The recent overseas stock sell-off inspired the White House and congress to start talking about manna from heaven, in the form of tax rebate checks. The same day, the Federal Reserve announced what can only be seen as a desperation measure–a one-day .75% interest rate cut on two key rates–has done little to reassure the traders on Wall Street. The market is starting to make some wild daily swings, mostly downward. This piece from The New York Times sums up the big picture nicely: Worries That the Good Times Were Mostly a Mirage [1]. Meanwhile, we read: Plenty to chew on for great minds of Davos [2]. All the signs point to a big, deep, recession. Even Herculean amounts of liquidity pumping and “helicopter dropping” won’t stop this one.
The core of the financial problem is that bankers won’t make loans when they cannot properly evaluate risk. As I’ve noted before, the credit collapse was triggered by the subprime mortgage debacle, and the contagion spread to all sectors of the banking world. There are so many loans that are wrapped up in so many “repackaged” aggregations and “investment vehicles” that nobody really knows who owns what debts, and exactly by what underlying assets they are backed. The CDO [3] and SIV [4] pundits use the term “marked to market.” But I have coined the term marked to mystery. That is a better description of what is going on. The global credit market is now like a giant mushroom farm–where everyone is kept in the dark and fed horse manure. There are mountains of mystery debts held by countless corporations, governments, and institutions. In this unprecedented credit environment, ultra-low interest rates will not revive the sagging economy. The bankers are still petrified, and who can blame them? We recently learned that even the credit ratings agencies were in on the sub-prime swindle. So the bankers can longer trust the word of the “expert analysts” at Moody’s and S&P.
No doubt the President’s Working Committee on Markets (commonly called the Plunge Protection Team [5]) will be working late and ordering pizza delivery. It think that Ben Bernanke & Company will need bigger helicopters, and more of them. This is going to get a lot worse before it gets better. Be prepared for a deep recession with layoffs, tax-funded bailout shenanigans, “incentive” programs, stagflation, huge write-offs of derivatives losses, failed municipal bond funds, the whole works. The big question is: will over the counter derivatives [6] trading carry on as before, without too much disruption? If the answer is no–if there is a derivatives meltdown, then all bets are off. We are talking about possibly hundreds of trillions of dollars in derivatives in play at any given time. A full scale derivatives meltdown would probably trigger a global depression that could last decades, and topple national governments. I’m dead serious about this.
For those of you that took my advice and bought silver and gold, congratulations. You will at least have your capital protected, and might even profit handsomely. Lower interest rates mean a weaker dollar, and that means higher precious metals prices. Jean-Claude Trichet, the head of the European Central Bank (ECB) has said that there is little chance of a European interest rate cut [7], to follow the Fed’s suit. So keep watching the US Dollar Index [8] in the months to come. Any further interest rate cuts by the Fed will probably result in a huge devaluation of the dollar.