NEW YORK (TheStreet) -- I've had a few changes of mind about the Fed.
If I have to choose a sociopolitical label for myself, I'd have to pick libertarian, although some in the Tea Party make me nervous. So I was instinctively against the Fed since QE1, and later QE2. Then as time went on and the inflation I feared never materialized, I began to rethink it.
QE1 was quite necessary, unlike the panic bailouts done by the Paulson administration. QE2 did push inflation expectation to uncomfortable levels and caused worldwide commodity (especially food) inflation, which was an important trigger for the Arab Spring that seriously damaged U.S. interest in the Middle East, probably permanently. But the Fed had its eyes on the ball.
I especially admire Chairman Bernanke, in retrospect, for calling the inflation pressure "transitory" in early April, 2011, which I was guilty of ridiculing at that time. He turned out to be right. Inflation expectation started to come down by the end of April. Maybe he had some pretty darn good forecasting models and he believed it. But in retrospect the five-year inflation expectation never quite reached 2.5%; if it had and stayed there for more than a week or two, he probably would have been forced to do something about it.
Here it is again, my favorite graph, updated.
As the graph shows, Twist 1 and Twist 2 were both done for very good reasons; inflation expectation was dropping and the risk of deflation was clearly outweighing that of inflation. I began to appreciate the importance of balance; Fed had done an excellent job at walking the tight rope. Ray Dalio gave by far the best explanation of this point in his recent interview with the
. If you have any interest in macro-economic issues or macro-investing, it's a must-watch.
Dalio said repeatedly that his biggest concern is losing the balance between deflationary deleveraging and money printing. Sorry, Mr. Dalio, your worst fear just came true, on 9/13/2012.
As I said
, I could not find any rational reason for QE3. But even if you take a more negative bias on reading the economic data, at least you have to agree there's no urgency for QE3.
In the Fed's own words from the announcement, "information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months." Inflation expectation had been going up above 2%; at close of Thursday it surged to 2.27%. Why now? Why not wait for some clear sign of economic weakness before acting? Why switching the focus to unemployment at this point in time?
It is theoretically possible that Bernanke has at his disposal some amazing forecasting model that sees a pending Lehman-class disaster, say Greece or Germany exiting the euro or Spain defaulting, or severe economic slowdown in the near future. Even then it doesn't make any sense to take pre-emptive action for two simple reasons: 1) you just don't know until it actually happens, and 2) pre-emptive disaster prevention before anyone sees the danger has the problem of having nothing to show for your success, by definition. It's economically risky and politically stupid.
Another fact is that the Fed's balance sheet automatically shrinks if they do nothing, as the bonds they hold accrue interest, mature or get pre-paid. But the rate of this shrinkage is only about $10 billion a month. By adding $85 billion a month, as announced for QE3, the Fed's balance sheet will increase $75 billion a month net, indefinitely. Even the most wild-eyed, far-out QE junkie dared not to expect this.
Some may say "indefinitely" also means he can stop any time. True. But the burden of proof for deviating from $40 billion is now very high, especially on the low side, given Bernanke's explicit promise that he will be late rather than early in stopping the stimulus. It's also odd that they didn't even bother to leave some flexibility in schedule, something along the line of "about $40 billion, subject to the committee's discretion taking into consideration any new economic data." No -- $40 billion, period. This is just absurd.
The only rational explanation left is election politics. This is the only factor with a hard expiration date. And it neatly explains the sudden shift of focus to unemployment rate. Remember how everyone was saying that no president gets re-elected when unemployment runs above 8%?
Now this is truly sickening.
I dislike Barack Obama and Mitt Romney equally. It's not about them individually; I'm sure they both are great guys. It's about the party establishment and politicking. As long as it's not George Bush or Sarah Palin.
And I understand the Fed's independence can never be 100%. But there is a meaningful difference between a clandestine lover and a streetwalker; the former pretends to have a sense of shame and tries to protect the partner's ego.
OK, now we got the ranting part taken care of, let's get back to trading. RIP Fed.
In the short term, risk-on seems quite certain. Long gold, e.g., via
SPDR Gold Trust ETF
, stocks, e.g., via
SPDR S&P 500 ETF
, commodities, e.g., via
United States Oil Fund ETF
PowerShares DB Base Metals ETF
PowerShares DB Agriculture ETF
, short USD, e.g., via
PowerShares DB US Dollar Index Bullish ETF
or the bearish version
and long every other major currency.
I was a bit nervous with my speculative gold long before; now I added to it right after the announcement and remain quite comfortable with it. Of all the possibilities I think gold is the safest and purest QE3 play. And this time it's about both inflation risk and the unmitigated lunacy of fiat currency care takers. There may be dips in the short-term; consider them gifts for adding on the cheap.
In the medium term (after election to a year out), I expect inflation to actually take root this time. Even though the U.S. has the most capacity in the world to avoid inflation, we're not immune. As all commodities go up, and import price rising along, we will have to eat the bitter fruit of inflation export.
Nominal GDP may pick up (funny how FOMC predicted slower growth in 2012 but improved growth in 2013, taking into consideration QE3 I suppose) but real GDP may not. It's a long way from lower mortgage rates to more jobs. In fact, if QE has any effect on employment, there must be a time lag of at least four years since we still haven't felt the effect of QE1 yet. Get rid of cash and stock up toilet paper if you must; at least it will hold value better.
In the longer term, I expect QE3 to bring mayhem to our little planet. Commodity inflation, especially food, has a devastating effect on developing world. In the developed world, it polarizes the rich and the poor. Think Arab Spring all over the world. Don't kid yourself, it's not a democracy movement. It's a revolution based on nothing more than raw anger and frustration. Buy guns.
But here's hope Mr. Bernanke gets fired soon. Maybe I should care about the election.
At the time of publication, the author was long gold.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.