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Economics

No tapering, no surprise

It was not too surprising that there is going to be no tapering for some very good reasons. The commencement of tapering would have led deliberately to bond yields rising, triggered by an increase in sales of government bonds to the public and at the same time escalating sales by foreign governments as they attempt to retain control over their own currencies and interest rates. This was the important lesson from floating the rumour of tapering in recent months.

The reason tapering was not going to happen is summarised as follows:

1.       Monetarists and therefore central bankers believe that rising bond yields and interest rates will strangle economic recovery. They want to see more robust evidence of recovery before permitting that to happen.

2.       Rising bond yields would have required the Fed to raise interest rates sooner rather than later to stem the flight of bank deposits from the Fed’s own balance sheet held as excess reserves, which only earn 0.25%.

3.       Importantly, the global banking system has too much of its collective balance sheet invested in fixed-interest bonds, and is also exposed to rising interest rates through interest rate swap derivatives. Tapering would almost certainly have precipitated a second bank crisis starting at the system’s weakest point.

4.       The cost of funding the US Government’s deficit would have risen, difficult when the debt ceiling has to be renegotiated yet again.

5.       Rising US interest rates will most probably destabilise emerging market currencies, risking a new Asian crisis.

6.       It is a bad time to shift the burden of government funding back into the markets, because foreign holders have shown they will sell into rising yields.

The Fed has reaffirmed that zero interest rates will be with us for some time to come. It simply has no choice: it has to play down the risk of inflation. The result will be more price inflation, which is bad for the dollar and good for gold.  This was reflected in the US Treasury yield curve, where prices of long maturities fell yesterday relative to the short end.

The markets had wrongly talked themselves into believing that tapering was going to happen, when the rumour was no more than an experiment. In the process precious metals were sold, driven by increasingly bearish technical talk every time a support level was breached. It is hardly surprising therefore that the recovery in gold and silver prices last night was dramatic, with gold moving up $70 and silver by $2 from intra-day lows. It looks like a significant second bottom is now in place above the June lows and the bear position, coupled with the shortage of physical metal will drive prices in the coming weeks.

The implications of the Fed not going ahead with tapering are bad for the dollar and won’t stop bond yields at the long end from rising. It shows that the whole US economy is in a massive debt trap that cannot be addressed for powerful reasons. The reality is the expansion of cash and deposits in the US banking system is tending towards hyperinflation and is proving impossible to stop. That is the message from this week’s FOMC meeting, and I expect it to gradually dawn on investors world-wide in the coming weeks.

3 comments to No tapering, no surprise

  • Paul Marks

    I believe that it was too late for “tapering” – that such an effort to turn away from the madness would have failed.

    However, we will never know now – as the Federal Reserve (like the Bank of England and ….) has decided to not even make an effort to turn away from insanity.

    The financial system is now doomed. There is not even going to be an attempt made to save it.

    We move from the economic question of “will the system collapse” to the question of “WHEN will it collapse”.

    A question best left to bookmakers.

    However, wise bookmakers will only take bets made in gold.

    • George Thompson

      Mr. Marks, after witnessing what I think could properly be called ‘money laundering’ today (9/19/2012 USA) when the very forces which drove the DJIA into record smashing territory yesterday, appear to have sold those overpriced paper certificates for cold hard cash, I would think your bookmakers will only prove wise if they take these bets in gold (or silver) but pay the winners with fiat currency – full faith and credit, good for all debts public and private, and all that.

      After all, how much does one have to sell a $15,000 position for to make a profit, if one’s cost was a mere campaign contribution?

  • Paul Marks

    Yes Mr Thompson – I stand corrected.

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