Fight the Fed...Sometimes

“In its prepared statement, the Fed said it was worried about the effects of tightening credit conditions on the economy, and that its rate cut was ‘intended to help forestall some of the adverse effects on the broader economy…and to promote moderate growth.’

“Incidentally, the Fed also expressed concerns about inflation. But talk is cheap. If the Fed were genuinely worried about inflation, it would not have slashed interest rates when the risk of rising inflation is so obvious. The Fed would not have slashed rates when commodities like gold, oil and wheat are threatening to make RECORD highs and the U.S. dollar is slumping toward historic lows.

“On the other hand, Bernanke probably realized that an ‘expected’ rate cut would have caused stock prices to head straight down. In other words, he was ‘targeting’ asset prices, primarily to try to rescue America’s major lending institutions from the consequences of their reckless lending and speculating.”

Ed Bugos
October 3, 2007

Keep reading today’s guest essay here:

Fight the Fed…Sometimes

And now over to Short Fuse, back in Baltimore…

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Views from the Fuse:

The falling dollar – is it a cause for panic…or is it a good phenomenon?

“Where you stand on the weak dollar depends largely on where you sit,” says Eric Weiner, writing for NPR.

He goes on to explain multiple scenarios in which a weak dollar is either cause for celebration or despair. For example, the commuter driving a gas-guzzling SUV is going to be pretty bummed, since a weak dollar equals high oil prices, which we’ve seen in the past few weeks.

On the other hand, a German tourist in America would be happy, since the euro buys more dollars than it once did. It’s as if “America’s on sale,” says Patricia Edwards, a managing director of Wentworth, Hauser, and Violich, a financial consulting firm.

“It’s like walking into Macy’s and finding that everything is 30% off.”

Obviously, the reverse of this scenario is true for the American tourist in Europe.

“If you are a worker at a Boeing plant it is cause for celebration, with one caveat. The weaker dollar means foreigners can buy more of what you make. That new Boeing 787 is now a lot cheaper for someone paying for it with euros or other currencies. The flip side is that a weak dollar makes U.S. firms vulnerable to a foreign takeover, because the firms themselves are also cheaper.”

And that’s just what is happening right now in the United States – foreign companies are taking advantage of the weak dollar and are buying U.S. companies…and who could really blame them?

The Boston Globe reports that “nationally, the value of purchases of companies by non-U.S. buyers so far this year totaled $257.4 billion – more than in any full year since 2000, the height of the technology boom.”

Now, that’s not to say that investment in U.S. companies is necessarily a bad thing – in fact, in many cases, a foreign takeover means upgrades, more patience than the company would see from a domestic investor, and company growth.

However, that’s not always the case. Job cuts are a big concern, as is consolidation, or the possibility that the jobs will be outsourced to India.

“Quite naturally, foreign companies want to play in this market,” said Alan Tonelson, a research fellow at the U.S. Business and Industry Council, a trade group for small and midsize manufacturers. “They want leading-edge technology, and the United States is still the technology leader. But when they buy these companies, they’re acquiring control over the most dynamic pieces of the American economy, and they’re acquiring control over America’s future.”

Foreign companies aren’t the only ones taking advantage of the current market environment…this is investor extraordinaire Warren Buffett’s favorite time to invest. And he believes that your best protection against a feeble greenback is to put your money into good, solid businesses. Chris Mayer’s investment strategies are very often in line with Buffett’s – and he’s found a way to place an automatic “cash cushion” under every investment you ever make.

So, it’s clear that the falling dollar is causing ripples throughout the global economy, as countries are questioning if the greenback should continue on as the reserve currency. Our friends, Addison and Ian, over at The 5 Min. Forecast report:

“Yesterday we mentioned briefly that currency speculators in the Middle East have been predicting a revaluation of local, dollar-pegged currencies. ‘Frenzied traders bid up the UAE dirham and the Saudi riyal to near record highs as a result,’ reports Joel Bowman from Dubai. ‘Saudi British Bank did their best to calm the waters by saying, ahem, they would only dump the buck, “if the dollar weakens at an alarming rate”.’

“Now it’s OPEC’s turn: ‘International banks and analysts have hinted at the possibility of the OPEC changing the price of oil to a currency basket, rather than the dollar,’ says Joel. With Iran all but there…and Venezuela not far behind, we’re not surprised.

“‘If the dollar were to lose its luster as a reserve currency,’ reads a note of concern released by Merrill Lynch, ‘this could prove disruptive to the global financial system.'”

There are three types of economies, say local economists. There are the developed economies. There are the undeveloped economies. And there is Argentina.

We’ll return to Argentina in a moment. First, let’s check on what is going on in the United States.

Checking is not as easy as reading the headlines. The problem is that everything floats. It is like trying to give the precise location of a cork, bobbing in the North Atlantic. The wind blows it. The currents carry it along. The next thing you know, it’s in Cape Town.

So, when the Dow hit a new record high on Monday…we had to ask: relative to what?

In dollar terms, the Dow has never been higher. Stock market players feel pretty good. The major Wall Street firms are telling clients that the good times are still ahead. Even Alan Greenspan says the credit crunch is easing off.

Now that the Fed is handing out more money…happy days are here again! Not only is the Dow up, but commodities are down! Oil is still over $80…but lower than it was a few days ago. The euro (EUR) is still over $1.41, but lower than it was last week. And gold got whacked on Monday…but wait, it is still a lot higher than it was a year ago, or the year before that, or the year before that…

What makes stocks valuable is that you can sell them and use the money for things that you want. You can’t eat a share certificate. You can’t live in one. You can’t drive one to work. All that really matters (apart from dividends) is how much you can sell them for, and what you can do with the money.

Well, five years ago – at the very bottom of the correction – you could have bought more oil with your share proceeds than you could today…about twice as much.

And wheat? Yes, more of that too – a lot more.

And gold too, of course. Taking the Dow from its peak in 2000…to its new peak in 2007…you still cannot buy as much gold with your Dow shares as you could have seven years ago. In fact, sell your shares today, even at higher prices, and you’ll get only half as much gold.

There is a way that you can buy gold…for a penny per ounce. Sounds like a pretty good deal, especially with the price of the yellow metal at 27-year highs. Find out more here:

Gold – For a Penny Per Ounce

Stocks may be going up…but the currency they’re quoted in is going down even more.

And now Bill Gross, head of the biggest bond fund in the world, says he thinks the Fed’s cuts are just beginning. He believes the housing problem will not go away anytime soon…and that the Fed will be forced to take another percentage point off the fed funds rate in response.

Good news for stocks? Many people think so. Lower interest rates are usually good for equities. And many think a lower dollar will be good for U.S. exporters too. U.S. prices are cheap and getting cheaper. Soon, America will be an export-led economic powerhouse – like Japan or China! Soon, people will be buying U.S.-made cars…our perfumes…our liquor…our computers…our gadgets. American business profits will rise. Wages in the United States will finally go up. And stocks will rise too, as earnings skyrocket.

Anything is possible. But our guess is that the dollar will go down faster than America’s stocks will go up…if they go up at all.

Nor do we imagine that all those other little corks bobbing around in world markets are going to sit still while trillions of dollars’ worth of dollar-based assets get wiped out by inflation. More than likely, they’ll dump dollars…recycling their own money into their own economies…

…forcing up real U.S. interest rates…even as U.S. financial authorities try to hold down nominal ones…sending the United States into a severe slump!

Similar things have happened elsewhere. Notably, in Argentina!

A dear reader:

“To the average American, nothing much has changed in the financial world…

“According to ‘Business News’ on PBS, everything is actually OK – there is nothing to worry about. In fact, during the middle of 2008, all problems will be solved. But when will the Chinese ever dump their U.S. treasury debts?”

A good question: when will the Asians get tired of funding America’s $800 billion annual current account deficit? Of course, we don’t know the answer. By the evidence, they should have already done so.

But the Asians bought U.S. dollar investments for two reasons:

First, because they were safe. They were a good garage in which to park their ‘surplus savings.’ They thought they wouldn’t have to worry about them.

Secondly, they put them in dollars in order to hold the dollar up. As long as the dollar stayed up, Americans could continue to buy beaucoup de stuff from Asian suppliers.

Now, both those reasons are beginning to look a little “so 2006.” The dollar is going down anyway…and their U.S. dollar investments no longer look so safe. Plus, Asians are becoming more confident about their own prospects. Their own financial instruments are becoming more sophisticated. The rate of return on Asian investments is much higher, of course, but Asians are also beginning to see that they can safely invest in their own economies, their own companies, and their own financial instruments.

When will they dump U.S. dollar financial instruments? Sooner or later is our answer.

It’s spring…south of the equator. Flowers and cherry trees are in bloom along the Avenida 9 de Julio. This morning, we got up at 5 AM and stood out on the balcony…as the great city was just beginning to stir. What a joy to see it…

We’re here for several reasons:

First, there are few places in the world where you can learn so much about economics. If there is any mistake the Argentines haven’t made yet, you can bet they are working on it.

Second, we have a feeling that America is on the road to the Pampas too. The masses clamoring for relief…the central bank offering unlimited cash and credit…the government reacting with one foolish initiative after another – welcome to the future of the U.S.A., dear reader. (About which…more to come…)

Third, we’re here because we invested in property down here. Everything takes follow-up…everything takes follow-through. Everything takes more time and money than you ever thought possible. We bought land because it was very cheap – but we quickly remedied that situation!

Cometh this note from the farm manager, in Spanish, of course:

“Señor Bonner, I hate to bother you, but the peóns are getting very unhappy. They haven’t been paid for three months…”

“But don’t you get the checks every month from the accountant in Buenos Aires?” we wanted to know.

“Yes, but something happened…the government stopped the banks from transferring money because it was coming from overseas and they thought we were laundering or something…”

“Well, what about that extra 75,000 pesos we sent in July? Why didn’t you use that?” we asked.

“Oh…we had to use that to buy hay. You know, there was a severe drought down here. I told you. We had to feed the cattle…”

But most important, we are down here because our daughter-in-law is going to have a baby! We’ve come to say “congratulations…and best wishes.”

Our old pen-pal Jack Lessinger has a new book out: CHANGE

Jack is a rare economist. He studies social trends and connects them to economic trends…and, finally, figures out how they affect the property market.

His book outlines the development of the U.S. property market over the past two centuries in terms of what he calls, “paradigmatic economic changes.” He notes that the shrewd investor always had to stay ahead of the trend. That meant, looking beyond what the then-current paradigm had raised up to what people were likely to want in the future. Instead of investing in the old colonial regions along the East Coast, for example, an investor in the early 19th century should have looked to the frontier. There, he would have found cheap land…and could have watched it soar for the next 50 years. He should have seen the huge development that would take place in Chicago and St. Louis, for example.

Later, after WWI, the landscape changed dramatically. New technology had created a new idea about how people should live – in the suburbs. For the next 50 years, fortunes could have been made simply by anticipating the growth of the suburbs – further and further out from the urban centers.

Our consumer economy did not exist before 1900, says Lessinger. Since then, it has grown and grown – “Sexy young women, smiling from the billboards, urging strait-laced and penny-pinching citizens to save less and spend more. Buy, buy, buy screamed the advertisers. Buy Coca Cola and be happy. Buy Dentine gum and be kissable. Buy Camels and be manly. The consumer economy blossomed. Houses grew bigger and more lavish, cars roomier, faster and more comfortable. What a great time to be alive!”

But buy, buy, buy is going bye-bye, says Jack. The consumer economy is unsustainable. People don’t have the money for it. It is based on cheap energy and cheap credit, both of which are running out. He thinks it will disappear by 2020.

“Get ready for an existential leap…” he warns.

The next Big Thing in American society will be a huge interest in downscaling, downshifting, and simplifying. When the baby boomers realize that their houses won’t allow them to Live Large, says another friend, they’ll begin to appreciate Living Small.

Jack comes at the subject from a different direction than we would, but his book made us think.

Until tomorrow,

Bill Bonner
The Daily Reckoning