Thursday, September 13, 2012

QE 3: Gold Bugs, Stockholders Celebrate While American Workers Starve

Joe, a retired, Kingston, NY commodities trader and Brooklyn College alum, is a drinking buddy. He predicted $1750 gold on Labor Day while he, Mike and Mark Marnell, a left wing attorney, and I were imbibing a 1.75 liter bottle of four-year-old single malt scotch called McClelland's.  I picked it up at JK's Wine and Liquor in the Kingston Plaza mall. For only $43 for a jumbo bottle, McClelland's is a good buy.

On that fateful Labor Day Joe predicted $1750 gold this month.  It just about hit $1750 the other day, but today it soared to a bid of $1769 (at 2:26 P.M.).  The reason is the Fed's announcement of quantitative easing.  My brokerage accounts, because of the recent moves in the general stock market coupled with the recovery in metals prices and real estate,  are at or near all-time highs.  According to Kitco: " Spot gold was last quoted up $37.50 an ounce at $1,769.50.  December Comex silver last traded up $1.298 at $34.60 an ounce."  The stock market is also buoyant: The Dow is up 224 points, or 1.68 percent, and the S&P 500 is up 1.76% at 1461.

Quantitative easing or QE3 is one more round of money printing. Monetary expansion boosts the stock market because increasing the quantity of money reduces the price of money, the interest rate. A lower interest rate increases the discounted future value of profits. That increases the stock market because stock prices discount future earnings. It is a mechanical relationship.  As a result, the Fed has played the Nixon card with Obama: in 1972 Nixon encouraged then-Fed Chairman Arthur Burns to ease so that the stock market would go up; now, Ben Bernanke's Fed is easing and Obama will win the election. Likewise, the Europeans are accommodating Obama.  A recent German court decision held that Germany can participate in a bailout of profligate Greece and other southern rim nations. Hardworking Germans can now sacrifice their savings to fund pensions of Greek public sector retirees who have produced little and demand much.

Joe does not have much faith in the stock market.  He is right in a fundamental sense: there is no reason to have faith in the structural reality of the underlying economy. The excesses of the Clinton and Bush years are still around, and Obama has done nothing to correct them.  Americans, for an unfathomable reason, tend to reelect presidents when the stock market is high. The monetary expansion that increases the stock market harms most of them; in other words, most Americans vote for politicians who directly harm them.

The reason is that the monetary expansion that boosts the stock market devalues wages.  As the money supply has expanded since the Reagan and Clinton years, the link between real wages and productivity has been eliminated for the first 40-year period in American history.  American workers are no better off today than they were in the early 1970s, but stockholders are much better off. In other words, the income inequality that liberals grieve over is directly due to the policies of Paul Krugman, Woodrow Wilson, Franklin Roosevelt, Richard Nixon, Ronald Reagan, Bill Clinton, George Bush, and Barack Obama. Obama has done nothing to clean up this mess.  Historically, he has contributed more to it than anyone else.

The stock market may continue up through the fall and possibly into 2013.  Eventually monetary bubbles implode as bondholders realize that their bonds are going to become worthless.  As real interest rates start to rise, Fed policy becomes irrelevant.  If the Fed continues to print money thereafter, there will be a monetary collapse.  Otherwise, there will be rising interest rates and stagflation as the expansion of the monetary base is transformed into cash money.

If real interest rates start to rise, the stock market will not do well, but commodities will because of the inflation.  If the dollar remains stable, the increasing money supply will continue to boost the stock market. 

I am easing out of the stock market.  I had sold the stocks in my pension fund (I still have real estate), which were about five percent of my total stock holdings.  I have low-beta (low-risk, high dividend) stocks like Philip Morris, Kimberly Clark, and Heniz in one brokerage account, and higher risk stocks in the other. I will sell the higher-risk stocks over the coming months, except for the gold mine stocks.  I hold both the gold index and the Van Eck juniors index.  I would like to be able to pick gold mining stocks, but I lack the expertise.

The stock market is likely to continue up into the coming year; thereafter, all bets are off.  If you look at a picture of the S&P 500 since 1950 there are two massive peaks in 2000 and 2007; we are approaching the height of those two peaks now.  Because of the massive monetary stimulus, the peak could get higher in nominal terms.  As the monetary expansion translates into a depreciating dollar the reverse can and will occur.



Anonymous said...

What are money market funds? Are they backed by real money? Yet I can write checks on them? Is this not money created out of thin air? Are these funds illegitimate?

Mitchell Langbert said...

Money market funds are legitimate. They are not involved in the money creation process. The money market is the means by which firms obtain short-term funds from lenders. They are low risk because their maturities are thirty days or some other short-term period. There is a close correlation between the inflation rate and the money market rate. Nevertheless, in the past few years the money market funds have yielded less than the inflation rate: they have been a losing proposition. They are low risk, though.

I would suggest a higher risk, higher return REIT (real estate investment trust) rather than a money market fund. The REITs are yielding about six percent right now.

If there is considerable inflation the REITS will likely hold their value better than the money market funds. Deflation would be a better environment for money market funds, but with QE3 I'm having trouble envisioning deflation.

The government is making clear that it will do all it can to boost asset values; in particular, it aims to boost the stock and real estate markets. Money market funds currently yield close to zero. If you have a million dollars, a six percent yield means an income of $60,000 plus likely some capital appreciate as real estate prices recover. Money market funds will force you to eat into principle, and they are not returning as much as the inflation rate, which means that your principle is really getting smaller.

Anonymous said...

Is it 'principle' or 'principal'?

Mitchell Langbert said...

The "al" spelling applies here because I am talking about it in the sense of capital. The "le" spelling applies when you're talking about rules of conduct.


   [prin-suh-puhl] Show IPA
adjective 1. first or highest in rank, importance, value, etc.; chief; foremost.
2. of, of the nature of, or constituting principal or capital: a principal investment.

   [prin-suh-puhl] Show IPA
1. an accepted or professed rule of action or conduct: a person of good moral principles.
2. a fundamental, primary, or general law or truth from which others are derived: the principles of modern physics.
3. a fundamental doctrine or tenet; a distinctive ruling opinion: the principles of the Stoics.
4. principles, a personal or specific basis of conduct or management: to adhere to one's principles; a kindergarten run on modern principles.
5. guiding sense of the requirements and obligations of right conduct: a person of principle.