Our Theory on the Market

Whoosh...whoosh...whoosh...

That's the sound of chopper blades. Yes, Fed Chairman "Helicopter Ben" Bernanke is getting his squadron warmed up...preparing to drop dollars all over the nation.

You'll recall, dear reader, that Ben Bernanke, former head of the economics department at Princeton, is also a leading student of the Sushi Slump - Japan's long on-again, off-again recession that began in 1990. He wants to stop it from reaching the United States in the worst possible way - that is, by dumping paper money, "even from helicopters, if necessary."

He tried soothing words. Then, he tried cutting rates. And he tried colluding with central banks all over the world to inject liquidity into the system (not since 9/11 has the word seen such a cascade). Finally, it looks like it is time to rev up the helicopters.

And so our theory got a test yesterday.

Our theory is simple: Mr. Market wants to correct. He wants to bring down asset prices...put the United States in recession...and reduce debt levels. And Mr. Bernanke wants to stop him, fearing that - with so much debt outstanding and consumer balance sheets so fragile - any correction is likely to end up in a Sushi Slump. Or worse!

But all the feds can do is to give Mr. Market more of the same medicine that made him queasy in the first place - more cash and credit. And whenever they force-feed the patient more cash and credit it causes a kind of gold fever ...sending the price of gold up and driving down the dollar.

If the medicine fails to work...that is, if they fail to head off a major recession, stocks come tumbling down.

If they succeed in stopping recession (and/or preventing a bear market in stocks) it will be at a ghastly price - inflation, which will drive up gold prices.

Either way, in theory, the best thing for dear readers to do is probably to do what we've been doing for the last eight years - sell stocks on rallies...buy gold on dips.

And yesterday, we got to see how it works in practice. The Fed chief said he was "ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks."

Translation: whoosh...whoosh...whoosh...

Investors didn't even have to wait for the news analysis. They saw a 50 basis point cut coming in the Fed's key rate later this month. And so, they bought stocks. The Dow rose...nearly 1%.

But if our theory were right, we'd see a pop in the price of gold too. And a lower dollar. And yes, that's what happened - gold hit a new all-time high of $894...and the euro spiked back up to $1.48.

What next? More of the same. As long as the economy keeps softening, the Fed has to keep its vault doors open. And as long as the vault doors are open, the dollar is bound to lose value and gold, what the Financial Times calls the "new global currency," is bound to go up.

The Fed is already lending money at real rates near zero. Subtract the inflation rate from the Fed funds rate and there is nothing left. If they cut the rate again, they will be lending substantially below zero.

The Fed is also running the loosest regime in the Western world. Real lending rates in both the Eurozone and Britain are higher than they are in the United States, and inflation rates in both areas are lower than those in the United States.

Still, just listen for the helicopters...the noise will get louder and louder.

It may be madness...but it is fun to watch.

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Related Articles:

• None Found