July 2013 – Market Commentary – You Say Taper, I say Tapir

“What the heck is this Tapir everyone is talking about, and why should I care?” This was a question posed by a guest at a wedding I recently attended in Montreal. The question was posed after I was introduced as an investment advisor to a family friend. We had been joking around so I initially thought I would provide a more humorous response. It got me thinking though, and I would surmise that the average investor has little detail on to this ‘tapir’ every financial pundit is talking about. So, this edition of our market commentary is dedicated to this little creature.

The Dictionary defines Tapir as: “any of several large, stout, three-toed ungulates of the family of Tapiridae, found in Central and South America, the Malay Peninsula and Sumatra, that somewhat resemble swine, and have long flexible snouts. All species are threatened or endangered.”

Ok, some of you just raised an eyebrow (or two). The financial term that has been on everyone’s lips recently is actually “Taper”. It is a verb, referring to making an object gradually smaller to one end. You say taper, I say tapir. Actually, there are similarities between the two.

Let’s step back a little. Back in 2009 when the economy was reeling from the after-effects of the financial crisis, Ben Bernanke the US Federal Reserve (US Fed) Chairman determined that since interest rates were so low (less than 1%) the US could not reasonably continue to lower those rates without other long-term effects. The US Fed decided that instead of lowering interest rates, they would buy long-term bonds. To do this, they would engage in a program called “Quantitative Easing”:

1. Print more money

2. Issue more bonds (borrow) at ultra-low interest rates

3. Buy the bonds they just issued at ultra-low interest rates, using the money they just printed.

The plan was ”brilliant, Brilliant, BRILLIANT!” to quote Yzma, the villainess in Disney’s animated movie “Emperor’s New Groove”. Since 2009, interest rates have remained a) unbelievably, b) unrealistically, c) and most importantly unsustainably low. To ‘fix’ the US economy, the US Fed first lowered interest rates, then launched into Quantitative Easing (or QE). By the end of 2010, when the first round of QE hadn’t worked, the US Fed moved into “QE2”. QE2 refers to a program in which the US Fed would buy $85 Billion worth of bonds every month until the US economy showed signs of life, which would be measured by the unemployment rate falling below a predetermined level.

Let’s recap. Buy lots of bonds, paying next to nothing in interest returns, drive up the price of the bonds by continuing to buy them – inflate your balance sheet. I once went to an auction which is a dangerous thing to do as a novice. I saw something I liked and decided to bid on it. When the auctioneer started the bidding, I put up my hand. The price seemed to be going up and others seemed to by bidding on the same item, so I kept raising my hand. I finally realized that I had been bidding against myself! The auctioneer was a friend of mine and had a good laugh at my expense, and the proceeds of the auction went to a good cause.

This illustration is identical to what the US Fed is doing. Imagine being one of the few buyers of a bond. You keep buying the bond and you tell the entire auction that you are going to buy the bonds, and regardless of the price, you are going to keep buying the bonds. This is essentially what the US Fed has done since November 2010. It has been buying its own bonds and driving the price it pays upwards, which has the effect of keeping interest rates (artificially) low.


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