US Economy

April 23, 2008

Is this the end of the economic crisis and financial market disintegration?

After the initial FED reaction, it was followed by hesitation as the credit markets froze, causing the markets to lose confidence and chaos ensued within the financial world. BSC, which had been solvent as soon as the previous week, was victimized after the first quarter scare took center stage. It was voided with assistance from Fed since it went bankrupt and could not effectively conduct business.

The financial crisis of 1998 triggered a bear market, which ended relatively quickly (14 weeks between crisis peak and recovery) with the Fed support of foreign currencies. How many weeks has this one gone on? From the August peak of 26 weeks this one has lasted significantly longer yet fourteen weeks have elapsed from the first low to this week’s breakout. Although there is more to it than just the mortgage issues, they greatly caused the financial problems that even spread to other countries.

As luck would have it, it was the Fed’s action with respect to BSC as well as its opening the discount window to non-primary dealers, and jumping the size and content of its auctions that finally led to the unfixable. This allowed markets to see that Fed was ready to backstop the problem. Also, it demonstrated that this Fed was different from the Greenspan Fed, for example continually meeting one financial issue after another with the inevitable rate cut. Instead, this Fed was thinking outside the box, looking at how to provide liquidity without resorting to endless rate cuts and associated dollar liquidation. As soon as the market received the memo, there was a halt in the decline of the dollar. There wasn’t a sudden rebound since the administration didn’t help. In the past five weeks it has only moved laterally.

The direction of bond yields is another sign. Interest rates for bonds rose, especially short-term ones. After remaining at 1.8%, on Friday yields rose to 2.2% during trading and closed the day at 2.13%. Prior to landing at 3.71%, the 10-year escalated from 3.4% to more than 3.8% on Friday. Breakouts occur on both ends but especially the short. This could suggest inflation as discussed on Thursday, the elevated rates are not inflated. The Fed says that they do not depend on the constant rate cuts. The dollar has firmed as noted and that, and even though we have those exporting, means a better economic outlook for the US. Bond yields reflect economic strength, and rising yields in the past have shown a firming economy.

Gold is also showing well and indicating that the Fed has done something right, since gold hit its high in the middle of March; giving up 15% off the peak, bounced, but then gapped lower Friday, falling 28 clicks and is now at a key junction a little above 900. There is an indication of a problem since the gold has fallen since the recession and the inflation trade is slowing. The Fed won’t cut rates so the gold inflation is over.
This indicates that the credit crisis and accompanying economic slowdown may be at an end. Leadership and stock market bounce are good leading indication but not fully conclusive in themselves. The action in bonds, the dollar and gold add weight to the favorable story, but even those are not conclusive as the dollar is still basing and gold has not broken down completely. More of the story will be revealed in the next few weeks.
As always there is a rub; LIBOR (London Interbank Offered Rate) rate spreads are increasing again. When spreads are high banks are less willing to loan money to the other banks. At the start of the credit freeze they were at 90+ points, but as a result of the Fed actions they fell back to an understandable 5 to 10 points. Although the economic outlook had improved, they have returned to the 94 basis point level. Borrowing cost higher than bank are indicating means profit impact yet undisclosed

Oddly, banks are not running to participate in the Fed auctions. Indeed, the participation has declined, indicating that liquidity levels are improving and quite livable. They would go to the Fed if they could not access funds.

In any case, today’s market allows us to profit from the moves as long as leading stocks and the indices show the right kind of action.

You think prices are high now?

According to a recent survey, the summer months are going to start with national gasoline prices soaring to the $3.60 mark. During the last few weeks we’ve seen an increase of approximately 20 cents. By summer $4/gallon gasoline is expected. The price last summer was $3.

Prices of gas are affected by the ethanol. Above all else, it’s caused wild regions to overflow, destroying wildlife habitations on the edges of farmland and tarnished streams with fertilizer surplus and the lands are gaining ground all the way up to the water’s edge. Minimal amounts of ethanol are being produced by using hundreds of gallons of our limited water supply resulting in very little or no gain at all. Severe environmental effects.

Food costs have skyrocketed because of this. The prices of animal feed are inflating just like stated by the CPI and PPI. That is causing price increase on top of a price increase. In what way? Corn is now being used for ethanol so food costs are going up. Rice is the basis of the Asian diet, corn syrup is the basis of our food. Diverting corn from food production to fuel production raises food prices Food prices are skyrocketing worldwide, causing riots, unrest and starvation and we continue to use food staples for fuel, CAT’s CEO wondered at the folly of this Friday in an CNBC interview.

There are issues besides the increasing prices for corn-based foods. Feed corn is so much higher that ranchers are slaughtering cattle and chickens to prevent themselves from buying the high-priced feed in a losing proposition as it costs too much to raise the animals. Therefore, we will have an insufficient supply of beef and poultry in a matter of months. As an example, we are hearing prices for ground beef as high as eight dollars per pound.

Once again, the US government has blundered foolishly into market manipulation, with its ill-conceived policies impacting both its own citizens and consumers around the globe. With the ethanol plan they have fused together food and energy prices and as a result there are increases in both. Saying there had to be a start somewhere, one of my clueless senator’s staffers discussed energy issues with me. Yes, but looking at the past it is evident that failure occurs over and over again when the government picks the method of solving a problem rather than providing incentives for anyone to find the best solution. People will uncover the top solution, so long as they are provided with the incentive. When the government picks the solution the only ones benefiting are those who basically receive the government monopoly. For instance, corn, our main food source. Nice move. We need to undo this decision yesterday or we are going to see a price explosion in food, and that is going to escalate unrest across the globe at a time that we simply don’t have the resources to meet it. Our enemies can only benefit from this course of events.

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