So much for laissez faire economics! The Bush Administration announced today that it was bailing out the Big 3 auto producers. Tuesday, the FED made a historic rate cut of 75 basis points, lowering the fed funds rate to between 0 and .25%. This is the lowest funds rate that the Fed has established since it was created in 1913. Additionally, the incoming Obama Administration indicated that it was going to advance a two year stimulus package of $850 billion. All of this screams----inflation, a weak U.S. dollar and higher interest rates beginning as early as 2010.
And how has the market greeted this intervention—not well. Equities continue to struggle and investors are so unconvinced of the government intervention that they are willing to accept a negative return on short term U.S. Treasuries and have driven the yield on the 10-year U.S. Treasury to 2.2 percent. In other words, the actions by our government leaders have not inspired confidence from investors. The more they do the worse it gets. According to the old aphorism, when you find yourself in a deep hole, quit digging.
As for the largest portion of the U.S. economy, consumers are being enticed to spend. Every store in the mall seems to be running a different kind of sale every week. On Black Friday you could buy 1 pick-up at full price and get an SUV for free.
All the while, the dollar printing press is and will keep running on overdrive, which was reflected in recent dollar moves. The US Dollar Index is down 12% from its multi-year high on 11/21. And today, the dollar weakened the most EVER in one day against the euro (since its inception in 1999).
Usually, dollar weakness means oil strength. On a day when the dollar showed record weakness, oil moved below $40 for the first time since 2004. In ordinary times, this wouldn’t make sense. However, we are in the extraordinary times, where falling world-wide demand for oil is overriding other fundamentals, including dollar exchange rates. Don’t expect this to last.
Recent trends show dollar weakness. Government intervention should lead to increased demand in equities and real estate. The combination of further slides in the dollar with an increased demand for oil (it can’t go much further down, can it?) will contribute to the last part—much higher inflation. So what should you do? Buy the TIPS.
Aaron Konen and Ernie Goss