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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: ild who wrote (2282)	11/17/2003 12:21:10 PM
From: Real Man	Read Replies (1) \| Respond to of 110194

It's only somewhat unique - currency and debt collapses happened before in many countries, such as Britain, Mexico, SE Asia, Korea, Russia, Argentina, Turkey, etc. But it never happened to the World Reserve currency

To: ild who wrote (2282)	11/17/2003 2:51:52 PM
From: Crimson Ghost	Respond to of 110194

The Inflexible Flexible Fed November 17, 2003 Eric Cinnamond is the Director of Research and Small Cap Portfolio Manager for Intrepid Capital Management (www.intrepidcapital.net). In August, Alan Greenspan preached the importance of flexibility in his speech, “Monetary Policy under Uncertainty”. In essence, Greenspan argued that policy makers should use their best judgment rather than setting strict numerical monetary targets. Greenspan went on to say that at times it may be necessary to have insurance for “a low-probability event” even if that insurance eventually proves to be unnecessary. With the federal funds rate at 1%, a 45-year low, the Federal Reserve has taken out a massive insurance policy that is intended to protect the United States from a low-probability deflationary event. Although insurance is a necessary ingredient to any prudent life, one can always have too much insurance or overpay for insurance depending on the stage of one’s life. So where is the United States in its economic life? During the third quarter, real GDP increased at an annual rate of 7.2%. According to Thomson Financial, third quarter earnings for companies in the S&P 500 increased by 20% on average. Even the employment picture has improved with 126,000 jobs being added in October. The last time the economy was growing this strongly was in 1984 when the 10-year treasury was yielding approximately 12% (currently 4.4%). Economic growth is expected to spill over into the fourth quarter as well, with GDP growth estimates reaching 5%. The economy is currently vibrant. Aided by exceptional GDP growth, the threat of deflation has declined as the third quarter GDP price deflator increased to 1.7% from 1.0% during the second quarter. Moreover, the third quarter PCE (personal consumption expenditures) increased to 2.4% from 0.8% in the second quarter. Gold is close to reaching $400 an ounce and commodity indices are soaring. Insurance, education, health care and other service related expenses are growing at double digit rates. Housing inflation is reaching historic proportions. According to the National Association of Realtors, home prices in cities and towns jumped at least 10% in the third quarter. Meanwhile, the median price of a home in California has breached the $400,000 mark. Is the Fed reconsidering its large insurance policy on deflation? Not according to the Federal Reserve Bank of St. Louis President William Pool, who Thursday stated that the Fed may keep rates low “beyond March” of 2004. Also on Thursday Chicago Fed Bank President Michael Moskow reiterated the Fed’s accommodative monetary stance in order to, “provide some insurance against unwelcome disinflation.” After these comments, the Federal Reserve now has little, if any, flexibility to raise rates before March of 2004. In essence, the Federal Reserve has placed a gun to the bond market’s head. The Federal Reserve is implying that it will not tolerate higher interest rates for the remainder of 2003 and the first quarter of 2004. Bond managers eyeing their year end bonuses have been warned. Are other central banks with similar economic environments also buying deflationary insurance? The Reserve Bank of Australia has recently taken out an insurance policy; however, its insurance policy is focused on the unwelcome event of inflation. The Bank of Australia raised its cash rate 25 basis points to 5%, citing strong domestic demand, rising credit outstanding, and a buoyant housing market. The Reserve Bank of Australia believes that current trends in credit and demand are unsustainable and by raising rates it is attempting to provide stable long-term economic growth. Absent from the Reserve Bank of Australia’s press release was any promise regarding pegging rates until a certain date or even a vague statement such as ‘considerable’ period. The Reserve Bank of Australia has preserved its flexibility. The Federal Reserve of the United States does not need a large insurance policy on deflation. The Federal Reserve needs an excuse to keep rates pegged at a 45-year low in the face of GDP growth that hasn’t been seen in 19 years. Deflation is that excuse. Deflation is not the real reason the Federal Reserve has the monetary pedal to the medal. The Federal Reserve is trapped by the mountain of debt that was built during the past few years of easy money. The government, corporations, financial institutions, and consumers are all addicted to essentially free money. Total debt outstanding reached $32.4 trillion in the second quarter, up from $25.7 trillion three years ago. Mortgage debt, the fuel for housing inflation, is up over 37% during the past three years to $6.5 trillion. The consumer can buy a car, boat, furniture, appliance, etc. with historically easy terms. Easy credit aided the 26.9% growth in durable goods during the third quarter. It’s a borrower’s party with the Fed serving strong credit. Consumers are having a blast and the Fed wants their party to continue at least until March of 2004. If the Fed raises rates the consumer party ends and a real deflationary event caused by over 300% debt to GDP could occur. Will the United States Federal Reserve eventually follow the lead of Australia and raise rates? The longer the Federal Reserve waits, the higher debt levels grow. As debt levels increase at historically high rates, the Federal Reserve loses its ability to raise rates without significantly harming the economy. Australia’s central bank has moved in a preemptive fashion and has room to cut rates if its economy slows. The Reserve Bank of Australia is flexible. The United States Federal Reserve has made it clear it will not raise rates in the near future. Flexibility is not an option. Opinions expressed are not necessarily those of David W. Tice & Associates, LLC. The opinions are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.