Fed Up (or Down) How (Not) To Get Off A Tiger



First, they announced “Happy Hours”, without telling the crowd when they would close for the day. Then, they sent the bouncers home and allowed anyone in, without checking ids. Then they let the girls in, and asked them to do the ‘strip tease’. And then, just as the party heated up late into the night, and the glass started to fly, they mildly informed the audience that checkout would cost them some……sounds like Hotel California?!!!  Now, who would you blame for the ensuing riot? The bartender or the ruffians…..?!

Declaimer: This article was originally in February 2014 and some of the data points may be outdated.

I won’t waste time with the background and introduction. If you don’t know the step-by-step build-up to the recent Fed-induced blowout, you shouldn’t be reading this article. A $ 2 trn Balance Sheet over 5 stages of “QE”, sometimes called TARP, sometimes QE1/2/3, LTRO, “whatever it takes”, Abe-economics; if the fattest Balance Sheet in the world announces a slimming program, it should make news, shouldn’t it?

If you want to get off a tiger, the last thing you do is ask it to ”slow down”. I don’t know what you should have done (which is why I am not the Fed Governor), but telling the tiger (to “slow down”) is not it…

You also need to learn how to look good with some visible egg on your face, if you want to aspire to be the Fed Governor. Right now, they are ‘revising’ GDP growth rates down from 2.4% to 1.6%, saying “Oh sorry! We are nowhere near our milestones……and by the way, there is a recession around the corner…..perhaps?!” They got some minor lackeys at the subordinate Feds to do the backtracking, but it is pretty clear that there is no switching off the booze in the middle of the party. Next time, they will have bouncers in place, and the glasses will be made of steel…

Ok, I am also getting tired of these metaphors, so let us get down to the serious stuff.  Why would the Fed be naive enough to believe that a transparent pathway to unwinding QE would be taken very kindly by the markets, especially when he has no idea where the QE money went in the first place? If the scaredy cat money was lying in carry trades on faraway shores, then he was beating down the yield curves in countries where REAL interest rates were just that, i.e. real, not zero. The first TARP money must have gone to recapitalize the Banks, but thereafter, the next few tranches went further and further away from Ground Zero of the Global Financial Crisis of 2008. The yield-searching money went into depressing forward premia in almost every commodity market, making it easier to hold inventories for China; then, it would have gone into Govt debt of various emerging markets, right up to the banana republic. Some of it (and we are still to find that out) would be financing some real estate holding operation and some of it would be into equities, of course. This is not an exhaustive list, of course, but I don’t have space……$ 4 trn should make a long list, I would think.

When you suddenly brake your car at a red light in Delhi, you make sure that the guy behind you knows that you are braking. The normal assumption, especially at night, is that you would jump it (i.e. the red light). If you want to be the contrarian and stop, you are at risk of being hit from behind. So the correct way to brake at a red light is to stop, go, stop, go, and then stop….Mr. Bernanke needs to complete his driving lessons here.

So what next? Well, frankly, nobody knows, but let me at least ask some of the right questions:

  • How much of the money got printed? I don’t mean just the actual Fed money printing, that carries a name (i.e. the alphabet soup recounted above, QE, LTRO, et al). I want to include the normal multiplier effect, if any, on credit creation through the transmission systems of the banks.

Mostly, the answer is: not really….!!! Much of the initial money just went into the banks/ insurance companies to sit back as reserves against losses already incurred. It gave the economy ‘confidence’, and shored up the remnants of economic activity.

Subsequent tranches went into ‘false income’, a repo transaction with the banks by which they borrowed the Fed’s newly printed dollars. They lent it back to the Govt, thereby pocketing a nice fat ‘profit’ (some of which got paid into the economy as bankers’ bonuses, which bought some new villas and yachts). This profit recapitalized the banks, created the illusion of a turnaround, and buoyed up the stock market. All very well, till the music stops…

Some of the money went into ‘asset’ markets, either holding inventory to finance future expected demand from China, or just ‘bubbles’, waiting to discount (non-existent) EM profits in their equity markets.

  • The history of the Great Depression tells us that the real trouble started not in 1929, but in 1933, and it did not start in the epicenter (i.e. US), but in the aftershocks (i.e. the Pound Sterling and the demise of the British Empire).

Could it be that the US, and to a lesser extent, the other developed countries, may have the resilience to deleverage and return to relative wealth (thanks to superior innovation built-in into their respective economies), while the ‘copycat’ economies of the Emerging Markets, which just have demand, but no productivity-enhancement systems, other than some natural improvements as you go from the bullock cart to the motor car…..that such economies will stagnate to death the moment the supply of cheap (external) credit dries up. The shift of purchasing power that will follow the multiple processes of deleveraging, higher savings, higher innovation, and new job creation in the US, will create massive ‘relative poverty’ before the world economy returns to stability.

What we could be seeing is this mega-trend, now reflected in all-round currency depreciation against the Dollar, what I keep calling the “Dollar is the new Gold”….a megatrend that will spell good news in 2020, but will create a readjustment of belts across the Emerging Markets in the period before that. We are going to see a return to the days before 1971, when ‘King Dollar’ had a gold peg, and was creating its position as the world’s reserve currency.

Perversely, when talking about the Dollar’s demise has been fashionable, you will see quite the opposite happening through multiple fundamental trends, which reverse the history of the past 5 years and create huge pain in the rest of the world.

In the long run, though, all this is for good reason and is good for the world. It represents the ‘return of virtue’, when innovation and rising productivity will decide economic futures. It will set parallel mini-trends in the rest of the world, for example:

  • ‘King Exporter’: for the last decade, the Indian exporter has lost purchasing power, while importers, gold, and real estate, have got richer. The latter will stagnate, and those who look to capture some of the incipient American demand through those now-valuable Dollars will get rich.
  • When your goods don’t sell, your people do……if the merchandise economy is stagnant, your currency will depreciate till your services exports take off. With falling unemployment in the US, India’s services will do better

But back to some closing remarks about the Fed. So how does he get off this tiger? By paying attention to the aftershocks he is seeing in the Emerging Markets, and calibrating his pullback in tune with the messaging of his actions across the world. Prepare for the DXY at 92, even 100, and tell me what the other currencies look like from there. Then recalculate the new commodity prices, impact on inflation, and see who benefits and who pays….

How all this helps you with the tiger, I don’t know. For that, he should consult a certain lady in Kolkata.



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