Bernanke to the Rescue...Watch out!

“As the market began to buckle at the knees in late July, certain CNBC commentators and other observers of the financial world began to howl like whipped dogs for a rate cut. Specifically, they wanted the Federal Reserve to cut the federal funds rate target, a key interest rate from which many other interest rates take their cue.

“The thinking goes that a rate cut would help the stock market and everyone would make money again. Crisis averted. Finger in the dike and all of that. But as financial analyst Michael Belkin recently noted, ‘The consensus is 100% convinced that the Fed rate cuts are always bullish (don’t fight the Fed, blah, blah, blah). But the data say otherwise.’

“Ah, the data. Yes, there is the little matter of looking to see what actually happened the last time the Fed began cutting rates. This involves some minimal work. Most of the blowhards on TV would rather stick needles in their eyes or swallow live goldfish. But if you just look at the last set of rate cuts, you dig out a rather stunning picture.”

Chris Mayer
September 28, 2007

Keep reading today’s guest essay here:

Bernanke to the Rescue…Watch Out!

Now over to Short Fuse reporting from Southern California…

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Views from the Fuse:

Ah, remember the good old days, when we were analyzing Greenspan’s every move…deciphering every word he did (or didn’t) speak? Now it seems like he simply can’t stop talking…

In an interview on BBC Radio 4 today, the former Fed chief said, “The danger of recession has obviously risen.”

No big shock there…anyone looking at today’s headlines could figure that one out. Today comes news that the dollar index is just a bit above the all-time low of 78.19.

“I’m not a chartist, nor do I play one on TV,” wrote Chuck Butler in this morning’s Daily Pfennig, “but I believe a break below this all-time low is not a good thing.”

Well, it is good for all of you smarty-pants out there who have heeded our advice and are holding onto gold. As the greenback continues its tumble against 14 of the 16 major currencies this quarter, gold is still sitting around $740.

Things aren’t looking too terrible for the rest of the commodity sector either – well, unless you are trying to buy groceries, that is.

“Illinois corn and soybeans are up 40% and 75% from a year ago. Kansas wheat is up more than 70%. In Georgia, three-pound chickens go for record prices, up 15% from a year ago. A pound of whole wheat bread is up 24%. Whole milk, up 26%,” reports Capital & Crisis’ Chris Mayer.

“The government wants us to believe that inflation is not a problem. Tell that to America’s families, who face the fastest rising food prices in more than 17 years. That’s on top of rising energy prices.

“The boom in food prices is great for the agricultural sector. The USDA projects net farm income of $87 billion this year. That’s 48% more than last year and a new all-time record.”

And a sign of the times, from our buddies over at The 5 Min. Forecast:

“The Department of Transportation approved 6 new, non-stop flights from the U.S. to China earlier this week,” writes Addison this morning.

“Each of the U.S. so called ‘legacy carriers’ were granted the right to fly one additional non-stop to the far east. Atlanta, San Fran, Chicago, Newark, Detroit, and Philadelphia will all begin offering these flights as soon as possible… most in time for the Beijing Olympics.”

“A fresh blow to the housing market,” is how the Financial Times describes it.

The Daily Telegraph comes up with a more bodacious headline:

“US housing market in freefall as prices crash.”

And follows up with this:

“Sales of new homes in the US plunged in August at the fastest rate since modern records began, prompting fears the economy is sliding into a full-blown recession…

“Total sales dropped 8.3% on the month and are now down 21.2% during the past year, a sign that the credit crunch has cut off mortgage funding for large numbers of people.”

Both papers give us new data on house prices:

“The median home sale value fell 7.5% from $246,200 to $225,000, its lowest since January 2005,” says the FT.

Two and a half years of price increase – wiped out.

But in go-go areas, even bigger gains have gone-gone. Miami was one of the hottest housing areas in the nation. Now, its condos are being marked to market. Here’s the report:

“There are at least 50 buildings under construction or nearly completed in the downtown Miami area alone, consisting of about 20,000 units,” reports David Sutta from CBS4.com in Miami.

“To move inventories along, developers have gone to the auction block to get them sold.

“On Thursday evening, at the Miami Biscayne Bay Marriott Hotel the gavel struck as auctioneers sold about 20 units in the 119-unit Platinum development owned by Alex Redondo.

“When it was all over, [one bidder] walked away with a two bedroom unit on the 19th floor. To put the price in perspective, a one bedroom priced at $350,000 sold on average at auction for $176,000, almost half.

“A two bedroom unit that sold for about $600,000 last year, sold on average for $295,000.”

Yes, dear reader; if you are thinking of moving to Killeen, Texas, you better act soon. Those big housing gains are disappearing. In Miami, prices are being cut in half.

You might be thinking…well…one man’s loss is another man’s gain. But think again. While the bidders got apartments at half-price, the owners of other apartments saw their assets lose 50% of their value almost overnight. A week ago, they may have had an apartment worth $600,000. Now it is worth only $300,000 – and falling.

What happened to that $300,000? It vanished. Poof. That’s what put the ‘d’ in deflation. Money d-isappears. Wealth d-issipates. Values d-ecline. The economy d-egenerates. People get d-epressed.

Meanwhile, stocks held steady yesterday. Stock market investors seem to think they’ve got a “Bernanke Put” on their hands – an option that will always protect them from losses; if stocks begin to go down…Bernanke will just cut rates.

But Robert McAdie, head of credit at Barclay’s Capital, addressed the issue yesterday. He noted that though the Fed may cut rates, and may bail out a few large speculators, there is no guarantee that money will find its way into the hands of the people who really need it. A bank can borrow from the Fed at the Fed’s rigged rates, but that doesn’t mean it isn’t going to be careful with the money. Rates dropped after the Fed funds cut last week, but long-term finance rates actually went up…and the gap between the Fed’s rate and the banks’ own interbank lending rates remained unchanged. What gives? Lenders are still worried. They’re afraid they might let out some money…and not get it back. So, they demand a little extra return, as protection. In July, the spread between commercial paper and the fed funds rate was only four basis points. Now, it’s 62.

Money is cheaper, generally, but as McAdie put it:

“Cheap money is now history. There are not going to be any more of the big leveraged buy-out deals for a long time because the CLO [collateralized loan obligations] market that financed them is effectively closed.”

Oh my… The homeowners can’t sell their houses. And the Wall Street hustlers can’t sell their deals. How d-isappointing. How d-iscouraging. For example, the Bank of Montreal – Canada’s fourth largest lender – announced that it couldn’t get rid of its asset-backed paper. And the global mergers and acquisitions market got hit in the head with a brick. After setting a record in the first nine months of the year, the deals declined 42% in the third quarter.

What’s an investor to do? Without ‘deals on wheels,’ what will keep stocks rolling? And without rising house prices, how will consumers keep spending? And without consumer spending (it is 72% of the economy…no economy in history ever depended so much on people spending money they didn’t have on things they didn’t need), what will prevent the U.S. economy from going into recession?

We don’t know. But, as a dear reader remarks below, there are many things we don’t know…

First, you will recall our Trade of the Decade. Sell the Dow…buy gold.

Well, in 2000 an aunt died and left our children a very small inheritance. We took our own advice, more or less. We set up an account for each of the children, put the money (not enough to merit diversification) into Newmont Mining (NYSE:NEM), and forgot about it. But now, Maria has turned 21. She has to take charge of her account herself.

“What should I do with this…maybe I should invest in something else? I think I should invest in China…that’s where the growth is,” she pointed out.

She is right. Chinese shares are rising at about 10% PER MONTH! CITIC, a fast-growing Chinese brokerage, is now said to be priced at $40 billion – or $8 billion more than Lehman Bros. (NYSE:LEH) and $24 billion more than Bear Stearns. (NYSE:BSC)

Looking at the entire basket of emerging markets, we find extraordinary growth. Gold has done well over the past seven years – up more than 150%. But Chinese stocks have risen that much in the last 15 months. Emerging stocks generally, have gone up about twice as fast as gold since the year 2000. Since the bottom in 2002, emerging market shares are up four times.

Newmont Mining has done well; it is worth about twice what it was when we bought it. But it is a laggard compared to emerging market shares.

If you were to look back another decade, you still would have done remarkably well in emerging markets. The MSCI index, in dollar terms, rose from about 200 in ’90 to about 1200 today – a 500% increase. (Meanwhile, the price of gold rose only modestly.)

Looking back even further…to that fateful year, 1971…when the dollar and gold parted company for the last time, where has the big money been made?

In U.S. stocks – up about 13 times. In emerging markets – up a bit more. And in gold – up from around $41 to over $730 – an increase of nearly 18 fold – though, admittedly, with long periods of time when gold was going down in dollar terms. But gold is not really an investment. All it does is measure out the pace of the dollar’s decline. For the past 36 years, simply betting against the dollar has out-performed every major investment class.

Yesterday, the dollar sank to a new record low against the euro (EUR). Compared to gold, the dollar sank too – putting the gold price up to almost $740. Oil climbed back over $80. And the commodity index hit a new record high.

What will happen next? Will the money that comes from trees finally find its roots? Will it stand as tall and straight as a mighty oak? Or will it continue to dry up…and whither like an autumn leaf? Might it will even blow away?

“I would stick with Newmont for a little while longer,” we told Maria.

Finally, a dear reader offers this comment:

“I greatly enjoy The Daily Reckoning and have bought more things than I could possibly need from you over the years and made some money from them despite you not knowing anything about anything. Notwithstanding the fact that you don’t know anything, I bought gold at under $300 and more at under $400 at your recommendation and I’m sure that you have no idea when I should sell this poor investment that has barely doubled my money in two years.

“However, when you talk about the U.K. housing bubble (compared to the United States), is it really like with like, when you consider available land and future housing requirements?

“I know you don’t know and I certainly wouldn’t take your advice if you did know. I have a house and I don’t care if it goes up or down, as house prices are (or should be) of academic interest only to people who already have them.

Regards

“PS: What piece of America shall I buy with all my dollars when I sell this gold? Hang on though, you won’t know this either…”

Our writer is a shrewd observer: ‘Never take advice from a man who claims to know what he is talking about,’ is his message.

In that sense, you are safe with us, dear reader. We know nothing.

The beginning of our ignorance dates back to 1980. Before that, we knew everything. But then gold began to fall. We couldn’t believe it. We assumed it was temporary. Everyone we knew back then expected the price of gold to keep going up. We were more sure…we knew it was going up. But it didn’t go up. It went down…and down…and down – for the next two decades.

And with each dollar gold declined – from above $800 to under $300 – some of what we knew for certain disappeared. By the time it reached $275…our head was completely empty.

But what we lost in certain knowledge, we gained in humility. As our gold stocks went down, our stock of humility went up. The more we lost, the more we gained. What we paid in tuition, we earned in wisdom…or so we’d like to think.

Of course, we’d rather have the money. But you have to make the best of what you have. And now, we have a full tank of humility. In fact, we’re about the most humble financial commentator we know. Whatever they claim to know, we know even less.

But we notice that gold is finally coming back. It is still below the record set 27 years ago…but considering all that has happened in the intervening years – the invention of the CDO, the explosion of hedge funds, the global liquidity glut, Warhols that sell for $72 million, Alan Greenspan, George W. Bush – we wouldn’t be surprised to see this cycle carry it well beyond the high set in January 1980.

But what do we know?

Enjoy your weekend,

Bill Bonner
The Daily Reckoning