Taylor on the us Dollar & Gold

November 12, 2002

In fact, that process of a dollar decline may now be in its very early stages, judging by the bearish posture of the dollar in the chart below. At 104.95, the Greenback has fallen below the 20, 50 and 200 day moving averages. In addition, the dollar has clearly broken through the up-trend line shown on the chart. What needs to happen now is for the Greenback to take out its lows of last summer, which was approximately 103.

Chart provided courtesy of
www.decisionpoint.com

Indeed the Administration may already be quietly orchestrating a reversal of the Clinton strong dollar policy, thus reversing the Clinton strong dollar policy, which along with an accommodative Fed, underwrote the bubble and its now terrible aftermath. Whether this is orchestrated or that market forces are working their own magic, we the dollar easing and stronger gold prices gives reason to hope a path toward global balance may be underway, though no doubt if it is happening it is in its very earliest stages.

Does a Positive Yield Curve Refute Deflation?

Friday evening, a guest on CNBC was suggesting that the positive yield curve for the debt markets in the U.S. was predicting that deflation was a non-issue for the U.S. The guest pointed to the a flat yield curve for Japan where deflation is a huge problem. Perhaps this analyst is right. But what I would like to suggest is that the positive yield curve for the U.S. has more to do with:

  1. Massive creation of new money by the Fed
  2. Rising credit problems in the U.S. which is pushing longer term corporate debt issues to very high levels (compared to U.S. Treasury debt)
  3. Foreign investors beginning to lose confidence in the dollar and thus beginning to sell their U.S. Treasury holdings

What happens when that $1.5 billion per day not only stops flowing into the U.S. markets, but begins flowing back out? Already even at low rates of interest we are seeing how debt service requirements are suffocating the demand side of our economy. What happens to personal and corporate bankruptcies when interest rates begin to rise dramatically as a result of foreign saving forsaking the U.S. Japan could not have that problem because that country is a net creditor nation, unlike the U.S. which is by far the biggest debtor nation the world has ever know. How can the yield curve remain flat in the U.S. if the money we have come to depend on for our consumer habits stop flowing into the U.S. Moreover, how can rising interest rates, especially on the long end of the yield curve be anything but deflationary given the total $32 trillion of debt owed by Americans? Imagine what surging interest expense will do further cut down the demand side of the U.S. economy!

Chart provided courtesy of
www.decisionpoint.com

Not surprisingly, gold's move upward has coincided with the dollar's decline. At $321, gold has broken above its 20, 50 and 200 day moving averages. What we need to is for gold to break through the resistance line shown above and then to take out the stubborn $330 longer term resistance level. Can that be achieved? As Dr. Fekete points out, if the U.S. is to have any chance of avoiding a deflationary collapse, our policy makers had better allow the dollar to devalue vis-à-vis gold.

Can Even a Dollar Devaluation Save the Day Now?

The Fed's ½% rate cuts last week was clearly a desperation move to try to overcome growing deflationary pressures. Related to that is a huge growth of money (M-3) which grew an astounding $32 billion this last week! But despite these attempts to reflate, we are doubtful it will work, even if the dollar is devalued vis-à-vis gold at this late stage. There has simply been too much mal investment funded by too much debt that has piled up in the American economy for too many decades. As the chart below illustrates, aggregate debt in the U.S. economy is growing exponentially while income (GDP) is growing at a much slower rate of speed, if indeed it is growing at all.

We have understood how mal investment (bad investments in wasteful industries like Internet and telecom), has robbed the economy of cash flow. And we have understood how, with exponential growth of debt, debt services charges represent a claim against cash flows, which when paid will sharply reduce the amount of disposable income corporations and consumers would otherwise have available to buy new goods and services. This is a simple lesson of economics 101. If we consume everything we have today or more (as the U.S. is doing), our standard of living will decline sharply in the future. On the other hand, if we save today, our standard of living will rise in the future. In the world today, China and Japan are big savers while the U.S. is consuming even more than it earns. (No wonder gold is flowing to those two countries while the U.S. is leaving the U.S. as it tries to extend is spending orgy a while longer by selling its gold and pretending the laws of nature and markets no longer apply to it.)

Ian Gordon has shown through his Kondratieff wave work, that in the "winter season" of the Kondratieff cycle, the magnitude of debt combined with the reduction of income simply overpowers the economy on the downside, such that nothing government tries to do, within conventional measures reverse deflation. Dr. Fekete now provides a further understanding of the dynamics of this pernicious self destructing pattern that humans seem not to be able to avoid from over the a period roughly akin to an average lifespan. Unconventional Measures May Reverse Deflation, But…… When Mr. Greenspan dropped rates last week, he presumably accomplished that by pumping reserves into the banking system with the purchase of government securities. When those bonds are purchased, money is pumped into major money center banks, including those who were behind the creation of the Fed in the first place. This is step one in the process of creating money from thin air. Beyond this first step, money is created when banks make loans. That is how the money supply bubble is blown up. Although no new wealth has been created, claims against wealth created by the productive sector (mining, agriculture and manufacturing) have been created.

Although there are signs that the consumer spending binge may be coming to an end, so far the consumer has, like sheep heading for slaughter, continued to buy like fools. Not only are they not saving, but they are leveraging their future by borrowing to live for today. Eventually this process will wind down, especially if businesses continue to cut their work forces and refuse to borrow to fund capital expenditures. In fact, for some very good reasons, it is becoming ever more difficult for banks to make loans to companies because a) Companies don't want to borrow because a worsening business climate makes doing so a foolish business decision or b) the banks wont make loans because corporate borrowers are no longer credit worthy. With this being true, no matter how many rate cuts are orchestrated by Mr. Greenspan, reflation of the money supply will be impossible.

But wait! Cant the Fed simply create more money to get prices rising? I have, on more than one occasion suggested to Ian Gordon what most hard money orientated folk argue, namely that governments can ultimately generate inflation if they want to. After arguing the debt is so excessive at this late stage of the Kondratieff winter that it impossible reverse deflationary trends until the process ends in massive debt repudiation, Ian finally does concede the following point: If the government literally printed money without any corresponding liability entries in the banking system, and then dropped billions of $100 bills all over America, inflation could be recreated. Not only would that lead to inflation, but to German style hyper- inflation.

But remember, the U.S. dollar is THE WORLD'S RESERVE CURRENCY! What would happen if the U.S. were to begin pumping money into the system without corresponding liability entered into the banking system? We think it would immediately be relegated to the dust bin of currency history! So while Argentina, or Brazil or some smaller countries can play games like that, it is hard to see how the U.S. can do it given the status of the dollar as the world's reserve currency. Yet, there is some serious talk among the ruling elite that such unconventional measures should be contemplated.

Last week in the "Financial Times" Adair Turner, who is vice-chairman of Merrill Lynch Holdings, argued that current deflationary risk means that unconventional measures, virtually like dropping billions of $100 bills out of airplanes should be taken in Japan. Mr. Turner says that it is untrue that Japan's attempts to stimulate growth by increasing the money supply won't work. He said, "If Japan wanted, it could cut taxes and increase its deficit and could fund that deficit with non-repayable, non-interest bearing "loans" from its central banks, loans that create no future burden on taxpayers and should not count in measures of public debt. "But that would be unconventional. It would make clear that governments can print money limitlessly if they want, a fact deliberately disguised by conventional arrangements. Governments fund deficits with interest bearing bonds. Central banks can buy these in the open market so that at the consolidated government plus central bank level no liability or interest burden exists. But when they do, that fact is not made transparent."

WOW! Setting aside the issues of further economic dislocations and distortions that such a policy would generate - that's an issue for another time, - things are indeed becoming desperate if such a high level guy at Merrill Lynch is publicly proposing such drastic and dishonest practices! And in fact, as umpteen rate cuts have been ineffective in generating growth, an official at the Federal Reserve Bank has floated a trial balloon with respect to what kind of radical measures the U.S. might take to overcome disastrous deflationary pressures, including the monetization of real estate and gold mines. Which we might add is a reason to hold a geographically diverse portfolio of gold mining stocks!

The Federal Reserve Bank of New York holds the world's largest accumulation of monetary gold.

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