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Surprises Abound - Central Banks Liquidity Flood Fails to Prevent Stock Market Plunge

Stock-Markets / Financial Crash Aug 10, 2007 - 12:17 PM GMT

By: Andy_Sutton

Stock-Markets Just as everyone thought things were getting back to normal. Just as everyone thought that all the bad and ugly stuff had receded into seldom-accessed portions of the subconscious. Just as the bulls were starting to get a little of that swagger back and talk of new records filled the airwaves... BANG! The markets were once again slapped with another dose of reality. The really interesting thing about today was not only what didn't happen, but what DID happen.

What didn't happen..

The week-long rally failed to continue, and the DOW, gave back all but a trivial amount of the ground gained. In the grand scheme of things, this hasn't been much of a correction. The DOW is 5.21% off the record high of 14,000.41 As far as corrections go; so far, this one has been pretty mild. The S&P500 has given up 6.44% from its 1553.08 high. Given the length and severity of corrections over the past 4 years or so, there is at least anecdotal evidence that this one is nearly over. However, the fact is that we still have a long way to go in terms of how the credit mess will shake out, especially now that it is pretty much recognized that this goes well past our borders. Couple that with the fact that the contagion also extends into the alt-a and prime credit markets as well and I'd say this is anything but contained. 

Gold again failed to decouple from the equity markets. We had seen a few small signs of a decoupling late last week as the yellow metal held its own and even advanced in the wake of equity weakness. Gold bears were quick to jump on this lack of a decoupling as a bearish sign for gold. I would urge caution in this regard. Today's gold market is full of smoke and mirrors. Manipulation runs rampant and there is a concerted effort by central banks everywhere to keep the price of gold down. To do this, they are parting with their own precious reserves. This is done to undermine investor confidence in gold as real money and a safe haven. Their mission is not served if you are buying gold. You are supposed to faithfully send in your quarterly IRA contributions so that Wall Street can continue to get rich. If you trade your fiat paper for real money; they don't make a dime. What a pity.

What DID happen..

In what will in all likelihood turn out to be a famous faux pas, the European Central Bank flooded the markets with liquidity today, pledging to make as much money available as anyone wanted to borrow. At last count, the ECB pumped 94.3 billion Euros into the system to keep it awash in liquidity. If this doesn't telegraph the attitude of central banks with regards to credit, the financial markets and inflation, then nothing will. The ironic thing is that the Euro promptly surrendered nearly a full percent of its value versus the dollar. Now Ben; what will happen when you do the same thing to pump up our markets? Surely you've already been doing this, but you'd better keep it quiet. The Europeans can afford to soothe their markets publicly with large sums of funny money. You cannot.

There are now rumblings out of China that if their hand is forced they may decide to use their $1.3 trillion of foreign reserves as a weapon. I wouldn't test their mettle too much on this one guys. The fastest way for the American consumerocracy to find out what's been going is to push the Chinese on this. The Chinese can end the party - and quickly. Remember, the consumerocracy is about at the end of the spending spree. Debt is killing them. This means that they will be buying less Chinese goods going forward. That means that there is less of a reason for the Chinese to continue to offer us the financial equivalent of artificial respiration.

Another note on bailouts..

On March 16th, 2007, I wrote a piece outlining briefly the history of some of our more recent financial bailouts. I outlined the S&L bailout in the late 80's and the LTCM bailout in the late 1990's. Then I made a few observations about the subprime bailout that is undoubtedly coming. We are now beginning to see the bailout begin. For now, the bailout, like its predecessors is contained (I love that word) to the financial players. As an addendum to the March piece, I'd like to get people thinking a bit about the dangers of bailouts. We all know who pays for them. But what is it that they accomplish? What bailouts do is prevent those who have made poor decisions from having to suffer negative consequences. It takes those who make poor investments off the hook. It is a moral hazard because if those who are making the poor investments know they will be bailed out, there is nothing to make them change their ways. We saw this in spades with regards to the mortgage debacle. I am not even going to call it the subprime debacle anymore because I feel that before this is done, it will cut a wide, nasty swath through all types of loans and all types of borrowers. 

Consumers deserve as much of the blame for this mess as anyone. Sure, there were unethical lenders, agents, appraisers and banks. But the consumers are the ones who signed on the dotted line. There is no excuse for getting duped when making the single most important (and often largest) decision of one's financial life. If the government rushes in sweeps this fullisade of poor decisions under the rug with a batch of funny money, what lessons will be learned? It will teach consumers that responsibility and due diligence are no longer required, and that government will always be there to make it right. Our currency and economy have already suffered enough because of bailouts of various types. Now is the time for a dose of tough love.

By Andy Sutton

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. He currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar.

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