Galland: Major Policy Shift Ahead
by Louis James, Editor, International
by David Galland: Are
ETFs Really Safe?
Note: David Galland, Casey Research partner and managing
editor of The Casey Report, sees a major shift in Federal
Reserve policy ahead and has advice on how to invest accordingly.
Time is short, so we’ve asked David to share his thoughts with us.
David, in recent editorials you’ve warned of what could be an important
shift in Fed policy – can you fill us in?
Sure. The purpose of The
Casey Report is to keep subscribers well positioned in
powerful, long-term trends – the kind of trend that will keep giving
and giving. The trend in precious metals – gold and silver – which
we’ve been heavily recommending for ten years is a good example.
The overarching goal of The Casey Report is first and foremost
to identify those critical larger trends and then closely monitor
them until they play out – which is another way of saying that we
aren’t big about market timing or jumping in and out of trades.
I mention this to set the context for the coming shift in Fed policy.
And that context is?
That the shift, and it is imminent, will not change the larger trend,
but it has the potential to be quite disruptive over the short term.
In terms of the larger trends, the fundamentals that have caused
so much pain and economic woe over the last ten years or so remain
intact. If anything, they’ve gotten worse. We’ve gotten currency
debasement, not just in the U.S., but especially in the U.S. dollar,
which is not just any currency, but the world’s reserve currency.
We’ve got a
truly mind-boggling expansion of the reach of government into all
aspects of society and the economy, with all that that implies in
terms of regulation, taxation, controls over investments and finance,
impact on personal liberty, and so forth. By recognizing this destructive
trend for what it is, investors can position themselves to avoid
the worst, and to profit by betting on things like the continuing
debasement of the dollar.
So that’s the
There is growing
evidence that in the next month or two, we will head into a very
dangerous period. The Fed has been extremely supportive of the U.S.
government’s insane spending, polluting its own balance sheet by
buying up toxic loans by the hundreds of billions and by pumping
enormous quantities of cash into the money supply.
You don’t have
to look very hard to understand why we have seen some small recovery
in the economy, much of which has been driven by the financial sector
that has been the recipient of so much largess – it was bought and
paid for by the government, working hand in glove with the Fed.
But there is
about to be a fundamental change in this arrangement. It appears
that the Fed has decided that it’s time to take a step back from
its monetization – or quantitative easing (QE), as they now term
it – in the hopes that the market will step in to fill the large
gap it will leave.
know how that’s going to work out, but if they don’t stop pumping
money into the economy, they never will know if the quantitative
easing has worked.
Based on a
lot of statements from a number of the voting members of the Federal
Open Market Committee, the change just ahead is that they are serious
about stopping QE in June.
As they won’t
wait until the last minute to confirm the end of their Treasury
buying, I would expect their intentions to be made clear following
their end-of-April meeting, the full minutes of which should be
released in early May.
To be clear, do you mean no QE3, or that they cancel the portion
of QE2 they haven’t spent yet?
They may leave themselves a bit of wiggle room by holding back some
of the funds slated to be spent as part of QE2, in the hopes of
demonstrating a high level of confidence in their decision to stop
also give them a bit of powder to use should the need suddenly arise,
without exceeding the mandate of QE2. The important point is that
I am increasingly sure they won’t just roll out QE3, and that will
Are you saying, no QE3 at all?
No. I think there will be a QE3, but it won’t materialize until
after a relatively lengthy period during which the Fed stands aside
in order to give the market the opportunity to adapt and adjust
to their exit from the Treasury auctions. In other words, once they
stop, I wouldn’t anticipate them jumping right back in at the first
sign of trouble – say, if the stock market crashes.
In time, however,
as the ponderous problems weighing on the economy come back to the
fore and return the economy to its knees, the Fed will be forced
to reinstitute the monetization, though they will likely try to
come up with a moniker other than quantitative easing to describe
You’re as cheerful as Doug. Why are you so sure there will be a
Because the problems that made the economy stumble in 2008 have
not been solved. As I said before, most have gotten worse. Have
the impossible levels of sovereign debt and trillions in unresolved
bad mortgages embedded in the balance sheets of Fannie, Freddie,
the Zombie Banks and even the Fed been resolved? Hardly.
Is there any
real sign coming out of Washington that the deficits will be substantively
tackled? You don’t have to be as active a skeptic as I to understand
that the deepest spending cuts being discussed don’t even scratch
the surface of the $1.5 to $2 trillion deficit. As for the $60 trillion
or so in debt and unfunded obligations, forget about it.
The U.S. government
and the governments of most large nation-states are fundamentally
bankrupt. In time, they will have to default on their obligations.
While there will be some overt defaults, I expect most of them to
follow the path of least resistance, which is to try to inflate
the problem away. And that means QE3.
For now, however,
the Fed will claim victory over the economic crisis and follow suit
with many other central banks – switching to a less accommodative
They’ve done their job and now it’s time for back-slapping and cigars.
If you look at a chart
of the dollar, you’ll see that it has been bumping along the
bottom recently. Logically, if the Fed stops monetizing the Treasury’s
spending, we should see a rebound in the dollar. The big traders
– the big institutional money out there – are going to use the change
in Fed policy as a clear signal that it’s safe to get back in the
It would be
wrong to underestimate the amount of money that needs to find a
home, and the liquidity advantages offered by the U.S. Treasury
market. If the river of money redirects into Treasuries, it could
– at least for a time – offset the Fed’s exit and push the dollar
up, maybe significantly so. And if the dollar comes roaring back,
commodities, including gold and silver, would likely take a fairly
is a short-term view. The longer-term trend for the precious metals
is absolutely intact, because the fundamentals are entrenched –
namely that the sovereign debt and spending is out of control, and
Let’s talk about that for a moment. These people – the big money
– are financial types. Bankers. They know about all the bad debt
they have, even if the ever-so-convenient new reporting rules allow
them to keep some of their problems off the books. They must know
that a so-called jobless recovery is not a recovery.
They are well
aware of all sorts of dirt they don’t discuss in public – how could
they be stupid enough to let the Fed convince them the economy is
healthy when their own information tells them it isn’t?
First off, “they” are not one guy. They are a lot of people with
a lot of different perspectives and a lot of different objectives.
Right now, for example, people look at the lack of yields in bonds
and the potential for inflation in bonds, so they’ve been easing
back on bonds and getting into equities more, in the hope of generating
some kind of return.
If you’re a
fund manager or a large institutional trader, you’re not paid to
sit on your hands. You’ve got to “do something,” even though there
are times – and I think this is one of those times – when doing
nothing is exactly the right thing to do. So, I wouldn’t say they
are being stupid–
Doug would: “An unwitting tendency toward self-destruction.”
Yes, he would – but these guys are not stupid; it's rather that
they’ve made their own calculations and concluded that U.S. equities
are still safe – a position that is supported by the very low levels
of volatility. Even the troubled financials have seen strong gains
of late, even though nothing has been fixed. Of course, if you look
under the hood, you find they’ve benefited substantially from the
cheap money and rigged deals the government has orchestrated to
bail them out.
While no one
can say when the shift out of equities and back into Treasuries
and lower-risk assets will begin, in my view the Fed’s exit from
quantitative easing sets the stage for that to happen. After that,
it will just be a matter of time before traders are going to wake
up and decide equities are not safe, and they’ll start leaving in
that the stock market and the economy are by nature very complex
systems. There are so many variables, you just can’t know which
variable is going to rule the day at any given time. But given the
importance of the Fed’s intervention and the government spending
that has helped engender, its policy shift is certainly a variable
to keep an eye on.
I find the capacity of bankrupt financial companies to defy gravity
truly amazing. Disbelief sustained for such lengths of time makes
You’re not alone. The vast ocean of bad debt out there is just as
big as ever. Everything I hear from people in the financial industry
is that the banks’ debt profiles are not getting any better. People
are not getting on top of their debts. They are not paying down
their mortgages. Default rates are still astronomical…
How could it be otherwise? Unemployment is still high.
Unemployment is still stubbornly very high, though if you
buy into the government’s figures, it is moving steadily in the
right direction. Of course, the government has no reservations about
jiggering the data to suit itself. That makes it important – if
you want to get a more realistic picture – to look at the topic
from different angles.
statistic is unemployment as a percentage of the employable population,
which screens out many of the government’s self-serving adjustments
to its official figures. Looked at that way, you can see that unemployment
is continuing to rise, even though the government is reporting that
it’s falling markedly.
No! You can’t be suggesting good old Uncle Sam would lie to us…
You could say we have another deficit, one in government accountability.
Clearly, it’s very politically important that unemployment
be perceived as declining, therefore, voilŕ, it is.
“Alas, Bartleby.” Okay, let’s back up a bit to the debasement of
the dollar. You mentioned that as a given, almost in passing, but
there are a lot of people who don’t see it. Inflation is low, Uncle
Sam assures us, so the dollar has not been debased. Q.E.D.
Well, anyone who can see beyond the tip of their nose can see that
inflation is going up. Just pull up a chart
of the CRB Index for commodities – the real stuff required for
life – and one can see it has been on a steep upwards trajectory.
Inflation is very much here and alive.
John Williams’ Shadow
Stats chart shows inflation at nearly 10%, while the Bureau
of Labor Statistics is reporting 2.1%.
But even Williams’
statistics don’t report real inflation; they just report what it
would be if the government reported inflation the way it used to,
before it started “improving” its reporting in the 1980s. It’s still
an incomplete view, because the government’s original reporting
was flawed to begin with.
Right. And one of those flaws is the way they weigh housing. It
plays a big, big role in CPI, and in 2008 housing was dealt, if
not a death blow, at least a blow that put it in the hospital. And
it will be there for a very long time, because government policies
encouraged bad decisions on the part of both lenders and borrowers.
This has left trillions of dollars of bad debt hanging out there.
of housing prices, as a component of official CPI, pulls the official
inflation figures down, even though those figures don’t sync up
with the actual cost of living. Of course, a low CPI gives the government
cover for continuing to monetize its debt.
What inflation problem?
The net of this for inflation is that the crushing of the housing
sector makes the CPI drop, making it look like life is getting cheaper,
whereas the reality is that people’s hard-earned wealth put into
real property has taken a beating at the same time as the things
they consume on a daily basis cost more. Life has gotten a lot more
expensive even as savings have been wiped out. Not good.
Right. And the government is trying to get people to ignore the
signs of inflation, saying everything is all right. But recently,
several Fed governors have been saying outright that there is a
problem and that they need to cool off the money creation and start
dealing with inflation. This is why I think there isn’t going to
be an immediate QE3.
So, what happens next?
Consider Japan as an example of an advanced economy that has been
struggling to deal with the aftereffects of a collapsed bubble in
real estate and stocks for many years – well before the recent earthquake.
If you look
at what happened when they did their equivalent of QE after
the initial stock market crash, the spending stimulated a fairly
significant recovery in Japanese equities, taking the market back
up about halfway to the bubble’s top; but the rally didn’t last.
Once the Japanese
government put an end to its quantitative easing, the Nikkei plummeted.
The government resisted reinstating quantitative easing for two
years before throwing in the towel and once again cranking up the
money engines in an attempt to break the economy out of the doldrums.
result is a Nikkei still well below the crash level (even before
the earthquake), and all the spending has caused Japanese government
debt to rise to 200% of GDP. While no two situations are identical,
I think the U.S. is following a very similar script.
If the Fed decided to hold off on QE3, do you think it could take
as long as two years for them to feel forced back to it, forced
to do something?
It could. It would depend on how sharp the downtick is. There are
so many factors at work here that it’s really unknowable at this
point. Nearer-term, all the signals are that the Fed will hold off
on QE3 at their next meeting. And, as I have tried to make clear,
that will have consequences – for equities, for the dollar, for
the commodities sector.
Can you give those readers not familiar with The Casey Report
some reason to believe your crystal-ball gazing? What’s your track
record with these sorts of predictions?
Well before the current financial storm hit, we were forecasting
that the Fed would begin monetizing the government’s debt, and we
were writing about a credit crisis leading to a currency crisis,
which is exactly what’s happened. We absolutely nailed it, and our
subscribers made a lot of money on some of our recommendations –
and safeguarded a lot of their wealth with others.
That’s true, though back then, before The Casey Report
separated out the big-picture writing from the International
Speculator our portfolio did take a temporary beating – along
with everything else at the end of 2008.
Yes, but everything we said about the debasement of the dollar and
its consequences for gold was borne out. Further, we made a bold
move, counseling people to go a third in gold and gold-related
assets, a third in cash, and a third in other assets that could
do well in an economic crisis. Subscribers who actually followed
this allocation suffered very little in 2008.
Isn’t it a bit contradictory to recommend that people keep 33% of
their wealth in cash, if you think the dollar is being destroyed?
The dollar is being destroyed, as one can see by how much gold,
oil, wheat, cotton or any other number of things one can buy with
it. However, while it’s not dropping day to day and the markets
remain extremely volatile, cash is not a bad thing to hold – especially
in relatively safer currencies, like the Canadian dollar and the
the big trends remain intact. Our question now is what’s going to
happen next, in the short term. And in that context, the Fed’s switch
in policy is a big deal. When you go from the Fed showing up every
week and buying Treasuries, to the Fed stepping back and saying
“No more,” it can send major shock waves through the economy.
So, if the Fed does what you think it will, by June, how do readers
[Laughs] This may not be a popular answer, but I think the correct
answer is that the best thing you can do in the near term is to
increase your cash position. I would be very cautious about moving
into any other asset class at this point, including gold.
You wound me.
I know. Listen, if you own high-quality gold stocks, such as those
you recommend in the International Speculator – companies
that have the goods and can weather the coming storm – you can certainly
just ride right through what’s coming. But if you’re not quite confident
enough to avoid panic selling in a correction, or if you have some
mutts in your portfolio that haven’t performed and you’re not sure
why you own them, I’d get rid of them fairly quickly.
time line on the Fed’s decision is quite near-term. That doesn’t
necessarily mean there would be an immediate stock market crash,
but it certainly would have an effect on the commodities sector.
On the other
hand, as I’ve said, markets are complex. Saudi Arabia could go up
in flames, sending oil and gold both way up. So I’m not telling
anyone to get out of the markets. There’s no way to predict such
events – but what we do feel confident about predicting is that
the Fed will not roll right into QE3.
Agreed. And if you’re wrong, having cash to deploy into new opportunities
won’t be a bad thing. Anything else?
If you’re of a mind to play in the currency markets, you could take
a leverage bet on the dollar rising against competitive currencies.
But right now, personally, I’m inclined to do nothing, except maybe
to lighten up on some investments and go to cash.
That sets you
up for the real play. If I’m right, and commodities – including
precious metals – sell off, and mining stocks sell off even more,
there will be some fantastic opportunities to take advantage of.
The people who are paying attention will be able to clean up.
Now you’re singing my song: short-term cash, and get your shopping
That’s the way I see it.
Okay then, thanks for your predictions – I look forward to seeing
how they bear out.
It was fun. We should do this again sometime.
I’m sure Doug won’t mind, especially when you get a strong sense
of where the markets are going, like this one.
Until next time, then.
is one of the editors of The Casey Report – a monthly
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April 20, 2011
is the managing editor of Casey
© 2011 Casey