Monday, August 06, 2007

State of the Markets

The 500 lb gorilla in the room that few talk about is not tied to sub-prime mortgages or the financial sector fall-out, but the inflation in stock prices due to the amount of borrowed money used. If a particular stock is held by 30% borrowed money, then the stock price is 30% too high. Wall Street firms can borrow to purchase new stock based on the market value of other stocks they hold to a near 100% match.

These actions essentially give the Wall Street firms the ability to print money. One draw back to this manufacturing money: no actual value is placed back into the economy. It's like the movie Wall Street: the illusion of value becomes real. An illusion of a market capitalization becomes real, and others buy into the "profitability" of particular companies.

The valuation of companies should be substantially lower; 30% lower is not outside the ability of the market to correct. 6% has been lost in the DJIA since mid-July, and I suspect we have about 20% more to go.

As far as interest rates recovering the flailing market, lower rates would further drive down the value of the dollar and spur inflation in the economy. Side note: I am a proponent of a weaker dollar to boost U.S. manufacturing, but realize there is a fine balance between a low dollar and an easily purchased U.S. economy.


Kelley said...

That's funny that you use a "50 lb Gorilla".....most people say a "pink suede elephant"
love, me

Annissa said...

You write very well.