The Turning Dollar Tide

Gold is and has always been a macro chip in the world of politics and finance. The bulk has always been in the hand of only a few selected players with the power to influence the market. Gold has never reacted to short term or minor trends. But it can react violently during political or financial upheaval.

When playing gold it should be in the knowledge that one is speculating against the big shots and that the game is probably fixed. But at certain times even the big shots will have to render account to the still mightier forces of natural adjustment. Consequently, the demise of the London Gold Pool and gold surge in January 1980 paid off handsomely for investors with insight and stamina. Today we might not be far away from a similar opportunity.

It needed the catastrophic collapse of the share markets in 1929 and subsequent world wide economic calamity to see gold revalued to U$ 35 under Franklin Delanor Roosevelt. And it was de Gaulle in the late sixties with his relentless pressure to get gold back to Europe to serve as the financial cornerstone for a future United Europe ( under the leadership of France of course) that forced the closure of the gold window, and without warning toppled the London Gold Pool. I still remember the headline of the London Financial Times the next day: "It could not have happened"!

So for all those waiting today for a gold price surge, do keep in mind that what is needed for gold to rise are underlying negative financials, topped off with a major political event or financial upheaval. Currently, the underlying negative financials are indeed in place. Moreover, the situation is exacerbated by an irreversibly rising oil price. What is still missing is a major event. Flare up in the Middle East? A political assassination? A Wall Street crash? A debt moratorium? A putsch in Saudi Arabia? A sudden collapse of the dollar? It is also quite possible that the financial paper credit bubble is already so near bursting, that it does not need a major event anymore for a crisis to erupt… just one little prick might do.

In 1979/1980 gold hardly reacted to the oil crisis. Neither did gold react to the Teheran hostage crisis. Neither to an escalating capital outflow from the USA. Or the weak Carter Presidency. Gold needed the Russian invasion of Afghanistan to break the camels back and finally explode to over U$ 800/oz in January 1980. In November 1979 not a single chart guru predicted a gold surge, not even a moderate rise was foreseen. Till the Russian invasion of Afghanistan, the opinion was negative for gold. If the oil crisis, the hostage crisis, the dollar hemorrhaging could not push gold higher, what pray tell could? A Parisian taxi driver summed it up in a nutshell: l'or, c'est fautu!

From 1945 till 1999 America poured billions of dollars out into the eager lap of the world. The dollar became the world's reserve currency, trading currency and investment vehicle. Everybody wanted to hold dollars.

The dollar reigned supreme. Any upcoming competition to the dollar was nipped in the bud. The supreme Pound Sterling before World War II lost its status as reserve currency. Gold was pushed aside as unpractical for modern finance, a barbaric relic. When the yen became too powerful, the carpet was pulled out from under Japan. Only the West European currencies managed to grow stronger against the dollar over the years. But the dollar does not tolerate competition for long. When the Euro was launched, I wrote in "Gold in Macro Perspective": "Now an attack on the Euro must be in the cards…" And so it happened that shortly after the launch the Euro began, it began to fall vis-ŕ-vis the greenback.

I am convinced that the same paper policies and tactics that keep the yen, oil and gold from appreciating against the dollar are also being used to bash the Euro: calculated, leveraged derivatives, consistent naked shorting accompanied by subtle propaganda! It is the war against competition to the dollar which guides New York. Everything turns around the almighty dollar: the power of Wall Street, the bond and the stock markets, the commodity markets, banking, insurance, the mortgage markets and the power of the USA itself! If the dollar collapses, so will the superpower status of the USA.

It is not so much the image of gold as an inflation indicator which worries the FED, it is the menace of gold competing with the almighty dollar which has put gold in the doghouse. Whereas heretofore nations conquered with armies and navies, the USA has uses the greenback in conjunction withi its supreme nuclear power status to achieve undisputed world hegemony. But at a cost:

Over 35% of US government financial paper has ended up in foreign hands. There are more dollar bills in circulation outside than inside the USA. (over $400 billion). Foreigners are holding far more US financial assets than the Americans possess overseas assets. These foreign owned assets present a potential I.O.U (I Owe You) claim against the USA.

The American balance of payment deficit, which is made up out of the trade account and the investment account could till recently still always be offset by official financing, meaning foreign central banks adding dollars to their reserves. This may not longer be the case.

The dollar tide is turning -

-The US trade and the US investment account together have turned decisively and dangerously negative. The American trade deficit for year 2000 is expected to exceed U$ 400 billion.
-The overvalued US dollar and the US stock markets are no longer attractive to foreigners.
-A resilient Japanese economy needs its money at home, and is ready to convert its huge dollar holdings back into yen,
-Japan, China and the Europe have dollars coming out of their ears.
-Africa and countries like Indonesia and the Philippines are now too poor to absorb dollars.
- Climbing oil prices do not only mean further deterioration of the US trade balance, they also mean that: Russia as a major oil and gas exporter is regaining its financial and political clout and independence. IMF credits are not that important any longer. Putin has brought a new found stability into Russian affairs and it can be expected that a major part of the flight capital which left the country after collapse of communism will now begin flowing back to finance the restructuring of Mother Russia.

The only value fiat paper currency has is the degree of political power behind it.

Defiance of the United States is rearing its head once again. The USA is vulnerable during an electoral transit period with politics tuned inward and skeletons coming out of the closet. The Middle East peace talks collapsed. No major American diplomatic successes of late. And the latest missile defense test a flop. There is Yassir Arafat's decision to proclaim a Palestinian State on September 13th, Saudi Arabia's declaration that Jerusalem is the capital of Palestine, The sudden and unexpected rapprochement of the two Koreas, with the likelihood of the USA going to lose its strategic outpost on the Asian Continent The build-up in the Chinese propaganda war against Taiwan, Opec's rediscovered self confidence, saying yes and doing no, The new political direction Venezuela has taken under Chavez, The diminishing influence of the USA in settling the Kasmir conflict, Japan's Central Bank's decision to begin raising interest rates, Japanese pressure to retire the US military from Okinawa, The growing trade disputes between the EU and the USA, The pressure to pull the US military out of the Balkans, Puerto Rico's defiance of the US bombing range.

The present western financial structure with the dollar as its central reserve currency can only maintain itself when the dollar keeps on flowing outward. The moment the dollar flow turns into reverse the whole western capitalistic house of cards will fall apart.

The Federal Reserve is desperately trying to keep dollars from returning. Normally, this would be done by keeping the dollar strong and maintaining dollar investment attractive by mopping up returning ex-pat dollars, and by reducing the supply of dollars by selling government bonds and US Treasuries with competitive higher interest rates. Under the present circumstances, however, hiking interest rates and reducing the supply of dollars would be a recipe for disaster. These conditions would push the economy immediately into recession -- and it would reduce the government's income from taxation drastically. It would cause a market crash in an excessively over-inflated stock market. It would aggravate the plight of debtors, and most of all the US government's own burden of trillions in official debt outstanding. It would paint the budget bright red. Foreign investors would see their US stocks and bonds turn south -- causing them to dump on the market. So in the end, the dollar would collapse in any case.

The US government has worked itself into a catch 22 position. The old financial policies do not work any longer. But the same as "modern accounting" has done wonders for business, as Silicon Valley can testify, so why could "modern accounting" not be applied by the government itself? And here Robert Rubin must have come in.

What is needed is plenty of money and credit to keep the economy and stock markets going, to let business and people make (paper) profits, ( to keep tax revenues coming in for the hungry politicians), and to keep the consumer happy in his goldilocks fools paradise. So better keep interest rates low and encourage the banks to proceed blowing bubbles of credit out of the blue and through off-balance sheet financing. But if the banks are allowed to make use of off-balance sheet financing, why not the Treasury? Why not bring in the ESF, the Exchange Stabilization Fund, Social Security and Medicare, Fannie May and so on? When banks can create credit out of nothing, why not the Treasury? If the financial establishment does naked shorting, that means without collateral, why not the Treasury on the sly? Could it be that the Treasury might already be involved in other additional credit creating transactions besides gold leasing? Should we not better begin adding the respective new credit volume created by the Treasury to the FED's M3 data in order to get the real picture of money and credit supply?

With what money is the Treasury going to buy back the long term bonds? There is no budget surplus! The official US National Debt published by the FED Reserve of St.Louis for the years ended September 1997, 1998 and 1999 show deficits of 131 billion dollars for the year ended 1998 and 130 billion dollars for the year ended 1999! With a budget deficit and no surplus, the Treasury will have to finance and the deficit and the long bond buy-back. Is the Treasury planning to finance the double deficit with the emission of shorter term debt paper via the FED as would be proper, or is the Treasury now resorting to creative bookkeeping and off balance sheet financing through the ESF, Fannie May and similar? Has the Treasury entered into clandestine competition with the FED in bringing money in the form of credit into circulation? John Kennedy signed a decree on the 4 June 1963 to have the Treasury issue currency directly, bypassing the FED. Shortly afterwards on the 22nd November Kennedy was killed and ten days later Johnson annulled the decree. Where Kennedy did not to succeed (or was not allowed), Robert Rubin did.

As per Oswald Spengler, the historian who wrote the "Decline of the West": The West, after having seen Finance taking over from Economics after the Second World War, has now arrived at the stage where brute Political Power is taking over from Finance.

By buying back the 30-year bonds, the Treasury has robbed the world of a long established benchmark. Its unexpected action has not only thrown foreign investors and Central Banks into confusion, it must have woken up a lot of suspicion at the same time. When in the business world a company changes over from long term to short term financing something is usually drastically wrong. The latest Treasury action might imply the same! Bluff the world into believing that there is a budget surplus and that everything is just great, no inflation and a strong economy , a new economy stock market. Tell them that there is now so much leeway that the government can buy its long bonds back. Should a prudent Treasury not have started by redeeming its short term debts first? It must have been the fear of Central Banks and foreign investors suddenly dumping the US long bonds they are holding that guided the Treasury in its action! It is Politics from now on. The long bond liquidation is in all probability only the beginning of a series of stop gap measures to keep the markets under control in never never land.

In 1993 I was a lone voice warning of a Weimar Republic type dollar hyper-inflation rearing its head inside the ballooning credit expansion. Today I am not alone any more. It is the analysis of the psychology of the nation and government one has to take into account. A gut feeling of how politicians and people will react to happenings. Its not so much statistics and data which should be looked at in evaluating future inflation, it its more the human factor.

In 1922 Weimar Germany began monetizing, read redeeming, its burdening government debt of over 53 billion mark against the ever increasing emission of currency. It ended in the worst hyper-inflation the world has ever seen. With the looks of the US Treasury now bypassing the FED in redeeming US government debt we might be well on our way.

Dollar and yen inflation have become unavoidable. Euro inflation looks still less likely at present. In how far dollar inflation will turn into a light or severe hyper-inflation is still a question. That depends on the people in power. Will they have stamina or be corruptible? Will they be able to make painful decisions?

A Wall Street crash is not a must. There will always be value left in basic enterprise. A Nasdaq crash however is a given. The economy might not collapse that severely. Hyper inflation might not immediately follow on the heels of inflation. Brazil is the prime example that inflation can go on for years on end, even for decades. Brazil went from the reis to the mil-reis, to the cruzeiro, to the novo cruzeiro ( 1000 old cruzeiros ) and has now made a temporary halt with the "real".

The up-coming battle will be between government paper and intrinsic value. The main contenders are the dollar and dollar denominated bonds against gold and silver. It will be a battle between Big Brother and personal freedom. Shares might suffer temporarily but will not be in the forefront.

Politics and politicians need money and lots of it. Whatever the consequences, the economy has to keep growing so business and people keep making money to provide tax income for the government. The stock market is not allowed to collapse. Tax income from stock market paper profits in 1999 alone accounted for more than 35 % of the US government's income. Interest rates have to stay down to keep a lid on the US government's own interest payments due on the trillions of its outstanding debt. Interest rates must remain low in order not to scare foreign CBs into dumping their US bond holdings. Interest rates have to stay down to provide cheap credit for business to keep the GNP wheel turning. But will the CBs keep holding dollars anyhow? And is business using the mushrooming credit available to finance production and expansion or is business using the easy credit for unproductive financial dealings? Where would General Electric's profits be without its financial services?

With Politics now imposing on the (mis)management of the currency, financial corruption has made its entry. Data are being manipulated and can not be trusted any longer for statistical purposes. Shady dealings and cover-ups are going on behind the scenes, especially in the gold markets. Where did all the gold exported from the US in the final quarter of 1999 end up? And where did all that gold come from in the first place? The numbers published by the World Gold Council not only show discrepancies on the supply side, the destination numbers for gold do not add up either. Has there been one specific destination for the exceptionally high gold shipments at the end of last year? Could the murder only a few weeks later of Edmond Safra, director of the Republic Bank, the most prominent New York bullion bank, be related to such specific shipment?

Markets are not working any longer as usual. Interventions, manipulations are blatant. As finance is becoming more and more opaque and murky, there must be many minor sharks taking advantage. Big sharks too. But big sharks hunt alone, they seldom cooperate. At the very top there is never much collusion, nobody trusts one another. There might be a short term convergence, but then for single deals only. The pattern behind today's happenings does not look like the actions of an organized cabal. Sooner one single strong individual, "He" with "They", his vassals, scheming in darkness. "He", one man, who has the power to get presidents elected, to call the G8 together on short notice, topple governments, control the media, the people and governments. Where have all the FBI files on Clinton gone?

We are now just waiting for the last straw to break the camel's back. And when the crisis breaks, we can expect autocratic measures to stem the tide. The temporary closure of markets and banks, foreign exchange controls, price controls, renewed gold confiscation and gold mining companies forced to sell their production to the government. There will be debt moratoriums, force majeure, bank failures, options and futures not being honored, brokers might not be able to produce your share certificates having sold them "naked" several times over! By the time foreigners are able to salvage what is left of their US investments, the dollar itself will have plummeted.

Forget about dollars, Euros yen or whatever, just "think in ounces"

Hans Schicht
Chapala, 28 August 2000