Time for the ‘crash alert’ flag

On Wednesday, the Bank of Ben Bernanke said it would continue to taper. Instead of counterfeiting $75bn every month, it will print only $65bn. At this rate, it will be out of the counterfeiting business completely by the end of summer.

On Thursday, America’s Commerce Department said the US economy was growing at a 3.2% annual rate, which is satisfactory. Until you look at it more closely.

On Thursday, too, stocks went up – 109 points on the Dow.

The Fed has little choice. It has to pretend to go straight at least for a month or two more. Otherwise, it won’t have a shred of credibility left. And so far, so good. It looks like stocks will close the month of January down only 3%. Not catastrophic.

For what it is worth, our ‘crash alert’ flag, the ol’ black and blue, flies over our worldwide headquarters. We say “for what it is worth”, because it hasn’t been worth very much. Not the last three years. We brought it out on several occasions. The wind whipped it. The sun bleached it out. The rain soaked it. The markets didn’t crash. Finally, we brought it in because we felt sorry for it.

But it’s back on the job today, even though we expect the crash will come later. Still, anything could happen. And it will.

Our guess is that the Fed will continue attending its ‘Counterfeiters Anonymous’ meetings – until the market really cracks. Then, it will roll up its sleeves and get out the paper and ink. Ms Yellen will not want to preside over a crashing market any more than Mr Bernanke did.

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Yes, the Fed has broken the US economy and its markets. Now, it owns them. It can no longer permit the stock market (and bond market, for that matter) to do what comes naturally to them – correct their mistakes.

And that means, the mistakes will get worse.

“Oh, you are so negative”, writes a helpful dear reader. “The economy has some traction already. Can’t it withstand a gradual withdrawal of QE?”

No, is our answer. A bogus ‘wealth effect’ is what keeps the economy’s head above water now. A real ‘poverty effect’ would sink it. Just take a look at the chart below. It explains why consumer prices are still so sluggish, even with the Fed at work. Money, like grease, gels up when an economy goes cold. When it heats up, on the other hand, it flows like water.

USA - M2 money velocityc chart

As you can see, the grease is stiff. The economy is cold. And our ‘crash alert’ flag is on its pole.

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