Prague Twin

Saturday, September 22, 2007

Now What?

You would have to be living under a rock not to have heard that the Fed cut both the overnight lending rate and the discount rate by a full 50bp (.5%) on Tuesday. Once again I was wrong in my prediction. I really didn't think that they would cut by more than 25bp. This also means that I was wrong when I predicted that the overnight rate would remain at 5.25% until the end of the year. Furthermore, it looks like now I will be proven wrong about my prediction that the Dow would stay between 12K and 14K until the end of the year (14K will likely be broken next week).

Right on cue, the dollar is taking a pounding dropping to an all time low against the Euro ($1.41). This is not only due to the rate cut, but also because Saudi Arabia is talking about dropping its peg to the dollar. More strikingly, the Canadian dollar is now equal to the American dollar for the first time in over 30 years. Meanwhile, gold is at a 30 year high, and oil has set new record levels above $80 per barrel. $100 oil and $800 gold now look to be on the horizon.

It is unclear what all this means for the greater economy, but one thing is for sure: one should really try to avoid making predictions, especially about the future.

King dollar has lost his crown, and the implications of this move I think are clearly that inflation will again lift its ugly head.

What really bothers me is that the Fed is making moves to rescue the financial sector from a crisis that it created all by itself. There is no external factors involved, no emerging market crisis or major default. If an external crisis were to emerge now, there is little the Fed could do to prevent major fallout without jeopardizing the dollar and price stability drastically.

In fact, with this move the Fed has okayed the risk taking by the financial institutions and has sparked a new round of irrational exuberance. The correction will still have to come, and now we can be sure that when it does it will be even more painful than it has to be.

Postscript: Two "small" things I forgot to mention are as follows. Firstly, in all the confusion no one seemed to notice that the U.S. public debt surpassed $9 trillion. I don't remember Congress changing the law to allow for that, but oh well. Secondly, net purchases of U.S. bonds came in at under $20 billion in July down from just under $100 billion in June. With a current account deficit running at nearly $60 billion per month, this is not good.

And of course if you want the full story on the dollar, you really can't beat this post from Econobroser. Be sure to scan the comments as well. Very enlightening.

4 Comments:

  • praguetwin, you wrote:

    "What really bothers me is that the Fed is making moves to rescue the financial sector from a crisis that it created all by itself."

    Says you. Your comment implies that you believe the Fed governors got together and crafted a plan to send the economy careening off into credit oblivion. Obviously no such plan was made.

    You wrote:

    "There is no external factors involved, no emerging market crisis or major default."

    Are you now suggesting the Fed bases its Fed-funds-rate decisions on such powerful factors as the inflation rate in Lithuania?

    You postulated:

    "If an external crisis were to emerge now, there is little the Fed could do to prevent major fallout without jeopardizing the dollar and price stability drastically."

    There's always a path on which the world can go to hell. Interest rates, at worst, are a symptom. Not a cause. Meanwhile, the Fed does not control long-term interest rates. Thus, the rates on Treasury notes and bonds, and mortgage rates reflect the sentiments of millions of investors and home buyers.

    The fact that some people mismanaged their finances is not terribly significant.

    You wrote:

    "In fact, with this move the Fed has okayed the risk taking by the financial institutions and has sparked a new round of irrational exuberance."

    The rate reductions by the Fed offer a small amount of help to financial institutions. But not a lot. When Teaser Mortgage Rates are set at 1% or 2%, and they readjust to market rates, the new Fed rates help -- a little. But the new rates don't turn losers who squandered their house equity into winners with a big financial cushion.

    You wrote:

    "The correction will still have to come, and now we can be sure that when it does it will be even more painful than it has to be."

    News flash! The "correction" is history. The market went from 14,000 to 13,000. That was the correction. Now the Dow is back to 14,000.

    You're waiting and wishing for financial disaster to strike the US. Get over it.

    By Anonymous no_slappz, at 9:12 PM  

  • First point you misunderstood.

    The crisis was created by the financial sector, not the Fed. My apologies for being unclear.

    Second point: no, just saying we have a crisis that was created without external factors such as the Russian default or the SE Asia crisis. Imagine if there was a real crisis.

    I'll get to your other points later.

    By Blogger Praguetwin, at 10:03 AM  

  • praguetwin, you wrote:

    "no, just saying we have a crisis that was created without external factors such as the Russian default or the SE Asia crisis."

    First, so what? Problems, problems, problems, there are always problems. At least a domestic problem might respond to our own self-prescribed treatments.

    Second, there is no crisis. You've been had by a hyperventilating media.

    The stock of Bear Stearns bottomed out around $100 a share. Check it now. North of $125.

    Meanwhile, a takeover of a substantial bank was announced this morning. TD Bank is buying Commerce Bank. No, this is not a government action to minimize the impact of a troubled home-mortgage lender.

    This is a good old takeover. One bank buying another. Why? Because now is a good time to acquire these businesses.

    You pondered:

    "Imagine if there was a real crisis."

    Yes. Imagine if there were a "real crisis."? Obviously you too believe the current hysteria promoted by the wide-eyed members of the uninformed press is something other than "real".

    You should look back at the S&L Crisis of the 1980s and early 1990s. That's a story of a real problem, and one that we rectified brilliantly.

    By Anonymous no_slappz, at 6:20 PM  

  • Ok,

    You know what? Lets just say there is no crisis and everything is just fine. Lets just work with that assumption going forward and see what happens.

    Bear Sterns is at $126 today. That is still a long way off of it's high.

    By Blogger Praguetwin, at 10:24 PM  

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