Yesterday the financial newswires were alive with reports that former Fed Chairman Alan Greenspan, speaking to a business conference in Hong Kong, had said, "When you get this far away from a recession, invariably forces build up for the next recession."
Greenspan went on, "For example, in the U.S., profit margins…. have begun to stabilize, which is an early sign we are in the latter stages of a cycle."
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But then he added, "…it would be very precarious to forecast that far into the future, I can not rule out the possibility of a recession late this year."
Greenspan is well known for his "Delphic" words. Usually, one has to think carefully and digest his words to form an opinion as to what exactly he is saying.
However, the financial markets and media leapt on the impression that there might be a recession and therefore lower interest rates.
Lower interest rates lead to strong bond and sometimes to strong stock markets and that is good for Wall Street.
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As expected, bonds rose in price. But, both the Dow and the S&P fell as people saw lower corporate earnings. This was evidence that this particular stock market is now driven not by interest rates but by earnings.
In his true "Delphic" style, in later comments, Greenspan added that he had seen no economic spillover effects from the slowdown in the U.S housing market.
On the surface, it was a confusing set of statements. But it was not atypical of the "Delphic" Alan Greenspan.
The big question is what to make of it.
It appears that some people may have ignored our warnings of stealth inflation and our prior warnings that a combination of recession and inflation spells STAGFLATION, the dreaded economic virus of the 1970s and 80s.
We note the increased flow of money into inflation protected bonds, or TIPS.
In addition, it appears that the financial media and Wall Street continue to ignore the new political imperative that our government may soon be forced to defend the dollar.
People who ignore these two crucial warnings will be tempted to think it is time for the Fed to lower interest rates.
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Here, we note items on Bloomberg (Feb. 26) of a survey by the Royal Bank of Scotland that "Central banks are increasingly diversifying their reserves, including cutting holdings of dollars."
According to Central Bank Publications, "Italy, Russia, Sweden and Switzerland have made major adjustments…favoring the euro and the British pound."
As Sean Callow, of Westpac Banking Corp of Singapore, said "There is no doubt that when they say ‘diversification' they mean selling dollars."
Our readers will not be surprised to see that we do not agree with the shaft of euphoria that shot through the bond market on Wall Street yesterday; that interest rates will soon be lowered.
We see inflation as still a cause of major concern to the Fed. As long as the slump in the housing market fails to spill over into the demand economy. We feel the Fed will favor rate increases this year.
We are convinced that the availability of massive liquidity is going to decrease, with upward pressure on interest rates and a widening of credit risk.
And that increased central bank diversification out of U.S. dollars into other currencies and even into gold, will tend to put yet more upward pressure on U.S. interest rates.
Finally, we note the increasingly disturbing rhetoric, this past weekend, by senior government officials, such as Dick Cheney and Condoleezza Rice. It appears that they are increasingly anxious, almost desperate, to justify a pre-emptive strike upon Iran.
We have warned constantly over the past seven months of such an attack and the possibility that it may involve the limited use of nuclear force.
History shows that pre-emptive strikes most often end up with unintended consequences.
Some people may argue that it would be totally illogical to attack Iran. But, we ask, would the same augment not have applied to the pre-emptive attack on Iraq?
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We feel that the risk of an attack on Iran is now so real and imminent that even Russia and China, conscious of the nuclear risks, are trying to bring pressure on Iran.
Geopolitical risks such as this do not favor either lower interest rates or oil prices, in the short-term.
This is why we have regularly pointed to gold as a hedge in today's market.
As far as the words of the "Delphic" Mr. Greenspan go, we feel they represent the typically calming words to be expected from a most formidable former Fed chairman, possibly even heralding a period of considerable strain for interest rates.
His words are held in high regard throughout the world, although history shows that all too often few people fully understand the underlying intention, meaning, or even sentiment behind them. But they sound good and encourage calm and that is good for markets.
Our reading is that, of course recession is possible, but is not happening yet. Even if it does occur, it will not automatically lead to a cut in Fed rates, in the short-term.
Therefore, our forecast remains that interest rates are most likely to remain on hold with a bias to the upside for 2007.
Editor's note:
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