The financial sector crisis is bad enough but a stock market meltdown is more than symbolic—it’s true wealth destruction.

Foreign Exchange Outlook : G7 will meet starting this Friday but it seems sensible to conclude from prices that the Foreign Exchange market has zero faith in G7 to take any action that will change the landscape. What we got instead was action from the central banks. This has a number of ramifications, not least that political institutions, including ministries of finance/treasuries, are shackled, whereas the least political institution, central banks, can take action.

In short, government gets in the way.

The best thing governments ever did was to make central banks independent.

What it also means is utter desperation. It is commonly accepted that interest rate levels have virtually no influence on trust and confidence, the lack of which is at the heart of the current liquidity and credit crisis.

What is important is whether European Interest Rates stabilize today and tomorrow. While the US banks are underbidding for special TAF money, the ECB, Swiss National Bank dollar offerings were over-subscribed with coverage ratios of 4.43 for the eurozone and 2.23 for Switzerland. The credit and liquidity issues are bigger in Europe than in the US and UK. It would be nice to think that the US and UK may now stabilize, each with its big plan, but if it is true that the world is flat, the US and UK need Europe to stabilize, too.

At some point the public is going to wake up to what the central banks undoubtedly already know -the US taxpayer will be rescuing banks in Spain and Italy. This doesn’t mean the US will take a loss -the ECB stands behind all its US dollar borrowings—but at some point it will look like an expensive bailout at US taxpayer expense. Just as the Mexican Peso bailout ended costing the US taxpayer nothing, this one will likely not be a net drag, either, but politically it’s dynamite. Top officials in Europe, like Brown and Germany’s FinMin Steinbrueck, blaming the US for everything, is not wise. It was hardly the US that allowed/encouraged European banks to leverage themselves to 50x.

This crisis is worse than we thought. We are still grappling with the economic outlook now that credit is sure to be cut to vastly lower levels for a long time to come. We do not have an estimate of what proportion of firms in the US absolutely, positively need to borrow to buy supplies and make their payrolls, but it must be a big number. Let’s say it’s 50%. Does that mean activity (GDP) will contract by 50%? Not exactly, but it’s not 5%, either. And the more stock markets fall and the cost of overnight and short-term money rises, the longer it will take to dig ourselves out of this mess.

We don’t know why the governments do not simply declare for the stock markets the equivalent of a bank holiday, which was the tactic used in the 1930’s. It’s not a run on the banks, like then, but it’s a run on the stock market. So far today stock markets are responding favorably to the coordinated rate cuts, but in the end, it’s foolish. Economic contraction is still ahead and any analysis of the situation that doesn’t take that into account is simply wrong. Yes, some companies will do well in terms of ongoing business - those who don’t need to borrow and who peddle essential items (Cramer names household goods suppliers like Colgate - we still need to brush our teeth during a crisis).

But stocks are certainly headed thousands of points lower and any rallyette today is a time to sell anything still on the books. Note that getting money of hedge funds is hard—they all have notification periods of 60-90 days, so that even a fund of funds, which faces the same notification criteria—is stuck holding ever lower-priced assets. It’s not the job of the government to protect rich people who invest in hedge funds or funds-of-funds, but surely they are not offal to be kicked to the dogs. The financial sector crisis is bad enough but a stock market meltdown is more than symbolic—it’s true wealth destruction. People who could tolerate and wait out the drop in home values are not going to be so calm about seeing their portfolios go to hell, too. There is an authentic wealth effect, even if we can’t measure it very well. People who feel poor simply do not spend. The consumer is two-thirds of the US economy. If industry is going down and the consumer is going down and finance is already in a hole, what is left? Government. What a terrible thing to be forced to say!

Out of all this emerges the ultimate vote-of-confidence—the dollar exchange rate. We continue to think that aside from the US dollar to Japanese Yen, the dollar will do very well against the other majors. Not because the US is superior in any way, but because the US is the biggest and the first and the most essential. We see the pound to dollars exchange rate down around 1.6500 (long-term) and the euro exchange rate at 1.2000 before year-end.

This may be one of the greatest George Soros standard Foreign Exchange trading opportunities ever.

Buy for Now,

Barbara Rockefeller - Forex Trading Reports

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