Ben Bernanke has not retreated from monetary tightening. The Fed is still on track to start tapering bond purchases as soon as September. There has been no volte-face.
The plunge in the US dollar since Ben Bernanke made his confused comments last night – and the $40 surge in the price of gold – is likely to be reversed in short order.
He did of course say that “highly accommodative monetary policy for the foreseeable future is what’s needed in the US economy”, and he is certainly right about that.
The broad measure of US unemployment jumped in June from 13.8% to 14.3%. Stephen Lewis from Monuments says this is biggest increase since 2009. The number working part-time – by compulsion, not choice – rose by 322,000 in a single month.
I might add that Taper Terror has already done this to 30-year mortgage rates (courtesy of Paul Krugman):
Which in turn has led to this slump in Wall Street’s home builders index, a leading gauge of the housing market.
The world economy remains flat on its back, which is why the IMF has just cut its forecast yet again and slashed its growth figure for Brazil, South Africa, and India, among others.
BNP Paribas said this morning that the trade data from Asia has been nothing short of disastrous. I notice that Morgan Stanley now thinks China’s growth rate may have a “5 handle” on it by next year. If so, the world is going to have very different feel.
What we have is serious debacle unfolding in the world yet again.
The Fed has delivered a global credit shock with its taper talk, pushing up yields by 70 basis points at a time when deflation is gathering force. (Data from Sweden today shows that it is now in outright deflation, along with Switzerland, Spain, Greece, and Cyprus. While China has been in producer price deflation for 18 consecutive months).
The net effect is that global real rates have been rocketing. That is hardly auspicious for equities. It is deadly for gold.
I certainly agree that if Bernanke were to back away from QE tapering, it would be highly significant. And he has good reason to so after the global bloodbath already caused by taper terror. But he did not do so yesterday.
He persisted with the line that tapering is not monetary tightening. He is trying to have his cake and eat it. He wants the extricate the Fed from QE without admitting to the markets what his real game is.
He claims that interest rate policy and QE are different animals. He wants us to believe that money remains ultra-loose because rate are near zero.
Well excuse me, Chairman, but central banks conduct QE as a substitute for rate cuts once rates have hit the “zero bound”, as he explained so eloquently in his November 2001 deflation speech. Ergo, the reverse holds true. To taper is to tighten, ceteris paribus. To reverse QE by selling bonds is to tighten further, even if rates are still zero.
As Milton Friedman explained long ago, it is perfectly possible for zero rates to be extremely tight, and that is exactly where we are today.
(As it happens, I agree that QE bond purchases outside the banking system – working through classical quantity of money effect – can work in an entirely different way from rate cuts. But this is not the argument that Bernanke has ever made. He is a “creditist” who views QE as a way of forcing down the long end of the credit curve.)
So what we have is a situation where the markets are taking his easy money talk at face value, but ignoring the hard money fist behind it.
Spooked by asset bubbles, the Fed is still hell-bent on winding down QE as soon as possible, and will try to do so unless the data is so awful that it is forced to backtrack.
Whatever happens, the great dollar rally seems likely to resume. Stephen Jen from SLJ Macro Partners says the ECB has been a “free-rider” on Fed stimulus until now. Finally it will have to do have to do some heavy lifting itself. The more the US tightens, the more Europe will have to loosen. And the more Europe loosens, the more the Fed will tighten, so the process will feed on itself.
That is an entirely new world, a world in which the US dollar is almighty once again (with nasty effects on China and many of the other 45 states linked to the dollar by pegs or dirty floats) and in which the euro comes all the way down parity (which is exactly what Europe needs, and should be welcomed). If the German bloc at the ECB tries to resist this, they will take EMU straight into a Japanese deflation trap. Indeed, they may have done so already.
So where does that leave with gold? You can certainly make bullish technical arguments. It has bounced off its support line around $1,200, the level where a lot of mines start losing real money. Near record short positions on Comex have created the springs for a vicious short squeeze, and therefore a powerful rally. But you have to be a brave man or woman to hold gold into a Fed tightening cycle and a dollar rally.
My guess is that the Fed will indeed to have to retreat from QE in the end, just as it had to back away from premature tightening after QE1 and QE2, but we are not there yet, and they will take longer to blink this time.
First we have to go through a nasty squall. The Fed is in fixed-bayonet mood. It will pull back only once it becomes clear that tapering risks pushing the world from a contained depression into a full depression.
It would not surprise me if the Fed has to double-down on QE before this is all over. It may even have to go full throttle like the Bank of Japan. Then gold will shine again. But that is a story for another day.