Steve Quayle News Alerts

November 12, 2002
Lear Financial

The twelfth time is the charm ... that's what the Fed is hoping. Unfortunately, every indicator lines up against it.

Since May of 2000, the Fed had cut interest rates eleven times, trimming the former 6.5 percent rate of eighteen months ago to a bare-bones 1.75 percent, the lowest since 1965. Not content with the way things were going after nearly a year of maintaining the rate, the Fed got out its carving knife again, slicing away another .5 percent and presenting us with an amazing 1.25.

The message the Federal Reserve is sending is unsettling, at best. One of the Fed's stated missions is to harness inflation. Yet it's looking more like the opposite economic extreme, deflation, is the main worry at the nation's money center. That's because the Fed has been virtually opening the dollar's floodgates in an effort to stimulate America.

In September for instance, the money base was up 5 full percentage points over this same time last year. October showed an even greater increase of 6.7 percent. Remember, due to 9/11, last fall was already one of the most inflationary seasons in recent memory. So a steep increase over those high levels would take some doing ... but the Fed did it.

Still, this flood of crisp new dollars, although intended to wash down to the average consumer and extinguish deflationary concerns, hasn't been doing the job. Over the past two years alone, US money supply (M3) has grown by $1.3 trillion ... even as the economy has grown by only $350 billion as measured by GDP.

Banks simply haven't been all that eager to lend money to business. That's because commercial America is nowhere near as attractive a prospect as it once was. As it is, business has struggled to get by. This is evidenced by a debt-to-asset ratio that's the highest in recent history, reflected by the mounting bad debts in US banks. In fact, the banking industry has grown so wary of lending that business loans have been declining ñ not increasing ñ for 15 months in a row now.

There's an ominous disconnect occurring somewhere between all that newly printed money and America's industrial output. Like Japan, our industrial production has slunk below its long-term trend for 18 straight months now. During most of those 18 months, the economy has been presented with eleven - and now twelve - rate cuts. Still, this normally failsafe economic stimulant has had no discernable effect on business. And, even though this latest interest rate decline of from 1.75 to 1.25 means that money is suddenly 28 percent cheaper, stocks quickly reacted with another triple-digit decline day.

Clearly, the business community is acting like an addict who no longer gets a buzz from the same dose of drugs.

Ironically, the very act of slashing rates a half point instead of a quarter can be more worrisome than encouraging. As Mitch Stapley, an investment officer from Michigan, put it: "The Federal Reserve is obviously seeing more risk of weakness than had been apparent to us." The half-point slashing has stunned investors who had anticipated a possible quarter point cut. "What they've effectively done is two moves in one meeting," said Ethan Harris, a chief economist at Lehman Bros. But, if these two-moves-in-one do anything, they leave investors worried that things are actually worse than they had suspected. "The Federal Reserve is basically saying the economy is so weak that it has to cut interest rates by a whopping half a percentage point," said Wells Fargo's chief economist, Sung Won Sohn. "And that's telling us that the economy is getting worse and not better."

Meanwhile, on the other side of the monetary fence, gold has never looked better. "The good news is that, according to Elliott Wave Theory, we are in a powerful bull market. I expect gold and gold shares to take off in a powerful advance to new highs," Clive Maund, an English technical analyst, recently observed. In addition, the internationally known Aden sisters predict "Gold is looking good on a long, medium and short-term basis."

Don Murphy, a technical analyst with Merrill Lynch speaking on CNBC said, "My view is that I like gold as an investment. I'm inclined to think that gold is making a secular low, a buy of a generation." He went on to say, "To be conservative, I'm going to say $450 to $550, but my thought is that gold could go back and challenge the levels we saw in 1980-81 at $850 an ounce."

The world seems to agree, too. Middle East demand for gold is up 30 percent, perhaps in anticipation of war with Iraq. Japanese gold demand has increased 75 percent this year, with investment demand up 150 percent. India is also seeing a great surge in demand.

To participate in this booming gold market and to reduce your anxiety over what the Fed does - and what the Fed sees ahead of us - it makes perfect sense to re-balance your portfolio with a solid component of gold. Then, at the very least, you won't have to be among the many casualties should the economy continue its downward spiral.

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