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Posted 10/31/2005
Contrarian Chronicles
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The trap Bernanke can't escape
Caught between rising inflation and a slowing economy, the new Fed chairman needs to be tough and tight if he hopes to gain credibility. He's not up to the task.
By Bill Fleckenstein
Despite the stock market's recent daily pattern of schizophrenia, we can't lose sight of the single-biggest story of the last five years. By that I mean the housing ATM and its ability to allow folks to spend beyond their means and live happily ever after, after our epic stock bubble of the late 1990s.
As the ATM gets jammed and ultimately broken, it will have a huge impact on consumer spending. This breakdown will be an inflection point.
Of course, just saying the phrase "inflection point" makes it sound as though there's a specific day or hour when everything changes. That is not the case. Inflection points often take a long time to evolve, as is true for the unwinding of the housing ATM.
When housing cries 10-year tears
However, I believe this process is under way. And, judging by last Wednesday's action in the 10-year bond -- it gapped lower, to yield nearly 4.6% -- it may have accelerated. Now, the number 4.6% may not mean much to anyone, but it is having an impact on the mortgage market. According to an e-mail from a daily reader who's in that industry: "This move will put the 30-year mortgage commitment rate at very close to 6.5%." Obviously, if the bond market continues to trade poorly, that pressure will only intensify.
Couple that with reservations about our new Fed chairman, Ben "B-52" Bernanke, and you have the makings of further problems. You will note that I have upgraded his dollar-bill-spewing helicopter to a B-52, as he's going to need a whole squadron of something more powerful somewhere down the road (though it may be grounded by the foreign exchange market).
Related news and commentary on MSN Money
'Omniscience' hits an oil slick
Relatedly, I encourage folks to read "Future Shock at the Fed," an eloquent Op-Ed in last Wednesday's New York Times. It's by my buddy Jim Grant, who, as always, puts things into perspective brilliantly -- this time, about the supposed omniscience of the central planners at the Fed:
"Let us say that Mr. Bernanke's field of expertise was energy prices rather than interest rates, and that the president named him to the Department of Energy rather than the Federal Reserve," Jim writes. "If Mr. Bernanke then ventured a long-term oil-price forecast, would anyone even bother to write it down? Would anyone expect him, once confirmed, to actually fix the price?" Jim says that the oil market would have a much better ability to discover the right price than would a price-fixer. The net of it all, he suggests, is that "the world would laugh."
From 'maestro' to merely mortal
Of course, no one laughs when the Fed seeks to pick the right interest rate to make the world run perfectly. But that mistaken viewpoint has been conventional wisdom for so long that some folks have lost the ability to look at the situation objectively -- and see it as the literally impossible task that it is. When viewed from Jim's angle, it becomes more readily apparent how absurd the whole concept is.
The Fed is really trapped. It has an inflation problem, and it has a weakening economy. Meanwhile, Bernanke's credibility appears questionable. For him to gain credibility, he will have to be far, far tighter than he would ever consider or want to be, which would obviously cause enormous damage to the stock market and the economy. (Not that the damage won't occur anyway.)
However, in my opinion, he's the last person to act pre-emptively on that score. After all, this is the one-time Fed governor who in a speech three years ago said: "Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost."
In any case, we are on the cusp of an incredibly dicey moment. Again, I am speaking figuratively, as this "moment" could be six months unfolding. But the end result is likely to be much lower stock prices, a weaker currency and higher metals prices.
A fest or a fall?
The question I continue to wrestle with is: How long can a fantasy-inspired rally last and how strong can it be? Can it last for two weeks and take the market up a few percent? Sometimes I think it can, and sometimes I think it can't. It's no secret that stocks have been trading badly, even on what might be considered good news. I don't see where the leadership can come from. On the other hand, I do understand how potent a force that fantasy can be. (The one now incubating: Stocks must go up at year-end.)
Thus, I continue to be of two minds about the near-term direction of the market, though over the longer term, I am quite confident in my opinion.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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