US will keep pumping money till it can't go on - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 8 November 2010
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Delray Beach, Florida

Was the Fed action already fully priced in the marketplace? Had investors anticipated the Fed's latest move and already bid up stocks and gold?

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No!

The New York Times explains more of the Feds' action:

"The [Fed's] action was the second time in a year that the Fed had ventured into new territory as it struggles to push down long-term interest rates to encourage borrowing and economic growth. In a statement , the Fed said it was acting because the recovery was "disappointingly slow," and it left the door open to even more purchases of government securities next year.

"The Fed is an independent body, its policy decisions separated from the political pressures of the day. But it acted with a clear understanding that the United States, like many other Western countries, seems to have taken off the table many of the options governments traditionally use to give their economies a kick, particularly deficit spending.

"The Republicans regained control of the House for the first time in four years in part by attacking the stimulus plan - begun by the Bush administration and accelerated by President Obama - as a symbol of government spinning out of control, contributing to a dangerously escalating national debt.

"This political reality has left Washington increasingly reliant on the Fed to take action, though its chairman, Ben S. Bernanke, has said the Fed cannot fix the problem alone.

"Ordinarily the Fed's main tool for spurring economic growth is to lower short-term interest rates. But those rates are already near zero. With no more room to go, it has to find another route to stimulate demand.

"While the Fed step was telegraphed to the markets in recent weeks, most experts had expected $300 billion to $500 billion in purchases of Treasury debt. Still, the pace - $75 billion a month for eight months - disappointed some investors.

"...in total, the Fed will buy $850 billion to $900 billion, just about doubling the amount of Treasury debt it currently holds."


So, what did investors make of it? The Dow shot up 216 points yesterday, after investors had time to consider what the Fed had done.

As for gold, it gained more in a single day than the entire price in 1971. That year you could buy an ounce of gold for $41. Yesterday, the price of an ounce GAINED $45.

Gold market investors figure they know what happens next. The Fed will pump in nearly $1 trillion more in this go-'round. If that doesn't revive the economy and lower the unemployment rate, they'll pump in some more. And they'll keep pumping until they can't go on.

When will that be? Nobody knows exactly. But if they keep this up, eventually the dollar will collapse and gold will soar. Maybe to $3,000 an ounce. Maybe to $5,000.

The point is this: the Fed has set its course. It has no reliable maps. Its captain doesn't no where he is going. As for the navigator, first mate and other hands, they are a bunch of misfits, malcontents, and meddlers who have given no indication that they know what they are doing. Do you think they will arrive at their destination?

We don't. But we're sure they'll end up where they ought to go.

More below...

And more thoughts...

*** That's the great beauty of a real economy! It rarely takes you where you want to go...especially if you're an activist central planner or an interventionist finance minister. But no matter how much you struggle with it...no matter how badly you manipulate it...no matter how much you try to stitch it up with rules and regulations...

...it ALWAYS takes you where you deserve to go.

Look at what happened back in '71. Nixon's move to take the US entirely off the gold standard was hardly noticed. Because he announced something even stupider that day. He told the world that henceforth prices and wages would be controlled by the feds. No kidding. His wage-price controls were designed to put a brake on inflation.

Did they work?

Ha...ha...do you have to ask? If you could control inflation by executive decree...well, it would be a lot different world than the one we live in. You can't do that. And when you try to do that, you don't get a world of stable prices, growth and prosperity. What you get is what they got in the Soviet Union, when the controlled the price of everything. They got a lot of nothing...

...nothing on the shelves...and nothing worth buying.

We remember visiting Poland in 1977. It was a delightful place for a driving holiday because there were no cars on the roads. People didn't have cars. And the trucks were usually off the roads too. They were broken down...usually alongside the road with their hoods up.

There were no hotels either. And no restaurants worthy of the name. You just had to make do.

You'd go into a shop. It was drab. Empty. There were usually two or three dozy clerks...but nothing to sell. Just a few cans. What was in the cans? It was hard to tell. But since that was all there was, you bought it and ate whatever dreadful thing was inside.

Later, in the '80s, we took a trip to the Soviet Union. On the plane with us, on a flight from Moscow to Minsk was a woman with a toilet seat in her lap. It turned out that she had been raised in Tennessee and had a twang to her English.

"What are you doing with a toilet seat," we wanted to know.

"Oh...I just bought it in Moscow," she explained. "There aren't any toilet seats for sale in Minsk."

"But isn't that an expensive way to get a toilet seat? I mean, this is a three-hour flight."

"No...the flight is priced in roubles. And the rouble isn't worth anything. It actually cost me more to buy the toilet seat than the roundtrip ticket."

See what central planning produces? Absurdities. Monstrosities. Imbecilities. Coming soon...to your neighborhood.

****

Plumbers Crack

Poor Ben Bernanke. There was a strange glow on his face as it appeared in Monday's Financial Times...like a bearded St. Joan of Arc; his hands were clasped together as if in prayer, and his eyes seemed to reach up to the gods, if not beyond.

He made his reputation as a master plumber in Princeton, New Jersey, interpreting drippy money supply faucets and deconstructing clogged fiscal drains. And now, he has become the hope of all mankind. Or at least that part of mankind that hopes to get something for nothing.

How came this to be? The answer is simple. The plumbers who came before him botched the job. Applying their wrenches to the recession of '01, they let too much liquidity into the system. Everything bubbled up. The sub-prime basement overflowed in '07...Ben Bernanke has been on the job ever since.

And this week the financial world held its breath. It waited. It watched. Ben Bernanke was hunched over...sweat on his brow... easing on his mind. Commentators, economists, and the public wondered if he could really create new money...new wealth...out of thin air? If this were true, it was a giant step forward for humanity, at least equal to discovering fire, creating Facebook or blowing up Nagasaki. Jesus Christ multiplied loaves and fish. But He had something to work with. The Federal Reserve multiplies zeros...creating money -- out of nothing at all. If it can really do the trick, we are saved. The legislature can go home. It no longer needs to worry about raising taxes or allocating public resources. Government can now buy all the loaves and fish it wants. And give every voter a quart of whiskey on election day.

During the course of last three years, the plumbers have spent hundreds of billions of dollars. It's hard to know what the final bill will be, since so much money more than $10 trillion is in the form of guarantees and asset purchases. They've pumped. They've bailed. They've squeezed and turned. They scraped their knuckles and cursed the gods.

You'd expect they might think twice before spending so much money. But on the evidence, they haven't even thought once. Quantitative easing has been tried before. Has it ever worked? Nope. Never. Do you dispute it? Give us an example.

Japan announced its QE program in the spring of 2001. The Nikkei 225 was around 12,000 at the time. It quickly rose to 14,000 as investors anticipated a payoff from the easy money. Then, stocks sold off again. Two years later the index was at 8,000. Today, it is still about 25% below its 2001 level.

Did printing money cause an up-tick in inflation? Not even. Core CPI was negative 1% when the program began. It rose to zero briefly...and then fell again and now stands at minus 1.1% after going down 19 months in a row.

America's own experience with quantitative easing is similarly discouraging. Between the beginning of 2009 and March of 2010, the Fed bought $1.7 trillion worth of mortgage-backed securities, creating new money specifically for that purpose. Where did the new money go? Into the coffers of the banks. Did it stimulate the economy? Not so's you 'd notice. The unemployment rate today is 200 basis points higher than it was when the program began. And despite the flood of cash and credit, core CPI in the US is still only a third of its level in 2008.

Of course, there are other examples where central banks printed money with more gusto. In Germany, during and after WWI, the nation's real money gold -- was used to pay for the war and the reparations following. The central bank felt it had to create additional money like the Fed without gold backing. It added about 75% annually to the money supply, from the end of the war until 1922. By late 1923, the US dollar was worth 4 trillion German Marks. Still other examples from Argentina, Hungary, Zimbabwe and elsewhere are fun to read about. But they are not exactly the sort of thing you'd want to try at home either.

Even if Quantitative Easing were a precision tool in the hands of a skilled mechanic, it might be little more than a wooden club in Ben Bernanke's dorky grip. This is the same man who missed the biggest credit bubble of all time! There is no evidence that he could fix a bicycle let alone the world's largest economy. But there you have a more interesting question. What if economists were duped by their own silly metaphor? What if an economy were not like a bicycle? What if the gods were laughing at them?

Central planning and cheap fixes have been tried before. When have they ever worked? Give us an example. Perhaps an economy is too complex...like love or the weather...unfathomable...and largely uncontrollable, something you can make a mess of but not something you can improve.

We have no more information as to the fundamental nature of things than anyone else. A toaster oven is designed and built for a purpose. When it doesn't work, it can be fixed. But an economy? Who built it? Who can fix it? It is an organic, evolving system...whose purpose and methods are infinitely nuanced. Does it let banks go broke? Does it back up once in a while? Does it permit a falling house prices...high unemployment...and deflation? Yes...so what? Does it always do what politicians and economists want? No? So what?

It has a sense of humor too. Wait until it turns around and kicks the clumsy mechanic in the derriere!

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

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2 Responses to "US will keep pumping money till it can't go on"

Swaminathan

Nov 8, 2010

Good for a sarcastic reading. No constructive opinion though. Most of us feel that QE2 is not going to work but what should US/Fed do? We will appreciate some constructive thinking.

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sach

Nov 8, 2010

good work Bill. loved the article.

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