The Rock. And the Hard Place.
Kevin DeMeritt
President, Lear Financial
We've seen the cartoons. The coyote chases the speedy Road Runner, misses it by inches, skids off a dizzying cliff, hits the hard ground far below-has a giant rock land on him for good measure-then crawls out and continues the eternal chase.
Cartoons can get away with that kind of brutal humor. Real life can't. In real life, just one Wile E. Coyote stunt would make us very dead indeed.
In real life, getting between a rock and a hard place isn't kid's play.
Take, for instance, the scenario we now suddenly (or not so suddenly, depending on your point of view) find ourselves in. Best-selling financial author, Doug Casey, puts it this way:
"We are fast approaching the point at which the U.S. government will have to choose between crushing hocked-to-their-eyeballs American consumers by continuing to increase interest rates (a rock) in order to keep the dollar attractive to the foreigners who lend U.S. markets about $2 billion per day… or letting the dollar tank (a hard place), triggering all sorts of fiscal unpleasantness."
There you go. The problem summed up in one neat, little paragraph. Casey's "rock" is America's desperate need to raise interest rates to ensure the flow of foreign money - the same foreign money that services our humungous debt. And "the hard place" is that we absolutely, positively cannot do that or else risk crushing real estate, consumer spending and, invariably, the American economy.
Yup, it's a rock-and-a-hard-place problem if ever there was one. And it's not likely to come with a happy ending.
The Rock, On Closer Inspection
The problem, on the rock side of this unhappy sandwich, is debt. Mind-blowing, can't- begin-to-imagine-it-if-you-try indebtedness. And it's only getting bigger.
Take our trade deficit. It keeps setting new records. Not that it should come as any big surprise, but we hit another one just last year (for the fourth year in a row). 2005's $725 billion trade deficit was up almost 18 percent over 2004. Bloomberg.com called it, "America's worst year for international commerce on record."
These deficits have led to an even scarier problem. Think we're dependent on foreign oil? We may be even more so on foreign capital. We need it, on a daily basis, to service our indebtedness. At this point, we can't even think of doing it alone.
It's a bizarre dependency. And a bizarre role for the U.S to play. In the last great empire, Britain was the world's creditor nation. We, on the other hand, have the nasty distinction of being the world's debtor nation. We owe more than anyone ever has. Our current account deficit has gone where no other account deficit has gone before, reaching a record 6 percent of Gross Domestic Product.
Which means we need as much as $2 billion a day in foreign capital just to "make the payments."
So what's stopping foreigners from keeping their money and thumbing their noses at us? Just this: Their self-interest is hopelessly entwined with ours. For starters, the dollar remains the world's reserve currency - foreigners literally hold billions of greenbacks of their own. A freefalling dollar would only mean they'd get hurt, too. And badly.
Next is our hopeless addiction to the stuff they make - and their hopeless addiction to sell it to us. We're like this giant, continent-wide shopping mall foreigners, particularly the Chinese (at $185 billion a year), depend on to sell their goods. Stop funding our debt and foreigners would soon watch the dollar collapse…and their goods get prohibitively expensive in the U.S. Should that happen, they might as well wave goodbye to the good, old "mall America."
Then there's the impossible-to-ignore fact that oil is denominated in dollars. It's been that way since Nixon took us off the gold standard in the early 70s. That means, unless the world is ready for a down and dirty "adjustment" to another oil currency - which Iraq tried and Iran is now trying - the dollar, with at least some purchasing power, is essential for the whole petroleum-based system to continue.
So…does this all mean we get to hold foreign nations hostage indefinitely? Just go deeper and deeper in debt - into the trillions and whatever the number is beyond that -while the rest of the world stands around shrugging its shoulders?
Not exactly.
Raising Rates to Keep the Scheme Going
The above pitfalls notwithstanding, Alan Greenspan warned a year ago that foreign investors might start dumping dollars whose value is falling as fast as the U.S. trade deficit is climbing.
For once, many agreed with the man. Europe, Asia and Middle East economic bigwigs are getting desperate and downright unpredictable. The greater the debt, the bigger chance a "financial accident" will happen. C. Fred Bergsten, author of Dollar Overvaluation and the World Economy, noted, "A run for the exits could happen any day, that's for sure."
Truth is, some have already been spotted walking very quickly toward the doors. Analyst William Thomas wrote about a trader, Paul Calvetti, who bet on the normally reliable foreign demand for a new $9 billion T-bill issue. But…"Foreign investors already awash in Bush's bad checks weren't buying anymore 'paper.' In five minutes, Calvetti lost $1.5 million on his currency play. 'It's amazing,' he gasped. 'I don't think I've ever seen this before.'
To keep that little scenario from replicating like a mutant financial virus, new Fed boss Ben Bernanke's first job is clear: He has to make at least a token effort to calm things down and reassure foreigners that a daily $2 billion investment in the U.S. is not a mammoth waste of money.
And he can only do that by raising interest rates, thereby making the dollar somewhat more attractive.
He has no choice. That's the rock.
And the Hard Place?
"So, there is some thought out there now that the Fed will probably overdo the rate hikes, thus stomping on the economy's heart, and smashing that sucker flat, The Fed will have sorta stomped on the economy's aorta!"
That graphic little analogy comes from The Daily Pfennig - AKA analyst Chuck Butler - and he pretty much nailed it. Except there's also some thought out there that even the next hike or two will cause Americans to scream, "Uncle!"
The hard place isn't so hard to understand. All you need to know is that real estate and consumer spending accounted for 90 percent of GDP growth these past few years (that includes adding some 700,000 jobs) but, boiled down, it's been all real estate. Americans hit their home equity awfully hard - another real estate component - which is what's goosed consumer spending.
The legendary economist Ludwig von Mises once observed: "It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself into believing he has discovered a wonderful new method of heating his premises." Americans have indeed burned their furniture - looted their (inflated) home equity unmercifully - and now find themselves deep in debt and facing falling home prices.
As do countless real estate speculators. Mostly using ARMs or interest-only mortgages, speculators have been buying about 30 percent of all new houses in an attempt to leverage the housing bubble to the hilt. When the Fed turns the screw to raise rates, think these speculators will hang in there…or just dump their cooled-off properties and run?
So, yes, consumer spending and real estate are both at the mercy of the Fed. And with the economy looking pale and feverish without them, you can start to see how spooky the hard place really is.
Getting Out from In-Between
That, in a nutshell, is the dilemma. Neither the rock nor the hard place is going to budge an inch. But, heaven knows, they're just about to collide.
You'll want to get out of the way before then.
So what can you do? Maybe shift investment gears and batten down the hatches on that likely-to-be-overvalued home of yours. In the wake of the stock and real estate bubbles, commodities have quietly been picking up steam. The CRB index, a daily commodity price index using quotations for 19 sensitive commodities, has risen 91 percent from its 2001 bottom - and is at an all-time record 350.
Does that mean you should now shy away from skyrocketing commodities - particularly the flagship commodity, gold? Hopefully not. Figuring inflation into today's prices shows commodities only trading at an early 1990 level. According to analyst Scott Wright, to actually be compared to, say, the commodity high water mark of 1980, today's record 350 CRB Index would have to be over 777.
No matter how you figure it, gold has a long way to go. Longer still when you consider the consequences of the coming rock-and-a-hard-place collision. The good news is, you don't have to be a real-life Wile E. Coyote victim - you can act now before that giant rock comes crashing down on you and the hard place you're standing on.
Kevin DeMeritt
www.goldcentral.com
February 25, 2006
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