RICHARD RUSSELL ON THE MARKETS
February 22, 2005 -- News: Oh no, the bank of Korea announces that they are going to diversify their reserves into other currencies -- translation, "We have too many dollars." South Korea is fourth in the world as to amount of reserves it holds. You can be sure that the central bank of Korea discussed "diversification" with other central banks before making this public announcement. Russia has already stated that it is using euro in its reserves.
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This is Alan Greenspan speaking, or I should say Alan Greenspan thinking. So talk. Alan, talk -- "Blast it, the core rate of inflation in January surged 0.8 percent. On an annualized basis this puts the rate of inflation at almost 10 percent. My low inflation spiel isn't working any more. So clearly I'll have to keep raising short rates to show the world that I'm an 'inflation-fighter.' But whoa, it isn't that easy -- not any more.
"These 'measured' rate increases are beginning to squeeze the long rates, and that means trouble for real estate. I can't let that happen, but at the same time I can't let inflation continue to heat up. Yeah, I know, Paul Volcker would have stamped out inflation with three or four percent boosts in the Fed Funds, but Volcker didn't have this damn real estate bubble (oops, did I say bubble?) I meant these towering real estate prices to worry about.
"Guess I'll just have to take a chance and continue boosting short rates. I warned about the coming rising rates in my talk before Congress, but those bird-brains don't understand what's happing -- they don't even ask the right questions. Hmm, wonder how far I can raise rates before this over-leveraged economy topples over?"
Question -- Russell, how do you know that the above is what Greenspan is thinking?
Answer -- Greenspan talks in his sleep -- and I've got his bedroom wired. But please, not a word of this to anyone, I could get into trouble
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On February 7, I received a brilliant report by Trey Reik of Clapboard Hill Partners. One particular chart in Reik's report caught my attention. It was a chart showing total credit in the US as a percentage of the US Gross Domestic Product. The immediate lesson here is that it's taking more and more credit in order to produce less and less of the US Gross National Product.
Happily, Alan Abelson must have received a copy of the same Reik report, and also happily, Alan reproduced Reik's credit chart in this week's Barron's.
A few facts from the chart. At the 1929 stock market high, total US credit was 176 percent of GDP. In 1933 with GDP collapsing and the Depression in full force, total credit rose to 287 percent of what was left of GDP
Now get this -- in 2000 at the top of the late bull market, total credit was 269% of GDP. That was wild enough, but do you know where we are today? Currently, total credit is 304 percent of GDP!
In other words, under Alan Greenspan's liquidity explosion and his mini-short interest rates, the United States is now awash with credit. And with it all, the Dow still can't make it back to its 2000 bull market high.
And then there's the law of "regression to the mean." Somewhere ahead the credit bubble is going to burst. When it does, the bear market will be on in full. Or -- somewhere ahead the stock market will topple over. When that happens the giant credit bubble will fall apart. Either way, the Greenspan Fed has created the greatest credit-balloon this nation has ever seen. This credit-balloon has created inflation, which is just now becoming visible -- even in the government's statistics.
Greenspan is now in the process of trying to "calm down" the credit bubble. He's doing it with his "measured" increases in short rates . But this is a very dangerous process. It's like rubbing a balloon with a pin rather than just puncturing the balloon. Will Greenspan be successful? Can Greenspan get out of office by early 2006 without triggering a disaster? Place your bets. Either way, it promises to be a fascinating year, and we still have ten months to go. (This is the end of the piece that appeared over the three-day weekend).
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What if the credit balloon actually does burst? What could we expect? One thought is this -- if the credit balloon collapses, there's going to be a panic for cash, cash to stave off bankruptcy on the part of tens of thousands of over-leveraged individuals and companies. This could set off a panic for dollars. Everybody would need dollars in order to stay "alive."
Which brings up another of the Russell scenarios. The giant US credit bubble constitutes a synthetic short position against the dollar. A credit contraction could trigger a mad rush to accumulate dollars. These dollars would be needed by individuals and corporations in order to remain solvent.
During the Great Depression of the '30s everybody hoarded dollars. Nobody wanted to borrow anything, nobody wanted to lend anything. Dollars meant safety. Pessimism ruled. People hung on to their dollars as if their lives depended on those dollars. And in many situations, that was actually the case.
Remember, the Fed can create liquidity. But the public and corporations create the credit, and they create credit by borrowing. Saving, paying off debt, cutting back on economic activity is basically deflationary. And that's why the Fed is so deathly afraid of a trend toward less spending and more saving on the part of the US consumer.
Technicals -- April gold gapped up 7 dollars on the Korean "diversification" news. Today's move took gold well above its 50-day moving average (430) and moved gold into its "buy" mode.
At the same time the dollar gapped broadly below its 50-day moving average, and had the "look"' of wanting to go lower.
March crude surged over two dollars, putting the price of March crude at over 51 dollars a barrel!
The chart below is a KEY chart for the US economy. This is the Philly Housing Index, and, as subscribers know, the current US "prosperity" lives by courtesy of the housing bubble. For this reason, I am watching the Housing Index very carefully.
Up to this point, nothing has shaken the bullish composure of the US consumer. But if housing tops out, this, I believe, would finally cause consumers to turn cautious if not actually bearish.
Just for the fun of it, Faye and I visited numerous homes that are on the market here in La Jolla. My impression -- It's like a descent into madness, and, of course, I'm talking about the prices. Even the meanest little shack in La Jolla costs near or above a million dollars. The scariest four words in the US economy today are the following -- "Regression to the mean."
Below we see the daily chart of the Financials. Big break here, and next to the housing picture, I guess you could place financials as equal in importance. Housing and Financials breaking down! How dangerous is this picture!
Something cracked in the markets today. Was is the swooning dollar? Was it the surging oil. Was is the plunge in the housing index? I don't know, I only know what I see on the charts, and today was an "everybody out of the water day." In fact, you don't see many days that are this damaging.
CONCLUSION -- As I said above, something "cracked" in the markets today. Oil surging, copper near a 14 year high, all home-building stocks down 2 to 6 points, gold up over 7, Fannie Mae under 58, Freddie just above 60, dollar whacked, breadth lousy -- and I ask myself, "Is the fun over." And the answer is that it's too early to tell.
Richard Russell
Editor-in-chief - DOW THEORY LETTERS
www.dowtheoryletters.com/ServicesOnline.nsf/Subscription+Form?OpenForm
February 22, 2005
The inimitable and venerable Mr. Russell gained wide recognition via a series of over 30 Dow Theory and technical articles that he wrote for Barron's during the late-'50s through the '90s. Through Barron's and via word of mouth, he gained a wide following. Russell was the first (in 1960) to recommend gold stocks. He called the top of the 1949-'66 bull market. And almost to the day he called the bottom of the great 1972-'74 bear market, and the beginning of the great bull market which started in December 1974.
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