Mother of Exiles
Related Articles
What an interesting week this promises to be. The Reserve Bank meets tomorrow to decide if Aussie consumers have slowed down their spending enough that the cash rate can be kept on hold. Let’s hope you didn’t eat a cake this weekend.
–If you think inflation of 4.2% per year in consumer prices is acceptable-as some pundits seem to think-remember the rule of 72. To find out how long it takes for something to double at given interest rate, you divide the number 72 by that interest rate (don’t ask us why 72 is used, it’s complicated).
–Growing at a rate of 4.2% compounded, a given good or service will double in price in 17.1 years. Granted, the rule of 72 is used to calculate returns on your capital. It helps you establish what rate of return you require on your capital to reach a given financial goal. The faster your rate of compounding the fast you get there. This is why Einstein called compound interest the “eighth wonder of the world” (bonus points if you can name the other seven).
–But we hope you see our point. Tolerating “just a little bit of inflation” seems to have become popular lately. But 4.2% is not “just a little bit of inflation.” Over your life time, it means that prices will double. This is how governments gradually tax your savings by printing more money. This is why fiat money is not “sound money.”
–Enough channeling of Murray Rothbard, though. What’s on tap in financial markets this week? Well, there is a view emerging in financial markets that the seven-year bear market in the U.S. dollar may be at an end. This view, if it can get some traction, would have big implications for commodity prices and Aussie resource shares.
–A rally in the dollar would take some steam out of oil prices for sure. We don’t believe that commodity prices are rising only because the dollar is weak, but we reckon quite a few international traders do, and will use a dollar rally to pare back their long positions in commodity futures and resource stocks like BHP Billiton and Rito Tinto.
–In point of fact, commodities are rising because demand is rising faster than supply. However that fact puts the dollar rally story in doubt and thus will probably be ignored. Dollar bulls have taken heart from last week’s Fed statement. It may indicate (depending on how you read it) that rate cuts are on hold in the U.S. If the ECB cuts and the Fed stands pat, presto! You have a dollar rally (at least against the euro).
–We have to admit, a mild dollar rally is not unimaginable. But let’s take a look at what the Fed actually said. Did it really reveal that its chief concern is now inflation and that it’s become hawkish? Hardly.
–This is all the Fed said about inflation: “Uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.”
–Yes. Yes, of course. “We’ll be keeping an eye on the inflation figures while we expand the money supply and take any sort of garbage collateral the banks can throw our way.” The great asset-laundering scheme continues.
–The market either didn’t notice or didn’t care that after its statement on interest rates, the Fed got even more deeply involved in the credit crisis by offering more loans to the banks through two of its newly established “facilities.”
–There’s a famous poem we want to introduce you to that you may not have heard of in this part of the world. It’s called “The New Colossus” by an American named Emma Lazarus. It’s the poem that appears on the base of the Statue of Liberty. We thought of it today when trying to explain what the Fed is doing:
- Not like the brazen giant of Greek fame,
With conquering limbs astride from land to land;
Here at our sea-washed, sunset gates shall stand
A mighty woman with a torch, whose flame
Is the imprisoned lightning, and her name
Mother of Exiles. From her beacon-hand
Glows world-wide welcome; her mild eyes command
The air-bridged harbor that twin cities frame.
“Keep ancient lands, your storied pomp!” cries she
With silent lips. “Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tossed to me,
I lift my lamp beside the golden door!”
–The Fed has become the mother of all credit exiles, accepting Wall Street’s over-valued, under-performing, dead-beat loans. At least that is what it’s done in a metaphorical sense. What did it do practically?
–First the Fed increased by US$25 billion the amount of money it will auction to banks (commercial and investment) through its Term Auction Facility (TAF). Here banker people, borrow more. Please.
–Second, the Fed expanded the list of collateral it will accept for asset-swapping through its Term Securities Lending (Facility). Remember, that’s the one that lets banks and prime brokers swap mortgage-backed securities for Treasury bonds for up to 28-days.
–The Fed is now expanding that list of asset-backed securities to include collateralized car loans, credit card receivables, and student loans. It’s doing so because the lack of demand for bonds backed by those assets has had a real political impact in an election year. Students can’t get loans for American universities because investors won’t buy bonds issued by the banks who made the loans to the students. No funding, no college.
–We don’t know if you are as agitated reading about the Fed loan programs as we are writing about them. It’s pretty agitating. You have to translate what the Fed has done from Central Bank speak to what it really means.
–What it really means is that that the Fed has lowered interest rates as far as it can to deal with the bank lending crisis. It still hasn’t encouraged banks to loan to each other, or investors to buy bonds backed by various kinds of consumer liabilities. But it HAS had some effects.
–Remember last week we said the interest rate on U.S. Treasury bonds is below the rate of inflation? Well, American real estate speculator Sam Zell says this has lured some investors back into the market for residential mortgage-backed securities. “Is it in large volumes? No. Is it the natural first step in the evolution? Yes.”
–The evolution of what? New credit markets? A credit market where the Fed trashes the yield on U.S. government debt in order to make the yield on mortgage-backed debt look less trashy? One asset might look less trashy in a side-by-side comparison. But for investors, isn’t this like choosing which leper you’d like to take home and introduce to your mother?
–Our take is this: the Fed has probably stopped cutting rates for awhile because it’s apparent that cutting rates has not solved the problem in the credit markets. That problem is still the same: poor asset quality. But even on that score, not everyone agrees.
–”Credit markets are likely to overstate significantly the losses that will ultimately be felt by the financial system and the economy as a whole… They will exaggerate to an even greater extent the potential damage to the real economy,” the Bank of England reported last week in its Stability Report. This from the people who brought the nationalisation of Northern Rock.
–More tomorrow on whether the BOE is full of it tomorrow (and the earnings growth for Aussie banks). But with China ready to rest its manufacturing sector in June to begin clearing the air for the Olympic Games in August, and with the rate cut outlook seeming to favour the dollar over the euro, we reckon that resource prices could be in for a bit of a lull.
–The good news about that is that resource shares might be in for a lull too. And with the fundamental earnings case for these shares being pretty darn good, that means the next few months could be a great time to establish entry points in some of your favourite resource stocks. We’re making our list and checking it twice, are you?
| Email Address: | Subscribe |
NO-SPAM PLEDGE: We will NEVER rent, sell, or give away your e-mail address to anyone for any reason. You can unsubscribe from The Daily Reckoning Australia with a few clicks.
Related Articles
Tags: bear market, Commodity Futures, dollar, ECB, economics, fed, inflation, Murray Rothbard, politics, Resource Stocks, Rio Tinto, TAF, The Reserve BankAbout the Author
Dan Denning is a contributing editor to Diggers & Drillers and a regular columnist for Money Weekly, a Taiwanese financial publication. From 2000 to 2006, Dan was the editor of Strategic Investment of Agora Publishing. His reporting and analysis for The Daily Reckoning is read by more than 500,000 people regularly.