Surprise! The Federal Reserve did something pretty much no one thought they would do: they announced dramatic additions to monetary accommodation less than two months before the elections. The a-political Federal Reserve stepped onto shaky political ground. They can claim not, but their announcement clearly favors the incumbent. But, our central bank wasn’t alone.
In the Far East, Japan’s central bank announced an increase and extension of its asset purchase program to 80 trillion yen.
In Frankfurt, Germany and the headquarters of the European Central Bank, Mario Draghi opened September by announcing “unlimited purchases” of Euro member-states’ debts. Essentially, his aim is to choke the life out of anyone betting on the demise of the Euro-zone. It’s not so much a plan as it is a blank check from the deepest well on the continent. Bears will continue to argue it doesn’t matter what Draghi says if the well water is poisoned anyway. But that would commit the sin of betting against the Central Bank.
Stateside, Ben Bernanke is following up on last week’s quantitative easing redux by sitting down for a private gathering of the members of the Senate Finance Committee with the aim of scaring legislators into action ahead of the impending fiscal cliff. We really hope his powers of persuasion prevail.
Last week we wrote about some of our past investment sins. High among those sins was fighting the Fed. If you haven’t been convinced previously, hang onto your hats because we’ve never seen anything like the current commitment: near-zero interest rates through mid 2015 and monthly bond purchases at a current rate of $60 billion for the foreseeable future. Holy cow! So more and more government money will be flowing and borrowing costs (if you can qualify) are very low. The obvious question is how long can the government print money until it turns to inflation?
Carmen Reinhart and Ken Rogoff are two famous PhD economists who wrote a famous study called This Time It’s Different. We have referenced this study often over the past few years. The study focuses on the ratio of debt to GDP and the hindrance it can cause beyond a certain point. Further, the study talks about a “Bang Moment” (thanks to John Mauldin) when all notions that perpetually low interest rates come to an explosive end. We have seen the “Bang” in Greece, Ireland, Italy, and Spain. We can’t imagine if there will come a time when investors begin to look upon US sovereign debt with suspicion, but it won’t be a happy day.
Amidst a fragile economic recovery with serious structural concerns domestically and abroad, it is tough to feel sanguinely secure. But if we go back to our tried and true rules, we know that it is folly to fight the Fed, and we have to stay invested. That said, our investment decisions are conservative, cautious and opportunistic. The current environment is without precedent, but with inflation as a significant abiding threat, there are few sensible alternatives.