Today we say goodbye to QE2- a failed program that brought few desirable results. Unemployment is down marginally, but home prices double dipped and commodity prices surged, contributing to the inflation we see today. The dollar and bonds are down, which indicates that quantitative easing has adverse consequences for a country riddled with debt. Remember, there was a debt crisis in Europe led by Greece, so the dollar should have rallied pretty substantially.
Besides bonds, the dollar, and real estate, one other thing took a hit: public confidence. As you will start to see in the years ahead, confidence is critical to both the value of the dollar and bonds. Continued weakness in Europe can easily lead to a run on money market funds, since many of these funds are invested in European debt. This would all be part of a contagion effect due to the collapse of confidence. If people don’t want to hold their money in money market accounts or banks, then watch out: inflation is going to rise substantially.
Rarely do you hear about a collapse in confidence leading to higher inflation. All you hear about is inflation caused by either economic growth, an increase in the money supply, or rising commodity prices. Never does it cross people’s minds that money is a medium of exchange, and that people can place votes for currencies in a floating exchange rate system. The U.S. has an advantage because it is the monopoly supplier of dollars. which happens to be the world’s reserve currency. But the U.S. can’t stop people from buying tangibles in the event that people lose confidence. Yes the government can confiscate gold, but then people would just buy fine art, antiques, or other tangibles. Let’s not fool ourselves into thinking the U.S. government has unlimited power to control the economy.
For awhile, talks of a currency or bond collapse seemed far-fetched. The permabulls still had some sway with people when they said the global economy would recover. Now, even the permabulls are starting to worry. I”ve explained before how it is the marginal buyer that largely determines prices. It is when the truly risk-averse people who never take their money out of their savings accounts start buying stocks that a top is imminent. It was when there were lines around the block in gold shops in 1980 that the bubble finally popped. In the same way, it is when even permabulls start losing confidence that a true crisis in confidence is coming.
What I like to call the smart money has been waiting for these trends to unfold for a long time. There are some groups of people, including the modern monetary theorists, who are just wrong about the future. For those not acquainted with MMT, it is a theory that is pretty solid except for the fact that it implies deficit spending is not a problem. The theory goes that since we are the monopoly supplier of dollars, we technically can not default on our debt and we are not beholden to foreigners. Excuse me? So the $200 billion in interest payments we send abroad must be part of my imagination. And the dollars foreigners accumulate to buy commodities surely don’t increase prices, thereby constraining out ability to create money. Quick history lesson, but the Romans were also monopoly suppliers of currency, and their currency collapsed quickly. They clipped coins, we print money- at the end of the day, it’s the same thing.
A lot of people are blind contrarians who think it is some ironclad law that fading the majority always works. So you have these deflationists who base much of their theory on being a contrarian while ignoring common sense. Pretty foolish. I’ve said before that sometimes the majority is dead right, sometimes they are dead wrong. If the majority of Americans are expecting inflation, guess what? All things being equal, it becomes a self-fulfilling prophecy because inflation expectations will drive consumer behavior. So predicting deflation because most people think inflation is coming is not exactly intelligent. In the same way, I know a lot of people think our debt load is unsustainable and that bond prices are going to crater. Well that’s because our debt load is unsustainable and bond prices do historically crater with the debt ratios we have today.
All in all, I believe it is time to be bearish on the economy, but bullish on most asset classes. We should see an impressive rally in stocks, commodities, and gold as the economy enters the abyss. All the theories that told you assets could not rise in an economic downturn? Throw them out the door, as I’ve been telling you from the start.
