Contrarian Chronicles11/19/2010 11:23 AM ET

Fed's power of the press hits limit

The second round of quantitative easing has received a chilly reception. The markets seem to realize that printing money won’t solve our problems.

[Related content: Bill Fleckenstein, currencies, gold, Federal Reserve, Europe]

By Bill Fleckenstein

MSN Money

For those who thought Europe's financial troubles were behind it, the last two weeks have proven otherwise.

The chess match concerning Ireland, Greece, the European Central Bank and others continues, and it seems the powers that be in the European community want the Irish to "take one for the team" by agreeing to be bailed out.

What are the eurozone countries?

The thinking appears to be that if the Irish do that, perhaps sovereign debt ratios will tighten and the problems inside the European banking system will be ameliorated.

Also, if Ireland calms down, perhaps the reverberations won't make it to Portugal, Spain or Italy.

Bonfire of the currencies

All of that is most likely wishful thinking.

The intractable issue of how to get all the disparate (and now largely insolvent) eurozone countries to pull on the same oar during tough economic times has always been the currency's Achilles' heel.

It is difficult to see how the European Union nations can collectively manage their way through this crisis -- apart from printing money -- since all the options they have are Draconian. (They can't even deal with the problems of Greece, much less bigger and better-run countries.)

The massive flaws of the euro (despite the attempts by Jean-Claude Trichet, the president of the European Central Bank, to be semi-responsible) are perhaps the main reason there is still relatively steady demand for the dollar.

(Of course, the yen is no better than the euro, which also helps prop up the dollar.)

That sinking feeling

While our currency continues to hang in there, warts and all, it is starting to be another story entirely for our debt. The latter has seen a fair amount of carnage in the two weeks since the Federal Reserve announced a second round of quantitative easing, that monetary stimulus effort now well-known as QE2.

While many (including, I think, the people who run the place) regard the Fed as omnipotent, the action in Treasurys has been a demonstration of the power of the market. The Fed may be bigger than certain small markets -- and even that is debatable -- but it is not bigger than the bond market.

If the weakness we have seen continues and printing more money doesn't work (i.e., if it drives yields lower), bond prices could tank. That means higher interest rates, which is trouble for stocks; thus, financial assets could really suffer.

In any case, given the fallout we have already seen from QE2, including an unusual amount of criticism directed toward the Fed, we are in the early innings of the funding crisis (which I have discussed many times), though we don't know the rate at which it will play out from here.

Those with a bent toward technical analysis could make a pretty good case that 10-year Treasury rates have formed an inverse (i.e., upside down) head-and-shoulders pattern, which signals that rates are headed higher. On the other hand, with Fed chief Ben Bernanke determined to buy $600 billion worth of bonds, if the Federal Reserve shifts its target along the curve, anyone betting that bonds will fall could easily find prices going against them in the short term.

The little printing press that couldn't

Nonetheless, so far it looks as though the news of QE2 has led to aggressive selling in the fixed-income market and, to some degree, the stock market and commodities as well.

It’s far too early to tell whether that is just noise or if it signals the end of the move in stocks and bonds. (But it does look to me like the bond market is starting to try to take away the printing press from the Fed.)

However, I certainly don't believe it is the end of the move in precious metals, even though they have been thumped pretty hard lately.

As noted earlier, the world's confetti (aka currencies) is a mess in search of a solution.

Precious metals -- in back-to-the-future fashion -- may help resolve currency turmoil, as more and more people contemplate the advantages of a return to some form of the gold standard. (See “Who needs dollars when we have gold?”)

If it is broke, maybe you should fix it

Along that line, my good friend James Grant wrote an excellent piece for the editorial pages of the Nov. 14 New York Times print edition. Headlined "How to make the dollar sound again: In gold we trust," the piece appeared on the Times' website Nov. 13.

As I pointed out last week regarding the World Bank chief Robert Zoellick's call for monetary reform published in the Financial Times (registration required), when thoughtful people make cogent cases for the elegant, self-correcting nature of the gold standard, the rest of the world, which is in search of an answer, will be forced to give such proposals due consideration.

Obviously, the permabears won’t count here, but not everyone is a pathological gold hater.

At the time of publication, Bill Fleckenstein owned gold.

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12Comments

Newest

1/10/2011 10:56 AM

I don't know who the real pros are, sure of one thing, it's not anyone we have ever seen. The real pros never show their face. Could be computers. Would like to know them.

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Justa Average Joe

12/16/2010 11:35 PM

The Out-of-Control Spending of Congress is only exceeded by the Out-of-Control Bank Bailouts the Fed is giving to banks via free money.

Savers are being crucified by the Fed's Zero interest rate policy.

Long Live The Debtor Nation!....until it disintegrates.

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Russell Herron (Yuansomemore)

12/13/2010 12:56 PM

Going to a gold standard doesn't fix anything but the mechanisms by which a money supply is managed. It doesn't create value.

I'm not a fan of a gold standard. But it is obvious that the mechanisms by which money supply is managed are freely manipulated by countries that have interests in having a strong middle class, improving education and building infrastructure. If currency valuations don't matter, then why do the Chinese peg to the dollar?

If deficit's don't matter, why can't we just borrow more?

Fiscal responsibility is needed. Currency valuations do matter. Further, in addition to the rhetoric, something must be done.

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AshinVT

12/11/2010 8:14 AM

Its not about gold, its not about the Fed. The Fed is ham-handedly doing what it can to recalibrate an economy by sloshing around the monetary system - and the mess of budget deficits and the under-invested human infrastructure of the US. In the end - its about the economy - gold standard or not. Economy = value created - value destroyed. In the modern world, value-created is proportional to the vitality of your productive people and technologies - and as certain extractive resources (e.g. oil) become harder to get at, value is destroyed by excess dependency on use of those resources. In an increasingly technological world, where value will be maximized by very precise use of resources by efficient technologies that maximize human potential, how do you think you will get there with a country that spends so little educating its young in fundamentals such as math and science (the precursors to engineering and technology), and values NFL teams and spending time on Facebook?

Going to a gold standard doesn't fix anything but the mechanisms by which a money supply is managed. It doesn't create value. In fact, it likely destroys value as it will put outsized economic emphasis on mining gold at a level of activity well beyond the human usefulness of that metal. It will put a new meaning behind the word "gold digger"

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tcgrich

12/07/2010 3:57 PM

Is this the Contrarian Chronicles? Its ok to have a different point of view, but all I ever read is negativity. It would be nice to see one piece of useful information here, instead of the same old "the sky is falling." How about some investing advice to take advantage of your unique point of view, instead of solving all the world's problem by criticizing anything and everything.

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LostOnEarth

11/22/2010 5:06 PM

Another great article from you Bill, as usual. Those of us with no economics degrees understand the problems and have the common sense and logical solutions, while the real economists with degrees are totally clueless. Go figure!

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Nick67

11/22/2010 4:52 PM

I hold gold -- but it isn't going to be currency again anytime soon. Look at history. The Greenback Party didn't come about because bullion was a panacea, and the Opium Wars weren't fought because Chinese use of silver as a medium of exchange--and the only thing it wanted to import from the West--worked out as good policy.

"Normalcy" will return when some element of sanity returns to international trade, and American domestic policy. US trade imbalances simply cannot be sustained, and haven't been sustainable for a long time already. Instead of silver, like in the 1840's, the Chinese have only been interested in US dollars. When those ran out, they accepted US debt instead. But they aren't really interested in purchasing US goods or services -- just stealing US intellectual property. That is going to HAVE to change. Either the Chinese are going to HAVE to start buying goods and services from the US, OR the US will HAVE to stop buying goods from China.

The underlying cause of the Great Recession is that trade imbalance, and the actions that have been taken over DECADES to avoid dealing with it. The Chinese have $2 TRILLION dollars in US currency and debt that they are holding. That didn't happen overnight. The crap that happened in the banking system was a direct result of the need to generate debt to buy Chinese goods that no one could pay for. It just took a long time, a very long time, to manifest.

And if you're honest, really honest, and you want to see the root cause of that trade imbalance--you have to look all the way back to Ronald Reagan. The whole casino economy, I-want-my-pork-but-don't-to-pay-for-it, rich-as-glorified, management-steals-all traces its roots to his Presidency. I don't really care about fault. But the roots of the cultural change that led to the glorification of wealth, getting rich by financial engineering, not real engineering, that happened on his watch.

And that has to change. America has to return to concentrating on how to build a better mousetrap and not on how to create a quant fund that consistently beats the S & P 500. The focus has to change back to creating wealth and not making money.

The fundamental problems have to be fixed. Bullion as money doesn't really address ANYTHING fundamental.

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Working Monday

11/22/2010 1:08 PM

When does a loaf of bread (wheat or oats preferred) cost a wheelbarrow full of dollars? Zooming at inflated light speed ---- dollars are going to still be the currency of choice due to Euro and Yen valuations --- excellent article Bill again!

I worry about where the dollar is going!

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vanhalen not vanhagar

11/22/2010 12:20 PM

Markets go up and markets go down.......You just have to be a conservative investor and get on the train and off before it wrecks or speeds up. I think rates are headed up long term and I think bond prices are headed south long term.

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Cniht

11/22/2010 9:37 AM

While I agree we need to end the current system as you do Mr. Fleckenstein, I offer a word of caution.

Never underestimate a Central Banker's ability to print money, and never underestimate a Politician's ability to spend it.

I thought the whole system should have failed years ago. However, the above keeps getting in the way.

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goodluckgary

11/22/2010 6:09 AM

Yes, I agree that shutting down the current fiat system and returning to a gold standard may possibly restore some normalcy to economics. For example, allowing people to actually save money in a bank account and earn real int-

erest. However, I have two questions. First, is this to be

done before or after we monetize our monstrous debt?

Second, at what figure do we set gold if this is to be done?

Any angle attempted to cut this pie is going to make for a

rough ride. 39+ years of fiat currency cannot be easily switched off, right?

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Flat tax10

11/20/2010 9:06 AM

END THE FED

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