	Generational Dynamics
	Forecasting America's Destiny ... and the World's

\| HOME \| WEB LOG \| COUNTRY WIKI \| COMMENT \| FORUM \| DOWNLOADS \| ABOUT \|

Generational Dynamics Web Log for 3-Oct-07
The effects of the Fed's August 17 discount rate cut

Web Log - October, 2007

The effects of the Fed's August 17 discount rate cut

Without the interest rate cut, things might be very different today.

It was on early morning, August 17, that I posted my essay, "The nightmare is finally beginning." I had reached the conclusion that the masses of investors had had a dramatic change of attitude that was so overwhelming that we would see a generational crash within a few weeks.

I set up a "real time experiment," comparing the day by day changes in the Dow Industrials to corresponding days in 1929, to see if we would have a generational crash in the same time frame. That didn't happen, as we now know. But even without following exactly the same schedule as 1929, it remains still true that something dramatic had changed on August 17.

Apparently I'm not the only person who's reached that conclusion.

Here's what PIMCO's Bill Gross, head of the world's largest bond fund, wrote in his October market commentary:

"I and other PIMCO professionals were attempting to describe to high-ranking Treasury and Fed officials the near-frozen commercial-paper markets and the draining confidence of bond and stock investors worldwide. It was Thursday, August 16. Stocks had closed down 210 points and were expected to open hundreds of points lower on Friday. The country’s largest mortgage originator, Countrywide Financial, was rumored to be in liquidation mode (it survived that crisis). This was to be Ben Bernanke’s first test, an opportunity to prove that he and his board of governors knew “something” as opposed to “nothing.” Pass the test he did, cutting the discount rate the next morning and calming markets in ensuing weeks. When Bernanke’s Fed met officially on September 18, it acted again and joined a convoy of global central bankers maneuvering to restore a semblance of normalcy to credit and equity markets. So far, so good."

Note that, according to Gross, the market was expected to open several hundred points lower on Friday. This, in fact, is what I was expecting.

In other words, Gross was talking to Washington officials at the same time, and telling them his own version of "the nightmare is just beginning."

Let's take a look at the table that was in my August 17 posting. This table measured the speculative real-time experiment, comparing the 1929 and 2007 markets, following the respective market peaks. This data is taken from my Dow Jones historical page. On September 3, 1929, the market peaked at Dow 381.17. By November 15, it had fallen 40% to 228.73. This year, the market had peaked on July 19 at 14000.

The table that I posted compares 1929 and 2007, following the respective peaks:

    1929   % of peak (381.17)
    -------------------------
    Tue 09-03 ( +0.22%) 100%              2007   % of peak (14000)
    Wed 09-04 ( -0.41%)  99%              ------------------------
    Thu 09-05 ( -2.59%)  97%              Thu 07-19 ( +0.59%) 100%
    Fri 09-06 ( +1.76%)  98%              Fri 07-20 ( -1.07%)  98%
    ------------------------              ------------------------
    Mon 09-09 ( -0.36%)  98%              Mon 07-23 ( +0.67%)  99%
    Tue 09-10 ( -2.04%)  96%              Tue 07-24 ( -1.62%)  97%
    Wed 09-11 ( +0.99%)  97%              Wed 07-25 ( +0.50%)  98%
    Thu 09-12 ( -1.23%)  96%              Thu 07-26 ( -2.26%)  96%
    Fri 09-13 ( +0.14%)  96%              Fri 07-27 ( -1.54%)  94%
    ------------------------              ------------------------
    Mon 09-16 ( +1.51%)  97%              Mon 07-30 ( +0.70%)  95%
    Tue 09-17 ( -1.04%)  96%              Tue 07-31 ( -1.10%)  94%
    Wed 09-18 ( +0.65%)  97%              Wed 08-01 ( +1.14%)  95%
    Thu 09-19 ( -0.25%)  97%              Thu 08-02 ( +0.76%)  96%
    Fri 09-20 ( -2.14%)  94%              Fri 08-03 ( -2.09%)  94%
    ------------------------              ------------------------
    Mon 09-23 ( -0.84%)  94%              Mon 08-06 ( +2.18%)  96%
    Tue 09-24 ( -1.78%)  92%              Tue 08-07 ( +0.26%)  96%
    Wed 09-25 ( -0.01%)  92%              Wed 08-08 ( +1.14%)  97%
    Thu 09-26 ( +0.96%)  93%              Thu 08-09 ( -2.83%)  94%
    Fri 09-27 ( -3.11%)  90%              Fri 08-10 ( -0.23%)  94%
    ------------------------              ------------------------
    Mon 09-30 ( -0.41%)  90%              Mon 08-13 ( -0.02%)  94%
    Tue 10-01 ( -0.26%)  89%              Tue 08-14 ( -1.57%)  93%
    Wed 10-02 ( +0.56%)  90%              Wed 08-15 ( -1.29%)  91%
    Thu 10-03 ( -4.22%)  86%              Thu 08-16 ( -0.12%)  91%
    Fri 10-04 ( -1.45%)  85%
    ------------------------
    Mon 10-07 ( +6.32%)  90%
    Tue 10-08 ( -0.21%)  90%
    Wed 10-09 ( +0.48%)  90%
    Thu 10-10 ( +1.79%)  92%
    Fri 10-11 ( -0.05%)  92%
    ------------------------
    Mon 10-14 ( -0.49%)  92%
    Tue 10-15 ( -1.06%)  91%
    Wed 10-16 ( -3.20%)  88%
    Thu 10-17 ( +1.70%)  89%
    Fri 10-18 ( -2.51%)  87%
    ------------------ -----
    Mon 10-21 ( -3.71%)  84%
    Tue 10-22 ( +1.75%)  85%
    Wed 10-23 ( -6.33%)  80%
    Thu 10-24 ( -2.09%)  78% Black Thursday
    Fri 10-25 ( +0.58%)  79%
    ------------------------
    Mon 10-28 (-13.47%)  68% Black Monday
    Tue 10-29 (-11.73%)  60%
    Wed 10-30 (+12.34%)  67%
    Thu 10-31 ( +5.82%)  71%
    Fri 11-01  (Closed)
    -----------------------
    Mon 11-04 ( -5.79%)  67%
    Tue 11-05  (Closed)
    Wed 11-06 ( -9.92%)  60%
    Thu 11-07 ( +2.61%)  62%
    Fri 11-08 ( -0.70%)  62%
    ------------------------
    Mon 11-11 ( -6.82%)  57%
    Tue 11-12 ( -4.83%)  55%
    Wed 11-13 ( -5.27%)  52%
    Thu 11-14 ( +9.36%)  57%
    Fri 11-15 ( +5.27%)  60%
    -----------------

The table stops at 8/17. As it turns out, the next line was:

                                   Fri 08-17 ( +1.82%)  93%

That is, the Dow Industrians gained 1.82%, after the Fed announced the discount rate cut.

If the Fed hadn't announced the discount rate cut then, according to Gross, the market was expected to fall several hundred points, let's say, -4%.

This would have matched what happened in 1929: On Thursday, October 3, the market fell -4.22%.

So, if Gross is correct, then we would indeed have been following the 1929 path, and the generational crash might well have occurred already, by September 21.

Gross adds that the basic problems that the problems that led to the near-meltdown on August 17 "remain to be disproved." He continues,

"The modern financial complex has morphed into something unrecognizable to many astute market veterans and academics. [Fed Chairman Ben] Bernanke’s fellow governors and [Treasury Secretary] Hank Paulson’s staff at the Treasury spread their roots during an era in which traditional banking activity – lending out deposits backed by a certain level of reserves – was the accepted vehicle for liquidity creation. Remember those old economics textbooks that told you how a $1 deposit at your neighborhood bank could be multiplied by five or six times in a magical act of reserve banking? It still can, but financial innovation has done an end run around the banks. Derivatives and structures with three- and four-letter abbreviations – CDOs, CLOs, ABCP, CPDOs, SIVs (the world awaits investment banking’s next creation; perhaps IOU?) – can now take a “depositor’s” dollar and multiply it ten or 20 times. Reserve banking, and the Federal Reserve that regulates the system, appear anemic in comparison."

This is the point that I've made many times. Only I believe the use of CDOs have created leverage by a factor much higher than 10 or 20.

He continues:

"I’m sure that Bernanke, Paulson, and their cohorts understand this, but it isn’t yet clear how much they appreciate it. Alan Greenspan admits in his newly published book that he didn’t appreciate until recently the impact adjustable-rate mortgages and their subprime character, accompanied in some cases by outright fraud, would have on the housing market. If the Fed was so slow to grasp the role that subprime mortgages played in the housing boom and bust, do the Fed and the Treasury of today totally comprehend what happens when the nonbanking private system suddenly stops flooding the market with credit? Do they recognize that such a shutdown puts spending for housing and business investment at risk, and job growth as well? The Fed will have to adapt its monetary policy, and the Bush Treasury will have to adjust its fiscal policy to this brazen new world dominated more and more by private rather than public policies and proclivities. To overcome private-market caution, the Fed may need to put on a bold face marked by even more decisive cuts in short-term rates. To prevent a housing-market slump from metastasizing into a cancerous self-feeding tumor, Treasury Secretary Paulson will have to coordinate policies that lend a helping hand to homeowners in distress."

I agree with what Gross says, except for his evident belief that it's still possible to do something to prevent a global economic meltdown.

Nothing has really changed since I wrote my August 17 essay, "The nightmare is finally beginning."

What these financial officials don't understand is that they have things backwards. They believe that a series of accidents -- the housing bubble, the distress of a couple of banks -- is the CAUSE of the investor anxiety and panic. They believe that if they can take a few confidence-building steps, and convince people that the banks are OK, then investor anxiety and panic will return back to "normal."

But that's backwards. The panic and anxiety is CAUSED by generational changes -- the people in the generations that survived the 1930s Great Depression have all disappeared, replaced by Boomers and Gen-Xers who have no idea what's going on, and are panicking as a result.

The generational panic and anxiety that had been growing silently among Boomers and Xers finally metastasized into action on August 17. The shot of heroin that the Fed provided with interest rate reductions has produced the desired euphoria, but that euphoria can't last much longer.

Something very significant happened on August 17, even if the comparison with 1929 didn't precisely occur. The issue is NOT the ups and downs of the stock market; the issue is the dramatic increase in panic and anxiety among investors. That's not going to change. It's still true that the generational panic I've described might occur next week, next month, next year or even later, it's still my expectation that we'll see it within the next few weeks. (3-Oct-07) Permanent Link
Receive daily World View columns by e-mail
Donate to Generational Dynamics via PayPal

Web Log Pages

Current Web Log

Generational Dynamics Web Log for 3-Oct-07 The effects of the Fed's August 17 discount rate cut

Web Log Pages

Generational Dynamics Web Log for 3-Oct-07
The effects of the Fed's August 17 discount rate cut