“Given all of the uncertainty, “it’s hard to argue to change course on monetary policy this month. My personal opinion is that it’s not in play. This is just too tender a moment.”- Dallas Fed President Richard Fisher October 17, 2013 speaking about whether the Fed would taper its quantitative easing program in October.
The Farce Continues
The United States Congress ended its impasse yesterday and as predicted came to a last minute deal to raise the debt ceiling. This was characterized by the media as averting default. There never really was a threat of default as there was enough money to pay the interest on the U.S. debt, but all sides (the President, the Democrats and Republicans) acted as if that was what was at stake.
The real issue was about how much discretionary spending the government wants and can afford. Yesterday Congress voted for all of it. A short term solution is now in place to raise the debt ceiling, reopen the small part of the government that was closed and to revisit the debt ceiling issue again early next year.
What does the latest Congressional debt deal mean for the economy, real estate, the dollar and gold and silver?
A Continuation of Dysfunctional Monetary and Fiscal Policies
Dysfunctional Fiscal Policy
Congress Pretends to Want to Cut Spending, Continues to Spend More
The deal struck last night raises the debt ceiling and allows the 18% of government that was shut down, to reopen. After years of not passing a budget, Congress still has no budget and no plan to cut spending. There is talk now also of eliminating the debt ceiling. Congress will revisit the new debt ceiling deadline of February 7, 2014 and we will see a repeat of the fruitless negotiations and yet another raising of the debt ceiling, to of course, “avoid default.”
Dysfunctional Monetary Policy
The Fed: Talk Taper, Print More Paper
We have been saying since the beginning of the year, that quantitative easing (QE) would remain in force as the banks, the U.S. government and the real estate and stock markets are dependent upon lower rates. Having surprised the markets by not tapering QE in September, the Fed has a new excuse not to taper in October-the government shut down. Indeed one of the Fed’s few critics of the Fed’s QE program, Dallas Fed President Richard Fisher told CNBC in an interview before the debt ceiling debate was temporarily settled that it would be hard for him to argue for tapering QE at the Fed’s October meeting because of the ongoing Congressional budget wrangling. After the debt ceiling was raised, Mr.Fisher told reporters after a speech today to the Economic Club of New York that any talk of cutting (QE) had “all been swamped by fiscal shenanigans”.
Coming from Mr. Fisher this is astonishing because back in June he said that the Fed needed to “get off the monetary cocaine” of QE. Four months later he is singing the QE tune.
So what’s next for the Fed? When the Fed’s most hawkish member turns dovish, we can expect the QE program to continue well into 2014. In “The King is Surrounded”, we noted the Fed’s no exit dilemma – print too much and the Fed risks a loss of confidence in the dollar and hyperinflation; print too little and rates will rise and the economy will crash taking down the stock and real estate markets with it. Now with the appointment of Janet Yellen to the Fed chair, it’s the queen who will be surrounded. We expect Ms. Yellen to employ negative interest rates and to continue QE and perhaps increase it in a vain effort to “fix” the labor market.
It appears the Fed will continue to try and solve the United States economic woes with never ending QE. We expect the Fed to continue to try and keep interest rates artificially low by monetizing U.S. debt and buying mortgage backed securities. If the Fed runs out of those securities to buy, we expect they might even print dollars to buy equities. We expect QE to be a permanent part of the economy in 2014. There are limits to how much money a central bank can print before creating a currency crisis. We don’t know how much that is, but it seems the Fed is determined to find out.
In the early and mid 2000′s Federal Reserve Chairman Alan Greenspan lowered interest rates and helped launch a massive housing bubble that burst resulting in the financial crisis of 2008. Chairman Bernanke reflated the housing bubble a little but it required him to lower interest rates to zero and print $4 trillion to use to support QE. In order to reflate the now stagnant housing market, the putative Fed Chair Janet Yellen will have to increase the size of QE, a move that that would be in line with her dovish remarks on monetary policy. The word taper at the Fed under Janet Yellen will become so 2013.
A Centrally Planned Economy
Ms. Yellen, a Keynesian economist, believes in an interventionist Fed. Keynesian economics is less a study of how markets work but rather academic justification for interventions by central banks through monetary policy and governments through fiscal policy and taxation and the study of how those interventions impact the economy. Ms.Yellen believes that through Fed interventionists programs like QE, the economy can be improved.
While the stock markets may have rallied on the news that a temporary debt ceiling deal had been reached, avoiding a default does not help the economy. Indeed the “shut down” did nothing to increase economic activity and actually cost the economy as government workers sent on furlough during the shut down did no work but will be paid their back wages.
The economy is now in a worse position than when the shut down began and has also suffered a loss of confidence as Americans were subjected to threats of a U.S. default for the past three weeks. With spending making up 70% U.S. GDP, consumer confidence is important to the economy especially during the upcoming holiday shopping season.
The economy remains weak. In June Ben Bernanke, Chairman of the Federal Reserve in a rare moment of clarity admitted as such. He stated “the economy is weak, inflation rates are low, if we were to tighten policy, the economy would tank.” In order to keep interest rates low, however, the Fed has learned that the market expects QE to continue. At the mere hint of “tapering” the QE program, rates skyrocketed. To keep rates low, Ms. Yellen may need more QE to keep the economy from tanking.
The Fed was foolish to count on lowering rates and embarking on a multi trillion dollar money printing scheme to push home prices higher to drive the economy. People borrowing money to move in and out of increasingly more expensive houses creates no sustainable productive capacity. A strong housing market should be the product of a strong economy, not the driver of it. If the economy is doing well, people will have well paying jobs and can afford to buy homes.
The mini surge in home prices, sales and building over the last year had been leveling off before the government slimdown. The closing of part of the government that related to housing slowed the deal pipeline as mortgage loan income documentation could not be verified by the shuttered IRS.
We foretold of the end of the housing recovery earlier this summer and declared its end in September. We said interest rates mattered and that higher interest rates, even though historically low, would derail the recovery, while others disagreed. Indeed this week, Wells Fargo reported that their loan origination business fell 29% in the quarter ending September 30 (pre shut down) even though they reported record profits. This highlights that the banks are not dependent on making low interest mortgage loans to make record profits.
Trulia Drops its Housing Recovery Watch
Another sign of the waning real estate recovery is Trulia’s abandonment of their “housing watch” which had as its core premise that there was a “housing recovery” that needed tracking as if it were pre-ordained event driven by an organically improving economy, rather than a dead cat bounce fueled by the Fed’s zero interest policy and QE.
Trulia’s housing watch was tracking the recovery back to “normal” and anticipated that household formation by millennials was going to aid in the housing recovery. Smaulgld challenged that assumption pointing out that millions of unemployed/underemployed millennials living in their parents’ basements saddled with student loan debt were not going to form a pipeline of new home buyers sufficient to continue to drive the recovery. Further we pointed out that the over all economy was weak and that job and wage growth since the recession ended in 2009 were poor and with a population barely scrapping by, rising home prices could not be sustained.
We wrote in the “Dark Side of Rising Home Prices”, that rising home prices were not a good thing as they put home affordability out of reach for many. Since abandoning its housing recovery watch, Trulia has released a study showing that in many cities, home prices are not affordable by even half of the potential middle class purchasers. Home prices can’t rise if there are not enough people who can afford the higher prices.
Higher home prices and sales don’t lead to sustainable jobs or economic recovery. A more aggressive Fed monetary policy under Janet Yellen may keep interest rates lower for a while and provide some support for the housing market such that housing might get a small boost from more QE before the system implodes.
The real estate market and the economy will only really recover when prices are allowed to fall and a much needed deleveraging and restructuring are allowed to take place. Piling more debt upon the remnants of a debt fueled crisis won’t solve anything. The debt band aid needs to be ripped off so the healing can begin.
The Dollar, Gold and Silver
China Calls for a De-Americanized World
Foreign creditors could care less about the politics between the President, Republicans and Democrats. What they heard during the debt ceiling debate was that the United States can only pay its creditors if it borrows more. To make matters worse, recognizing this perilous state of their finances, Congress could not agree to borrow more until right before the interest owed to creditors was due!
China, the United States’ largest creditor, wrote in its state run news agency on October 13, 2013 about the United States “such alarming days when the destinies of others are in the hands of a hypocritical nation have to be terminated“. China has been diversifying its reserve assets out of U.S. Treasuries for the past few years. For more on the United States Dollar and its status as the world’s reserve currency and challenges to its hegemony click here.
Last week China entered into a $60 billion swap agreement with the European Central Bank with the intent of internationalizing THEIR currency.
Today, one of Asia’s largest credit rating agencies, China’s Dagong, down graded the U.S. from A to A- noting that the U.S. is “still approaching the verge of default crisis, a situation that cannot be substantially alleviated in the foreseeable future.”
Japan, the United States’ second largest creditor and with a debt to GDP ratio of 250%, added to the chorus of concern regarding the United States fiscal position saying the “United States must avoid a situation where it can not pay and its triple AAA rating plunges all of a sudden.”
We predicted a budget deal that raised the debt ceiling would cause people to buy gold and silver. The day after the deal was announced gold and silver rose 2.5% each, while the U.S. dollar index dropped 1%.
The dysfunctional monetary and fiscal policies of the United States are making its foreign creditors less comfortable lending money to it. China has been making arrangements to diversify its reserve assets away from the dollar. China recently has stepped up its acquisition of gold as either a hedge against its U.S. dollar reserves and/or to ultimately back its own currency by gold.
Gold and to a lesser extent silver, have historically been considered safe havens. In recent years, the dollar has been the currency that the world flocks to in times of crisis. If the dollar loses some of that confidence, or is the source of concern itself, we may see greater interest in gold and silver and a sharp increase in the prices of both precious metals.
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