Monday, June 28, 2010

RBS: "Monster" Money Printing

Ambrose Evans-Pritchard continues with another column on deflation and what he sees as essentially a spiral which will end with the US Federal Reserve printing an enormous amount of money to prevent deflation. He cites a new an RBS letter to clients that talks of "Monster" money printing.

From the article:

Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on "monster" quantitative easing (QE)".

"We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable," he said in a note to investors.

Roberts said the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure said this is the option "which I personally prefer".

A recent paper by the San Francisco Fed argues that interest rates should now be minus 5pc under the bank's "rule of thumb" measure of capacity use and unemployment. The rate is currently minus 2pc when QE is factored in. You could conclude, very crudely, that the Fed must therefore buy another $2 trillion of bonds, and even more if Europe's EMU debacle goes from bad to worse. I suspect that this hints at the Bernanke view, but it is anathema to hardliners at the Kansas, Richmond, Philadephia, and Dallas Feds.

Societe Generale's uber-bear Albert Edwards said the Fed and other central banks will be forced to print more money whatever they now say, given the "stinking fiscal mess" across the developed world. "The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant," he said.

I've been saying this now for months.

The question is whether you should take this seriously or brush it off as another doomsday perma-bear trying to gain headlines (Pritchard is not a perma-bear)?

My old self would have brushed it off and told you to stay invested, even if things fall they will come back - however that theory has not proven itself out. I'm not saying get out of stocks, I am saying that you should get out of risk assets if you can't handle significant fluctuation. Yes, you may miss out on some upside, but preservation of capital is of the utmost concern now. A bird in the hand......

Does this mean you shouldn't ever own stocks? No, I still hold an allocation to stocks but have lowered it significantly and will increase this allocation if we get a significant fall. However, realize that we don't know exactly how the government will act in the future - if the Fed embarks upon another round of Quantitative Easing (i.e. Money Printing) we could actually see an eventual rally of stocks to heights we never thought possible. Of course this QE induced melt-up will eventually crash as well.

Unfortunately the path to prosperity does not lie with an ever increasing debt-load.

My gut tells me to be very, very cautious in this market - for me this means not holding too much in the way of risk assets, but being aware that some great deals may come down the pipe. If we have another deflationary scare and if TIPS (Treasury Inflation Protected Securities) react the way they did in 2008 (late) we might have another opportunity to buy these at very good prices.

I realize that many economists are calling for inflation, massive inflation and hyper-inflation, in fact many of these economists are individuals that I have a high degree of respect for, which makes things all the more difficult for me in determining how to design client portfolios. I do believe we are in a deflationary episode, but also believe it could lead to significant inflation. Let me emphasize that I could be wrong, very wrong. This is why I haven't advised people to buy commodities, specifically gold and silver - though I have advised how to buy if they want and said that I don't believe its a bad idea to have some precious metals on hand along with paper money (outside of the bank).

Where I might have dismissed these bearish prognosticators in the past, I feel I was wrong to do so. They may not be right, but they are reflecting information that should be incorporated into your financial plan.

My stance may prove to be imprudent from a growth perspective, but I can live with myself if my clients earn only a few percent if the markets return 20% better than I can live with myself if my clients earn a few percent and the market falls by 50%. This is a Will Rogers market.

Scott Dauenhauer CFP, MSFP, AIF