Thursday, February 3, 2011

The Future Of QE

One thing that is certain is some day QE will end.  Either because the economy is truly self-sustaining or because someone forces the Fed's hand, possibly even the Fed.   Too many people use the blanket excuse "the Fed will just print money."  The reality is, 90% of those who say that don't even understand what it means.

It is truly amazing how the Fed has conditioned all of us.  If you are bullish, you are leveraged and unhedged.  You believe in the power of the Bernanke put. If you are bearish you have been beaten up pretty badly and are now simply managing risk and limiting any exposure to the short side.

Something will occur that is unforeseen that will stop QE and in a timeline different than what the majority think.  I say that for the simple reason that the majority is always wrong.  There will be some event that no one factored in.  With QE the Fed expected a weak dollar and lower yields.  Lower yields is what they sold as the benefit of QE but the opposite has happened.  The Fed did get their weak USD but its impact has reached far beyond exports.

US manufacturing data has been solid the past few months as was the trade portion of the Q4 GDP report.  Beyond the headlines though something that has stood out are rising prices.  The Fed knows of these price increases and their negative impact on the consumer.  They can't come out and say that though.  They are in the business of conditioning us to believe all is well.  I think the Fed made a huge miscalculation with their QE policy.

They underestimated the impact that QE would have on input costs.  Costs are rising so fast right now that margins are being squeezed.  For manufacturers of discretionary items, passing along these prices are next to impossible so costs will have to be reduced including lower payrolls (notice today's reported productivity gains at the expense of labor). Non-discretionary items will see prices passed along to the extent it is possible. Name brands though are losing market share to the generic brand sitting on the same shelf, so pricing power is limited.  Games will be played by selling smaller size products for the same price to hide inflation, but it's there and the consumer will be taxed.

The piece the Fed truly underestimated and what I suspect is the event that possibly forces the Fed's hand are global food riots.  What started as peaceful demonstrations have truly grown both in size and method.  Just two nights ago I watched protestors in Egypt picking up the trash to maintain the integrity of their community.  Tonight, the media is banned and molotov cocktails, rocks and gun fire litter the street.  Yemen saw 20,000 protestors come out tonight, Saudi Arabia had a small protest, Algeria, Tunisia had a successful protest, the list goes on.  Watch for this movement to grow faster than anyone ever expected.  I don't know of anyone who had this on their 2011 prediction list.

When QE2 was announced in August of 2010, it was a monetary policy to "inflate" the economy.  One of its many unintended consequences is the foreign policy nightmare is has created.  Global security is now at risk.  As the 2008 financial crisis taught us, many bad decisions are made during a crisis.  Watch for things to unfold and the poor decision making to continue.


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