Are You Ready for This Coming Disaster?

Last month, everyone thought the punch bowl was going to be taken away.

On June 19, Federal Reserve Chairman Ben Bernanke said he planned to reduce the size of the Fed’s money-printing program (Quantitative Easing) later this year.

But last week, Bernanke backpedaled by pouring a couple bottles of liquor into the punch bowl to keep the party going.

On Wednesday, he suggested that the economy may actually be weaker than he initially thought. For that reason, cutting the size of QE is not a done deal. Heck, Bernanke could still increase the size of the Fed’s money-printing program. He made it clear that all options remain on the table.

The stock market loved it.

But, here’s the bad news…

This party will not end well. Bernanke’s easy-money policy will end up creating another bubble, followed by a crash.

This doesn’t surprise me. The Fed has always had a bias toward easy monetary policy. It tends to keep interest rates too low for way too long, therefore mastering the art of creating booms and busts.

We’ve Seen This Movie Before …

When Alan Greenspan was the Fed chairman in 2001, he kept interest rates below 3% for about four years after the tech bubble burst. Starting in July 2003, he kept the rate at 1% for a full year.

Greenspan’s actions led to a boom in the economy and financial markets between 2003 and 2007.

But, by keeping interest rates below the rate of inflation for a long time, Greenspan planted the seeds of the next bubble. His easy-money policy helped create the housing and credit bubbles.

Bubble Creation 101: Keep Interest Rates Below the Inflation Rate

See larger image

Bernanke is now repeating Greenspan’s mistakes, but on a much larger scale. He’s not only keeping interest rates at 0%, but also printing trillions of dollars.

Bernanke is planting the seeds of the next bubble in a very big way.

With interest rates below the inflation rate, investors feel they have no alternative but to invest in stocks. After all, if they keep money in the bank, inflation will eat away their purchasing power.

That’s why keeping rates below inflation is a surefire way to create speculative bubbles.

Exiting in Baby Steps

It’s clear that interest rates will remain at low levels for a very, very long time. The Fed will remove the stimulus in baby steps because it has no other choice. Any significant moves would send world markets into a tailspin.

First, the Fed will reduce the size of QE. For example, it may print $65 billion a month, instead of the current $85 billion a month. It will likely take at least 12 months before the Fed stops printing money all together – maybe even longer.

And when the money printing finally stops, the Fed will still keep interest rates at zero for a while, just to make sure the economy can stand on its own feet.

Only then – and if everything goes well – will the Fed slowly begin to hike rates.

How Will This Party End?

Well, most bubbles burst when the Fed starts to move rates above the inflation rate. As you can see in the chart above, that’s what happened in 2006.

But, the Fed will only do that when inflation starts to get out of control. We’re not there, yet.

For now, stay invested and make sure you use a trailing stop-loss for all of your positions.

Your best strategy is to keep dancing until the music stops.

Just make sure you’re dancing close to the exit door. Because when the music stops, only those who are prepared to move out of the market quickly will be able to escape the bloodbath.

Regards,

Evaldo Albuquerque
Editor, Retirement Strategist