By Bill Fleckenstein
In some ways, the present environment reminds me of the fall of 1987, when the dollar was going down, bonds were getting hit every day and stocks were holding in there, “acting well,” which everybody thought was so great. We now know that folks weren’t selling, since they thought portfolio insurance would protect them — and we wound up with a crash.
Today, people don’t worry about portfolio insurance because they don’t think they’ll have to sell. But there is the portfolio-insurance-like time bomb, via folks’ ability to redeem their mutual funds with a phone call. We’ll witness that one day, and it will be a sight to behold.
As for the potential time bomb in the geopolitical arena, a case could be made that equities have acted pretty well, despite developments in Iraq and terrorism generically. On the other hand, it could be said that many folks are just whistling past the graveyard in total denial, opining in essence that since the market has acted well in the face of this bad news, it must really be ready to go up.
In addition, a fair amount of “other” bad news just seems to be ignored. For example, folks seem completely oblivious to the mammoth size of our debt problems and to the fact that the dollar may be in trouble once again. (Of course, that problem only comes to matter when it matters, and then there’s not much to be done.)
While bulls are content to feel good because the market “acts great,” bears like myself are concerned about a whole litany of things that could go wrong (which I’ve covered many times). And we’re also concerned that valuation for equities not only has “no margin for error” but is almost “priced for perfection.”
The laser-jet-setting Fed
Another problem that folks seem completely oblivious to: The Fed continues to print money furiously, generating an inflationary problem. For the time being, they appear much more focused on deflation. (I would just note that it’s only in the absence of inflation fears that inflation really gets stoked.)
The money-supply numbers are so large as to be incomprehensible, but I’ll try to put them into perspective: Two weeks ago, M3, the broadest measure of money supply, rose by $46 billion. (This particular surge has been more a result of assets shifting into institutional money funds than any overt action by the Fed. So for once, this isn’t an example of pure Fed pumping.) At that rate, we’ll have created about $1.5 trillion from thin air — in about seven months’ time.
I pick $1.5 trillion because it’s the approximate value of all the gold that’s been found since the beginning of time. Though obviously an estimate, as no one knows for sure, I think the point survives. I thank Richard Russell for sparking this thought. I also note his observation that about two weeks’ worth of M3 creation would buy all the gold equities in existence. That should give you some idea why folks like myself, who think the Fed is totally out of control, want to own gold, silver and foreign currencies.
Which brings me to another point: That “money” creation I just described is only the amount created here at home. Obviously, the Japanese have created liquidity by sopping up dollars, as have the Chinese, as have the Europeans. When the light bulb finally goes off on how irresponsible the Fed has been and we get to the juncture where all that irresponsibility still hasn’t saved the day, you can be your own judge as to how high the price of metals may go or how low the dollar may go.
The dollar’s day in the sun has come undone
The dollar has seen its countertrend bounce. Earlier this year, I talked a lot about what the correction for the dollar might look like. And in fact, it played out quite similarly to what we saw last summer and fall. (Recall that back in January, the dollar was being hit daily. Foreigners were really starting to complain and jawbone down their own currencies, especially the Europeans.)
The dollar then began its bounce, and it lasted about three months. My opinion continues to be that the rally is now over. This next time down, the dollar should go even lower, engendering even greater concern. What’s not clear is how many more iterations of this we must go through before all hell breaks loose. But given the external imbalances in this country, i.e., the trade deficit, the budget deficit, and our dependence on foreign flows, we are really playing with fire.
The moral (hazard) of the story
This, of course, means that the Fed is trapped, as it has shown no willingness to do anything except print money. Even if we are headed to deflation somewhere down the road, as many people think, for the moment we have an inflation problem. The Fed needs to tighten (and not just raise the price of money by a freckle), but it is obviously reluctant to do so, despite its chirping about all the great economic data. Bulls should ask themselves, if the data are so great, how come the Fed still feels like it must print money hand over fist?
If things start to get nasty, the Fed can’t ease, because of the pressures that are already building. The Fed has finally engineered itself to the point where it’s between a rock and a hard place — and will be unable to respond to the next catastrophe. We will have one, unfortunately, thanks to the policies pursued by the Fed and the response to those policies by the public and the world at large.
Source: MSN Money