Watch For Falling Dollars Or For Falling Helicopters?
Jay Taylor
The following chart and quote were taken on March 7 from the excellent Prudent Bear Web site. The Prudent Bear Fund (www.prudentbear.com) is headed by my friend David Tice, a frequent guest on CNBC, Bloomberg, and other major
financial shows.
"The market appears to be questioning the
quality of GSE guarantees. Are they the
next shoe to drop in the unfolding saga of
credit insurance?
"A major business of the Government
Sponsored Enterprises is the guarantee of
mortgage backed instruments for a fee.
The GSEs often insure these guarantees to
protect against losses. With the viability of
the bond insurers in question, the market
has turned its attention to Fannie and
Freddie."
Once upon a time, it was generally
accepted that the Fannie Mae and Freddie
Mac were essentially guaranteed by the
full faith and credit of the U.S. Treasury's
printing press, just as U.S. Treasuries are guaranteed. Because of that, the yields on this so-called “agency paper” were almost identical to Treasuries. But now, with enormous losses to these agencies because of horrifically poor mortgage lending policies enabled by Greenspan’s easy monetary policies, investors are apparently beginning to wonder if in fact
this informal guarantee will be honored. At least that’s what the chart above seems to be telling us. Although the housing market debacle began to come into view last summer, we can see that the spread for Fannie Mae versus 10-Year Treasuries has risen from 140 basis points (1.4%) to nearly 220 basis points (2.2%). Investors are clearly demanding more
yield because they doubt that the U.S. will reward bad behavior that allowed bankers to pull down the huge salaries and bonuses that effectively have caused millions of American homeowners to go broke. For the long-term good of our nation, let’s hope the markets are perceiving the future action of our government correctly, though in the short term that will lead to huge levels of pain.
Certainly, if the Fed isn’t there to monetize this debt, there is no doubt in my mind that we might be in store for a business contraction the likes of which we have not seen since the 1930s. On the other hand, if the Bernanke Fed lives up to its word and showers the U.S. with helicopter money sufficient to reward the pernicious borrowing and lending behavior, is
there any doubt that we could be heading toward accelerating rates of inflation and possibly even a hyperinflationary meltdown?
The problem with the Keynesian and monetarist mindsets that have dominated policy increasingly since WWII is that they disallow markets to ever fully correct to the excesses of the past so that a true equilibrium is restored. With mal (bad) investment, incomes are insufficient to repay all debt never mind returning a good return on equity. And so, with each
Keynesian and monetarist stimulus package aimed at averting a business dowturn, debt is piled upon debt and the problem over the longer term becomes greater than before those policies were implemented. So, in the aggregate, debt grows much more rapidly than income. At some point, the debt burden can no longer be sustained and the system breaks down either
through a deflationary or inflationary depression. Which way does our current system tip? That is the $64 trillion question.
From a macro-perspective we can see this happening in the U.S. economy as the chart on your left illustrates. We see a mind boggling $48 trillion in total U.S. which includes debt from all sectors of our economy including the financial sectors. The important thing to realize when looking at this chart is not so much the absolute amount of U.S. debt. What is important to realize is that debt is growing exponentially while incomes are growing in a rather steady linear fashion over time. The spread between debt and income is growing very, very rapidly. You do not need a Ph.D. in mathematics to understand this relationship will at some point break down.
Ian Gordon's chart (shown below), which takes real U.S. economic
data dating back to just after the Revolutionary war with Britain,
documents the Kondratieff cycle. It shows how, even before Lord
Keynes sewed his inflationary pathology on the western world, that
debt becomes so extensive over time that it can no longer be inflated
away. Of course, not until 1971 have we had a global monetary
system without any anchor to the amount of money created. Now,
without any gold backing any currency anywhere, there would seem
to be no limits to the amount of paper money (and hence inflation)
that politicians and central bankers can create.
Yet there is a limit to this inflationary process as we have seen in
many hyper inflation countries around the world. When prices surge
higher not monthly but weekly, then daily, then by the hour and
ultimately by the minute, you have a system breakdown in which
case you have a hyperinflationary depression. The debt is in effect
repudiated as it is in a deflationary collapse. The only difference is that in a deflationary collapse, savers and prudent investors are rewarded as the currency is not only preserved but gets stronger and buys more. In a hyper inflationary situation, everyone who keeps their savings in paper money instruments gets wiped out because paper becomes worthless.
The Fed Looks Worried? Have We Reached a Point of No Return?
A few years ago, our family drove along the Niagara River in Canada, which flows over the famous Niagara Falls on the border of the U.S., and Canada between Ontario and New York State. There is a point on that river which if you are too close to the falls, there is no turning back because the force of the falls, even if you are in a boat with a strong motor, cannot overcome the force of the falls. One way or another I believe this economy is heading “over the falls.” The only question is exactly how we take the plunge and how well are we insulated to survive it? I think the Fed is now becoming desperate. I say that because almost every day, two or three Fed governors are out making speeches to try to con us into thinking everything is O.K. and that we should not go out and buy gold and sell dollars. One Fed governor was telling us at the end of this week that just because we are having the worst housing crisis in
decades and just because the housing mess is now spilling over into the general economy, we shouldn’t count on more interest rate cuts. So, are we not to believe Ben Bernanke’s promise that he will print as much money as necessary and then shower it on Americans via his fleet of “helicopters?” Are we now not supposed to believe he meant what he said in a paper he wrote in which he suggested virtually anything and everything could be monetized, including real estate and even gold mines?
Might Bernanke’s Bosses Ground His Fleet of Helicopters?
One last reason I believe Ian Gordon’s deflationary scenario could yet play out is because the powers behind the throne—the banking elite who control our system—may be starting to realize that if the dollar crashes, so does the U.S. Empire! (For those of you who doubt who Mr. Bernanke’s “boss” is, you might consider reading The Creature From Jekyll Island, by G. Edward Griffin.)
Certainly the Fed is aware that if the dollar crashes all that is the U.S. Empire will go up in smoke. Their concern about the problems a crashing dollar will cause to the established order was no doubt a reason one Fed governor wanted Wall Street to stop betting on lower interest rates, even though, if we are to take Bernanke seriously, that is exactly what we should expect.
As a 60-year-old guy who remembers vividly the last time we entered into a serious inflationary period during a period of slower economic growth, I do not rule out a 180-degree turn in policy by the Fed. Thinking back to 1979-90 when inflation was accelerating into and quite possibly beyond double digits, no one predicted that Paul Volcker would step on the monetary brakes, causing the deepest recession since the Great Depression. The betting was all in the other direction. But what was happening then was a very rapid move out of the dollar into Deutsche marks, Swiss francs, and gold. The dollar was on its way then toward total obliteration, and if that had happened, the U.S. would have lost its ability to compete geopolitically with the Soviet Union.
Now I ask you. Do you suppose the folks who hold controlling interest in the Federal Reserve—the banking powers of the western world and Japan—would willingly allow the dollar to be replaced as the world’s reserve currency, when that would mean a loss of global domination and wealth they have enjoyed over the past few centuries? Can “they” afford to allow the dollar to collapse, if that means a loss of their Empire?
I have suspected “they” have a “Plan B” in place, such as the “Amero” or some such currency that combines Mexico, Canada, and the U.S. into one currency-trading block. If we self-destruct through hyperinflation, you might trade in 1,000 or perhaps 10,000 old U.S. dollars for one new Amero. But who knows for sure? I still think you can’t count out the sacking of Bernanke and a brave new “Paul Volcker” returning to save the dollar
and with it the American Empire.
QUESTION: But wouldn’t a depression be awful for the American people? Wouldn’t the politicians fight against tough monetary policies in order to try to get re-elected?
ANSWER: Yes, but so would a hyperinflation be tough on the American people. Although the inflationary route would likely still buy a little more time, it would ultimately wipe everyone out. Those who worked hard and saved their money in the form of fiat money (as opposed to gold) would get wiped out as surely as those who borrowed to the hilt and are unable to repay their debts, because the paper money you have in your bank account or under your mattress would become completely worthless. Yes it can happen here! Besides, do you believe the ruling elite really care about the working stiff?
I’m not predicting we will have a revisit of Paul Volcker II in our future. Indeed, I asked both Ron Paul and Marc Faber whether another Paul Volcker could be sent to the Fed to save the dollar and hence the American empire. Neither of them thought that was at all likely to happen. Yet, I hold out that possibility because exactly that 180-degree policy turn did happen in 1980 when everyone was betting on $2,000 gold and $100 oil and
prices rising at a faster and faster pace. In order to be as ready as possible, we will continue to watch our IDW like a hawk. As of now, the inflation side of this debate is winning, though we are seeing powerful deflationary forces in evidence as well. This week equity prices plunged even as commodities continued to surge higher and as noted below, our IDW fell during the latest week.
March 10, 2006
Jay Taylor
Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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