End of Quantitative Easing?

If we take a minute and set aside weekly jobless claims, retail sales numbers, housing starts, and other economic data; probably one of the most important factors to focus on is that the Federal Reserve seems to be quietly tightening up on credit. Tom McClellan of the McClellan Market Report believes this is likely the largest single contributor to the recent market volatility.

While the Fed did leave its policy rate unchanged when it concluded its two-day meeting this past week, that hasn't stopped the central bank from quietly removing cash from the financial system.

One measure of money is the system is known as "money w/zero maturity" or MZM, is now contracting for the first time since 1995. MZM represents currency in circulation as well as deposits that could be withdrawn at anytime, such as checking accounts, savings accounts, and money market funds. After growing over the past decade and by over 4% during the first quarter of 2009, MZM started contracting in March at the rate of 2% per year.

It is possible the Fed has ended quantitative easing and is in the beginning stages of tightening monetary policy while leaving interest rates at zero. We could be entering a period where the Fed has decided that days of easy money are over. This, just as the global economy seems to be slowing down from the growth experienced in the second half of last year and first few months of 2010.
The global markets are becoming more volatile as traders react to the stealth tightening of credit by the Fed and possible impact on the the global economy. In addition, with less money to borrow at cheap rates, hedge funds have been caught flatfooted as borrowing costs may begin to increase; which would cause them to raise more cash by selling investments, since they won't be able to borrow at zero percent in the future.

Over the next few months, we will know whether this is just a blip in the monthly data or if quantitative tightening has begun.

Voluntold

If you are not familiar with the word “voluntold”; here is the definition per the Urban dictionary:

Voluntold: The exact opposite of volunteering. Always used in reference to an unpleasant task to which you have been assigned by your boss.

Example 1:

Co-worker A: I hear you got a transfer to another division.
Co-worker B: Yes. I didn't want to take the job, but I was voluntold.

Example 2:

Co-worker A: Hey, do you want to go to the baseball game on Saturday?
Co-worker B: Unfortunately, I can't. I got voluntold I have to work this weekend.


But “voluntold” doesn’t apply to just the workplace. Husbands are often voluntold to do a variety of tasks, myself included. Some of these tasks may be tolerable but most are not as none of the activities were my idea. Most of us are voluntold to do X and in the interest of marital harmony, we do them.

But watching BP CEO Tony Hayward leaving the White House yesterday, I couldn’t help but notice he looked very similar to our largest banks CEOs after their November 2008 meeting with the Bush administration when they agreed to accept TARP. Like the bank CEOs before him, Hayward had been voluntold to turn over $20 billion in assets to the US Government.

Don’t get me wrong, I believe BP, like anyone who does something wrong, should be held accountable. In addition, the more negligent or egregious the action, the more severe the punishment should be.

Still, being voluntold feels very unsettling, particularly as it seems like it's becoming more the norm than the exception.

About a week ago, Governor Mitch Daniels of Indiana marked the one-year anniversary of the bankruptcy of GM and Chrysler with an op-ed in the Wall Street Journal in which he shared that “It was June 10, 2009 when the government tossed aside the option of proven, workable bankruptcy procedures in order to nationalize Chrysler on behalf of its union allies.” In other words, the bondholders of GM and Chrysler were voluntold to accept less than historical precedent would have suggested.

But I would note the pattern. In all of the voluntold situations to date (our largest banks, GM, Chrysler, and BP) we’ve had enormous organizations with staggeringly large liabilities.

It looks to me like companies with large liabilities or those which are considered “too big to whatever” entities; public policy outcomes can trump capital markets precedent?

But if Washington believes this, I believe that investors must too. And I'd offer that the bondholders and shareholders of the world’s largest companies now face a substantial risk of being “voluntold” should something negative happen.

When it comes to big corporations, the public policy outcome now matters most and will take precedent. But we'd be wise to consider the long-term implications, particularly as the global nature of our largest corporations and financial institutions makes the public policy outcome far more complicated than I believe most people currently appreciate.

The Upside of the Financial Crisis

Below is an excerpt of an article written by Todd Harrison, founder of Minyanville and former hedge fund trader. The article is posted on the Minyanville website. We believe it decribes the process of discovery we are experiencing as a result of the financial crisis.


"The unfortunate capital market destruction is an inevitable comeuppance, the cumulative result of risk gone awry. It’s been percolating under the seemingly calm surface for several years, magnified by financial engineering and consumed by an immediate gratification society.

The socioeconomic consequences will be pervasive as we enter the other side of the business cycle, an unenviable retrenchment that politicians and policymakers have tried so hard to avoid. It’s certainly scary as new beginnings always are.

Therein lies the opportunity.

The media portrays the Great Depression as one where everyone in America stood on street corners or waited in a bread line. A closer look shows that similar to today, economic hardship for the middle class began well before 1929.

We’ve got a few lean years ahead but that’s nothing to fear. In fact, it’s a healthy and positive progression.

To get through this, we need to go through this. As painful as the process is, it takes us one step closer to an eventual recovery.

I view the Great Depression as the framework for optimism. Most of society worked, great discoveries were made and formidable franchises were established.

Indeed, if the greatest opportunities are bred from the most formidable obstacles, we’re about to enter a most auspicious era.

The 90’s were about wealth, accumulation and consumption and we’ve now entered a period that is entirely more austere, if not more sensible.

Debt reduction and the rejection of materialism will continue to manifest as we come to terms with doing more with less.

Flashy rides and big-ticket items that were once badges of honor now serve as hollow reminders of misplaced priorities.

Humility, once viewed as weakness, will be embraced.

Doing for others -- rather than asking what others can do for you -- will become more commonplace as people learn to appreciate what they have rather than constantly keeping up with the Dow Joneses.

This mess is a bitter pill to swallow, particularly for the mainstream American who doesn’t know a derivative from a dividend. We can point fingers and wallow in the “why” or take a deep breath and begin the process of recovery.

Something good comes from all things bad and the greatest wisdom is bred as a function of pain.

It’s unfortunate that the structural foundation of the global capital market system had to shake before people -- and policymakers -- paid attention but it is what it is and we’ll do what we must.

Surround yourself with people you trust. Practice risk management over reward chasing.

It won’t be an easy road but it won’t be impossible either."

Deflation versus Inflation

Back in October 2009, we talked about the possible deflation and inflation scenarios that could play out. See link below -

http://brightassetmgmt.blogspot.com/2009/10/puzzle-pieces.html

In this piece there were two scenarios that were likely -

Scenario 1: Dollar decline, lower bond prices, higher stock prices, higher commodity prices, higher gold

Scenario 2: Dollar rises (as of function of deleveraging), higher bond prices, lower stock prices, lower commodity prices (as a function of a reduction in global demand.)

While Scenario 1 dominated during the second half of 2009 and into the beginning of 2010, Scenario 2 has been playing out over the past few months as debt and financial concerns in the Eurozone are creating expectations for deflation.

Remember, deflation is the contraction (reduction) of money and credit. It occurs when an economic system is carrying too much debt to be supported by the level of income generated by economic activity - both in private and public sectors. It occurs because too much debt has been incurred to create unproductive assets that don’t generate income. Deflation is a corrective process, it’s simply the market not being able to service debt, so the debt must be forfeited.

Inflation is just the opposite involving the expansion (creating) of money and credit. Since the 1950's, central banks and accepted economic theory are all about creating debt to grow economies (artificially), so periods of inflation (creating money-debt and credit) last a very long time. Debt is accumulated slowly and incrementally during periods of economic expansion until there is just too much of it.

The current job of global central banks is to fight deflation. Hidden behind the bailouts, stimulus packages, zero interest rate policies, mortgage workouts, housing credits, and working groups are politicians attempting to engineer a business and economic recovery while fighting off the forces of deflation.

While these plans seemingly worked over the past year, none of these plans will affect the larger deflationary credit contraction. Debt deflation is occurring outside of the Fed’s control at many of the world’s money center banks. This process will probably take several years to work out but will ultimately yield positive results. The destruction of debt will allow world economies to build a solid foundation for future expansion that is entirely more secure than what we currently have in place at the present time.

There are no easy answers but there are certainly simple truths - truths that don't get politicians re-elected, however.