After QE2, What’s Next?

In our last post about U.S. Quantitative Easing (QE) http://investmentsandbeyond.blogspot.com/2011/06/deadline-june-30th-end-of-quantitative.html, we discussed about the background and actual results of the QE program. We also mentioned about the possible outcomes that might emerge. As anticipated, the Federal Reserve is contemplating on injecting another bout of “money-pumping” program, as evident from Fed Chairman’s testimony to the Congress Financial Services Committee on July 13, “the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support”. Ironically, the same period coincides with crossing the full-limit of U.S. debt ceiling, which needs to be enhanced and pending repayments must be made by August 2.

We can surmise from careful reading of Ben Bernanke’s statement to the Congress that the Fed would somehow and someway (however they name it) come to the rescue of the flat economy with another trillion or so free dollar. The stalled debt talk would reach a synthetic conclusion at the 11^th hour, the U.S. debt would narrowly escape the default. Actually the US government and correspondingly the Fed have no alternative. As Bernanke himself testified before the Congress, “Any U.S. default would be a major crisis and would throw shockwaves through the entire global financial system”. The US economy is being cut by a double-edged sword, on one side, further indebtedness crushing the U.S. dollar further; on the other, the U.S. mandatorily has to borrow more (as the US default would permanently jeopardize the government’s credibility) to repay and to further expand the economy. This is imperative, as in the U.S., where consumer spending accounts for 70 percent of the GDP, without increased consumer spending, the economy would again be recession-bound. And the less people are out of work, the less they consume.

 So, we can fully expect another DILUTION of money. Through the haggling over “money”, by means of endless credit expansion, the government has put the “trust” in money (which acts as a legal tender provided by the state) in serious jeopardy.  Already the ratings agency Moody’s announced it is considering downgrading of U.S. debts. This would further increase the interest rates and the borrowing costs. The increased payment costs would just make the likelihood of pulling out of downward debt-spiral almost impossible.

Another aftershock of this attempt to crush the Dollar would be the fall of housing prices further. According to Gary Shilling, President of A. Gary Shilling and developer of S & P Case/Shiller  Housing Index, we can expect “another big leg-down in housing”, which might trigger serious problems for the economy in 2012. The Bottom Line is: Gary Shilling thinks house prices probably have another 20% to fall.  

The same story holds for European countries, where sovereign indebtedness for lot of countries has gone beyond their actual capacity (i.e. national economic output). For example, Italian Debt-GDP ratio is now 120%, for UK it is 77%. For Japan, it is the highest indebtedness rate of 225%! So, clearly we are heading for a global economic anarchy.

Thus we are witnessing the Dollar fall and inherent reciprocal rises of gold and oil. Bernanke, himself testified, “the rising prices of gold reflects global uncertainties…the reason that people hold gold is as a protection against what we call tail risks: really, really bad outcomes’. As the governments all over the world have become the source of systematic risks by abusing the powers they have been entrusted with: power to spend, borrow, tax and print money. We don’t see any possibility of respite from this vicious cycle in foreseeable future.  Amid these uncertainties, gold is poised to shoot further in price, with the value of $2000 knocking at the door.