Tuesday, December 18, 2007

They Will Inflate The US Dollar Abroad Too

Federal Reserve Official Declares "Financial Crisis," Asks Markets and Universities for Advice

Despite the new dollars flooding into our banking system, our economy's woes continue. Today the Dow Jones is down over 150 points at a little past 3PM. The bleeding continues as more and more analysts are starting to predict a "recession ".

That's why the Federal Reserve had a "liquidity conference" last Thursday. Economic experts were summoned to the 12th floor of the Fed bank building in New York, to brainstorm for solutions.

As President and CEO of the Federal Reserve Bank of New York, Timothy Geithner opened the conference with a brief speech. His remarks were very revealing.

Geithner said we're facing a "financial crisis" which has the danger of "an adverse, self-reinforcing dynamic." Translation: it's threatening to spiral out of control.

Plus, the Fed's usual tools to manage the economy aren't working. As Geithner said, "The evolution of the financial system has altered the role and importance of liquidity provision by banks and how that provision of liquidity responds to different types of stress to the financial system."

At the end of his speech, he said, "We will be looking both to financial market participants and to the academic community for advice."

Of course, he wasn't admitting defeat yet. He spoke of the Fed's new Term Auction Facility and other actions announced last week. These expand the allowable range of collateral accepted by the Fed for loans, and broaden the list of counterparties who can enter into these agreements.

Translation: the Fed has new ways to create money and inject it into the economy.

Geithner also said the Fed would be "adjusting policy proactively." Translation: the Fed will flood the economy in dollars, before it is even obvious that such an action was needed.

In addition, he mentioned that the Fed has now "activated swap lines to help [other] central banks provide liquidity in dollars in their markets."

Translation: it's not enough to inflate the dollar here at home. We're going to inflate the dollar in other countries too.

Interestingly, Geithner admitted that despite all this, the Fed is still impotent in some important ways. He said, "The auction facility and other measures we have taken to address market liquidity problems do not directly address the balance sheet or capital constraints facing financial institutions. Nor can they be expected directly to reduce the perceived risk in exposure to other financial counterparties."

Translation: the Fed is helpless to fix our economy's problems directly. All it can do is drown the economy in dollars, while hoping the problems go away. And it is preparing to do so.

In fact, we're seeing this already, because...

The Fed's Rate Cut Has Failed

As you know, the Fed took action last week, dropping the federal funds rate again. (Rates are now down by a full point in just three months.) How effective have its actions been?

Judging by the tidal wave of dollars created last week, apparently the Fed has accomplished nothing.

On Monday and Tuesday, the Fed injected $24 billion into the economy. Since these were done before rates were dropped, we'll ignore these for now.

However, by Wednesday, the rate cut was done. Did the banking system conform to the Fed's new rate? Nope.

That's why the Fed injected another $27.75 billion of liquidity on Wednesday. And $20.75 billion more on Thursday. And then another $5 billion on Friday.

Last week, $77.5 billion was created out of thin air, and dumped into our banking system. Of that, $53.5 billion was created after the rate cut. Obviously, the rate cut had little effect on the banking system. Otherwise banks would be conforming to the federal funds rate, and none of this would be necessary.

Wall Street Doesn't Like It Either

The Street was disappointed by the quarter-point rate cut last Tuesday, falling 300 points. But that loss was reversed immediately when the Fed announced its new, improved ways to inflate the dollar on Wednesday.

Nevertheless, what was the ultimate outcome? After Wall Street digested all the news, the Dow plunged again. It finished the week down by more than 500 points from its high on Tuesday.

After its initial relief, the Street eventually realized what this means. We're going to get massive inflation, but the underlying economic problems will remain.

Sounds to me that...

Stagflation--that nasty combination of inflation and economic stagnation--is returning.

The United States hasn't seen stagflation since the 1970s. That period triggered an explosion in gold prices—from $35 all the way up to $850.

A similar rise today would bring gold up to $19,200. That seems too high. Or does it?

I think we'll be amazed at how high gold will go in the next 7-10 years!

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