The Magic of Quantitative Easing

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Published on Monday, 16 July 2012 14:49

Written by Bill Bonner, Founder and President, Agora Inc.

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The Dow rose 203 points on Friday. Gold was up $26/oz.

What do these markets see? A real recovery? Or more QE?

Most likely, they are hoping for more of the same thing that has been driving markets for the last 40 years: more cash and credit from the feds.

Here's Bloomberg, on the case:

Federal Reserve Bank of Atlanta President Dennis Lockhart said the central bank may need to begin a new program of asset purchases if recent economic weakness continues and undermines his forecast for a pickup in the second half of the year.

"If the economy continues on the track indicated by the most recent incoming data and information, that forecast will become untenable, as will the policy premises underlying it." Lockhart said today in Jackson, Mississippi. "My support for the current stance of policy rests on a forecast that sees a step-up of output and employment growth by year-end and into 2013."

U.S. stocks rallied, erasing a weekly loss for the Standard & Poor's 500 Index, as JPMorgan Chase & Co. jumped after reporting earnings. The S&P 500 gained 1.7% to 1,356.78 at 4 p.m. New York time and advanced 0.2% for the week.

Treasury 30-year bond yields rose from almost record lows amid speculation central banks around the world will take more action to stimulate the economy. The 30-year bond yield rose one basis point, or 0.01 percentage point, to 2.57% at 5 p.m. in New York, according to Bloomberg Bond Trader prices. It fell to an all-time low of 2.5089 percent on June 1.

The Atlanta Fed president said asset purchases and expansion of the balance sheet are not a "miracle cure" yet are still effective. "I think we should have modest expectations about what further action can accomplish," Lockhart said.

"Some further use of the balance sheet to promote continued recovery and/or financial stability brings with it manageable risks," he said. "Reversal of the cumulative balance sheet scale and maturity structure can be accomplished in an orderly manner. But the step of additional balance sheet expansion should be undertaken very judiciously. Such a step would take us further into uncharted territory."

The papers this morning announced that China's growth is slowing. The most recent figure is 7.6% annual rate -- the lowest level in over three years... and the sixth consecutive quarter of economic contraction.

How much information content there is in this GDP number is unclear. Other measures of Chinese growth -- electricity use and rail freight -- show a much faster decline. What the correct reading is, no one knows. But it is clear China's red-hot economy is cooling off. And that means less demand for commodities... and fewer dollars to recycle into U.S. Treasuries.

Taken in conjunction with recession in Europe... and fears of a renewed recession in the U.S. (we may already be there, folks)... it appears the entire world economy may be headed toward a synchronized slowdown. And what that will probably mean is a plethora of new initiatives on the part of central bankers to goose up GDP rates.

Which is what the bulls are hoping for....

Trouble is, of course, cash, credit and QE soon run onto the soft mud of declining marginal utility, just like everything else. When you do it the first time you get a nice boost. Each boost after that is less dramatic.

A report a few days ago told us that the "BRICs Priced for Economic Meltdown."

The biggest emerging markets are contributing more than ever to the global economy as their proportion of the world stock market shrinks, leaving investors with the widest valuation gap in seven years.

Brazil, Russia, India and China, known as the BRICs, will comprise 20% of the world economy this year after growing more than four-fold in the past decade, International Monetary Fund data show. At the same time, their combined stock-market value has dropped to a three-year low of 16% of the total invested in equities, according to data compiled by Bloomberg.

Maybe BRICs are a buy at this level. And maybe they will be an even bigger buy when a meltdown actually happens. Eventually, the magic of QE will backfire and markets will crash...

Stay tuned...