Wednesday, December 12, 2012 - Life is Beautiful and Easy

Life is Beautiful and Easy

by Sinclair Noe

DOW – 2 = 13,245
SPX +0.64 = 1428
NAS – 8 = 3013
10 YR YLD +.05 = 1.70%
OIL +.99 = 86.78
GOLD + 1.20 = 1712.60
SILV +. 45 = 33.55

And now, the DC Players present: The Grinch Who Stole Christmas, starring John Boehner.

Speaking to reporters this morning, Boehner said: “We’re going to stay here right up until Christmas Eve, throughout the time and period before the New Year, because we want to make sure that we resolve this in an acceptable way for the American people.”

Yesterday, we told you reporters in Washington were optimistic a deal could be reached; and we told you that story literally dripping with sarcasm, because we were fairly certain it was just idiot reporters projecting their own fantasy that they could spend the holidays with family and people posing as friends; it was a last gasp hope to shame inept and incompetent politicians to get a deal done. It didn't work.

Republicans and the White House appeared no closer to a deal, as both sides pressed each other to cede ground. Republicans want to extract spending cuts from the White House while the Obama administration is demanding that taxes go up for the wealthiest 2% of Americans.

Wow, I just had a feeling of deja vu. It's almost like I've heard this before.

Washington has a way of diverting the nation's attention on tactical games over partisan maneuvers that are symptoms of a few really big problems, but we almost never get to debate or even discuss the big problems because the tactical games overwhelm everything else. The bigger debate is over whether we should be embracing austerity economics and reducing the budget deficit in the next few years (which has been tried in Europe with alarming failure) or, alternatively, using public investments to grow the economy and increase the number of jobs, which increases demand, which forms a virtuous circle.

Even this larger debate is just part of of a bigger debate; why we still have poverty, why median wages continue to drop at the same time income and wealth are becoming ever more concentrated at the top, and what can and should be done to counter the trend.

With a shrinking share of total income and wealth, the middle class and poor simply don't have the purchasing power to get the economy back on solid footing. The wealthy don't spend enough of their income or assets to make up for this shortfall, and they invest their savings wherever around the world they can get the highest return. As a result, consumer spending, 70 percent of economic activity, isn't up to the task of keeping the economy going. This puts greater pressure on government to be purchaser of last resort.

So why are none of our political leaders looking beyond the cliff, planning for what happens next? Far from having a debate about how to grow the economy, all they're currently talking about is how to preserve the status quo; and as we all know, the status quo is that life is beautiful and easy. I'm sure we can all agree.

Why is life so beautiful and easy? Because there is a man, a jolly old man with a white beard; yes Virginia there is a Federal Reserve Chairman, and today he promised that he will fly in a sleigh, all across the land, throwing out gobs of money until the unemployment rate drops to 6.5%. Yes, the jolly old elf himself, Ben Bernanke announced QE4, but don't call it that. Whatever you're not calling it, the Federal Reserve sent its clearest signal to date that it will keep interest rates super-low to support the economy even after the job market has improved significantly. The Fed said it plans to keep its key short-term rate near zero until the unemployment rate reaches 6.5 percent or less – as long as expected inflation remains tame. Unemployment is now 7.7 percent.

That plan adds detail to what the Fed had said before: that it expects to keep the rate low until at least mid-2015. For the first time, the Fed is making clear to investors and consumers that it will link its actions to specific economic markers. Bernanke said, "This approach is superior" to setting a timetable for a possible rate increase, "It is more transparent and will allow the markets to respond quickly and promptly to changes" in the Fed's economic outlook.

Bernanke made clear that even after unemployment falls below 6.5 percent, which will probably happen in 2015; at least that is the guess. It is kind of a gloomy guess. It means all the stimulus doesn't really kick in like a V8 motor, more like a MoPed. And that means the economy is so weak that even a boost of $85 billion a month isn't enough to get us rumbling down the highway. Or maybe it means that the $85 billion a month isn't going to the right places to stimulate the economy. Undeterred, the Fed might decide that it needs to keep stimulating the economy well past 2015 or well past 6.5% unemployment. Other economic factors will also shape the Fed's monetary policy decisions.

Surely, one consideration is whether any of the Fed's machinations can actually get money to start moving through the economy with a little more velocity than a poorly tuned scooter. Part of the idea behind suppressing interest rates is to spur lending, but if you're not borrowing now, nothing from today's announcement will get you to borrow; the other motivator is to force investor cash off the sidelines and into the stock market, or into anything.

The Fed updated its forecasts anticipating unemployment to remain at least 7.4 percent next year and 6.8 percent by the end of 2014. The earliest it sees unemployment dropping below 6.5 percent is the end of 2015. The Fed predicts the economy will grow no more than 3 percent next year before picking up to as much as 3.5 percent growth in 2014 and as much as 3.7 percent in 2015. Now, we all know the Fed's prognosticating abilities are roughly on par with the bicycle riding abilities of a fish, but let's look on the bright side. They have a printing press and they are not afraid to use it.

In a statement after its final policy meeting of the year, the Fed said it will also keep spending $85 billion a month on bond purchases to drive down long-term borrowing costs and stimulate economic growth. The Fed will spend $45 billion a month on long-term Treasury purchases to replace a previous bond-purchase program of an equal size. And it will keep buying $40 billion a month in mortgage bonds.

The latest bond-buying program would replace an expiring program called Operation Twist. With Twist, the Fed sold $45 billion a month in short-term Treasurys and used the proceeds to buy the same amount in longer-term Treasurys. Twist didn't expand the Fed's investment portfolio, it just reshuffled the holdings. But the Fed has run out of short-term securities to sell. So to maintain its pace of long-term Treasury purchases and to keep long-term rates low, it must spend more and increase its portfolio. So, the Twist is being replaced by out-and-out purchases. So, in a way, it is just a continuation of the Twist; the level of bond buying remains the same, just that the Fed's portfolio looks a little ugly, but when you have a printing press, you really don't have to worry about aesthetics.

With its new purchases of long-term Treasurys, the Fed's investment portfolio, which is nearly $3 trillion, will swell to nearly $4 trillion by the end of 2013 if its bond purchase programs remain fully in place. Plus everyone gets cookies and oranges in their Christmas stocking because life is beautiful and easy.

As long as we don't go over the cliff.

If the politicians go over the cliff, Bernanke says there will be pain; sharp tax increases and government spending cuts cannot be overcome by misdirected stimulus. Just the thought of the fiscal cliff threatens economic well-being and a possible recession.

So clear your mind of all negative thoughts, it just drags down the economy. Remember, life is beautiful and easy.