outstanding shares than physical gold, or that they don't own all the gold outright, which would become a problem when demand skyrockets. To the extent that every share of a gold ETF can be redeemed for actual physical gold, there are no liquidity problems. Like we said, we don't see this being a problem for PHYS or GLD, but we will be keeping an eye on it.

Jim,
When the Fed buys Treasuries, it generally does so on the open market, rather than purchasing directly from the Treasury. So it doesn't change anything on the Treasury's balance sheet except the owner of the securities. Also, a crucial justification for quantitative easing is that the Fed hopes to sell most of those bonds back on the open market. We don't see that happening, but that assurance is a big part of staving off concern.

What you may be thinking of is the fact that quantitative easing can both reduce the value of the government's debt (through inflation) and lower the interest the government has to pay (by creating artificial demand for bonds). If the interest rates are lower than the inflation rate, the process effectively liquidates some of the government's debt. Of course, as we spend much of our books explaining, this process does not come without consequence.