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The Epic Battle of a Lifetime

January 2nd, 2008 1:07 PM by Ron Mastrodonato

The Epic Battle of a Lifetime
by Martin D. Weiss Ph.D.

The year 2007 is closing — and 2008 is about to open — with an epic battle between two of the most powerful economic crosscurrents we've seen in a lifetime:

  • An unprecedented credit crunch threatening to strangle the debt-addicted U.S. economy, and ...

  • Equally unprecedented money pumping by a Federal Reserve determined to flood the economy with all the cash it needs to overcome the crunch.

With the Money and Markets issues of recent days, my team has done a great job in laying out some of the potential consequences. So on this last day of 2007, I will be very brief, summing it all up with some simple questions and some not-so-simple answers:

Question #1. Which of the two crosscurrents will prevail in 2008? The credit crunch or the Fed's money pumping?

Answer: Neither force will neutralize the other. The credit crunch will continue to spread. Delinquencies and defaults will continue to surge among consumers, corporations, even local governments. And in response, lenders will continue to pull back, deepening the crunch.

Meanwhile, to combat the credit shortages, the Fed will take some of the most extraordinary measures ever seen, even to the point of virtually requiring banks to make more loans.

Question #2. Which of these two forces will impact the economy and the financial markets?

Answer: Both! The credit crunch will drive the U.S. economy into one of its worst recessions since World War II.

But at the same time, the Fed's efforts will help pump up inflation, sending more money into inflation hedges like gold and other natural resources, safe-haven currencies like the Japanese yen, plus foreign stock markets.

Question #3. At some point, isn't there a risk that either (a) the credit crunch will cause a deflationary collapse or (b) the Fed pumping will create hyperinflation in consumer prices?

Answer: At some point, perhaps. But not now.

Question #4. How will we know that critical point has been reached? How will we know when the Fed has won or lost its epic battle against the credit crunch?

Answer: The market for long-term Treasury bonds will give you the best signal. As long as there are buyers for long-term Treasuries, the Fed can continue to attack the credit crunch with every weapon in its arsenal. But on the day that those buyers vanish — the day the U.S. government itself has serious difficulties raising the funds it needs — the game will be nearing an end for the Fed.

Question #5. What should I do about all this?

Answer: First, keep a big chunk of your funds in the safest securities in the world today — short-term U.S. Treasury securities. That helps protect you from the shockwaves of a credit crunch.

Second, allocate a substantial portion of your funds to investments that help protect you — or profit from — the kind of inflation that's now gathering momentum: Gold investments like the gold ETF (GLD), foreign currency investments like the Japanese yen ETF (FXY), and the others our team has recommended.

Above all, remember that conditions will change. So stay flexible. Don't lock yourself into investments with big exit penalties. And for most of your money, avoid those with illiquid markets.

Good luck and God bless!

Posted in:General
Posted by Ron Mastrodonato on January 2nd, 2008 1:07 PM

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