Good day…And what a day it was! As I stated in yesterday’s Pfennig, Columbus day is just sort of a holiday for the markets. These ’semi-holidays’ can create some volatile trading, as not all of the markets are open and many desks are short staffed. So with the Federal Reserve and the banking system closed, the equity markets had the largest one day gain in over seven decades.

I guess the stock jockeys figured they weren’t going to get any bad news out of the credit markets, which were closed, so no news is good news!! The rally was certainly welcomed, and hopefully some of the gains will stick today as we return to a normal trading environment.

And I guess some of the credit for the stock rally has to go to finance ministers around the globe who finally agreed on a plan which seems to be able to work. The leaders of a majority of the worlds largest economies borrowed a page from Warren Buffet’s playbook and decided to invest directly into some of their largest financial institutions. The Bush administration announced it would invest $125 billion in nine of the biggest US banks. The US move came after France, Germany, Spain, the Netherlands, and Austria committed $1.8 trillion to guarantee interbank loans and take equity stakes in European banks.

The investment represents a new approach for US Treasury Secretary Henry Paulson, who first promoted a bailout targeted at buying up illiquid mortgage-related assets. The government will obtain its stakes by purchasing preferred shares with warrants similar to investments that Berkshire Hathaway Inc. made recently in Goldman Sachs and General Electric. The move could be just what was needed to ‘unfreeze’ the credit markets and restore some liquidity in the markets.

I really think the new president should do all he can to try and convince Warren Buffet to at least take an advisory position in the new administration. Now that we have followed his lead on the $125 billion we should see what he suggests for the rest of the $700 billion ‘rescue’ package. Just think, with his guidance maybe the US taxpayers can come out of this whole episode with a bit of a profit!

The move got the backing of former Federal Reserve Chairman Paul Volcker who said the inevitable recession in the US would be made ‘more manageable’ by the new government plans to invest directly into American banks. The bailout measures were ‘distasteful’ and ‘not consistent with a capitalistic system,’ Volcker said at a lecture in Singapore today. ‘But however distasteful, they are necessary to restore stability to the financial system.’ But Volcker also warned that the global financial system is in ‘intensive care’ and will remain there for a considerable time before things return to normal.

The largest mover in the currency markets yesterday was the Australian dollar which has surged up 12% vs. the US$ since late last week; the biggest two day gain since it began trading freely in 1983. The Australian dollar gained as investor’s confidence was restored and stock markets rallied. Australian Prime minister Kevin Rudd announced a A$10.4 billion spending package aimed at bolstering Australia’s economy, adding to his Oct. 12 pledge to shore up the nation’s banks. These moves by the Prime Minister should provide some support under the Australian dollar which had been falling fast. But the Aussie dollar will likely still be subject to some volatile swings, as investors continue to buy the Aussie dollar on carry trade investments, which have proven to be very erratic.

With investors moving back into carry trades, and some confidence returning to the equity markets, the Japanese yen fell against the higher yeilders. The yen headed for a record decline vs. the Australian dollar, but fell less against the US$. Japan’s currency has become an excellent gauge of risk appetite in the markets, and the currency has risen as investors exited highly leveraged ‘carry trades’ over the past few months. But risk appetite has returned as we have exited the ‘panic mode’ and investors have started to move money back into these leveraged trades.

The Bank of Japan said it will hold an unscheduled monetary policy meeting today to discuss ways to make it easier to add funds to money markets. The bank said yesterday it’s considering offering an unlimited amount of dollars to financial institutions, following a move by European counterparts to provide lenders with as much of the currency as they want to reduce short-term borrowing costs.

This recent flood of US$ into the markets has seemed to stabilize them, but what will it do to inflation in the US? One of the first lessons in Economics is that increasing money supply causes an increase in inflation. The billions or trillions (I can’t keep up with all of the ‘rescue’ packages they keep announcing) of US$ which have been placed into the markets will eventually create a big up tick in inflation. And the huge amount of dollars which are being printed and pumped into the credit system will undoubtedly lead to an erosion of the value of the dollar. Simple supply and demand tells you that if we continue to throw unlimited supplies of US$ into the market, the value of these dollars will decrease in value.

And who is holding most of these dollars? China! China’s foreign-exchange reserves rose to a world record $1.906 trillion at the end of September. Currency holdings rose 32.9% from a year earlier, the People’s Bank of China said on its website yesterday. These reserves have helped to strengthen China’s finances as the credit crisis threatens to trigger a global economic slump. The world’s fourth biggest economy can still expand 10 percent this year and 9 percent in 2009 according to the central bank. Close to $2 trillion in foreign reserves provides China with a strong foundation and more room to adjust policies to enable it to maintain relatively fast growth. The worlds economic engine will continue to purr despite the slowdown in the US and Europe. Internal demand among these fast growing Asian economies will take the place of some of the exports which will undoubtedly slow. I look for the Chinese currency to continue to be a rock solid performer, with no big movements either way.

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