The US Federal Reserve this week surprised no one by leaving its key rates
unchanged and gave no indication that the committee was preparing to raise or
lower rates any time in the foreseeable future. As always, the market reactions
were much more interesting and unpredictable. In this case, bond markets barely
changed, the US stock market jumped, and euro futures strengthened slightly
against the US dollar.
Although few monetary hawks felt that there was any reasonable chance for an
inflation-fighting rate hike this week, there was hope that lone dissenter on
the rate-setting Federal Open Market Committee, Richard Fisher, would be joined
by other committee
members in voting against the current round of liquidity injections. No such
luck there.
For now at least, Mr Fisher is still a one-man band. The rest of the committee
still shows no stomach to really take on inflation (despite this week's
alarming consumer price index report) and plenty of willingness to push back on
the gathering recession. As a result, my feeling is that the next rate move
will be down.
Last summer, I predicted on CNBC's Kudlow Show, that the Fed would lower rates
from 5.25 to near 1.00% and that the US dollar would continue in relative
decline. I was scoffed at and ridiculed. Well, I believe that the Fed statement
indicates that rates will soon head south, towards 1.00% or even lower.
On July 3 this summer, I predicted, again on Kudlow's show, that oil would soon
drop in price, due to demand destruction. Again, I was ridiculed. On the very
next business day, oil began to fall. Two days later it reached the peak, from
which it has since fallen dramatically as the recession of which I have long
warned has become clearer.
I say these things not to boast, but to lend weight to my arguments and warning
of impending hyper-stagflation. Facing the prospect of both inflation and
recessionary forces, the Fed is boxed in.
As a student of the Great Depression, Bernanke has correctly, in my view,
sensed that whereas inflation does the greatest long-term economic damage, it
is recession that his political masters most fear. He is also aware that it was
the raising of interest rates that turned the 1930 recession into the Great
Depression of 1933, which lasted until World War II.
Depression, especially in a highly leveraged world that is accustomed to
prosperity, would likely result in serious civil strife. Politically, it must
be avoided no matter what the economic or financial costs. Despite "spin-talk"
to the effect that the Fed is pursuing a dual mandate to both fight inflation
and promote growth, in reality they are simply trying to promote growth pure
and simple. This is the reality that few market analysts or journalists dare to
mention.
With 5 million American homes vacant, the Big 3 auto giants heading towards
bankruptcy and some US$4 trillion already wiped off of American home values,
things look bad for American consumer demand. With consumer spending accounting
for 72% of GDP, this should ensure recession. To try to change this outcome,
the Fed stands ready to implement the most inflationary monetary policy in its
history.
Looking ahead, Nouriel Roubini, the former Clinton White House economist,
forecasts credit losses will amount to some $2 trillion. So, while the Fed has
applied Band-Aids to the financial crisis, the evidence is that internally,
financial institutions are still bleeding fast.
The latest fall in commodity prices has given Bernanke the wiggle room that he
has hoped for desperately these past months. The pullback in oil and other
commodities will give him the golden opportunity to lower interest rates
further to avoid the looming recession from morphing into depression.
Investors should expect falling worldwide interest rates. Short-term government
bonds in inherently strong currencies, like Swiss francs, remain attractive. As
hyper-stagflation and acute financial stress becomes manifest, gold will likely
rise significantly.
John Browne is senior market strategist, Euro Pacific Capital. (Euro
Pacific Capital commentary and market news is available at
www.eurpac.net It has a free on-line investment newsletter.)
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