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Emailed 12/17/08

Here comes the Flood




Here comes the flood of Federal Reserve money.  As this chart neatly shows the Fed has turned on the spigots and let the liquidity fly.  

So why isn't all of this lending (increase in assets) causing the dollar to drop, commodities to rise, and raise bond yields?  Fear.  The velocity of monetary transactions has collapsed along with asset prices.  The Federal Reserve may be throwing money at the problem, but the banks refuse to lend out the excess cash created by the Federal Reserve's activities.  A recent Merk Fund commentary neatly explains the current situation.

Here's an excellent article describing how the bankers succumbed to financial engineering wizardry.   The high tech equivalent of turning dross into gold didn't quite work.

Since the banks are refusing to lend the Fed is going around them and lending directly to corporations in the form of supporting their commercial paper operations.  As you can see from this chart the drop in yield on GE (General Electric) 90 day commercial paper is quite impressive. GE evidently has enough money now because as of December 15th they are no longer offering 90 day paper from their parent corporation!

Since this has not been enough to bring the bankers out from their hiding places the Fed recently announced the direct purchase of  mortgage backed securities (home loans) from Fannie Mae and Freddie Mac as well as their bonds as well.  This caused an immediate drop in mortgage rates.

Who needs to nationalize the banks when the Federal Reserve can do it all themselves?  

Turning Japanese
On Tuesday December 16 the Federal Reserve cut the Federal Funds rate to effectively zero. I don't however think we are in for the same nearly generational malaise the Japanese suffered through.  'Helicopter' Ben Bernanke, the chairman of the Federal Reserve is determined to prevent deflation from striking the American financial system. See the first chart above.  If the current round of monetary stimulation doesn't work the Fed will keep trying until something works.  However I fear the cure may be worse than the disease.  The Federal Reserve will have to drain the markets of excess liquidity once some semblance of normalcy returns and they may be too late in their actions.

Like most other assets, Treasury bonds of the plain vanilla and inflation protected form have been driven to extremes. While US stocks are down around 40% for the year right now, US high yield bonds and preferred stocks are down around 35% I mention this 87.5% correlation for two reasons. In this market everything has fallen with almost perfect correlation. Low risk strategies designed for low but steady returns failed. The baby, tub, and the entire kitchen have been thrown out with the bathwater.

As I have mentioned before I'm not bullish on the US consumer. Since 2000, much of our economic growth has come from the US consumer spending the equity of their appreciating home. Once our economy recovers this ATM machine will no longer be available to the country as a whole and will inhibit strong GDP growth.

While the market action of the last few days is encouraging, it is only a thin veneer covering the deep anxieties felt by the entire world.  Don't be surprised when there are more violent market actions up and down.   


 As this is most likely my last email communication of the year I'd like to wish you a Merry Christmas.  I'll see you in the New Year.




(253) 927-0998

Strategic Asset Management
1113 A Street #208
Tacoma WA 98402


Strategic Asset Management is a fee only financial advisor intent upon providing its clients with independent and unbiased advice and portfolio management.


Note:  This communication is not an offering for any investment.  Greg Merrill is President of Strategic Asset Management which is an investment advisory firm registered in Washington State.







Strategic Asset Management
voice: 253-927-0998

Strategic Asset Management is an investment advisory firm registered in Washington State.

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