Rethinking Words

In our January article “Let’s Talk Interest Rates” we said

Most of the larger players in the game including commercial institutions and hedge funds understand this game well. They know the risks of the system and in the bets made therein. Many therefore are ready on a minutes notice to liquidate just about everything. This was one of the dynamics experienced during the late 1920s. The speculators, masters and novices alike, new damn well that their money was at risk. But who wouldn’t take on that risk for gains of 20-30% a year? Furthermore, each reasoned with himself that on the first sign of imbalance money would be taken off the table, bets closed and a dashing for the door would be in order.

Of course the financial markets don’t have a very good track record of maintaining peace-of-mind for the investors that push it to sky’s limits… If the wise and intelligent investor were a caveman he’d warn “Catch the beast when its weak and tired not when it’s mad and hungry”.

When the floor drops, as it always does, many will be quite disappointed. Meanwhile with the dam of equities along with the credit of both housing mortgages and the Federal Reserve crashing in, the Fed will face its true debacle. Plummeting house prices, sub-prime loans defaulting all over and stocks being sold fervently, all the while flooding the marketplace with billions if not trillions of dollars of liquidity. Hence, contrary to popular belief inflation will occur regardless of whether or not the Fed and the government attempt to flood accounts with easy credit and loan Repos. Post facto this liquidity would have inevitably been filtered in through financial assets.

We have found this to be half true with its premise intact. We will understand based on our assumed knowledge of inflation. Inflation, once again, is categorized as the increasing of credit and expansion of monetary restriction. When this occurs, we perceive an overall trust in the nations money and in the nature of business expansion as a whole.

Conversely, in regard to deflation we have the opposite. A flee from fiat trusts is formed, as all issues of promise and of future marketed worth, as oppose to physical intrinsic value, are abandoned.

Where we currently stand the latter is inevitable. Financial assets currently sell for far more than they are inherently worth, stocks sell for historically high multiples to earnings, derivatives have infused the system with a breadth that bodes well only for high-net-worth risk-savvy speculators. Many investors are sitting out, while hedge funds scour their way from private equity to the latest IPOs.

When this begins to collapse, and many already believe it has, the Federal Reserve will have its final chance to hold on raising rates and dump as much of their magically created money and credit as they can before the system realizes what has happened. But what will stop it then? Nothing. It will only stall what has been a process in the making since late 1999. More investors are coming to light of the truth, as oppose to those being sucked in as they were at the height of the last century.

So there are two courses the Fed can take. Allow free-markets to unravel themselves, resulting in a deflationary scenario where money is saved and hoarded rather than invested and spent bringing a halt to the momentum that the speculators currently thrive on. Or they can disallow markets to take their course. This would result in hyperinflation – any nation’s worst nightmare – where money becomes absolutely worthless, the dollar goes to zero and the U.S. falls into an economic debacle of cataclysmic proportions.

In regard to interest rates there really isn’t much the Fed can do to help the situation if it isn’t willing to face the facts openly. It can save the dollar from its ultimate value or the economy from recession, but not both. Their policy in the future will dictate their intentions. For now they are watching like so many other investors wondering.

Wondering which, the fiscal assets or the physical, will give way, as it’s assured that one no doubt will.


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