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Generational Dynamics Web Log for 19-Sep-07
US and British central banks shock investors with large monetary loosening

Web Log - September, 2007

US and British central banks shock investors with large monetary loosening

Wall Street markets surge 2.5-3%, the biggest increases since October 15, 2002, following an unexpectedly large lowering of the Fed Funds rate.

European markets spiked 1.5-2%, after the Bank of England changed policies and guaranteed the safety of ALL Northern Rock bank deposits. And as of this writing (evening in US, morning in Asia), Asian markets are up 3%.

Champagne corks are popping again! The party is in full swing! Euphoric investors are ready to go full steam ahead!

In the US, the Fed lowered interest rates by a full point, when only point was expected. Furthermore, the point reduction applies the both the Fed Funds rate (the rate that banks pay when they borrow money from another bank) and the Fed Discount rate (the rate that banks pay when they borrow money from the Fed).

Thus, the Funds rate went from 5% to 4%, and the Discount rate went from 5% to 5%. It is thought that this will reduce the "credit crunch," by providing cheaper money that can be offered for credit.

The size and rapidity of the rate cut was almost completely unexpected, and resulted in the market surge.

Also unexpected was the guarantee, by UK finance chancellor Alistair Darling, that all Northern Rock bank assets would be guaranteed by the government.

In normal times this would be considered a wildly inappropriate move by the government, since it shows such favoritism to one bank, and thereby puts other banks at a disadvantage. However, these are not normal times, as a panicky bank run was spreading throughout Britain.

From the point of view of Generational Dynamics, nothing has changed. This is because the stock market is STILL overpriced by a factor of around 250%.

Equally important, Tuesday's stock market surge is actually a sign of increased panic.

Let's take a look at what happened:


Dow Jones Industrial Index, September 18, 2007
Dow Jones Industrial Index, September 18, 2007

Take a look at what happened at 2:15 pm in the above graph, and then read the following message that I received from an online correspondent:

"Today when the Fed anounced, I experienced a massive system failure in order placement. This is the first time I have seen this. Maybe you were right when you told me that there would be no system access during a major crash. I had 2 isolated systems with their own connections during the outage and both failed to respond.

Luckily for me I was on the correct side of the trade and was not affected much by the outage. But this has scared me. My broker told me that there were multiple firms that all experienced the same problem."

I don't know how widespread this computer failure was, since it hasn't been a media story, but it doesn't surprise me at all.

The above graph shows that at 2:15 pm, when the Fed mades it's announcement, the Dow spiked by 150 points in something like a nanosecond.

It's obvious that large financial firms, with special access to the NY Stock Exchange computers, were able to place buy orders instantly, and get them filled.

But my friend, who is just an ordinary investor, didn't have a prayer. He was so far back in line, that it would have been many hours before he could have placed an order, if that had been necessary.

This is a point that I've made in the past.

There are many people today who are willing to agree that the stock market may be due for a correction, but many of those people believe that they can get out quickly, without losing too much money, if it becomes necessary. Such people have no idea of the dynamics of what's going on.

Here's the next sentence from my online correspondent's message:

"PS: I am very bullish now 70%. I expect new highs in the Dow soon."

What?? Why would anyone believe that there's any significant chance at all that what happened Tuesday means that the market will reach new highs?

What actually happened on Tuesday is what might be called "upward panic." Investor anxiety has been increasing steadily since February. This kind of anxiety leads to panicky decisions -- either in the downward direction (stock market crash) or upward (what happened on Tuesday).

And remember this: On Monday, October 7, 1929, anxious, panicky investors pushed the stock market up +6.32%. That was just two weeks before Black Thursday.

So I would very strongly challenge any assumption that the market is going to keep going up. What happened on Tuesday was not a sign that the party is on again. It's actually a sign of panic among investors, who, for that moment on Tuesday, believed that the Fed saved the world.

But will they still believe on Wednesday that the Fed has saved the world?

We'll have to see, of course, but the huge spike at 2:15 tells me that it's very unlikely. When you have a massive "upward panic" like that, so large that it crashes multiple computer systems, it's not a sign that things are returning to the good 'ol days.

If the Dow can spike up 150 points in a nanosecond on Tuesday, then it can spike down 150 points in a nanosecond on Wednesday. And now, thanks to the message from my online correspondent, we have someone's personal experience to tell you what will happen -- you won't be able to do anything, because the computers will crash. You'll have to just sit there and watch your assets disappear, just as all the people of Salt Lake City, Utah, did in 1929. (19-Sep-07) Permanent Link
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