“Pushing on a string” is a phrase used to describe the Fed’s problem but I think pulling on a noodle is apt because if you pull too hard the noodle breaks. If you have even a passing interest in money you have to be spellbound by the fiscal shenanigans afoot in the global financial markets these days. I was watching CNBC India last night and at one point the host of the show was nearly in tears.
The Fed just made an emergency 75bp (3/4%) Fed funds rate cut. To give you some idea of how unusual that is consider that the last time it happened was after 9/11. Gold is all over the place. Down just like most other commodities until the rate cut and it’s now hovering around 890.
I have no idea what gold is going to do. Based on that last little panic I think the golden goose is going to get thrown out with the bathwater if things get hairy again, and I think they will. People aren’t going to be concerned with the inadequacies of the Fed when their retirement is evaporating and they’re afraid that GLD might fold. If everybody actually had gold stashed in their houses then I doubt prices would be off as much but they trade it just like wheat… which I assume most people don’t hide under their mattresses.
The Fed just applied a band-aid to a stab wound. Deep in my bones/soul I know this is going to get worse based on the degree of dysfunction in housing and mortgage backed securities but the world hasn’t seen anything like this in 70+ years so it’s hard to know where things go from here.
Predictions (take with a large grain of NaCl):
Gold: Based on yesterday I’m convinced deflation leads to the death of gold. Some people make good arguments that it can act as a deflation hedge but I don’t see it happening when investors think of gold less as an alternate currency and more like a hunk of useless yellow metal. In other words I think gold tanks in the next month or two (I’m selling tomorrow) as the Fed’s band-aids start to fall off. In the longer term I think it will rally as Bernanke pulls out the stops to prevent credit destruction.
Bonds: Follow the Fed’s lead (or maybe the other way around) to zero. Just like Japan as bottom caller / knife catchers realize that it actually is different this time. I heard someone jokingly predict the American carry trade meaning people borrow dollars at 1% or so and use the money to borrow better yielding currencies.
Insurance: The Fed will bail out Ambac, etc. because if they go down, it all goes down. This will probably work a lot like the FDIC except for muni-bonds and the like instead of consumer deposits.
Real Estate: If the Fed cuts rates to zero the monthly payment on a 500k home is something like $1380 a month. So in theory super low rates could help the foreclosure epidemic. Problems – The FFR doesn’t affect long rates, upon which many mortgages are based. Also, people can’t refinance if they owe more than their house is worth. That includes a LOT of people. Lastly, risk premiums are through the roof, mirroring defaults. It’s hard to get a loan when prices are dropping. If you’re smart enough posses the means to buy a home right now you’re probably also smart enough to know better than to buy a home right now.
The egg heads at Davos are predicting 30% price drops nationally. That sounds about right but that would wipe out Trillions of dollars of wealth which would eviscerate the economy, which would then feed on itself as more homeowners with exploding rates reset through 2011. The only thing that can save housing is a morally hazardous gung ho bail out of people who bought houses in the last 6 years. That would decimate the dollar but Ben appears to be OK with that.
Tech: Bernanke astutely pointed out the other day that US manufacturing has collapsed in part due to rising productivity. Robots kill… jobs. More specifically IT enabled automation. Our economy is having a hard time retraining workers to take advantage of the new jobs that are out there. This is my explanation for a growing wealth divide currently blamed mainly on ill conceived tax cuts.
Inflation vs. Deflation: Short term I think we’ll see deflation. But Bernanke will take more drastic measures as things unwind because, unlike the BOJ, we simply can’t afford deflation. Why? Because the average American is so indebted that deflation would mean the end of the entire financial system we know and love.
Optimism: We’re getting closer to the point where nobody knows what happens next, even the people who could predict things up to this point. If we have a depression I don’t think we’ll see people starving and living in the forrest. Productivity is so much higher now than in the 30′s that a serious push by America’s brains coupled with modern IT would make a collapse a bit more comfortable. The problem is debt. We’re so indebted that a new system could be the only way forward. Maybe that’s a good thing.