Reflections On The News

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Over the past few days, several interesting items appeared in the news and in investment-related reading that crossed my desk.

Thanks to Richard Russell, long-term publisher of Dow Theory Letters, for a quote from Ernest Hemingway: “The first panacea for a mismanaged nation is inflation of the currency.  The second is war.  Both bring a temporary prosperity.  Both bring a permanent ruin.  But both are the refuge of political and economic opportunists.”

Richard, now well into his 80’s, is an old friend from La Jolla, California.  Back in the early-1980’s he was one of the guest speakers at our annual client conference, followed over the years by such economic and market heavyweights as Marty Zweig, former Federal Reserve Governor Martha Seger and “Irrational Exuberance” author Robert Shiller.  Richard is still an eclectic reader and his experience makes his insights worthy of attention.  Very much in concert with my beliefs is the following excerpt from his February 7 commentary:

The Fed is printing like mad in an effort to keep the economy “above water.”  If so, you ask, “then why aren’t interest rates rising?”  I’ve stated that the Fed can continue to print until the bond market “says it can’t.”  Then, you ask, what’s holding the bond market up?

Here again it’s the Fed.  The Fed is buying $85 billion worth of bonds a month in its game of not allowing bonds to decline and not allowing interest rates to rise.  The whole manipulated situation has forced investors to move into the stock market.  The current low VIX demonstrates that option traders don’t perceive any danger while the Fed retains control and while the Fed continues its manipulations.

Corporate earnings remain good and dividends continue to be paid.  As I see it, there’s no timing the situation.  My belief is that we’re building a speculative and manipulated edifice like no other that I’ve ever seen.  At some point the edifice, with literally no warning, will topple over.  At that point, we may see one of the worst crashes in stock market history.  At that point, an angry crowd will turn against a chagrined Fed, and a new monetary system will have to be created.

The underlying question is whether central bankers can create wealth by essentially printing money.  Never in my 44 years of investment experience have so many central bankers pledged their troth to the common cause of cheapening their respective currencies.  Since there is no acknowledged standard of value, currencies measure their strength or weakness against one another.  It should be obvious that all currencies cannot be weakened simultaneously without substantial inflation.  Right now, the still powerful force of deleveraging at the consumer level is suppressing that tendency toward inflation.  That suppression fosters an unstable equilibrium.  When central bankers last behaved similarly – in the 1930s – currency wars and trade wars exacerbated the Great Depression.  Such experiences could be in our future.

I saw a CNBC interview yesterday with Fed Governor Charles Evans, a leading advocate of aggressive money printing.  Admitting that current Fed policy is experimental, he characterized it, not as a marathon, but rather as a half marathon.  Carrying his metaphor further, he indicated that the Fed has loaded the economy with carbohydrates and “energy bars.”

Having run a couple of dozen marathons–even one ultra-marathon–back when my knees and other body parts were far more tolerant of 50-to 100-mile training weeks, I can attest to the inadvisability of attempting even the half marathon distance without sufficient training.  Weaknesses in body parts you didn’t even know you had start screaming for attention when a runner ventures into distances not properly trained for.  Over the decades, the Fed has metaphorically run a few 5K and 10K races, and their healthy recovery record from those has been spotty at best.

The Fed’s acknowledgement that the current policy is experimental is a frank admission that they haven’t trained for this distance.  They don’t know what possible difficulties await them when they get past the 10-mile mark.  Their singular inability to promote even a historically normal economic recovery despite unprecedented stimulus is clear testimony to the difficulty of this race course.  Their biggest surprise could still lie ahead of them.

Fiendish race directors may not place a finish line at the 13.1-mile mark.  Instead, they may demand that the Fed keep running.  Having not even prepared properly for a half marathon, the Fed may be forced to proceed toward a more distant target.  The potential for serious damage to the system grows exponentially as the course lengthens.

I don’t know if Fed Governor Evans is a runner or not, but his analogy may be very apt, and even a half marathon may reveal weaknesses that the Fed doesn’t yet appreciate.

One last item from this week’s news.  CNBC this morning featured an interview with Rachel Fox, a 16-year-old actress with a part in Desperate Housewives.  She acknowledges her off-screen activities to include day-trading stocks.  While she is both intelligent and well-spoken, you can just imagine how much experience she brings to her financial endeavor.  This tale evokes recollections for anyone with a memory of the excesses at the two prior stock market peaks in this still young century.  I read (but don’t recall where) another comment about this story:  “Be afraid.  Be very afraid.”