Saturday, June 7, 2008

Bernanke's legacy

In the next few weeks Fed president Bernanke will in my opinion determine how history remembers him. As the economy weakens we are going to see more banks poised on the edge of bankruptcy. Will he take the same path and pump liquidity in to save them or will he realize his mistake and let them fail? The decision to cut rates drastically to try and prevent the economy and specifically the financial sector from experiencing any pain during an election year will most likely go down in history as one of the biggest central bank blunders of all time.

Everyone seems to be denouncing the ECB for their stance on inflation but they are making the exact right choice to save their future. Bernake on the other hand seems to be locked into save the banks mode. If he doesn't stop and stop quick he risks putting the country into a hyperinflationary depression. I'm guessing in the next couple of weeks we are going to have another large financial institution teetering on the edge. If he doesn't let it go bankrupt but instead pumps up more and bigger TAF auctions, TOMO's TIO's, etc. then we are likely going to be in for some seriously bad times by next year.

We have tough times ahead anyway. That's the end result when a bubble pops. There's no way around it. The question is will the Fed do the right thing and let the bubble correct so we can have a future.

In order to do that Bernanke needs to start raising rates. He needs to raise them aggressively just like Volker did in the 80's. We need to strengthen the dollar. Just talking isn't going to do it anymore. We need action. Yes raising rates will make the recession worse. More people will go into foreclosure... a lot more. There's no way around that one. Sure that is going to deepen the recession, it's unavoidable.

Despite the Fed's efforts none of that can be avoided at this point whether they raise or lower rates. The only thing the Fed can do is stop inflation from getting anymore out of control. My suggestion is that the Fed concentrate on what they can fix and not on what they can't.

If I see the Fed raising rates then commodities will take a breather the recession will remain just a nasty recession. It won't be the end of the commodity bull by any means. That will only end when supply and demand move back in balance and that's still a ways into the future.

If however I see the Fed expanding the TAF auctions again or guaranteeing a buyout of another crippled bank, anything other than letting the financial system pay for their mistakes then I'm going to prepare for the worst. That means buying gold and silver aggressively.

The Fed's actions in the next few weeks are going to be critical to commodity prices and Bernanke's legacy.

We certainly do live in interesting times. I wish they were good interesting instead of bad interesting though.