Unintended Consequences of Printing Money in Trillions?

London, UK - 8th November 2010, 06:35 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

There is an old investment adage: Don't Fight the Fed! Yet Paul Volcker, Mohamed el-Erian, Jim Rogers, David Stockman, Tom Hoenig and several officials from Brazil, China and Germany have all either written or spoken out against Quantitative Easing II or QE2 commenced by the US Federal Reserve recently. They have warned of the dire consequences that could be forthcoming from further monetary stimulus in the form of central bank purchases of US government debt as we have warned not so long ago! [ATCA: Beyond The Tipping Point: Setting the Stage for Weimar? Metamorphosis in 2009/2010: 23rd December 2008].

Federal Reserve prints money

Most national stock markets are now trading at levels not seen since before the collapse of Lehman Brothers in September 2008. There is a back-to-the-races explosion of risk appetite across the world! The Indian market hit an all-time high after rising five percent last week alone. Gold is advancing furiously and the oil price is heading back towards USD 90 a barrel faster than before. In recent weeks since QE2 was mooted, it has hardly mattered which asset class investors have chosen to own in this resurgence of animal spirits. Gains are to be had without risk, because the Fed’s QE2 is seen as placing a floor against market declines. Note “Key Fundamental Questions” below.

We at ATCA and the mi2g Intelligence Unit are pondering what the unintended consequences might be of printing money in trillion(s) as a result of QE2 and potential future waves of QE3, QE4, QE5 etc? Some of our fundamental questions are:

1. Is QE causing misallocation of capital resources and further inflating asset bubbles including the "Eight Bubbles" we have already outlined in previous briefings? [ATCA: The Eight Bubbles: What are the Numbers suggesting? 8th November 2008]

2. Is QE also the pin that eventually bursts asset bubbles and causes equities to collapse because consumer demand will likely fall as prices of food, fuel, and all other commodities and goods rocket upward too fast and too far? [ATCA: The Four Scenarios: Debt Deflation, Hyperinflation, Quadrillion Play and Muddle Through: 15th November 2008]

3. If the Fed continues to inject high-grade monetary stimulus into the heart of the financial system of the world, is it going to paralyse or kill the patient one of these days? [ATCA: Derivatives Quadrillion Play: How Far Away Are We From A Second Financial Crisis? 23rd March 2010]

4. Is the danger of the Fed's single-minded attention to solving the US's economic problems likely to be that other countries are inevitably damaged? [ATCA: G20 Summit must focus on Derivatives, Off-Balance-Sheet Vehicles, 8 Bubbles Quadrillion Play Grows 22% to $206k per person-on-planet: 19th March 2009]

5. Will QE further encourage more rapid deployment of momentum-driven high frequency trading to garner profits without regard for long term value investing principles? [ATCA: Systemic Crisis: The Rise of Machines, Casinos and Illiquidity: 16th May 2010; The Achilles Heel of Markets? 30th May 2010 & Market Distortions, High Frequency Trading and Systemic Risk: 2nd June 2010]

6. While bulls see QE as an essential without which we would be heading back to the abyss of a double dip, are the bears right in saying that QE is a more direct path to that same outcome? [ATCA: Run Turkey, Run! Bill Gross & QEII: 29th October 2010 & Could Rising Bond Yields Trigger An Equity Market Correction? 5th April 2010]

7. Will QE precipitate a Eurozone crisis given that Ireland, and other PIIGS, are again experiencing widening bond spreads and increased concerns on overall funding issues? [ATCA: Pressure on The Euro from Below: Germany, Strong Deutschemark and 'Das Deutsche Volk': 13th February 2010 & Asymmetric Threat Of A Second Great Depression? 23rd May 2010]

8. As a result of QE, will much of the new money simply leak into booming emerging markets which may precipitate another Emerging Markets (EM) crisis? [ATCA: II Phase of Global Financial Crisis? 5 Interconnected Black Holes: 28th November 2009]

9. What is the result of QE on economies with currencies pegged to the dollar that are obliged to maintain a monetary policy that is wholly inappropriate in light of their strong growth? [ATCA: Spiralling Financial Contagion: Sovereign Debt Crises to Corporate Chaos? 5th February 2010]

10. Could waves of QE precipitate the second market crash of 1932? [ATCA: 1932 - The Unexpected Second Shock: 21st November 2009]

Key Fundamental Questions

1. The somewhat rigid political system of the US and untidy "laissez-faire" capitalism has often been denounced as inferior to the nouveau technocratic industrial policies of the USSR (1960s), OPEC (1970s), Japan (1980s), EU (1990s) and China (2000s). If the US is becoming more and more irrelevant, why haven't the competitors of the '60s, '70s, '80s and '90s overtaken the US? Is China going to go same way -- as other traditional US competitors from previous decades -- as a result of its inability to cope with the extra internal and external pressures caused by American QE and continuous dollar devaluation(s)?

2. Some analysts argue that the quick rebound of China, India, Brazil and Germany from the deep recession is proof that the world is decoupling from the US. We are told the world is becoming more multi-polar, and that the US needs to learn how to shift into obsolescence and be just another nation state amongst the club of nations. If the US is as vulnerable as many of these so called experts make it out to be, and the rest of the resurgent world is more powerful and resilient, why does the Fed's QE generate so much anxiety and protestation among officials of other world powers?

3. Most of the industrialised and rapidly industrialising countries across the world appear to be concerned that the QE programme may threaten their entire economies. Is this really the case or are those countries using it as cover to justify policies that they wish to enact anyway?

4. In a recent article in the Washington Post, the Fed chairman dropped a clear hint that future levels of QE will be determined not just by the state of the economy but by the level of the stock market. This is the so-called "Bernanke Put", whereby investors believe that if the worst comes to the worst the Fed's helicopter will simply drop a new load of freshly printed dollar bills to bail them out. Will the "Bernanke Put" cause the markets to go up too fast too far, promptly collapsing when fundamental earning do not materialise?

5. Other central banks are most likely to follow the Fed's QE lead in order to prevent their own currencies from appreciating against a weakening dollar. The Bank of Japan cannot tolerate a much stronger yen and The Bank of England will probably follow suit early next year as the spending cuts and VAT hike begin to bite. The Eurozone will also have its own crisis-of-confidence caused by debt restructuring in peripheral countries before too long! This means developed world interest rates will stay lower for much longer than expected as a result of QE. What does QE do to capital flows searching for high yields by way of return on investment?

[ENDS]

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Best wishes