THE FED WILL PUT THE OXCART IN THE DITCH AGAIN! Prepared by Dohmen Capital Research Institute, Inc.
(November 17, 2000) The Federal Reserve Open Market Committee decided this week to maintain the status quo. That includes maintaining a bias towards tightening and keeping the overnight lending rate between banks at a very high 6.5%.
This decision means that all the factors that have led to the very abrupt and significant slow down in the economy, and the tightening of the credit squeeze, will continue. It also means that all the conditions that produced the plunge in the NASDAQ composite still exist. The index is down over 40% from this year's high.
The market was having a strong day until the Fed announcement. But after the announcement stocks traded down sharply. It took a late-day rally to bring the major indexes modestly back into positive territory.
Here's what the Fed said in their statement accompanying their decision to maintain the squeeze: "Softening in business and household demand, and tightening conditions in financial markets over recent months, suggest that the economy could expand at a slower pace" than it has in recent years. The statement also said that the shrinking labor pool and rising energy prices had only a "limited effect on core measures of prices." In other words, there was no inflation in sight.
In effect, this confirms exactly what I have been saying for the last eighteen months, namely that there was no inflation danger, and that the Fed was on the wrong track by trying to apprehend something that didn't exist, thereby inflicting severe damage on the economy and the financial markets.
Yet, recognizing this, they keep the overnight lending rate, which banks pay for money, at a very high 6.5%. But their statement that "the economy could expand at a slower pace in the future" is incredible. The last GDP number shows that the growth rate has plunged over 50%.
In the meantime, industrial output for the nation in October showed a decline of 0.1%. Manufacturing is contracting! In the longer term, I consider this non-action by the Fed very negative. It confirms that their eyes are closed and their brains are comatose, not able to see the damage they have already inflicted. Refusing to remove the "tightening bias" makes no sense in view of their statements. They admit that there is no inflation, that the economy is weakening, and credit is being squeezed, yet they lean their bias towards tightening. It looks like they will keep their foot on the brake until the economy stalls out and plunges into the abyss. I really feel bad about criticizing the Fed again, but these people never know what they are doing. The free market can set interest rates much more efficiently than 12 economists who admit that they don't even know how to measure inflation, or the effect of their policies.
As I wrote in my most recent Wellington Letter of November 13, the Fed has really overdone things. Just take a look at the current situation. GDP growth was roughly 6%, and it is likely to slow to around 2.5% or less. PC revenues are expected to slow significantly, down from 17% to 12% for 2001. That's a 30% decline.
Corporate finance and credit markets are in a crunch, and the junk bond market is really suffering. Smaller, fast-growing companies are finding it difficult, if not impossible, to finance growth. And two big banks, Bank of America and First Union, just announced they're writing off some very large loan losses. What more do the gentlemen at the Fed want?
Even if the Fed cuts rates early next year, it will take many months for the beneficial effects to work their way into the economy. In the meantime, you have a credit squeeze. That's always bearish for the markets.
Shrinking margin loan balances of investors indicate that the "irrational exuberance" which pushed the NASDAQ to 5,000 has turned into realistic pessimism. In October, margin loans plunged more than $20 billion. I saw one analyst interpret this as bullish. But if you've been investing a long time, you know that a strong decline in margin loans is a sign of a bear market.
Earnings are slowing, the internet company bubble has burst, oil prices are high, etc. But apparently, all of these factors aren't enough for the Fed to change its stance just yet. They want to show who is boss.
The ongoing drama in the Presidential election continues to add great uncertainty to the markets. With all the court challenges which I expect, a clear result is likely to be weeks away.
By the way, someone did a test, giving the "confusing" ballot to 50 people between the age of 92 and 97. Everyone completed the ballot without a problem. That's 100%! Of course, older people are smarter than younger ones, so that was probably an "unfair" test. No one said whether or not any of these test ballots had "hanging chads." A similar test with 4th grade students also showed 100% accuracy, with no confusion.
November 17, 2000 Bert Dohmen Dohmen Capital Research Institute, Inc. 1132 Bishop Street, Ste. 1500, Hololulu, Hawaii 800-545-2243
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