Wednesday, October 8, 2008

The Third Crash is the Charm - Fed to the Rescue

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.

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As predicted in earlier entries to this blog, there was a coordinated global interest rate this morning. The only mystery is why it didn't happen yesterday morning instead. Apparently two crash days in a row in the U.S. markets were needed to expedite this action. A G7 meeting is scheduled for this Friday in Washington and it was likely that the world central banks were waiting for the meeting to be over to show that it had resulted in them taking bold, decisive rate cutting action. The U.S. Fed also probably thought that its Monday/ Tuesday announcements of $900 billion increased lending from it various credit facilities and that it would buy up to a trilion plus dollars of commercail paper would be enough to bull the market up. Instead, U.S. stocks crashed again on Tuesday. So now the ever reliable 'cut interest rates to juice up the stock market' is being tried, not just in the U.S., but globally. Instead of bold, decisive action, it smacks of bold, decisive desperation.

Tuesday's market behavior in the U.S. indicated that the monetary authorities were losing their ability to impact stock prices with their usual bag of tricks. While the announcement of the Fed's massive liquidity injections did cause a major intraday rally on Monday and a strong opening on Tuesday morning, it didn't last. At the Monday low, the Dow, S&P500, and Nasdaq were down over 8.0% and because of the Fed's announcements they closed down only in the 3% to 4% range (still a pretty bad day). If you measure a crash by intraday action, there was most certainly a market crash on Monday. If you measure it only by a closing price drop of over 5.0% on the indices there was only a crash on Tuesday (as well as Monday a week ago). While stocks were up a good bit on Tuesday morning and everything looked like it was going according to plan, the market nevertheless quickly faded and selling accelerated toward the end of the day. By the close, the Dow had dropped 508 points or 5.1%, the S&P 500 61 points or 5.7%, the Nasdaq 108 points or 5.8%, and the Russell 2000 37 points or 6.2%.

So this morning the Fed has turned to more interest rate cuts to save the market. The funds rate was lowered by half a point to 1.5% and the discount rate by the same amount to 1.75%. The ECB also dropped rates by half a point, to 3.75%, as did the Bank of England, to 4.5% (the UK recently passed an $87 billion rescue package for its banks similar to the U.S. Wall Street bailout plan). Canada, Sweden and Switzerland also joined the rate cutting party (noticeably absent, at least so far, is Japan). China lowered a key interest rate for the second time in a month. Australia had cut rates a full percentage point on Monday. This was the U.S. Fed's second intermeeting rate cut this year (the next Fed meeting is October 28, 29th), following the large cuts that took place to prevent a market meltdown in January.

The reason that central banks have avoided rate cutting recently is because of the inflationary implications. The Fed itself has stated in the minutes from it recent meetings that it sees entrenched inflation as a danger in the current economic environment. It avoided lowering rates at its September 16th meeting because of this. The stock market which had been conditioned to expect automatic rate cuts during its bouts of weakness, starting selling off and entered a crash period. Like all addictive processes, if you don't keep feeding the addict the drug, painful withdrawal follows. Supplies of the rate cut drug are almost gone however.

NEXT: Meltdown Microcosm - U.S. Future Can be Seen in Iceland Today

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.

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