-- Posted Monday, 14 April 2008 | Digg This Article | Source: GoldSeek.com
by Howard S. Katz
4-11-08
A key rule for all who trade the market is don’t fight the Fed. And the central question for those who recognize this is, what will the Fed do next? From the time that Bernanke astonished conventional opinion by cutting rates last September in the face of a collapsing dollar, the two questions on everyone’s mind have been: how far, and how fast?
But this past week we got a strong clue. Former Fed chairman Paul Volcker stepped forward and made some sharp criticisms of the way that Bernanke is handling his job.
For years, many people have preached an independent Federal Reserve on the argument that, if left to Congress, monetary policy would be too easy, and only the Fed Chairman had the fortitude to resist the public’s demand for easy credit. But of course, what we have witnessed over the past 7 months is a Fed Chairman gone berserk and easing in the face of a massive, world-wide increase in prices and a corresponding collapse of the dollar. Indeed, we have witnessed an easing policy going back to 1981, and there were few examples of fortitude.
But few people, most prominently the Wall Street Journal’s Paul Pigot, have criticized Bernanke. The reason is the pseudo-mystique of the Fed chair. Monetary theory sounds like a mass of incomprehensible gobble-de-gook, and everyone is afraid to criticize the head of this institution. They knuckle under to what they do not understand.
But on Tuesday April 8, 2008, Paul Volcker gave a speech to the New York Economic Club. He stated:
“Out of perceived necessity, sweeping powers have been exercised in a manner that is neither natural nor comfortable for a central bank.”
Paul Volcker, as quoted by Michael M. Grynbaum, “Ex-Fed Chairman Chides His Successors,” New York Times, 4-9-08, p. C-1.
The Wall St. Journal commented:
“The present climate Mr. Volcker told his audience, reminded him of nothing so much as the early 1970s.”
“Volcker’s Demarche,” WSJ, lead editorial, 4-9-08, p. A-14.
The importance of this criticism lies in the fact that your average newspaper editor or radio talk show host will shy away from a criticism of the Fed chairman if it comes from you or me. But coming from another Fed chairman it commands respect. This is the key step in an attack on Bernanke which has been building since Jean-Claude Trichet went eye-to-eye with Bernanke on Jan. 23. But Trichet did not verbally criticize Bernanke (and as head of the ECB it was not his place to). But even before Volcker’s speech, there was a palace revolt against Bernanke at the Fed. Grynbaum again:
“Minutes released on Tuesday of the Fed’s March 18 policy meeting revealed strenuous disagreements among top central bankers, with two of the 10 officials present voting against the decision to lower interest rates by three-quarters of a point.”
Michael M. Grynbaum, Op. Cit., 4-9-08, p. C-4.
What are the implications of this for Fed policy? We are rapidly approaching the time when the Fed will be forced to stop easing and then a little later it will be forced to resume tightening. The Fed funds futures are predicting another quarter point, possibly a half, by year end, and they have been very good. But that will probably be it.
The long bond is very close to its June 2003 high. It may or may not make it. But a 25-year bond chart indicates that, when the long bond gets below 4½% yield, this creates an enormous demand for credit and makes it almost impossible for the bond to go much higher. It is likely that 4½% nominal yield is very close to 0% real yield. (Many people make an important mistake in calculating the real yield on the long bond by taking the nominal yield and subtracting the past year’s CPI. However, the bond market is not looking backward to last year’s CPI. It is looking forward to the average price increase over the next 30 years, and that is a harder number to calculate.)
A yield of 0% in real terms on the long bond creates a virtually infinite demand to borrow, and an infinite demand for credit is an important part of a bubble. The internet bubble of 1999 and the housing bubble of 2003-2006 indicate that real interest rates at those times were close to 0. Hint to Alan Greenspan: If you are wondering if you did anything wrong during your period as Fed chair, these two bubbles are a big clue. The fact that people around the world are rioting for food is another clue. This tells us that, although T-bonds are not yet in a bear trend, it is almost impossible for them to go significantly higher.
And if there is little upside in T-bonds, then the stock market is in some trouble. We did have a classic stock bottom on Jan. 22-23 with a secondary test on March 10. But without leadership from bonds, any stock bull market will be weak and of limited duration.
And what of commodities? What will commodities do when bonds turn down? Well, the interesting thing is that it is normal for commodities to move opposite to bond prices and together with bond yields. The period 2002 through early ’03, the period mid-’04 to mid-’05 and the period mid-’07 to present are rare exceptions in the past 50 years of commodity/bond history, and the conclusion to be drawn from them is that commodities are so undervalued on the very long term that they had the power to go up despite the yield declines of the above periods. Therefore, assuming that in the not-too-distant future bonds turn down (and yields up), we can look forward to the commodity bull market intensifying.
And as for the dollar, Bernanke said “to blazes with the dollar” back on Sept. 18, 2007. At that time, the T-bill rate was just starting its decline from 5¼% to the vicinity of 1%. But the dollar was already weak at 5¼%. Perhaps if Bernanke is impeached, removed from office and sentenced to the guillotine and if U.S. short rates return to 5¼%, then we can begin to make a case for strength in the dollar. But this eventuality is in some hazy, distant future, and I would prefer not to speculate so far in advance.
The above is an example of the kind of analysis I do in The One-handed Economist. Interested readers are invited to visit my web site, www.thegoldbug.net (which comments on economic and social issues, no cost). And if you want the kind of hard predictions that can make you money, you can subscribe to the One-handed Economist (via the website) for $300/year.
Your interest is appreciated.
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-- Posted Monday, 14 April 2008 | Digg This Article | Source: GoldSeek.com