Welcome 2018: The End of Free Money
" We’re enjoying solid economic growth with low inflation, and the risks in the global economy look more balanced than they have in many years."
"And I think when we look at other indicators of financial stability risks, there’s nothing flashing red there or possibly even orange. We have a much more resilient, stronger banking system, and we’re not seeing some worrisome buildup in leverage or credit growth at successive levels."
So there you have it, there are no warning signs of any risk in the eyes of the Fed. What could be better news to those pouring money into the markets.
Of course those with means have been enjoying the fruits of a massive inflation party for years. Not the type of inflation the Fed would have us follow. Not the inflation measured by the current CPI formula, which misses the mark of inflation across many segments of the economy. When the Federal Reserve decided to run head long into its money printing euphoria during its previous financial debt crisis with multiple rounds of Quantitative Easing (QE), asset valuations sky rocketed on the the back of central bank inflationary policy.
When central banks, like the Fed, print more money and dump it into the economy it doesn't end there. The money multiplies through the fractional reserve lending system and leveraged positions of large financial institutions. All that money finds a place to occupy within the economy and that is inflation. Currently the banking reserve ratio is 10%. Which means when the Fed dumped an 3.4 Trillion additional dollars of Quantitative Easing into the economy the actual amount of money injected into the broader economy ended up being much higher. The current multiplier would indicate that a maximum amount of money added to the economy could be north of $30 TRILLION. Throw in the additional leverage by many of the largest private equity funds who are levered up to 20:1 and higher, it is very hard to imagine how anyone could ignore this form of inflation. Of course if it is not reflected in consumer prices it doesn't count, or so the Fed would have us believe. Who could possible suggest there is inflation, unless it has resided in another form of inflation.
The Fed's policy has created a massive new debt bubble in place of the old debt bubble. Only today's debt bubble is many times larger than the one that nearly took down the American economy in 2008/09. When an economy is highly leveraged, such as the one we had through 2005 to 2007, and the one we have today, the stability of system is put at great risk. As more and more money searches for a return, the conventional ROI is pushed lower and the desire for alternative investments increases. The problem is often these alternative investments become malinvestments. For example: Sub-prime auto loans are well beyond a trillion dollars of mostly bad debt, by people who were suckered into a bad loan (sound familiar??). These loans don't sit on bank balance sheets. Nope, they are packaged together and sold in the bond market. These are among many risks facing today's debt fueled economy, but rest easy because the Fed sees no risks in any of this. (phew!!) Just remembering them saying the same thing in 2007 about the mortgage bubble makes me feel so much better.
The massive monetary manipulation, also known as debt monetization (See: QE) was designed to paper over the failed monetary policy of the past that lead to the financial crisis of a decade ago and to absorb the trillions of dollars of malinvestment as a result of loose monetary policy which resulted in a market collapse. The money printing (QE) that they created out of thin air was directed towards the financial markets. They were buying up toxic assets left, right and center that were weighing down the economy and crippling the largest investment banks in the country.
Socialialized Wall Street:
The Fed bought up all the toxic debt along with massive amounts of government treasuries as a means of manipulating the markets and the pricing of risk, thereby removing the risk premium. Today there is a complete disconnect between market risk and economic pricing. That is not to suggest that the risk has disappeared from the market. There is tons of real risk. It is just not priced into the market. We know this because if the Fed's QE was removed and not allowed to manipulate the market pricing, risk premiums would be significantly higher than they are today. That risk would be reflected in market pricing, through higher interest rates and higher implied volatility. It is amazing what a few trillion dollars can do. There is no true price discovery in today's markets, just a boat load of easy money keeping everything inflated.
Newly printed money was pumped into the bond markets as the Fed proceeded to buy up trillions of dollars of toxic waste. This allowed those who were desperate to unloaded their unwanted toxic positions (See: Wall Street banks) to find the only willing buyer (See: The Fed), which allowed them to climb out of a very deep hole of malinvestments. Who needs risk management when you have the Fed. As central banks pumped more and more money into the markets they bid the bond markets up to all time highs, leaving investment capital to search for better Return on Investments elsewhere, which pushed equity markets to up to all time highs as well. As Wall Street has become socialized on government money the stock market capitalization of the US has reached 149% of GDP, surpassing the previous debt bubble. This in itself is a massive red flag. Anything above 115% is considered significantly overvalued.
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| Stock Market Capitalization to GDP for the United States |
The P/E ratios of the market darlings known as the FANG stocks have valuations scream dot com.
Facebook (FB): 35
Amazon (AMZN: 330
Netflix (NFLX): 220
Google (GOOG): 38
Today the levels of leveraged investments in the market are at an all time high. In addition derivative positions utilizing trillions of notional values have added to the uncertainty of an economy if there is a sudden unexpected market shift. The desire to hedge is often overwhelmed by the "need" to maximize profits during a surging market. Ramping up risk in a "risk-less" environment seems like the logical move.
This tinder box is packed full as we celebrate a free money environment like the world has never seen. Stocks and bonds which typically move inversely have climbed together for years as a result of the Fed's QE policy. High end real estate is booming, paintings and high end collectibles are at all time highs. Crypto-currencies are surging higher at break neck speeds. Bit Coin alone climbed from $997 to $13,860 in 2017 or 1290%. The free money party evidence is everywhere you look, well except where the Federal Reserve looks. It is to the point where by adding "blockchain" to a company's name can send a stock price soaring. 1999 anyone?? Its wonderful and the Fed is in its usual position deeply asleep at the wheel.
(insert your own snoring sound here)
Its not like the Fed is good at recognizing market risk and has never stayed awake long enough to do much about their Frankenstein debt disasters in the past. And after its far too late and they eventually realize the whole economy is off the rails and their only solution is to put their heads together and figure out how to to create an even larger debt bubble. Since the US went off the gold standard in 1971 it has been a regular race to the printing press as a means to manipulate what used to be a free market based on true price discovery.
As we enter a new year the levels of risk have only increased since the beginning of 2017. Personal, corporate and government debt levels have continued to reach the stratosphere. Equity markets continue to rip higher, fueled by artificially low interest rates, stock buybacks and massive levels of free money inflating equity bubbles to ridiculous levels. Of course when interest rates are below inflation, money is essentially free, since the principle of any loan loses value due to inflation faster than the interest rate charged on the principle amount. With money being essentially free, or very close to being free the environment for bubble economics has remained alive and well the past decade.
The Fed have said in the past that they have been waiting for the CPI measurement of inflation to reach a sustained 2% level before allowing interest rates to increase and they have been saying this for years now. Unfortunately the Keynesian policies of the Fed have failed to drive CPI inflation higher, but the Fed has decided that they are tired of waiting and has chosen to begin to raise rates anyways, even while CPI remains below target. Even though October CPI inflation rates reached an anemic 1.4%, the Fed continues to push interest rates slowly higher. The bond markets are teetering at extreme levels, even while the Federal Reserve have openly stated their intentions to continue to raise interest rates in the years ahead. In addition the Federal Reserve continues to make statements that they intend on unwinding their massive balance sheet and to slowly take away the heavily spiked free money punch bowl.
This will be an incredible magic trick, as you can not unwind a ponzy scheme the size of which the Fed has created, without severe pain coursing throughout the economy. Of course they have been saying this unwind was to begin months ago, but the balance sheet has not really moved, so only time will tell when the Fed will follow through. Perhaps they are measuring the market response to their intentions, before popping the only thing keeping this bubble economy going.
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| Photo by AgnosticPreachersKid CC BY-SA 3.0 |
2018 promises to be a very interesting year as the Federal Reserve tries to reconcile their own economic fantasies against economic reality. They can suggest there is little inflation, little risk and that all is well, but of course if all had been well and good as they state they would have moved away from the emergency measures they set forth as a result of their last financial collapse and let the economy stand on its own two feet. My best advise for the coming year is keep at pot of coffee at the ready because there might be some very late nights in the year ahead.
