Central Banking for Dummies

Discussion in 'Financial Cents' started by Clyde, Mar 19, 2008.

  1. Clyde

    Clyde Jet Set Tourer Administrator Founding Member

    Central Banking for Dummies
    <hr>"Since we're sticking with our Trade of the Decade - buy gold on dips…sell stocks on rallies - the news of this latest Fed intervention gives us another great opportunity to dump shares. Don't miss it."
    <hr>by Bill Bonner
    "There's a time to go long…there's a time to go short…and there's a time to go fishing."
    Our colleague in South America, Horacio Pozzo, reminded us of Jesse Livermore's famous remark…and went on to site a study of goalies in soccer games. Some tend to move to the right, when an attacker presents himself. Others tend to move to the left. But the ones with the greatest success stay put, squarely in the center.
    In today's markets, Horacio suggests, doing nothing may be the best move.
    Inactivity comes easily to us. We almost never regret doing nothing. It's the times we were too slack to do nothing that got us into trouble.
    But this is a family publication, so we will pass over those events…and focus on the financial world.
    Yesterday, the Fed took more action - cutting its key rate another 75 basis points to 2.25%. See how easy central banking is? You read the headlines. If they're negative or scary, you cut rates. If they're positive…or inflationary…you increase them.
    "I think the Fed was pretty shrewd," says colleague Ben Traynor here in London. "They were widely expected to cut rates by a full point. It makes 75 basis points look conservative - as if there was really nothing to panic over. And it leaves them with more room to cut in the future."
    Yes, dear reader, there are still 225 basis points from here to zero. In the '90s, the Bank of Japan, of course, used up all its basis points. Still, the Japanese economy sank…and sank some more. Even today, an investor who bought Japanese stocks in January 1990 is still looking at a loss of more than two-thirds of his money - 18 years later.
    But investors yesterday ignored the Japanese example and gathered up U.S. stocks with both hands. The Dow rallied 420 points.
    "Buy the rumor, sell the news," is another old Wall Street saying. Since we're sticking with our Trade of the Decade - buy gold on dips…sell stocks on rallies - the news of this latest Fed intervention gives us another great opportunity to dump shares. Don't miss it.
    On the other side of the trade, the price of gold slipped yesterday…but not enough to qualify as a genuine dip. Commodities, generally, are getting whacked. But gold is a special case. It's the ultimate money. People buy it when they suspect that there's something with the other kind of money…the kind people use when they go to the grocery store.
    What exactly is wrong with the dollar? Ah, dear reader, that's a long, long story. Will the dollar go up or down? Ah, dear reader…we wish we knew.
    We're betting against the dollar - over the long run - for the many reasons we've discussed in these Daily Reckonings for the last eight years. But in the short run, anything can happen. In fact, we think it is time for a rally in the dollar…and a fall in the price of gold. We have no econometric study to back us up…and no sophisticated math that proves it. It's just an intuition…and a worry.
    The supply theory of money is simple enough. The more dollars you have, the less each one will buy. So, the question for a dollar watcher is: how many dollars are there? But there is no simple answer. Imagine we have an account at a brokerage…and we invest it in gold. Now, imagine that the price of gold doubles. Suddenly, we have twice as many dollars in my account, right? But where did they come from?
    And now, we can sell the gold and buy something. We can, for example, have our brokerage wire the money to someone else's account. That person, then, could transfer title to a house, for example. And, then that person might wire the money to yet another account where it is invested in a derivative contract, which in turn doubles in price, so that now he has twice as much money again. Where did that money come from? And all of this has happened without anyone actually touching a single dollar bill.
    Now, imagine that there is a market crash…suddenly, all that money that came so easily goes just as easily. It disappears. Where did it go? Into the ether!
    Right now, a lot of money is disappearing. House prices are falling. Stocks all over the world are going down. Many financial assets - specialized derivative contracts and junk bonds - are getting hammered. The amounts of "implied" wealth lost are enormous. Worldwide stock market capitalization may be down about $5 trillion. Residential housing in the United States has lost about $2 trillion.
    In addition to the quantity of money, there is also the velocity of it. If we leave a dollar in a desk drawer, it may be part of the 'money supply,' but it is an inactive part. Prices are said to be the result of demand chasing supply. But the dollar in the desk doesn't chase anything. So it doesn't drive up prices.
    When investors and lenders become fearful, the velocity of money tends to go down. People leave money in their safes…in their wallets…and in their accounts. They are reluctant to let it out for fear that it won't come back. This, too, further diminishes the number of dollars chasing goods and services (not to mention financial assets).
    As we have opined many times, we are witnessing a great battle - between the forces of inflation and the forces of deflation. In the last few weeks, it looked as though inflation was going to be the clear winner - with gold and oil hitting new milestones. But the battle is far from over. And despite the feds' attempts to fix the fight - with rate cuts, bailouts and Bernanke's helicopters waiting on the tarmac - inflation is no sure bet.
    You are well aware, dear reader, there are no sure bets in the wacky world in finance…but when it comes to our favorite yellow metal, colleague Ed Bugos assures us: You ain't seen nothing yet.
    As the latest addition to the Agora Financial family with the newly launched Gold & Options Trader, you'd think Ed would want to lay low for a while…get a taste for his surroundings. But no - he's hopped right into the mix with this claim: gold should soon hit $2,138 per ounce. And Ed's got the data to back up that bold assertion. We think he's going to fit in here just fine.
    Check out his special report that lists the 9 reasons gold can only go up from here - and if you act fast, you can get into Gold & Options Trader before we raise the price. Get all the details here…
    P.S. To get The Daily Reckoning sent directly to your inbox, sign up for our free email newsletter, or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
    Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

    Bill's latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here:
    Mobs, Messiahs and Markets
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