Thursday, September 19, 2013

FED Helicopter Drop for Joe Sixpack

Quantitative easing looks played out. The press and public (that is aware) see QE as a sop to the banks and wealthy. Obama said that we have to get away from the bubble and bust mentality. Larry Summers pulled his name out of the running for FED chairman. There is no war in Syria right now. Sequester is still in effect. The economy still slowly chugs along, hovering around the 1% growth line. How will the mandarins keep the machine moving? It appears that the US economy needs trillion dollar deficits just to squeeze out +2% growth. If there is no taper yet budget deficits are coming down slightly, how do they fill the deficit beast to get to the FED's $85 bil/month line? With the coming FED chair confirmation process approaching and an election coming in 2014, the political class may propose a new and exciting program: a FED-financed tax cut.

The Fed-financed tax cut gets the big thumbs up from the economists that Jim Pethokoukis cites in his article, but make no mistake, this is a helicopter money drop. The Economist spotlighted it this summer. The FED even said taxes, not the sequester, is a drag on the GDP. This is the nuclear option in the words of Jim Reid via zero hedge. It is unconventional. Much shorter, these fools have run out of ideas. Due to the credibility trap between Wall Street and Washington, it is politically infeasible to get the banks to write down bad debts and properly handle derivatives that are concentrated to a level over 95% within several entities (data from 2011). Only a handful of banks own those financial weapons of mass destruction in large amounts. Those banks have an amazing defense between interconnectedness, percent of total US assets owned and campaign fundraising capabilities. Even though debt write downs and a restructuring of the TBTF banks would be a government revenue neutral quasi-tax cut and makes sense in a balance sheet recession, it will not happen. Therefore, we are following Bernanke's plan.

A FED-financed tax cut is a weapon in Bernanke's arsenal. This is a further step in the Bernanke "Deflation: Making Sure "It" Doesn't Happen Here" playbook. In a coincidence to his order of mechanisms for handling our current predicament, he mentions this move in the speech after all of the QE talk followed by purchasing foreign government and domestic government debt with a short statement:
"A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money."
If bending the long term UST yield curve did not work, the FED could buy foreign debt and domestic debt. Check-check-check. Broad based tax cuts are next in line. Despite being laid out in Bernanke's playbook, this is why I think the next FED chair will be someone considered new and different taking policy in a new direction (spin, not reality). It is straight from Bernanke's plan but needs a new salesman. Obama and Reid just need to talk enough GOP house members into supporting the tax cut portion while ignoring the FED financing, dollar dilution portion. Boehner and his merry band of cathedralized republicans will go along for the ride. Considering the fact that the Senate Democrats were close to swallowing their tongues and voting for a Syria strike just to save Obama's face (too late), any tax cut aimed at 'the people' will be an easy sell. Knowing how a modern Congress works, there will be provisions for the fat cats and businesses galore in any deal. Everyone will get a tax cut and be happy in spring of 2014 just in time for midterm elections.

This will do nothing the the long term problems we have but exacerbate the federal debt situation. Will Americans use the money to pay down debt as they still have a tremendous debt overhand from the financial crisis? If so, banks prosper per Bernanke. Will Americans use it for consumption? Possibly, so China Apple and Walmart will move more consumer goods. This can be framed as little people getting a square deal, but what does a one time helicopter drop of $1500 or even $3000 do for the average American? Next month's bills still roll in. This does not relocate a manufacturing plant. Empty homes will still stand empty. Health care and insurance is definitely not dropping in cost. College tuition isn't dropping. One thing this will do is place a lot of cash in the economy at once chasing after whatever is out there. Hard assets, agriculture and precious metals would be winners.

Due to America's size, debt levels and recent inflation stability, if we see 10% or 20% inflation, America would experience pain similar to developing countries going through hyperinflation. This is an old research paper on hyperinflation in South America in the '80s, but it's an interesting read. The classic "When Money Dies" is another great economic read on periods of high inflation. Hyperinflation does not have to happen for there to be problems. Due to so many Americans on the dole and a significant chunk in salaried positions or in non-unionized hourly jobs with the threat of global wage arbitrage, the mechanism for employees to catch up to an inflationary cycle is nonexistent (unlike the '70s). Americans could use this cash to pay off debt, which would flood our banks with more money, making formerly questionable debt holdings healthier or cleared. Everything else will remain elevated in cost. If you think Americans could get a jump on the banks and pick up hard assets before they do, think again. The big banks have the fastest computers that can make trades without delay, off hours and without service fees all with the trillion dollars they have parked with the FED.

2 comments:

Anonymous said...

Hyperinflation will happen; it is only question of time. The dollar is in a very precarious situation; and has nothing fundamental going for it.

The purpose of QE is not to help the economy but to fund our overgrown federal government due to a lack of foreign demand for treasuries.

International political support and credibility inflation allowed for dollar overvaluation and dollar-debt savings to grow far larger than the world of real things. Eventually the monetary plane will reconcile with the physical plane and the value of those savings will be shown to be worthless.

PRCD said...

It's increasingly obvious that the Fed and political class have no plan for real reform and are just trying different things.

Re: inflation. Let's say you got paid every 2 weeks and immediately put a portion of the paycheck into stock index funds, REIT index funds, and bond index funds. Wouldn't your portfolio beat inflation?

Even if it did, it seems like your paycheck would still somehow have to keep up with the rate of inflation to pay for monthly expenses, though your mortgage would be paid-off faster.

China has bad inflation too, btw. The Chinese complain about it every time I'm over there. It's part of the reason their wages are going up so fast: they have to.