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Hero or Villain?

July 13, 2013

Another week dominated by Federal Reserve Chairman Bernanke’s remarks has passed in the financial markets. Any market participants worried about economic conditions were reminded that there will be “liquidity” provided to the markets as long as necessary.

As a result, practically all assets went up in price against the currency($) they are valued in. After all, the prospect of endless future supply of money lowers the desirability of holding it. As for stocks, Dr. Bernanke has created the Goldilocks scenario as he promises to inject “liquidity” into the market should economic indicators decline. In the case of decent earnings stocks should rally with or without the Fed’s support. Therefore, stocks have nowhere to go but up. That is the theory currently prevalent in the market and it will continue until something breaks. For now, there are no troubles in sight but when they are apparent, I hope I will be able to identify and forewarn.
Interestingly, the stock market chart for 1987 and 2013 look eerily similar.

1987 crash

Now, I do not predict a crash as in 1987 but I do think that with every uptick, the probability of a crash increases as the divergence between economic reality and asset valuation is large and growing.

Dr. Copper

As for the global economic indicator of choice, I want to point out the price trend in (Dr.) copper.

Market lingo for the base metal that is reputed to have a Ph.D. in economics because of its ability to predict turning points in the global economy. Because of copper’s widespread applications in most sectors of the economy – from homes and factories, to electronics and power generation and transmission – demand for copper is often viewed as a reliable leading indicator of economic health. This demand is reflected in the market price of copper. Generally, rising copper prices suggest strong copper demand and hence a growing global economy, while declining copper prices may indicate sluggish demand and an imminent economic slowdown


As you can see, copper prices are currently not constructive in pointing to a rebound in global economic activity. Central banks can add infinite liquidity to address structural problems yet the likely outcome of such policy is stagflation as the economy does not improve while the currency loses purchasing power due to dilution.

The Fed and other central banks

As most of you know, I am very critical of the Fed’s monumental QE programs. Furthermore, I do not believe that any central bank should be in the business of creating money to buy Treasuries and mortgages. One negative effect of such policy is the distortion of price discovery in financial markets. The whole point of capital markets is to determine efficient capital allocation that should lead to productive investment and growth. Currently, this function has been taken away from the markets as central bank policy distorts all markets simultaneously. Having no short term interest rates while suppressing long term rates and providing funding to some instruments rather than others is a very problematic road to be on. I think this will end in tears as we are swapping short term gain for long term pain. I hope I am wrong but in my experience everything goes in cycles. Night follows day, spring follows winter, age follows youth… The longer the central banks push all markets one way the bigger the counter reaction in the future.

Just for the record, I am NOT in the camp that proposes getting rid of central banks. The Fed has an incredibly important role in arresting financial crisis and restoring monetary health in a scenario where panic breaks out. Akin to the fire department in emergencies, the Fed should be there as lender of last resort and use all current policies when necessary. Considering the last crisis was five years ago I doubt that the same policies are still necessary today. Perhaps, we should listen more to former Fed Chairman Volcker who successfully steered the US central bank from the inflation ridden 1970’s into the booming 1980’s. Trying to solve an issue of solvency with liquidity has not- and will not work.

Finally, I highly encourage you to listen to this interview on Bloomberg Radio. It involves, Jim Rickards, author of best selling book “Currency Wars”.

Currency wars

Mr. Rickards is a rather strong critic of current central bank policy himself and his views practically mirror mine. What makes this interview interesting is the fact that the interviewer takes the opposite point of view and does so very eloquently and intelligently. Enjoy and be patient. It takes a few seconds to upload the interview.


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  1. Tim permalink

    Hi Richard,

    It’s obvious based on your entries that you have a deep understanding of economics. In your June 22 piece you mentioned the Jurassic Park scenario. I guess the gist of that is that the Fed and other central banks will essentially have no choice but to capitulate to political forces and print money until eventually all Hell breaks loose. And I was wondering, well, what does that look like exactly? Thinking that historical comparisons might shed some light, I read two books, “When Money Dies” by Adam Fergusson, and the diary of Anna Eisenmenger (a.k.a. The Blockade). Both describe the hellish existence that life became after WWI in the hyperinflationary economies of Germany, Austria and Hungary. Too extreme a comparison? How bad will life in our version of Jurassic Park be? Admittedly this may not be an answerable question because of so many unknown variables, but I think it’s worth asking.

    Thank you for this outstanding blog. Better than any economics class I had in college.


  2. Hi, Tim,
    Thank you for your kind words regarding the blog. I have read “When Money Dies” but not the diary of Anna Eisenmenger. As you point out, it is very speculative to paint a picture of the “Jurassic Park” scenario as the future actions of many key players are simply unknowable.
    For what it’s worth, I do not believe we will face hyper inflation in America. Hyper inflation historically happens only to “bombed out” economies(Weimar Germany post WW1) or to peripheral economies whose trust is lost in global markets(Argentina 2002, Asia 1998). The world’s reserve currency does not hyper inflate as capital flees toward it in times of crisis. That is what you see now. Despite all the money printing by the Fed, the dollar remains relatively strong. As the economy is global, capital in downturns flees towards the “center” which is the dollar for now and will be as long as the US has the strongest military in the world. Therefore, I do not see a (rapid) switch into dollar hyperinflation on the horizon and much rather assume continued and increasing stagflation in which the economy is weak and prices/taxes gradually rise. What that leads to down the road is an entirely different discussion but let’s not get ahead of ourselves as it is always dangerous to think too many steps into the future.
    Feel free to comment or disagree. Thanks,

  3. Tim permalink

    Hi again Rich,

    “When Money Dies” actually contains some representative quotes from Anna Eisenmenger’s diary, so one wouldn’t miss too much having “only” read the former.

    It sounds like you’re expecting something more along the lines of the 1970’s, at least in the near term. Would that be about right? In any case, that sort of feels like what we have right now. Hardly a bowl of cherries, though not outright catastrophe either. I just wish we could just have a more normal economy without all the rank manipulation. It’s frustrating. But as you say, c’est la vie.

    Thanks for answering my questions. Great stuff.

    Cheers, Tim

  4. Tim,
    I don’t recall the Eisenmenger diary quotes in the book, perhaps it’s time to reread it. Jim Rickards also spends some time one the Weimar period in “Currency Wars” which I highly recommend.

    Anyway, yes, like you, I do see stagflation already but the true inflation in the pipes is currently subdued due to “flat wages” and low interest rates. At some point, one of those two factors will give and unlike the 70s where wages climbed, I suspect we will have the bond market raise rates on the Fed no matter what monetary policy is. The chaos that will ensue will be much worse than the 70s as the whole economy is leveraged to the max(unlike the 70s). Imagine interest rates at 20% as they were in 1980. The government would have to default on its debt and/or unfunded liabilities and so would most borrowers within the economy. Imagine earnings with a bust consumer and corporations having to service debt at 20%. Real estate would enter an ice age as nobody could afford a mortgage. Any extra QE would increase the problem as the dollar would lose value and add more inflation to the system.

    I am not sure where this is going but I think the best case scenario would be a replay of the 1970s stretched out over a decade. Mathematically, I cannot see how we get out of this mess as lightly as that although I think we had a chance to make changes in 2009 but nothing was done and the consequences of papering over the problems are yet to appear. Hard times ahead in my opinion.

  5. Tim permalink

    Wow, this post is as fascinating as it is unsettling. But it sounds about right. It looks like we will be living through a major paradigm shift in the history of economics.

    And yes, I will certainly follow up and read Currency Wars. Thanks for the recommendation.

    • Tim,
      I agree with your assessment regarding major economic paradigm shift. However, keep in mind that the world is constantly changing and the assumptions used to forecast will also change thus the further you look into the future, the murkier the picture.

      To be sure, there are encouraging developments as well. Whether the energy renaissance in the heartland or other technological advances, mankind keeps progressing. Who’s to say there won’t be a cure for cancer or an energy revolution discovered/developed in the next decade. That would change the picture significantly. Of course, there could also be natural catastrophes or wars pointing the other direction.

      The point being, you have to look at the world as it is and change with it when it does. Hopefully my future posts will be less unsettling but I’m just trying to get it right…


      • Tim permalink


        Good food for thought.

        Cheers, Tim

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