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A brave new world

October 18, 2013


When Christopher Columbus set sail to discover a new trade route to India, he hoped to find and establish a quick way to the East by going west. Due to the silk road issues post the fall of Constantinople in 1453, the Spanish monarchy supported his efforts that eventually led to the colonization of the Americas. Many countries in the New World and elsewhere celebrate the anniversary of Christopher Columbus’ arrival in the Americas, which happened on October 12, 1492, as an official holiday. The landing is celebrated as Columbus Day in the United States, as Día de la Raza in many countries in Latin America, as Discovery Day in the Bahamas, as Día de la Hispanidad and Fiesta Nacional in Spain, as Día del Respeto a la Diversidad Cultural (Day of Respect for Cultural Diversity) in Argentina, and as Día de las Américas (Day of the Americas) in Belize and Uruguay. And thus, a bank holiday was observed this past Monday in the United States. In many ways, Columbus set out to find one country and discovered a “new world”. To some extent, the current monetary experiment that is under way  is also a voyage into the unknown. Never has the world seen global mass monetization of this size in practically all countries simultaneously. Do I exaggerate? Take a look at the chart below and decide for yourself:


This chart depicts the total amount of securities held by the Federal Reserve and compares it to the total amount of securities of all US commercial banks combined. Historically, the central bank has always owned a fraction of total capital market share to allow it to act as lender of last resort in a crisis. Yet today, it officially owns the largest slice of all assets out there. Aside from the obvious ideological issues that arise with the Fed’s omnipotence, it remains to be seen whether one semi-political institution will be a better allocator of capital than the private, “free” market. What is undisputable is the fact that we are in a new era of economic planning that may or may not work. Clearly, the US government is unable to implement fiscal reform and therefore, the Fed must now conduct fiscal policy via QE on top of monetary policy via zero interest rates. Furthermore, the Fed now intervenes in practically every capital market turning the world’s exchanges into political pin ball machines. In effect, the central bank has morphed from lender of last resort to lender of, well, every resort.

So far so good. Interest rates are kept low, currency markets remain in slumber and equity prices keep rising. As for the long term of this gargantuan experiment I turn to Jim Rogers who tends to have the best crystal ball in these matters.  “Two  or three years later we’ll be right back where we started, only the debt will  be that much higher. Eventually the markets are going to say we don’t want to  play this game anymore and we’re not going to lend you money at any price.  America will then go into a steep and steady decline just as it happened in the  UK, Spain, and many other countries over the last 200 years.”

Of course, there are prominent economists like Paul Krugman who claim that debt doesn’t matter and that everything will be fine. While I cannot understand his logic, I sincerely hope he is right.

Stock market

Last week, I pointed to the near perfect correlation between the Fed’s balance sheet and the S&P500.  As the “taper” has slipped into oblivion, we can assume the  $85 billion a month money creation to continue. If you apply the statistical correlation to the future of the stock market the following chart appears:

S&P projection

As I have said many times before, this party is set to continue for all the wrong reasons but if you must dance, make sure you stay close to the emergency exit. What would Columbus think of today’s digital voyage into the unknown?



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