Are Central Bankers Out of
Touch with Reality? I Hope Not!

Today's comment is by Eric Roseman, Investment Director and editor of Commodity Trend Alert.

Dear A-Letter Reader,

The credit markets are now clearly in a major freeze across the United States, Canada, Europe and parts of Asia. And last week, Europe took the booby-prize when bond insurers scrapped two offerings because of poor demand.

Once again, short-term lending rates like Euribor (€) and Libor (US$) are trading way above central bank targets. The reason is simple: Bankers are still reluctant to lend for extended periods in a growing credit crunch. The chart below shows the big spike in Libor rates since August 9 when signs of the credit squeeze first erupted.

The question is: How will the world's leading central banks respond to this credit squeeze?

Thus far, the Fed has cut rates. You can bet they will continue to aggressively reduce borrowing costs as recession fears escalate. But the Europeans are reluctant to cut interest rates, despite pumping billions into the European inter-bank market.

Fashionably Late for the Rate Cutting Party

Some central banks, like the Federal Reserve, are late coming to the rate-cut party.

As recently as March 28, Fed Chairman, Ben Bernanke, claimed "the impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained."

Then on June 5, he exclaimed "Fundamental factors - including solid growth in incomes and relatively low mortgage rates - should ultimately support the demand for housing, and at this point the troubles in the sub-prime sector seem unlikely to seriously spill over to the broader economy or the financial system."

Naïve Not Stupid - We Hope

Bernanke is not a stupid man. But just by looking at these statements, you can see the Fed's misguided monetary policy response and poor economic forecasts. You can also see a certain naiveté on the part of the world's most influential central bank. I've also got to believe the Europeans are thinking the same way.

The renewed credit freeze two weeks ago is not about to calm down any time soon. That is unless the Europeans start aggressively cutting interest rates. That's especially true for the Bank of England (BOE), which literally "lives on another planet." They still believe inflation is the primary concern. While they're debating inflation, it's possible that one or two of England's smaller banks will collapse in this squeeze.

The European Central Bank (ECB) and the Federal Reserve have this same "out of touch mentality." With housing clearly in a massive bear market and credit hemorrhaging, the threat of deflation, not inflation, has surfaced for the first time since 2000.

Would a series of European interest rate cuts alleviate pressure on credit markets? That's an academic question at this point. The world's largest central banks have pumped the financial system with over US$600 billion worth of liquidity since August.

Where the Tidal Wave of Liquidity Must Come From

But emergency rate cuts now from London and Brussels would throw the markets a tidal wave of liquidity. European rate cuts could jack-up government bond yields and finally inject a dose of confidence into credit markets. Rate cuts would also deflate the high-flying euro versus the dollar.

Central banks usually act in concert on monetary policy, especially amid a financial panic. This time won't be any different.

The sooner the Bank of England and the ECB abandon their fight against inflation the better. As soon as they start tackling deflation in credit and housing, the sooner this bear market in financial assets will end.

ERIC ROSEMAN, Investment Director

EDITOR'S NOTE: Eric Roseman is recommending a special "chaos market hedge portfolio" in December's issue of The Sovereign Individual. He recommended nine separate investments that can keep your portfolio in the black whether the markets go up, down or sideways next year. Click here to get a sneak preview of Eric's new "chaos" portfolio in next month's issue.

Consumers Are Losing Their Faith...
Is a Spending Slowdown Next?

This week consumer confidence numbers dropped to a low not seen since Hurricane Katrina.

The numbers came in at 87.3 vs. 91 expected. October's number was revised downward to 95.2 vs. 95.6 previously. None of the 67 economists polled thought it would drop by this much. So these numbers caught ALL the pros by surprise. Translation: things are definitely not looking good in the U.S. economy.

Why should they be? After all, the average consumer realizes that gas prices are through the roof right now. That's like a tax on the consumer because the extra money they have to put into their tank to get to work, school, etc. they don't have to spend in stores. Consumers are never happy when they have to focus on "needs" rather than "wants."

Coupled with this, average consumers know their home values have decreased also. They see the "for rent" and "foreclosure" signs in their neighbor's yards as they drive into their neighborhoods. These signs of a bruised economy are staring them right in the face.

Consumers may not always know where the Dow or Nikkei is at the moment. However, they can tell you what gas prices are in their area and how many houses are being foreclosed around them.

With consumer confidence numbers, we get a sense of the "mood" of the consumer. When they're not feeling strong about the future of the economy, then they're not going to open their wallets wide and spend. So when the economy feels uncertain, consumers shut their wallets. When the economy feels more stable, then they spend more freely.

So while we may have gotten off easy this year as far as hurricanes go, we're experiencing an "economic hurricane" and the consumer is feeling its effects.

SEAN HYMAN, Currency Director

EDITOR'S NOTE: Today's currency comment is an excerpt from our currency E-Letter, My Two Cents. Five days a week, our currency writers provide their latest insights on the currency markets - including what's happening to your dollar's purchasing power. Click here to receive all our currency insights in My Two Cents - absolutely FREE.

Privacy & Rights

The Computer Found You Guilty...
How Do You Plead?

Your bank or broker will never tell you, but every transaction you conduct through a U.S. bank or broker - deposits, withdrawals, credit card, currency conversion - creates a secret financial profile of you.

The USA PATRIOT Act and similar laws actually require banks, brokers, car dealerships, jewelers, and many other types of businesses to spy on you. And none of these businesses are allowed to tell you they're doing it.

If the computer software these businesses MUST use to spy on you triggers a "guilty account" alert, you'll never know until your assets are frozen or confiscated. The law makes it a crime to tell you if you're under suspicion.

One mistake - withdrawing too much cash, writing a check to the "wrong" person, etc. -and you could be the next victim.

MARK NESTMANN, Privacy Expert &
President of the Nestmann Group
www.nestmann.com

P.S. The all-new third edition of The Lifeboat Strategy, updated in October 2007, can help protect you from having an innocent transaction from being deemed "suspicious," and deal with hundreds of other threats to your wealth and privacy. To learn more about the Lifeboat Strategy, click here.