Back in January, I predicted that a ‘taper’ – or a reduction in money printing by the Fed – would be one of the four lies you’d be told in 2013. I said not to believe central bankers who said they’d stop printing. And that’s exactly what’s happened. Having talked about ‘tapering’ quantitative easing (QE) in recent months, the Fed announced this week that it planned to keep going full steam ahead.
Because the story is so important for your long-term wealth, I find myself coming back to it time and time again. In fact, central bank manipulation of the markets is the story of the decade.
And there’s a dirty, little secret at the heart of the QE programme. The powers that be would really rather you didn’t know about it. Today I’ll explain what it is, and why it made me so confident we wouldn’t see a tapering announcement this week…
The Fed is stuck in a loop
The mainstream media lapped up the story that the Fed would slow down its bond purchases. But had these guys read the Fed statements with an open mind, they’d have seen that shutting down the bond-buying programme was always going to depend on economic indicators improving and then staying improved.
As it turns out, the economic figures haven’t been convincing enough. And here’s the choker: the very reason the global economy isn’t convincingly in recovery is because of the taper talk.
How about that! The very act of ‘guiding’ markets with the idea that the economy may be strong enough to consider easing off bond purchases has screwed the economy over, thereby making sure there’s no taper. In fact, the board voted nine to one in favour of no taper. How could the media have got this so wrong?
But there’s another twist to the story – and it’s what really convinced me that tapering wouldn’t happen.
The dirty secret
In Wednesday’s address, Ben Bernanke hinted that there’s trouble brewing in the US government’s finances. He’s talking about one of the other big stories to reappear this year. I’m sure you’ve heard all about it before – the debt ceiling. Unlike in the UK, where the government can borrow as much as it likes, in the US there’s an absolute limit on what the government can spend. That limit – the debt ceiling – has to be raised by Congress if the US government wants to keep borrowing and spending.
Now, historically, the guys on Capitol Hill have always agreed to just keep increasing what is effectively the government’s credit card limit. But in the post-financial crisis world, the borrowing figures have just gone bananas. Now, thanks to the debt ceiling, Obama is finding it extremely difficult to ram through his budget programme.
Like most politicians, Obama would rather borrow than tax. But the opposition are adamant: either rein in spending or start raising taxes. But the thing is, there’s a third option: a way of reducing government spending, without cutting public services, and at the same time increasing the government’s income stream.
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The Fed’s money-spinner
QE is so simple, so effective and so wildly misunderstood.
The planners buy government bonds. And some curious minds know why: it’s to drive up the value of the bonds, which in turn keeps interest rates on them down. Thus the government can relax, because the interest it pays on its credit card stays low.
But those with even more enquiring minds will understand the more insidious trick at work here – what I call their ‘dirty little secret’.
You see, the Fed doesn’t just buy Treasury debt. About half of the Fed’s $85bn monthly spend goes on mortgage-backed securities. Of course, these things yield interest – interest which is collected by the Fed and then passed on to the government.
Think about that. They print money for free, use it to buy mortgage-backed securities and then skim the interest. This means that the central planners can raise money without having to tax people – and instead of borrowing money, they print it and make it work for them. It’s the perfect wheeze.
And it’s simply too good to taper away. In fact, I suggest that far from tapering, over the medium term we’ll see more of it.
Where to now?
Now, though I’ve always maintained that we’re on the ‘QE to infinity’ path, I have to admit, I’m still expecting some ‘phoney tapering’. That is, at some point we may see the planners cut back a little on their bond purchases to win a little credibility.
I mean, without credibility, the Fed could soon be presiding over a Zimbawean currency.
But there’s no doubt in my mind that the Fed has painted itself into a corner. Just look at what the faintest talk of cutting back bond purchases did. Yields on US government debt nearly doubled and the emerging markets were put on panic alert as their currencies tumbled.
And therein lies another killer unintended consequence for the Fed.
In order to keep their currencies from imploding, many in emerging markets have been selling US Treasuries and using the proceeds to prop up their deflated currencies. Clearly that means less demand for US Treasuries. So if the Fed stops buying these bonds too, then who exactly will buy the stuff?
As news of the Fed’s decision not to taper hit the markets, just about everything rallied. Including commodities like crude oil. To my mind, we’ll continue to see more of the same over the coming months. And after a while, these price increases will feed into the real economy, which means inflation.
It’s already started to show up in the gold miners. They’re highly sensitive to changes in the gold price, so I’m sure they were popping champagne when they heard Bernanke’s latest announcement.
The GDX gold miner index shot up on the news. And Simon Popple’s portfolio of gold miners is looking very interesting all of a sudden.
At the end of the day, you can’t just magic money out of thin air so as to avoid taxation. The truth will out in the end – and it comes out by way of inflation. All of this gives rise to the new lie: that inflation will stay low. The Fed confidently predicts 1.2% to 1.3% this year, and remaining below 2% next year.
Now, I know that the planners have a knack of fudging the figures, but if commodity prices continue to rise, and the dollar continues to fall, they’re going to find it awfully difficult to disguise what’s going on.
To my mind, inflation hedges are going to have a fine time of it for the foreseeable future. I’ll bring you some ideas on how to play it over the coming weeks and months.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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