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So much has happened this month, where
to begin? It’s been a month to end all months with one monumental
crisis following another. At times, events were moving so quickly it was hard
to keep up. Many analysts we know stayed up all night, several times, as
developments and markets spiraled out of control in what’s being called
a financial tsunami.
What lies ahead is unknown because
massive changes are still taking place as the worst financial crisis since
the Great Depression unfolds. We do know that this is clearly the end of an
era and the beginning of a new one, and we’ll all be affected in one
way or another.
LENDER OF LAST RESORT
For now, opinions are running rampant
and although we can make some valid assumptions, no one actually knows how
this will all end up. Here’s why…
As you all know, the bailouts this
month were massive and truly mind boggling, but the big spending actually
started before. First, there was the $150 billion in stimulus checks, booming
money supply, super low interest rates and the Bear Stearns bust.
Then came the takeover of Fannie Mae
and Freddie Mac, which made the government responsible for about half of the
mortgages in the U.S.
, totaling about $5 trillion. This amounted to the biggest bailout ever,
costing $200 billion. But if just 10% of those loans have to be covered, it
would mean another $500 billion and this alone equals the size of the entire
annual defense budget... Then things really intensified.
A HOUSE OF CARDS
Lehman Brothers went bankrupt, Merrill
Lynch agreed to be bought and the foundation of the financial system took a
serious blow. Wall Street started to panic and the Federal Reserve, along
with the world’s largest central banks, poured unprecedented amounts of
money into the banking system to provide ever more liquidity as stocks fell
sharply and the banking situation grew more serious.
The government then took over AIG, to
avoid the worst collapse in history of the U.S.
’s largest insurer. Money market funds, which have always been
considered safe, came under pressure. Worried investors started pulling out
of these to preserve their savings, resulting in the Fed also having to lend
banks about $400 billion in guarantees to meet these withdrawal demands. The
bottom line was that in just one week, the Fed spent over $1 trillion to keep
things going.
Next, Washington Mutual failed, which
was the biggest bank failure in U.S.
history. While all this was happening, the bailout package was a top
priority. Bernanke and Paulson were desperate to get it passed, and fast. The
President pushed for it too as they all warned that the alternative would be
far worse.
PANIC SET IN
But the House rejected it and this
shocked the markets. The Dow plunged in its biggest one day loss ever,
dropping $1.3 trillion, which was way more than the $700 billion requested in
the bailout.
Seeing the market’s reaction,
the package then passed quickly but stocks continued falling sharply anyway. The
general feeling was that the $700 billion won’t be enough and the plan
is insufficient. Some feel this could be like the initial low estimates for
the Iraq
war and the final bailout tally could be $2 to $5 trillion, or more.
REALITY HITS
MAIN STREET
Meanwhile, folks on Main Street were generally against the
package. They simply didn’t trust it or the politicians. Once they saw
the stock market’s reaction to the no vote, however, many people
changed their minds as it became more obvious hat this wasn’t simply a
plan to bailout the mistakes made by greedy Wall Street big shots. People saw
the writing on the wall and realized that this would affect everyone,
resulting in a worsening economy, more job losses and no credit. And
since U.S.
retirement assets are already down $2 trillion in the past 15 months,
dropping 401 and real estate values, bank failures and insecurity are also
taking their toll.
The economy is the number one concern
for most people and they’re irritated at the mud slinging direction the
election has taken while the priority issues take a back seat. So it’ll
be interesting to see how the election unfolds too.
DELICATE GLOBAL FINANCIAL SYSTEM
There’s no question these are
dangerous times and the financial world is in uncharted waters. The global
financial system is on very thin ice, teetering on collapse. Yesterday’s
coordinated interest rate drop by seven central banks clearly illustrates
this because it was the first time ever that so many central banks lowered
rates together and by half a percent. They’re literally pulling
out all the stops to revive lending and the world economy.
Will these efforts work? Will they be
enough? Those are the most important unanswered questions of the day and only
time will tell, but we should know much more in the critical month or so
ahead. Why?
HYPER-INFLATION OR DEFLATION?
The Fed is spending money at an
astronomical rate. It’s creating this money out of thin air by
monetizing bad debts and whatever else it has to. Remember, this is on top of
all the other ongoing government expenses and it’s extremely
inflationary.
Normally, there is a lag of about a
year or so between money creation and inflation but eventually, what’s
recently happened will result in massive inflation, a much lower U.S. dollar
and a soaring gold price. This is inevitable but as our dear friend Chris
Weber points out… not necessarily.
The bottom line is this, if the banks
start to lend again, then the economy will be on the road to recovery and
inflation. But we know the banks are scared and they’re being extremely
cautious, for good reason. So if the banks decide not to lend and instead
just sit on their cash, then the inflation process will freeze.
In other words, the risk of deflation
has greatly increased. Inflation is not a given and much will depend on what
the banks do, or don’t do in the period just ahead. The Fed is
providing the ammunition but the banks have to use it. If they don’t,
the outcome could be much different than what most analysts feel is a done
deal.
WHAT TO DO
At this point, it’s best to be
prepared for either outcome. That means gold for inflation and cash for
deflation, at least until we see how things unfold.
For now, important changes are taking
place but that also means challenges and opportunities. This may all end up
differently than what we initially thought, but we’ll adapt and keep an
open mind. Whatever lies ahead, the current challenge is getting safely from
here to there relatively unscathed and we’ll do our best.
Mary Anne and Pamela Aden
Editors,
The Aden Forecast
Aden Forecast.com
Mary Anne and Pamela
Aden are internationally known analysts and editors of The Aden Forecast, a
market newsletter providing specific forecasts on gold, gold shares and the
other major markets.
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