Taylor On US Markets & Gold
The Effects of Hurricane Katrina?
As we know all too well, it is very easy to get caught up in the emotions of the moment and let those emotions lead to behavior that is damaging in the long run. In my 58 years of life, I cannot recall a more extensive natural disaster than of Hurricane Katrina. The tragedy of human life is enormous. The looting and violence that is taking place in New Orleans as reported in our press and on TV looks like something straight out of the darkest, most ungodly countries of Africa. There was one report of a helicopter that was bringing supplies into New Orleans but as the pilot approached his landing spot, he noticed a throng of thugs armed with power weapons waiting for him to land. Seeing looming disaster for him and his flying machine, the pilot took off as fast as he could for a saver landing spot. This is just one incident of hundreds if not thousands of acts of violence by increasingly desperate people in New Orleans. And you thought it couldn't happen here eh? I'm afraid that as the K-winter freeze up sets in, what we have seen in New Orleans may become a much more wide spread phenomenon in America.
Beyond the human tragedy of this event are economic costs, which of course will add to human misery in the weeks and months to come. On Friday I had a call from my friend Dr. John Whitney, CEO of Itronics, Inc. Dr. Whitney and I frequently talk about macroeconomics and he had some interesting, and I think valid, concerns about what all this will mean in the future for America. Dr. Whitney suggested there are three areas of focus he is concerned about:
- Rising Gasoline Prices - With prices rising as high as $5 and $6 per gallon, and with America built around the automobile, there will be a growing number of lower income people, perhaps those in the lower one-fourth to one-third of the population, who will no longer be able to fund transportation to work. Accordingly, there could be a rising number of unemployed lower income people who will become increasingly impoverished. Since Americans as a general rule, and especially those in the lower income groups, have no savings, there is no cushion to tide them over until such a time as lower gas prices are reached, if indeed we do see lower gas prices in the future.
- Massive Credit Card and Mortgage Defaults - With people not being able to afford to drive to work, higher gasoline prices could very quickly lead to massive credit card defaults, not to mention mortgage defaults. Regarding credit card defaults, it is very important to note that the new bankruptcy law, which goes into effect in October, has several provisions that are likely to put enormous strains on the budgets of marginal debtors, even before the dramatic rise in gas prices. (See "New Bankruptcy Law Will Cut Into Consumer's Flesh" below.) The strains on marginal homebuyers are well documented and were also a cause for concern even before the exogenous shock of Katrina was introduced into our economy. Interest-only loans and variable-rate loans have been granted, to a great extent because millions of Americans who have been purchasing homes do not have sufficient cash flow to service conventional mortgages. Now suddenly, these economically stretched folks will find unexpectedly high fuel costs will push them into insolvency and default on their home loans, even before higher variable rates hit them or before they are required to being paying principal on their mortgages.
- Sharp Rise in Diesel Fuel Costs - As Dr. Whitney pointed out, America no longer manufactures things locally and sells to local markets. In fact, America manufactures very few things at all these days. Instead we mostly import. Something like $2 billion more is purchased by America than is sold overseas. A large percentage of imported goods enter our west coast and then are hauled east ward on our nations highways by truck toward the heavily populated East Coast. This flow of goods is a major reason why transport stocks had been doing so well even as the American manufacturing sector has deteriorated. Now however, with diesel fuels rising dramatically, trucking costs which are very significant, will have to be passed on to Wal-Mart and other retailers throughout the land.
The above points concern people outside of the area directly affected by Katrina. The costs and economic dislocations to people and businesses in the area of damage will be much greater than for most of us. Since New Orleans is such a key port for grains and other commodity shipments, there will be immediately affected businesses beyond those we noted above. The overall cost is now being estimated at over $100 billion.
But really, what is $100 billion to a country that prints money out of thin air with such relative ease? In fact, since America during Greenspan's tenure at the Fed no longer worries about how things will be paid for. The assumption is that more money can always be created out of thin air by the Fed to relieve unwanted and unpleasant economic realities like Katrina. Just as Keynes suggested, Wall Street seems to think this kind of damage is a good thing for the economy because it means there will be massive rebuilding just as there is after a war. Don't worry how we will pay for it. Remember, Bernanke's helicopter printing press is always available. Don't worry. Party on! (See "Markets Appear Pleased by Katrina Catastrophe".)
But, The Greenspan Put Could Go Away. Then What?
The "Greenspan Put." That's the term PIMCO's Bill Gross assigned to the implicit guarantee of Alan Greenspan to print more money whenever economic trouble brews. In fact, what Greenspan has done is introduce a "moral hazard" into America the likes of which we have never seen before because he has always responded to problems by printing more money. The first incident was the 1987 stock market crash. That was followed by the Mexican crisis, the LTCM crisis, the Russian crisis, the Asian crisis, the Y2-K crisis, the post stock market bubble crisis of 2001-2002, the September 11 crisis, and now the Katrina crisis. And Greenspan has created one heck of a dilemma for the Fed and everyone who needs to plan their financial future, because he has taught us that we can always count on giant monetary bailouts every time there is a crisis.
The "Greenspan Put" may in fact be the reason for Greenspan's long bond rate conundrum. As Paul McCulley of PIMCO wondered in his September essay posted at www.pimco.com, "Why should we in the bond market bearishly discount an ever-rising Fed funds rate, if an ever-rising Fed funds rate will surely burst property prices, begetting a reversal to vigorous easing?" His essay was written before anyone knew Katrina would heap such enormous damage on America, but even before that, Paul concluded that Greenspan would not have the intestinal fortitude not to print lavish amounts of money once the housing bubble popped. In other words, McCulley is betting that the Greenspan Put will remain in place because Greenspan and other policy makers simply don't have the courage do the job that any responsible Federal Reserve Chairman would/should do. In fact, McCulley is betting that the housing bubble will decline under its own weight, thus saving Greenspan the need to cancel his put.
Given America's Indebtedness, Keep Your Eye on the Dollar
A different view on the Greenspan Put is offered by Richard Maybury who in his latest monthly issue of "U.S. & World Early Warning Report, suggested that Greenspan (or his successor) may fool everyone and reverse policy by removing the put much to the chagrin of masses of investors.
Richard noted how, in 1980, Paul Volcker was called to a meeting of international bankers, where he was told that he had better hike U.S. interest rates or other nations would dump their holdings of the U.S. dollar and it would approach a state of worthlessness. Volcker immediately slammed on the monetary brakes and interest rates rose dramatically. What followed was the deepest recession since the Great Depression.
Recently, the Bank for International Settlement, the global bankers' bank, warned central banks that they'd better stop printing so much money because they were doing the same thing they did in the 1970' that led to massive global inflation and double digit inflation in the U.S. Certainly we now see signs of foreign governments, most notably China, saying they are getting their fill of U.S. dollars. Only the inner circle knows what is really being said within the Group of 8 when they meet, but it isn't hard in my mind to envision a situation where creditor nations like China and Japan might say to the U.S. "Shape up or we are shipping out of your currency." There is no gold standard to lead countries to stop printing so much money, and Greenspan's inclination to print money whenever there have been market problems, is exactly a reason why creditor nations would be getting their fill of greenbacks. Very little commentary is made these days on CNBC about how currency issues could force the Fed's hand on domestic monetary policy. But history suggests to me, this is one factor that could cause the removal of the "Greenspan Put." In my view, there are few things as important to U.K. and U.S. policy makers than retaining their position of dominance in the global scene and a dollar that is heading toward zero would most certainly lead to political and economic power for the staus quo. Moreover, since bankers own and run our political and economic system, ultimately they too will stop inflating in order to save the currency vis-à-vis other relatively worthless paper currencies.
Greenspan has encouraged moral hazard at every major turning point during his tenure at the Fed for the global economy, because he has encouraged us to believe that macroeconomic risks will always be removed by an ever-active Federal Reserve printing press. But the shocker of all shocks may soon be at hand, if Richard Maybury is right and the Greenspan Put is taken away especially now that Katrina has provided just one more reason to believe the Fed will pump billions more dollars into the economy. True to form, the market is once again conforming to this moral hazard mentality. Short-term Treasury rates began to fall dramatically this past week as soon as the magnitude of the Katrina tragedy began to come into focus. Like Pavlov's dog, Wall Street has heard the bell ring one more time and it is salivating for its next feeding of cheap money which it in turn can use to allocate wealth form the rest of the nation into its own coffers.
But what about our creditors. How do we assume they will continue to buy $2 billion worth of U.S. securities every day when we continue to behave like this? I do not assume they will and the evidence is growing that our creditor nations are getting sick of dollars and sick of our behavior. I don't know if the Greenspan Put will be taken away before or after Easy Al leaves the Fed. But it will be taken away and when that day arrives, I believe thee will be a bloodbath on Wall Street.
Dr. Whitney suggested Katrina could be the tipping point into the Kondratieff winter. He may be right; or perhaps by spin and the printing press, the effects of this disaster will be dealt with in a way that could allow our chairman to retain his "genius" status in the minds of many Americans, including our lawmakers who make a habit of kissing this man's posterior end. But as Stephen Roach noted on September 2 in, "The Endogenous Oil Shock," exogenous events like Katrina can be and usually are temporary. However, the moral hazards that lead to structural economic dislocations and thus become endogenous events are much more dangerous and long lasting and in the end cause much more destruction than exogenous events. Also seemingly agreeing with that point of view is Bob Hoye, who noted in this weeks "Pivotal Events" that major economic and market cycles are not altered by "…sudden calamities such as this horrendous hurricane season."
September 4, 2005
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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