…as the Band Played on, the Crowd Called For an Encore

The Economic and Real Estate Recovery is Based On QE

You can ignore reality, but you can’t ignore the consequences of reality” – Ayn Rand

It’s raining horrible economic news, yet the real estate and stock markets are staying dry and heading higher.

It has been nearly five years since the financial crisis of 2008. That crisis, caused by a meltdown in the housing market, devastated the stock markets, took down a couple of large banks (Bear Stearns and Lehman Brothers) and but for bank bailouts via the Troubled Assets Relief Program (“TARP”) would have taken down a few more.

Today after TARP, the American Recovery and Reinvestment act (the $831 billion “Stimulus’) and many rounds of quantitative easing (“QE”) by the Federal Reserve involving billions of dollars of purchases of US Treasuries and Mortgage Backed Securities, with dollars created out of thin air, the economy remains at best stuck in neutral.

But don’t tell that to the stock and housing markets or to hedge fund manager David Tepper.

Even though most economic indicators – employment, personal income, average work week, manufacturing, durable goods, GDP, CPI/PPI, manufacturing, mortgage applications, industrial production and housing starts are all down, the stock and housing markets are roaring. Consumer sentiment also seems to be improving -especially for those in the top 1/3 who own stocks and homes.

A frothy stock market and “recovering” real estate market are proof to Paul Krugman, assorted central bankers and Keynesian central planners that stimulus and quantitative easing work wonders for an economy.

Indeed, lately there has been a lot of self congratulating from the Keynesian camp that all this spending of someone else’s money at their direction or printing and taking on ever more debt has created economic recovery. Pundits have crowed “Krugman won” and called for an end to the bull market in gold. Krugman also declared himself the winner.

Gold, that contrarian measure of healthy economies has been under fire recently. Goldman Sachs presaged gold’s historic drop when it issued a bearish report just days before the plunge noting that unless there was “an unexpected sharp turn in the U.S. recovery” gold would fall. After the drop, Credit Suisse piled on noting that gold was going to get crushed because the “worst risks to the global economy were waning.”

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Pride Comes Before a Fall

These victory laps appear premature.

The supposed strength in the stock and real estate markets is not what it appears and the employment situation is worse that it appears.

Stock Market

The stock market benefits from low (no) interest rates paid on deposits. Any money that people might have saved has to go into the stock market or real estate.

Stock market apologists will note that the S&P 500 sports a modest average 16 P/E ratio. For many companies these earnings are mostly based, not on revenue growth but on cost cutting and share reductions through company buy backs.

Real Estate

The real estate market is up also because of historically low interest rates engineered by quantitative easing and because inventory is down.

-Inventory is down because the foreclosure rate has been dropping and fewer distressed properties are being put on the market;
-many home owners are still underwater from the last real estate bust and can’t sell;
-still other home owners who have positive equity in their homes are viewing the recent uptick in home prices as a sign that prices will continue to rise and are holding back on listing their homes hoping for higher prices; and
-new home starts in the past five years are well below their historic average.


The job numbers released by the U.S. Bureau of Labor statistic are cheered on by those witnessing the recovery mirage. Yet the numbers are dismal as they show approximately 350K people a week applying for unemployment benefits and 160K new non farm jobs created each month.

While the unemployment rate has been declining gradually, it is due mostly to two factors:
-the labor participation rate is at a 32 year low
-many of the jobs created are part time jobs with the average work week falling to 34.4 hours.
Fewer Americans are working and the ones that are working are working fewer hours.

Industrial Production

Industrial production as measured by the Fed is also down.

The recovery is not that great and indeed is faltering, yet victory is being declared because the devastating inflationary consequences of running the printing presses 24/7 for nearly five years have not shown up yet. They have not shown up across the board but they have appeared in the price of gas (up approx 60% in the past four years) college tuition, the stock and real estate markets, all of which have far outpaced the consumer price index, highlighting the uneven distribution of the “benefits” of quantitative easing.

The nature of inflation (defined as an increase in the money supply and easing credit) is that it benefits those that receive the newly created dollars first. In this instance its oil companies, colleges, homeowners and share holders. By the time the new money washes down to the rest of the economy and causes the price of basic items to rise, the purchasing power of everyone else diminishes. For people of modest means there is some consolation in this scenario as they may own stocks and homes which are rising.

The cracks in the economy as noted above are visible yet ignored or explained away by the Keynesians as “transitory” or blamed on the weather.

To keep the recovery going they cry for more quantitative easing and warn that cutting it off is a deeply misguided notion.

Krugman also thinks the stimulus should have been bigger and that we would all be better off if aliens invaded.

Look Ma, No Hands!

But what happens if the training wheels are taken off and the Fed follows through with their threat to “taper” their purchases of US Treasuries and Mortgage Backed Securities. David Tepper says the Fed should taper – not to worry! a little tappering is a good thing, a necessary thing opines Tepper and won’t harm the market at all. For this bull, the glass is always full and too small!


The Fed and now the Bank of Japan have a dilemma on their hands. Once they deemed to have cured the economic patient with massive doses of stimulus, can they keep the patient alive with out it? Faced with this they will delay a final diagnosis for a long time.

It seems they have painted themselves into a corner. If they pull the stimulus, the economy will collapse. If they continue with quantitative easing eventually they will finish blowing up the biggest sovereign debt (along with real estate and stock market) bubble in history, certain to burst with even more devastating consequences than the consequences of the last housing bubble. The former option would be a brave move; a self inflicted wound that would allow the economy to restructure naturally and probably more quickly than pumping the bubble until it bursts.

Its seems there is No Exit for the Fed that will end nicely. Here are a few illustrations for music and architecture that highlight the bind the Fed is in.

Hotel California -“You can check out any time you’d like, but you can never leave”

I Can’t Quit You

The Sagrada Familia – 130 years in the making- and still not completed!

So all this talk of tapering is probably, for now, just talk. We will get more clues this week when Ben Bernanke testifies to Congress.

Talk Talk

The world has never embarked on a monetary experiment like the one underway. While it may seem that because the US stock market and now the Japanese one is soaring, its smooth sailing, Mission Accomplished.

If only it were that easy…..

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