The money torrent

Why this money torrent…will last… or won't last.

If the grinning buffoons on CNBC are an indicator of bull market bubble madness, then the market is set to soar higher.

But by the same token, the grinning buffoons are just as much a sign to tread carefully with this market too.

Seriously, we haven't seen so many smiling faces on that business channel since… well, since the last unsustainable price bubble.

The torrent of new money that's about to flood into global markets will push some asset prices higher.

Just beware, don't be fooled into thinking that because the stock market is strong that it'll result in a strong economy.

Right now markets are high. And by that I mean they're high on drugs… money-printing drugs.

High on cheap money. When that happens mistakes are made, more risks are taken, and eventually a lot of money is lost.

An example of how dangerous - but profitable - this rally is was a caption we saw on CNBC this morning. We've searched their video archives to see if we can find the clip, but we've come up blank so far.

Anyway, the gist of the caption was along the lines of, "Why QE3 and QE4 are on the cards." That's not exactly what the caption said, but as I say it was the gist of it.

It's the mania of the quick drug-induced hit. The Fed announces it's going to print money and sure enough stock prices soar, and bond yields collapse… oh, and gold is up over 3%, besting the 2% rise of the US stock markets. And silver is up a whacking 7%!

Now that market participants and central bankers have seen how easy it is to create an asset bubble, guess what, they'll use their powers to try and keep that bubble expanding. Hence QE3 and QE4.

The torrent of cash over the next eight months will likely be followed by another torrent of cash after that. And then another. And another, until as Dave Rovelli at Canaccord Adams told CNBC:

"Eventually we're going to be printing so much money the dollar is going to really go down and everybody's going to try to deflate their currency against us. I just don't know how this could end well."

And that's the position I'm in right now. I'll be honest, trying to figure out every consequence of what's happening right now is making my brain ache. But we'll guess that even the chumps who are creating this mess don't entirely know what the consequences are either - but they're doing it all the same.

What I do know is this one simple fact, if just printing new money was the solution, then why wouldn't you do it all the time? In fact, why would you bother having a productive economy when you could just print free money and give the stuff away?

Of course, based on what the Fed has done with QE2 and the prospects for a QE3 and QE4, it seems as though they are moving closer to that idea.

Forget the economic theory, simple common sense tells you that it's not a sustainable course of action.

Even if you argue that just a little bit of money printing is OK as it helps kick-start the economy ignores the fact that nothing comes for free. Printing money does indeed help some, but it's at the cost of others.

That's how inflation works. It benefits those who get their hands on the money first - the government, banks and Wall Street - and penalises those that get it last or not at all - the average consumer.

And remember, we're not talking about a little bit of money printing here. We're talking about a lot of money printing.

To put it in context, take this quote from the Wall Street Journal:

"In essence, the Fed now will print money to buy as much as $900 billion in U.S. government bonds through June - an amount roughly equal to the government's total projected borrowing needs over that period."

Got that? The Fed will in effect fund the debt requirement of the US government almost single-handedly from now until next June. And what with? With money it has created from thin air.

Although to be clear, the Fed won't buy the securities directly from the US government, the Fed is buying securities from investors on the market and it's those investors - such as pension funds, foreign governments, etc - who will then recycle those newly created dollars into government hands by buying new issues of government debt.

That's why all the talk about the US government cutting spending is just hogwash. Thanks to the Fed it will have an extra $900 billion up its sleeve to blow on wasteful government spending programmes.

In the end, with so much money being created from thin air with nothing to back it up, it will lead to a dangerous inflationary impact on world economies… and not just the US. Don't forget that thanks to the carry trade, the US is exporting its inflation overseas, so that right here in Australia we'll get the full brunt of it.

For the moment hyper-inflation - as in prices rising by hundreds or thousands of per cent each day - is off the cards. Hyper-inflation arrives when individuals become so fearful about the devaluation of their money they rush to get rid of it in exchange for tangible goods or assets as soon as possible.

But what about normal every-day price inflation? The type of gradual inflation you hardly notice, yet which eats away at your wealth and income on a daily basis?

That could and probable will continue.

But what about a new version of stagflation?

If you're not familiar with it, stagflation last did the rounds during the 1970s. It occurs where inflation remains high but the economy doesn't grow with it. The 1970s oil shock didn't help matters as energy prices soared leading to increased prices.

So, what are the odds of a similar scene playing out now? Well, we're not expecting an immediate oil shock, but look at it this way. The monetary devaluation of the US dollar and the knock-on effect of higher commodity prices is likely to see similar pressure on businesses that rely on using those commodities.

And remember, we're not just talking about iron ore and copper. We're talking about commodities such as cotton, corn, sugar and coffee. Consumer driven commodities that you buy and use every day.

Now, if those commodities rise and consumers continue to buy goods and services then the economy will give the impression of growth - even though it's only inflationary growth.

But what if consumers and businesses don't or can't play ball. What if consumers and businesses decide not to go along with the old way of doing things, and they don't leverage themselves or their businesses up to the temples with more debt?

Think about what the majority of Australians, Americans and Europeans are being told right now. They're being told that the global economy is on the ropes - which it is - and that only the government can solve the problem - which it can't - and that if we're not really, really careful then deflation will strike the economy and ruin everything.

Well, considering that consumers and businesses make most of their decisions based on whether they're optimistic or pessimistic about the outlook, you'd hardly say that those were messages that would encourage a consumer to go out and treat themselves, or for a business to invest in capital goods in expectation of an increase in consumer demand.

In fact, it's such an environment where a business or consumer would be more likely to save their money for a rainy day.

Which, considering the higher interest rates in the Australian market is something worth doing. Saving money and paying down debt makes a lot of sense when interest rates are higher and set to move even higher.

But there's the problem for Australia in particular. The monetary inflation from the US is pushing up asset prices and pushing up input costs for businesses and consumers. And because Australia is a resources based economy, consumers aren't seeing the full advantage of higher commodities prices because the Aussie dollar is rising too.

Take copper. Below is a chart from the London Metal Exchange showing how copper has performed this year:

Source: London Metal Exchange

Since January, the price of copper has gained from around USD$7,500 to about USD$8,400 today, or over 12%. Yet when you take the movement of the Australian dollar into account, in Aussie dollar terms the price has only moved from AUD$8,220 to AUD$8,275.

A better gain has been achieved in Aussie dollar terms since July where the gain is around 9%, but the point is the net gain to the Australian commodity prices isn't as great as the rising US dollar price of commodities would have you think.

In addition to that, because commodity prices have risen, the benefit of a strong Aussie dollar to importers is less as well.

If producers of goods have to pay higher prices for commodities that's something they're going to have to try to pass on to consumers.

But if consumers are less willing to buy goods and services because other costs have also risen - such as mortgage repayments and food - then businesses are going to find themselves battling price inflation on the cost of doing business and price deflation from a lack of consumer demand.

You see, this goes to show that the Australian economy isn't as strong as many would have you believe. It only looks like it's strong.

The share prices of Aussie mining companies are going through the roof but just because share prices are going up, it doesn't mean the economy generally, and you specifically, are benefiting from it.

What I'm trying to say - in a round the houses kind of way - is that with interest rates increasing on debt, and higher input costs feeding through to higher prices, the opportunity for companies to increase their profits and for consumers to increase or even maintain their consumption is actually much more limited than many would have you think.

Businesses and consumers are being squeezed. Squeezed by rising interest rates on the one hand, and squeezed by rising costs and rising prices on the other.

And that's only set to get worse. Based on the most recent statement from the Reserve Bank of Australia they seem to have gotten the message that price inflation is out of control and likely to get worse… and based on the noises coming from the US, it seems more money printing is on the way when the Fed has finished its current programme.

It's all mixing up for a stagflationary environment of higher prices than there otherwise would be thanks to inflation, higher costs for businesses thanks to higher commodity prices, and higher interest rates due to the previous two points.

Remember that consumer prices don't necessarily have to rise for it to have a negative impact on the consumer. If monetary inflation is keeping prices higher than they otherwise would be then that's just as bad for the consumer, especially if they are being crippled by higher debt costs.

Companies won't stay around for long if they're selling goods below cost price. But if they can't get commodity prices down because of monetary inflation, their only alternative is to reduce supply and sell goods at a higher price to those that can afford it.

That means the potential for higher unemployment as companies look to cut costs and increase margins any way they can.

But look, to be honest it's anyone's guess what's going to happen next. The whole thing is a mess. And trying to figure out exactly what will happen is nothing more than pure guesswork.

Everything we've described above could be entirely wrong if just one of the scenarios is different to the picture we've painted. However, that's the point we're trying to make.

No-one can pinpoint with 100% accuracy what the ultimate outcome will be. Not us, and most certainly not the US Federal Reserve. But that's what makes everything so scary right now.

The Fed is playing around with the markets based on what it hopes it can achieve but without knowing whether it'll be right or wrong until it's too late. We know the Fed will end up being proven wrong.

But what we don't know for sure is how much damage it will cause before that happens.

There's little doubt the torrent of freshly printed cash has the potential to drive stock and commodity markets much higher.

But it's doing so by increasing the risk for investors the higher these markets go.

You've got to be in it to take advantage of this inflationary madness, but you've also got to make sure you don't get suckered in to the false belief that the rally is built on fundamentals, because it's not.

It's built on nothing more than the inflationary devaluation of the US dollar and the consequent desperation of investors searching for higher returns from higher risk. And it's this excessive risk taking - engineered by the Fed - that will lead to the market's downfall.