On His Way Out – Who Will Replace Bernanke?

Ben Bernanke steered the Federal Reserve during some tumultuous times, but the most difficult decisions may yet be ahead: How do you take away the punch bowl without causing a withdrawal whiplash? Well, he may not have to face this problem.

Ben Bernanke’s term as chairman ends on January 13, 2014.

In a TV interview with Charlie Rose, President Obama said that Mr. Bernanke “has already stayed a lot longer than he wanted or he was supposed to.”

The Wall Street Journal reports that many of Mr. Bernanke’s friends and associates say he wants to step down. In January Bernanke will have headed the Federal Reserve for eight years.

The Wall Street Journal continues that “the Obama administration is assembling a short list of candidates to lead the Federal Reserve, in expectation that chairman Bernanke won’t seek reappointment when his second term at the central bank ends.”

Who’s Next?

The White House hasn’t divulged any names, but here are a few names rumored to be in the running (in no particular order):

Janet Yellen, Federal Reserve vice chairwoman and right hand of Mr. Bernanke
Lawrence Summers, U.S. economist and Harvard University professor (more below)
Timothy Geithner, former Treasury Secretary
Roger Ferguson, president and chief executive of TIAA-CREFF
Alan Blinder, former Fed vice chairman and Princeton professor
Christina Romer, former head of Mr. Obama’s Council of Economic Advisers

Charles Ferguson, author of the book (and documentary) Inside Job describes Larry Summers as: “a compromised man who owes most of his fortune and much of his political success to the financial services industry, and who was involved in some of the most disastrous economic policy decisions of the past half century. In the Obama administration, Summers opposed strong measures to sanction bankers or curtail their income.”

Summers served as Bill Clinton’s Treasury Secretary where he oversaw passages of the Gramm-Leach-Bliley Act. This act paved the way for many of the mergers that created too big to fail banks.

Based on his resume, Summers would be best suited to continue the Fed’s course of coddling Wall Street.

Gold’s Performance Tells Bernanke ‘QE is Not Infallible!’

The Federal Reserve has become somewhat of a financial super hero. Sure, it’s not acting in everyone’s best interest (unless you’re a big bank), but it has the air of invincibility. But invincibility is a fickle thing and gold is showing Bernanke how fast it can be lost.

When looking at various markets, I often search for investment themes or trades that seem too obvious. Why? If it’s too obvious, it’s obviously wrong.

One of the obvious beliefs today is the power of the Fed to control markets. It has become a foregone conclusion that Fed stimulus lifts stocks. The only concern is when the Federal Reserve will start withdrawing the punchbowl.

Two recent events show that central banks are not the all-powerful and infallible entities they’re cracked up to be:

1) Despite Japan’s historic stimulus, the Nikkei dropped 23% in eleven days. That’s not what “Abenomics” was supposed to look like.

2) Gold prices plummeted over 30% (including the worst meltdown in decades) at a time when central banks were buying the yellow metal at record pace.

Not as an immediate forecast, but as a general investment lesson we should review the sentiment leading up to gold’s all-time high. I will use media headlines to chronicle the ‘great gold rush’ of 2011.

ABC News: Gold Rush also A Boon for the Refinery Biz – August 10
Bloomberg: Gold Exceeds $1,800 as Investors Seek to Hold the ‘Ultimate Collateral’ – August 10
Forbes: Jim Rogers Says Gold Going Higher – August 10
Forbes: Gold at $1,870 is Being Seen as a Haven – August 22
TheStreet.com: Wait to Buy Gold at a Pull Back – August 22
Beacon Equity Research: Gold Price Poised to go Parabolic – August 22
MoneyControl.com: Gold in Portfolio is Mandatory – August 22
Barron’s: Is $5,000/ounce the New Target in Gold’s Run? – August 22
Chicago Times: The Gold Rush is On Again – August 26
BusinessWeek: Gold Not in a Bubble as Central Banks Print Cash, Faber – September 6
Reuters: Hard Hit Gold Bulls Not Yet Out For The Count – September 26

On August 26, 2011, the SPDR Gold ETF (GLD) becomes largest ETF with $77.9 billion in assets.

The reasons for gold to rally and continue rallying were seemingly endless:

• Gold is a protection against inflation
• Somehow gold is also viewed as protection against deflation
• Gold is a safe haven during stock market meltdowns
• Somehow gold also rallies when stocks rally
• Central banks are buying gold, so should mom and pop
• Gold is the only real collateral in a QE world

Despite all the bullish rationale for higher gold prices, there were even more compelling reasons to avoid the hype. Throughout August and September 2011, I warned subscribers multiple times about the eventual pain ahead:

August 10, 2011: “Gold is extremely stretched and trading significantly above its upper Bollinger Band. Any break in the armor could lead to a scary and unexpected decline.”

August 21, 2011: “I don’t know how much higher gold will spike, but I’m pretty sure it will ‘melt down’ faster than its melting up. Resistance is at 1,915 – 1,975.”

August 24, 2011: “Even though gold is the logical fear trade, price action is also dictated by liquidity. At some point investors will have to sell holdings to pay off debt or answer margin calls. Commonly the most profitable asset is sold first. Gold has been the best performing asset for a decade and a liquidity crunch could produce sellers en masse.”

The moral of the story is that even deeply entrenched convictions are eventually overthrown by ‘unexpected’ events that should have been expected simply because they were so unexpected.

PS: Remember Apple.

Banks – More Money Doesn’t Buy Smarter Decisions

Believe it or not, the Federal Reserve is creating some ‘serious’ problems for big banks. JPMorgan’s CEO Jamie Dimon and BlackRock’s CEO Larry Fink explain the catch 22 situation, and former Federal Reserve Chairman Volcker offers some poignant words of wisdom for Bernanke.

U.S. banks earned $40.3 billion in the first quarter of 2013. That is more than at any other time in history.

For greedy banksters that’s a problem. What to do with all the money? According to JPMorgan Chase CEO Jamie Dimon, there aren’t many good options to put the money to work.

Dimon threatens that banks may just sit on their cash and do nothing.

We know what banks aren’t doing. They aren’t putting any money away for a rainy day. Based on FDIC data, ‘rainy day reserves’ are at a 6-year low.

BlackRock’s CEO – Larry Fink – isn’t worried about future risks either. Fink said on CNBC that the bull market may well continue another five to six years and drive the Dow as high as 28,000.

If there’s anyone you can trust, it’s Fink. With some $4 trillion under management, his firm is the largest asset manager in the world and he surely has no incentive to talk stocks up, right?

Of course banks’ ‘big problems’ are caused by their biggest ally and protector – the Federal Reserve. Without QE (quantitative easing) banks wouldn’t be flush with cash, they’d probably still try to recover from their crash.

Paul Volcker, Federal Reserve Chairman from 1979 – 1987, offered at few disguised words of wisdom for Bernanke at the Economic Club of New York.

• The Federal Reserves basic responsibility is for a “stable currency.” Asked about the dual mandate, Volcker said: “I find that mandate both operationally confusing and ultimately illusory.”
• Is the Federal Reserve squandering its credibility: According to Volcker, “Credibility is an enormous asset. Once earned, it must not be frittered away by yielding to the notion that a little inflation right now is a good a thing, a good thing to release animal spirits and to pep up investment.”
• What about inflation and the Federal Reserve’s ability to control inflation: “The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives. All experience demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse.”
• Will there be a tipping point for Fed policy to stop working: “The Federal Reserve, any central bank, should not be asked to do too much to undertake responsibilities that it cannot responsibly meet with its appropriately limited powers.”
• More Wisdom about the Fed’s limits: “Asked to do too much, for instance to accommodate misguided fiscal policies, to deal with structural imbalances, to square continuously the hypothetical circles of stability, growth and full employment, then it will inevitably fall short,” Volcker said. Those efforts cause it to lose “sight of its basic responsibility for price stability, a matter that is within the range of its influence.”

To sum up: Bank executives fear of risk is drowned by too much cash and greed. They will find ways to make more money, riskier ways, which will cause more pain and less gain in the end. According to ex Fed Chairman Volcker, the Fed may soon be unable to enable.

Operation Twist about to Expire – Will it be Replaced by Outright QE?

The Federal Reserve’s $45 billion a month Operation Twist program is scheduled to expire at the end of this month. Based on the sound bites of several Reserve presidents, there will be a replacement. Will it be more outright QE?

Operation Twist is circling the drain, set to expire on December 31, 2012.

Will Operation Twist be extended or even be replaced by outright QE?

What’s the difference between Operation Twist and Quantitative Easing (QE)?

Operation Twist Basics

Since September 2011, the Federal Reserve has been buying about $45 billion of longer-term Treasuries per month with the proceeds from sales of a like amount of shorter-term debt.

Unlike outright QE purchases, the Operation Twist asset reshuffle does not add to the Fed’s balance sheet.

Will Operation Twist be Replaced by Outright QE?

Boston Federal Reserve Bank president Eric Rosengren, one of the most vocal proponents of Fed asset purchases, advocates to continue spending $45 billion a month buying long-term Treasuries.

St. Lois Federal Reserve Bank president James Bullard has a different opinion. He said that the expiring Operation Twist program should not be replaced on a dollar-for-dollar bases, because asset purchases that expand the balance sheet (like QE) have a bigger effect than Twist.

QE Tally

So far the Federal Reserve has purchased about $2.4 trillion worth of government bonds and mortgage-backed securities.

During QE1, the Fed spent about $78 billion a month.

During QE2, the Fed spent about $75 billion a month.

During QE3, the Fed is spending about $40 billion a month.

Concurrent to QE2 and QE3 the Fed is reinvesting the proceeds of maturing securities. Based on a balance sheet of $2.4 trillion, this is a significant amount.
Abount $25 billion a month.

For the month of December, the Fed will spend about $65 billion buying Treasuries and mortgage-backed securities. This is “new” money.

An additional $45 billion of the proceeds from selling short-term Treasuries is re-invested in long-term Treasuries.

QE’s Effect on Treasury Prices

What does all of this artificial demand for long-term Treasuries mean for Treasury prices and corresponding ETFs like the iShares Barclays 20+ year Treasury Bond ETF (TLT)? It appears that the effect of QE3 on Treasury prices has been muted. It certainly hasn’t driven prices up as should be expected.

In fact, 30-year Treasury prices have been stuck in a trading range capped by two long-term resistance lines and buoyed by an 18-month support line. As long as prices remain in that range the stalemate is likely to continue.

With strong seasonality for stocks straight ahead (and an inverse correlation between stocks and long-term Treasuries), I assume that price will break down.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

News Flash: Is Bernanke Going to Throw in the Towel?

Abstract: Former president George W. Bush first appointed Ben Bernanke to run the U.S. central bank on February 1, 2006. President Obama confirmed a second term on January 28, 2010. But latest news suggests that Bernanke is done.

The New York Times reports that Federal Reserve Chairman Ben Bernanke has told close friends he probably will not stand for a third term.

Mitt Romney has made no secret that he would not re-nominate Bernanke if he wins the presidency, but it’s news that Bernanke told friends he wouldn’t go for a third term even if president Obama gets re-elected.

The Fed and the White House declined to comment and Bernanke’s own words from a new conference last month are ambiguous: “I am very focused on my work, I don’t have any decision or any information to give you on my personal plans.”

Bernanke’s term as chairman ends in January 2014.

Treasury Secretary Timothy Geithner already stated that he wants to leave by the end of the year.

Why would Bernanke and Geithner want to leave their prestigious jobs?

Here’s my opinion: Bernanke and Geithner are the center of the financial world. They know exactly what’s going on and what the Federal Reserve can and cannot do.

They know how many skeletons banks (corresponding ETF: SPDR S&P Bank ETF – KBE) and financial institutions (corresponding ETF: Financial Select Sector SPDR – XLF) have in their closets.

They know how good or bad the shape of the European financial system is in and realize the implications of the growing U.S. deficit.

The U.S. economy has hit an iceberg. The Federal Reserve’s “pumps are pumping as hard as they can,” but the ship is still taking in too much water. It’s just a matter of time for the inevitable to occur. Who wants to be the captain of a sinking ship?

But does leaving a ship – damaged but afloat – relieve the captain of his accountability? Perhaps we should ask Alan Greenspan.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.