Monday, November 05, 2007

 

Ameritina: History's warning about the price of money

I have been hearing this a lot lately:

We have sympathy for Ben Bernanke, Fed chairman, and company.

Or some variation of we feel sorry for them because they are in an impossible position. And the truth is they are, the Fed has an incipient credit crunch to deal with while the dollar is falling and commodity prices are rising. Cut rates and risk an out of control fall in the currency. Don't cut and watch the economy sink as the housing depression gets worse.

Truly no good solution but that still doesn't make me any less mad that they seem to have decided to trash the dollar and risk a 1970's style inflation and I am not alone. The "good" side of this choice is that it postpones reckoning with the housing market. In fact, I am sure the Fed's thinking goes something like this, "If the dollar doesn't get out of control by the end of next year we can get through the worst of the housing crisis." Of course, they might be right but it is a dangerous game which they are playing with the knowledge that previous crises were averted by the very same tactics. The problem is that times are different. The dollar is in a much more precarious position.

Between August 2001 and August 2007, the dollar price of gold soared 144 per cent, while the CPI rose only 17 per cent. The last time such a substantial and sustained appreciation of gold was observed was in the 1970s, on the heels of America's loose money policy and balance of payments deterioration in the 1960s and Rueff's warnings regarding "the precarious dominance of the dollar". There were two episodes, from 1971 to 1975 and from 1977 to 1980. In both, the increase in the price of gold and other commodities presaged substantial increases in CPI inflation as well as significant falls in the international value of the dollar.


Full circle will bring us back to the next Fed chairman who will be forced to raise interest rates, a la Volcker, and crush inflation...and the economy. Better to let the housing market correct itself without the intervening bout of inflation. This won't happen because Helicopter Ben thinks he is smarter than the rest of us.

I haven't had a clear idea about what the stock market might be doing since the July-August turbulence showed itself to be just a correction. Right now I still think we are in a correction and there are a couple of ways it can shake out. (See the chart.) Support remains around 13,100 and 12,500. The volatile markets of late just reinforce my opinion that stocks will stay above 12,500 and move sideways probably until the New Year then rally for a final(?) blowoff top.



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