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December 11, 2006

Time to Be Fed

Markets saw little movement today ahead of tomorrow's gathering of the FOMC. With the script already written for this meeting... no change in policy with little or no change in language... it is not likely that this meeting will provide a catalyst for any sort of movement. If there is to be any surprise tomorrow, it could come in the form of overly hawkish language regarding inflation. Bernanke and crew have maintained somewhat aggressive overtones with regard to such concerns, but if they were really serious about nipping higher prices, rates would still be going up.

Speaking of double-speak, former cabal leader Alan Greenspan helped the dollar lose ground when he said he expects the dollar to keep dropping until the nation gets its current account deficit under control. Sir Alan makes a good point which critics of the Fed should keep in mind: given our fiat currency system, the Fed's discretion with regard to money creation is severely inhibited by the fiscal discipline... or lack thereof... of our government. In order for our government to spend more than it receives in taxes, it must sell bonds. Someone has to buy those bonds, and if no one wants them, the price falls and the rate the government must pay goes up.

Problems start to arise when vast sums of these bonds start maturing. If the government cannot repay the bonds out of tax receipts, it must refinance them, and it naturally wants to do so at low rates. Politicians then lean on the Fed to be a buyer and provide liquidity through money creation. In other words, they monetize the debt.

Based on similar comments about fiscal discipline made by Greenspan throughout his term, I believe he understood the problems of money creation. He was faced with the dilemma of either forcing discipline via higher rates... and possibly sacrificing his career... or keeping the game going. He chose the latter. The problem with Greenspan's approach is that it encourages risk tolerance, thereby increasing the odds of disaster. Such is the environment inherited by Bernanke.

I'm not so sure our current chairman understands the malevolent effects that frivolous money creation has on the allocation of resources in an economic system. Bernanke's studies and published papers give the impression that he believes liquidity is the cure for economic woe. The current hawkish tones regarding inflation are nothing more than posturing to defend the U.S. Dollar. When the full force of the housing downturn is felt, he will print like mad.

Turning back to the markets, the slip in the dollar helped levitate precious metals a bit, and miners once again followed them higher. I have been using Newmont Mining as a proxy for the near-term prospects of mining shares, and NEM once again failed to conquer resistance at $47.60. I am really holding my breath on this one, because $47.60 seems to represent serious resistance for Newmont. If the shares can close resolutely above that level, I believe it will be a sign that the whole group is ready for a major breakout.

As for equities in general, Monday looked like an instant replay of Friday: break higher on the open and drift lower for the remainder of the session. Both days witnessed lower volume than Thursday, and major indices have failed to regain Thursday's highs. This action is at least a temporary straw in the bear hat. Let's see if we can hold the line with November retail sales and CPI out later in the weeks.

Disclosure: Long NEM; Long NEM Calls


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