Now that markets have had a little time to absorb the effects of the Fed’s surprise 50 basis point cut in the Fed funds and discount rates, much continues to be made of how the U.S. dollar apparently is being sacrificed in an effort to avert an economic recession. The U.S. Dollar Index has fallen below 78 for the first time, and a number of commodities have reached new highs in dollar terms, leading some analysts to conclude that higher inflation rates are inevitable.
That’s disturbing enough. But in today’s globally interconnected markets, several other related developments also seem disturbing, although it may be a little early to tell, and we aren’t into making dire gloom-and-doom predictions.
The first is the investment of Middle East countries into exchanges, investment firms and banks. Dubai has purchased a stake in Nasdaq and the London Stock Exchange, Qatar has also taken a stake in the LSE as well as the OMX, Abu Dhabi now owns a piece of an investment firm . . . the list goes on and probably is bigger than publicly revealed and likely to get bigger. Who can blame those holding their oil earnings in U.S. dollars from trying to preserve their wealth by getting into something else? Anything looks better than the dollar at the moment. Individual investors are doing the same thing by getting into gold and other commodities so it’s easy to understand their decision.
But when you have sovereign states loaded with profits from oil competing with other investors and putting their state-owned funds into companies and exchanges and hedge funds in place of U.S. Treasuries, it could have consequences yet to be understood. How will the regulatory and security issues be resolved if states become the owners of the market?
The second development that could have some disturbing consequences revolves around the UK’s Northern Rock bank debacle that required a bailout from the Bank of England. According to some press reports, depositors made a frenzied run on Northern Rock to draw out their money that brings to mind the run on some U.S. banks in the 1930s that my grandfather talked about. The bank’s tie to the housing slump is probably not isolated, and similar runs on banks or other institutions holding people’s funds could unfold elsewhere. That has occurred in some hedge funds but, for the most part, has not touched the man in the street in the United States yet.
We are not predicting runs on banks and financial collapse, but much hinges on maintaining people’s confidence in the financial structure. Confidence can be a fragile thing. Once it starts to erode, it can turn from crisis to panic in a hurry and is hard to reverse.
Meanwhile, stock markets are enjoying the situation, with the Dow Jones Industrial Average starting the fourth quarter Monday by setting a new record above 14,000, seemingly ignoring its October history.
The Mystery Trader will be on a mystery trip to get a first-hand look at one of the world’s most dynamic economies over the next three weeks, including the time of the 20-year anniversary of the Oct. 19, 1987, stock market crash. It will be very interesting to see how the market has fared by the time we return. See you in late October.