If in fact there is and is going to be a greater Liquidity Crunch, per Frank, then what would be the best things to 1) invest in and/or 2) do to protect current investments?
Thanks,
Jake
Individual Investor

Hm, correct me if I’m wrong, but doesn’t “liquidiy crunch” imply people rush to sell government bonds as well, meaning you shouldn’t be investing in them, but wait for their yields to spike and buy them? (side note: anyone holding government bonds is bankrolling aggression … or something)

Hey person, you’re correct that a liquidity squeeze could force holders to sell US Treasuries to raise badly needed cash to cover other obligations that arise from the sell down. But Treasury yields will ultimately fall, and Treasury bond prices rise, in the wake of the squeeze. I don’t know whether or not a liquidity squeeze will produce a spike in yields in Treasuries this time.

There’s nothing wrong in buying and holding Treasuries, or in receiving farm subsidies, or driving on public roads, for that matter. What is wrong, I think, is to set oneself up as a tax taker–net of one’s tax payments to the government.

And if Bush/Clinton decide to go Hoover/FDR on America … what’s the plan then? I gather that what with all the hyper-surveillance and all it will be harder to smuggle one’s gold coins and bullion to Canada or the Caribbean than in the 1930s. Well, Canada’s land border might be easier to run, but they probably have banking treaties that require each country to report whenever the other’s citizens rent a safety deposit box. I s’pose it’ll have to be gold mining shares, and pray there isn’t a windfall tax …

HA! Do your own dirty work, guys…

PS: Liquidy crunch? Sounds delicious.

Roger M, You’re correct that over the long run, the rate at which a central bank inflates its money supply influences the value of that currency versus other currencies. If the Federal Reserve system inflates more slowly than the Bank of Japan over a considerable time frame, that difference ought to manifest in prices that rise more in Japan, and Less in the US. This price differential reduces demand for yen by American importers, and increases demand for dollars by Japanese importers. The effect is to lift the dollar against the yen until the price differntial is elimminated.

There is only one sound reason to go long the yen: the yen must be undervalued in terms of purchasing power relative to the dollar. I don’t know for sure that the yen is undervalued, i.e. that prices in Japan (at today’s exchange rate of yen/dollars) are lower than prices in the US. But some analysts believe it is, such as James Grant, who publishes Grant’s Interest rate Observer and writes a column for Forbes.

If the yen is not fundamentally undervalued according to purchasing power parity, then the unwinding of the carry trade–if it happens in a hurry–would probably lift the yen against the dollar, but only temporarily.

Frank Shostak’s article makes it pretty clear that we’re probably on the brink of a recession. Look at his chart of the growth rate of the AMS–Shostak’s definition of US fiat money. From a growth rate of roughly 8% in the 4th quarter of 2004, the rate of increase has declined to just over 1% recently. That’s an extended and gradual tightening of money, which argues for declining price inflation as well as falling asset values–stocks, corporate bonds, real estate–and recession. It’s pretty likely that low inflation and economic contraction will in a year’s time bring considerably lower T bond interest rates and substantially higher T bond prices.

commonjunk: “Would you mind to tell which book you are refereeing to?”

I read Schiff’s book, “Crash Proof”, which someone reviewed last week on this site, I think.

Mark: “…the yen must be undervalued in terms of purchasing power relative to the dollar.”

That may be true. James Grant is very knowledgeable. The Yen may be a good hiding place for awhile.

Mark: “From a growth rate of roughly 8% in the 4th quarter of 2004, the rate of increase has declined to just over 1% recently.”

Yes, and the real danger is that it could get out of hand. The Fed doesn’t really control the money supply as well as they think, otherwise, they would have met their money supply targets of the 1980′s. Financial deregulation has taken a lot of lending out of the Fed’s control. The Fed may intend to engineer a soft landing (as they always do) but if bankruptcies begin to pile up and business people lose their confidence and refuse to borrow money or invest retained earnings, the mild slow down in AMS could turn into a wrenching dead stop! Also, consumers stretched to the limit with high mortgage payments and second mortgages may refuse to borrow money to buy durable goods.

Stephen: “Walter Williams assesses current M3 money supply growth(Yes the one the fed now will not declare)running at 13%.He sees hyperinflation in the coming.I suspect that more likely.”

I admire Walter Williams greatly! And he would tell you that monetary pumping can’t stop a recession. Germany in 1920 and the US in the 1970′s are proof. The clash of interests between consumers wanting goods and business people investing in capital equipment is what causes businesses to fail in mass and bring on a recession. Monetary pumping can’t save those businesses; it only increases prices. If the Fed “helicopters” money to the economy, we’ll see a return of stagflation and the recovery will take longer. Right now, Bernanke seems concerned about rising prices, so maybe he won’t succumb to the demand to lower interest rates.

Those of us who have retreated to cash in our portfolios have the opportunity to buy stocks and bonds and real estate at blue light special prices in the coming months. Then, when Bernanke turns on the tap again, we can ride the wave of new money to greater profits.