Gold Rush or Just a Streak?

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Gold had a good run for twelve years but has fallen by as much as 20% this year alone. Is that set to continue? It looks as if gold will increase marginally again this week and may even continue reaching a peak next month due to the weak dollar and the fact that the world’s highest consumer of gold (India) will be entering a festive season typically associated with marriages and gold-buying time. But, will investors soon be losing interest in gold? Prices are predicted to increase by at least 3.8% on average (as in previous years) in November. It may even be beyond that percentage increase due to the weakened dollar.

  • 68% of those people polled by CNBC believed that gold would increase again this week after last week topped the highest price in gold for the past four weeks.
  • Now, there is some belief that there will be a high that goes beyond August’s $1, 400.
  • Only 18% of people believe that gold will drop this week while the rest see prices remaining stable.

     Gold Rush or Gold Streak?


    Gold Rush or Gold Streak?

Bullion increased last week by 1.7% and that was mainly due to the lower-than-expected US non-farm-payrolls data that was finally released by the administration for the first time since the government shutdown. The Bureau of Labor Statistics was inevitably one of the non-essential federal government departments that were asked not to come into work. Why on earth do we have non-essential government departments anyhow and why did they come back to work? It was probably only so the administration could inform us that despite the shutdown there was a 0.1% drop in unemployment from 7.3% to 7.2%.

My, the economy is really taking off! You’ll have to hold on to your hat President Obama as the wind that gets whipped up might just knock it off your head as the people stampede to the factories to get to work. Of course, the real unemployment figure is still roughly nearly 15% and that looks like it is set to increase even more as people become more and more discouraged about looking for work. Dropping out of the work market means dropping out of the figures.

But, the current situation means that the Federal Reserve will definitely not be able to withdraw its stimulus plan and Quantitative Easing will end up becoming a lengthy drawn-out process that could be equated with doing nothing more than lining the pockets of the banks so that they can create the next bubble on the stock market. The dollar will be weakened even further by the mere fact that tapering has yet again been postponed. It’s also lower still as a result of the shutdown and worry over the ability to pay back debt for the US.

This week it is expected that the two-day policy meeting for the Federal Reserve will end in an announcement that the easy money will continue well into 2014 and even beyond. Normally it’s loose lips that sink ships. But, this ship will be well and truly sunk by the loose money of Ben Bernanke and President Obama’s monetary policy that is far from conventional.

There are some analysts that believe that the strife for the dollar will bring about a rally in gold that will amount to+$200 in the next few weeks. There are even some that expect gold to go beyond $1, 500 by the end of December 2013. That would mean getting back to levels that have not been seen since April 2013. Gold came down pretty quickly after QE tapering was being bandied about and it could go up just as quickly now that tapering is being postponed. The dire situation of the US will certainly give gold a push and that could be good business to invest in. US debt is not going to go away and the country will end up spending more and more. People will inevitably go back into gold to secure their money. The price of gold can only go up and now is the time to cash in on that.

If the US is going to be in a position to deal with its national debt, paying it down, then it will have to let a little bit of inflation creep in there. That in itself will be more fuel to the fire and will drive up the price of gold again.

So is it a gold rush or a gold streak? Most people will be betting on the fact that this is not just a short burst and that it will last a lot longer than a wet firework that fizzles out.

Originally posted: Gold Rush or Just a Streak?

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UBS On The Importance Of 3D Printing

Over a year ago we discussed the “next Industrial Revolution” and where it might appear from. 3D printers were envisioned among Goldman’s top disruptive themes earlier this year and as UBS notes, 3D printing – or additive manufacturing – has been catching investors’ imaginations in recent months. Some commentators have suggested the technology has the potential to literally transform the world economy and dismantle global supply chains; while UBS points out that, others have suggested the technology is hyped and has little promise beyond a few niche product areas in manufacturing. The truth, Andrew Cates believes, probably lies somewhere in between but he is nevertheless more sympathetic to those who champion the technology’s disruptive – even revolutionary – qualities.

 

Via UBS’ Andrew Cates,

For those readers who are not yet aficionados on this technology we start with a brief explanation. Additive manufacturing (AM) techniques (a.k.a. 3D printing) create 3D objects directly from a computer model by depositing material where required and by building products up layer by layer using a range of different materials (e.g. polymers, ceramics, glass and even metals).

This stands in contrast to conventional subtractive manufacturing techniques which involve taking blocks of material, cutting them down into the right shape, and assembling them into more complex products. The technology is admittedly still in its infancy and it suffers from a range of limitations at present. However, we think the optimists who argue that this technology will be revolutionary have a strong case. As one author has quipped:

“This is not the third (industrial revolution), nor the second, but rather the first real revolution in how we make things since a pre-historic man picked up two rocks and started banging them against one another, trying to shape them into something useful” (Dr Alexander Elder)

The technology has not yet generated a major impact on the world economy. A recent report from UBS analysts, for example, noted that the AM market (USD 2.2 billion) amounted to just 0.02% of the global manufacturing sector. Still, as the analysts equally noted, the technology is starting to spread more broadly both at a sector-specific and at a country-specific level. A recent report from Wohlers Associates, for example, reveals that AM is now used in a number of different economic sectors with consumer products/electronics the leading industrial area. The motor vehicle and aerospace sectors are also keen users while the medical/dental profession has additionally established itself as a strong sector for AM over the last few years (see chart 1 below).

The technology is – at present – particularly advantageous in low-to-moderate volume markets (e.g. aerospace) that regularly operate without economies of scale.

At a country-specific level the data from that same report from Wohlers reveals that the US is the lead user by a large margin. Japan, Germany and China have the second, third and fourth largest installed bases, respectively, of systems worldwide (see chart 2 below).

There are a number of reasons why the technology has not yet had a bigger impact. Challenges include production speed, materials availability, precision and control. Issues concerning legal responsibility are also problematic. Still, as we explore below, incentives to overcome these challenges clearly exist because of the potential advantages that the technology affords. And matters at present may already be moving more rapidly than many of the pessimists might contend. The use of nanotechnology, for instance, could mean that plastics in 3D printing soon rival the strength of metals in more conventional manufacturing.

Meanwhile the printing of human kidneys, of houses, of hamburgers (and other food products) and even – in the distant future – of an aeroplane are being actively researched and in some of those cases (e.g. houses and hamburgers) even printed.

The reasons why the technology has so much potential are as follows:

It lowers energy intensity by saving energy, by eliminating production steps, by enabling the reuse of by-products by producing lighter products and by cutting the need for transportation. It is in these respects obviously environmentally-friendly as well.

 

AM techniques yield less waste. The US Department of Energy estimates that by building objects layer by layer instead of traditional machining processes that cut away material AM processes could reduce material needs and costs by up to 90%.

 

It heightens incentives to innovate by eliminating traditional design restrictions. It makes it possible, for example, to create items previously considered too intricate and accelerates final product design. The ability to improve performance and functionality – literally customizing products to meet individual customer needs – should open new markets and improve profitability.

 

It yields greater flexibility in the production process by enabling rapid response to markets and new production options outside of the manufacturing factory. Spare parts can be produced on demand, for example, reducing the need for inventory and complex supply chains.

In short the technology enriches the capital base and enhances the scope for an economy to achieve faster capital- and total factor productivity growth. Its disruptive qualities emerge from the ongoing fall in its relative costs and the increasingly broad reach of its potential. Arguably of most significance from the vantage point of potential global economic benefits the technology lowers the barriers to entry in manufacturing and allows almost anyone to become an entrepreneur.

As we have explored in more detailed research in recent weeks there are a large number of technologies that are rising to the surface of the world economy at present which offer a great deal of promise. AM in isolation would arguably not be so potent were it not for these other innovations that are acting alongside it. The marriage of nanotechnology and AM techniques is perhaps the bestillustration of this. But the increasingly connected world economy via the increasing use of mobile and cloud technology and the ease with which digital designs can now be transported around the planet are notably also helping to foster the take-up and deployment of AM techniques.

We have tentatively estimated that the efficient deployment of new technologies in the information and communications sector, in manufacturing (including AM) and in energy could lift the potential growth rate of the world economy by as much as 0.5 percentage points in the coming years. The winners from this potential transformation
, however, are more likely to be those economies, sectors, companies and consumers that are active users of these new technologies and not necessarily its active producers.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Bn9QzOb278M/story01.htm Tyler Durden

David Einhorn's Three Questions For Ben Bernanke

From David Einhorn of Greenlight

The amount of media and market attention focused on whether the Federal Reserve will taper its quantitative easing (QE) would border on comical if it weren’t so serious. In August, the San Francisco Fed published an economic research paper that estimated that the $600 billion spent on QE2 added a meager 0.13% to real GDP growth in late 2010 (about $20 billion) and that the benefit fades after two years. Given that, what practical difference does it make whether the Fed buys a monthly $85 billion or $75 billion or no additional securities at all for that matter?

We maintain that excessively easy monetary policy is actually thwarting the recovery. But even if there is some trivial short-term benefit to QE, policy makers should be focusing on the longerterm perils of QE that are likely far more important. Here are some questions that come to mind:

  • How much does QE contribute to the growing inequality of wealth in this country and what are the risks this creates?
  • How much systemic risk does the Fed create by becoming what Warren Buffett termed “the greatest hedge fund in history”?
  • How might the Fed’s expanded balance sheet and its failure to even begin to “normalize” monetary policy four years into the recovery limit its flexibility to deal with the next recession or crisis?

No one is sure what the Fed is focused on. After spending several months bracing the market for fewer QE donuts, the Fed decided that it was premature to taper. Even a token reduction (from a baker’s dozen to a dozen?) was ruled out despite the fact that the economic trajectory has not materially changed. We responded the next morning with our own stimulus by ordering jelly donuts for the entire office.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/YRagU0U6d9c/story01.htm Tyler Durden

David Einhorn’s Three Questions For Ben Bernanke

From David Einhorn of Greenlight

The amount of media and market attention focused on whether the Federal Reserve will taper its quantitative easing (QE) would border on comical if it weren’t so serious. In August, the San Francisco Fed published an economic research paper that estimated that the $600 billion spent on QE2 added a meager 0.13% to real GDP growth in late 2010 (about $20 billion) and that the benefit fades after two years. Given that, what practical difference does it make whether the Fed buys a monthly $85 billion or $75 billion or no additional securities at all for that matter?

We maintain that excessively easy monetary policy is actually thwarting the recovery. But even if there is some trivial short-term benefit to QE, policy makers should be focusing on the longerterm perils of QE that are likely far more important. Here are some questions that come to mind:

  • How much does QE contribute to the growing inequality of wealth in this country and what are the risks this creates?
  • How much systemic risk does the Fed create by becoming what Warren Buffett termed “the greatest hedge fund in history”?
  • How might the Fed’s expanded balance sheet and its failure to even begin to “normalize” monetary policy four years into the recovery limit its flexibility to deal with the next recession or crisis?

No one is sure what the Fed is focused on. After spending several months bracing the market for fewer QE donuts, the Fed decided that it was premature to taper. Even a token reduction (from a baker’s dozen to a dozen?) was ruled out despite the fact that the economic trajectory has not materially changed. We responded the next morning with our own stimulus by ordering jelly donuts for the entire office.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/YRagU0U6d9c/story01.htm Tyler Durden

Guest Post: 5 Ways To Create A Monopoly

Submitted by Brian LaSorsa via The Ludwig von Mises Institute,

It’s hard to maintain monopoly status in a free market when you have to deal with all that competition and whatnot.

Between other companies’ low prices and new, updated products entering the market each day, it’s almost like Rich Uncle Pennybags is a thing of the past. But fret not!

The politicians of the world would like to offer anyone dead set on controlling an entire industry the chance to shine. So come one, come all — government agencies, cronies, and all their friends — as we present the five best ways to create a monopoly and to ensure you never have to compete again.

1. Regulations. When the cost of doing business is high, make it higher. Small firms can’t survive government imposed regulations while bigger firms can certainly bear the burden, at least temporarily. Taxes, mandates, and especially “safety regulations” (e.g., clinical trials at the Food and Drug Administration) will wipe out your competition before they even have time to ask what the new rules mean. Then hire a lobbyist in Washington. I’m sure he or she will come up with a good reason that the industry should adhere to stricter and more expensive guidelines.

2. Subsidies. There’s no such thing as a free lunch. But, when the government is paying for it, the lunch sure does taste free. Subsidies offer an alternative, consumer-driven focus to acquiring monopoly status. Arbitrary revenue-boosts from the government will allow you to reduce prices to essentially nothing, all while maintaining profitability. You can give away (what used to be) a $10.00 item for free and, with the help of $1 million in subsidies from our nation’s capital, you can stay afloat. Your competitors, however, will have to make do with reality. Even if they somehow manage to slash prices to $1.00 per unit, what kind of customer will pass up free? The subsidy doesn’t have to last permanently, either. It will only take a few weeks before your competitors begin to default on paychecks and other loans without transaction revenue.

You can also take this route without the government revenue injections if you have a contingency plan in the form of a bailout. Both you and your competitors will go bankrupt, but only one (fingers crossed it’s you) will receive CPR.

3. Nationalization. Shout out to government officials! This one’s for you. The easiest and most straightforward way to create a monopoly is to simply write the monopoly into law. Federal control over an entire industry — much like we’ve done with the United States Postal Service — is effectively the prohibition of competition from the private sector. But don’t ever reference the USPS. It’s a terrible (albeit realistic) example of a government monopoly, what with its inefficiency, perpetual deficits, and general lack of regard for any sense of advancement in mail delivery. Rather, tell everyone you want to monopolize “for the good of the people” and then talk about the Department of Education or some other public sector operation people don’t like to criticize in front of company.

4. Tariffs. Neighbors can be annoying. Some are loud and others are strange, but the absolute worst neighbors are the ones who compete with you in the marketplace (and then win). In the beautiful Southwest, this neighbor is Mexico. Companies south of the border produce certain commodities much more cheaply than American companies do, and they have the nerve to think that they can export their inexpensive products to the United States on a whim. We don’t think so. If Mexican companies sell sugar for $2.00 per pound and you charge $3.00, don’t let them satisfy customers like they own the place. Make sure they pay an import fee of $1.01 and it’s guaranteed you’ll win new business one cent at a time. Better yet, propose a complete ban on the sale of foreign goods in your state, city, and town until you’re so isolated from the rest of the world that no one has a choice to buy from anyone except you.

5. Intellectual property. If you have a good idea, why let anyone else have the same one? Take that idea, write it down in the broadest words possible, and send it straight to the United States Patent and Trademark Office, where public officials will (hopefully) grant you the exclusive right to use it. And don’t worry, if someone else thinks of the idea one day later … too bad. You filed first. Even if someone halfway across the globe comes up with the same idea independently … too bad. You filed first. Milk your monopoly for all it’s worth. Put a huge price tag on that beast and feel free to ignore quality. What are consumers going to do: purchase your exclusive product elsewhere?

We wish you the best of luck in your venture. You deserve it.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/u5Pue4gXoIk/story01.htm Tyler Durden

Halloween Humor: How To Slay Zombies With Economics

Presumably you’ve already made plans for surviving a zombie apocalypse. You have detailed escape routes, stockpiled weapons made for killing zombies, stores of food… or at least plans for these things. But have you thought through the important economic factors that might make the difference between surviving and losing your brain to one of the walking dead? If uncertainty about how market prices and currency changes might affect your odds in a zombie-dominated society has been keeping you up at night, fear not. In this video, Prof. Anthony Davies provides a crash course in how a zombie apocalypse is likely to affect the economy. Hint: sell your designer shoes now while you can. And buy bullets.

 


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/4mujdZLrIiw/story01.htm Tyler Durden

Germany Advises Journalists To Stop Using Google Over US Spying Concerns, May Ask Snowden To Tesity Against NSA

The spat between the US and Germany is getting worse by the minute. Following yesterday’s meaningless escalation by the Treasury accusing, via official pathways, Germany of being the main culprit for Europe’s lack of recovery (and Germany’s subsequent retaliation), it is Germany’s turn now to refocus public attention on Big Brother’s spying pathology when a union representing Germany’s journalists advised its members earlier today to stop using Google and Yahoo because of the latest report implicating the NSA in eavesdropping on Google and Yahoo.

From Reuters:

“The German Federation of Journalists recommends journalists to avoid until further notice the use of search engines and e-mail services from Google and Yahoo for their research and digital communication,” the union said in a statement.

 

It cited “scandalous” reports of interception of both companies’ web traffic by the U.S. National Security Agency (NSA) and Britain’s GCHQ.

 

“The searches made by journalists are just as confidential as the contact details of their sources and the contents of their communication with them,” said Michael Konken, head of the union which represents about 38,000 journalists. He said there were safe alternatives for both searches and email.

And while in the US having one’s dirty laundry is almost perceived as a status symbol by a culture that encourages online exhibitionism via Facebook and other social media (so what if some bureaucrat in Virginia knows more than what is public), in Germany privacy is actually taken seriouysly.

The German government said last week it had evidence that Chancellor Angela Merkel’s mobile phone had been monitored by U.S. intelligence.

 

Government snooping is especially sensitive in Germany, which has among the strictest privacy laws in the world, since it dredges up memories of eavesdropping by the Stasi secret police in former communist East Germany.

 

Earlier this month, Deutsche Telekom said it wanted German companies to cooperate to shield local internet traffic from foreign intelligence services, although experts believe this could be an uphill battle.

 

In August, Deutsche Telekom and its partner United Internet launched an initiative dubbed “E-mail made in Germany” to protect clients’ email traffic.

And in other news, it is increasingly looking likely that none other than Ed Snowden will be called to testify against the NSA in a German court of law. Germany’s ARD reported that Snowden is willing in principal to help shed light on U.S. spying but outlined his complicated legal situation. As we noted earlier, German Greek politician Stroebele proposed possible safe conduct to Berlin, and granting Snowden a residence permit that would prevent extradition. Snowden attorney Anatoly Kutscherena earlier said he wouldn’t comment on alleged NSA spying on Angela Merkel.

Ironically, this follow news that Snowden would take a position with Russian Internet company Vkontakte, a local analogue to Facebook, to develop major website, according to his lawyer.

So if Obama was hoping that all the late summer scandals that have taken his reptuation to an all time low would at least push the NSA spying scandal away from the front page, he may need some additional fabricated and YouTube-validated false flag wars very soon.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Kbu-WBQxubk/story01.htm Tyler Durden

Guest Post: Are Constitutional Conservatives Really The Boogeyman?

Submitted by Brandon Smith of Alt-Market blog,

Power, or perceived power, is a viciously addictive narcotic. It doesn't matter what political or philosophical background a person hails from, very few have the self discipline or the self awareness necessary to relinquish the trappings of power once they have tasted it. This truth applies to conservatives as much as it applies to liberals.

I began my early political life as a Democrat, and until I came to understand the nature of the false left right paradigm in 2004, my view of the negative within government was slanted entirely against the GOP. When a finally grasped the fantasy of the two party process, I did not let go of my criticisms of the Republican hierarchy as much as accept the fact that the same criticisms applied to the Democrats as well. They are, ultimately, the same entity with the same exact ideological goals hidden by cosmetic differences in shallow rhetoric. I have no interest whatsoever in perpetuating the false left/right paradigm, or giving undue credit to the GOP.

However, as stated earlier, power is a drug, one which the so-called “left” has been hooked on since the Obama Administration took its seat in the White House. While the Republicans have much to answer for (the Bush years are a nightmarish example), it is the Democratic Party, and those who blindly identify with it, that must be addressed today. It is they who are now directly feeding the elitist machine, giving it momentum, and aiding in the destruction of the American economy and culture. It is their madness and thirst for control that is being exploited by the establishment to demonize legitimate activists who seek Constitutional transparency (the only people in this country today who understand the bigger picture and who the real enemies are) thus undermining any chance our society has for a free and prosperous future.

A new propaganda theater has exploded in mainstream media outlets and the liberal side of the blogosphere spectrum. This initiative centers on a not so subtle attempt to connect “Tea Party Conservatives” (basically lumping all people who espouse limited government ideals and constitutional principles under one easy to marginalize label) to any and all of our nation's fiscal and political problems. The debt ceiling debate has added a new dimension to this defamation program, sending leftist talking heads into a bloodthirsty frenzy akin to a Bolshevik street mob. Constitutional conservatives have been compared to “extremists”, “separatists”, “new southern confederates”, “traitors”, “saboteurs”, and “domestic enemies of the United States”. Here is just a sample of the MSM hate parade:

http://www.alternet.org/tea-party-and-right/robert-reich-tea-party-americans-dont-traitors-our-system-government

http://www.rollingstone.com/politics/news/republican-extremism-and-the-lessons-of-history-20131010

http://www.washingtonpost.com/opinions/david-ignatius-how-republicans-can-sideline-the-tea-party/2013/10/18/01c24536-377c-11e3-80c6-7e6dd8d22d8f_story.html

http://www.salon.com/2013/10/07/tea_party_extremism_has_me_worried_tammy_baldwin_talks_to_salon/

http://www.youtube.com/watch?v=gb6LMB2FX3w

There is a particular brand of rabid shameless zealotry to this rhetoric that I have not seen since the days of the Neo-Con drive to invade Iraq. It's worse in many ways, in fact, because it attempts to link political dissent with “treason” in a very dangerous manner, and sets the stage for an “acceptable level” of totalitarianism. These are the same people who fought tooth and nail against identical tactics only a decade ago, and now, they have happily (and hypocritically) adopted the nefarious methods as their own.

We have gone beyond mere talk into a realm where political witch-hunts may become an Orwellian reality, and it is the “Tea Party” that the establishment wants to burn at the stake. Even now, federal agents are training active duty military personnel to view Constitutional conservatives as “terrorists” bent on annihilating America:

http://www.foxnews.com/opinion/2013/10/23/does-army-consider-christians-tea-party-terror-threat/

Because of this danger, I am forced to dismantle the ludicrous arguments of my former party, and expose the vile and dishonest nature of their motivations. Here is why the loyal left has become a far greater threat to the safety of our country than they could ever hope to paint conservative activists. Here are the reasons why they hate us…

Why Neo-Liberals Distrust Limited Government Champions

In my time as a Democrat I did not always agree with the party line. I believed that if a massive government system was an inevitability, then it SHOULD at the very least exist to help, not harm or control, the American public. I never attached myself to the notion that government was the answer to every crisis. Many liberals, however, do assume that government can be tamed, and if they gain total control of the system through political maneuvering it will somehow naturally gravitate towards humanitarian concerns. Government, in their minds, is a tool they can exploit, when in reality government is a self contained entity that exploits them as tools.

The great downfall of orthodox Republican culture is the blind faith it commonly places in the corporate world and the vestiges of big-business. They believe free markets actually exist in America today (they don't), and that the captains of industry are what drive our country forward. Liberals, on the other hand, also believe that free markets exist in America today (they don't), and that these “uncontrolled” financial organizations are the cause of all our social grief. Liberals are correct to be suspicious of the corporate oligarchy; the professed goal of many banking elites of dominant globalization is certainly a threat to us all.

The problem is, liberals don't really take issue with the concept of globalization, per se. In fact, many of them love the philosophy. They just don't like the idea of “conservatives” being at the helm of such vast change. Liberals attach themselves to government and rabidly defend it because they falsely imagine that government can be used to stifle or destroy what they assume to be a conservative dominated corporate machine. They want the destruction of American sovereignty. They want a system that dictates and micro-manages the citizenry. But, they want that system to operate on their terms and enforce their particular world views, which they believe not only politically correct, but sacrosanct.

In the minds of many average liberals, government is the only recourse to affect their battle against corporate dominance. When faced with a person or group of people espousing the principles of limited government, reduced spending, reduced taxes, and cuts to bureaucracy, liberals immediately presume that those people are seeking to support the corporate oligarchy by de-fanging government and removing their greatest weapon. Tea Party and Lib
erty Movement conservatives do indeed seek to de-fang government, but we have also broken from the Republican orthodoxy and recognized that government actually colludes with corporate elites on the most vital issues. We understand that they are part of the same monstrosity, and so, we are just as uncompromising in our fight against big government as we are against unaccountable business. This confuses liberals who are so acclimated to the traditional boundaries of debate between Left and Right.

They don't know how to classify or pigeonhole us, and they certainly don't have the capacity to argue with us on a rational level because half the story has gone over their heads. And so, they follow the natural human inclination, which is to hate and despise what one does not understand and what one cannot quantify. In the eyes of bewildered Democrats (and some elitist Republicans) we are extremists, because they have never been confronted before with people who are so fully committed and immovable in their principles. Uncompromising opponents, unshakeable opponents, are the most terrifying opponents.

The Left's Inclination Towards Collectivism

The liberal subculture is permeated with frightened people. They are frightened of authority yet infatuated by authority. They are frightened of independence yet feign independence. They are frightened of the blunt truth in serious matters, yet fascinated by the blunt truth as a form of comedic anesthesia. They like to imagine themselves as socially heroic but they have never had the concrete courage required to achieve a truly heroic deed, which is why they constantly argue that state designated officials are the only people qualified to manage or defend the public interest. It is much easier to hand responsibility over to a man in a uniform who may or may not do anything proactive than it is to take responsibility by one's self.

One of the most off-putting character traits inherent among the many Democrats I've met along the way is a complete incapacity to stand alone against a dilemma. The average liberal is, I'm sorry to say, invariably weak and always searching for someone else to handle their messes for them. Their love of government stems in large part from their desperate need to find a parental figure to cradle them, or a group structure that will reinforce their beliefs without question.

I have rarely if ever seen any substantial measure of individual action or resolve amongst liberals. The activism of the left almost always gravitates towards asking government for permission with as many pleading hands as possible, or asking government to repair a malfunction it created, or begging the system to PLEASE respect their rights. To suggest to them that perhaps they should compete with the system, build their own more honest social paradigms as individuals, defy criminal authority even at the risk of their own lives, or actually physically fight back, is a waste of time.

The liberal activist's dream scenario? A safe majority of the population suddenly and magically standing up together with one mind to achieve a singular goal while facing no meaningful pain, struggle, or risk. They sit around waiting for that day, when we all dawn our V For Vendetta masks and march on Washington D.C. together while the Plutocrats stand down in silent defeat. It is a pointless fantasy with little to no historical precedent.

This is why they treat Constitutional conservatives with disdain. They are incredulous when we state that we will fight even if we are the so-called “fringe”. They are shocked and unsettled when we state that the mainstream view is irrelevant. They laugh at the concept of independent action against the system regardless of the risks simply because they know personally, deep down, that they don't have the balls to make the same stand, and so snide ridicule is their only safety mechanism.

This cancerous attachment to the collective is what makes the “left” so easily manipulated by political elites, who play on that which they fear most to lose – their socialist safety net. The existence of an ideological movement like Constitutional conservatism which openly and defiantly pursues an end to government sponsored collectivism and the crutch of economic socialization is the ultimate boogeyman for the liberal front.

The Liberal Land Of Infinite Comfort

The recent debt ceiling debate was incredibly effective in driving home the insurmountable differences between hardcore Neo-Liberals and proponents of limited government. This conflict is only going to become more pronounced as the next debt debate approaches in the Spring of 2014. The roughly 25% to 30% of the U.S. population that still worships the Obama Administration despite all logic is more than enough cannon fodder for the establishment to throw at us.

They believe we are out to destroy the nation because we “aren't getting our way” on Obamacare. They believe we have placed our political desires ahead of the good of the collective. They believe we are self absorbed extremists; mad bombers strapped with TNT and ready to take everyone to hell with us. They believe our entire movement is a hologram created by the mysterious Koch Brothers – Libertarians with money now lampooned by liberals as secret corporate Decepticons responsible for grassroots activist initiatives that started long before the Koch Brothers ever put money into them. The fairytale is flourishing in their minds, and we are the villains.

More than anything, Liberals want a future of unlimited ease. Some are motivated by a desire to help others, but many are motivated by a desire to help themselves. In either case, they must understand that infinite government growth and infinite government spending will NEVER get them what they want. No matter how hard they wish for it, socialist utopianism will always fail. Why? All government is inherently flawed, because all government is administrated by inherently flawed people.

Constitutional conservatives don't hate Obamacare because we don't want people to have healthcare. We hate Obamacare because it is a horrible solution to a problem that needs a working solution. We hate Obamacare because it makes the existing problem worse, not better (as the past couple weeks of bureaucratic failure have shown).

We haven't abandoned the general good of this country, but we do demand that the founding principles of freedom, independence, and limited government that built this country be considered a priority. There is no “general good” without foundations of honor, reason, and transparency. If liberals are suggesting that the greater good requires us to ignore conscience, reality, and basic mathematics, then I will have to disagree, and I am willing to put everything on the line to defend that position. Are they willing to do the same?

As far as the Koch Bros. are concerned, I don't take orders from them, and I don't know anyone in the movement who does. I've also seen no indication that the Koch Bros have any desire to give orders to anyone in the movement. We do what we do because we BELIEVE in what we do, not because we get paid for what we do. If the Koch Bros didn't exist, the limited government movement would continue on without missing a beat. Let's direct our energies into the legitimate conspiracy of globalization and stop wasting our time with made-up conspiracies perpetuated by the mainstream media, shall we?

Constitutional conservatives have been the only people attempting to inform the American public of the facts surrounding our current fiscal crisis. Some have been doing it for decades. Many of us have been doing it since before the average liberal was even aware that a crisis existed. We are trying to help them, even though we disagree with them on numerous fundamentals.

The bottom line is, whether Obamacare is successfully implemented or not, whe
ther the debt ceiling is raised again or not, whether the Left passes every agenda on its list or not, our system is broken and it is going to collapse. There is no way around it. More debt and more fiat printing means stagflationary collapse. Default and austerity means stagflationary collapse. If liberals want to place blame for this conundrum, then they should focus on the people who actually set the original fire – international and central bankers.

To my former political ideologues, I do not expect most of you to shift to a Liberty Movement perspective. I know all too well that you already think you have the whole of the world figured out and the rest of us are simply to ignorant to grasp your liberal insights. But I do ask that you remember what you read here today. File it away under “Tea Party Propaganda” if you want, but never forget. Your ambitions for a big government you can control will end in disaster. Your willingness to scapegoat Constitutionalists will backfire. The system you deify will turn on you. And, the fake power you think you have gained in the past five years will disappear just as quickly as it materialized.

If you want to avoid being caught in the tides of history with your proverbial pants down, or being used by elitists like pawns in a brutal game of global chess, consider quitting the system entirely and adopting a more independent position. That is what I did, and I can't imagine ever going back. Often it is the philosophies most despised by the mainstream that end up being the most right. The boogeymen of the present sometimes become the heroes of the future.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/OnQqW6Ud3io/story01.htm Tyler Durden

BNP Warns "You Can Never Leave" From The Fed's "Hotel California"

Via BNP's Paul Mortimer-Lee,

In the 1977 Eagles song, Hotel California, a luxury hotel appears inviting and offers a tired traveller comforting relief from his journey. It turns out to be something of a nightmare, however, and he finds that "you can check out anytime you like, but you can never leave".

Does that sound a little bit like QE and the Fed? The FOMC signalled its intention to check out of QE at its June meeting, but by September, it found it could not leave. The backup in yields that the announcement had sparked, together with worries about fiscal fisticuffs in Washington, was damaging an already not-very-vigorous recovery and hurting confidence. So, the Fed took a rain check. Is that not just like QE1 and QE2, the scheduled ends of which had to be reversed within relatively short periods?

The question now is whether or not we should expect repeated market obstacles to a QE3 exit.

Chart 1 shows that at the end of previous QE periods, stock-market volatility has, after a short time, risen considerably. This is part of the rationale behind the “open-ended QE” introduced in 2012. Instead of being date-dependent, Fed balance-sheet expansion became state-dependent: QE will be scaled down only when the economy is robust enough and the recovery sufficiently well entrenched that QE can be phased out without a derailment.

The effects of this most recent episode of QE compared with others have been different for the bond market and for equities. What we saw with QE1 and QE2 was that the start of QE was marked by a bond-market sell-off. This time, it was the flagging of the end of QE that prompted higher bond yields. In contrast, the end of QE1 and QE2 was marked by lower bond yields. When QE1 and QE2 ended, we saw a rise in VIX volatility. This time, it did not happen. The question is, how to explain these differences?

Let’s take the last one first. Previous episodes of QE saw higher equity-market volatility after a time. It may be that the VIX was affected by other events (such as the euro crisis) in the earlier episodes, or that the change in flows takes a while to feed through to the equity market. In May/June, QE3 did not end. There were extraneous events – the fiscal shenanigans in Washington, for example – but the market shrugged them off. Our assessment is that QE does matter to the equity market, but it takes time to work through. What appears to matter to equities is the actual size of the Fed balance sheet, as is clearly shown in Chart 2.

 

 

What about bonds? Why did the end of QE1 and QE2 result in lower bond yields, when bond yields rose this year on the suggestion of QE3 ‘tapering’? The answer is that bonds are a far simpler asset than equities and their pricing depends much more on expectations of future rates. Chart 3 shows 10-year bond yields and Fed funds futures 24-pos. It is clear that bond sell-offs and expectations of higher Fed funds go together (the simple correlation is about 70%). Also, in state-dependent QE, a decision to taper is a signal by the Fed that everything is okay – so prompting the markets to price in a return to normalcy quickly.

 

Exactly how bond yields and future Fed funds expectations move will depend on the circumstances surrounding changes in market expectations as to Fed policy, in its various dimensions. QE1 and QE2 were responses to concerns about deflation, as shown in Chart 4, while 10-year breakevens were at local lows before the announcement of each programme. QE was seen as potentially inflationary to a greater degree than it is now. QE was, therefore, associated with a rise in breakevens that was pronounced. Higher future inflation raised market estimates of future Fed funds and bonds sold off. When QE1 and QE2 ended, breakevens fell back. To a considerable extent, the first two episodes of QE were perceived by the market as a substitute for Fed funds action.

 

This has not been the case with QE3. Breakevens had been on an upward drift during Operation Twist. Q3 was not motivated by fears of deflation, as QE1 and QE2 had been, but by hopes of achieving “escape velocity” for the economy. Furthermore, previous experience had calmed market fears – and the fears of some on the FOMC – that QE would be inflationary. Signals that ‘tapering’ would come were associated with the market moving forward its estimates of the timing and extent of Fed funds hikes. Why the difference?

The answer is that the first two episodes of QE were date dependent and QE3 is state dependent. Tightening policy – what the end of QE1 and QE2 represented – was not seen as economically justified by the market, so bond yields fell when they finished. QE3’s state dependence makes it logical for the market to conclude that an economic state that would persuade the Fed to taper would also be likely to prompt it to hike earlier than previously thought. To the market, Fed funds and QE are now complements, not substitutes.

The other important factor that explains the sell-off in bonds over the late spring and summer is the increase in term premium sparked by the talk of ending QE3 (Chart 5).

So, now that we understand the past, we can ask whether we are ready to check out of hotel QE or not. We can break this down into a number of parts:

  • What will be the effect of tapering on Fed funds expectations in future?
  • What will be the effect on the term premium?
  • What will be the effect on equities once the Fed’s cash flows change?

The minutes of the Fed’s September meeting make it clear that the committee was disturbed by how much the market was pricing in higher Fed funds. It discussed various ways of delinking the decision to taper from the decision to move the Fed funds rate, including clarifying its guidance to state that the committee would not raise its Fed funds target if inflation were seen running below a given level, or providing more information about its intentions after the 6½% threshold for unemployment was crossed.

Other options could include, we would suggest, reverting the Fed funds to date dependency (unlikely, considering the relatively recent switch from date to state dependency) and giving a clearer forecast path for the Fed funds rate (à la Riksbank). It would be useful, we think, if the Fed were to give some metric to guide the market about how the economy’s evolution would affect the pace of tapering and its duration. We know what the threshold is for rates, 6½%, but what is it for tapering? 200k payrolls? If tapering starts and then payrolls fall back to, say, 140-150K, will tapering cease or slow down?

Some action to try to separate Fed funds and tapering expectations (if not these specific measures) seems likely, though the timing is uncertain. Will it succeed? The efficacy seems doubtful. Expected Fed funds will increase when the Fed announces tapering, because the market will conclude it has changed its assessment of the robustness of the recovery. The only question is, how much? There is some evidence from the eurozone that is pertinent here.

Remember the rate hike in July 2011? The ECB at that stage was appealing to the “separation principle”. It contended that it could use interest rates to control the economy and inflation risks, while less conventional policies could be used to control the crisis. It quickly learned that the separation principle was one thing and separation practice was something entirely different. The market saw them as two aspects of the same thing. It will probably be like that for the Fed also, no matter how fervently the FOMC wants to separate Fed funds action from QE tapering.

The term premium seems less likely to spike when actual ‘tapering’ is announced than in May/June, simply because it has not gone back to previous levels, though it has declined a bit. Another way of looking at this is that the Treasury 5y5y sold off very aggressively during the ‘taper tantrum’ and has only rallied part of the way back. Based on where future nominal GDP growth and the Fed funds rate are likely to settle, this does not seem as overly optimistic as it did early in the year.

Closely tied in to the discussion of how far the term premium can rise is whether QE’s effect is due to the stock of QE outstanding or the flow?

The Fed has historically been in the stock camp, as this ties in with the portfolio-balance model it has used to calibrate QE. Markets generally put more emphasis on the flow, as prices are determined at the margin. Even if the stock matters, we can rationalise an apparent important flow impact by saying that a change in the flow alters the long-run expected stock of assets the central bank will hold.

One other reason that central banks may be inclined to believe that it is the stock that matters is the Hotel California syndrome. If it’s the flow that matters, stopping purchases may be tough, especially when the flow is large. Like a smoker needs another cigarette to feel normal, the economy may need continued purchases to feel ‘normal’. If, in contrast, it’s the stock that matters, then stopping purchases leaves a very large stock of easing still out there and the impact on markets of tapering should be much smaller.

What does the evidence suggest? May/June indicates that there is a significant flow effect. Certainly, the sell-off in bonds and the associated rise in mortgage rates were much larger than the Fed expected and they had a notable impact, on mortgage applications, for example. However, we could rationalise some of the effect on the back of the Fed statement pointing to a big change in the future terminal stock of purchases in circumstances where the market did not view data as sufficiently strong to trigger tapering.

Perhaps more instructive is the end of previous date-dependent periods of Fed QE. The end date was known in advance, so the expected shift in stock should have been small. If this was a pure stock effect, there should have been no impact on markets. As we saw in the charts above, this was not the case. This is very decent evidence of a flow effect.

In terms of QE’s impact on markets, a variety of studies (by the Bank for International Settlements and the Bank of England, among others) put the impact on bond yields of QE at 100bp or more (the BIS calculated that in the absence of altered Treasury issuance, US yields could have been 180bp higher than they were and that the net Fed/Treasury effect was of the order of 120bp). However, these tend not to isolate the term-premium effect from the Fed funds expectations effect. Nonetheless, it is interesting to note that the impact of ‘tapering’ talk was broadly of the same order of magnitude.

With markets having rallied since the FOMC baulked at ‘tapering’ in September, we should still expect some impact from the announcement of future QE ‘tapering’ on the term premium and some further effect as ‘tapering’ proceeds. How much will depend on the economy, as the Fed has said it is data dependent. Overall, we should not expect the same degree of sell-off in bonds as with the false start to ‘tapering’ this year. But it seems likely that we will breach the 3% barrier (the previous high) within a few months of the announcement of the start of ‘tapering’.

When it comes to equities, announcement effects seem less important than for bonds, and flows seem to matter more. Moreover, with state-dependent QE, the signals are more mixed than for bonds. Equities will have to cope with higher bond yields, but these will only come if the Fed thinks the economy is sufficiently robust to withstand them. Moreover, if QE adversely affects the term premium on bonds, investors may choose to switch from bonds to equities. It is possible to argue for a more favourable reaction of equities after the end of state-dependent QE than date-dependent QE.

We should, on the basis of past evidence, expect stocks to suffer with a lag and maybe to see a fuller reaction once QE stops altogether. At that stage, and depending on the impact on the economy, we could see the adverse impact on bonds diminish or reverse.

Our overall assessment is that when the Fed decides to ‘taper’, there will be an adverse effect on markets. Bonds will suffer from a higher term premium and an upward revision of expectations about future levels of Fed funds. Equities are likely to suffer, too. How big the selloffs will be will depend on the circumstances – how robust the recovery looks, to what extent inflation remains quiescent and to what extent the current period of maintained QE leads to excess valuations in markets. Those markets that sold off most during the ‘taper tantrum’ tended to be those markets that had rallied most in previous months.

Clearly, this is one of the disadvantages of QE – one of its purposes is to distort markets. When QE ends, those distortions begin to unwind. Because of the disequilibria in financial markets under QE, relative valuations, as well as valuations of the risk-free asset, are distorted. Markets may go through considerable gyrations as they try to find the “right” constellation of equilibrium prices. It is possible that sufficiently vigorous reactions could adversely affect the economy. Chart 6 suggests that when bond yields rise by more than 25% of their previous level, it tends to represent a challenge to economic growth.

It may be difficult to foresee all the effects of ending QE. After all, except with relatively brief breaks, the Fed has been using its balance sheet to stimulate the economy since 2009. Markets and the economy have gotten used to it. Will there be unexpected effects when QE ends? Seems like a good bet. What they will be is more difficult to say.

What does all this mean for Fed ‘tapering’? On the one hand, it can be argued that the ‘taper tantrum’ in the earlier part of the year should make the Fed more cautious about beginning to wind down QE now. The counter-argument is that as the level of yields has moved up a good deal, the benefits of QE are now less than before, so that hurdle has been lowered because the benefits of continuing QE have diminished. Both are probably too tactical in outlook.

The Fed will make the choice on strategic grounds, namely, whether the rec
overy is sufficiently robust to warrant a slower pace of purchases.
The prospect of fiscal disagreements early next year and uncertainties about the data and distortions to them currently make it difficult to be sure when tapering will start. Our best estimate is March, with roughly a one-third probability that it will come later.

Once tapering does start, the indications are that the Fed would like to complete it within a year. However, if it is data dependent, this is far from certain. In the event of adverse reactions from markets that impact the real economy, the Fed may have to slow its exit, or even pause it. We do not buy into the full Hotel California story, but we can see that leaving, as with QE1 and QE2, might be a bit more difficult than the Fed expects. Why? Because flows matter.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/FSPicrXBYEw/story01.htm Tyler Durden

BNP Warns “You Can Never Leave” From The Fed’s “Hotel California”

Via BNP's Paul Mortimer-Lee,

In the 1977 Eagles song, Hotel California, a luxury hotel appears inviting and offers a tired traveller comforting relief from his journey. It turns out to be something of a nightmare, however, and he finds that "you can check out anytime you like, but you can never leave".

Does that sound a little bit like QE and the Fed? The FOMC signalled its intention to check out of QE at its June meeting, but by September, it found it could not leave. The backup in yields that the announcement had sparked, together with worries about fiscal fisticuffs in Washington, was damaging an already not-very-vigorous recovery and hurting confidence. So, the Fed took a rain check. Is that not just like QE1 and QE2, the scheduled ends of which had to be reversed within relatively short periods?

The question now is whether or not we should expect repeated market obstacles to a QE3 exit.

Chart 1 shows that at the end of previous QE periods, stock-market volatility has, after a short time, risen considerably. This is part of the rationale behind the “open-ended QE” introduced in 2012. Instead of being date-dependent, Fed balance-sheet expansion became state-dependent: QE will be scaled down only when the economy is robust enough and the recovery sufficiently well entrenched that QE can be phased out without a derailment.

The effects of this most recent episode of QE compared with others have been different for the bond market and for equities. What we saw with QE1 and QE2 was that the start of QE was marked by a bond-market sell-off. This time, it was the flagging of the end of QE that prompted higher bond yields. In contrast, the end of QE1 and QE2 was marked by lower bond yields. When QE1 and QE2 ended, we saw a rise in VIX volatility. This time, it did not happen. The question is, how to explain these differences?

Let’s take the last one first. Previous episodes of QE saw higher equity-market volatility after a time. It may be that the VIX was affected by other events (such as the euro crisis) in the earlier episodes, or that the change in flows takes a while to feed through to the equity market. In May/June, QE3 did not end. There were extraneous events – the fiscal shenanigans in Washington, for example – but the market shrugged them off. Our assessment is that QE does matter to the equity market, but it takes time to work through. What appears to matter to equities is the actual size of the Fed balance sheet, as is clearly shown in Chart 2.

 

 

What about bonds? Why did the end of QE1 and QE2 result in lower bond yields, when bond yields rose this year on the suggestion of QE3 ‘tapering’? The answer is that bonds are a far simpler asset than equities and their pricing depends much more on expectations of future rates. Chart 3 shows 10-year bond yields and Fed funds futures 24-pos. It is clear that bond sell-offs and expectations of higher Fed funds go together (the simple correlation is about 70%). Also, in state-dependent QE, a decision to taper is a signal by the Fed that everything is okay – so prompting the markets to price in a return to normalcy quickly.

 

Exactly how bond yields and future Fed funds expectations move will depend on the circumstances surrounding changes in market expectations as to Fed policy, in its various dimensions. QE1 and QE2 were responses to concerns about deflation, as shown in Chart 4, while 10-year breakevens were at local lows before the announcement of each programme. QE was seen as potentially inflationary to a greater degree than it is now. QE was, therefore, associated with a rise in breakevens that was pronounced. Higher future inflation raised market estimates of future Fed funds and bonds sold off. When QE1 and QE2 ended, breakevens fell back. To a considerable extent, the first two episodes of QE were perceived by the market as a substitute for Fed funds action.

 

This has not been the case with QE3. Breakevens had been on an upward drift during Operation Twist. Q3 was not motivated by fears of deflation, as QE1 and QE2 had been, but by hopes of achieving “escape velocity” for the economy. Furthermore, previous experience had calmed market fears – and the fears of some on the FOMC – that QE would be inflationary. Signals that ‘tapering’ would come were associated with the market moving forward its estimates of the timing and extent of Fed funds hikes. Why the difference?

The answer is that the first two episodes of QE were date dependent and QE3 is state dependent. Tightening policy – what the end of QE1 and QE2 represented – was not seen as economically justified by the market, so bond yields fell when they finished. QE3’s state dependence makes it logical for the market to conclude that an economic state that would persuade the Fed to taper would also be likely to prompt it to hike earlier than previously thought. To the market, Fed funds and QE are now complements, not substitutes.

The other important factor that explains the sell-off in bonds over the late spring and summer is the increase in term premium sparked by the talk of ending QE3 (Chart 5).

So, now that we understand the past, we can ask whether we are ready to check out of hotel QE or not. We can break this down into a number of parts:

  • What will be the effect of tapering on Fed funds expectations in future?
  • What will be the effect on the term premium?
  • What will be the effect on equities once the Fed’s cash flows change?

The minutes of the Fed’s September meeting make it clear that the committee was disturbed by how much the market was pricing in higher Fed funds. It discussed various ways of delinking the decision to taper from the decision to move the Fed funds rate, including clarifying its guidance to state that the committee would not raise its Fed funds target if inflation were seen running below a given level, or providing more information about its intentions after the 6½% threshold for unemployment was crossed.

Other options could include, we would suggest, reverting the Fed funds to date dependency (unlikely, considering the relatively recent switch from date to state dependency) and giving a clearer forecast path for the Fed funds rate (à la Riksbank). It would be useful, we think, if the Fed were to give some metric to guide the market about how the economy’s evolution would affect the pace of tapering and its duration. We know what the threshold is for rates, 6½%, but what is it for tapering? 200k payrolls? If tapering starts and then payrolls fall back to, say, 140-150K, will tapering cease or slow down?

Some action to try to separate Fed funds and tapering expectations (if not these specific measures) seems likely, though the timing is uncertain. Will it succeed? The efficacy seems doubtful. Expected Fed funds will increase when the Fed announces tapering, because the market will conclude it has changed its assessment of the robustness of the recovery. The only question is, how much? There is some evidence from the eurozone that is pertinent here.

Remember the rate hike in July 2011? The ECB at that stage was appealing to the “separation principle”. It contended that it could use interest rates to control the economy and inflation risks, while less conventional policies could be used to control the crisis. It quickly learned that the separation principle was one thing and separation practice was something entirely different. The market saw them as two aspects of the same thing. It will probably be like that for the Fed also, no matter how fervently the FOMC wants to separate Fed funds action from QE tapering.

The term premium seems less likely to spike when actual ‘tapering’ is announced than in May/June, simply because it has not gone back to previous levels, though it has declined a bit. Another way of looking at this is that the Treasury 5y5y sold off very aggressively during the ‘taper tantrum’ and has only rallied part of the way back. Based on where future nominal GDP growth and the Fed funds rate are likely to settle, this does not seem as overly optimistic as it did early in the year.

Closely tied in to the discussion of how far the term premium can rise is whether QE’s effect is due to the stock of QE outstanding or the flow?

The Fed has historically been in the stock camp, as this ties in with the portfolio-balance model it has used to calibrate QE. Markets generally put more emphasis on the flow, as prices are determined at the margin. Even if the stock matters, we can rationalise an apparent important flow impact by saying that a change in the flow alters the long-run expected stock of assets the central bank will hold.

One other reason that central banks may be inclined to believe that it is the stock that matters is the Hotel California syndrome. If it’s the flow that matters, stopping purchases may be tough, especially when the flow is large. Like a smoker needs another cigarette to feel normal, the economy may need continued purchases to feel ‘normal’. If, in contrast, it’s the stock that matters, then stopping purchases leaves a very large stock of easing still out there and the impact on markets of tapering should be much smaller.

What does the evidence suggest? May/June indicates that there is a significant flow effect. Certainly, the sell-off in bonds and the associated rise in mortgage rates were much larger than the Fed expected and they had a notable impact, on mortgage applications, for example. However, we could rationalise some of the effect on the back of the Fed statement pointing to a big change in the future terminal stock of purchases in circumstances where the market did not view data as sufficiently strong to trigger tapering.

Perhaps more instructive is the end of previous date-dependent periods of Fed QE. The end date was known in advance, so the expected shift in stock should have been small. If this was a pure stock effect, there should have been no impact on markets. As we saw in the charts above, this was not the case. This is very decent evidence of a flow effect.

In terms of QE’s impact on markets, a variety of studies (by the Bank for International Settlements and the Bank of England, among others) put the impact on bond yields of QE at 100bp or more (the BIS calculated that in the absence of altered Treasury issuance, US yields could have been 180bp higher than they were and that the net Fed/Treasury effect was of the order of 120bp). However, these tend not to isolate the term-premium effect from the Fed funds expectations effect. Nonetheless, it is interesting to note that the impact of ‘tapering’ talk was broadly of the same order of magnitude.

With markets having rallied since the FOMC baulked at ‘tapering’ in September, we should still expect some impact from the announcement of future QE ‘tapering’ on the term premium and some further effect as ‘tapering’ proceeds. How much will depend on the economy, as the Fed has said it is data dependent. Overall, we should not expect the same degree of sell-off in bonds as with the false start to ‘tapering’ this year. But it seems likely that we will breach the 3% barrier (the previous high) within a few months of the announcement of the start of ‘tapering’.

When it comes to equities, announcement effects seem less important than for bonds, and flows seem to matter more. Moreover, with state-dependent QE, the signals are more mixed than for bonds. Equities will have to cope with higher bond yields, but these will only come if the Fed thinks the economy is sufficiently robust to withstand them. Moreover, if QE adversely affects the term premium on bonds, investors may choose to switch from bonds to equities. It is possible to argue for a more favourable reaction of equities after the end of state-dependent QE than date-dependent QE.

We should, on the basis of past evidence, expect stocks to suffer with a lag and maybe to see a fuller reaction once QE stops altogether. At that stage, and depending on the impact on the economy, we could see the adverse impact on bonds diminish or reverse.

Our overall assessment is that when the Fed decides to ‘taper’, there will be an adverse effect on markets. Bonds will suffer from a higher term premium and an upward revision of expectations about future levels of Fed funds. Equities are likely to suffer, too. How big the selloffs will be will depend on the circumstances – how robust the recovery looks, to what extent inflation remains quiescent and to what extent the current period of maintained QE leads to excess valuations in markets. Those markets that sold off most during the ‘taper tantrum’ tended to be those markets that had rallied most in previous months.

Clearly, this is one of the disadvantages of QE – one of its purposes is to distort markets. When QE ends, those distortions begin to unwind. Because of the disequilibria in financial markets under QE, relative valuations, as well as valuations of the risk-free asset, are distorted. Markets may go through considerable gyrations as they try to find the “right” constellation of equilibrium prices. It is possible that sufficiently vigorous reactions could adversely affect the economy. Chart 6 suggests that when bond yields rise by more than 25% of their previous level, it tends to represent a challenge to economic growth.

It may be difficult to foresee all the effects of ending QE. After all, except with relatively brief breaks, the Fed has been using its balance sheet to stimulate the economy since 2009. Markets and the economy have gotten used to it. Will there be unexpected effects when QE ends? Seems like a good bet. What they will be is more difficult to say.

What does all this mean for Fed ‘tapering’? On the one hand, it can be argued that the ‘taper tantrum’ in the earlier part of the year should make the Fed more cautious about beginning to wind down QE now. The counter-argument is that as the level of yields has moved up a good deal, the benefits of QE are now less than before, so that hurdle has been lowered because the benefits of continuing QE have diminished. Both are probably too tactical in outlook.

The Fed will make the choice on strategic grounds, namely, whether the recovery is sufficiently robust to warrant a slower pace of purchases. The prospect of fiscal disagreements early next year and uncertainties about the data and distortions to them currently make it difficult to be sure when tapering will start. Our best estimate is March, with roughly a one-third probability that it will come later.

Once tapering does start, the indications are that the Fed would like to complete it within a year. However, if it is data dependent, this is far from certain. In the event of adverse reactions from markets that impact the real economy, the Fed may have to slow its exit, or even pause it. We do not buy into the full Hotel California story, but we can see that leaving, as with QE1 and QE2, might be a bit more difficult than the Fed expects. Why? Because flows matter.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/FSPicrXBYEw/story01.htm Tyler Durden