LunaticTrader

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Posts Tagged ‘QE’

Paradoxical effects in the economy

Posted by Danny on December 8, 2014

We got a few down days early in the week, but still ended with new record highs on a number of indexes. Even the German DAX is clocking in new records. As I said last week, pullbacks can be very shallow as long as enough investors are looking for a chance to get back in. And December is normally not a month of big corrections. We have a few more days of lunar red period to go and then we will be starting another green period until the final days of the year. So, it seems to be increasingly likely that we will end 2014 at or near the highs. Or not?
Here is the current S&P 500 chart (click image to enlarge it):

S&P 500

The S&P has basically gone sideways for the past two weeks. Will it pull back or will it push higher?
There is room to rise to 2125-2150 before an overhead trend line comes into play. Technically the slower Earl2 (orange line) has clearly peaked, indicating a correction or sideways phase is starting. But the faster Earl (blue line) seems to be etching out a shallow bottom and may turn up again. It is dangerous when the market makes new highs with Earl below zero, because that has given some nasty drops in the past. We saw that as recently as early September. So no, it is not safe and we may see a sudden 5% drop if some rabbit gets pulled from a hat. But, December being December, we may just as well grind higher for the rest of 2014 and then get a pullback in early 2015.
Back to 2000, up to 2150, 2000 before 2150,… all are quite equally possible at this point. I don’t know.

One of the rabbits that many observers expect to see is a new quantitative easing (QE) program announcement by the ECB. We will see if that comes true. But I am wondering, what do they need QE for if just talking about it is already enough to lower the Euro and give the desired boost to exports (presumably)?
The problem is that once an economy is completely messed up by Central Tampering you start getting more and more paradoxical effects. Paradoxical effect is a term mainly used in medicine. A typical example is taking a medicine for pain relief and getting more pain as a result. So, this differs from the so-called unintended consequences, where action on a given point leads to undesirable outcomes elsewhere in the system. A paradoxical effect means we don’t get our intended result but its exact opposite.
And it doesn’t only happen in medicine. Another beautiful example, and one that every student should take a look into, is described in this study. Repeating information for two or three times will help to put it to memory. So, logically we would think that repeating it more often will lead to even better memory. Wrong! At some point more rote rehearsal starts having the paradoxical effect of making our memory worse.

Typically, paradoxical effects start to be seen when a certain saturation point is exceeded. I think we have already reached the point where zero interest rate policy and QE are having paradoxical effects. Instead of creating inflation they may lead to more deflation. How? As we see in Japan, the latest QE program has knocked down the value of the Yen. While this has temporarily pumped up their inflation rate by making exports more expensive, it also has prompted many Japanese to save more because now they figure that they will need more Yen to have a comfortable retirement. As a result of the drop in consumption they have an economic contraction that may eventually lead to even more deflation once the inflationary effect of the lower Yen fades away. And because consumption is down, Japanese businesses may decide to invest less rather than more.
There is also a second way in which zero interest rate policies can become deflationary. Zero interest rates make it cheap to invest in new capacity, easily leading to overcapacity in some sectors. It’s hard to get any real inflation when there are no shortages (and why would we want shortages anyway?). The overcapacity created by cheap money can become a deflationary force. That’s a paradoxical effect.
If they want higher inflation, then interest rates should be raised. That would raise costs for companies, bankrupt some of them, and lead to shortages down the road. Then we would have real inflation after a few years. But would anybody feel any better because of that?
Enough food for thought.

Be well,
Danny

 

Posted in Financial Astrology, Market Commentary | Tagged: , , , | 3 Comments »

Why QE fails to start the economic engine

Posted by Danny on November 20, 2013

I get occasional questions about the quantitative easing (QE) programs that are being perpetuated by the world’s central bankers. Will it work? When?

The idea of QE is to add some extra money-fuel to start the economic motor. This is really no different from priming an engine before you start it in cold weather. If you own a classic car or an airplane, then you may still know the art of priming the motor before starting it. But with modern cars it isn’t needed, so most people, including our central bankers, have probably forgotten how to prime an engine.

I used to sell motorized vehicles in my early 20s, so I have explained the problem of over-priming countless times. But to keep this piece short you can read all about it in this well-written article: http://www.premierflightct.com/newsletters/TrainingArticles/ColdWeatherStarting.html
The dynamics of an economic motor are really very similar. So where the article correctly states: “Engines will fail to start for 2 reasons: too much fuel and too little fuel!“, we could as well say:

Economic engines will fail to start for 2 reasons: too much money and too little money!

When the economic weather turned unusually cold, and they tried to prime the economic engine with QE1 and QE2, it made sense. But since QE3 they are basically saying: we will continue to prime this engine until it starts. And that makes no sense. Then the engine fails to start because of over-priming. Then all you get is black smoke coming out. The motor stutters along but doesn’t really catch on properly. Black economic smoke has been belching out of Europe, Japan and the USA for years, but these central bankers fail to make the proper diagnosis: they have flooded the engine. It would have been better to put a car mechanic at the head of the Fed, because it looks like universities fail to teach such basic principles in their economy classes.
The mentioned article also correctly describes the dangers of continued priming. The extra fuel-money will accumulate in certain places and risk causing an engine fire. So the stock market could catch fire (speculative mania) or commodity prices could go crazy (hyper-inflation), both very damaging for an economy. At the moment it looks like we are coming close to the first possibility.

Now, for the sake of this little exploration, let’s assume that despite repeated over-priming the economic motor catches on somehow. Some more black smoke is seen and suddenly we hear the promising noise of an engine coming up to speed. Then our grounded economic plane is still not up in the air. There are still a few other problems to tackle.
Given the weather conditions and the amount of horsepower, an economic plane can only take a certain maximum load. Three things are typically weighing down an economic engine: interest rates, taxes and regulations. The burden of interest rates has been reduced to near zero. But governments in Brussels and Washington have not stopped inventing new taxes and adding more regulations on top of the old ones. Even with zero interest rates this plane may not realistically be able to take off anymore, it is overloaded.

And to make matters even worse, what we have is that the cockpits have gradually become bigger than the rest of the plane. Champagne is being served in those cockpits, quarrels are being heard from them,… but the plane doesn’t fly, it always stalls as soon as it gains a little bit of altitude. And the mechanics are getting the blame.
That is an ugly situation.

In a second part we can explore how to unburden this plane so it can fly again.

Be well,
Danny

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