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Mike Kosares: The morning after the open-ended bailout

Section: Daily Dispatches

By Michael Kosares
Centennial Precious Metals, Denver
Saturday, August 11, 2007

This time it IS different.

In past financial bailouts, the destruction was limited to one or two institutions. A group was put together in the private sector, or the central bank stepped in, and the troubled entity was bailed out.

When the Federal Reserve, the European Central Bank, and Bank of Japan moved last week to bail out the entire financial industry worldwide, they offered, as the Financial Times pointed out today, the equivalent of a credit card with no credit limit and subsidized rates 1 or 2 percent below what would have been the free-market rate had they not stepped in.

What's more, it was done on a global basis to the tune of hundreds of billions in "liquidity."

Thus the central banks have set a dangerous precedent.

One of the points made repeatedly in the financial press today is that no one in the banking industry or the central banks knows the extent of the losses. Take it a step further and you have to assume that no one knows the extent of the ongoing bailout either.

The bailout could end up being open-ended -- AND without borders. All commercial banks and hedge funds around the world will feel that it is their birthright to be given unlimited credit -- and now, it appears, the central banks, as a matter of fairness, will be at their mercy.

When CNBC's Jim Cramer experienced a meltdown of his own on national television in the United States last week and actually screamed for a bailout by the Fed, he spoke for the financial industry as a whole. Most of the nation's trading rooms were nodding their heads and saying, "Give 'em hell, Jimmy!"

Now, in the heat of the moment, comes the bailout. As its open-ended nature begins to be recognized, we will see how the markets react -- the morning after.

What, for instance, will all this credit translate to in the real world, the real economy?

This is a question that I am sure is being entertained right now at the meeting tables of the world's financial engineers. But what the press has failed to point out in its treatment of the financial crisis is that the actions of the Fed, the European Central Bank, and the Bank of Japan last week amount to printing money.

Money was created out of thin air. When you do this, it tends to force down the value of your currency against everyone else's.

But wait a minute. Practically the WHOLE WORLD, not just the United States, is printing money to put the crisis at bay. How can the dollar go down against the euro when the people in charge of the euro are printing just as much currency as the people in charge of the dollar?

Where the rubber meets the road, the open-ended bailout may translate into a massive depreciation of the world's major currencies against goods and services globally.

In other words, chances are that the cost of living is about to erupt higher -- much higher than expected, and globally.

As a result, gold demand is likely to rise considerably, driven by safe-haven buying globally -- and gold supplies are already strained.

On the other side of the ledger, paper assets -- anything denominated in and linked directly to the major currencies being printed furiously -- will be seen as suspect.

Will this inflation evolve into hyperinflation? Only time will tell. But the open-endedness of the bailout is troubling. Where do the central banks stop? Who, if anyone, is going to get cut off?

When no one knows how deep the damage is, there is no way to know how much money will need to be printed.

All this is the result of just one small sector of the massive derivatives market going haywire. There are similar time bombs buried all over the markets -- more bailouts to come now that the precedent has been set.

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