I’ve been writing in the pages for weeks on how economies worldwide are slowing and how this will affect the earnings of the major U.S. corporations. Yesterday, the fears came to fruition for stock markets. The Dow Jones Industrial Average tumbled 250 points Thursday.
The combination of slowing world economies and Moody’s Investors Service downgrading 15 large American banks was too much for the market to overcome.
What happens next? Follow this story…
The Federal Open Market Committee (FOMC) met earlier this week and decided to extend the FOMC’s “Operation Twist” program until the end of the year, to the tune of $267 billion. Operation Twist is simply the Fed and FOMC buying long-term U.S. Treasuries from the money it receives on its short-term maturing investments.
The FOMC decided upon this action to ensure that long-term interest rates continue to remain very low in an effort to support the still lackluster recovery. The FOMC also felt it needed to extend Operation Twist in order to help reduce the unemployment rate in this country.
The Chairman of the FOMC, Ben Bernanke, also mentioned that the FOMC is ready to step in and help the economy should economic conditions deteriorate or should the European crisis cause issues with the financial system here in the U.S.
This extension of the FOMC’s Operation Twist ensures that, should Europe somehow convince Germany to print money to keep its banking system going, then the market may sell U.S. Treasuries to buy European treasuries.
With the European crisis, investors have moved money into what is perceived to be the safe haven of the world: U.S. Treasuries. If the European crisis were to be resolved, even temporarily, investors could sell U.S. Treasuries to buy other assets.
With the extension of Operation Twist, the FOMC and Ben Bernanke would ensure that interest rates won’t rise dramatically, because the FOMC will step in to buy the U.S. Treasuries investors would be selling, ensuring rates remain low.
With the FOMC announcement came the admission that the projections of U.S. GDP growth were too high (something I started telling my readers as far back as January). Ben Bernanke explained how the FOMC felt the need to reduce GDP growth forecasts for 2012 from 2.4%-2.9% to 1.9%-2.4%.
The FOMC expected the unemployment rate to fall to between 7.8% and 8.0% by the end of 2012. The other day Ben Bernanke explained how that forecast was cut to 8.0%-8.2%.
The FOMC—through Ben Bernanke—went on to describe how inflation is under control and how the long-term projections show that inflation will remain in the FOMC’s target of roughly two percent.
The FOMC also reiterated that its dual mandate is to keep inflation in check while maximizing employment. Since the FOMC feels inflation will remain in its target range for some time to come, but that unemployment remains stubbornly high, I believe the FOMC is ready and “justified” to step in with a third round of quantitative easing (QE3) to help create jobs at any time.
World economies continue to contract. The stock market in the U.S. took it on the chin yesterday. QE is a big gun.
Right now the situation is not extreme in America, but as the economic slowdown continues its downward spiral, the extreme will arrive, the stock market will take bigger plunges and so will QE3. Enough economic dangers exist in the U.S. and Europe that could cause QE3 in 2012.
The Bank of International Settlements (BIS) is an institution that was established by central banks around the world. The BIS essentially is a bank for all of the world’s central banks, the aim of which is to foster financial and monetary stability globally.
Because of this role, the BIS creates many reports to monitor the conditions of countries and banks around the world.
Recently, the BIS reported on the state of foreign reserves held by central banks around the world. Foreign reserves are simply the assets—currencies, bonds—held by central banks. For instance, if the People’s Bank of China buys European bonds to help Europe, then China’s central bank now holds European bonds as part of its assets or foreign reserves.
The BIS noted that, while the Western nations, especially Europe, have little growth in their foreign reserves due to their contracting economies, Asian central banks have experienced tremendous growth in their foreign reserves, to the tune of trillions of dollars.
So Asia has the money through its foreign reserves, but the West has the gold bullion. I’ve written in these pages about the fact that Europe and the U.S. have the highest concentration of gold bullion in the world.
For example, Spain’s central bank has 34% of its foreign reserves in gold bullion, while France has 84% of its foreign reserves in gold bullion (source: Reuters, June 12, 2012)!
Contrast this to South Korea, the central bank of which has just one percent of its foreign reserves allocated to gold bullion and Kazakhstan’s central bank, which has 12%.
Here’s an example of what is taking place in Asia: recently, Kazakhstan’s central bank publicly disclosed that it is aiming for gold bullion to be 20% of its foreign reserves. This means that if it only has 12% now, there are more purchases of gold bullion to come.
South Korea has not mentioned anything about its one-percent holding of gold bullion, but that one percent has been accumulated since May 2009 and the central bank has recently made more purchases of gold bullion, which seems to indicate South Korea could continue adding to its foreign reserves.
I’ve written in these pages about how the most recent gold bullion holdings have identified Asian central banks as the large buyers. If they want to achieve the level of reserves that the West has, they are going to have to continue to increase their buying of gold bullion dramatically.
What are the central banks of Asia selling in order to buy gold bullion? Kazakhstan is saying it will sell its European bond holdings to buy gold bullion.
The Asian central banks have the money, dear reader, but they don’t have the gold bullion. That looks set to change, which means the demand for gold bullion will continue to be very strong for years to come.
Where the Market Stands; Where it’s Headed:
The unraveling has begun. Money managers in the U.S. finally understand Europe is exporting a recession to the U.S. and China’s economy is slowing.
Yesterday’s 250-point drop for the Dow Jones Industrial Average is just the beginning of the next leg of the bear market. But remember: the lower the stock market goes, the more likely the Fed will unleash QE3, QE4 and maybe even QE5. So the stock market is too risky to short right now, because of the Federal Reserve wild card.
My big bet: the Fed will need to expand the money supply as the stock market continues to fall. QE3 will be announced. The stock market will have a very short-lived rally. When it becomes apparent that QE1, QE2 and QE3 have all failed to stimulate the economy, faith in the after-effects of more money printing will diminish and there will be no stopping the downward spiral for the stock market.
What He Said:
“Even the most novice investor can now read the chart of the Dow Jones U.S. Home Construction Index and see that it is trading at its lowest level in five years. If, like me, you believe that stocks are an indication of what lies ahead, this important index is telling us housing prices are headed to 2002 levels! What would that do to the economy? Such an event would devastate the U.S.” Michael Lombardi in Profit Confidential, December 4, 2007. That devastation started happening the first quarter of 2008.