Thursday, March 13, 2008


Late in 1999 one could buy 42.3 ounces of gold or use the same amount of dollars to buy "one share of the Dow Jones Industrials". Today, gold hit $1,000 per ounce, up from $252 per ounce in 1999. At today's price, the "trade" is less than 12 ounces of gold for one share of the Dow. In other words in relative terms, the Dow has decreased in value. Einstein said that if one sits on a hot stove for just a second, it will seem like an hour but an hour sitting next to a pretty girl will seem like just a second. Those who have been sitting with gold are happy campers but the hour is almost up.

On the other hand, gold could still be "cheap". At the height of the stagflation bubble in 1980, it only took 1.29 ounces of gold to buy "a Dow share". By the same token, those who bought bonds in 1980 have seen their value rise from $44 to $118. Bonds are very expensive in historical terms. The most recent action by the FOMC appears to be pushing bonds back to their recent peaks. The 30 year fixed mortgage dipped down to around 5.5% in 2004, 2005 and again last month. Since then it climbed quickly to 6.2% but in the last few days the rate has been falling rapidly. Should this rate hit the 5.5% area again, homeowners should refinance the maximum they can for the maximum term. For the next 30 years, they will enjoy paying a low rate.

One of the reasons that rates are set to climb is that the great "buying panic" by the public will soon be over. At the height of the stock market bubble in 2000, the public ownership of government t-bills and bonds was falling at the annual rate of 9%. The public sold the great majority of their bond holdings (cd's through intermediaries) and bought tech stocks. The opposite track has been taking place the last few years. Public holdings of federal instruments has grown at an average compounded rate of better than 5% for more than 5 years. The public is holding mountains of short term securities.


The Bush administration continues to find ways to stall the economic turn while appearing to be actively engaged in "solving problems". The 150 Billion or so stimulus package has been well discussed as a "political stunt". The package will stimulate the economy for a quarter or two before the election but this "helicopter money" will be added to the debt that Americans must repay. The 150 Billion sounds like a lot of money but it is only about 1% of one years worth of "US income". This one percent "bonus" is like the husband that comes home to the wife to say that his boss has granted him a 1% Easter Bonus but it must be repaid next year. Wow! what a powerful stimulus. Still, it will hit soon after the last of the FOMC rate cuts and will therefore be perceived as a powerful blessing bestowed on the little people by the politicians.

The market reaction to the FOMC's action earlier this week was a 400 point move in the Dow. All this over a $200 Billion loan commitment by the FOMC. OK, this $200 Billion is in addition to the $150 Billion to the public. This $200 Billion is a short term loan to the banks and brokerage companies. Since it is a low interest rate loan that will have a multiplier effect, it may be a little more powerful than the stimulus package but it is still peanuts relative to the total economy. The bottom line is that the Bush administration has left us sitting on the hot stove. The market rate on 90 day t-bills is 1.45% and the FED funds rate is still 3%! It is well past the time to bring rates in line with the market but, instead, the "insiders and the insider pundits and the unknowing" have all heaped praise on the "rifle shot" taken by the FED, which apparently was just another way to stall. Who among us would say that it is logical for banks to borrow from one another at 3% when the market rates are 1.45%?

The big cannon shot will be bringing bank borrowing rates down close to market rates. For now, trillions of dollars of loans are being priced by "state regulators". Here we are in a "free economy" that is being overly controlled for political purposes.

As you know, it is my belief that the big objective for Bush is to make a deal or two in the Middle East before his term expires. His "other objective" is to keep the presidency in republican control. The failure of congress to authorize drilling for oil in America will cost democratic votes if the oil market is in "crisis mode". Huge new supplies or oil have been discovered but bringing those supplies on line has been slowed. There is a lot of blame to spread around as both democrats and republicans have failed to go after the "low hanging fruit" of easy oil reserves in America. At the same time, we tax productive assets heavily but do not fully tax products that hurt our country.

Some changes are coming. In addition to huge new oil fields, for the first time in a very long time, nuclear power plants are being designed and constructed at a rapid pace. Some environmentalist have seen the folly of using food products for fuel and some of these have come to be proponents of low emission nuclear power. One nuclear power plant produces more power than thousands of windmills.


Some would say that the housing down turn in the US is spreading. The facts are that price appreciation around the world is still strong. Those who bought homes in China, India and many other places in recent years are very pleased. In London, prices increased by only 2% over the last year. A slowdown in appreciation but not a serious problem. Home prices in America have not fallen anywhere near as much as is commonly believed. Indeed, most houses have increased in value substantially above their values of three years ago.


A YouTube video tells the story of Lynsey McCree, a Canadian who just had a brain tumor operation. When his Canadian doctor suspected a problem, he ordered an MRI. The earliest available date was four months away. Instead of waiting for the "free" MRI, McCree had one done in Buffalo NY. When the MRI showed a tumor, McCree discovered that the "free" operation could be scheduled after 3 months. McCree had the operation 8 days later in Buffalo. His life was saved. His American "time line" from start to finish was 4 and one half weeks, his Canadian "time line" was over 8 months. Had he waited in Canada, he would have probably been dead soon before or after his operation was done.


When people come to believe they are smarter than markets, services are priced incorrectly. The result is a shortage of supply or waste. The effect of intervention in the energy markets has restricted drilling, limited construction of power plants, and wasted natural resources, including top soil. The intervention of government in health care has caused prices to soar in America and supply to be limited in other countries. The intervention of the FOMC in the financial markets has caused the "stop and go" of markets that has enriched the powerful while hurting the "little guy". Of course, all the politicians help all the "little guys-small businesses and consumers".

Next week, the FOMC is expected to lower rates by at least one half of one percent. Powerful medicine! The 200 billion dollar swap offered this week is small potatoes compared to lower cost for millions of people and businesses on trillions of dollars worth of current and future loans. Many pundits are screaming NO, NO, NO to further rate cuts. They are caught in the trap of not understanding the price of the US dollar. Here again, we have people who are theoretically proponents of free markets asking for the federal government to intervene in currency markets. If they do, it will only cause a temporary ripple. The price of the dollar is seeking the appropriate level and this price is influenced by 1,000's of pieces of info. I believe the dollar is low for several reasons; 1) that this is the natural time in the business cycle for the dollar to be low, 2) that there is risk of war with Iran, and 3) that US tax rates have gone up relative to tax rates in the rest of the world. The key point to be made is that lower US interest rates will not cause the dollar to go lower (except perhaps as a short term reaction). The growth rate of the US economy will increase after rates are lower. As the economy grows, the demand for US dollars will increase. The US dollar is considerably lower today than it was at the mid cycle turns in 1980 and 1990. Historically, a great time to buy stocks has been when the dollar is sitting on new all time lows.

The case of BMW tells the whole story. BMW has announced layoffs of 7.5% of its workforce in Germany. BMW has also announced plans to increase employment in the USA by 50% between now and 2012. BMW can buy and build in America for much less than it can in Germany. The low price of the dollar is serving its natural exchange roll which moves production to the most profitable place. When BMW increases its work force in America, all kinds of parts suppliers will increase their work force in America. The move is under way to "import" the fast growth of the rest of the world to the USA.

The increased production of goods in America is a deflationary event. When the supply of goods goes up, the price goes down.

The bottom line is we are looking at good news ahead. The shame is that politicians are playing games. Broker dealers and banks that contributed to the problems are now the recipients of 200 billion dollars of low cost loans. The rich get richer! Will the FOMC cut enough next week to end the "squeeze play"? No one knows for sure. Bush would like for the FOMC to "hit the gas" just about the time a deal is made, but who knows if a middle east deal will materialize. If it does or if it does not, the squeeze play is almost over. With mortgage rates down sharply, home sales are going to climb. The $200 Billion and other cumulative actions of the FOMC will take effect. The mountains of cash on the sidelines will be put to work rapidly, as soon as the fear of recession converts to the fear of missing "THE BULL".