Tuesday, September 23, 2008

Pump up the Market, Pump up Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

If you examine the press coverage about the government bailouts of banks, brokers, insurance companies, Fannie Mae, Freddie Mac and now the first major system wide bailout ($700 billion to handle $13 trillion in toxic bonds somehow just doesn't seem enough), you will see little coverage of any possible consequences. Just as always, there will be no free lunch even though you aren't hearing it from the media. Lunch in fact will not only not be free, but its price will be skyrocketing.

While it is possible for governments to manipulate markets in the short-term, it is not possible in the long term. Markets will always return to their equilibrium points eventually. Blatant government interference in the U.S. stock market began last August when the Fed announced a reduction in the discount rate one hour before the futures expired, causing a dramatic reversal in their prices and wiping out the profits of the shorts. Last Friday, just before options expiration, the SEC just out and out banned shorting (of financial stocks) and then the Treasury announced a massive bailout for financial companies. If you look back you will see major Fed and/or Treasury actions around options expirations during the market meltdown in January, the Bear Stearns bailout in March and the Fannie and Freddie bailout in July (and there is other activity during other expiration dates as well).

While manipulation results in the biggest bang for the U.S. buck during an options expiration, the impact has lasted at most two months and usually not even that long. Over time, even though the government's market interference has become more desperate and more extreme, the effects are nevertheless becoming more transitory. The short-selling ban and announcement of the biggest government gift in history to financial companies rallied the Dow 369 points and the Nasdaq 75 points on Friday. The Dow then fell 373 points and the Nasdaq 95 points on Monday completely wiping out Friday's gains. The market was still off the bottom though because the big rally began Thursday, the afternoon before this major news came out. Of course, only the most cynical would think that this news was leaked to the big Wall Street players so they could take advantage of it at the expense of the small investor.

While the U.S. government on one hand is busy trying to support the collapsing floor of the stock market, it is blowing off the roof in the commodity markets related to inflation. The biggest one-day rallies ever had already taken place in gold and silver last Wednesday with gold up over 11% and silver up over 14%. Oil though put them to shame Monday when it was up $25 a barrel (or 24%) at one point . . It closed up 16.37 or 16% on the day (even more amazing than it seems since the easily manipulated U.S. dollar was also rallying). The price then fell on Tuesday after the September contract had settled and the October contract became the front month. Commodities simply do not go up these amounts in one day, but it's happening right before our eyes. While the government has done everything possible to juice up the stock market, there are reasons to believe that it has done the opposite with gold, silver, and oil, or at the very least turned a blind eye to manipulations by the big players to drive down prices in these markets. Gold, silver and oil though will have to return to their equilibrium points just like stocks. They are gushing upwards because the inflation pressure cooker, filled with government bailouts and seemingly limitless money pumping, looks like it's about to explode.

NEXT: Buffet Sacks Goldman

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.