http://www.dailyreckoning.com/Yesterday, Don Kohn, number two man at the Fed, told the world that America's central bank would be "flexible and pragmatic."...People knew what that meant. The Fed is prepared to cut rates next month. So encouraged by this were investors that they set about buying every stock in sight. The Dow rose 331 points. That brings the total to 546 points gained in the last two days. Not bad...
But let us look at what is happening. The Fed funds rate is 4.5%. Investors now imagine that a 50 basis point cut is coming. That will take the signal rate down to 4%. But in this instance, the Fed will not be leading…it will be following. The 10-year note already yields less than 4%. Bonds have been falling since June. They are just another of the many signs of deflation - of a draining away of credit, cash - liquidity - from the markets.
In other words, now the Fed is no longer driving inflation
…it is trailing along behind deflation, trying to keep up with it.
We indented that last sentence, because we didn't want you to miss it; we are so proud of it. Remember it. Quote it to your friends. To put it another way…the Fed is no longer pulling on the string…it is pushing on it. In offering money at 4% (just a hypothesis) it will only be catching up to what investors have already been doing.
Now, it's private lenders who are doing the pulling. They're reluctant to lend into the open market; because they fear they won't get their money back. But they're happy to lend to the U.S. government. Spreads are widening - always a sign of a tightening credit market....For example, Citibank got itself into subprime trouble and needs big money, fast. So, it turned to Abu Dhabi. But the Arabs wanted a lot more than the T-note rate. They wanted a pound of flesh - forcing one of America's leading financial institutions to pay a rate normally associated with third world hellholes and first world shysters - 11%....
Houses are selling at their slowest rate in eight years, Bloomberg reports. In California, sales are down 40% from a year ago.
And here's more from Bloomberg:
"The worst U.S. housing recession in 16 years will drive down property values by $1.2 trillion next year and slash tax revenue by more than $6.6 billion, according to a report by the U.S. Conference of Mayors… 'The real estate crisis of 2007 and 2008 will go down in the record books… The wave of foreclosures that has rippled across the U.S. has already battered some of our largest financial institutions, created ghost towns of once vibrant neighborhoods - and it's not over yet.'"
No, it's not over yet. In some ways, it has barely begun…because the knee-bone of consumer spending is still connected to the thigh-bone of house prices, which is still connected to the hip-bone of mortgage credit. And if one of these bones breaks, the economy stops walking forward and falls on its face.
That is what we think is happening.
There's a greater than 50% probability that the financial system "will come to a grinding halt because of losses from mortgages said Gregory Peters, Head of Credit Strategy at Morgan Stanley (NYSE:MS)....Well…yes…the ankle bone is connected to the shin bone. That's the way it works. You can't take $1.2 trillion out of the consumer economy, without consumers feeling it...And now the Fed is rushing to try to put the money back in. Alas, it is not that easy. Japan's central bank tried it for 17 years.
And America is in a much tighter spot than Japan. With a very positive trade balance, and abundant savings, the Japanese had room to maneuver. Not so the United States. Investors have already shown what they could do to the dollar. Let the Fed cut rates more and there could be a bloodbath in the currency markets…forcing spreads even wider, and pushing the U.S. economy into an even deeper crisis.
ENTRY CONTINUES WITH SPECULATION ON WHAT WILL HAPPEN NEXT....
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