“Fed keeps short-term interest rate at 2%”, said yesterday’s big financial headline. Stock market investors loved it. They bid up the Dow 331 points. “The correction is over,” they seemed to say.
The Bernanke team knew it would be damned for sending the U.S. into recession if it raised rates. It knew too that it would be damned for allowing inflation out of its cage if it cut them. So it decided to do nothing.
“Although downside risks to growth remain,” said a Fed spokesman, “the upside risks to inflation are also of significant concern to the committee.”
Here at Markets and Money headquarters we are fans of doing nothing – at least in financial matters. Not spending money, for example, keeps us from going broke. Not investing money often has the same effect. When it comes to money, politics or romance…the sins of omission may cause you to miss opportunities, but the sins of commission get you sent to Hell.
We’ve had our binoculars out for the last couple of days. What we’ve seen is a major correction. Initially, the correction was centered on housing and subprime mortgage finance. Then, it hit stock markets – doing most damage in the go-go markets of the emerging economies. And now, it is leaking into the rest of the financial industry.
“Defaults hurt credit card bonds,” reports the Wall Street Journal. Morgan Stanley is said to “freeze client home equity loans,” adds Bloomberg.
Everything gets corrected eventually. Total debt to GDP reached 230% in 1931. Total debt probably peaked out a couple of years earlier, but by the ’30s, GDP was falling, while the debt had yet to be liquidated – producing a record debt/GDP figure. Then, in the following correction, the ratio collapsed to 50% by the end of WWII.
But the last quarter century has been a great time to be in the financial industry. Everybody wanted to borrow…or to lend. The debt to GDP figure shot back up to near 300%…as the financiers collected their millions in bonuses. But now, another major correction is underway.
Commodities are correcting too. China announced a slowdown in manufacturing last week. This means less demand for oil, iron, copper and the whole complex of resources. So far, they’re down 10-20%. Yesterday, oil lost another $2.83, bringing the price down to $118 a barrel.
Gold, too, took a beating yesterday. It fell $21, to $886. “Will we ever have an opportunity to buy gold below $900,” we asked a few days ago. Now we have our answer – yes. Will we have an opportunity to buy gold below $800? We will have to wait for the answer to that one. But our guess is ‘no.’ Because a bigger correction still lies ahead – a correction of the post-Bretton Woods, dollar-dependent, faith-based monetary system. Stay tuned…
*** We noted yesterday that the Dow stocks are losing money. Taken together, they no longer add value to the economy – they subtract it. The last time this happened, in 1932, proved to be a great buying opportunity.
But now we leave the facts for an opinion…and history for the future. Will 2008 prove to be a great buying opportunity in stocks? We doubt it. Stocks traded as low as 4 or 5 times earnings in ’32 – because the bull market prices had been corrected. Once knocked down, they could get up and dust themselves off. The difference today is that the stock market hasn’t been knocked down yet. So, it can’t get up – it’s already up. In an earlier, less optimistic age, the collapse of earnings caused a selling panic that made stocks cheap. Now, after a quarter century of rising prices…and an almost religious faith in the Federal Reserve…people read the financial news as though it were the summer weather forecast. Yes, it may be cloudy today, but soon the bad weather will pass and it will be sunny again. Stocks are still expensive.
What investors don’t realize is that the seasons change too.
Our guess is that a few pages have been turned on the monetary calendar too. The dollar has seen fairly decent weather since March. “The worst is over,” say the fair-weather forecasters. “It’s clear sailing from here on,” they guess. Then, looking at the decline of gold: “See, I told you so,” they say.
But here at Markets and Money, we treat our dollars like we treat our salads: there’s no sense in saving them. Not that we have a prejudice against the greenback. We feel the same way about the euro. And the pound. It’s all funny money as far as we’re concerned. In a correction, the real cost of things goes down. Because there are fewer people with the desire and the means to buy them. So, we’d expect the price of gold to go up – since it must become more valuable compared to the things it will buy. That is what happened in the Great Depression; Franklin Roosevelt first confiscated all the nation’s gold and then he raised its price 60% – effectively increasing the money supply the same amount.
Paper currencies, meanwhile, are created and managed by people who have a deep loathing for corrections of any sort. These are the people who set the U.S. government on course for a half a trillion dollar budget deficit this year…and who stand ready to spend $300 billion to bail out America’s over-confident mortgage lenders and over-stretched homeowners. They want to prevent a serious correction in the worst possible way. What’s the worst possible way? Ben Bernanke has already described it. He said he would “drop money out of helicopters” if that is what it took.
We don’t expect to see it raining $100 bills anytime soon. But we don’t expect any serious effort to contain inflation either – as evidenced by the Fed’s decision, yesterday, to do nothing. Instead, one way or another, they will do what Roosevelt did; they will lower the price of the dollar.
“Inflation accelerates; growth stagnates,” summarizes Bloomberg.
The country should be listening to the “inflation alert,” says the Wall Street Journal.
The latest official tally puts consumer price increases at 5%. But the Dallas Morning News issues a word of caution:
CPI numbers “may not reflect your family’s reality.”
Inflation is on the rise; it will get worse. As it gets worse, the dollar will fall against gold.
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