ZIRP

Let's begin with a look at the Dow Futures, which I like to do as the Dow is the market that everybody looks at to get a guide to the economy no matter where you are in the world.

As you can see, and as I noted a couple weeks ago, the Dow broke through that first main resistance level around 12,200 or so.  Since then, it has continued to go up, but in a tight trading range.  Also, there's the development of an ascending wedge pattern that began in November which is a bearish indicator.  If you remember, it was the end of November when I thought the market would continue to drop into the abyss.  Lo and behold, the Fed announced their reduction in interest on Credit Swaps with Europe that started this wedge pattern.  Again, this is bearish and it looked as if the chart was going to break down soon.  Like it started to do yesterday and this morning.  Lo and behold, the Fed announced it will extend the low interest rate policy (ZIRP - Zero Interest Rate Policy) now through 2014.  Before it was through mid 2013.  So that's where we stand.  As you can see, it's getting pretty close to the highest Dow price in the last year.  If you go back and look at a weekly chart back to 2007 (before the financial crises started) you'll see that the top of the current trend goes all the way back to early 2007's top.  This, in my opinion, was the first time when people were starting to figure out the problems in the financial system and began to sell.  Then there was the last rally with a head and shoulders top, a breakdown, an island rally, then all hell broke loose in the economy and the financial system.

I would like to point out the lack of volume in the commitment of traders (COT) numbers below the chart. Clearly, the futures market has not been trading very often in the Dow. In fact, the entire move from 2009 to 2011 was without many traders in the futures market. Maybe there's an issue, or maybe it's because you can't accurately predict this market as it's not a fair and free market any more?
http://en.wikipedia.org/wiki/Commitments_of_Traders


Now that we got that out of the way...let's go back and discuss ZIRP.

Originally, Ben Bernanke set up his ZIRP back in December 2008 after the financial crisis started and reduced the Discount Rate to 0-0.25% in order to jump start the economy (like priming an engine).  This set rate has continued for 3 years straight and was expected to expire multiple times, the latest in mid-2013. http://online.barrons.com/article/SB122945676231311277.html

Well, the Fed decided that ZIRP should continue through the end of 2014 today, or another year and a half past the updated mid-2013.  To say that ZIRP will end at any point is probably just folly.

So what is ZIRP and what does it aim to do?  Well, it's a highly inflationary policy to have.  The idea is that you make loans cheaper and attractive, with 0% borrowing from the Federal Reserve, that money will just pour into the economy, creating inflation on purpose to offset the deflation that the economy would normally experience during a correction/contraction of money supply and recession/depression.

That is to say, if there was a major bubble (like the housing bubble), and it popped and was ready to correct to sustainable levels, instead of allowing the bubble to re-adjust to reflect current and accurate prices, you would loan out money for free to keep the prices from falling (i.e. replace deflation with inflation, and hope that the two offset each other or inflation was greater than the deflation).

Here is a link, and I encourage you all to do this if you haven't already...Start the Fed's game and immediately change the Fed Funds rate to 0%.  Then run that for 12 quarters, or the 3 years ZIRP has already been in place.  You should see a 1.5% unemployment rate and a 15.91% inflation rate.  From the beginning of the game, that's a change of -3.25% in the unemployment rate, and an increase of 13.77% inflation in 3 years.
http://www.frbsf.org/education/activities/chairman/

Let's test those numbers...with John Williams' Shadow Stats which shows the different gov't data variants.

Unemployment...


Unemployment was 7.3% "officially" in December 2008.  It is currently 8.5% "officially."

I'm not seeing the unemployment data decreasing as expected through this ZIRP policy by the -3.25% especially if you look at the SGS Alternate unemployment which is calculated based on the pre-1994 model of calculation, which included discouraged workers.  That number has actually been rising the past 3 years instead of falling like the "official" BLS (Bureau of Labor Statistics) reports.

Inflation...


Inflation however has been increasing since ZIRP was started.  Maybe not to 15.91%, but there's been a definite increase from 0% to 4% "officially."  I think the inflation number may be closer to the 12% or maybe higher that the SGS (1980 based) calculation indicates.  I say possibly more, because if you look at the price of oil or gold, historically stable in price vs. each other, you'll see they have both risen by more than 10-12% vs. the dollar in the past few years.

So if the goal is to keep prices from falling...job well done!!  Inflation has not only stopped deflation and falling prices, but has done enough to swing it upward almost back to pre-crash levels of 2007.  Who can forget paying $4.25/gallon for gasoline in the summer of 2007.  Can't we please go back to those days?  Well, we're already there, just 6 months early...$3.30/gallon for gas in the winter of 2012 is the highest it's ever been...and that's on seriously lowered demand...makes sense right?  Well, you can thank ZIRP and it's inflation.

There's another thing that I would like you to try on that game.  Do 0% for 2 years (or 1 year less than the current ZIRP).  Then raise it to the highest Fed Funds rate of 19% and do that for the remaining quarters (2 years).  Interesting huh?  That's basically what the Federal Reserve did back in the late 1970's to stop the insanely high inflation, shortages from price caps, and return the country to a more sound economic footing for growth.

THIS CAN NOT BE DONE IN OUR CURRENT ENVIRONMENT.  It would be political, economic and civilization suicide.  The government would default and go bankrupt within a year as interest payments would outpace tax revenue, even if it was increased 3 fold.  15 Trillion x 19% is $2.85 Trillion in interest PER YEAR.  Total tax revenue right now is only around $2.5 Trillion.  That would mean $0 for any program, politician, employee, or building INCLUDING no IRS to even collect the money owed the gov't.  This being in today's dollars.  That world is a world without a United States in it.  It's impossible for anyone to allow that to happen, so raising interest rates to stop the onslaught of inflation is OUT.

So what does ZIRP look like over time beside being inflationary...

Luckily we have a country that has done this and continues to do this...Japan.

Keep in mind, this is a 10 year bond.  Somehow, people (not smart ones) are willing to receive 1% over 10 years to lend to the Japanese government.  Again, I'm sure people aren't willing to lend at those rates (at least I hope), but the Japanese Central bank and interbank lending sure are.  Free money, and free profits from the spread.



http://www.zerohedge.com/news/%C2%A51086000000000000-quadrillion-debt-and-rising-and-whythe-%C2%A5-will-soon-be-lost-decade-or-two

I encourage you to read about the Lost Decade in Japan.  The summary of ideas by Richard Koo is probably accurate and what took place.  That is exactly what is taking place right now in this country.  Extremely low rates are causing people, businesses and banks to deleverage their balance sheet.
http://en.wikipedia.org/wiki/Lost_Decade_(Japan)

Here is Obama after taking office warning that the U.S. could end up in a Lost Decade just like Japan.
http://online.wsj.com/article/SB123419281562063867.html?mod=djemalertNEWS

To say that there was a lost decade in Japan and that the U.S. is now in a similar situation is popping up everywhere recently with the announcement of ZIRP through 2014.

http://www.tlnt.com/2012/01/26/following-in-japans-footsteps-how-a-lost-decade-could-impact-employers/
http://www.forexnews.com/2012/01/market-outlook-for-january-26-2012/
http://avidinvestorgroup.com/2012/01/welcome-to-japan/

This is a very good paper written in December (before this announcement obviously) on the similarities of the Federal Reserves policies with the policies of Japan in the lost decade and the deleveraging that it caused.
http://www.cirje.e.u-tokyo.ac.jp/research/dp/2011/2011cf828.pdf

Here's another good paper...
http://www.imes.boj.or.jp/research/papers/english/09-E-25.pdf

All of this may look and sound similar.  Yes the US is embarking upon the same policies that Japan has done.  NO, the results will not be the same.  There is one simple reason for that...Japan's economy, although originally had a housing boom and collapse the same as in the US in the late 1980's, the Bank of Japan DID NOT immediately intervene to the same extent.  The bust was actually caused by monetary contraction, that leveled out and allowed growth and strength in the country to build for a long period of time.  This was also around the time where Japan became a manufacturing giant in the world economy.  Contrast that with the US, where the same things happened, but this is at a time when the US is losing more manufacturing and investment into the country than ever before.

The paper below called, "The Myth of Japan's Lost Decades" by Kel Kelly clearly explains that things are not what they seem on the surface.  While Japan had a "Lost Decade" or two, due to very low GDP growth, the actuality is the country had a strong currency and economy that other countries wanted to invest in, which they did.  The Bank of Japan's inflationary policies just offset the inflow of massive investment into the country and purchase of their manufacturing and goods.  If they did not do that, they would have never been able to sustain their growth as their products would have been too expensive to import.  This is similar in my mind to China today.  Everything is made in China just about these days, and in order for China to make sure their products stay cheap for the rest of the world's consumption, they need to peg their currency to the other countries in order to keep products cheap to their buyers.  If not, they will turn away and produce the items themselves.

http://mises.org/daily/5170

So where does that leave the US?  Well, since we don't have the strength in currency and the manufacturing and investment to support sustained ZIRP and quantitative easing like Japan, these policies will be inflationary indeed.  And instead of the average person looking around and seeing great growth even though the official numbers look bad as described in Kelly's paper...the US will have numbers that look ok, but underneath the surface will be the complete decimation of the average person's wealth and standard of living through inflation.  Meanwhile, the ZIRP will allow all the failed banks to deleverage and exit their positions, as well as allow the Federal Reserve to exit their previous purchases of toxic, worthless assets on unsuspecting people, making the situation even worse for the average person.

In case you haven't figured it out yet...the government is definitely not on our side.

Italy, Cash and the People

In this previous post (Europe and Today) on Nov. 17th, I commented about the Greece and Italian leaders being replaced.  The people replacing them are being called "technocrats" or technical experts in a managerial or administrative position.  Generally, a technocrat is someone who wants the government to be run by academics, scientists, engineers or technology experts vs. politicians, businessmen or economists.
http://en.wikipedia.org/wiki/Technocracy

In this case, Greece is being led now by Lucas Papademos, and Italy by Mario Monti as Prime Ministers.  Not really technocrats as they were both economists and businessmen, but that's what they are calling them because they were academics.
http://en.wikipedia.org/wiki/Mario_Monti
http://en.wikipedia.org/wiki/Papademos

http://www.nytimes.com/2011/11/11/world/europe/greece-and-italy-ask-technocrats-to-find-solution.html?pagewanted=all
http://www.economist.com/node/21538698

I said this in my original post about these two and I'm highlighting three keep points...

"George Papandreou and Silvio Berlusconi were forced to resign in the past two weeks for not getting their fiscal house in order and putting the entire European Union at risk of collapse.  This will not end in my opinion until every country's head of state has been considered "friendly" in helping the EU and the European Central Bank do whatever it is they are trying to do.

The replacement of Berlusconi with Mario Monti is just what I am talking about here.  A politician being replaced by a banker.  The problem with this is that Monti will force the fiscal house to get in order.  What's wrong with that, sounds like that's what they need, right?  Sure, if they want more taxpayer funded bailouts of banks, increased retirement ages, lower social programs, etc.  Banks who should be bankrupt already.  Banks who pay their CEO's millions of dollars (or Euros) to run an already failing business into the ground with more taxpayer funded "loans."  This is what is constituting an "answer" to the problem.  This is no solution, only more problems."

So the first highlight I said that Monti would help the European Union and the European Central Bank do whatever it is they are trying to do.  Well, it should be obvious that the European Union wants to have the Euro currency survive, and the European Central Bank wants what's best for their interests, for the banks to make money and survive.  So at stake is the strength of the Euro and the banks.  The same banks who should be bankrupt already, as my second highlight reflects.  And in order for the Euro currency to survive, both the countries who are causing the "fiscal issues" (i.e. Greece and Italy, right now) need to get their house in order, and the banks need to stay afloat.  So their solution was to put Mario Monti in as PM and help do this.  I said it was no solution, only more problems.

Well, it didn't take long for Monti to get to work.  

“What we need,” Monti told reporters on Dec. 5, “is a revolution in Italians’ thinking.”

1.) Cash caps.

http://www.businessweek.com/magazine/italys-cap-on-cash-payments-12082011.html

On Dec. 4th, Monti instituted a 1,000 Euros (about $1,340) cash cap on all transactions.  So no more going to the store to pay cash for a nice new tv, used car, item at a pawn shop, etc.  All illegal now.  Everything must be done by check, debit card, or credit card.  

Why?  So it's traceable.  You can't collect taxes on cash transactions.  Heck, most governments consider it illegal, nefarious, terrorist behavior to use cash these days.  Well, Italy, who is a very cash oriented country just eliminated larger cash transactions.  Monti's goal...300 Euros as a cap.  Why didn't he do that right away, uprising. He knew people would have a big issue with 300 Euros, so it'll be in steps so people will have "time to adapt to new rules."

Problems with this?

Oh yeah, there's problems.

http://www.bloomberg.com/news/2011-12-22/italy-attempts-to-kick-the-cash-habit-as-monti-cracks-down-on-tax-evaders.html

One issue I immediately see is the near forced use of debit and credit cards.  Sure you can write a check, but who does that any more when you can swipe a card so easily?  So why is debit and credit card use a problem.  Well, the banks charge money for their use.  Debit cards are about 1.00-1.50% of the total, and credit cards are 1.25-3.00%.  They charge the merchant or business this fee to accept them.  This increases the price of items in stores to cover that cost.  How many people have noticed that the price of Diesel for trucks on the highway are $.05-$.07 less per gallon if using cash vs. credit/debit cards?  This is why.  In the future, I would have thought the use of cash again would become the in thing to do as stores picked up on this.  Well, not if the gov't makes it illegal they won't.

There's another issue at hand, and that's the culture of America...borrow, spend, repeat.  

Italy’s tradition of saving won’t be at risk from the new measures, said Nicola Borri, an economics professor at Rome’s LUISS University. “Italians mainly use debit or credit cards with stringent limits,” he said. “Financial instruments that allow you to pile up debt are very limited in this country.”

The bold is mine.  So, Italy already has a culture of fiscal prudence.  But Monti wants, "a revolution in Italian's thinking" more directed to the borrow, spend, repeat American thinking.  We all know how that turned out.  

So as you may be able to see, throughout all of the world's leadership, they want to create more debt and create more money to pay for the financial crisis that was caused by too much debt and too much money.  

2.) Tracking People

http://www.cdt.ch/ticino-e-regioni/cronaca/56250/fiscovelox-riapparsi-no-mai-tolti.html

This is an Italian article (will need to convert using Google translator) that discusses the new "demands for tighter use" of the Fiscovelox (looks like a camera surveillance van) of the Guardia di Finanza at the border of Switzerland to identify possible tax violations and "to prevent the flight of capital abroad."

No comment necessary for that. The goal is clearly said to make sure people don't leave the country with their money.

So here in one month, Italy's Mario Monti has done two things to make sure that Italians will pay the huge debt burden that has been incurred by the gov't in order to help the Euro currency, and to help the insolvent European banks make more money through the use of transaction costs of debit and credit cards.

I see a lot of problems with these two things.  This is what happens in a country that spends too much money that they don't have.  Or has a government that spends too much money that the people don't have.  Eventually, it will fall on the people of that country, and the noose will be tightened.  This is the beginning of what will eventually occur in all major debt burdened countries.  The government's will make the people pay by any means they can.  And who exactly are they paying again?  Who does the government owe money to?  If you remember my previous posts, the financiers (banks, wall street, central banks all around the world, anyone who buys their gov't treasury bonds).  These are all private institutions.  And they are owed money.  They need the government to help collect this money for them, so they put people in power like Monti and Papademos to institute laws and regulations like these to make sure the debt is paid.  If you try and leave the country, they won't let you.  All for the sake of the creditors.

New Day, New Year, New Market??

This is a very interesting start to the new year.  That area that the DOW had to cross in order to prevent that ugly trend was broken.  Why?  I have no idea.  I haven't seen anything in the news that tells me 2012 will be any different than 2011.  I HAVE seen reports of record Christmas gift returns.  How that helps the market improve is beyond me. 

My guess, everybody knows that QE3 or some new stock buying program is coming this year and they are front running.  That or it's an election year and Obama's numbers haven't been good, so make sure the economy looks pretty to get votes.  Again, who knows when markets are manipulated.  We'll see if this gap open holds.  If it does, I say something has definitely changed, but I haven't seen any reason to believe it's because of something real.