Dear Mr. Armstrong-
You seem to hint that Bernanke didn’t want rates to go up especially when there is a ceiling impasse. Yet, he talked about taper/untaper and torchured the market for 3 months to prepare investors for a smooth QE-reduction. Most investors I know were expecting a small taper that could have still been interpreted as dovish. By missing the opportunity to do it now, doesn’t he lose credibility plus doesn’t he create a potential waterfall later when he actually tapers. The credibility loss could be long-term as Yellen may be in hence the notion of continuity in the Fed now exists. For the Fed to risk so much they must know of some serious problem, which could be real debt ceiling crisis. On that point I also don’t believe the majority of investors expect it after the budget resolution cum tax compromise earlier in the year. If by his actions Bernanke reveals a serious problem going forward, wouldn’t that imply that for some time EM flows into the dollar may actually reverse. Then there is the Euro which rallied although doesn’t seem the shorts have capitulated yet. I, very much influenced by you, believe the Euro is a disaster but as you also wisely teach it doesn’t matter what I believe but what the market thinks. It could be temporarily preferred safe-haven for capital, yet we are just a few days away from the German election. Elsewhere you have written about the risk of a grand coalition in Germany and based on your post I feel investors underestimate the odds of such coalition actually raising a chancellor other than Merkel. If this comes to pass in the 1-2 weeks after the election, then capital will flee the Euro as well. There is potential here for a situation where neither the Euro, nor the dollar are desired very reminiscent of late summer 2011, when gold rallied hard while Euro/USD remained strangely static and range-bound (then US faced the first ceiling impasse while Italian bonds/banks were going down so the Euro bulls could no longer argue that Greece is an isolated case). 1-2 months into this of course a ceiling compromise could allow the USD to rally while gold and Euro decline. I guess we would see, but I would appreciate if you could comment on the following view/question: It feels that the last two QEs were in attempt to keep the USD as weak against the Euro as possible; not an actual peg but in support of ECB during its monetary operations designed to lend funds to distressed peripheral banks. It probably also helped US capital (dollar denominated repo loans from US money market funds to European banks) to remain in Europe, while allowing European banks to sell US mortgages/Tsys at attractive prices and repatriate the funds in Euros. The downside is that QE destablizes the Tsy market. Did the last such QE-Euro-porting attempt go too far? Are we now at a point when the only way to keep Tsy well bid is to almost encourage massive capital outflows from the Euro creating a bid for Tsys. In that context perhaps that is the last QE for a while? It doesn’t seem that flows from EM go into Tsy but rather US stocks and real estate. If capital is to concentrate into the US from the other 3 corners of the world, isn’t there capital flow at least from one of these areas that benefits Tsy. Especially if not all international investors come here for growth but for safety. After all flows into the dollar should be more bullish for Tsy than the alternative reflation scenario of domestic money selling bonds to go into tangible assets? Finally, thinking about Twister in retrospect (the last time Europe sent any capital in the US) is it possible that Fed did it as they saw flows mostly in the bills and not in longer duration, didn’t want negative short rates with a steep curve and figured if rates are going lower let it be across the entire term structure? Maybe Twister was indeed designed to mask weakness in the Tsy bonds that we would have seen otherwise?
On a final note, many thanks for you incredible writings.
ANSWER: That is a mouthful. It is standard operational procedure to float ideas and see how the market reacts. The problem is that from the outside people THINK the Fed is really in control. If that were the case, they would not need people like me. I have been dealing with central banks a long time. I understand the game and they know that. They have no real control. It is all a CONFIDENCE game. Bernanke floated the idea of stopping the tapering to see what the market would do. His tough talk has already led to a 140 basis point rise in US 10-year Treasury yields, the benchmark price money for US mortgages and for the world (ex-China). He might as well have raised rates six times. The Fed succeeded in causing mortgage costs to rise resulting in the tightening of financial conditions. The utter failure to direct banks to lend was a complete disaster. There is not much the Fed has done that will help the economy long-term at all.
The unbelievable shock decision on Wednesday night to continue tapering is a recognition that the market response was far greater than expected demonstrating what I have been warning – they boxed themselves in and introduced FAR GREATER volatility than they ever anticipated. They went running around to the banks warning to re-calibrate their models for there will be no FLIGHT TO QUALITY being treasuries. Unlike 99% of the people out there, I do not offer my OPINION, SPECULATION, or THINKING on such issues. I have been an institutional adviser not a retail sales guy selling sensationalized newsletters. I report FACTS, what is happening, and what is taking place.
I have been the keynote speaker for central banks at meeting in Paris. I have sat at head tables with the bankers. I have sat in central banks when the phones were ringing between them. For the 1989 crash, I had two central banks on two phones simultaneously with both taking jabs at the other. I am not speculating here or pontificating. I understand the game because I have been DEAD CENTER in it. They have long called me the “Man Who Knew Too Much”. Perhaps? I was requested by the Bank of China to fly to Beijing before they opened up – the first from the West to be invited. I have been there and done that. No guessing how things work or speculating.
The central banks float ideas to see how the market reacts as a matter of strategy. That does NOT mean they will do what they actually say. They say things to judge the condition of the market BECAUSE they know better than anyone else this is a CONFIDENCE game and nothing more. This is called “talking the markets” up or down. It is why I was accused of “manipulating the world economy” in court papers by the CFTC demanding lists of all my clients so they could prove that nonsense. They judged me by what they themselves do. They assumed I was “too” influential and could “talk” the entire world into doing whatever I said. Complete insanity.
True, I warned the White House in 1985 not to start G5 and manipulating the dollar for they would inject volatility and cause a crash which they did in 1987. That only caused the Japanese to take all their money home, which resulted in the Japan Bubble in 1989. Yes I became famous for forecasting that one as Barron’s reported. True, at times I have had to remind the newcomers how to act as was the case when Rubin started talking the dollar down trying the same nonsense that created the 1987 Crash.
I have been the one screaming at the Fed for QE1 and QE2. I advised people on the House Financial Services Committee what questions to even ask Bernanke. Trust me. They know our model and what we are saying. They switch and stopped buying the Treasuries because they finally saw what I was saying – the “stimulus” had no impact because the sellers were non-American taking the cash home.
The US net loss of jobs over the summer months has been entirely among men, mostly aged 25 to 54 and university educated. The cohort aged over 55 has been growing, so this is not happening because baby boomers are retiring early. I reported that the new trend is to get rid of people prior to retirement to save pension costs. The labor so-called “participation rate” dropped to 63.2% during July. This was the lowest level we have seen on this indicator since the late 1970s. The rate for educated men is now at an all-time low. The unemployment rate has been falling, but chiefly because so many people are giving up hope and dropping off the rolls. There is a rising entrepreneurship where people are starting to work for themselves to survive.
There is little doubt that some Fed governors seem to want to wash their hands of this like Pontius Pilatus calling this problem “structural” beyond their capacity to manipulate: They see evolving technology that replaces jobs, the internet that reducing book stores and is collapsing newspapers, or a “skills mismatch” where people are not qualified to cope with the rapid pace in technological advancement. Then there is the catch-all conceptional change in “demographics”. Indeed, all of this is true. This is also why unions are dead. They have promoted higher wages for the same job not advancement in skills to adapt to new technologies. These claims have been around since the early 1980’s when jobs were scarce back then and much was blamed on the take-over boom, which they also blamed me for since we pointed out that the Dow book value was a historic lows and you could buy a company, sell its assets, and more than double your money. Our forecast that the Dow would rise from 1,000 to 6,000 was shocking but when it happened, ah – there was the prove we caused it.
The economy evolves like a child. It goes through growing pains because there is a business cycle everyone tries to flat-line. Capital has no choice but to park in US dollars. China has been shifting from PUBLIC to PRIVATE. They shortened their maturities in US Treasuries and have been buying mortgage paper. True, I seem to get blamed for everything they do since they have been following our model perfectly right down to instructing the Treasury they would no longer buy through the NY bankers and would only buy Treasuries direct. What I say is from a strategic institutional perspective – not random speculation based upon a dream or vision.
There was a secret meeting of central bankers in 1925 to try to deflect capital flows back to prevent a European debt crisis. That manipulation failed and it was misinterpreted entirely among domestic economists and pundits. Unless you have swam in these waters you will not understand the behind-the-scene machinations. Today, there have been discussions behind the curtain dealing with a rising global problem, but there are no grand schemes to deflect capital flows as of yet. I have no doubt we will be hauled in during that crisis as well.
It is what it is. Major capital needs a place to park. That is the dollar. This will not change. However, what is changing is the shift from PUBLIC to PRIVATE. China is buying mortgage backs now rather than Treasuries. The US share market fell into the shallow September low and has taken off sharply running back to the highs. This is indicating PRECISELY what I have been warning about – we may yet see the Phase Transition in US assets and a bubble top in the US market for 2015.75. Gold will rally when the crisis becomes obvious. But stories of $30,000 gold are not practical and gold will never be the haven for big money – it is way too tiny of a market to be a reservoir for serious money. It is the individual’s hedge.