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Back From the Brink?
New York: December 05, 2011
By John Stephenson

The global economy took a big step back from the brink last week as the world’s major central banks, led by the U.S. Federal Reserve, rode to Europe’s rescue pledging to lower the cost of emergency loans in U.S. dollars. The move should help shore-up the global banking system by ensuring that the system remains flush with the cash needed to make good on any obligations and to keep the credit taps open. For months, Europe’s financial crisis has crept from Greece to Ireland and Portugal and then towards Italy and Spain as politicians have dithered. Stock markets surged as investors bet that the move by central banks would serve as the necessary breakthrough solution to the rampant debt woes in Europe.

With credit markets showing signs of strain as the cost of borrowing for European banks had risen to its highest levels since the Lehman Brothers collapse, central banks felt compelled to act. And with coordinated efforts on the part of six of the world’s most important central banks, the message was clear—we are working together to forestall a recession by boosting the supply of money.

Helping to stoke the fire under global equities was another surprise move, this time by the Bank of China, which cut the required reserve ratio for all Chinese lenders by 50 basis points. This move by the Bank of China, the first cut in three years, signals a more accommodative monetary policy and suggests that Chinese inflation may be tamed.

Also boosting markets were the details about a possible European proposal to channel central bank loans through the International Monetary Fund (IMF). The euro zone’s 17 national central banks operate under the umbrella of the European Central Bank (ECB), which is governed by EU treaties banning the direct financing of states. And that has become a huge sticking point in the crisis. Because the ECB’s unlimited financial resources have been prevented from coming to the rescue, the crisis has continued to spin out of control. But with this latest proposal, at least a chance exists that a new source of funding could open up without violating European rules.

For Germany, following the rules is what it’s been all about from the very beginning. The Germans, like Americans, believe in a simple formula: effort should lead to reward. And that ethos has made both countries rich. But, today, Germany is under assault by the other members of the euro zone who want them to bail out nations like Greece, Italy and Spain, which did not sacrifice and instead borrowed huge sums of money that they are choosing not to repay. And now, with a clear and present danger to the European experiment, Germany is refusing to bend the rules to allow the ECB to become the lender of last resort to these indebted countries.

But a compromise appears to be brewing. ECB president Mario Draghi last week told euro-zone leaders that the bank is ready to take stronger action if leaders are ready to impose tougher fiscal discipline across the 17-nation region. Draghi also suggested that the ECB needed to ensure price stability in inflationary or deflationary times—a novel interpretation on the bank’s sole mandate of price stability. On this and the news of the coordination action of central banks, bond yields across European sovereigns slumped—taking huge pressure off financial institutions. With Europe pulling back from the brink, the potential of a market crash before the holiday season seems to have been averted.

With the ECB signalling that they may be willing to maintain price stability in falling price environments as well as rising ones, the door to further money printing on both sides of the Atlantic has been thrown wide open. The revelation by Draghi comes just as warnings about U.S. monetary policy are being sounded. Late last week, Dallas Fed president Richard Fisher, warned that using the Fed as a printing press to solve the U.S. deficit problem risks unleashing the “sinister beast” of inflation.

But faced with few alternatives, it looks as if central bankers have chosen growth and cohesion today, over inflation tomorrow. And that’s likely to light a fire under commodities as investors fret about the value of paper currencies.

For, gold, the prospect of inflation and a falling euro is manna from heaven. Gold will continue to shine, as the ECB lowers rates and will be potentially engaged in large scale bond purchases. And oil, buffeted by the largest October demand on record and surplus capacity of less than one million barrels per day is poised to move sharply higher.

Oil prices will get a boost, as they often do, from rising geopolitical tensions in the Middle East. The latest salvo came from Iran which made headlines again for the storming of the British embassy in Tehran. With Iran seemingly committed to developing nuclear weapons, and European parliaments keen to boycott Iranian crude, can higher oil prices be far away?

Fuel and precious metals should be the go-to sectors in the months ahead. The fundamentals are extremely supportive and the goings on in Washington and Brussels will only help. The oil and gold producing companies are grossly undervalued based on historical norms, making this the best way for investors to benefit from the rise of these two commodities.

Long-time readers will begin to notice a change in my newsletters and website over the next couple of months. In an effort to better brand myself, I am in the process of converting Money Focus to an E-Letter that will be called John Stephenson's Strategic Investor and will become to be consistent with my Facebook, Twitter and YouTube posts. I trust that you will bear with me during this change.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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