Stocks in a Free-Fall

It's the end of the world as we know it - and we feel fine. Really.

Usually, markets stumble along, day after day. But occasionally, their hearts start racing and their palms sweat. They stop sleeping at night and begin pacing the room. When this happens, one of two emotions has gotten the better of them - greed or fear.

Greed made fools of investors for many years. At its height - probably in 2006-07 - people were ready to do the damnedest things with their money. The moms and pops bought an extra house - sure it would go up. The masters of the universe sold moms' and pops' debt to each other. Rich investors gave their money to hedge fund managers - and paid them hundreds of millions for gambling it away. Others paid fortunes to executives to run companies they didn't really understand into brick walls they didn't see coming. But, for many years, everybody was getting rich; so what was not to like?

Now, fear is back.

Delayed...denied...denounced...fear is back - and he's mad as hell.

This week, panic set in. On Monday, the Dow fell more than 350 points. After such a big drop, you'd expect a big bounce. But not Tuesday. Stocks just kept falling, with the Dow down another 508 points.

Oil rose $2 to $90. The dollar held steady at $1.36 per euro. And gold rose $22. Coin dealers say they can't keep up with the demand for bullion coins. No wonder; smart investors are looking for shelter.

It's full-scale war, in other words, with the forces of inflation in full retreat - even rout.

Investors await every bit of news like dispatches from the front lines. Will the Dow hold at 8,000? When will the Fed cut rates? Can our soldats keep the huns out of Paris?

The news comes fast - too fast to take it all in. Today, Russia has lent 4 billion euros to Iceland - 'we'll work out the terms later,' said the nice Russkies. The Russians are also pumping $37 billion into its own banks. England says it will bailout its banks - with 50 billion pounds of equity and another 200 billion in loans.

The Australians already cut their key rate by 1%. And this morning, the Fed, the ECB, the Bank of England and Swiss, Canadian and Swedish central banks made emergency rate cuts. While coordinated rate cuts do happen on occasion - the Fed and the ECB made cuts following 9/11 - joint statements announcing a cut at multiple banks is a rarity. But in this market, we suppose anything is possible.

At first, it looked like it might turn the tide in the Asian theatre. Reports last night showed Asian stock markets holding the line. But this morning comes news that Japanese stocks are falling even harder - down 9% today alone.

In the United States, the Fed says it will buy commercial paper; that is, it will buy up loans made to U.S. companies...or even loan the money directly to troubled firms. And not just financial firms. General Motors says it is turning off the lights at all its European production plants.

The poor lumpeninvestor doesn't know what to make of it. It seems like only yesterday he was told that everything was all right. Alan Greenspan said so. So did Hank Paulson. And Ben Bernanke. And George W. Bush. We have the strongest economy in the world. We're unbeatable. Our economy is so dynamic! Our financial sector is so inventive! We're just so damned smart!

The Japanese can live with a 20-year slump if they want. The Europeans never seem to get their economy revved up. But we Americans know how make an economy hum - just give the consumer more credit!

But when the cycle turns from greed to fear...all that credit is like excess fuel in a crash landing. It tends to explode. When a bank takes a loss - say, from its holdings of sub-prime debt - the fractional reserve credit system sends out sparks. A loss of $100 million causes as much as $1.5 billion in credit to go up in flames. As the credit disappears, so does the leverage that kept up asset prices. So far this year, the world has lost $20 trillion in market capitalization. By September, U.S. property was down a total of about $6 trillion over the last two years. That's why the feds are losing this fight - they've got much less fire power. They've just passed a bill to put $700 billion back into the system - buying up Wall Street's mistakes. The Fed is loaning another $900 billion, according to yesterday's report. Put all the bailout spending together and you get a figure that is still not even 10% of what Mr. Bear Market has taken away.

Yes, it's all working against us now...the credit...fractional banking...and our own emotions.

Bill Bonner
for The Daily Reckoning Australia

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