Another Mistake, Another Rally: Time to Switch to Cash

Sunday, the US government announced its plan to bail out Citigroup (C). Stocks staged a huge illogical rally on that plan again. I call it illogical because in the first place, it was built onto another big mistake by the US government, which is hell bent on digging itself far too deep into debt in the hope that eventually things will stabilize and it will be able to get into the same get-debt-and-spend-it-all soon again.

Secondly, this rally was built onto another illogical rally on Friday, which happened because Tim Geithner was finalized as Obama's Treasury Secretary. This guy has been the president of the New York Fed for some time now and was very instrumental in the US government's bailout of AIG.

I think bailing out AIG instead of Lehman Brothers was one of the most fundamental mistakes. As discussed in my previous article, AIG's bailout started with an initial $80 billion price tag, which has by now ballooned into almost $200 billion with no end in sight. And, if you just see the numbers for Citigroup, it's $326 billion to start with.

I think that was the reason why the market welcomed Tim Geithner so much. He has absolutely no idea about how deep the holes are that he is digging. And he will keep doing so as long as the markets can scare him enough. In fact, the markets realized and accepted the reality of the correct valuations of most companies' stocks (especially financials) when Henry Paulson (the current Treasury Secretary) realized the gravity of the situation that the US Treasury is facing. But here comes Geithner, and here come hundreds of billions of dollars in bailouts. Not one or two, but many down the road.

Now we have been seeing the US Dollar rebound and a huge demand for US treasuries in the recent past. But let's not confuse the short term situation with long term evolution, if the US government keeps driving the down the road it has chosen. The current rally in Treasury bonds (10 year yield is around 3.3% but 3 months yield is .13) reflects the huge demand for these instruments due to a squeeze of availability of US dollars, especially when, until July, the Euro was hitting new highs every day. Then, traders were selling USD.

Now, as banks started going belly up, their leverage (read collateral) had to be unwound, which was mostly in US denominated treasuries. As a result, US Treasury demand started going up. As a side effect, US dollar started going up. This created a squeeze on all those shorts who were betting on the rise of the Euro. This scenario has helped the US government tremendously, which is getting delusional about the Dollar and Treasury demand and thinks that it can get away with all these enormous bailouts very easily.

Bloomberg news announced that the actual price tag (cumulative value) of these bailouts is not $700 Billion or even $1 Trillion, but it is a staggering $7.7 Trillion. Also, the speed and recklessness with which the US Federal Reserve is printing and pumping dollars in not only the US but also the whole world's financial system, will decimate US dollars not too far in the future.

Unfortunately, I don't even want to imagine the US dollar's actual worth in a year from now if the US Treasury and Federal Reserve don't abandon this road immediately. I have still not understood why these agencies are so fixated with the stock market and trying to manipulate stock values in such a reckless manner. I hope that some official will be brave enough to finally say, "No". Otherwise, the dollar is headed down very soon.

But I want to add one more point here, that somehow commodities traders (specifically oil traders) treat the dollar's decline as a way to boost oil price. That's a big mistake, as oil and every commodity have a fair value, and demand of each commodity, by definition, is determined by supply. But we should not forget that which supply and demand curve is being traced depends on price. If price is either too high or too low, then both demand and supply shift. And that's why commodities can trade only at a fair value barring short time spikes or troughs. So ideas for investors, US financials are a 'Sell'. Oil still has some more room to go down (around $45) to reach its fair value.

Stock position: None.

Comments

[Larry House:]

Just about any movement upward makes one think of going to cash. Risks are still weighted to the downside, and upward movement appears unsustainable. Healing has not been accomplished in financials, and the recession/depression is still in full force.

2008 Nov 25 10:30 AM

[anarchist:]

With Geither we get a resurrection of Paulson. These guys haven't a clue as what to do about the financial crises at hand (not that I do either but I don't have an MBA from Harvard or was I the CEO at GS) so the would rather fight the enemy they know(inflation) than the enemy they fear most (deflation). I agree with GOLD DIGGER in that it is ridiculous that the Market has a 400 point rally on the news that Citi is going to get a massive bailout but thats what we investors are stuck with-a volatile market that has big irrational swings that scare the hell out those who are long or short.

2008 Nov 25 12:55 PM

[bigmoney:]

if the dollar tanks, then it must tank relative to something, which means there will be a bubble in something. What will that be?

2008 Nov 25 01:16 PM

[Moon Kil Woong:]

Big Money: How about Japanese Yen. Anyway, I think the Fed and Treasury can deflate the money supply pretty rapidly. They just can't really inflate the money supply to offset fundamental de-leveraging because even if they dump money into the financial system, there aren't any credit worthy people to lend it to.

If you are credit worthy, you would be saving money, not borrowing more right now. So what are we trying to do? Get people to spend more than they can afford once again? Silly Silly Silly.

2008 Nov 25 10:14 PM