Thursday, November 4, 2010

Quantitative Easing Explained

Before we begin the conversation on the ultimate effects of Quantitative Easing, it is important to understand what exactly it means and how it takes place. 

When the United States government needs money they borrow it from the marketplace.  They do this by issuing I.O.U.'s called treasury bonds.  These bonds are given out at an auction where investors show up with some cash to bid on treasury bonds. 

The government takes the cash, and the investor goes home with his I.O.U. piece of paper promising to pay them X amount of interest every month.  At the end of the life of the bond the investors receives back the entire amount originally lent.  Bonds can be as short as 3 months in duration up to 30 years.

One of the investors that shows up at these auctions is called a primary dealer.  This is a designated major bank such as Goldman Sacs.

Let's go through an easy example to show the entire process:

The US government is auctioning off $75 billion in debt.  Goldman Sacs shows up with $75 billion in cash and they go home with a suitcase full of I.O.U.'s that will pay them interest on their new investment.

Here is where Quantitative Easing comes in:

The Federal Reserve then prints $75 billion in fresh new dollars out of thin air.  They take a ride over to the Goldman Sacs office, hand them the suitcase full of money, and the Fed drives home with a the suitcase full of I.O.U.'s.

(This all happens electronically, but this helps to visualize the process)

Goldman Sacs is now sitting on $75 billion in fresh new bills that they need to invest.  What can they do with this money?  Anything they want.  Here are a few investment choices:

1. More treasury bonds
2. Stocks
3. Corporate bonds
4. Municipal (state) bonds
5. Foreign stocks
6. Foreign bonds
7. Real estate mortgages
8. Gold
9. Cotton
10. Bonuses

Do you see how this boosts asset prices?  Money in the global economy flows like a river downstream bouncing off of rocks.  Money never sleeps.  It constantly moves around the world to different asset classes where it feels it will be best treated.

It does not feel like money is moving rapidly today because it is hiding in the treasury bond market which is currently in a bubble.  When that bubble pops, and funds rapidly leave that market, you will see that cash move to the next location.

The problem foreign countries have with the Federal Reserve is that they know a large majority of the money from the Federal Reserve's $900 billion in "Quantitative Easing" over the next 8 months is going to wind up on foreign shores.


That is where money is currently being treated best.  Goldman Sacs is not stupid.  When they receive their $75 billion in cash they understand that by the Fed printing the money it debases the value of the underlying currency. (the dollar)  They then will move that cash into another currency and the money will then enter that money supply.

For example, if Goldman Sacs takes their $75 billion and purchases $75 billion in Australian bonds, that means the investor in Australia who was holding the suitcase full of Australian I.O.U.'s is now holding a handful of Australian cash.  What will they do with the money?

They could purchase Australian real estate.  They could purchase Australian stocks.  This new money will create an asset "bubble" in these markets.  In addition, because Goldman Sacs is selling American dollars in the transaction and purchasing Australian dollars the American dollar weakens and the Aussie dollar strengthens. 

Currencies work the same as stocks.  Prices are determined on an open market based on the number of buyers and sellers.

Are you with me so far?  Good.  Here is where it gets interesting:

Countries like Australia are dependent on their exports for economic growth.  If a country has a stronger currency relative to other nations it makes their goods more expensive to purchase and reduces the total number of exports.


Imagine a boat from America pulls up to the Australian shore with $100 in American dollars.  In order to purchase goods from the man on the dock the American has to convert his dollars into Aussie dollars.

If the Aussie dollar is worth $.90 against the American dollar, the American gets $110 worth of goods.  If the Aussie dollar has strengthened to $1.10 against the American dollar, the American only goes home with $90 worth of goods.

This is why you hear about a global currency devaluation taking place around the world.  Central banks are intervening in their currency markets as the Federal Reserve weakens the dollar.  It is a race to the bottom.

The best analogy of the currency devaluations are ships sinking together out in the ocean.  It is just a matter of who will sink the fastest.

And how do you measure the ships sinking? 

Follow the price of gold.  It continues to watch the markets and accounts for every new Quantitative Easing and every subsequent currency devaluation on foreign shores.

While this printed money floods into the global economy and sinking ships, gold is the water surface measuring the depths of the debasement.

TIME Magazine Winner: 2010

David Stockman On Bloomberg

S&P On Housing

Standard and Poor's this morning came out with their most recent report on the state of the housing market.  The two biggest details of the report:

1.  The total cost for the Government Sponsored Entities (GSE's) Fannie Mae and Freddie Mac to cleanse their balance sheet and continue to provide over 90% of the new mortgage loans in this country (as they do currently) would be $685 billion. 

2.  The total inventory on the market including the shadow property is currently at 40 months supply.  A 3-6 month supply of homes represents a normal healthy market.  This number is beyond staggering and only includes data through the first half of 2010.  The housing market entered back into collapse mode around August so I would anticipate this number to be far higher today.

Fortunately, we have a Federal Reserve chairman fully prepared to buy every mortgage, bond, or stock in our country with a printing press as was announced yesterday.  A $685 billion loss is far less troubling under that context.

QE2 Discussion With Glenn Beck

I will be presenting a full analysis on Quantitative Easing 2, but until then here is the presentation last night on the subject with Glenn Beck.  I do not watch his show but millions of Americans do; his ratings are extraordinary week after week.

It is scary to think that many Americans are hearing this truth......

Tuesday, November 2, 2010

Investor Sentiment Vs. The Real World

Retail investor sentiment for the stock market hit a 3 year high this week as over 70% of investors are bullish on the stock market over the next 6 months.  The exuberance can be seen rocketing higher in the chart below.

Executives and employees of the companies that the retail investors are purchasing stock in were not quite as exuberant.  Last week we saw a multi-month high in insider selling at $662 million.  The ratio of sellers to buyers was a massive 423 to 1.  The executives that live in the real world understand exactly what is happening, and they are jumping ship as fast as possible.

Some other people living in the real world are the Americans that are fast approaching the end of their 99 weeks of unemployment pay.  In anticipation of this event, Indiana News reported yesterday that unemployment offices will now have armed security guards on site in anticipation of violence.

America has thus far been very complacent with the economic depression due to the fact that most Americans are not currently paying their mortgage and living rent free as mortgage lenders currently take 484 days on average to begin the foreclosure process.

Many of those living rent free have been collecting unemployment checks to pay for other needed goods.  The reduced cost of living and checks coming in the mail for no work have most likely been a boost to their previous lifestyle.

However, once the 99 weeks expire and the checks stop, the violence will begin as Americans become angry and hungry.  Look for either an extension to unemployment benefits after the election, or a much larger militia currently seen at the unemployment offices of Indiana and around the country.

Home Mortgages and Ownership

LPS Applied Analytics released their mortgage data today for the month of September.

The average number of days delinquent before a home enters foreclosure is 484.  That is 484 days of rent free living.  (A recent research piece estimated this as a $2.6 billion monthly boost to consumer spending.)

The following chart shows the percentage of mortgages non-current and delinquent.  The bottom line shows the percentage of mortgages in foreclosure.  As we move forward the percentage of homes in foreclosure will rise upward to meet the top two lines.  This will be when the real flood of inventory hits the market.

The Wall Street Journal reported this morning that the number of months to clear the banks housing backlog is now at 107.  That is 9 years of housing backlog if no additional homes were to become delinquent moving forward.

We also found out today that the home ownership rate, once the  darling political statistic, has now reached 1999 levels at 66.9%.  Many forecasts showing this number reaching 60% over the next few years.  That would be a dramatic plunge downward in the chart below:

Classrooms In 2030

The election side show today, which has no real impact on the future of our country due to both parties fully focused on a path of destruction, has media outlets buzzing on what a certain party win will mean for the future.

If you'd like a real glimpse at the future, no matter which party wins today, it can be seen in the commercial below.

The real news for the week will come from the Fed announcement tomorrow, and I will discuss that in great detail when we get the final QE number around 2:30 PM.

Sunday, October 31, 2010

John Taylor On Bloomberg

This week famous currency trader John Taylor spoke with Bloomberg about his outlook on the markets.

He made waves earlier in the week when he compared Ben Bernanke to Adolf Hitler, saying he was trying to "get people's attention."

He references the famous 2002 Bernanke speech where he said he would "drop money from helicopters" if he felt it was necessary.  Taylor says the long term outlook for the dollar was sealed when that speech was delivered.

Bloomberg interview below:

Bye-Bye, Bear

Barron's this week was kind enough to say goodbye to the bear market with the following cover.  I for one, am glad the bear market is finally over.