By Michael Mccune: The Rant (US Government auditor for 16 years In Cheyenne, WY. -Fed Tapering Threatens Emerging Markets?- (( to Have Michael send you the Rant to your Email contact Him Here (( mccrant@gmail.com))

 Fed Tapering Threatens Emerging Markets

The Federal Reserve does not think of itself as the central banker of the world. However its practices have kept America in economic turmoil for years and promises to hurt the world in the future.

 

By playing fast and loose with the American dollar's real value, the Fed drove capital into emerging markets. It allowed the President to unilaterally expand expenditures on domestic social issues by decreasing the debt service we needed annually and that had been budgeted. The printing press run encouraged unwarranted, speculative investment in emerging market currencies while the U.S. debt millstone grew exponentially.  

 

But now the Fed is openly talking of relaxing its buying spree once again. The shock waves setting in could be the precursor of currency angst not seen in almost two decades.

 

Markets took a turn for the worse when the Fed dropped its bond-buying program from $85 billion each month to $75 billion near the start of the year. Now it looks as though the money wizards are going to trim another $10 billion. This tightening (tapering) by the Fed was well-announced and took nobody by surprise but the markets reacted badly anyway, the DJIA was down 5% in January for instance. 

 

But few have looked to side effects.

 

This tapering means outside private investors who demand some reasonable Return on Investment will be asked to buy bonds so the U.S. bonds will require greater interest rates to attract buyers. This means the long-term outlooks for government expenses will rise, meaning the government will have to raise tax rates or cut spending. The latter doesn't seem to be on anyone's agenda so the debt will rise incrementally faster than before or the economy will take another sharp hit as more discretionary dollars are sent back to Washington instead of being spent.

 

Foreign central banks dumped the U.S. bonds this past week but the dollar held up very well against their respective currencies. These two actions reinforced the notion that the dollar is still the world's benchmark but raised even more warning flags because, knowing our problems, if the dollar is perceived as that much better in foreigners' minds, how bad must their economies really be? It also might mean a long dry spell for emerging markets and their supporters.

 

Foreign currencies were hit hard, but none of the biggest foreigners yet. The shock waves are still flowing out and one of the bigger playing pieces, China, might very well come undone under the pressure.

 

While the Chinese economy has slowed recently, the real cruncher is the shadow-banking crisis looming inside the rigidly controlled state. The details of the shadow-banking system show the it has reached or surpassed the Chinese GDP. This generates a life of its own as the threat of a systemic default rises inside that market no matter how tight the state controls are.

 

The Fed tactic of keeping interest rates low forced investors to look for returns elsewhere-usually the emerging market. But if the Fed goes ahead with its stated intention of another $10 billion per month cut (bringing the monthly average down to $65 billion from the $85 billion it had been at) rates will have to rise in order to attract auction buyers. The markets cannot stand this dollar pullback given the weakening strength of the overall economy. If the government loses the support of the record surge in stock prices, what happens to its highly-publicized "recovery"?

 

Stock analysts have noted 'met revenue expectations' by most American companies for two straight years. The problem now is, looking forward, the companies are projecting declining revenue expectations and the downward revisions that have set the table for the markets' rise by meeting expectations are anticipated to have the 'magnitude of the downward revisions worsen'. If base interest rates on U.S. bonds do rise, how is the President going to continue his proposed domestic program expansion when so many more dollars will have to be diverted into debt service?

 

Seventeen years ago, Asian currencies were devastated when foreign capital investment slowed. They fought back by draining their own foreign reserve holdings to support their currencies (this now means American bonds in many instances.)

 

But when they put their U.S. holdings on the market, who will buy when the ROI is so weak? And those 'For Sale' signs on the U.S. bonds will increase the pressure to raise tax rates because our government is already spending more than it receives. Soon that $17.3 trillion national debt will be squeezing more dollars from the social programs just to fulfill our debt service obligation.

 

But there is a tie-in effect as well. Our market surged with the influx of capital that cost very little while the Fed ran the press. Without this continued support, the market, admittedly over-valued by most economists, will begin to drop towards the bottoms it wanted to get to in 2009 but was forestalled from reaching by the Fed's printing press.

 

In essence, the Fed press covered up the symptoms but didn't cure the disease of over-regulation the economy suffered from in 2008. 

 

This retraction of support will force the markets to seek their bottoms once again. The cries for action will have the Fed once again turning up the speed on its press and inflating its balance sheet. This stop-and-start process will continue until the system collapses on itself for lack of real support.

 

The markets' internal urge to go lower to get the growth fundamentals in shape is still there. Many of the analysts are picking 20-40% as the size of the current market bubble.

  

Outside influence could hasten the dollar's decay. In 1997 Asiatic countries de-pegged their currencies (like America did under Nixon). That combined with deficit government spending and speculative investment helped trigger a market collapse around the globe. 

 

We are not in as good of shape today as we were 17 years ago--witness the insipid State of the Union speech.

 

A pebble tossed against the economic engine machinery today could have the effects of a landslide by 1997 standards. A landside that can only be balanced by another printing press run which can't be continued indefinitely.

 

To paraphrase Hillary Clinton in this economic quagmire, "What does it matter when the dollar is dead if it was done by an out-of-control printing press or an over-reaching government? We still wind up with a broken economic system."

 

True, true. All too true.

 

"I have sworn on the altar of God eternal hostility to every form of tyranny over the mind of man."--Thomas Jefferson