Thursday, April 4, 2013

Thursday, April 04, 2013 - Experimental Therapies

The Wealth Protection Conference kicks off tomorrow afternoon in Tempe, Arizona. I will be the keynote speaker, starting at 4PM. This year's roster of speakers includes Mark Liebovit, Nathan Liles, David Smith, Roger Weigand, Arch Crawford, Ian McAvity, and Bill Tatro. These are some of the best technical analysts in the markets and top researchers and economic minds, and me. The conference is Friday and Saturday. For more information: To make a reservation, please call 480-820-5877. I hope to see you there.

Experimental Therapies
by Sinclair Noe

DOW + 66 = 14,606
SPX + 6 = 1559
NAS + 6 = 3224
10 YR YLD - .05 = 1.76%
OIL – 1.07 = 93.38
GOLD – 4.30 = 1554.60
SILV- .08 = 27.00

A big day for central bankers. The European Central Bank left its benchmark interest rate unchanged at 0.75%, while the Bank of England held its key rate steady at 0.5%. With both central banks’ rates already at record lows, there might be little room to use interest rates as a stimulus. But the euro zone economies, like that of Britain, are stagnant and in need of help wherever they can find it. What to do when interest rates are already near zero? The Fed playbook calls for Quantitative Easing, and today the Bank of Japan took that playbook and put it on steroids.

First in Europe, ECB President Mario Draghi says the ECB was looking for new ways to stimulate lending in the weak euro zone economy, and could move quickly, but he didn't offer details of any new stimulus plan. Instead, Draghi tried to clean up some of the mess left by the botched Cyprus Bank Heist. Draghi emphasized the ECB's determination to shore up the euro and insisted that Cyprus is not a template for the future and is not a turning point in euro policy.

Draghi said the plan to steal small depositor was not smart, but things changed and they didn't steal from small depositors, only big depositors, and heck, a lot of them may or may not be Russians.

Meanwhile, economic reports showed a drop in business activity in France Germany. Draghi thinks the Eurozone will recover, but he acknowledged tight credit conditions are weighing on economic activity, and he generally looked like he didn't have any tools in his toolbelt.

Meanwhile, the Bank of England left rates unchanged. The BOE governor, Mervyn King has said he wants to try Quantitative Easing but he's been overruled by other members of the central bank’s interest rate setting committee; apparently content to wait a few months for the new governor, Mark Carney to see if he brings any new and exciting tools to his new job.

For a long time, Japan has resisted QE, and then they got a new Prime Minister in December, Shinzo Abe, and a new governor of their central bank, Haruhiko Kuroda; and today they announced an aggressive bid to end years of stagnation and deflation. The Japanese central bank said it would aggressively buy longer-term bonds and double its holdings of government bonds in two years, in effect doubling the money in circulation in the process.  They anticipate this will result in inflation; they hope it will result in inflation; they would love to see inflation surge to 2%. And if prices do not rise as expected, they promise to step up the bank’s easing program.  That represents a sea change from his predecessors, who were faulted for being too ready to pull back at the first sign of higher prices for fear of runaway inflation.

The BOJ will buy about 7-trillion-yen a month, which is equivalent to a bit more than 1% of gross domestic product, or about twice the pace of the Federal Reserve's QE bond buying plan. The policies are part of a new asset purchase framework that focuses on the monetary base instead of the overnight interest rate, which has remained close to zero for years doing little to increase prices or otherwise help the real economy. The bank will also consolidate all its purchases in a single operation in an attempt to improve transparency of the bank’s purchases.

Also, the bank will suspend a longstanding rule that limits its bondholdings to the amount of money in circulation, a limit that has already been surpassed.

Kuroda said that risks or doubts should not hold the central bank back from fighting deflation. He said: “We have debated the side effects, but we are currently not concerned that long-term interest rates might spike, or conversely, that there would be an asset bubble. That risks exist should not hold us back from pursuing much-needed monetary easing. We will keep in mind those risks, but push ahead.”

He also said that once Japan had fought off deflation and reignited its economy, lending would surely follow, spurring more economic growth in a virtuous cycle. One little side effect is a noticeable drop in the value of the yen.

So, we now have diametrically opposed central bank policy, a broad spectrum of plans to watch and evaluate. Japan has tossed the switch on wide open easing; the US has embraced Quantitative Easing with the effects muted by fiscal austerity; and the Eurozone seems content to accept month after month of seemingly meaningless and self-inflicted pain, or hyper-austerity. New numbers this week show the self-inflicted torment has resulted in 12% unemployment across the Eurozone; meaning some countries are in a worse economic condition than back in the Great Depression, which you may recall, ended in a bang, not a whimper.

Also this week we had some Federal Reserve doves indicating they would like to wean the US economy from QE to infinity and beyond, but this appears based on overly optimistic assumptions about the labor market. Of course we know this is just jawboning. Quantitative easing looks like it will never be reversed. Today's QE relies on pushing down borrowing costs. The idea is to encourage more credit, or more accurately it encourages more debt. That is a very blunt tool in a deleveraging bust when nobody wants to borrow.

The flip side is to push demand, a strategy that would require a more direct injection of capital into the economy, bypassing the debt cycle (and the banks); largely because the current policy has become dangerous, yielding ever less returns, with ever worsening side-effects.  It would be better for central banks to put the money into railways, bridges, clean energy, smart grids, or whatever does most to regenerate the economy. In other words, a direct injection that doesn't raise the debt; in other words, money printing. Yes, there might be some unintended side effects, but obviously, these are the days of grand experiments by central banks. In other words, nothing seems to be working, let's try flipping this switch.

The hope is that the hard days are passing and happy days will return, and the need for experimental therapies won't be necessary. Maybe the stock market is signaling a return to better days. Or maybe the stock market bull run is just an unintended side effect of the QE experiment. The stock market certainly seems disconnected from the economy. The M2 money stock has contracted over the past three months, and M2 velocity has dropped to the lowest ever recorded at 1.5. The country still has to navigate the sequester, a fiscal squeeze worth 2.5% of GDP over the rest of the year. Copper futures have dropped 10% since mid-February. Copper is the early warning signal for housing. The bull case for global recovery rests on US recovery, where the US is the economic engine pulling the world from the abyss; a seductive story as the housing market comes back to life and the shale boom revives the US chemical industry.

Tomorrow morning, we will get the monthly unemployment report for the Bureau of Labor Stats. It is expected the economy added about 190,000 jobs last month and the unemployment rate will hold steady at 7.7%.

The economy must add more than 360 thousand jobs each month for three years to lower unemployment to 6 percent. That would require growth in the range of 4 to 5 percent and is not likely with current policies. Tomorrow's jobs report will come 5 weeks after the start of the sequester; maybe too early to really feel the impact. Still, we'll watch the jobs report; since jobs are one of the better indicators of demand. And there will be no virtuous cycle without broad-based demand. If things truly start to get better, we'll happily get in line and march back to normalcy. If the jobs picture deteriorates, the experimental therapies will continue.

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