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Playing with Fire

Energy Efficiency, Stimulus, Tax Stuff1 comment

I was pretty much like every other 12 year old boy.  I liked fire, explosions, and crashes.  If you think I’m crazy, why are movies sometimes beginning to end filled with the same?  Enough said.  Growing up on the farm there were always plenty of things to burn.  One time I asked my dad if I could burn an old cattle feeder that we no longer used.  No problem.

You never see these things anymore but they were wood structures, like a weekend cabin that could withstand an F4 tornado, except it was all wood, nails and fasteners – solid fuel.  So I loaded it up with 40 or 50 paper feed bags – like the big dog food bags.  This probably would have been enough to get it going and burn it down.  But I’m impatient and I want a big fire.  So I grabbed a milk jug and put some diesel fuel in it and thought, eh, what the heck.  I’ll go half and half with gasoline.  I knew gasoline was risky.

So I sprinkled that all over the pile of paper bags and lit a bag (there was a door on the end about waste high).  I watched the flame creep up the paper until it got into the fuel-soaked portion of the bag.  That started to burn as I watched and then, Fahwoom!  A giant fireball blew up and rolled me back, bass over teakettle like when I was kicked one time by a cow – which may explain my dementia.  Fortunately, I knew I was playing with fire and I was prepared to backpedal real fast.  All I got was singed hair on my arms, knuckles, and eyebrows.  I got what I wanted though!  It was a hell of a fire.

As I mentioned a while back, I’m an efficiency freak, and not just for energy.  I also get riled up regarding economic efficiency and how it could impact our industry.  There are many things that apply the brakes and throw sand in the gears of the economy but I’ll get to that later.

This week, I want to discuss the Federal Reserve (Fed) rather than energy efficiency directly because the stakes are enormous and I think everyone should know what is happening.  For years and years (forever) there has been a lot of concern about the nation’s debt.  Why?  I would guess that 99.9% of Americans think we will need to pay it off sooner or later and that’s going to hurt like a tooth extraction with no painkiller.  If only.

Last week beneath all the election buzz the Fed announced it would buy $600 billion in U.S. Treasuries over the next six or nine months.  This is on top of the $1.3 Trillion it’s already purchased.  These numbers, by the way, are staggeringly incomprehensible.  See what a trillion dollars looks like.   I did a little “measurement and verification” on this and it appears to be fairly accurate.  Furthermore, companies in the U.S. have a total of $800 billion cash on hand.  So in the end, we are talking 2.5x companies’ cash on hand.

What is the Fed?  It’s a mysterious central bank with twelve regional banks run by appointed egg heads who are accountable to no one.  Typically, these people have spent their entire lives in academia, politics, think tanks – i.e., a parallel universe.  They set the federal funds rate – the rate central banks charge one another for overnight loans.  When they talk about cutting or raising interest rates, this is it.  The Fed’s mission is supposed to be monetary stability; to avoid extreme fluctuations in inflation, deflation and the exchange rate of the dollar.  If you have an interest bearing money market fund or certificate of deposit, you already know these interest rates are zero.  Controlling the federal funds rate is all they normally do, but they are now going crazy.

Real lending rates (personal/business loans) for all of us track interest/yield on federal Treasury bonds.  For example, the 30-year mortgage tracks in step with the 10 year Treasury bond (I think).  The 15 year mortgage tracks the 5 year Treasury and so on.  “Real” interest rates are set by the marketplace by buying and selling bonds and other debt.

Never think you can’t lose money in bonds.  Bond prices and interest rates move in opposite directions.  For example, a thousand dollar bond may be issued at 5% interest.  Consider the $50 payout fixed.  In this simple example, it would pay $50 per year in return for your cash and risk.  When interest rates go up to 7%, the value of your bond drops because it’s paying you only $50 per year and the bond price will adjust to reflect the current 7%.  The value of the bond would drop to something probably in the $70s.  The opposite would occur if interest rates drop.

It’s all supply and demand.  If there is tremendous demand for bonds, the bond price is high relative to the interest rate.  Enter the Fed.

The nearly $2 trillion in bonds the fed will own will be purchased with freshly printed money.  They are buying U.S. bonds with funny money.  Why?  To “stimulate” the economy.  By sopping up bonds like crazy, they get very low interest rates.  The borrower (U.S. Treasury) wants to sell bonds with the lowest possible yield and as long as they have the Fed throwing gazillions at them, it’s easy.

Many of you have probably refinanced your homes at unheard of rates lately as a result of this Fed activity.  That’s great and you should do it but don’t for a minute think the ball-peen hammer isn’t coming around.

Here is the risk.  The huge gamble the Fed is making is artificially driving down the cost of borrowing to spur the economy so people buy stuff.  They hope the economy will get going and people will pay taxes to lower the deficit/debt and have money to invest in U.S. bonds, rather than the Fed doing it all with funny money.

Injecting all this cash into the world economy and “monetizing our debt” is driving down the dollar.  Supply and demand.  More dollars floating around, more supply, means the value declines.  All you have to do is watch commodity prices for the results.  Comparing to a year ago:  Gasoline up 10%, Gold up 23%, Silver up 42%, Copper up 27%, Corn up 55%, Soybeans up 22%, Beef up 13%, Cotton up 117%.  Do you think this escalation is due to supply/demand (although cotton, used to make the greenback is really up)?  No.  They are up in large part because of a weak dollar.  It’s inflationary for us.  You can easily find information on rising food prices in case your trip to the store doesn’t do it for you.

A weak currency is good for trade to a certain extent.  A week dollar generally means a strong yen, euro, franc, pound, etc.  Strong currency means people from these countries can buy American goods for cheap because they exchange their highly valued currency for a lot of our currency and buy our stuff.  The opposite is true for us.  Imports are expensive, which also puts upward pressure on inflation.  This is great until the people buying our debt start to squeal.  Go back to that thousand dollar Treasury bond.  If that is purchased with Japanese yen and the dollar subsequently drops 20% against the yen, the Japanese guy is stuck with crappy dollars so when he cashes out, he gets 20% fewer yen than he would without the devaluing.  Or he can just keep his crappy dollars and hope for the best.

So what the fed is doing is very dangerous.  They are devaluing the dollar.  The Fed can’t keep printing money to buy bonds.  Sooner or later the debt will need to be financed with real money from real investors seeking what has been the safest investment on the planet.  Continuing to use printed money, the currency will continue to fall until foreign investors that are buying like 40% of our debt give us the middle digit and pull out.  Then what?!!  Trillions of dollars will be lying about.  Everyone has cashed out and the U.S. dollar won’t be worth anything because nobody wants them and there are gazillions of them.  Compounding the problem, interest rates will go sky high because the Treasury can’t find people to buy their debt that melts faster than a Klondike Bar in downtown Bagdad on a summer day.  Inflating our way out of debt is easy but devastating.

The Fed and the government have to stop treating employers and investors like lab rats.  We are not stupid.  We can see the lunacy.  And they wonder why they can’t “create jobs”.

I’ll be out buying gold bullion at $1,400 an ounce to hide in an undisclosed location.  Once it takes a grocery cart full of cash to buy a loaf of bread, I’ll be able to buy the bakery with an ounce of gold.[1]

Epilogue

There are other very negative consequences of buying debt with printed money.  First, it takes a lot of pressure off free wheeling congress to control the deficit.  Second, what is the Fed going to do with all these bonds that pay extremely low yields once interest rates start rising?  They are going to lose a gazillion dollars selling worthless bonds, that is if the economy ever gets going.  Who will take that hit?  Sounds a bit like Fannie and Freddie to me.  Taxpayers will be stuck with that bag.

Since we lab rats won’t behave like they do in a text book, things may not pick up for years and years.  See Japan which has tried this for what, 20 years?  They have enormous debt.  Government tried to stimulate the economy about a dozen times.  People aren’t spending due to deflation.  Stuff just keeps getting cheaper as they sit on their cash.  This with the Fed’s activity has dropped the value of the dollar by 15% against the yen since April of this year.

U.S. officials are being lectured around the world about these reckless policies.  The death spiral of 2008 was all due to ruthless, evil banks, we are told.  Well the Fed has had interest rates very low for a long time, in addition to congress pushing home ownership onto people who can’t afford them.  We had a stock market bubble in the late 1990s.  A commodity bubble just before the 2008 collapse and the housing bubble just popped.  Another commodity bubble is building and I would say the late stock market run-up is building a bubble as well.  Stocks are rising as companies are improving earnings by slashing costs – laying off people.  This won’t last as companies have limited costs to cut.

When will these people look at past policies and the ensuing results and learn from history, rather than their bogus theories?  The economy is not like physics where there are laws like gravity, speed of sound, and conservation of energy.  The economy has a huge macro human element.  The most accurate prediction of what will happen can be found by looking back at history.  I remember as I sat on the sidelines in the late 1990s while people were paying insane prices for stocks.  Valuations were far, far outside historic norms.  But we were in a different era.  Sure, Sonny.  The NASDAQ composite has gained minus 50% since then.

Thinking hyperinflation could never happen here is short sighted and dangerous.  Nobody imagined 9/11, the submersion of New Orleans, or last summer’s unstoppable oil spill.  The Fed didn’t prevent the 1930s from happening and they won’t stop the next one either.  In response to the 1929 stock market crash and recession, Hoover did exactly what gave us 10 years of misery; raised taxes sharply to cut the deficit and Smoot Hawley to cut off trade with the rest of the world.  We are trending toward the same thing all over again.  HELLO!

Lastly, I’ve said before that we need a strong economy and demand for energy to have a strong EE industry.  We’ve done ok through this recession but no one will care about EE when the dollar isn’t worth the paper it’s printed on, or we spend the rest of my career in a grinding contraction like Japan.

Tidbits

Back in March I railed against daylight savings time because it doesn’t save energy.   National Geographic referenced reports saying the same.  But one study claimed there was savings: The Department of Energy.  The hell you say!  It saves precisely 0.02% total energy consumption.  This reminds me of predicting CO2 levels by viewing 500 year old tree rings.  The reported precision is about 1000X greater than they can possibly measure or calculate with confidence.  I wonder how many millions of dollars somebody got to build a model that would support the answer they pulled out of the air to start with.


[1] Do not construe this as investment advice.  Roll your own dice at the casino of the Federal Reserve.

written by Jeffrey L. Ihnen, P.E., LEED AP

One Comment
  1. [...] I can’t let this pass, because it explains almost exactly what I said about two years ago in Playing with Fire.  The Wall Street Journal opinion writers just penned this: which states the Federal Reserve’s [...]

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