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Jim Grant did an interview this morning on CNBC where he argued with Steve Liesman over the success of the Fed’s QE policy.  He summed it all up in one sentence, “The Fed can change how things look, not how they are.”  This statement IS absolutely correct by definition.  I say, “By definition” because if it were not true we would have never made it past mid 2009 without the complete closure of the financial system.

Let me explain this in exactly the same words that I wrote back in late 2008:

The problem is solvency; you cannot solve a solvency problem with more liquidity.  More liquidity can only be created by adding more debt which by definition adds to the solvency problem.  More liquidity can postpone or mask the bankruptcy but it cannot magically make bad debt into good debt.

Without question the problems that led up to 2008 and persist even worse today is “too much” debt, much of this debt is already “bad” with even more “going bad.”

So back to the Fed’s success or lack of with its use of “QE.”  First I’d like to remind you that the word “printing” and QE are absolutely equivalent and interchangeable.  But…if the word “printing” were used from the very beginning we would have had an immediate dollar collapse.  Had the Fed initially told the truth and said, “We will attempt to print our way out of trouble.” Bond yields would have exploded, the dollar would have collapsed, stocks would have collapsed (then exploded in nominal terms) and gold/silver would have added a “zero” to their prices.  What I have simply described here is that we would have hyperinflated from the get go…but we didn’t.  Why?

The simple answer is “derivatives.”  Derivatives and their use have been more important to the Fed and their “financial artists” than any other tool.  Mundane derivatives offer 10 to 1 “leverage,” the more powerful types have 100 to 1 or even more leverage.  In other words, one can push, pull, support, suppress or otherwise “paint” asset prices in whatever manner or “picture” that they’d like by using derivatives with 100 times more force than the “$1” that they start with.  When you add in the fact that the Fed can create unlimited “dollars” and then multiply the dollars by 100, “managing” the overall picture to look however you want becomes a fairly easy task until…

The picture itself is so far from the reality that things don’t make any sense at all.  Or, until the “reality” begins to prove the farce of the picture.  The “reality” such as cars and real estate not selling, municipalities (Detroit) going bankrupt, retirement plans or bank accounts being bailed “in” rather than “out” or the Federal Reserve being forced to purchase ALL debt issued by the Treasury.  This is where we are now.  We are 5 years into a “painted picture for the greater good” (sounds socialist doesn’t it?).

There is just one little fly in the ointment.  Beyond what the powers that be can paint and manipulate is a very real economy that uses some very real assets and goods.  Herein lies the problem and is exactly what Jim Grant was talking about this morning.  Is there inflation in food or energy in the U.S.?  Yes but it has been muted and more easily seen overseas in countries with peripheral currencies like Brazil, India, Egypt etc.  The dollar has been “supported” (by derivatives) and these currencies have fallen versus the dollar by up to 20% over the last couple of years…so whatever inflation that we have seen here in the U.S. has an additional 20% kicker overseas…and is the reason that riots have broken out.  People are ticked because they work hard all day and cannot pay for shelter, food and clothing in even the most basic of fashions.

This “fly in the ointment” of reality can also be seen in the gold market.  Demand has exploded and the price has dropped to levels under where it costs to produce.  No need to scratch your head on this one because the ETF’s, COMEX and LBMA are being drained of their inventories to supply Eastern demand.  Demand not satisfied by these stockpiles has been satisfied by Western central banks leasing gold out.  The good news is that this “supply” is finite and looks to be “dented” enough where Chinese and Indian demand will not be satiated for much longer.

The East will not be satisfied by pieces of paper.  They will not accept a piece of paper that may (probably) be one of 100 others or more that “say” gold ownership on it.  They will only accept the real thing and they want it in hand.  They want no part of “fractional reserve” gold, silver or anything else real for that matter which will ultimately disrupt “the painting” of a pretty economic picture.  As I have said all along, “game over” will arrive when the East attempts to use dollars to purchase gold (real stuff).  When they are either told “no” or “there isn’t any left,” the whole “picture” will evaporate like a hologram with no power source.