Backed Into a Corner

Another hot one today and only minimal improvement on the way this weekend. I love the heat but this stuff is rough with the poor air quality. I will warn you that tonight is one of those nights that I think I have a top 5 all time post as I have it thought out but as I am writing the thing I think "wow, this is coming out wrong" or "this is dog poo". Any real writer will tell you that is how it feels to write anything, but especially so for me tonight.

When Everyone is Screaming Something Bad Usually Happens
I wanted to set up tonight's missive with an observation that I have made over my lifetime that has held true over 90% of the time (back of the envelope of my mind calculation):
When Everyone is Screaming Something Bad Usually Happens
Now do not confuse this with slasher flicks or your wife telling you the weekend chores!

What I mean is that when something that is deemed very important is hotly debated and that debate boils down to two sides screaming what they think must happen, something extreme and bad usually ensues. Right now we have the "STOP SPENDING" camp and the "SPEND ANY ALL THAT IS NEEDED" camp both wearing my ears out with the high pitched squeals for action. Thus I am on the lookout for some kind of over reaction or major event on the way. Or it's ok, its a 10% member.

Backed Into a Corner
While the glacial pace of things economic can be frustrating at times, events should move a little quicker due to a squeeze on action called the next election. Any policy or action will have to be in place soon so that whatever expected effects can be seen due to the lag time common to such things. This affords an opportunity for this writer to set up some positions which will be my shot at meeting my yearly target for returns on my portfolio. I also could get smoked, but that's the way it goes.

All you need to know in a quick recap;
The actions of the FED/Treasury/Major Banks/Government have been able to engineer a stock market liftoff (nice no volume ramp job today boys!) and some degrees of change in various indicators but nothing organic has taken hold. With a key metric, unemployment, still in the nosebleed section it is clear things have come up very short of expectations. What is next?

The argument for all the Quantitative Easing, asset buys, zero interest rates, and tax incentives was that a real recovery would take hold if demand could be stimulated until REAL demand came back. Of course no one ever mentioned that demand at an all time high crest due to the biggest credit bubble of all time may well be impossible to recapture, but let's leave that be. It didn't happen.

What is giving me pause right now is the slow realization that monetary policy MAY NOT be enough, but many still want to try.

Some examples;
-Paul Krugman (my favorite!) writes today:
How Much Can The Fed Help?
The title itself is a monster leap for Krugman. Krugman notices that if the FED targets longer term interest rates (which will require monster amounts of money) this will not really do much either:

Even if the Fed bought a couple of trillion dollars’ worth [of long term bonds], probably not all that large [effect on long term rates]. I’m not saying don’t do it, but don’t expect miracles.

So are we making progress? Not so fast. Here is the scary part:

Way back when, Goldman Sachs guesstimated that it would take an expansion of the Fed’s balance sheet to $10 trillion to accomplish as much as the reduction in short rates the Fed would have undertaken already if it weren’t up against the zero lower bound. That still sounds plausible. Is the Fed ready to act on that scale? Probably not.
What would really be effective would be a credible commitment to a higher inflation target, which would reduce real interest rates. But that’s not on the menu, at least not yet.
So, it’s good to see the Fed getting worried; but don’t get too excited.

Mr. Krugman thinks a worried FED that will be tempted to lash out with wild actions will be a good thing. Maybe he likes that kind of party.

Another of my favorite opposite side of the opinion river writers is Mark Thoma. Thoma arrives at about the same place as Krugman on the long rates issue:

Don’t Expect Miracles from Monetary Policy
For the policy to be effective, there is a second step that must occur. Firms and households must respond to this incentive by investing more in new plants and equipment and purchasing more durable consumer goods. But as this discussion at The Economist I took part in notes, firms are saving rather than investing right now, and the reason seems to be due to a poor outlook for the economy along with considerable existing excess capacity. Under those conditions, a poor outlook and lots of excess capacity, a point tor two fall in the interest rate is unlikely to spur much new activity (and households, who are still struggling with high unemployment rates, are unlikely to increase their purchase of durables enough to make up the difference). So I fully agree with Krugman. We should try this, the state of the economy demands that we try something even if it may not work, but we shouldn’t expect miracles.

I am all for giving something a whirl to see what happens, but I think a 3-5 Trillion dollar whirl is not something to be taken lightly.

I was shocked to read at Mr. Thoma's own web blog the following discussion in the comments section:

Jeff said...
Your column, saying that huge Fed purchases of long Treasuries would have little effect, is nonsense. Suppose the Fed stops paying interest on reserves and buys up $3 trillion of long Treasuries. The sellers of those Treasuries now have $3 trillion in idle funds. What are they going to do with them? Are you really certain that none of that money will be loaned out or be used to increase consumption? If that's the case, why not cut taxes to zero and let the Fed buy up all the new Treasuries that result?
Repeat after me: In a fiat money system, there is no such thing as a liquidity trap.

To which Mr. Thoma offered:

Mark Thoma said in reply to Jeff...
They already have lots and lots of accumulated saving and aren't investing, more won't matter much.
Your argument is that when a person already has a big bag of candy, but has no desire to eat any, giving them more candy will somehow change their mind. That's pretty unlikely unless it's all earmarked for a specific use later. That's clearly not the case for corporate saving.
Repeat after me, despite protestations to the contrary, we are in a liquidity trap. Fiat money has nothing to do with it.

I had to do a triple take on that one!

For the trifecta, how about state based "advance loans" on Medicare and other Federal matched programs as a "temporary" way to aid states:
Let Treasury Rescue the States
Payday loans for states, oh boy.

The common theme here is that the frontline policy tools were used up a long time ago, the secondary ones went right after, and now we are even at the end of the more novel approaches. Nothing is happening. This is why I think the following:

-Rather than accept that they did their best and it did not work, it will be double or triple down time for the FED monetary belief system. When numbers like 3, 5, and 10 trillion are thrown around as "things worth a shot" you know it's a nervous crew.
-Something big, maybe not the ideas presented tonight, is on the way unless the policy makers want to admit they have no real control over the economy.
-As I have written, the only path ahead for the party in power (and no, it really makes no difference so please don't bother with the partisan stuff here) is too give massive handouts, assistance, credits, and free toasters and force the other party to promise to take them away. Craven, yes. Politically worthwhile, you betcha!

It seems both the party in power, the FED/Treasury, and a President that has had a rough go are backed into a corner. Either they will sit down and survive as best they can, or they will come out fighting, no holds barred.

I really do not think any of them will sit down.

I will be putting together my plan of action over the next week or so (still plenty of time and earnings season may well factor in to some ideas) so no hurry. As always I will share any and all positions ahead of time and with targets and stops so you know what I am doing. I hate it when I see at some other places smart guys come out 2 months after the fact and state they did x, y, z and made out big but they could not share that info. That is a crock. I want to see the trade orders guys, what's the big deal?

Of course, nothing here is advice, just sharing my own two cents. You must always do your own evaluation and are responsible for your own actions.

Disclosure: In gold/silver physical bullion for 25% of portfolio and the rest is in cash. Plenty of gunpowder to use!

Have a good night.