Beware the Turbulence that Lies Beneath the Surface, Part I

October 9, 2007 – Those of you that have been reading my blog and newsletters for a while know that I view the vast majority of government released economic reports as nothing but manufactured, cooked reports designed to generate whatever confidence governments need from their citizens to keep the economy and stock markets stable and growing. In the U.S., the reported numbers about inflation, housing starts, and so forth are so distorted and distant from reality that they are virtually meaningless. I’ve always said the same about the statements made by the most powerful Central Bank in the world, the U.S. Federal Reserve. Yet at times, their Chairmen have been exceedingly honest in their comments, though the masses seem to ignore them. Years before he would spend more than two decades as the Chairman of the Federal Reserve, Alan Greenspan stated, “This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.” At least Greenspan told us the Fed Reserve’s plan and before they executed it and explained why a bear market would be manufactured in gold for 21 years.

Likewise, current U.S. Fed Reserve Chairman Ben Bernanke explained his deep 0.50% rate cut on September 18th with the following statement: “We took the action to try to get out ahead of the situation and try to forestall (emphasis mine) potential effects of tighter credit conditions on the broader economy. The resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans.” Yet all the permabulls applauded the rate cut as the end to all the subprime credit woes with massive triple-digit rallies in the DJIA. In fact, think about how many times in just the past couple of weeks that you’ve read headlines stating that the subprime credit fiasco has bottomed out? So in essence, this time around, I can’t blame the feds, but only the talking heads in the media that parade as experts for fooling the masses. The words Bernanke used were not “solve” the tighter credit conditions, not “turn around” the tighter credit conditions, but “try to forestall” them. He admitted as much that slashing interest rates were nothing but a mere band-aid solution to a much deeper problem. The signs are everywhere, from skyrocketing gold prices, from silver prices that will most likely explode soon past the $15 an ounce territory and maybe even approach $20 an ounce in 2008, from a rapidly deflating dollar (despite its current rebound which can not possibly be anything more than a short-term bounce), to the presence of inverted yield curves this year when 3-month U.S. T-notes yielded greater interest rates than 10-yr U.S. T-bonds (by the way, an inverted yield curve has only happened 7 times since 1960, and 6 of them preceded recessions).

However, I won’t give the Feds too much credit for being aboveboard because I always laugh when I hear Bernanke speak of “fighting inflation” being one of his top priorities. How does tinkering with the CPI to lower the true inflation numbers achieve this (to be fair, the greatest changes in the formula used to calculate the CPI happened under Greenspan’s watch during the Clinton Administration)? How does slashing interest rates by 0.50% and making dollars cheaper to borrow (which will eventually expand money supply), achieve this? Especially since the U.S. dollar supply outside the U.S. has increased from $600 billion in 1990 to over $6 trillion today? By the way, it has been said that money expansion should occur at approximately the same rate as inflation. Given that the U.S. Federal Reserve targets inflation at 2% -3% a year, then in 17 years, money supply outside the U.S. should have grown from $600 billion to about $913 billion. Somewhere along the line, the Feds happened to grow money supply by $5,087,000,000,000 too much (perhaps, if you are a dollar holder, you now understand why today, your U.S. dollar seems to buy you nothing, whether in London, Montreal, Paris, or Singapore. So can stock markets APPEAR healthy and thus respond with bullish action in spite of everything I’ve mentioned? Yes, and for irrationally long periods of time. I still think that the state of the U.S. economy dictates some days of very bad triple-digit losses for the DOW in the future, and I think they should come soon. The only question that remains to be answered is, “How long can the Feds forestall this from happening?” If they get their way, they won’t happen for a while, but if reality wins out, they may be coming soon. And if they don’t happen soon? Does it mean the underlying economy is healthy? Far from it. Stay tuned!

[tags]gold, U.S. Federal Reserve, Ben Bernanke, dollar crisis, stock market crash, inflation, deficit spending[/tags]

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