The economy: not looking good

We've recently seen the greatest expansion of credit in history. It was a product of Asian and Mid-Eastern countries holding down the value of their currency by creating more of their own money and buying dollars. The Fed got into the act in 2003 when it held down Fed Funds to 1% for month after month. It was a wild expansion of money and credit. Now the party is over.

The US and the economies of the free world run on credit. In the US it now takes six dollars in credit to produce one dollar in Gross National Product. Maybe the biggest problem today is that the banking system has become so traumatized that it is restricting credit. Today "nobody can get a loan," the complete opposite of the situation which existed prior to the housing bust. The danger -- constricting credit will impact heavily on the nation's GDP. If that happens, say hello to a blistering recession.

With credit being restricted, a second and very serious danger surfaces. That danger is asset deflation. The very thought of asset deflation sends chills of fear up Fed chief Ben Bernanke's spine. Credit contraction, asset deflation -- shades of the Great Depression.

What's the antidote for deflation? It's print, print, print. What would gold's reaction be to "print, print, print"? Gold's reaction would be -- rise, rise, rise.

I just received the latest issue (Aug. 18) of Fortune magazine. On the cover is a picture of Meredith Whitney, currently the hottest analyst in the nation (she called the credit meltdown a year ago before anyone else knew what was going on). So what's her verdict now? Here it is, fresh out of Fortune --

"Whereas her peers keep searching for some sort of light at the end of the tunnel, Whitney thinks the tunnel is about to collapse. Bank stock investors will get crushed if they jump back in now, she contends because the banks are facing much bigger credit losses than what they've reported so far. Moreover, Whitney is convinced that the economy is about to sink into an "early 1980s-style" recession that will devastate the 10% of the population that became over-extended during the housing boom. "It feels like I'm at the epicenter of the biggest financial crisis in history," says Whitney.

If the sage Meredith Whitney is correct, the market is probably fated to fall apart. That is, if the stock market has not yet discounted all the bad news she's talking about. So there's always that nagging question -- how much of the bad news has the stock market already discounted?
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Discouraging development from Lowry's -- At yesterday's close Lowry's Selling Pressure Index was at exactly its multi-year high. Major stock market lows have never in the 75-year history of Lowry's occurred within a month of a new high in the Selling Pressure Index.

The best hope for the bulls is that this market will record a final bottom in the October-November period of 2008. The further best hope is that the Dow will be able to register its final low this side of Dow 10,725.

From: DowTheory