LACK OF PARALLEL TO 1970 DECADE
Jim Willie CB September 21, 2004
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Much has been written about strong parallels, similar conditions from rising energy costs, to the 1970 decade. In 1973 OPEC delivered the world economy a shock, in particular to the USA from a targeted oil embargo. The entire US Economy was obliged to adjust to systemically higher energy costs. No mistake should be made. We have seen a 35% increase in crude oil costs and a 30% rise in gasoline costs in the last year. Home heating costs have risen roughly 100% since 2000. Electricity costs are up in a slow steady climb. The effects have been widespread to various industrial sectors. Fertilizer costs, dairy costs, and a wide assortment from plastics to glassware to lubricants to synthetic fibers have all been elevated in price. This time around, enormous increases in material costs have been suffered, which did not occur in the previous cycle. Many analysts have submitted that a strong parallel exists between today and a longsuffering period 30 years ago. They point to a strong correlation between crude oil and gold. They forecast an inevitable cost push within the economy whereby price inflation will be stirred and shaken once again. While many similarities and parallels exist, some distinct differences are worth mention, and they are doozies. Links to the 1970 decade are missing in innumerable critical respects. We are very far from the shadow of that distant decade.
Economists surely deserve a failing grade in the mainstream, where public policy and legislative policy dominate. The gold community has a better comprehension of economics, the role of money and debt. However, when it comes to claiming parallels exist from the 1970 decade to today, gold bug economists fall short and exhibit serious lack of depth. Austrians continue to warn about secular deflation, while gold bugs maintain their knee-jerk simplistic comparisons to the last gold spike events. Gold is not likely to show a major series of spikes. Instead, gold will in all likelihood see a long and nearly endless sequence of stuttered, jerky, and confusing jumps in price, complete with regular setbacks. Talk about a wall of worry! Secular deflation provides an avalanche which should petrify! Robert Prechter has often talked of gold falling to $200 per ounce. Gold has gone in the opposite direction, and will continue to do so. On its upward course, it will have to overcome wave after wave of powerful deflationary forces. Gold will prevail, but with much more stiff resistance than the gold community expects. They point to the end result, with seemingly poor appreciation for the rocky road to higher ground.
The 1970 decade marked the climax of the Kondratiev Summer. The entire process of premeditated inflation was easy to execute along the entire chain characterized by the multiplier effect. The banking system eased restrictions and released money into the system, which quickly offset the elevated costs with higher prices and higher wages. In the 2000 present "naught" decade, we are in the clutches of the Kondratiev Winter, the wrong side of the supercycle. Debts have begun to default, high profile failures have been witnessed, and a stock crash took place. The banking system once again eased and released money on a much greater scale. To date, wages have lagged far behind rising costs. The current climate is as different as summer and winter. In the 1970's, Paul Volcker was a paragon of wisdom. Contrasted to him, the current Chairman Greenspan is the poster boy of reckless inflation, the chief apologist of failed monetary policy, and a second-rate economist who perpetuates one myth after another to cover his failures. His refusal to permit natural recession has brought the world economy to the brink.
NO "COST PUSH"
The entire US Economy has been obliged to adjust to systemically higher energy costs. While many similarities and parallels exist, some distinct differences are worth mention. China was not a factor from 1975 to 1980, the epoch of time when price inflation hurtled out of control. Chinese imports flood into our economy, not just with Wal-Mart, but also with Circuit City, Best Buy, CompUSA, Staples, Office Depot, Home Depot, and Lowe's. Appliance makers cannot compete any longer with China, as Maytag and others leave our country. The influx totally eradicates pricing power. Outsourcing is a constant threat to the labor market. Our economy has a 60% weight from its service sector, under extreme pressure. Wages cannot rise to counter a higher cost of living. Without pricing power, corporate profitability is limited, a necessary ingredient to both hiring and granting wage hikes. Labor unions now negotiate plant closures, not wage and benefit proposals. Asian imports keep a ceiling on the entire price structure in the US Economy, in a manner totally dissimilar to the era 30 years ago.
China was largely asleep from 1975 to 1980, when the USA was wrestling free of a painful and costly Viet Nam War. The era of Chou Enlai and Deng Shaopin are long gone, sleepy days for the now emerging powerhouse. In fact, Japanese and other Pacific Rim offshore manufacturing sites had only begun to be exploited by US firms at that time. Intel almost died in the early 1980 decade from Asian competition, and is now a leader leader which has exploited Asian strength. While the US Economy was being successfully reflated over those several years following the OPEC energy shock late in the 1970 decade, the movement of manufacturing offshore accelerated, Asian dominance grew in the sector, and capital left the USA on a massive scale. The missing piece was that the US Economy had little if any "cost push" resistance after a couple years, UNLIKE NOW. Back then, the Fed reflated, prices rose, but wages rose in almost lockstep. The US Economy cannot execute the typical cost push this time around. In my personal experience, wages seemed to rise at 8-12% per year almost automatically. It was assumed that wages would rise to respond to the increase in the cost of living. In fact, many firms and institutions used to distinguish between the cost of living portion of the wage hike and the merit portion. My label came to be "egalitarian" raises, in keeping with socialist policy objectives, since even poor performers were given generous raises. Corporate expansion was robust. New hires were brisk. Technology industries from computerdom to the military complex bid for new workers. In some cases, starting salaries for fresh graduates exceeded those of three-year veterans in the work force.
The US Economy cannot execute a similar cost nowadays. First of all, Asian imported finished products flood our shores. A ceiling is kept in place atop the price structure in the real economy, where things are made and serviced. So US firms do not command any pricing power whatsoever, at a time when their production costs are rising fast, and their labor costs are rising fast. Older firms face an additional pain, from pensioner health care costs. Without pricing power, corporate profitability is not there, a certain necessary ingredient to both hiring and granting wage hikes. Second, and painfully, Asian outsourcing accelerates. Domestic firms respond to rising costs by turning to foreign sources, sometimes with the only alternative as shuttered operations, closure.
Manufacturing does not get much attention, but the offshoring movement has not stopped. Of more immediate concern is the massive movement in service outsourcing to Asia. From lower level skilled jobs to higher level skilled jobs, service outsourcing to Asia has been pursued by US firms in order to lower their costs. Whether the strategy proves successful remains to be seen, as quality output must be delivered. That will be measured in the coming quarters and years. The consequence of the service job dispatch to Asia has been a second powerful force used to keep wages down in the United States. A collection of dynamics was absent 30 years ago. Broadband speeds, widespread computer connectivity, and proficient skilled Asian work forces are strong at work now. Both China and India have grown in population by a greater extent since the initial OPEC oil shock, than the current entire US population. More Chinese exist today with the names of Chen, Cheng, Chang, Chuang, and Tsang than there are people in the USA, over 300 million in number!
The cost push (both production & household) is interrupted before it reaches wages and job growth. This is the singlemost disappointment for the Fed's Reflation initiative. The system cannot engineer rising wages in the age of globalization, since Asia interrupts the process. This is not your father's typical business cycle. The global village includes Asia. Efforts to block Asia will not emerge until a trade war erupts. That is coming like night follows day. Analysts and pundits who pound the table, including gold bugs, overlook this lack of parallel to the 1970 decade. It stands out like a missing pair of front teeth in a movie star. Numerous obstacles will provide interference for the relentless unstoppable gold bull market underway, factors absent decades ago.
Gold bugs assume inflation's impact on commodities on the cost side must cross the great barrier and reach prices and wages. They believe eventually costs will be passed along in final product prices, rather than businesses to endure widespread failure. They regard rising prices and wages as inevitable, the last link in the inflation chain. The presence of Asian production interferes loudly with this process; Asia breaks the links in this chain. The solution to the problem will come when Asia solves its own problem, with their interests in mind, not ours. They will eventually permit currency exchange rates to increase. The Japanese yen and the Chinese yuan will be permitted to rise. For several months, my writing has described pricing power for US firms to be enforced by China. When they either pass along higher costs, or permit a higher currency, only then will US firms see an opportunity to increase their prices. To conclude, Asia controls the ceiling on the price structure within the US Economy, a byproduct of globalization. They also control movement of the ceiling upward. That ceiling did not exist in the 1970 decade.
CHINA & INDIA INTERRUPT THE "COST PUSH"
Our national initiative, orchestrated by the Fed, is to inflate the economy. The failure of this initiative lies in its inability to close the boundaries of the system, namely access to and from China and Asia. The information age makes boundaries impossible to either close or patrol. In an information based economy, output is delivered by computer systems across national boundaries. This time around, the Asian production output finds easy access into the US Economy. The Greenspan Fed has succeeded only in raising production costs and household living costs. Instead of raising prices, and thus incomes, it has rolled out a giant red carpet of inked debts. In the process, corporate profit margins are squeezed, and household budgets are hindered. The only areas of flush profits lie in financial sector and financial operations of older firms like General Motors, Ford Motor, and General Electric. GIVEN THE OPEN SYSTEM BOUNDARY, THE HISTORICAL CORRELATION BETWEEN CRUDE OIL AND GOLD IS NOT SO RELEVANT. Slippage in the FOREX transmission gears, designed to adjust for fundamental imbalances, renders the linkage between crude oil and gold as loose. Unable to execute a gear shift, world commerce extends the imbalances to unprecedented levels never seen before. The stress in capital markets, with each passing month, builds toward a shock wave much like tectonic adjustments, known as earthquakes. That shock is most likely to be currency adjustments, certain to cause greater disruption when they finally occur than otherwise. Those shocks will come from Asia, regarded currently as the endless wellspring of capital, evidence of the Macro Economy mythical flexibility.
The entire cost-push thesis has been rendered toothless, and with it the correlation between the principal financial (gold) and commercial (oil) commodities. Any tight link between gold and oil requires free and easy currency adjustments, up to now greatly obstructed by central bank intervention. It also requires an uninhibited Treasury market, where higher federal deficits would enable higher interest rates. The prices for gasoline, natural gas, heating oil, and other petroleum products could continue upward even as the US Economy endures hardship. That hardship encourages lower long-term rates, a certain signature of the Kondratiev Winter. The possibility exists that crude oil and gold correlation might not be so tight as it has been in the past, when systemic price inflation and bond bear market were huge powerful forces for the 1980 gold spike. A declining USDollar will do much to keep both oil and gold on an upward path in price. Realization of price inflation is essential for gold to continue the ongoing momentum offered by the USDollar. Avoidance of world recession, or at least Asian regional recession, is essential for crude oil to continue its upward price path. A great irony exists. Should prices and wages finally move up, and through the Asian imposed ceiling, the principal damage will be to bonds. For gold bugs to realize their big payday, bonds must be crushed like they were in the 1970's. Asian participation in exports and intervention make for enforcement of a tight ceiling.
Many gold bugs view the energy market as highly correlated with the precious metals market. This time things are different. Three decades ago, the extreme rise in gold price occurred ONLY AFTER higher prices and wages were engineered across the United States, with the helpful hand of the Federal Reserve reflation, in direct response to the presence of a higher cost structure. The only thing in common between higher gold price and higher crude oil price is their cantilevered effect from a declining USDollar. Higher energy prices this time might cause economic recession and a constant overhead weight resistance to gold.
COMPLETE PARADIGM SHIFT
Changes are pervasive. Every single aspect of the US Economy has changed for the worse in the last 15 years, as dislocations have become solidly engrained. Some might argue that we are evolving to a higher order, where the information economy can produce money for profit without the need for work, sweat, and sacrifice. Past cycles in no way provide insight or guidance for the future course of price paths. By far the most profound metamorphosis in recent degradation has been the outsourcing of manufacturing jobs, and more recently, service jobs.
Since the 1970 decade, we have truly eye-popping changes. Business savings used to be commonplace, in the form of dividends. Those dividends are now either puny or more typically quite the opposite, replaced by enormous corporate debt. The yesteryear federal budget surpluses are now annual crippling deficits, financed largely by foreigners, well beyond safe and harmless levels. Each year, debt claims to our nation's wealth grow by 1% of the United States GDP. The federal debt used to be a "mere" $1 trillion three decades ago, now over $7 trillion. The trade surplus used to be a badge of honor, worn by a nation steeped in manufacturing strength, competent enough to build what it needs. Now we have massive trade gaps financed by consumer debt for the purpose of buying foreign worker output. What used to be an "alarming" $100 billion trade gap is now a "no big deal" $600 billion gap. Money supply growth used to be managed carefully, not to exceed the growth rate of the economy itself. Now monetary expansion is off the chart, rising by one third in three years, totally disconnected from economic expansion.
Our vaunted manufacturing base has been discarded, forfeited, and abandoned for Asian versions of the same using cheaper labor. Three decades ago, the Pacific Rim Asian Tigers were coming of age, as they followed Japan's lead to become export economies. Consumption used to be tame and unremarkable. Now retail sales and omnipresent spending make up the central visible pillar of the economy, a sure signal of trouble. Debt service has become an indication of total economic suffocation, as almost 78% of all transactional flow for goods & services is devoted to payment of principal and interest. The new business cycle is not recognizable as anything but the result of financial cancer, a sick outcome from decades of excessive money growth and credit explosion. A paradigm shift has taken place in the last 30 years. Globalization has on the whole displaced American jobs, created outsized trade deficits, and replaced them with massive debt obligations. The entire US Economy has been rendered uncompetitive. The only remaining engines of growth are powered by asset inflation and leveraged speculation.
The North American Free Trade Agreement brought the offshore manufacturing movement home to our continent in 1994. It began with the migration of mfg plant, operations, and jobs to Asia for the production of finished goods late in the 1970 decade, only to accelerate in the 1980 decade. Most notable were the automobile and consumer electronic sectors. NAFTA lowered costs for participating corporations, and developed free trade zones in Mexico. The 1999 Most Favored Nation status was granted to China, surrounded by great controversy and vitriolic objection by the AFL/CIO. Global trade would never be the same again. Worse still, with the aid of technological advances in broadband transmission, computer networking, and fiberoptic connectivity, the service sector was laid vulnerable to outsourcing. That trend is accelerating. On the domestic front, the prevalence of "Big Box Superstores" has changed the retail front. Supplied largely by Asian goods, they reinforce the trade gap and abandonment of US workers. Major retailers offer poor pay scales to their workers, as confirmation of the low wage pressure in the nonexistent cost push. The end result of all these undeniable changes has been the institutionalization of absent pricing power and wage pressure. Money simply does not come easy to pour into gold in order to push a major bull market. Not yet.
In central banking, everything is different from the 1970 decade. Back then the US Federal Reserve, the German Bundesbank, and the Bank of England each possessed enormous gold treasures. Now perversely, the word "Treasurys" stands for debt, not gold hard assets. The 1990 decade of prosperity was built on the back of massive dishording of those same gold treasures, to subsidize the USDollar and USTBonds. The commitment of central bankers to fortify their debt and continue to trample on gold has become more desperate. Back then, central banks were beginning to lose control of the gold price, held fixed at $32 per ounce by an absurd decree. Now gold is stable at a price 12 to 13 times higher. Back then, the practice of interfering with currency markets was regarded as very dangerous, a precedent which signaled instability and undermined the world financial system. Now that same intervention is not only commonplace, but it is desired. My view is that intervention will come to be routine, regular, and permanent. The Working Group for Financial Markets was a reaction to the 1987 Black Monday event. More recognized as the Plunge Protection Team, their arrival at 10am and 3pm on most days is almost as welcome and routine as the morning bathroom constitutional with a trusty newspaper. The flood of paper is so prevalent, that markets find nothing wrong with unlimited paper gold supply suppressing the gold price, even as world gold supply is dwindling. The consensus opinion is that holding gold down, with vicious gold cartel ambushes is desirable, despite the absurdity that short open interest exceeds two years of world production. Artificial supply makes for stiff resistance to hold back the gold metal price. For now.
Now, our central banks are not so interested in pursuing sensible monetary policy. They are too busy dealing with justification of Zero Rates, purchase of massive US Treasurys in an exercise in international economic welfare, and backroom monetization efforts. They are too busy boasting of their new machinery to fight deflation, and too eager to declare their "Open Mouth" techniques successful. Whereas three decades ago, rates were zooming past 10%, now they have been cratering toward zero on the short end. Savers has suffered mightily, no longer able to gather in 6% and 7% on life savings, retirement funds, or other secured money. In a manner reminiscent of the late 1980 decade, when central banks purchased over one third of US Treasury supply, the current portion of official purchase is 38%. Rumors abound of sanitization initiatives for JPMorgan's damaged hedge book, and Fanny Mae's imploded debts. How, if JPMorgan owned 85% of bond derivatives, and we experienced bond revolts in June 2003 and March 2004, did they escape even a partial hedge book meltdown? The GSE mortgage story is more transparent. Fanny Mae and Freddy Mac each were taken from the Housing and Urban Development (HUD) grab bag of unaccounted gravy train money parade, to the more careful scrutiny of Dept of Treasury. This is most likely a move to receivership.
The gold price is like the speedometer on a souped-up turbocharged Ferrari race car. In the first 18 months on the track, the first gear which powered the sleek race car was clearly the euro currency. A 35% rise in the euro versus the USDollar gave lift to gold, pushing it from $265 lows to $430 last winter. THE SECOND GEAR MUST NEXT OFFER GOLD ITS POWER FROM THE ASIAN CURRENCIES. TO DATE, THE FOREX CLUTCH HAS SLIPPED, AND INTERFERES WITH SMOOTH MOVEMENT TO THE SECOND GOLD GEAR. The Japanese yen resists all attempts by the free FOREX market to rise. Beijing leaders insist on the maintenance of a rigid yuan peg regime, fixed at 8.3 Chinese yuan to the USDollar. Unless and until the Asian currencies realize a fully justified considerable rise, gold will continue to struggle. Like with a car whose clutch cannot find the next gear, aggravated by the shrill sound of grinded gears, speeds stutter and even slow down. Gold will find its next gear and make great strides in price. However, to conclude that it did so easily in the 1970 decade and therefore will again, such is evidence of shallow economic analysis. Almost every conceivable factor worked in its favor back then, and now many powerful factors work to provide a stiff headwind of resistance.
CHANGES TO COMMERCE & SOCIETY
A worthwhile exercise is to point out the truly remarkable changes in commerce and everyday life. When snap conclusions are made about what happened 30 years ago, which extend to today, one should observe the many profound changes in the way we do business. Profits for major computer companies used to be as simple as ordering a price increase, easily passed along to captured customers locked into an architecture. Other supply sources make that practice impossible now, as does the level field imposed by price information accessed from the internet. The major force behind the telephone industry used to be AT&T. Now that name is synonymous with dinosaur, yesterday's technology, antiquated phone lines, and lost profits. Pensions used to be safe, ensuring retirees of their golden years to be played out on golf courses, motor boats, and gardens. Now middle aged workers see wrecked pensions and insufficient funds for later years.
The most visible change in commerce is the abuse of debt. Write a check for that $300 consumer electronic purchase? No way, instead take it on a six-month 0% credit deal. Want that $20 thousand car but have spotty credit? No problem, put yourself in that car with a five-year 0% financed deal. An astonishing fact is that 23% of college graduates have already declared bankruptcy. Three decades ago, the idea of granting credit cards to students who have no income was a total absurdity. If gold could be purchased with a credit card, if zero finance deals were secured for gold purchase, if corporations were motivated to ruin their balance sheets in order for our economy to corner the gold market, then sure, gold would be ready to rock & roll nowadays. Unfortunately, credit cards, zero deals, and corporate debt all work to strengthen the secular deflation forces of today. They work against gold.
Considerable changes have also become engrained in our society and home life over the past three decades. These listed revolutionary differences have little to do with finance. What used to be big problems would be dismissed as harmless nowadays. Strains have grown, as have risks. They point out how our social landscape could not any more different. Transformation is confirmed from commerce to finance to social fabric. Most of what follows aint pretty.
Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.
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