Friday, November 19, 2010

The Real Reason for Fed Easing? Debasement Inflation?

Well, one of my major arguments made it to the op-ed page of the Wall Street Journal today, but I didn’t write it: Andy Kessler, a former hedge-fund manager wrote it. I agree with most of what Mr. Kessler says in his piece, “ What’s Really Behind Bernanke’s Easing?” (See

I have been arguing for more than a year that the real concern of the Federal Reserve is the solvency of the banking system. The Fed’s given arguments for pumping so much liquidity into the banking system is that the economy is weak and the level of unemployment is unacceptable. The Chairman of the Board of Governors of the Federal Reserve System cannot say just say out loud that “the banking system is at risk.” Nor can any other Federal Reserve figure say this out loud.

My concern over the past year of so has constantly been that the economic and financial situation did not warrant the injection of all the Fed was throwing at it. See my post “Bernanke’s next round of spaghetti tossing”: A recent post continues to exhibit my belief that the justification for the Fed actions has been the solvency of the banking system and not just the health of the economy:

But, the behavior of the central bank not only represents concern for the commercial banks, but also for the real estate market. Elizabeth Warren, in Congressional testimony earlier this year, indicated that 3,000 commercial banks were threatened over the next 18 months or so, especially in loans in the area of commercial real estate. Plus, we have a massive problem in the municipal bond markets concerning the solvency of our state and local governments. The pension programs of these entities loom large over the financial markets and many individuals I know that work in this sector are scarred silly.

The efforts of the Fed, therefore, are attempts at “debasement inflation”. This was uttered by William Browder, who now runs an investment fund in London. (In the morning New York Times: “Emerging markets went through more than a decade ago in the Asian Financial crisis what developed markets are experiencing now.” Browder added, “you want to own hard things that can’t be printed.”

But, these efforts extend beyond the borders of the United States. Given the fluidity associated with funds flowing throughout the world, the additional liquidity extends to the situation related to many Euro-nations in terms of their sovereign debt. Writedowns are going to occur in Ireland, Portugal, Greece, and possibly Spain and Italy. Even France is feeling some of the heat. International financial markets also need liquidity.

The question here is whether this concern over sovereign debt will extend to the United States. Browder goes on to say that there are limits to how much governments are able to borrow. And, investors move from one weak market to another. Eventually, these investors work through to even the “strongest” of the fiscally challenged states. When it gets to this stage, he argues, the only thing these governments can still do is print money.

Where are the hard assets? Real estate. Commodities. Companies.

These are the areas that will attract a lot of the money going around.

The prices of commodities have already experienced a significant bounce. This will continue.

Big money will also eventually be made in real estate and the merger and acquisition business of corporations. The prelude to this is the massive buildup in the cash holdings at many of the largest companies in the world, in the largest commercial banks in the world, and in hedge funds and other private equity funds. And, really, the move has already started in a very selective way.

I continue to believe that over the next five years of so we will see a substantial acquisition of assets, across the board, of a size we can barely imagine now.

The objective of the Federal Reserve is to keep things as stable as possible so that the FDIC can continue to close banks as smoothly as it can; that mergers and acquisitions can occur in an orderly fashion so that weaker institutions can be removed from the scene; and that more and more money will move into the real estate area so as to eventually put a floor under real estate prices.

All this may be done, but it may not exactly take the path that Mr. Bernanke would like it to take. Furthermore, all of this activity may not achieve the goals that President Obama would like to achieve.

Mr. Kessler argues that, in his view, the stock market will not view these developments as favorably as they have received earlier efforts at spaghetti throwing. He claims that this attitude has been shown by the recent behavior of stock prices. In addition, bond yields have backed up (prices of bonds have fallen) not what quantitative easing was devised to do. Both of
these outcomes are “exactly the opposite of what Mr. Bernanke was trying to achieve.”

In the case of mergers and acquisitions and the acquisition of real property, the early results are indicating that the bigger organizations are getting bigger, both financial and non-financial institutions, and the wealthy are getting wealthier. These outcomes are exactly the opposite of what President Obama was trying to achieve.

Mr. Browder spoke to students at the Columbia Business School several weeks ago. He argued that “the high-inflation scene” described above “could be another lucrative opportunity” similar, although not as great, to one he made so much money in while in Russia.

In such a situation, therefore, the emphasis in investing should be on what companies or assets can be acquired that will benefit from the credit inflation. Caterpillar, for example, moved into the mining equipment field, one reason being that mining will benefit from the surge in demand coming from emerging nations like China and Brazil. So, one is looking for “targets” and not long-term value creation.

One has to be careful, however, in buying into acquiring companies. Not all companies are good acquirers. History shows that many acquirers have to “unwind” their acquisitions within five years or so because the purchases are done for the wrong reasons or the managements cannot effectively integrate the properties they have obtained. However, there may be some very good “buys” amongst the acquirers.

For example, the value of the Caterpillar stock went up after the acquisition was announced. There is the feeling that the Caterpillar management can effectively put the two companies together to the benefit of the shareholders.

The Federal Reserve is creating a lot of opportunities with its new policy stance. However, the beneficiaries of the policy may not be the people it wants to help: the unemployed and the less-well-off.

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