Gold and Energy Advisor
Gold and Energy Advisor's Real Wealth

Real Wealth #134  12/12/2007



Dow Plunges 300 Points Despite Fed Rate Cut

After another cut in interest rates by the Federal Reserve, the Dow plummeted by over 300 points yesterday. It ticked up slightly at the close, to finish the day 294 points lower than it opened.

 

Wall Street expected a half-point cut, but only got a quarter point. Thus, the selloff.

 

Just another day on Wall Street? Nope. Yesterday was very enlightening.

 

First of all, which stocks got hit the hardest? You'd expect a drop in stocks related to real estate, and this did indeed happen. The Dow index of homebuilders' shares took a dive of 9.8 percent. On the S&P 500, mortgage lenders Bank of America and Citigroup also got pummeled (by 4.3 and 4.2 percent, respectively).

 

But some other big losers were very surprising. Boeing and United Technologies both pulled the Dow down, falling by 4.3 and 3.1 percent. Retailers got hammered too: the S&P retail index sank by 4.2 percent.

 

In fact, of the 30 blue chip stocks on the Dow, only 2 finished higher. The first was AT&T, which announced a $16 billion stock buyback. (That's enough to pull any stock up.)

 

The second was McDonald's, which said November sales were doing well. (Apparently, when housing prices are falling and consumer spending is drying up, people start lining up for those 99-cent cheeseburgers.)

 

On the New York Stock Exchange overall, falling stocks outnumbered gainers by 5 to 1.

 

Why was the carnage so broad? This tells us that our economy's problems extend far beyond the credit markets.

 

Obviously, anything related to real estate is sinking fast. On Monday, UBS announced an $11.5 billion sale of stock to a Singapore fund to raise capital. And yesterday, Washington Mutual became the latest casualty. It announced a huge layoff, a slash of its dividend, and a set-aside of $1.6 billion this quarter for losses, with even heavier losses expected in 2008.

 

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Meanwhile, about 1.8 million adjustable rate mortgages are waiting to reset next year at much higher interest rates, and there's a large overhang of unsold homes already on the market.

 

Real estate (and anything related to it) is bleeding badly. However, according to the market's collective opinion, broader sections of our economy need to be rescued as well.

 

Notice that rates have already fallen a full point in less than three months (!) But apparently, even that isn't enough. The Dow fell by 300 points anyway.

 

So why didn't the Fed give the market what it wanted? As I've said here before, the Fed is trapped—and Bernanke & Co. know it.

 

The Fed's press release acknowledged that economic growth is slowing, and business and consumer spending are both slowing. It also acknowledged "strains in financial markets," and "deterioration in financial market conditions." That's why the Fed needs to drop rates.

 

But the Fed is also worried about inflation risks. That's why it needs to raise rates.

 

Which do the Fed officials sacrifice—the value of the dollar, or the viability of the markets? We can't keep both.

 

In fact, as the Fed's recent (and ineffective) liquidity injections show, we might not keep either one. So far, that seems to be our situation.

 

Finally, I should also mention yesterday's reduction of the Fed's discount window rate. This is the rate charged to banks that approach the Fed for short-term loans.

 

What does this reduction accomplish? Not much. A bank would only use the discount window as an absolute last resort. This form of borrowing is considered an admission of serious financial problems. (Presumably, a bank that can't get loans from other banks is on its last legs.)

 

So why did Fed officials bother changing this rate? Only to make it seem that the Fed was taking decisive action. This was supposed to cover up the weak drop in the federal funds rate.

 

Judging by the market's plunge, this cover-up obviously didn't work.

 

US Criticizes United Nations for Overspending.
Oh, the Hypocrisy...

 

United Nations members are arguing over a proposed budget. It hasn't been finalized yet, but it might be as high as $5.2 billion, up from $4.17 billion in 2006/2007.

 

The United States has criticized this "massive increase." US ambassador Mark Wallace complained, "With the largest budget increase in history... the credibility of the U.N. is at stake."

 

I think this criticism is absurd.

 

Now don't get me wrong. I'm no fan of the UN. It has botched almost every situation it's ever been involved in, it likes to defend dictators, and its leadership is famously corrupt.

 

But we're talking about a $1 billion increase in the budget for the entire year. Our government in Washington spends $1.51 billion more than its income every single day.

 

Do I think the UN should spend $5 billion this year? Absolutely not.

 

But our national finances are a cruel joke. Until we clean up our own mess, we have no right to criticize anybody else's.

 

Last Word on the Fed

 

Few people seem to notice, but whenever problems occur in our economy, how do the 'shepherds of our economy' respond?

 

Well, they cut rates. Or they inject liquidity. Or they boost lending. But ultimately, all these actions do the same thing.

 

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They devalue the dollar.

 

(Yes, once in a while the Fed will raise rates instead. But that's only because the greenback currency is already depreciating too quickly.)

 

My point: our fiat-currency economy is inherently inflationary. The dollar will always lose more value each year. Long-term, its inherent value is only the paper it's printed on. In other words, zero.

 

And long-term, the dollar will reach that inherent value.

 

That's why I like gold so much. One troy ounce of gold in your palm is one troy ounce—period. Nobody can depreciate it, or devalue it, or default on it. It is what it is—an amount of beautiful, industrially useful, highly desired, and valuable metal.

 

An inherently depreciating piece of paper, versus an inherently valuable physical asset with a 6,000-year history. Which do you prefer?

 

Best Wishes,

 

James DiGeorgia

Publisher and Editor

 

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