The Fed, and other matters - emailed to subscribers - Sat, 26 Aug 2006

In the second day of his testimony speech to Congress in July, Ben Bernanke told the House Financial Services Committee that over tightening Monetary Policy is 'possible.'

"Our objective is to achieve non inflationary sustainable expansion but there are risks to that in both directions," the Fed chairman declared.

Do understand, the Fed does not cause things to happen - they react to events. I also find it preposterous that the Fed seems to think that with a few tinkerings here and there it can 'control' what the economy is going to do. This is utterly false, never forget that. The Fed acts within the system, i.e. it is endogenous to it. Real estate shows a very clear 18 year cycle wherever its rental value has been permitted to capitalize - since about 1600 at least anyway. This will re-occur in some fashion in the US despite whatever the Fed does.

Do note too, this recent Fed reaction to inflation is the same as it has always been, lift interest rates to counter the increase in prices. (It is doubtful whether prices are in fact being measured accurately anyway, however it is the psychological reactions to all the news that takes precedence here.) And all the credit created to finance war had to lead to higher prices at some point, as my emails since 2002 have been saying to you.

The Fed's reaction will prove overdone ultimately. (But not yet) Beware when the suggestion comes out that Bernanke is 'tinkering' for a "soft landing". We've never achieved that yet. As stated before, any rises in rates toward the end of the 18 years in the cycle must be treated with caution by we traders. This is because the economic system is built on a mountain of land debt created and financed by banks. The point at which it looks the most strong, is in fact the weakest point. The sun always shines brightest at midday...

But not yet. Barron's reports, July 24, 2006, the S&P 500, at 1240, is trading at 15 times projected 2006 operating profits. This is not overly expensive. The S&P in fact is not often below such a projected figure of 15. 1994 was the last time this occurred.

To the war costs so far: Disgusting isn't it. If only my trading profits ticked over like that...

They're just so-ooo short Well you know the story, the higher the market goes... Great time in the real estate cycle for this to happen. (And I did suggest to you they'd both go higher into 2008/9 - land prices and the hemlines.) They will be much lower by 2010 (damn it) See, the more confident we feel, when house prices are high and going higher, the more confident the fashion statement.

Confidence built on quick sand. It will sink quickly (the hemlines as well as the confidence) once the land price (understood as house prices by Joe and Jane Public) has been seen to have turned. Nothing will stop them buying like the knowledge that house prices will be cheaper next year than this year. Presently however, most of those under 40 believe that house prices only ever go up, for this is all they have ever experienced.

Average 18 year cycle guys, I'm telling you:

Some interesting news on the banking front, I have attached a scan of the front page of the AFR in case you missed it. If you have read my US real estate history chapters, you will know exactly what this is going to cause. (If you haven't read these chapters yet, they will be up on the new site shortly.) In the US, such laws have led to a situation of moral hazard. Since the bankers now know for sure that the government will reimburse depositors whatever happens to the bank, the bankers will take more risks with their lending. Exactly the sort of thing we need to see at this time in the cycle to put credit creation - fractional reserve banking - into overdrive. The effect of this situation, governments guaranteeing deposits, SOMETHING THEY SHOULD NEVER DO, is quite clear historically.

Watch over the next couple of years for smaller finance companies to start offering deposit interest rates ever slightly higher than those of banks, to attract more deposits, so they can lend more. You know the story from there. If you don't know the story, read the 1989 US real estate chapter in particular.

As regards the US, i think the next move on interest rates in the US could easily be down (slightly), which will allow markets one more move up, asset prices to hit final highs, raw land subdivisions to go over the roof, then we will turn into recession. But this process forward requires years, not months.

Costello - PDF

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