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America at Tipping Point
It’s the evil marriage of the law of diminishing returns with the tipping point.
Speaking of diminishing returns and bad hangovers, the second round of “Quantitative Easing,” the last shot whisky to an already comatose American economy, will be ending on June 30th.
What does this mean for the US stock market, the price of gold, and the economy?
Quantitative Easing: Saving financial institutions
The Quantitative Easing policy (QE1&2) involved the Federal Reserve buying huge amounts of federal debt such as mortgage backed securities, US Treasury Securities, US agencies debt and Treasury Inflation Protected Securities.
The Fed did this by creating trillions of dollars for its purchases, thereby monetizing the debt and renaming it Quantitative Easing. As a result, the Federal Reserve, not China, is now the largest holder of US debt.
Note that the feds first referred to the policy as “financial stimulus,” and “economic stimulus,” and “stimulus packages."
But were these "stimuli" really meant to help the economy? The answer is, not really.
The stimulus packages were never about injecting trillions of cheap dollars into the economy to stimulate economic activity. No, it has all been about saving banking institutions, both in the US and abroad. These big banks are necessary for providing the credit for economic activity to occur further on down the food chain.
In fact, the Federal Reserve continues to reward recipient banks of Quantitative Easing “stimulus” to maintain “excess reserves” by actually paying them high interest on their excess reserves.
So what did this accomplish? A few points in temporary GDP growth, with the second quarter 2011 GDP forecasts trending downward. US GDP has essentially stagnated.
But the stock market is up, so the economy is rebounding, right?
The Fed and the stock market
Conventional stock market wisdom has always been to never bet against the Fed. If the Fed intends to stimulate the stock market, don’t short the market because the Fed has the power to do what it wants.
It appears to be true...but for how much longer?
Consider that the balance sheet of the Fed will have grown from about $800 billion in September 2008 to an estimated $2.8 trillion by the end of June, 2011.
Some have wisely noted that the Quantitative Easing and the S&P 500 experienced an 88% positive correlation during that period, a strong indicator that QE1 & QE 2 have been directly responsible for the stock market “recovery” from the lows of late 2008 and early 2009.
But what about now? The stock market is looking quite shaky of late.
Diminishing returns and tipping points
The stock market will be headed into a correction since the economic numbers from the private sector just aren’t there to support current pricing in the market. Profits have been massively assisted by federal deficit spending, not so much from private business activity.
A third round of Quantitative Easing (QE3) is unlikely and would at best continue to crowd out private sector growth. It may, temporarily, forestall a major market correction, but it’s not a long term solution and will only make the economic hangover much more severe when it happens.
At worst, a third round of Quantitative Easing may speed up the rejection, devaluation, and ultimate destruction of the US dollar...if that’s possible.
It could send the American economy into greater depths of contraction, precipitate galloping inflation, and lead to rapid impoverishment of the middle class.
That would be the tipping point part.
Think about it; if Quantitative Easing had worked, employment would be rising; there would be expansion of private business activity, rising wages, an improvement in housing starts and the Case-Schiller index.
The truth is, none of it has occurred, and $2.8 trillion later, the private sector is not just stagnant, it’s shrinking and will continue to do so.
The Fed and Gold
Quantitative Easing has, however, caused the price of gold to rise to historic levels.
And why not?
Financial uncertainty always makes gold more valuable. And right now, there is no shortage of uncertainty.
As the economic situation deteriorates, as the dollar continues its slide into history, and as the Fed continues to throw money at a structural problem that history shows cannot be solved in such a manner, (see Japan’s lost decade of quantitative easing from 1989-2000), gold will continue to have ample reason to become more valuable.
And, just what will happen when QE2 ends?
Hopefully, congress will begin to head down the right path. This is important both in economic terms and psychologically.
But they probably won't.
So soon, the economy will fall faster...Unemployment will rise, housing prices will drop more, and food and fuel prices will rise.
Most of GDP growth will be due to primarily federal deficit spending, and private sector economic activity will continue to contract.
And those are...The Gorrie Details.