Yeasty

There is an old Wall Street adage for investors, “Don’t fight the Fed,” meaning the Federal Reserve bank has a lot to do with the direction of the stock market. If the Fed is reducing interest rates and expanding the money supply, then the stock market should go up … and vice versa. Over the last eight months we have seen a perfect example of this working in Japan where its national bank has been engaged in this very process, it’s own version of “quantitative easing” (QE) … see: The Economist Explanation.  It is basically printing yen to a fair-thee-well while holding interest rates at zero (see: Trading Economics.) The result … the Nikkei 225, the primary stock index in Japan has been quite yeasty … going from 14,000 to 17,900 in just the past eight months, a 29% gain (almost 42% on an annualized basis) … see the chart below:

Nikkei 225

And this has occurred during a period of effectively an economic recession in Japan. Also note that the yen has weakened considerably against the U.S. dollar … going from 102 per dollar to now almost 120 per dollar. This obviously helps the Japanese exporters but does nothing for American investors in Japanese stocks as it has cut into their gains in yen after converting these yen back into dollars.

Now comes the rub. The American stock market has been on a roll ever since the U.S. Federal Reserve Bank started its own QE back in 2009 (see: NY Times Article.) This impetus has also helped the U.S. stock market considerably … boosting the American stock market’s Dow Jones Average from below 7000 to 17900 during this same six year period … also quite frothy ... see the chart below:

Dow Jones Average

The issue then becomes, will the U.S. stock market continue on its extended roll even after the Fed stopped the money supply expansion part of its QE program two months ago? The next shoe to drop will be when it increases interest rates ... maybe next summer.

Personally, I’m not one to fight the Fed …

Race to the Bottom

The world is taking a dangerous and rocky path to universal monetary collapse.  Japan is now following the United States's Federal Reserve in devaluing its currency ... in order to give its economy a shot in the arm, see: CNBC Story.  The U.S. Fed’s Chairman, Ben Bernanke, has been pushing “quantitative easing” (QE) for the last three years in order to sop up all the debt that this country is forced to issue to cover it’s fire-hose federal spending … to the point where it has expanded our money supply (and its balance sheet) by $3 trillion.  And, in order to keep this crushing debt burden from sinking things further, it has kept generic interest rates artificially low with its banking muscle.  It has been able to run the monetary printing presses night and day without setting off crushing inflation because our economy is still so weak …  reflected in our poor employment and wage-increase statistics.

But one economic “benefit” of this monetary expansion is a weak U.S. dollar which tends to help export markets and crimp importers.  Given how poor the U.S. balance of payments actually is … image what a disaster it would be without the Fed’s dollar deflationary measures?  However, our trading partners are losing patience with us and, as indicated in the referenced article, are now mimicking Bernanke’s strategy.  The European Central Bank (ECB), China, Great Britain, Japan, and even Switzerland (for heaven’s sake) are falling over one another to try to devalue their currencies with their own QEs.  A U.S. Dollar slide begets a Chinese Yuan slide which begets an Euro slide which begets a Japanese Yen slide which begets a British Pound slide which begets a Swiss Pound slide.  This is all a very dangerous race to the bottom.

How will this end?  With all this quantitative easing, the world will be, in short order, awash in money.  The balance sheets of the central banks will have reached unsustainable levels … probably the ECB first; and the only way out will be for them to let the dogs out … allow inflation to reduce the carrying-cost pain of their excessive debts.  And, this time, run-away inflation will not be as localized as it was in Germany in the 1920s.  It will be world-wide and will engender political upheavals that are likely to be quite painful.  (At this point Bernanke will not look quite so angelic.)  So be forewarned and be prepared … own real hard assets (not cash) and owe lots of money … and live in an area of relative political sanity.