Sorry, I’m not buying it… the taper is a con!

Man wants to control his environment. Be it for food, shelter, or security, we go to great lengths to drive out nature and take control.

So I guess it shouldn’t have come as such a surprise that in the last few years, man seems to have tamed the last wild place… the financial markets.

Let’s see how the taming of the markets helped the investment case during 2013, and how it’s set to continue in the same vein for 2014. We just found out that the taper is finally going to happen in January 2014. So perhaps now is a good time to see what it all means for your portfolio.

Driving down the animal spirits

As an academic, Ben Bernanke spent a lot of his time pondering the Great Depression. He decided that it should never have been allowed to happen. His thesis was that man could and should control the markets. And by Jove, did he get the chance to prove his theory!

Of course, we shall never know what would have happened to global markets had the Fed not printed its way out of the 2008 crisis. But what we do know is that ever since 2008, the Fed has taken an ever greater role in manipulating our finances.

The market was on edge for a lot of last year, waiting for the Fed to scale back its money printing antics. The suggestion of a taper at one point led to a crash in emerging markets. And the taper took a considerable shine off precious metals too.

Sometimes careless words from the Fed sent markets in to a spin… while at other times, words of comfort beefed them up.

In years gone by, Fed chairman Alan Greenspan was the markets’ “maestro”. He said it was his job to remove the punchbowl just as the party was getting started  – to raise interest rates when the economy was going strongly and inflation was starting to rise.

But it seems like Ben Bernanke saw the job differently. He added amphetamine to the punchbowl – quantitative easing (QE).

And news this week is that just as Ben Bernanke is set to bow out of the Fed, he has begun the amphetamine withdrawal programme. The ‘taper’ is on.

That was supposed to be particularly bad news for the markets. But instead, they spiked!

They tried to make me go to rehab and I said, no, no, no

Don’t be fooled into thinking the markets will crash because the amphetamine dose is being reduced. It’s not time for the hangover yet.

Let’s get one thing straight: the Fed has tried this twice already, and it wasn’t pleasant. After both QE1 and QE2, the Fed shied away from asset purchases. On both occasions, the economy faltered. It was therefore decided that the drugs should be delivered by intravenous drip. QE3 came by way of a constant $85bn per month.

And now that the dose has been reduced to $75bn, can we really say that it’s going to make any real difference? I suggest that it won’t matter a darn.

Anyway, and perhaps more importantly, there’s a secret dose that nobody really talks about…

The secret QE programme

Now, you know how compounding works. As a Right Sider, you’ll understand the powerful notion of how interest on interest grows exponentially.

So here’s the thing: even if the Fed was to completely stop QE, the drug dose will continue anyway. How so? Because the bonds the Fed has bought continue to generate interest. This interest is re-invested in buying more bonds. That’s in addition to the $85bn in monthly QE (or call it $75bn as of next year). Five years of bond purchases by the Fed have grown its balance sheet to over $4trn.

So a heck of a lot of interest is coming the Fed’s way. And yet it continues to mint $75bn a month to buy more bonds, which generate more interest. And all this interest goes straight back into the QE programme.

So in that sense, the QE programme will never end… not unless the Fed actually comes out and does what it said it would do in the first place. And that is, sell back all the stuff it’s already bought.

But of course, there’s no way they’ll ever do that. That would be monetary suicide. Deflation would rip the economy apart.

Whatever the press may say, QE will go on pretty much on full throttle. Together with the official dose of $75bn per month, the unofficial stimulus in the form of compound interest keeps on coming.

I suspect the Fed will keep things ticking over at the new $75bn official rate for the whole of 2014. Janet Yellen will take the top seat at the Fed and she’ll be very happy to preside over much the same policies that have been in place for the last five years… negligible interest rates and more money printing. No change… nothing to see here.

Of course, that has implications for how you should invest. So next week, I’ll bring you a bumper Christmas edition of the Right Side with an update to my asset allocation for 2014. There are a few subtle changes that I’ll be very happy to expain. And if you want more detail than that, it’s very simple – you need to read David Stevenson’s debt bubble report.

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  • finisc

    “And yet it continues to mint $75bn a month to buy more bonds, which generate more interest. And all this interest goes straight back into the QE programme.”

    No it doesn’t – it goes to the Treasury and fills part of the budget deficit.

  • Bengt Saelensminde


    As I understand it, it is but a journal entry that the money goes back to the treasury (and, as you say, reduces the deficit). But, the actual cash proceeds from the interest payments are used by the Fed to reinvest in the asset program.

    This is how I understand the program to work.

  • Tyler Durden

    Of course it’s a con. There can be no ‘taper’ because the financial system utterly depends on it now.

    Finisc: I’m afraid all you’re describing there is one big shell game of IOUs and dollars between the Fed and the Treasury. The whole thing is completely meaningless.

    What they’re doing is running the printing presses.

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