Depression ahead of us?

Another brutal day on Wall Street. There seems to be no let up. The market did not have a single up day for the last eight days. The passing of the bailout last Friday did not serve to sooth jitter investors. Credit spreads remain wide, and stocks continue to sell off. Investors are shunning risky assets and parking liquidity in the "safe heaven" of Treasury bills. Most notable is that commodity prices are sliding as well, with crude oil now trading below $87, down from the peak of $147 set sometimes in March of this year. Gold edged up during this period of stock sell-off. But rise in gold price is not as much as I would have expected. It appears that the likelihood of going back to gold-based currency is very low (although that may be the right choice), because governments around the world are addicted to the power of printing money to finance spending without raising taxes.

Are you heading to a a 1929-style depression? Hardly. I think we have more financial tools now to prevent a depression from happening. I have long maintained we do not need a Federal Reserve (central bank) system to regulate the interest rate (or price of credit). In fact the Fed is incapable of regulating interest rate. Despite the rate cut Fed announced yesterday, Libor remains high. In normal situations, Fed action does affect the credit. But in times of financial crisis, Fed has very little power to influence the credit market. The Fed has pumped tremendous amount of liquidity (in the order of trillions of dollars) into the financial system, and in fact central banks around of the world have done the same. Yet banks are just hoarding the cash and refuse to lend.

Yesterday, UK government decided to take ownership of some of its banks. Today, Treasury secretary Paulson also indicated that the Treasury may buy stock shares of the troubled banks. It feels more and more like socialism. I guess when capitalism runs into trouble, socialism comes to the rescue. How ironic.

Notwithstanding the flaws of the Federal Reserve System and fiat money, I do think the Federal Reserve, if there is any use of it, is precisely designed for the current situation. Investors want to sell risky assets at depressed valuation and buy risk free Federal Reserve Notes? OK, keep coming. As long as the printing press at the Federal Reserve still works, there is infinite quantity of paper money to meet the demand. Someday these investors will realize what they are holding are worthless papers. Then they will start to come back into assets such as bonds and stocks.

In a long run, I think inflation will go up dramatically. Economic activities will be slow for a long stretch of time. Yes, there won't be a depression. But we are going to have multi-years of stagflation (stagnation + inflation).

For future reference, it is worthwhile to record the dramatic selloff of the stock market towards the afternoon of today. Here is what yahoo finance recaps today's financial market activities:

Stocks plunged Thursday, sending the Dow Jones industrial average down 679 points -- more than 7 percent -- to its lowest level in five years. Stocks took a nosedive after a major credit-rating agency said it might cut its rating on General Motors and Ford, further rattling investors already fretting over the impact of tight credit on the economy.

The Standard & Poor's 500 index also fell more than 7 percent.

The declines came on the one-year anniversary of the closing highs of the Dow and the S&P. The Dow has lost 5,585 points, or 39.4 percent, since closing at 14,164.53 on Oct. 9, 2007. It's the worst run for the Dow since the nearly two-year bear market that ended in December 1974 when the Dow lost 45 percent. The S&P 500, meanwhile, is off 655 points, or 41.9 percent, since recording its high of 1,565.15.

U.S. stock market paper losses totaled $872 billion Thursday and the value of shares over all has tumbled a stunning $8.33 trillion since last year's high. That's based on figures measured by the Dow Jones Wilshire 5000 Composite Index, which tracks 5,000 U.S.-based companies' stocks and represents almost all stocks traded in America.

Thursday's sell-off came as Standard & Poor's Ratings Services put General Motors Corp. and its finance affiliate GMAC LLC under review to see if its rating should be cut. The action means there is a 50 percent chance that S&P will lower GM's and GMAC's ratings in the next three months. GM has been struggling with weak car sales in North America.

S&P also put Ford Motor Co. on credit watch negative. The ratings agency said that GM and Ford have adequate liquidity now, but that could change in 2009.

GM, one of the 30 stocks that make up the Dow industrials, fell $2.15, or 31 percent, to $4.76, while Ford fell 58 cents, or 22 percent, to $2.08.

"The story is getting to be like that movie 'Groundhog Day,'" said Arthur Hogan, chief market analyst at Jefferies & Co. He pointed to the still-frozen credit markets, and Libor, the bank-to-bank lending rate that remains stubbornly high despite interest rate cuts this week by the Federal Reserve and other major central banks.

"Until that starts coming down, you'll be hard-pressed to find anyone getting excited about stocks," Hogan said. "Everything we're seeing is historic. The problem is historic, the solutions are historic, and unfortunately, the sell-off is historic. It's not the kind of history you want to be making."

The Dow ended the day at its lows, finishing down 678.91, or 7.3 percent, at 8,579.19. The blue chips hadn't closed below 9,000 since June 30, 2003, and haven't closed at this level since May 21, 2003.

The Dow's 2,271-point tumble over the last seven sessions is its steepest seven-day point drop ever. Its seven-day percentage decline of 20.9 percent is the largest since the seven-day plunge ending Oct. 26, 1987, when the Dow lost 23.8 percent. That sell-off included Black Monday, the Oct. 19, 1987 market crash that saw the Dow fall nearly 23 percent in a single day.

Broader stock indicators also tumbled Thursday. The S&P 500 fell 75.02, or 7.6 percent, to 909.92, while the Nasdaq composite index fell 95.21, or 5.5 percent, to 1,645.12.

The Russell 2000 index of smaller companies fell 47.37, or 8.7 percent, to 499.20.

A wave of fear about the economy sent stocks lower in the final two hours of trading after a volatile morning in which major indicators like the Dow and the S&P 500 index bobbed up and down. The Nasdaq, with a bevy of tech stocks, spent much of the session higher but eventually declined as the sell-off intensified. Still, its losses were less severe because of the relatively modest drops in names like Intel Corp. and Microsoft Corp.

On the New York Stock Exchange, declining issues came to nearly 3,000, while fewer than 250 advanced.

The sluggishness in the credit markets that triggered much of the heavy selling in markets around the world since mid-September appeared little changed Thursday following days of efforts by the Federal Reserve and other central banks to resuscitate lending.

Libor, the bank lending benchmark, for three-month dollar loans rose to 4.75 percent from 4.52 percent on Wednesday. That signals that banks remain hesitant to make loans for fear they won't be paid back.

The Fed and other leading central banks this week lowered key interest rates to help unclog the credit markets and promote lending to help the global economy. While a rate cut can take up to a year to work its way through the economy, the move was aimed as a boost to investor sentiment.

"We're stuck in a morass and I think it's going to take quite some time to come out of it," said Stephen Carl, principal and head of equity trading at The Williams Capital Group.

Demand remained high for short-term Treasurys, a refuge for investors willing to trade modest returns to protect their money. The yield on the three-month Treasury bill, which moves opposite its price, fell to 0.58 percent from 0.63 percent late Wednesday. Longer-term debt prices fell, with the yield on the 10-year note rising to 3.79 percent from 3.65 percent late Wednesday.

Investors across markets were mulling a plan being considered by the Bush administration to invest in hobbled U.S. banks as a way to stabilize the financial sector. The $700 billion rescue package signed into law last week allows the Treasury Department to inject fresh capital into financial institutions and obtain ownership shares in return.

Britain rolled out a similar plan, though no U.K. bank has received any investments. In Iceland, the government now has control of the country's three major banks as it struggles to contain the troubles there.

Wall Street is also looking for any effects of short selling now that a three-week ban imposed by regulators has expired. Short selling is a technique in which investors borrow shares in a company from a broker and sell them, hoping to buy them back later at a lower price. Essentially, it's a bet that a stock's price will fall. Short sellers can lose money if they have to repurchase the stock after it has risen.

Some analysts believe the unprecedented ban on short selling -- an effort to bolster investor confidence -- did more harm than good at a time of historic market volatility. They contend that short sellers help the market rally by covering their bets and creating demand for stocks.

"I think the market's way oversold. But I can't stand in the way of this falling knife -- I'd get sliced open," said Phil Orlando, chief equity market strategist at Federated Investors. "Investors are just saying, get me out at any price."

He also said that with the short-selling rule back in play, hedge funds might be shorting again to make up for their forced liquidations.

Energy names were among the biggest decliners as the price of oil fell and investors worried about a slowing economy. Exxon Mobil Corp. fell $9, or 12 percent, to $68, while Chevron Corp. fell $9.10, or 12 percent, to $64.

Light, sweet crude fell $1.81 to settle at $86.62 a barrel on the New York Mercantile Exchange, the lowest closing price since October last year.

Health insurer WellPoint Inc. fell $3.94, or 9.7 percent, to $36.50, while insurer and investment manager Lincoln National Corp. fell $9.66, or 35 percent, to $18.31.

The tech sector saw less selling than other parts of the market after IBM Corp. affirmed its forecast.

IBM fell $1.55, or 1.7 percent, to $89. Meanwhile, Intel fell 65 cents, or 4 percent, to $15.60 and Microsoft fell 71 cents, or 3.1 percent, to $22.30.

Consolidated trading volume on the NYSE came to 8.14 billion consolidated shares compared with 8.54 billion traded Wednesday.

In Asia, Japan's Nikkei 225 closed down 0.50 percent while the Hang Seng added 3.31 percent. In Europe, Britain's FTSE-100 fell 1.21 percent, Germany's DAX fell 2.53 percent, and France's CAC-40 declined 1.55 percent.