As we suspected, the Fed went for broke yesterday. We predict it will work: we will go broke!

“Fed effectively cuts its key rate to zero,” is how today’s International Herald Tribune brings the news.

This year has been a 1929 rerun. The feds don’t want to see the ’30s too.

Investors were buoyed up by the news. The Dow rose 360 points. Gold rose $6 too – to $842. If it can hold above $838, it will end the year in positive territory. Get your gold while the going is good…and the price is still reasonable.

“Going further than analysts anticipated, the central bank cut its target for federal funds rate to a range of zero to 0.25%, a record low, bringing the United States to the zero-rate policies that Japan used for six years in its own fight against deflation.”

As predicted, the US follows the Japanese model…and its own model from the ’30s…the ’70s…’80s…’90s…and ’00s. Borrow it, lend it, spend it and print it. Money, that is.

It doesn’t seem to bother anyone that these policies don’t work. Last time we looked, Japan was still in the on-again, off-again deflation/recession it’s been in for the last 18 years. And more recently, Japan’s share market is at a 22-year low. A whole generation of Japanese investors have gotten nothing for their trouble. Stocks for the long run? It’s a good thing the Japanese have long life expectancies!

But we are all Japanese now. Sushi it is! ZIRP – the “zero interest rate policy” – was tested in Japan for many years. There is no evidence that it did any good. Zip! Nada! Now, it will be used here…again, for many years.

There are really only two ways out of this mess – up or down. People owe too much money…and they’ve invested in too many things that aren’t worth what they paid for them. There’s no easy way out. Mistakes are mistakes; somebody’s got to pay for them. Either the people who made the mistakes…or people who didn’t.

The feds can just butt out…and let the market take care of itself. That will mean HIGHER real returns on capital. Real money will be scarce. People will pay for their own mistakes – dearly. Savers will be rewarded with higher yields. They will save more. Prices will fall. The economy will go through a tough, but relatively quick, reorganization. Debts will be written off or paid off…or worked off. Investors will lose money…business and consumers too. It will be long and hard, but gradually balance sheets will be strengthened…and the economy will be re-capitalized with savings. Still, many people will go broke. And riots will break out …as the lumpen malcontents take to the streets demanding that their government ‘do something.’

Of course, there is nothing the government can do…but cause more mischief. That’s the low road – the road the feds have taken…by cutting interest rates to zero and spending trillions of dollars they don’t have. It’s the low road they’ve been on for many years…it’s where they feel most comfortable…and where they can do most damage. Instead of recapitalizing the economy by favoring savers, the feds are continuing the process of de-capitalizing it. Yields go down, not up. Savers get discouraged…and ripped off. Money becomes cheaper and cheaper…eventually reducing the debt load via inflation. Reckless spenders’ debts are erased. Mortgages are wiped away. Speculators make money on wild bets. Debtors come out way ahead – including the biggest debtor of all – the US federal government,

Meanwhile innocent savers, ordinary householders, taxpayers, foreign creditors, unborn children – all pay the price.

We’re not arguing with it. Nobody asked our advice anyway. (Nevertheless, we give some advice…below.)

The feds are on the low road, no doubt about it. But so far, they’ve haven’t gotten very far. Instead of inflation, they’re getting deflation. Yesterday’s news reports tell us that consumer prices are headed down. Sales are down too – with luxury goods off 33% since Thanksgiving.

And, of course, housing starts are down…states are cutting back spending for the first time in 25 years (they don’t have printing presses…poor things)…and even the mighty Goldman Sachs has had to report its first quarterly loss since it has been a public company.

If the Japanese example were the only thing we had to look at, we’d think the feds couldn’t win this fight. Mr. Market is bound and determined to lower prices. So far, he’s clearly winning.

But there are other examples that boost our confidence in the feds. They’ll get the hang of it eventually.

The rate cut “means the Federal Reserve will have to reach for new and untested tools in fighting both the recession and downward pressure on consumer prices,” says the IHT report. Untested? We bet Gideon Gono can show them how to use these new tools.

*** If our sage counsel had been courted, we would have told the feds to take the high road. Don’t cut rates, raise them. Get it over with. Reward savers, not spenders. Give people a bonus for doing the right thing, not for doing the wrong thing.

We’re not above a little showmanship either. If Obama wants to keep the masses at home watching TV rather than marching on the White House, he should offer a real stimulus:

Give people back their tax money. Declare a Tax Jubilee. No taxes in ‘09. No income taxes. No capital gains taxes. No federal taxes of any sort…not even any inheritance taxes. If we had our druthers, you could die in ‘09 and rest in peace…with no tax consequences…leaving your money to whomever you wanted.

But we know what you’re thinking…how could the federal government operate without tax revenue? Ah…that’s the other part of the plan. We would shut it down. Take a holiday from government. Send everyone home for a year. Tell them to make do with what they’ve got.

*** One thing is sure; we’d get along fine without the SEC on the job. It does more harm than good. It merely helps perpetrate a fraud – misleading investors into believing that their money is safe on Wall Street. As we’ve seen, donuts were safer on a fat farm.

Christopher Cox, chairman of the SEC, assured investors nine months ago that their investments in Bear Stearns were perfectly safe. The firm collapsed three days later.

“You are dealing with a commission whose effectiveness in fraud deterrence is open to serious question,” said Professor Joel Seligman, an expert on the subject. Open to question? We would say the question is settled. The SEC does not fight fraud; it aids and abets it. In the largest heist in Wall Street history, Bernard Madoff was able to tell investors that their funds were safe: the SEC had examined the company carefully twice in the last 3 years…and given it a clean bill of health.

*** “Don’t you know there’s a worldwide financial meltdown?” we asked Elizabeth last night. “This is no time to be buying new furniture.”

“Well, I needed a new desk. But I’m not buying anything else.”

“Aren’t you picking up a new horse trailer tomorrow?”

“Yes, but I ordered that before the crisis hit. When I thought you had some money…before you started worrying about going broke.”

The phone rang.

“Who was that?” we asked a few minutes later.

“That was the curtain man. I need to get new drapes for the living room.”

“What’s wrong with the old drapes?”

“They’re just not right.”

“They’ve been okay for the last 13 years…what’s suddenly not right about them?”

“They’ve never been right…and I’ve finally realized what it is…so I’m going to change them.”

“Don’t you realize that there’s a global financial crisis? This is no time to be spending money.”

“Yes, but the crisis is likely to go on for 10 years…and I don’t want to live with drapes that aren’t right for a whole decade…and then buy them after we’re too old to enjoy them.”

“You’re not one of those ‘toxic wives,’ are you? You know, those women who leave their husbands after they lose their money.”

“Don’t be silly. You didn’t have any money when I married you. And I’ll stick with you even if you go broke. We may not have any money. But at least we’ll have nice curtains to look at. That’s why I’m getting them now…while you’ve still got some money left.”

Source: We Are All Japanese Now

So if the world’s major gold companies can’t find any new gold deposits in the ground, they’ll have to find them in the stock market…by buying companies that already possess proven reserves.

Therefore, forward-looking investors might want to take advantage of the current weakness in the gold share market to invest in some of the small mining companies that would be attractive takeover targets.

One of the most intriguing aspects of the current market is the dearth of major discoveries so far in this cycle. This despite record amounts of money spent on exploration since this bull market began in 2001.

Older and smarter minds than mine had predicted that the soaring price of gold would produce a new wave of exploration that would, eventually, produce a new wave of major discoveries.

But so far, as Barrick Gold’s CEO, Peter Munk, recently observed, “There have been virtually no new discoveries.” Only Aurelian (ARU: TSX) has landed a legitimate “elephant” deposit bagged. Unfortunately, the carcass of that particular elephant rests entirely within the sketchy outlines of the nation of Ecuador where the locals are currently circling like a pack of hungry hyenas.

It has been our contention that what was needed to light the fuse on the junior exploration stocks would be, in no specific order:

1. Sustained higher gold prices.

2. Improving financials and free cash flow of the major producers.

3. A discovery to heat the blood of the investing community.

So far, we have had (1) and we are beginning to see (2), but (3) has proved remarkably elusive.

Now, don’t misunderstand. You can have a whopper of a bull market in these stocks without the discovery — that was the case in the 1970s bull market. But a discovery that fires the imagination can jump-start things in a big way, no question about it.

Too bad nobody has found one recently.

In short, we appear to have reached the era of Peak Gold. Whereas a major discovery used to be 10 million ounces or more, the threshold for attention-getting discoveries these days has fallen to more along the lines of 1-3 million ounces…and even those are hardly falling off the trees.

Viewed from the perspective of an investor in the junior resource sector, this lack of discoveries means the fuse is lit — starting with straight-up supply and demand fundamentals — for a rocket shot tomorrow. Adding boosters to the rocket, we have a commodities bull market that shows no sign of ending anytime soon and, while the U.S. dollar will periodically rebound, it is not going to somehow reinvent itself as sound money in our lifetime.

Importantly, as you can clearly read between the lines in Chairman Munk’s words, once the majors get cashed up and get serious about replacing their reserves, they are going to have to look downstream to the juniors with discoveries…even if those discoveries are below the five-million-ounce threshold they previously required to even consider taking an ore body into production.

Of course, lowering the threshold on deposit size will require trade-offs. For example, in order to be considered for an acquisition, a smaller deposit will almost certainly have to be near surface and open-pittable. It will also have to be near good infrastructure, and located in a jurisdiction with good laws and reasonable taxation. There is, in this situation, an opportunity and a risk.

~~~~~~~~~~~~~Special~~~~~~~~~~~~~

The Next Bear Stearns

The horrible financial practices that have already taken down some top investment banks were not as rare as we may have hoped. In fact, shoddy bookkeeping and risky business maneuvers were being used in several financial institutions.

Now the next victim is about to be claimed. Which financial giant is going down next? Click here to find out…

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Starting with the latter, if your portfolio now includes companies going after deposits in the one- to five-million-ounce range, you need to make sure they are not in a remote location that would require a massive infrastructure investment.

As for the opportunity, while the odds and the amount of exploration spending still favor that we’ll see the discovery of at least one and maybe two monster deposits in this cycle (there are a couple of companies advancing projects with that potential), and early shareholders will make fortunes as a result, there has rarely been a better time to invest in junior exploration companies with modestly sized projects in good locations. That said, you should still be focusing only on projects with at least two million ounces, or the strong potential of same.

In other words, take the opportunity in these down markets to invest in the kinds of junior mining companies that major mining company might want to acquire… That’s where the big money will be made as the gold market gathers steam again.

Regards,
David Galland, Casey Research

Greg’s Endnote: If the falling dollar wasn’t enough to send the price of gold ever-higher, the idea of its relative scarcity certainly will. And what happens when the idea of peak gold hits the mainstream? Can $2,000 gold be that far behind? I don’t think so. Click here to see just why gold could soon be doubling in price…

Source: Where There’s Gold