There are some absolutely fascinating dynamics at work in the global economy
right now.
Today, the stock market rose sharply after the Federal Reserve released the
minutes from its December meeting, and investors interpreted those minutes to
indicate that interest rate hikes are nearing an end. But something else also
happened today. The Federal Reserve increased its level of temporary liquidity
to the highest level since 9/11. For those not familiar with the term,
liquidity is essentially money created by the Federal Reserve that acts to
support various assets such as stocks, bonds and commodities. Today, that pool
of liquidity reached a stunning $60 billion, up from $23 billion in
mid-December. To be sure, the Fed boosts liquidity at the end of every year,
but size of this increase is extraordinary and far greater than any previous
year-end.
As a result, both oil and gold rallied sharply as well. As I type this, oil is
at $63, and gold is up $20 from its close on Friday. Oil and gold (and stocks,
of course) are reflecting the incredible amount of liquidity that's been
created during the past few weeks (and months/years, for that matter).
Investors are watching the Federal Reserve's actions---creating a huge amount
of money out of the blue, hinting that rate hikes are almost done---and
realizing that the Fed has decided to follow only one course of action:
inflate. The Fed's actions are utterly irresponsible. If the Fed was truly
independent from political influence as is supposed to be the case, Alan
Greenspan would be yanked onto the carpet before he retires in a few weeks and
forced to explain himself. That won't happen, of course, so we should all
expect to pay higher prices for everything we need. Did you think gas prices
were high last summer? Wait until you see them this coming summer.
The Fed's actions have profound implications. From the early 1980's through the
late 1990's, OPEC was willing to play ball with us; the U.S. could create
enough liquidity to ameliorate economic weakness, and OPEC (particularly Saudi
Arabia) would recycle its oil revenues into U.S. financial assets and take any
action necessary to prevent the price of oil from rising. For various
reasons---9/11, the war in Iraq alienating the Muslim world, the rise of
players like Hugo Chavez---that relationship has completely broken down. Simply
stated, OPEC is no longer willing to let us print our way out of messes; thus,
the inexorable rise in the price of oil as the Federal Reserve continues to
create a historic amount of paper and OPEC demands a higher price for its only
natural resource. And instead of parking all those extra dollars in treasuries,
the oil producers and other nations like China increasingly are snapping up
gold to diversify away from the dollar and protect themselves.
To Washington, that's unacceptable. When China, Russia, Venezuela, Iran and
Saudi Arabia refuse to play ball and start creating consequences for our
profligate fiscal and monetary policy, that's when the gloves come off. Did you
think the increasing speculation about military action against Iran is just
about its nuclear program? Did you dismiss Russia's temporary halt in natural
gas deliveries to Ukraine as a minor regional tiff? Have you been wondering why
we seem so obsessed with someone like Hugo Chavez? Statists abhor consequences,
and these nations are creating them for us. For any new readers, here's the
link to a longer post I wrote about this important dynamic; I think
understanding it is crucial, particularly regarding the issue of Iran.
For many months now, the Federal Reserve or its mouthpieces have hinted that the
cycle of rate hikes is coming to an end. Keeping it somewhat open-ended is
important, of course. If the Fed left absolutely no doubt that the cycle of
rate hikes had ended, oil would shoot straight for $80 and gold for $600.
Conversely, if the Fed made it clear (as it should) that it was concerned about
inflation and that interest rates could possibly increase throughout most of
2006, the stock market and the economy would weaken right before the crucial
mid-term elections and just as Bush's approval rating shows signs of
recovering. That dynamic also applies to the burrs under our saddle. Want to
take Chavez or Putin or the Mullahs down a notch? Stop printing so much money,
and the price of oil---the source of their newfound influence and power---will
back off. Or we can keep inflating to avoid unpleasant domestic consequences,
and the event horizon draws ever closer. That's the box the Federal Reserve has
created for itself, and for all of us.
In the past, we held the key to that box. Today, the keymasters are in Beijing,
Moscow, Riyadh and Caracas---and most certainly Tehran. And that, of course,
has profound geopolitical and military implications.
http://cunningrealist.blogspot.com/2006/01/event-horizon.html
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