Some pundits are pointing to a pickup in C&I (Commercial and Industrial) loans as a sign of the malaise ending here, but we suspect that bump is likely tied to deal making and stock buybacks. We just do not see any convincing evidence of a major pickup in bank lending when we look at the balance sheets of the big banks and now a recently released forward looking survey of credit managers has us thinking the spigots are closing. No wonder small business optimism and hiring plans rolled over.
We suspect that some business owners and consumers who may not be versed in analyzing the big picture financial data are making decisions that they might not if more informed. Like us, Japan, China, and Europe have also seen each marginal unit of debt spurring less growth. What’s more, if debt is just future spending brought forward, then real final demand in coming years is a major question mark. Importantly, much of the debt created has been low power because it was not used to buy productive assets that lead to future growth.
Suffice it to say that we suspect that a good portion of the business activity that has occurred since 2009 was predicated on the assumption that extremely easy Fed policy could continue with no negative effect to us from a QE counter-attack by our trading partners. They were forced into the same shenanigans by our QE zeal. The assumption has been that QE just must lead to growth! Debt growth was confused with real income growth. The notion that the music will never stop is still a common refrain, so any move to even a slightly less easy stance has and will produce an inordinately negative response.
Economists from the Austrian school of thought, who for decades have routinely received nothing but derision from the Keynesians that dominate positions of power, predicted this debt exhaustion outcome decades ago. The idea of solving over indebtedness with ever more debt, of course, has mostly been celebrated as brilliance by governments and central banks because it is what they like to do to stay in power and Keynes is still their hero. Oh, for just one Austrian economist at the Fed…or, even better, just one of us from the “unwashed masses” that helps meet payroll at a real company somewhere other than a Wall Street bank! We know, that’s pure and utter heresy.
It now appears that with such a high percentage of the newly issued government debt being monetized through QE in places like Japan and now the EU, it is getting tougher for the central banks to find additional sources of debt to monetize. We still think the national central banks in Europe will struggle to buy enough sovereign bonds to meet targets because many sellers have so few choices for reinvestment and new capital requirements make alternatives much more costly to hold. These factors are enormously important in a world addicted to money printing and it may mean that we have reached an upper bound to these foolish policies.
Although we have learned that one can never be cynical enough in analyzing the realm of the deciders, we think the deflationary signal being sent by precious metals and other commodities may well be a sign that the central bankers are running out of room to manipulate markets and the news cycle at least for now. However, because it is foolish for us to underestimate their “creativity,” we do own precious metals positions as insurance against more of the only trick the central bankers know and that is printing or otherwise debasing fiat currencies by holding short rates below the level of inflation.
We suspect the Fed must be concerned over the fact that it dominates stock market activity to a degree that would have seemed laughable not that long ago. We do wonder how long confidence can be maintained when it takes “sweet nothings” from the Fed to prevent panic every time the S&P 500 sells off even 1-2%. After all, stocks cannot continue to go one way while the economy and earnings go another.
We think investors are about as exposed to equities as they ever have been just as more doubts begin to surface about what QE has really accomplished. The Fed is in the astounding and untenable position of needing to tighten to restore some semblance of discipline to euphoric markets just as the economy hits the softest patch in years. Investors have been taught to fear nothing and leave risk management to the central banks. The gap between the real economy and equities has never been wider in our view.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.