As widely expected, the Fed announced last Tuesday that it had held its Fed
funds nominal rate at 5.25 percent.
The media immediately announced, "Rates on hold." Based on the media hype, the
markets contented themselves that the Fed was not tightening.
But what is the reality?
Observers of even "apparent" real interest rates (nominal interest rate, less
the rate of inflation) will notice that, since October 2006, the CPI core
inflation rate has actually fallen from 2.90 percent to 2.70 percent (a fall of
0.20 percent). Today's announcement was that core CPI had fallen to 2.60
percent, or 30 basis points, from 2.90 percent.
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Therefore, by holding their nominal Fed funds rate at 5.25 percent, the Fed had
actually tightened by some 0.20 percent, or almost a quarter of a point! After
today's inflation announcement, that looks like 0.30 percent. But where do you
see or hear any comment on this in the mainstream media?
Subscribers to Financial Intelligence Report, will know that,
contrary to most media and financial pundits, we have long warned that the Fed
would not drop nominal rates and might even tighten in December. Well, they have
apparently done so, by about 0.30 percent, or over a quarter of a point. But
very few people see it.
[Editor's Note: Protect yourself from hidden inflation.
Go here now.
]
As we say in a piece in the December issue of FIR, the markets
appear to have roared in 2006, based largely upon record corporate earnings.
However, in the face of a slowing economy, the markets continue to advance
based, in our opinion, largely upon the injection of excess liquidity and
hype-words.
We feel that the markets are increasingly leaving reality behind.
As highlighted in Barron's (Nov. 27 and Dec. 11) the use of such hype-words as,
"goldilocks," "soft-landing," and "liquidity" have increased in media use at an
exponential rate in 2006.
In this respect, we remain concerned that the Fed discontinued the publication
of the M3 broad money supply figures in March 2006.
We feel this hindered the monitoring of excess liquidity, a most important cause
of inflation. No wonder the Fed wishes to hide it, for it is the prime cause of
"true" inflation, which is stalking us in stealth.
At the same time as the Fed, the engine of inflation, holds its nominal rate, it
pumps liquidity into the system, boosting stealth inflation. (More on this in
the January issue of FIR.)
We believe that the Fed is secretly concerned about not one, but two major items
— inflation and the dollar!
Is the U.S. Propping Up the Dollar?
The Fed and the Treasury tell us they are prepared to let the dollar find a free
market level. At least that's what they tell us.
Don't you believe it!
First, a falling dollar is inflationary in the longer term and the Fed knows it.
Far more concerning is that the Fed has pumped massive amounts of dollar
liquidity into the system.
Today, the world is awash with dollars. So much so that the central banks of
major nations have long been concerned about a falling dollar. They have
diversified into other assets, particularly the euro.
You may wonder why they have not brought gold with their dollar surpluses.
The reason is that, led by America, the major central bankers got together, a
few years ago, to dream up a method of demonetizing gold, by massive coordinated
central bank sales through the IMF to break the free market and get far away
from any measure of "real" money.
America was so politically coy about reducing American gold stocks to near zero
that U.S. sales were conducted, via the IMF, under the name of Germany!
Now, any central bank that starts to diversify out of unwanted dollars into gold
would be viewed by the IMF as "cheating." With the Olympics dawning, trade
booming and western capital flowing, China is keen to keep a "clean conduct
slate."
So central banks have diversified into the "political" euro currency. But as we
said in an item yesterday, the euro appears to be under threat of breaking
apart. If it does there will be panic.
If there is panic, the dollar will benefit. And that leads us to our next major
observation.
Today, we see Treasury Secretary Henry Paulson posing for high profile
photographs with Chinese leaders. The media is agog over the tough talks about
the value (or rather "unfair" undervalue) of the yuan. It all appeared as a
negotiation between two great powers.
No one mentions or even hints at what is not the exclusive, but the major item
up for discussion — the value of the dollar as a reserve asset!
Very carefully disguised was that, in fact, our American delegation was actually
there to "beg" China not to start selling the dollar (of which it has a
staggering $700 billion), which is already near a multi decade low, relative to
a weighted average of other currencies (themselves depreciating)!
If the "real" negotiations were to leak out there may be a real run on the
dollar.
We feel that Paulson did, however, have some telling cards in his hand. These
included: the Democrat threat of trade sanctions; the threat that a major
recession or even depression in the U.S. would hurt Chinese exports very badly,
risking internal problems of a crisis of expectations inside China; and the fact
the euro appears increasingly unsound, risking a major international financial
panic, which may cause the dollar to rebound as investors flee for cover.
Our guess is that the Chinese agreed to maintain their dollar assets for the
time being.
However, we believe the Fed was forced to agree to maintain a real rate of
interest on the dollar — a difficult and delicate task in the face of a
weakening U.S. economy.
So the Fed is in a real bind. They fear the effects of the housing crisis upon
the U.S. consumer. At all political costs they must avoid a depression taking
hold. But they must maintain a real return on the dollar.
[Editor's Note:
Can Ben
Bernanke avoid the coming currency crisis?]
What better than to hold rates, while "apparent" (CPI) inflation falls, so
covertly increasing real rates and maintaining U.S. consumer morale in front of
the vital Christmas shopping season?
We believe the Fed is genuinely concerned about inflation, not just the official
CPI "core" rate, which is above the Fed's "comfort zone", but also the hidden or
stealth inflation about which we have long warned. However, it is more worried
about a depression and therefore maintains liquidity at very high levels, which
hides stealth inflation.
In this respect, we note Fed member Jeffrey Lacker's continued dissention in
favor of hiking rates. We sympathize with him that, "further tightening was
needed to bring inflation down more rapidly . . . the recent surge in core
inflation had persisted and appeared broad based." This week the Fed appears to
have heeded his advice.
In effect, by putting rates "on hold," the Fed appears to have covertly accepted
the Lacker view satisfying both the Chinese and an anti inflation stance, at
least for a while. Amazingly, you see virtually no mention of this in the media.
We urge our readers to remember what Winston Churchill once observed; that the
truth is so precious it must be guarded with the utmost care. We believe the Fed
follows this advice. So how do you tackle them?
Basically, unlike the rest of the herd, don't look too hard at what the Fed says
in public. Rather, observe their actions with great care and act accordingly. It
is the same in tackling an oncoming rugby or football player; don't look at his
eyes or his hands; watch his feet, to see what he is actually doing!
At present, the Fed chairman, having covertly "tightened" rates, is assiduously
"chatting-up" the Chinese, in a desperate attempt to defend the dollar, without
risking stagflation or depression at home.
Editor's Notes:
