Fed's Dollar Velocity Play
Research for Online Investors

by John Dalt

12/02/11

Inflation is not caused by the amount of money in the market place.  Inflation is caused by the velocity of money.  What did the Federal Reserve do on Wednesday?  They increased the velocity of money.  European credit markets were slowing as banks didn’t know who they could trust and the European Central Bank was faced with a potential shortage of dollars.

This happens when people lose trust in the currency.   Greek and Italian citizens are pulling money out of their banks because of fear they will fail.  If you live in a failed state with the banks facing insolvency, what currency do you want to own?  Euros or dollars?

What currency do you want to be paid in for services, euros or dollars?  The Federal Reserve technically is not printing money, they are loaning it against euros held by the ECB.  The Fed is not buying treasury bonds or mortgage backed securities, but they increased the velocity of money.  This will lead to inflation in the eurozone faster than increasing the money supply.

By lowering the interest rate on dollar swaps to the European Central Bank, the Federal Reserve increased the velocity of money.  The action also kept the ECB from having to go into the market and buy dollars to supply them to their member banks.  This would have driven the value of the dollar up and pushed the value of the euro down.

The central bankers did not want this to happen.  The Federal Reserve is determined to keep the value of the dollar down compared to other currencies and the ECB did not want to depreciate the value of the euro any lower.  Buying dollars in the open market would have done both.

The market looks to complete the biggest week in almost three years.  We have had a big run on headlines and rumors out of the eurozone.  Eurozone finance ministers met earlier this week and did not accomplish anything except approving the $10.7 billion dollar payment to Greece.  This payment had been in limbo for the last two months as Greece vacillated between fiscal austerity and delaying any hard decisions.

Prime Minister Papandreou resigned and the new unity government signed off on austerity measures to satisfy demands from the European Commission and International Monetary Fund.

European leaders are meeting next Friday in Brussels.  Merkel and Sarkozy hope to present a plan to tighten the fiscal integration of countries in the eurozone that desire European Central Bank (ECB) or European Financial Stability Facility (EFSF) assistance.

We can see a two prong approach with the ECB supporting bonds from selected countries in the secondary market and the EFSF supporting country’s new issue bonds if they sign a new eurozone agreement allowing veto power over their government budgets.

Merkel has repeatedly called for more fiscal integration, and this veto over sovereign budgets is what she wants. Changes to the Eurozone governance treaties require unanimous support.  This intrusive plan would be impossible to pass through the 17 government legislatures of the eurozone.  Germany can avoid ratification by all 17 eurozone countries by asking only the countries that desire help to sign.  This makes it voluntary.

This will be seen as an intrusion into most country’s sovereignty, but if required for assistance, they will sign under duress.  Other countries that manage their national budgets conservatively will not have to go through an approval process since they do not require assistance in the credit markets.

The eurozone debt crisis has affected our markets for the last two years.  We don’t think anything eurozone leaders do at this time will change that, but they may be able to lower the fear by agreeing on a mechanism for fiscal controls and support.

The market is at resistance at 1250 to 1260 on the S&P 500 index.  The DJI, Dow transports and NASDAQ transports pushed through resistance this morning.  The market looks like it wants to move higher on the short term.  The next resistance level is 1285 on the S&P.  That was the closing high on October 27.  We expect turbulence in the market next week as rumors give way to results.

Mailbag:
War is the name of the banking cartel’s game.  It is sick.---subscriber T.M.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions. It may contain errors and you should not make investment decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any securities discussed. The editor may have held a position in a security earlier, or in the future.

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