US Fed will eventually lose to Mr. Market

Jun 24, 2013

Paris, France

    "All due respect, you got no f-----g idea what it's like to be Number One. Every decision you make affects every facet of every other f-----g thing. It's too much to deal with almost." Tony Soprano
Whew! The Fed is number one in central banking. And it's finding out how tough it can be to meddle with a $16 trillion economy.

On Wednesday, Ben Bernanke came out with a public statement. He said that if all went well... and he didn't change his mind... and nothing unexpected came up...and the Fed's Open Market Committee felt like it...the Fed would begin tapering off sometime.

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That was all it took to send a shiver up investors' spines...and a sell signal to Wall Street. Everything sold off - stocks, bonds, commodities, name it.

Over the next two days, the Dow sank more than 500 points, before stabilizing on Friday. The New York Times:

    Fed Signals Rattle World Markets

    "Clearly, the Fed tapering is on the table now. There is a reversal of perception in liquidity and it will take some time for investors to digest, rebalance and what not," said Adrian Foster, head of financial markets research for Asia- Pacific at Rabobank International in Hong Kong.

When the Fed's EZ money programs end there will be Hell to pay. We're not sure that bill has come due yet. We'll have to wait and see.

But Mr. Market wants a correction. Mr. Bernanke wants to avoid it.

In the long run, we don't have any doubt about who will win. Mr. Market always wins. But rarely in the way you expect. He might play with Mr. Bernanke for years before administering the coup de grace. Investors might be deceived, surprised, and completely faked out once...twice...three times before the curtain finally falls.

Do you want our best guess?

Here it is. Japan...then Buenos Aires. We suspect that the Great Correction is intensifying. Stocks will fall. Bonds will fall. Real estate will fall. Just like they did in Japan.

But unlike Japan, yields will rise. Yes, that's the most interesting thing that is happening. After 30 years, the bull market in bonds appears to have finally come to an end. Yields are rising. Bond prices are falling.

And this is happening at the worst possible time. Just what you'd expect, in other words.

Let's go back a bit further to get more perspective.

Aided and abetted by the Fed, for 60 years, America's private sector loaded itself with debt. Then, in 2007, the weakest link - subprime mortgage debt - broke apart. The end of the cycle was at hand.

We estimated that the process of de-leveraging - paying down, writing off, defaulting, going broke, inflating away and otherwise shucking debt - would take 7 to 10 years. We're now in year 6.

We knew the feds would fight the correction, but we didn't realize how reckless they would be about it. Their interventions, worldwide, have cost $7 to $12 trillion, depending on whose tally you believe. These meddles make it very hard to know what is really happening. The Fed rigs the most important price in the most important economy in the world - the price of credit. All other prices are affected. You can study price movements, but it's impossible to know what they really mean.

One thing is sure, the Fed - and not a real recovery - was responsible for the big run-up in stock prices from 2009. So, it's reasonable to expect that when the Fed backs will stock prices.

Then, instead of the 'wealth effect' helping to hold up the economy, we'll have a negative wealth effect -falling asset prices -- pulling it down.

A correction is meant to correct mistakes. The Fed has tried to stop it. It has kicked the can down the road. But over the last 6 years...we have gone further down the road. And there is the can again! And now, it appears that the Great Correction must must continue its work: Correcting the foolish mistakes of the bubble period AND the foolish mistakes of the last five years too.

But if the bond market has turned against the Fed, falling bond prices will make it harder for borrowers everywhere to keep going. And the biggest borrower in the world is the Fed's own boss - the US government.

Fed governors know they have to 'taper off' sometime...or risk a bigger calamity. But they can't back off now...not with the bond market falling. They'll have to increase their buying...and cause even more distortions.

That's how we get to Buenos Aires. Deflation Now, Inflation Later.

Hold on tight!

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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