Friday, September 21, 2007

Market talk and gold

I'm hearing and reading a lot of dire predictions about the market and the economy and where it's all heading for in the ominous months and even the year ahead. The forecasts tell us that the housing mess will get messier. After all, just because rates are lower won't make frightened potential home-buyers want to rush in to buy a house. Furthermore, in the past, contracting credit has almost always led to recessions and bear markets -- so what's so different today? Next year it's a given that we're going to be dealing with an epidemic of home foreclosures, and there's nothing bullish about that. No, there's no shortage of bearish forecasts, you can read about "the coming disasters" in every newspaper and financial publication.
In the meantime, Ben S. Bernanke and the Fed crowd have opened up the floodgates of liquidity, while at the same time they've dropped both the Fed Funds and the Discount Rate a full (and surprising) half-percent each.

The Bernanke dilemma -- move fast to avoid a recession -- or attend to the swooning dollar. It's no contest -- the Fed will avoid a recession at all costs. The Fed has justified it's action by announcing that there's little or no danger of inflation, so why worry if we lower rates? To Bernanke, a recession means the possibility of deflation, and deflation is something Bernanke doesn't want in his vocabulary.

But there are problems. One is that the dollar is falling out of bed, and this has to be worrying our foreign friends, who hold tens of billions of securities all denominated in dollars. As the dollar sinks, our overseas friends are taking enormous losses. Should they sell their US holdings, should they stand pat and take it, or should they simply diversify out of dollars and hope for the best?

Question -- suppose the pessimists on the economy prove to be correct -- or even partially correct? The Fed is currently increasing M-3, the broad money supply, at a 14% rate, and if the economy doesn't respond to that, they'll push the M-3 growth rate even higher -- to 15%, 17% or 20%, whatever it takes. They'll also drop interest rates again -- and again. If, despite all the Fed's machinations, the economy doesn't respond, we could easily experience something akin to hyper-inflation as the Fed funds go totally wild.

Ironically, all this is providing the ideal background for gold. For our protection, it's OK to sell dollars and switch into euros or Canadian loonies (dollars), but what if we're moving into a situation which can best be termed competitive devaluations? That's a condition where all fiat currencies tend to lose purchasing power? And what would these various currencies be losing purchasing power against? Currently, the fiat currencies are losing purchasing power against wheat, soy beans, heating oil, gasoline, basic foods such as bread and vegetables along with the cost of utilities, medical care, college tuition. And, of course, fiat currencies have been losing against gold.

he VIX was down 1.45 to a low for the move at 19.00. Stock market heading up -- investors calming down.

Pretty good action for a Friday in a still-nervous stock market. Market is a bit overbought, and now a lot of left-behind investors are waiting for a decline so they can get in. The market, being the ornery mechanism that it is -- won't oblige.


Blogger Ravi kumar said...

This comment has been removed by a blog administrator.

5:12 AM  
Anonymous Anonymous said...

Wow! Thanks, Ravi. I think your english is great to you!

4:52 PM  

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