Bernanke Fumbles, the Market Tumbles, The Daily Reckoning Grumbles

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Ever played Chairman Mao? It’s a card game that goes a little something like this:

You are the Chairman. You make up a couple of rules and don’t tell anyone. For example, when an ace is played, the next person has to stand up and turn around once. You then tell your fellow players these three pieces of information:

  1. I am the Chairman
  2. Only I know all the rules
  3. I will tell you these two rules (but there are more):
    1. No talking
    2. No talking about the rules

Then, you deal each player, including yourself, seven cards and turn over the first card from the deck. The game begins. The aim is to get rid of all your cards (but don’t tell anyone that either).

Inevitably, the person to your left won’t do anything because they don’t know what’s going on. After a few seconds, say ‘too long’ and hand them a card off the deck. The next player to the left might figure out it’s their turn and play a card.

It’s only correct if it’s the same number or a number either side. So a seven must be followed by a six, seven or eight. You can ignore suits if you want — you are the chairman after all.

At some point, you will encounter one of your secret rules you haven’t told anyone about. When a player fails to stand up and turn around upon playing an ace, give them a card and say ‘incorrect’.

Of course, people will be complaining and yelling the whole time, so don’t forget to enforce the no talking and no talking about the rules. Players who talk about the rules have to pick up two cards because they breached both.

If you’re confused, the point of this game is deductive reasoning. Players have to figure out the rules based on what happens as you go along. Over time, people slowly figure out more and more of your rules. That makes it a great party game after a certain amount of drinks. We’ll try it this weekend when we head to the Grampians with ten people and three dogs.

Anyway, the point of the story is that a chairman rules the stock markets right now. Chairman Bernanke is his name (and money printing is his game). Since 2008, we’ve all been playing by a new set of rules he made up.

Let’s go back to the card game to understand what’s going on. The most important person to watch in the Chairman Mao game is the chairman. You can usually get an edge by watching their facial expressions. More importantly, the chairman has to follow his own rules.

In his speech on May 22nd, Chairman Bernanke did the equivalent of playing an ace, standing up and turning around. He gave you a massive hint at one of his rules. But what does that hint mean?

Well, Bernanke said that his next move as Federal Reserve Chairman was dependent on the economy. If it improves, he will reduce his QE. If it worsens, there’s more to come.

Remembering how central bankers move stock markets around the world, that has big implications. If the economy does recover, we could see falling stock prices. If it gets worse, stocks could keep going up.

That’s pretty much what’s been going on these last few weeks. At first, there was good economic news. Durable goods orders, consumer confidence and home starts were positive in the US. The market tanked. Then US GDP for the first quarter was revised down dramatically. The market soared.

The problem with this situation is that money printing increases asset prices, but it doesn’t solve underlying problems in the economy. It makes them worse. If Chairman Bernanke decided to control the price and quantity of oranges, there would be shortages or surpluses of oranges around the world.

It would mess around farmers and orange eaters. But Bernanke doesn’t control oranges, he controls money and debt. So any part of the economy reliant on money and debt is being messed around.

Houses are a perfect example. People borrow to buy houses, so they are particularly sensitive to Bernanke’s control of debt. Leading up to 2006, the Chairman held the price of debt too low.

People borrowed and bought houses like mad, increasing house prices and debt levels. Then interest rates spiked and house prices and purchases crashed, triggering a financial crisis. Then rates were pushed to zero and a new housing boom began.

As an aside, rates are spiking again. Zillow fixed mortgage rates went from 3.88% last week to 4.38% two days ago. That’s a huge jump, and so people have stopped borrowing as much to buy houses. The famous housing bear Peter Schiff is already predicting another house price crash. He’s not getting laughed at this time around. Back to that in a moment.

But the point is that the Chairman is in charge. You won’t get anywhere without focusing on him. If you want to win at Chairman Mao and investing, you need to know the chairman. For example, when your editor is the chairman, he’s likely to make his rules similar to the Uno card game rules, because that’s what’s familiar and easy to remember.

Federal Reserve Chairman Ben Bernanke was known as ‘Helicopter Ben’ for his fear of deflation. If the worst came to worst in the economy, he would shovel money out of a helicopter.

But Helicopter Ben was recently given the political equivalent of an F off by his Commander in Chief: ‘He’s already stayed a lot longer than he wanted or he was supposed to,’ Obama told Bloomberg.

This job ad quickly hit the net:

On a more serious note, given it was Bernanke’s efforts which saved the world’s banks in 2008 and elevated stocks since, you might be worried about his replacement. Will he be as much of a high flyer?

The answer is yes and no. The leading candidate is a she and she is even more of a money shovelling helicopter flyer. Janet Yellen is the current Vice-Chair. Bob Janjuah, from Japanese investment bank Nomura, told CNBC all you need to know about her:

A client said to me a few weeks ago that if Karl Marx was in charge of the world, he’d have Janet Yellen as his central bank governor.

Karl Marx is a Chairman Mao kind of chairman. He wouldn’t just control the price of oranges. He would control who gets how many and who gets shot in the head.

Yellen is famous for linking the economy with money printing. Bernanke linked money printing to asset prices and asset prices to the economy via something called the wealth effect. If you make people feel richer by pushing up stocks, they buy more, increasing GDP.

Yellen reckons you can take out the middle man. She wants to tie money printing to GDP instead of asset prices. In other words, she’ll print money until the economy does what she wants (grow), regardless of the effect on asset prices.

Here’s an example of her policy prescription:

 ‘At present, I view the balance of risks still calling for highly accommodative monetary policy to support a stronger recovery and more rapid growth in employment.’

Want to take a guess at when she said this? In 2008, perhaps, when the markets and economy were plunging? Or 2009, when it was time to engineer a recover? No, she said it a few months ago in March 2013, while the economy was growing.

But what if money printing doesn’t improve the economy at all? What if she keeps printing more and more until asset prices go bananas?

We don’t know what will happen, but we’re likely to find out… 

Then again, the alternative scenario to soaring asset prices and a moribund economy is pretty similar to what happens to a Chairman Mao game if you start it too late into the party. The drunk players get rowdy and the chairman loses control, shortly followed by a revolution, the end of the game and no winners.

This is the situation alluded to above when we discussed rising mortgage rates. The US 10 year Treasury interest rate was up 60% since the beginning of May at one point. That’s crucial because mortgage rates are tied to this rate, which explains why they’ve been rising. Corporate bonds are rising too.

Chris Mayer from one of our sister publications in the US pointed out that ‘The market magnifies the effect on lower-quality credits. So Tenet Healthcare, which is trying to pull off a $1.7 billion deal, saw its bond rate go from 5.9% on June 1 to 7.7% on June 25. Not too many firms can absorb a 30% increase in interest on new debts without it affecting corporate planning. Suddenly, the bar gets higher for new investments, new acquisitions, etc. Everybody’s pretty little models have to be reset.’

This is how QE could backfire, triggering a crash  in the economy and the stock market. So keep your eye on the interest rates.

Until next week,

Nickolai Hubble+
The Daily Reckoning Weekend Edition

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Ben Bernanke is losing control. He desperately wants inflation. He’s getting deflation instead. He wants low interest rates; yet rates are rising. Bernanke is now getting the worst kind of deflation — sluggish price increases against a backdrop of rising interest rates… This is the exact opposite of what the Federal Reserve wants.

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Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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4 Comments on "Bernanke Fumbles, the Market Tumbles, The Daily Reckoning Grumbles"

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watcher7
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* Martin Armstrong, Rising Interest Rates – Bullish for the Market, armstrongeconomics.com, June 23, 2013:

“Rising rates will be bullish unto 2015.”

This is what history suggests:

The Greatest Bubble – And the Next Great Depression:

http://www.members.optusnet.com.au/futurewatch/id120.htm

BP
Guest

watcher7 on October 9, 2008 8:26 PM: “Bubble history suggests that Australian house prices will drop by at least 60%. Bubbles give up their gains, and then some, in the bust. Since house prices have increased 150% since the mid 1990s this implies a fall of at least 60%. But this bust comes at the end of a “supercycle” which suggest that falls will be greater than 60%.”

truth and integrity
Guest
Interestingly a 150% increase since 1995 is only a 5.2% compound growth for housing. That is less than the growth of money being closer to 8% to 10% which at 9% is 370% increase. The critical parameter is whether the wage structure can maintain the interest rate cost to service the goods. This remains the $1.5 quadrillion DEBT. If there is no productivity there is no employment and this is what will reduce the value of housing. It is a corrupt mechanism through obfuscated and false GDP figures where true productivity is most likely close to -5% negative! The question… Read more »
BP
Guest

Moral indignation will no doubt elevate PMs to their right place as the jewels-in-the-crown of asset classes, T & I. We’ve been reading these ethical imperatives here for almost seven years. What’s needed is austerity (read unemployment), destruction of banks (read national penury), and a new sales pitch now that PMs, small caps and uranium have plummeted. Wait-a-bit… a boom in housing is on-the-way. Let’s sell that. These Aussies will buy anything. Now about this Sydney bridge over here…

wpDiscuz
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