- As one who lived through and watched carefully the breakdown
of Bretton Woods, I can't help but feel we may be very close to a major
breakdown in the existing floating rate currency system, which is clearly
- The U.S. has managed to keep the U.S. economy from the
recession/depression it needed and deserved following the bursting of the
tech bubble in 2000. It has done so by blowing one bubble after another,
with the latest and most absurdly overvalued bubble of all being the housing
bubble. And certainly war expenditures have helped keep the demand side
of the economy alive, even as consumers have been spending themselves into
bankruptcy at a record pace.
- Equally or perhaps even more responsible for avoiding
an economic catastrophe has been the willingness of foreigners to buy U.S.
Treasuries. That may now be coming to an end, based on rumors from China
and an increasingly arrogant Chinese government, which is now lecturing
the United States to put its economic house in order. And there is no doubt
in my mind that the re-election of President Bush is also leading to geopolitical
hostility that is resulting in less willingness on the part of foreign
countries to support the dollar, especially when the very core of the U.S.
economy is rotting away. If the U.S. military exercise in the Middle East
is in large part undertaken to ensure dominance in the most prolific oil
producing regions in the world, and if China and Asia in general covet
those supplies of oil, why would they continue to support U.S. military
endeavors by collectively spending $3 billion of their savings every day?
By merely decreasing the purchase of U.S. securities, foreign nations are
in a position to cause our heavily indebted nation to "cry uncle"
in more ways than one.
- In my view, the table is set for a devastating deflationary
collapse, notwithstanding all efforts on the part of policy makers to (a)
inflate, and (b) convince you that they can always do so. I keep remembering
the lecture I was given in the late 1960s when I took economics 101. We
were told that during the 1930s, savings was bad for the country because
while it may have been good for the individual, savings collectively reduced
demand, which in turn caused shops to close, people to get laid off, and
incomes to decline, leading to still more savings and thus a spiraling
decline in the economy. The notion was that if policy makers could only
keep people thinking positively, so that they continued to spend, there
was no need to face recessions and depressions.
- And so we have bubble upon bubble and CNBC spouting encouragement
every day that everything is okay. "Don't worry, be happy," we
are told. And so we have. But even Lord Keynes knew that in the long run
we are all dead. Keynes has long been dead. It is looking increasingly
like our turn is fast approaching, because his policies and those of the
monetarists, which are aimed at keeping the natural cleansing forces of
free market economics from working, are reaching a breaking point where
the global economy is teetering on the brink of an ominous breakdown.
- Writing the "International Perspective," Marshall
Auerback, as always, provides great insights into the underlying dynamics
that now threaten international monetary stability. In his column dated
November 23, 2004 (which I encourage you to read at www.prudentbear.com),
he talks of how the floating rate system and globalization is not only
not working, but is leading to increased global imbalances. Here are some
of the points Marshall made in this excellent essay:
- The Chinese are refusing to allow their currency to float.
Marshall quoted John Brimelow, who recently stated, "China has been
allowed to operate on a covert Bretton Woods system since 1993. By keeping
its currency artificially low, it has been practicing 'exchange rate mercantilism'
-- concentrating productive capacity in its own hands to the detriment
of the world economy (and ultimately its own consumers)." In other
words, by not allowing its currency to float, China, which is quickly becoming
one of the most important economic powers in the world, is not playing
by the same set of rules that the rest of the world is forced to play under.
Why this is taking place and why the U.S. and others have not protested
against this unfair behavior is explained by various political interests
of various parties, as are spelled out in Marshall's essay for those of
you who are interested.
- The result of China's failure to allow its currency to
float is that it retains an unfair trading advantage in the rest of the
world. As conditions in the U.S. economy deteriorate, in part as a result
of that unfair advantage plus an unwillingness of America to stop living
beyond its means, Europe is being forced to bear the brunt of the U.S.
dollar currency devaluation. This is leading to a slow down in the European
economies and potentially growing pressures for protectionism.
- Because the dollar's decline has come against the euro
rather than the Chinese currency, the decline in the dollar has not only
failed to curb the U.S. trade deficit but it has actually grown worse over
time. In other words, because China is not playing by the rules, the floating
rate system on a global basis is breaking down. (The issue of an unfair
trade advantage was in fact was first brought to your editor's attention
by my friend Dr. John Whitney, CEO of Itronics, who noticed the unfair
advantage Asian imports were having around 2000 in the California agricultural
markets as well as in the mining sector. When I visited Marshall Auerback
at his home in England in 2001, he wasn't convinced it was a problem then.
But now he clearly believes it is.)
- U.S. policy makers chose to use a beggar-thy-neighbor
approach to try to fix the U.S. trade imbalance, even though this process
has proven to be totally ineffective thus far. Both the U.S. Treasury and
the Fed (Greenspan) are pushing for continued fiscal stimulus and dollar
devaluation as a means of sustaining balanced economic growth. Marshall
points out that unless the U.S. trade deficit declines faster than the
U.S. federal deficit, the U.S. private sector will go even deeper into
an already over indebted condition, which most certainly puts the U.S.
economy at still higher risk.
- China is showing no signs that it will begin playing
by the rules anytime soon. A weakening of the dollar vis-a-vis the euro
is no solution. And thus, the stage is set for a continuing worsening of
the trade imbalances around the world with the consequences of increasing
joblessness and lower incomes in the U.S. and some of the same in Europe.
This kind of impasse is like a game of chicken for policy makers. Neither
party is willing to back down from the current modus operandi. This suggests
there is no way for policy makers to alter course and thus avoid a devastating
economic and financial market collision. Regarding growing weakness in
the U.S. economy, Marshall stated, "Perhaps American consumers have
finally hit a wall in relation to debt growth. In addition, the Fed has
hitherto been relying on capital spending to take over from consumer spending
to carry economic momentum into 2005. Given that businesses also appear
to be determined to retain profits, rather than spend them, and given the
Bush governmentís commitment to halve government expenditures over
the next four years (reiterated this past weekend at the G-20 summit by
Treasury Secretary John Snow), this leaves a major reversal of the trade
deficit as the only means possible of averting complete economic meltdown
in the US. Which in turn means a continued sharply falling dollar."
- You get the sense that the world is an increasingly hostile
place for America. China is refusing to play by the rules of fair international
trade. Russia is telling the West to stay out of a contentious election
in the Ukraine that could boil over into a civil war. The one billion strong
Islamic world is increasingly hostile (I think for some good reasons) toward
the U.S. And Europe is not very happy about our military adventures in
the Middle East, and they are most certainly not happy about our policy
of dollar devaluation.
- But alas, perhaps the U.S. no longer has any politically
easy answers. The Clinton Administration apparently implemented a "Strong
Dollar" policy by dishoarding gold or arranging with other governments
to do so. As the gold price declined, folks like Larry Kudlow could chortle
how the U.S. should print more dollars, which in turn helped drive more
economic activity (as well as mal investment). Dishoarding gold or getting
other governments to do so created the illusion of a "strong dollar,"
which helped create the first major bubble in stocks that culminated in
early 2000. GATA calculates that roughly one half of the U.S. gold is gone.
- For a long time, this strong dollar policy of the Clinton
Administration pleased Bob Rubin and his crony capitalists in the banking
industry because it sucked in foreign capital and allowed easy money policies
that enabled them to get rich at the expense of other sectors in our economy.
And that policy played a large role in creating an explosive equity and
bond bull market in the 1990s. The Clinton Administration could lay claim
to a budget surplus as taxes from funny money equity gains poured into
the Treasury as around 50% of Americans became invested in stocks that
were posting double-digit gains annually. Life was grand. We were told
the old laws of economics no longer applied. All we superior Americans
had to do was "talk up the economy," and there would be no reason
- But something has happened with that ill-advised policy
of dishoarding gold to implement a strong dollar. Recently, some central
banks, especially those who are especially annoyed if not outright angered
by the Anglo-American controlled global monetary system, have begun to
defy the U.S. controlled IMF by buying gold as well as seeking euros as
a reserve currency at the expense of dollars. Argentina comes to mind for
their purchase of gold. China and Russia may well be doing the same. Vietnam
has said it would use gold more and the dollar less as a reserve currency.
And as the basic fundamentals of the U.S. economy and thus the U.S. dollar
deteriorate, even our anti-gold, pro-theft oriented paper printing establishment
may be having second thoughts about dumping gold to save the currency.
Indeed in the end, the opposite will be true. Those countries with the
gold will have the wealth, because throughout history, gold always follows
- The current game of chicken and the pressures of political
expediency that keep policy makers from returning to a free market approach
in international finance are, I believe, leading toward a deflationary
collapse. Just as in the 1930s, we see countries "fighting" each
other for trade by trashing their currency. This had been going on for
quite a while during the 1990s with China leading the way. Until the early
years of the first Bush Administration, the financial sector, which likes
a strong dollar, held the upper hand politically. But because of growing
political pressures in the U.S. for job creation, and perhaps also because
of an absence of gold, or simply some recent insights gained about the
foolishness of dishoarding gold, the U.S. has obviously now joined the
fray of beggar-thy-neighbor currency devaluation driven economies. This,
I believe, is a very frightening prospect and one that may well be leading
us ever closer to the freezing point in Ian Gordon's Kondratieff winter
- I say that because the forces of competitive devaluation
combined with the forces of globalization are deflationary. And, with the
U.S. now joining in that game rather than being the buyer of last resort
for the world, those deflationary forces would appear to be intensifying.
Again quoting from Mr. Auerback's above-noted essay, "In reality,
the national ambitions and competitive energies of globalization, at least
as currently practiced, persist in developing new productive capacity--more
factories--faster than they generate rising incomes and adequate demand
to absorb the surplus of goods. This leads inevitably to falling prices
and stiffer pressures for cost reductions. The convenient remedy--somebody,
somewhere has to shut down factories--has typically begun by closing America's
and moving its high-wage production offshore for cheaper labour. The resultant
political backlash has manifested itself through ongoing complaints about
"offshoring" during the most recent Presidential campaign.
- And now it is manifesting itself by the U.S. piling on
the competitive devaluation race, which is clear from recent statements
made by Alan Greenspan and U.S. Treasury Secretary Snow. And those statements,
combined with the Bush policies, have intensified the plunge in the dollar,
threatening the stability of the global financial system. As the chart
below shows, the dollar index is nearing a multi-year support level at
0.80. On Friday the dollar index closed at 0.8181, so we are getting very
close to a potential free fall. Roger Wiegand tells me the next support
is at 0.7723, then 0.7300. He sees 0.5100 as a "maximum low."
- Is a Continued Decline of The Dollar A Slam Dunk?
- As we approach that all important 0.80 dollar index support
level, and while everyone is betting 100% on a relentless fall in the dollar,
it might be smart to ask if the U.S. can be successful in devaluing the
dollar further at this time. Bob Hoye, for one, believes it may not be.
In his latest "Pivotal Events," he makes a good point when he
observes that U.S. policy makers are behaving in a very unusual manner.
They are actually encouraging everyone to bet against the dollar either
by their statements or by their omissions.
- Mr. Hoye stated, "Thus our general observation that
'the world is long inflation and short U.S. dollars.' Speculative booms
and busts are nothing new, but what is rare is the dedication of today's
policymakers in promoting speculation against the deliberately depreciated
dollar. There hasn't been anything to this degree since England's South
Sea Bubble or France's Mississippi Bubble in 1720. Yes the tech bubble
in 2000 was wild, but the street and policy makers had little doubt that
the boom could be sustained.
- "Now, the desperation to keep the depreciation and
the boom in whatever-is-hot is becoming very intense".
- In other words, the Fed and other policy makers are continuing
to fight deflation. What is there after the housing boom to keep the party
going? The consumer may still be spending, but one wonders how much longer
it can go on, especially when you read articles like the front page story
in the New York Times on November 21, about how banks are suddenly doubling
interest rates on credit cards and how that is quickly throwing many overly-indebted
borrowers into greater debt.
- With the dollar approaching that $0.80 level, we may
soon know whether the deflationary views of Bob Hoye (who Ian Gordon and
your editor agree with are correct, or whether the wider held inflationary
views prevail. If the dollar breaks through support and falls dramatically
lower, what happens then? Do foreign creditors dump the dollar, forcing
interest rates to rise dramatically and sending the U.S. housing industry
and all of America into bankruptcy?
- Or, as Bob Hoye suggests, will a dollar-short world suddenly
began to liquidate "stuff" in order to scramble for dollars to
make good on their huge dollar debt? Hoye maintains that after a major
bubble like we have experienced, the senior currency strengthens, not weakens.
He also says history supports a correction in the equity markets in the
third year following the bursting of the bubble, as we experienced this
year. Of course, all that is made more difficult in that we have now had
bubbles manufactured to bail out other bubbles, the latest being the housing
bubble. Can another bubble be found to keep the party going when Americans
are so extremely over indebted and when foreigners see fewer and fewer
legitimate reasons to invest in America?
- Ultimately, I am betting deflation wins, and I believe
that day is much, much closer than most people think. That is not to say
we don't want to keep our eyes open with respect to inflationary forces.
But ultimately, I remain convinced this major 70+ year Kondratieff cycle
will end as they all do, with a devastating repudiation of debt that leaves
cash and gold as the only stores of value as the price of virtually everything
else collapses in a rush for liquidity via the dynamics of John Exter's
inverted pyramid. Of course, as we discuss elsewhere here, gold is actually
the best asset to own during inflationary and deflationary periods of time.
- We believe 2005 will bring a recognition in the markets
that the primary bear market trend in equities and a primary bull market
trend in gold are both very much in their early stages. When investors
begin to realize that the old equity highs registered in 2000 will not
happen any time soon, we could see a mass exodus out of stocks which by
the way, insiders are increasingly doing as the latest data from the Wall
Street Journal shows.
- Since we began tallying these statistics on October 10,
during this six-week period we have seen $174.5 million of stock purchases
by insiders, and stock sales of $7.5 billion, for a ratio of $42.49 of
sales for every $1.00 of purchases. With the post-election rally, we have
seen this trend of selling accelerate. Last week, as the chart above shows,
$77 of sales was registered for every $1 of purchases.
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