Capital Ideas Newsletters


Ex Nihilo

July/August 2010

“Ex Nihilo” means “out of nothing” in Latin… It is just what the Federal Reserve will have to do — create money out of nothing. They do this through quantitative easing, a phrase you may have heard but may not understand. In practical terms, the central bank purchases financial assets (mostly short term), including government paper and corporate bonds, from financial institutions (such as banks) using money it has created “ex nihilo.”

Normally, the central bank increases the money supply in the economy indirectly by lowering the discount rate on reserve requirements. But when it cannot lower rates any further, it can attempt to seed the financial system with new money through quantitative easing, otherwise known as “printing money.” Because economic stimulus will probably be required for some time, “printing money,” we believe, will be happening for quite awhile.

Nevertheless, the economy is in a good news/bad news phase. One day we trade based on fear and deflation, and the next on greed and inflation. Mohamed El-Erian of Pimco said recently, “We are on a journey to an unknown destination at an unknown speed over an uneven road and we have already used our spare tire.”

This is clearly a grim view of where we are, but to me, it also speaks to the lack of leadership in this country. Leaders are supposed to paint a vision of where a country should be going, build consensus, and then implement policy to get us there.

Do they know the questions to be asked? If we are to reduce spending, should we be fighting in Iraq and Afghanistan? Is the economic imperative the most important issue for our country’s strength or is it the military? Will the social fabric of our country crumble if the middle class continues to get squeezed? Is the rule of law being upheld? Is everyone really paying their fair share of taxes?

We believe that the corporate profit recovery is real, but one cannot expect that this recovery will be like those in the past. The drag of huge public debt will keep this recovery from creating jobs quickly. Therefore, unemployment is likely to stay at stubbornly high levels and corporations will be slow to hire — why create overhead?

The stock market can do better “slowly,” but watch for signals surrounding the November elections. Success for the Republicans could mean a better market and the beginning of rougher sledding for this administration.

Keep focused on your needs and game plan.

Remember that the economy is still in a deleveraging phase, and painful corrections may take place along the path to “the new normal.”

Patience has its limits. Take it too far, and it’s cowardice. The politicians have run out of time — action is needed.

Just remember, success comes to those who say “I can make it happen!”

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