I posted this on the Yahoo BZH message board, but thought that I would get much more intelligent comments here. Have at it:

Most of you know that the FOMC is meeting on Tuesday, 7 Aug. If you're long or short this stock and are unaware of it, you're not an investor; you're a speculator because you are blissfully ignorant of the financial markets.

I will quickly go through three possible rate scenarios and the impact of each on BZH. I'll then discuss the problems with changing the rates.

I see three possible scenarios: no change (95% probability), 1/4 point cut (4.9% probability), and 1/2 point cut (.1% probability).

1) No change. BZH continues to tank, dropping unabated and will probably be setting new 52 week lows by the end of the week.

2) 1/4 point cut. BZH has another dead cat bounce on Tuesday afternoon and Wednesday. Continues downward path into the weekend.

3) 1/2 point cut. BZH has a big dead cat bounce and finishes up slightly for this week. It will continue downward the following week.

The odds on the Fed cutting rates is very, very slim. For those that don't understand why they're slim, you need to look beyond the US borders.

The rest of the world is hiking interest rates to cool inflation. Of course, thanks to the manipulation of our CPI, the US doesn't show real inflation; anything that has increased significantly is underweighted.
If the US cuts rates, it will kill the dollar exchange rate, which will have a large negative impact on the US markets in terms of liquidity. How so? The yen carry trade will vaporize. As of today, the US dollar only buys 117.93 yen. If it goes below 117, you will see a massive unwinding of positions in the US to close out the books on those carry trades, further eroding the dollar compared to the yen.

Another reason why the Fed is in a bind in terms of cutting rates is that inflation is more like double digit than 2.5%, as advertised. That's the reason why Bernanke is in no hurry to cut rates until the core CPI is solidly under 2%.

Someone in another post mentioned that falling housing prices would lead to deflation, causing the Fed to cut rates. I disagree. The reason why I disagree is that rapidly rising home prices haven't shown up in the CPI because the CPI doesn't take home prices into account. Here's an article from 2005 explaining why the CPI didn't go ballistic during the housing boom: http://www.businessweek.com/the_thread/h....

The fact that the government did not include housing costs into the CPI over the last few years allowed them to keep interest rates artificially low, feeding into the housing bubble. Had home ownership been factored in, we would likely have had higher interest rates and would not be in the mess that we are today.


Counterpoints, rebuttals, pointing out errors/flaws in my logic, and intelligent comments are all welcome.

Why is 117 yen the magic number?

@Iflyjetzzz

I think you have summed up the factors in the situation very well. However, the bind the Fed is in transcends BZH and is really a key factor in the future of the US economy. Looking at the macroeconomics and the politics of the situation, we see the proverbial immovable object facing the irresistible force.

First, the macro economics...

If the Fed lowers rates:
Negative...
- the dollar tanks, with implications of loss of reserve currency status, etc.
- inflation, possibly hyperinflation is right around the corner
- foreign Treasury debt holders may dump to get better returns elsewhere
Positive...
- stock markets rally
- consumer spending increases with renewed access to credit
- housing may revive
- US exports more attractive
- Government debt reduced by inflation

If the Fed raises rates:
Negative...
- economy in a tailspin with reduced consumer spending
- major equity market decline
- last nail in housing coffin
- US exports less attractive
- government debt more expensive
Positive...
- dollar rally
- real inflation curbed
- US Treasuries more attractive

Second, the politics

If the Fed lowers rates:
- consumers consume, complacent and happy with the government
- real estate and financial industries happy with the government
- stock brokers, money center banks happy with the government
- US multinationals happy with the government

If the Fed raises rates:
- consumers, i.e., voters mad as hell and want to throw the bums out
- US business feels betrayed and political contributions dry up

So, even though the fairly tale reads that the Fed is an 'independent' body, it is subject to political pressures just like any other institution in this country, possibly more. In the current bubble climate, with the banks and financial industry gaming the system for all it is worth, do not expect a cartel of banks, i.e., the Fed, to stick it to their financial industry comrades. Also, do not expect another Paul Volker to emerge to give the system a much needed enema by raising interest rates two points off the bat. We are long past the days of a principled statesman doing the right thing.

We are in this perilous situation because of a dishonest fiat currency that allows politicians and debt merchants to print an unlimited money supply. The public and equity markets are so addicted to this drug of liquidity that they are willing to swallow their ethics and sacrifice the long term financial future of America to revel in the pleasures of today. The voting public is in an entitlement mindset, where they think that they can get 'free' goodies from the government and someone else pay for it.

The only way that an economic collapse, brought about by untenable levels of debt at all levels of the economy, can be avoided is to keep the game going by printing more money, increasing liquidity, increasing debt, increasing inflation and building more bubbles. This is the classic 'crack-up boom' theory from the Austrian school. The end game of this is an inflationary depression, ala Weimar Germany, Argentina, etc.

Crosseyed: It is actually around 117.5

It is just a support level, same as for stocks.

Gms:
Good precis. However, if rates are lowered, your "positives" depend on there being someone left to borrow. If B/S are full of debt, lowering interest rates won't make any difference here - just like Japan.

@Gmak

You are probably right. The consumer (70% of the economy) is so tapped out with debt that there is little room left to expand credit to them. That is the reason for the debt merchants turning to sub-prime, the only 'new frontier', since they weren't tapped out, since no rational lender would give them money to begin with.

And sadly, the area of the economy that really does need to take out loans to build and expand, the US manufacturing industry, probably will not. It is more lucrative to be bought out than to actually produce anything and create jobs.

Gms,

Lowering the rate will immediately cause the Yen carry trads to unwind This immediately would cause the dollar to devalue and increase the value or goods and services. Gasoline $5-6/gal, etc. Wages would take alot longer. I think this would be the start of a recession.

One thing that concerns me is that no one seems to be worried that this could happen. Not only does Cramer keep calling for a rate cut but multiple other people also. Are we the only ones who can see this? I hope Ben can!

Jetzzz,

One scenario you didn't include is the dollar dropping below 117 Yen and Ben has to defend the dollar by an immediate rate rise. I think this will tank all the housing and financials and we see immediate recession. Market down 30% plus.

@Av8rphil

I agree. To mitigate a US rate reduction, the BOJ would have to lower rates to save the carry trade. But, I am not sure if Paulson could get the Japanese government to put enough pressure on the BOJ to lower rates by .25%. The rate is hovering just below .5% this morning. Is a return to .25% really in Japan's best interest?
http://www.bloomberg.com/markets/rates/j....

I would even suggest that we are currently in a recession, but will not admit it. Even though most people are obsessed with the nominal value of the Dow, if you price the Dow in gold, euro's, loonies, copper, corn, etc., it has declined. This is because the dollar itself has declined because of inflation, which is caused by excess money supply and credit expansion. Add to this the cooked inflation numbers that exclude anything that people actually purchase, the increase of credit card debt (the lender of last resort), and we have one sick economy already in a recession.

And why doesn't anyone else see this? They do. Ben & company are not stupid guys. But there are reasons why change is hard to implement. First, the Fed is a cartel of banks, led by Ben Bernanke, an academic and former Fed governor. The cartel's primary job is to make sure the cartel does well, very well in fact. Second, Princeton and other business schools do not focus on Austrian theory, and lean toward Keynesian economics. They do not believe that they do harm when they try to steer the economy, regardless of what empirical data or history has shown. Austrians believe that that central banks cause the business cycle, not just react to it.

Third, there are just too many connected people in the financial industry making a killing in the bubbles. This leads to moral lapses, such as wholesale fraud in the lending industry, naked short selling, Cramer-esque market manipulation, etc., making the people you think have a fiduciary responsibility to watch out for your interests turn out to be the wolves in sheep's clothing. Add to this a happily ignorant public and a complicit financial media afraid to report anything negative about their main sponsors, and you end up where we are today.