Why You Must Invest for Inflation From Now On

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The Fed made history today by announcing an open-ended money printing policy — a policy heretofore unseen outside of history's hyperinflation havens. The news conference that followed the announcement revealed a central bank acting out of extreme desperation.

While the Fed is doing another round of quantitative easing, QE3 is not the same as QE2. The previous QE involved the purchase of U.S. Treasuries. This time around, the Fed is buying MBSs (mortgage-backed securities). In QE1, various types of securities were bought. The previous QEs also had specific limits to the amount of money that was going to be printed whereas QE3 doesn't. QE3 is supposed to be ongoing until somewhat after the economy and employment situation have been improving for a while. How long that will be is anybody's guess.

Despite several questions in the press conference that followed the announcement, Bernanke made only vague statements about how the Fed would determine when enough money printing was enough. The purchase of mortgage-backed securities is likely to continue for some time because doing so is supposed to reduce unemployment. How that will work is not clear other than perhaps reducing unemployment in the construction industry. The Fed's actions should lower already historically low mortgage rates and Bernanke specifically stated more than once that getting the price of homes up was one of his major goals (he seems to have forgotten that the global financial collapse in 2008 was the result of the collapse of the housing bubble).

Anticipating the obvious objections, Bernanke tried to head off the major criticisms of the Fed's new plan at the beginning of his news conference. While he admitted that the Fed's action hurt savers and would make it difficult to prepare for retirement, he said that if you don't  have a job you wouldn't have any money to save anyway. So, apparently the large majority of people who have a job should risk having their retirement unfunded in order to pursue Bernanke's high risk policies that have been tried for the last five years, but haven't worked. I wouldn't have been surprised if a couple of retired people were brought up to the podium and Bernanke kicked them a few times to emphasize his point.

Bernanke also denied that the new round of money printing will cause inflation. The basis of his argument was that the members of the FOMC aren't prediction inflation in their projections, so obviously it's not going to happen (these are the same people that failed to foresee the subprime crisis coming). Also Bernanke claimed inflation has been around 2% for years, so there is no problem. Even a casual perusal of commodity prices since 2009 shows increases of 100%, 150%, 200% and sometimes more however. It is true the government isn't reporting inflation, but that isn't the same as it doesn't exist. The head of the Weimar German central bank also claimed inflation wasn't a problem as he printed more and more money. Eventually, inflation reached 300 million percent.

One of the real eye-openers of the Bernanke news conference was his admitting the impotency of the Fed and monetary policy. Over and over again Bernanke stated that the Fed's actions were, "not a panacea". He said that, "We [the Fed] can't solve the problems by ourselves". He also emphasized that the Fed's, "tools are not so powerful that they can solve the problem". If the chances of success are so limited, why is the Fed taking a course of action that could have serious negative consequences for the American people?

In addition to his desire to reinflate the housing bubble, Bernanke was also proud that when the Fed speaks, economic forecasters change their numbers and that, "markets respond to [the Fed's] guidance".  This was a blatant admission that the Fed purposely manipulates the stock and bond markets and financial news. Obviously, this destruction of free market mechanisms is not something that he considers shameful, even though this represents a major power grab on the part of the Fed.

Bernanke was much more coy however when the question of whether or not the Fed's money printing decision was base on political considerations. One reporter mentioned that Romney was not planning on reappointing Bernanke and asked if the policy shift was an attempt to help reelect President Obama. Bernanke denied this of course, his voice almost breaking when he stammered out, "our decisions are based entirely on the state of the economy." I must admit that I am personally surprised that the Fed did this before the election because this question is only going to be the beginning and the Fed has now made itself an ongoing issue in the presidential campaign. I didn't think Bernanke was so foolish to take this risk, but obviously I overestimated his political awareness.

Earlier this month, ECB head Mario Draghi promised unlimited bond buying. This is different from what the Fed is doing because those purchases are supposed to be sterilized (new liquidity put in is neutralized by liquidity being removed). Many people however believe that the ECB will have to engage in money printing despite its claims. Added to the Fed, this means inflation investments will have a bid under them for some time to come.  Investors should be looking at gold and silver, energy and agriculture. Ironically, shorting Treasury bonds also look like a good bet now as well, since the Fed is not buying them as part of its QE program (Operation Twist though will be going on to the end of 2012 however and this acts to lower interest rates around the 7 to 10-year maturity level so be careful). Keep buying as long as the Fed keeps printing.


Disclosure: None


Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

From Bailout to Bailout - The Prelude to Bear Stearns Collapse

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video on the material in this post is 'The Bear Stearns Bailout'. It can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

The New York Investing meetup first mentioned in August 2007 that Bear Stearns was likely to fail. Two of Bear's hedge funds had gone under in late July and this helped t0 precipitate a sell off in the U.S. stock market by bringing media attention to the subprime crisis. Even though the subprime crisis had begun by at least December 2006 with the sudden failure of mid-sized mortgage lending company, the financial media failed to recognize its importance until the forced closure of the Bear Stearns funds. The precarious state of Bear Stearns finances that this failure indicated was in turn also missed by the U.S media. As usual, the media took its cues from Wall Street, which remained bullish on Bear Stearns right up to the very end (as was the case for Enron and a number of other major corporate failures).

Furthermore, the September 20, 2007 earnings report indicated everything was fine. Despite the failure of the two hedge funds, Bear Stearns claimed to have earned $1.16 a share. A write off of only $200 million (an insignificant amount for a Wall Street firm) was taken as a charge for closing the funds. Another $700 million of mortgage assets were also written down, also not that great an amount. In the earnings conference call, the CFO stated that he “expect[ed] a return to more favorable conditions next year”, stressed the underlying business was sound, and market dislocations tended to run a quarter or two. The only thing he was correct about was that the market dislocations would only last two more quarters - although he certainly didn't imply that this would be because Bear Stearns would no longer exist after that time.

While the September earnings report was reassuring, Bear Stearns December 20th earnings report was an indication of serious and possibly fatal problems. Suddenly, the company lost $6.90 a share, the first loss in its history (Bear was even profitable in every quarter during the Great Depression). Wall Street analysts were expecting a loss of only $1.79 a share, missing the actual loss by over $5.00 a share. The loss included only $1.9 billion of write downs in subprime mortgage exposure. Despite the indication that analysts had completely missed the extent of Bear Stearns problems, the stock actually went up after the earnings report, instead of sharply falling as it should have. The CEO subsequently 'resigned' - something that usually only takes place when a company is in trouble.

By December 2007, Bear Stearns was hardly unique in suffering losses because of the ever expanding credit crisis. The Federal Reserve attempted to address these system wide problems by creating its first new lending facility, the TAF (term auction facility), which gave it an additional conduit for its money pumping operations. In January 2008, reacting to the further deterioration in the financial system, the Fed cut its funds rate by an additional 1.25%. Bear Stearns, however, could not benefit directly from any of these moves since it was not a commercial bank and was therefore not allowed to borrow money from the Fed, so its situation continued to deteriorate.

Nevertheless, even as late as early March 2008, neither Wall Street, nor the media were ringing any alarm bells that Bear Stearns was about to implode. No Wall Street analyst had a sell recommendation on Bear Stearns stock even though it was about to lose almost all of its value. It apparently didn't bother them that the balance sheet indicated 33 times leverage, an amount that can only be described as enormous and which was greater than any other broker dealer or commercial bank. While the public facade that everything was fine was being maintained by Wall Street, rumors were circulating behind the scenes that Bear Stearns might go under. The big players were quietly getting their money out in what was basically a secret run on the bank.

NEXT: Bailout to Bailout - The Collapse and Rescue of Bear Stearns

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

Central Bankers Gone Wild

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The New York Investing meetup has made a companion video to this blog entry. To see it, please go to: http://www.youtube.com/watch?v=y9kzKAzn2Ig

In the hundred years before the Federal Reserve existed, aggregate inflation in the United States was approximately zero. This does not mean that there was never any inflation, inflation did indeed exist, but that the periods of inflation were offset by periods of deflation so that over a long period of time there were essentially no changes in prices. A new era for inflation began when the Fed was created in 1913. Except for the Great Depression in the 1930s, deflation essentially disappeared from the United States economy and there were only periods of lower or higher inflation. This continuing inflation resulted in a 1923% inflation (based on understated official figures) for the first 95 years of the Fed's existence. Conversely, it could be said that the U.S. dollar had lost 95% of its value during this time. And the remaining 5% seemed to be endangered as well.

The beginning of 2008 saw what was probably the biggest injection of liquidity into the U.S. monetary system by the Fed in history. There were two massive rate cuts separated by only 8 days. First there was a 75 basis point cut in the Funds Rate on January 22nd and this was followed by a 50 basis point cut on January 30th. The previous time the Fed had cut rates by 75 basis points was when the Funds rate was at 20%. The January cut took place from a 4.25% level and was the first inter-meeting cut since the 9/11 crisis. Only two months later the Fed would again cut the Funds rate by another 75 basis point, this time from the 3.00% level. Based on the starting levels, the cuts in the Funds Rate was enormous and took place in a very brief span of time.

The cut in the Funds Rate was by no means all the liquidity that the Fed was pumping into the system. The TAF (Term Auction Facility) auctions were raised from $20 billion to $30 billion each by January and would reach $50 billion for each auction in March. Two additional auction facilities were added to the TAF by March - the TSLF and the PDCF. The TSLF (Term Security Lending Facility) was set up to swap $200 billion of treasuries for illiquid securities being held by the banks. The PDCF (Primary Dealer Credit Facility) opened the Fed's credit operations to the 20 firms that bought treasuries directly from it. The Fed had only lent money to commercial banks during its entire history and the PDCF represented a big extension from its traditional scope of operations.

The impact of the Fed's liquidity boosts caused the money supply to explode. MZM (money with zero maturity and therefore available for immediate use) grew by an over 37% annual rate in the first quarter of 2008. This would have been OK if the economy was expanding by around 37% as well, but the economy was contracting instead. The difference between money supply and economic growth was more than enough to create a massive future inflation problem and possibly even hyperinflation. How much inflation would actually take place was something only time would tell.

NEXT: The Fed's Manipulation of the Stock Market

Daryl Montgomery

Organizer, New York Investing meetup

For more about us, please go to our web site: http://investing.meetup.com/21

The Fed's (long) Term Auction Facility

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

On November 28, 2007 the Federal Reserve started a massive year end injection of liquidity into the financial system. On December 11th, the Fed once again lowered the funds rate a quarter of a point (for a total of 100 basis point drop since the half point cut on September 18th). While neither of these events were extraordinary, what happened the next day was.

On December 12th, the Fed announced the creation of its Term Auction Facility . The TAF program was open to any bank or depository institution, which would be allowed to bid for one-month loans up to the total amount of funds being auctioned off. The winners had a wide-choice of what they could pledge as collateral, including mortgage-backed securities that could not be traded and had no market price. In exchange for their possibly worthless securities, banks and brokers could get cash from the Fed. This new program represented a sea change in Fed operations.

First, the Fed would be offering up sums of money in auctions to banks and depository institutions instead of having them come to the Fed to get a loan. Using the Fed's discount window was usually only done by institutions teetering on insolvency and was carefully avoided by any institution that wanted to preserve its reputation. The Fed finally found a way around this impediment to getting money to struggling banks by offering the money at auction, guaranteeing an injection of liquidity into the system at the amount auctioned off and removing the stigma for those who got the money.

The second major change the TAF introduced was that the Fed was willing to take even worthless paper as collateral for a loan. During its history the Fed usually only accepted treasuries as collateral. With the TAF, it effectively began engaging in subprime lending itself . By doing so, it was bailing out the banks that had foolishly engaged in this practice - and who might have become insolvent if they couldn't get rid of their subprime paper.

When the TAF was announced in December, the original auctions were for $20 billion each. By January 2008, this amount was raised to $30 billion. By March each auction was for $50 billion and two additional Fed lending facilities would be introduced (the TSAF and the PDCF) - breaking even newer ground for Fed operations.

Next: Economic Predictions for 2008

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21