Tuesday, December 16, 2008

The Crossroads - Bernanke's Carpet Bomber

Here I was thinking the FED had become irrelevant and today was the first FED meeting in awhile that I didn't even care about. Well today may have been the been the biggest FED announcement ever and was truly historic. The ramifications, the potential consequences, and unintended consequences are mind blowing. As everyone should know by now the FED lowered its FED target rate to a range of 0% to .25% (first time the FED has ever given a range). This was the bomb shell in the FED statement:

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.....The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.

There has never in the history of FED statement's been wording about the duration of federal funds rate. The words of using all available tools is also significant as is the reference to open market operations. If your a FED follower these statements are jaw dropping. It is the taking the kitchen sink and not only throwing it at the problem but taking a kitchen sink launcher supercharged with jet propulsion and using that to send the kitchen sink hurling in the air.

Will it work? The FED has essentially used its last bullet, after today it is "click, click, click" if they pull the trigger. It becomes a fiscal stimulus game now. So will it work? I don't know. Exactly the answer you wanted to hear right? At the bottom of this post is a link to an interview of Mohamed El-Erian, Bill Gross's right hand man and co-CEO of Pimco. He echoed my thought (or my thoughts echoed his thoughts) that whether it will work or not will be determined by the mass psychology of Americans. What does that mean? Essentially the FED is taking a gun, placing it to the temple of conservative American's who would be savers and saying borrow, spend, stimulate the economy. Your money is going to get nothing sitting in savings so take risk buying riskier assets. It is a failed cattle drive and the cowboys are making one last effort to prod the cattle in the direction they want to go. If American's get on bored, this will work. Investors and individuals will start grasping for risk and our next fear will be inflation twelve to twenty four months from now. If American's say "f you," I want to stay tightly bound in my bunker then this will be the beginning of the end. I don't know and would be a moron if currently I thought I did.

The real danger is unintended consequences. You could see the dollar start going into full crash mode (I personally don't think is going to happen). You could have the W economy I referenced in another post which would wipe out everybody who was short as the market rallied and inflation picked up for months or even longer before once again wiping out all the long investors once you rolled over. You could have our international lenders say enough is enough and stop lending us money (that goes with the dollar collapse above). You could start another large spike in commodities, especially gold, as investor flee to hard assets. You could have foreign countries take action trying to destroy the U.S. actions. Look at the YEN today. It surged. Is Japan going to sit by while they become more uncompetitive as the U.S. government devalues their currency? Many unknowns.

One thing I think is fairly certain is this will cause the current rally to continue for the foreseeable future. I have been saying buy on dips for several weeks and think this reconfirms it. I now think you will see 1000 on the S&P before you see 850 again. Think of all the bad news in the last two weeks that could not drive the markets down. The markets want to rally and this will add to the excuse needed to rally. MOST IMPORTANTLY I think you must remain small. There is no need to be a hero with so many ways this can play out. There is the possibility that the investors will step back and say oh ****, the FED can't do anything more, we are screwed, sell sell sell.

I don't think you will have an idea of whether this FED missile did its deed until later January to mid February at the earliest. Six months to a year ago my response to the bulls clamoring to buy stocks was that credit tightening doesn't show up for nine months just like credit easing doesn't show up for nine months. Bulls like to forget this when it is working against them. As a bear I don't want to forget it on the other side of the coin. The action of the Treasury and the FED in the last 3 months has been unprecedented. It is being combated with further tightening in the private market but regardless this is alot money the government is throwing into the financial system and it will take 6 to 9 months for it to work if it were to work. This is the W economy I have been referring to.

Once again I don't know the outcome of all this. My personal opinion is that you can't change the inevitable. You can change the way inevitable looks, you can postpone, but in the end you will end up at the exact same spot. What I mean by that is the world is headed for a once in 50 to 100 year slowdown and the FED can change the way the inevitable looks but in the end can't change the inevitable. People will still crawl into their bunkers as more jobs are lost and excess capacity in all industries is taken out through the capitalism destruction process. You may have massive inflation in the interim but if the system is broken and needs to be purged it will purge itself (Germany after WWI) What is less clear to me is what it looks like in the interim. Stubborn bears could be wiped out in the next few several months if the FED causes a return to risk taking.

The interview I referenced above. I highly recommend it:


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