Table Set For 'Devastating
Deflationary Collapse'

By Jay Taylor
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 not working.
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, 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 to worry.
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 wealth.
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 scenario.
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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