Wednesday, March 14, 2007

Market Tumbles, Bernanke Panics, Gold Soars

13 March 2007

OK. This is not today’s headline. But how long do we wait before the above sequence of events becomes the news of the day?

I am now thinking that the wait will not be long.

US investment markets have been running on the notion that the Federal Reserve will maintain a moderate-to-aggressive stance based on a strong economy.

The strong economy notion is now unwinding – along with the carry trade In the Japanese Yen.

The collapse of the US subprime lending industry is bringing with it the realization of the obvious – that the other sectors of the economy are not far behind. That is – deflating home values make subprime loans unrecoverable. That returns something like 2 million homes to the faltering US real estate market. That in turn places downward pressure on mid-range home prices, and so on. You can figure it out. Anyone can.

(As one example, and this is today’s news, General Motors announced that it will be flowing $1 billion to its formerly profitable GMAC finance arm to cover losses on subprime loans. GM has not made money selling cars for years, and is selling the GMAC unit to prop up its moribund auto manufacturing business. Unfortunately, GM is now losing more money due to its careless speculation in the subprime and no-documentation mortgage market – think Ditech. It does not take a sophisticated analyst to see that this is merely the tip of the iceberg.)

US workers have had no substantial income gains to support their feverish spending habits, so if they cannot generate cash by advancing loans against the (now declining) equity in their homes, the consumer market must slow. The US economy is based 70% on consumerism – a consumerism so powerful that it has undergirded much of the expansion in the global marketplace over the past two to three decades.

The coming “whoosh” downwards in US equity markets will rapidly confirm that the capacity of the ever-spending, ever-borrowing US consumer to continue to fuel global economic growth is finally drawing to an end.

Is this a panic scenario for Ben Bernanke and the US Federal Reserve?

I think so.

What will Mr. Bernanke do?

The only thing he knows how to do.

You can forget about inflation targeting. That is talk. Mr. Bernanke is afraid of deflation – read “economic collapse” if you prefer.

Mr. Bernanke doesn't want another 1929 on his watch.

Mr. Bernanke will inflate the US money supply, and lower interest rates.

No more Mr. Tough Guy. When the going gets tough, Mr. Bernanke will be Mr. Nice Guy.

Is dropping interest rates and inflating the money supply really a nice thing for a “nice guy” to do?

We've discussed this before. It is a policy of short-term gain for long-term pain. More inflation by the US Federal Reserve will mean yet more capital misallocation and more inflation (though Mr. Bernanke talks against it).

What will preserve value when this occurs?

Precious metal investments (gold and silver).

Here is the sequence.

1. Market plummets.
2. Bernanke panics.
3. Gold and silver soar in value (relative to the ever-devaluing US currency).

It has often been noted that every new Federal Reserve Chairman gets his crisis.

Mr. Bernanke's crisis is coming. In fact, it is now here.

Mr. Bernanke will panic – and be loved for doing so.

It is a very bad response, but a very predictable one.

Gold and silver investors will benefit.

It now looks as though this will be occurring sooner rather than later.


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