1. Rodney Johnson President, HS Dent an independent economic research company www.hsdent.com How the Fed Is Changing Our World

2. The World Has Gone Crazy If economic news is bad, the market goes up, and if the economic news is good, the market goes down. Everyone assumes the dollar will fall as the Federal Reserve prints more money. What is the Fed doing, and why?

3. The Problem - Deflation Less spending Falling prices Lower employment Less income Less spending This is AFTER $700 billion in bailout, then $800 billion in stimulus, then $1.25 trillion in Fed purchases, which was increased to $1.4 trillion. We STILL have the hallmarks of deflation!

4. The Fed Solution – Use Tools to Force Spending, Raise Prices Interest rates - Lower rates make borrowing cheaper, lowering bar for ROI, causing payments on mortgaged items to be lower, punishing savers Printed money – adding liquidity frees up credit markets, devalues currency, forces rational decision to buy hard assets or otherwise put dollars at risk, and lowers interest rates on longer maturity government debt, causing entire yield curve to fall

5. Chairman Bernankes Explanation of Quantitative Easing Large increases in bank reserves brought about through central bank loans or purchases of securities are a characteristic feature of the unconventional policy approach known as quantitative easing. The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. Such purchases should in principle both raise asset prices and increase the growth of broad measures of money, which may in turn induce households and businesses to buy nonmoney assets or to spend more on goods and services. In a quantitative-easing regime, the quantity of central bank liabilities (or the quantity of bank reserves, which should vary closely with total liabilities) is sufficient to describe the degree of policy accommodation. Bernanke, 10-08-09, FRB Conference on Key Monetary Policy Developments.

6. Chairman Bernankes Explanation of Quantitative Easing Large increases in bank reserves brought about through central bank loans or purchases of securities are a characteristic feature of the unconventional policy approach known as quantitative easing. The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. Such purchases should in principle both raise asset prices and increase the growth of broad measures of money, which may in turn induce households and businesses to buy nonmoney assets or to spend more on goods and services. In a quantitative-easing regime, the quantity of central bank liabilities (or the quantity of bank reserves, which should vary closely with total liabilities) is sufficient to describe the degree of policy accommodation. Bernanke, 10-08-09, FRB Conference on Key Monetary Policy Developments.

7. We have printed over $1.7 trillion out of thin air, with more to come, effectively betting the country on idea, hope, should, and may !

8. Real Personal Consumption Expenditures January 1995 through June 2010 Missing Growth Source: Bureau of Economic Analysis

9. Real Monthly Retail Sales

10. Unemployment Rate January 1948 – August 2010 Source: US Census Bureau Unemployment Rate

11. Out of Work 6 Months and Longer, as Percentage of Labor Force

12. Ignoring the Facts Government policy is ignoring the situation and motivation of consumers/investors. The individual goal is to repair personal balance sheets, not collect more stuff.

13. Who Spends What in the Economy 2010 Source: U.S. Department of Commerce, Bureau of Economic Analysis

14. 18-22 Single 22-30 Young Married 31-42 Young Family 46-50 Family, College Kids 50+ Empty Nesters 60+ Retired Changes in Spending at each Age & Stage of Life Spending By Age

15. Immigration Adjusted Birth Index Immigration Adjusted Births

16. Household Debt as % of Disposable Income, 1946-2009

17. 30-Year, 10-Year, and Fed Funds January 88 through April 2010

18. Adjusted Monetary Base

19. Data from Federal Reserve Federal Reserve Balance Sheet as of 10/20/10 in $ millions

20. The Trend Lower in Consumer Spending is Here

21. Consumer Metrics - Daily Growth Index Real Time Measure of GDP Source: Consumer Metrics

22. Change in U.S. Debt Outstanding 2000 - 2010 Source: Federal Reserve Flow of Funds Report (FRB Z1), including Domestic Financial Sector

23. The Fed Is Pouring Money In While Borrowers and Lenders are Leaking Money Out Amount of Money in the Economy The Money Supply Fight

24. Outcomes – Desired vs. Actual Wanted – inflation expectations, increased borrowing and spending, falling unemployment, higher wages, asset inflation (reinflation). Got – split prices – deflation in services and real estate, inflation in commodities – local vs. global. Workforce is a local commodity, and oversupplied, price is falling. But global trade makes agribusiness international.

25. Source: Casey Research Select Commodity Prices Oct 2009-2010 Year-Over-Year Change

26. Who Gets Helped, Who Gets Hurt? QE favors real assets, hurts dollars, so the question becomes, what is more important to your household, real dollars (dividends, interest, paycheck) or assets such as stocks, metals, commodities? Assets Income

27. Who Gets Helped, Who Gets Hurt? Wealthy households tend to hold assets, poor households tend to rely on income. While higher food/energy costs might annoy rich households, the increase in their assets more than offsets the price difference. Not so for the poor. Affluent households own more hard assets Modest households rely on earned income

28. Percent of After-Tax Income Spent on Food and Energy by Income Source: U.S. Bureau of Labor Statistics, CEX, 2009

29. The Results Are Painful Food Sellers Grit Teeth, Raise Prices Apparel Makers to Raise Prices Earnings Continue to Climb Despite Higher Costs Oil Rallies, Hitting 6-Month Highs Sugar Near 30-Year Highs Wall Street Expects 5% Bonus Raise All headlines are from the WSJ on November 4, 2010

30. The Fed Is Printing A LOT More Federal Reserve to print an additional $600 billion, bringing total printed to $2.3 trillion since March 2009. Fed will effectively monetize US debt issuance from November 2010 through June 2011… NO NEW TREASURIES!

31. Where Does Money Go In The End? The Fed prints $1.7 trillion, buys MBS, some USTs. Now the Fed uses runoff from MBS to buy more USTs. What happens when USTs mature on the books of the Fed? The answer will hurt your brain.

32. What Happens If Securities Just Mature? In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Federal Reserve mature or are prepaid. Bernanke, 10-08-09, FRB Conference on Key Monetary Policy Developments At the end of each year, all excess monies earned by the Fed are turned over to the US Treasury, and are thereby an offset to US debt. In 2009, the Fed earned over $46 billion, the highest in history. This is a basic forgiveness of debt for the US Govt.

33. Where We Are In an effort to bolster economy, Fed has devalued dollar, pushed food & energy higher, pushed stock market higher, and pushed bond prices higher. The wealthy made more and the poor pay higher prices for necessary goods In the end, US Government will have hundreds of billions if not trillions of dollars of debt forgiven through a central bank accounting maneuver.

34. Rodney Johnson President, HS Dent an independent economic research company www.hsdent.com