Fed expects a firecracker of a recovery

Dec 23, 2010

Los Perros, Nicaragua

Nothing comes from nothing. But what comes from something?

Did you see what happened? The Fed's holdings topped $2 trillion for the first time ever. It took 95 years to get the Fed's holdings to $600 billion. In the space of 3 years, it has added $1.4 more. That's something.

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Extraordinary, no? Amazing, n'est-ce pas? Incredible, huh ?

And yet, the feds expect this explosion of Fed assets to produce an ordinary firecracker of a recovery. They expect - or hope - that this fantastic increase in the base money supply of the US banking system will result in a rather run-of-the-mill rebound in the US economy.

The inflation rate (CPI) is only 1%...they think it will go to 2%. Long bond yields are expected to go up a little too - but not too much. Investor experts are predicting a 10% increase in stock prices in 2011. Almost every economist is talking about a 'gradually strengthening recovery.' Unemployment is supposed to go down a little. House prices are expected to stabilize...and even rise.

In other words, an out-of-control monster of monetary inflation is expected to sire a pipsqueak of a recovery.

We've talked in the past about how nothing comes from nothing...and how you can't produce real wealth with ersatz money. But what about this? Here we have the Fed doing something really big. Three times as big as anything they did in all the years since 1913.

And yet, economists expect nothing much to happen.

How likely is that? The feds don't know what they are doing. They are juggling nuclear bombs...and testing runaway viruses on an unsuspecting population.

What might happen?

Here are some guesses:

1) It will create more speculative bubbles. We wouldn't be at all surprised to see oil go to $100 and above, for example. The Fed's money is, so far, not making it into the real economy. But it is available to speculators. And speculators are betting that they can put more money in commodities than in US T-bills. So, keep an eye open. Most likely, you'll see some bubbles in 2011.

2) Emerging market stocks could soar. Imagine that you're 'trading' for Goldman Sachs. You can borrow dollars for nothing. What do you do with them? Invest them in the world's fastest growing economies! If you're lucky, you'll get 10%...maybe 20% return - on someone else's money. And if you're unlucky? Who cares? It's not your money. And you won't go broke. The Fed will give you more money.

3) Gold to $1,500. Why not? The IMF just completed selling. China, India and other emerging economies are adding to their stash. Speculators are getting in on the biggest and most reliable bull market in the financial world. Heck, even individual investors are catching on.

Passing through the airport in Miami last week, we noticed a gold vending machine! We had heard they were around. But this was the first time we saw one. How surprising would it be if more and more ordinary people started imitating the rich, who've been buying gold for years? Suppose people realize that their central bank is now working against them...and that they have to maintain their own real money reserves? We could easily see gold over $1,500 in 2011.

4) US bond yields rise...the bond market begins to break down. It looked like it was beginning a week or two ago. Bonds were going down just as Ben Bernanke was trying to push them up. Sooner or later, it's bound to happen. Investors must eventually realize that buying US debt is a dangerous proposition; the Fed is actively trying to reduce its value. And if there is one thing the Fed ought to be able to do it's to undermine the value of US debt. After all, the feds control the currency it's calibrated in.

5) In contrast to this bubbly and bodacious outlook is a not-insignificant risk that the whole shebang will blow up. US stocks could crash. Bubbles can explode. Unemployment, housing, sales, consumer price inflation - all could get worse. Then what? Then, the US dollar and US debt will go up!

Well, which is it, you're probably wondering. Inflation or deflation? Boom or bust?

Our answer? Yes!

It's all coming. If not in 2011, then...later.

*** When we arrived in Nicaragua, a group of Dear Readers was already at the house. They were having a dinner party on the lawn. Tables had been set up...looking out over the ocean. By 6pm it was dark. A full moon arose in the East. It had been windy earlier in the day, but now the wind had eased into a gentle breeze.

Joselito brought out his guitar.

"Besame. Besame mucho..."

"You must love it here," said a young woman. "This is about the most beautiful place in the world, isn't it?"

The next day, we took a tour of the development here in Nicaragua yesterday.

Housing is in a slump in the US. Developments in Latin America and the Caribbean have fallen on hard times too. Especially here in Nicaragua, where president Daniel Ortega has driven off foreign investment.

"I think he's becoming paranoid," reported our local contact. "He doesn't want to go anywhere. And when he goes out, he has a whole team of bodyguards. He's afraid someone is going to kill him."

But Ortega or no Ortega....real estate bust or no real estate bust...Rancho Santana is booming. There is a new pool at the clubhouse and a new clubhouse under construction. New condos. A huge new woodshop. New heavy equipment. A team of 250 workers...some of them working day and night.

What's going on?

"This is the only project in Nicaragua that is still doing well," explained a sales agent. "It's practically the only project in Latin America that is still solvent. Down the coast, several of them have gone bust. In one, the owner just left. The homeowners tried to call. But he just packed up and left the country, leaving them without roads or water.

"And that's not that uncommon. These guys sold lots during the boom years. Then, when the bust came they didn't have the money to complete the projects. Lot owners were left holding the bag.

"Developing is a tough business, even in the best of times. And developers are generally a stupid bunch. If not actually criminal. Either they are dreamers who keep investing in their own projects. Or they are schemers who take the money out. The dreamers go bust in hard times. The schemers high tail it out of the country.

"You need a serious developer. One who's been through a couple of complete cycles. One with enough money to survive. And one with enough integrity to do what he's promised. Unfortunately, there aren't many like that. Not down here.

"You can buy very cheap property here now. But you have to be careful."

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

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