Cheap Money May Keep the Market Going

10/31/2007 12:00 am EST

Focus: MARKETS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says the central banks are keeping the money spigots open, hurting the dollar but probably helping fend off deflation.

It’s getting insane. On the one hand, the three biggest banks in America are meeting behind closed doors with Treasury Secretary Henry Paulson, trying to stop the subprime mess from turning into an economic nightmare. They’re also trying to get cooperation from international banking giants, like Barclays and HSBC. Then there’s the market. All it sees is that money is getting looser, and so, the party is on!

But this cannot go on. We have to see a very nasty drop in here somewhere, and I suspect it will be soon. We will not try to time the market. We’ve done best in the past by just holding through the rough spots, but there may be a real stomach churning in our future.

The TV traders are focusing on "The New Interest Rate Cycle." Lower interest rates are good for stocks, all else being equal. In my view, however, all else is not equal. The domestic economy shows signs of growing weakness, and I think the effects of the housing recession will be deeper and last longer than Wall Street would have us believe.

However, so far, the world economy seems unfazed. There was no housing bubble in the BRICs--Brazil, Russia, India, and China. We’ll have to see whether the slower spending by American consumers has a domino effect or not.

Central Banks, including our beloved Federal Reserve, can and do attempt to influence the price of gold, despite their government’s professed belief in free markets. There is a lot of fast money (hedge funds and speculators) whose entrance or exit from the gold futures market affects the metal’s price inthe short term. Longer term, the rate of money supply growth above that of GDP determines the gold price in dollars.

The Fed and Treasury Secretary Paulson talk up a strong dollar, while continuing to inflate the money supply. The talk is a sham designed to keep the dollar from sliding too quickly and causing panic selling among huge dollar holders like Japan, China, and the oil-producing countries. The same was true under Treasury Secretary John Snow and Fed Chairman Alan Greenspan, as I repeatedly pointed out in 2005 and 2006.

The dollar index has declined more than 12% since then, but The Fed and other central banks have no choice but to help it slide. The excesses of the housing bubble must not be allowed to deflate too rapidly. That would bring down some major investment banks and hedge funds, and with them, the US and world economies. We’ve become too entangled with the machinations of the major financial institutions. Sooner or later, it is going to cause very serious problems. For now, however, the markets will probably climb higher on a pile of cheap money.

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