Picking up pennies in front of steamrollers

The huge moves in the market at the moment are sending a big warning signal to those who are willing to listen.

The threat of a new round of quantitative easing (QEII) by Federal Reserve chairman Ben Bernanke has set off a chain reaction in world markets that can only end in tears. Emerging market economies are being placed under extreme pressure as their currencies appreciate under the weight of hot money looking for a home.

Thailand announced on Tuesday that it will impose a 15 per cent withholding tax on interest and capital gains made by foreign investors on Thai bonds. Export dependent economies like China, Brazil and Japan have been trying to fight back huge flows of capital chasing yield. Brazil last week raised a tax on foreign portfolio inflows into bonds.

Korea has been rumoured to be intervening repeatedly in the currency markets and in the Philippines, government officials are saying that the rise of the peso is a matter of concern.

Australia has even had to react to the flow of money by delaying the raising of interest rates to keep the interest rate differentials between Australia and the USA to a minimum.

Global imbalances are increasing in response to the ridiculous attempts by Bernanke to reflate the system. All he is managing to do by threatening QEII is to force investors to search for a safe haven for their money while Bernanke tries to trash the currency.

Hard assets are of course the desired destination and the huge spike in the Australian dollar and rally in commodity markets are seeing this race accelerate.

Bernanke’s desire is to stoke lending in America and inspire investment and job growth. I assure you that printing money is going to do no such thing.

Long term interest rates in America are at generational lows already and banks are unwilling to lend and consumers and businesses are unwilling to borrow. Lowering the 10-year bond by another half a percentage point is not going to miraculously change this situation.

Instead of inspiring more lending at home it is going to inspire capital flight out of America and into high yielding currencies as is happening right now.

What will be the outcome of commodities going through the roof?

Input costs for businesses are going to go up and disposable income for consumers is going to go down. There is a lack of demand anyway so why would a business invest to increase production when his input costs are going up and he has no pricing power because the end demand is so weak.

Why would a consumer go out and spend when he is paying far more at the petrol pump every week because the price of oil is going through the roof?

Greenspan created the technology bubble and the housing bubble by keeping interest rates artificially low. At least these bubbles made people feel rich. Bernanke is going to create a commodity bubble. A commodity bubble will make the resource companies feel rich, but it will impoverish everyone else. This is not the sort of bubble that Bernanke wants to create.

Who knows when this house of cards is going to come tumbling down but many are starting to talk about QEII as the largest buy the rumour/sell the fact trade that we have seen in years.

My own view is that we are not going to make it to early November and the announcement of QEII before the markets turn and dive.

Do you think that the rest of the world is happy to allow the Fed to ruin their economies with their policies? Do you think Ben is sitting back in his office scratching his beard and wondering what on earth he has done?

I believe the Fed has finally arrived at catch 22. It is damned if it does and damned if it doesn’t.

The best course of action it can take is to step back from QEII and allow the markets to deflate to where they will end up going anyway. But we all know this is not going to happen. Instead we are going to see cracks slowly appearing all over the world and one of those cracks is going to blow wide open and take everyone else down with it.

Will it be Japan with their 200 per cent debt to GDP ratio (caused by years of following the same inane policies that the Fed is about to embark on) or perhaps the PIIGS will start to squeal as the Euro continues to appreciate and their economies fall in a heap. European banks could be brought to their knees by such an outcome as they are so heavily exposed to sovereign bonds of Portugal, Ireland, Italy, Greece and Spain.

There is no doubt we are in the middle of a currency war and I fear that the end result will be the end of Bretton Woods II.

Gold is flying high because the world is finally waking up to the fact that America printing money and monetising its debt is the beginning of the end. Physical demand for gold is going through the roof as the rich hedge their bets by buying a lazy tonne of gold at a time.

Are we going to see the crash of the dollar that was always going to be the end game for the US. Does China stand up to America and threaten to sell their US investments if the Fed doesn’t back off from QEII.

There are so many places where the volcano can erupt. The smoke is billowing out and telling those who will listen to pack up shop and catch the first boat off the island. Most are standing around and saying how pretty the volcano looks while stock prices shoot all over the place and investors convince themselves that there is some easy money to be made before the music stops.

There is an old market saying that is one of my favourites and I think it sums up the current situation perfectly. The market is currently “picking up pennies in front of steamrollers”.

It seems easy to do because the steamrollers are moving so slowly and there are lots of pennies about. But don’t get distracted because one day the steamroller is going to roll right over the top of you!