Friday, July 03, 2009

So California is Issuing IOU's?

By Jeff Diamond - So California is issuing IOU’s… And Bank of America, Wells Fargo, and others are accepting them as cash? It has been far too long since anyone has asked the question as to what qualifies as money these days. The Federal Reserve is creating dollars out of thin air at record speed, and the Federal government is spending stimulus and TARP money faster than anyone can count. If the old saying of “as goes California, so goes the nation” holds true, then we’re going to see a new kind of money printing in addition to to what the Federal Reserve and the U.S. Treasury have hidden up their sleeves.

Personally, I am very concerned about how all this is going to play out. At every level of government the only answer to our problems that politicians and bureaucrats seem capable of offering is to print money and issue more debt. Of course, FASB did its part by rejiggering accounting rules so that banks could hang onto their toxic assets and claim that they are still worth 100 cents on the dollar (bravo!)

If real estate hadn’t become so over-inflated (and over-built), then I would be telling everyone I knew to get out of stocks and bonds and to grab up as much “real” assets as possible… Unfortunately, real estate has become the epicenter of this financial implosion thanks to too many years of low rates, easy credit, massive leverage, and speculation. So, that’s hardly going to provide shelter in the storm.

Clearly, our government is hoping that their massive new money printing will avert deflation and bring on inflation. The rally in the stock market off the March 9 low is a good start, but since the economy is still clearly sucking wind, the government cannot remove their foot from the fiscal or monetary throttle. Increasingly, I hear more calls for a second round of economic stimulus in addition to the extraordinary measures already undertaken by the Fed. So here’s the trick… How do they do this without crashing the dollar and/or the bond market? Both are creaking more loudly all the time!

It seems that whenever the stock market rallies, the dollar weakens and bonds sell off. When the stock market falls, then we see the dollar rally and bonds hold firm. Seemingly, there is no formula for a steady currency and rising stocks and bonds… Clearly, our government is happy to throw the dollar under the bus, but while that has helped to rally stocks while also plugging holes in the financial system, the recent harsh sell-off in bonds helped to undermine the rally in stocks.

The answer is that our government cannot and should not be trying to save everyone and everything. Money printing, low rates, and debt got us into this mess in the first place, so why should that now get us out? Let’s just hope that all of these extraordinary measures don’t break what’s still working and that a new crisis isn’t the catalyst that ushers in real change.