Bernanke and the FED: Oblivious or Liars?

Its almost Friday! It has been a wild financial week to be sure. Longtime reader Anon G is expecting some news tomorrow concerning a possible job opportunity. Please keep a hopeful thought in mind for him in his endeavor.

Gold and The Dollar - Economic Stimulus Does Not Go Unpunished
Like many readers here, I am LONG Gold and Silver. The pretty metals took it on the chin earlier in the week, but like Rocky Balboa they refused to stay down. News came out today concerning the "Stimulus Plan". It seems if you make less than $75k as a single and less than $150K as a couple you will get the full rebate with less for the higher earners (That's fair! The wife and I get hosed on this deal). There are also some funky tax breaks for business as well. The entire plan will cost 150 BILLION dollars.

The Dollar really fell hard today, going back down to the 75.5 level on the index. I have been wondering how the dollar can rally with so much activity being done to destroy it. Gold took off and ran like a thief, closing at $913 an ounce. The entire "Deflation vs. Hyperinflation" argument is a difficult one, and one I will need to see tons more information that only time can provide to make a definitive call. Until then, I want to recap some of the items that SHOULD push gold higher and the dollar lower. I said should. The markets right now are wild and seem disconnected at times from reality and rationality, so take this with a grain of salt:

• FED looking to cut rates to 1% this year


• Economic Stimulus plan will not be the last injection this year


• FED continues the auctions of cash for crap capital


• Slowing economic conditions


• Bailout plans from the monolines to the flooded basements of the country with FED dollars

That is quite a bit, and I bet readers here know a few more. Let GOLD run!

Bernanke and the FED: Oblivious or Liars?
We all know the story this week. In the face of a serious sell off in world markets on Monday (MLK holiday here) the FED was panicked enough to drop rates Tuesday before the open by a historic 75bps. Hoping to stop a market sell off, I mean "ensure price stability and full employment", the cuts did seem to take the edge off the markets. Barry Ritholtz at the Big Picture has a great post which details how the FED may have been fooled by the market action into thinking there was a stock run, while in fact the selloff was due to A french bank unravelling the positions of a fraudulent trader. The details are amazing, and I encourage readers here to check it out: http://bigpicture.typepad.com/comments/2008/01/fed-we-didnt-kn.html#trackback

Barry does a great job with links and the like, so I will leave the details to that post. This also reminded me of the time when the FED cut rates by 50bps in the face of a poor unemployment number a while back that was revised away not even 3 weeks later.

What this means in total is that the FED is very quick to pull the rate cut trigger (faster than Josey Wales, "mister chain blue lightning!") even though the data they are relying on is marginal at best. In a prior post I suggested everyone adopt the "Slow down and Think" model, and it seems the FED could use that idea at this time. The FED stated today that they had "No Idea" about the MAJOR unwinding of the french bank positions. No idea. That is encouraging.

The FED has made two "emergency" cuts in the last 6 months, both based on data that was easy to misread or overreact to. Fair enough. But just to put it out there, here are the two items of contention and possible explanations for the actions taken;

Unemployment Numbers Very Weak -The September unemployment numbers were so bad, an emergency cut of 5obps was hurried out to combat the poor reading.

• The poor numbers were revised away as a blip. The FED either has no idea what the actual unemployment numbers are, or they wanted to cut anyways and used this as an excuse.

Global Stock Selloff - The horrible Monday spurred the FED to cut by 50bps a week before their scheduled meeting, to ward off a US market selloff.

• The selloff probably had quite a bit to do with the french bank unravelling fraudulent positions taken by a rogue trader. The FED said they had no information about that. Three possibilities here 1) they are lying 2) they did not know and acted to support stock prices which is not their mandate 3) they wanted to cut anyways and used this as an excuse.

The recurring theme here is that the FED wants to take rates significantly lower, and will use any data point, and market moves, and any cover to do so (See below point for a possible reason). I believe that is the case. If in fact the FED has NO IDEA what the economic picture is, and NO IDEA about massive stock position unwinds done in conjunction with a foreign central bank we are more screwed than you can even imagine. Food for thought, so please leave a comment!

Can the US Consumer Tolerate Rates Over 5%?
Came across this cool, chart which shows the FED Funds rate over time with recessions highlighted. Pay particular attention to the more recent 2000-2008 time frame:



Now keep that in mind and look over this chart from PrudentBear.com which shows Household Debt as a % of Assets (Please note the chart stops in 2006 and things are much worse now!):


It would seem that as the US consumer has gone on a spending bender, the sad fact is that no matter what macro conditions could confront the United States, interest rates as set by the FED may need to sat below 5% for the foreseeable future. How is that for a long term tradeable idea? There is simply no way for households to service the enormous debt they have unless interest rates across the entire credit spectrum stay at historical lows forever. The next time BernanSpan is on the Hill someone should bring this up. Again, some ideas on this are appreciated!

Have a good night.