End of Days
"If the dollar-centric world is on its last legs," says Outstanding Investment’s John Myers, "you can expect real assets to flourish."
"Whatever it takes, whatever it costs, this patient, this resolved nation will win the first war of the 21st century."
– President George W. Bush,
in a speech to the Reserve Officers Association, Jan. 23, 2002
We are entering a dangerous new era…an era that started in early 2000 when the stock market peaked and began a steep slide. Then came Sept. 11, 2001. Since then, nothing has been the same. Just consider some of the geopolitical and economic upheaval over the past three and a half years.
The markets reflect the political and economic discord – creating an environment that is fraught with volatility. But more than the markets, the economy, even the nation itself, is on a new track, one quite different from what existed during the 1980s and 1990s. As long as this track remains in motion, it will fuel a weaker dollar and higher prices for real assets.
These are definitely tenuous times to be invested in paper, especially debt instruments, but they do offer incredible profit opportunity in the broad class of investments called real assets.
The bond and stock markets love predictable times. Stability allows investors to focus on earnings and yields without worry of political or economic calamity. The bond market in particular enjoys a serene horizon because during such times the dollar is stable and manages to hold much of its purchasing power.
Fiat Money: How Far Can the Dollar Fall?
It is no coincidence that two of the biggest bull markets – 1950 to 1960 and 1991 to 2000 – occurred when the dollar was strong. What we have now is dollar weakness, and I expect the greenback has much farther to fall.
To understand where we’re going, we need to look at where we’ve been – notably the incredible deviation between what happened during the last half of the last century and what is occurring in the first few years of this century. Consider briefly the events of the past few years:
* Since Sept. 11, 2001, U.S. forces occupy Afghanistan and Iraq, and military operations have occurred in the Philippines, Liberia and Pakistan. The United States has about 8,000 soldiers in Afghanistan, about 150,000 in Iraq and 2,500 in Kosovo. Defense spending, after falling for 30 years, is rising at a time when the U.S. government can ill afford it.
* Between January 2000 and July 2003, the federal government budget soared from a surplus of $255.9 billion to a projected a deficit of $324.2 billion. During the same period, gross federal debt rose from $5.7 trillion to $6.5 trillion. Sometime next year, the federal government will have added another $1 trillion to its debt load.
* The U.S. dollar has plummeted against indices of major currencies since 2001. In 2001 $1 would buy 1.8 Swiss francs. By July 2003 $1 would buy less than 1.4 Swiss francs…a decline of over 22%.
* Between July 2000 and July 2003, the central bank cut the Fed funds interest rate from 6.85% to 0.96%. In July 2003 Fed Governor Ben Bernanke said that the central bank would stand ready to cut interest rates to zero and adopt an ‘inflation target’ if necessary.
* In June 2003 the yield on the 10-year Treasury fell to 3.09%, the lowest since 1956.
Fiat Money: Commodities, Recently
But then, take a look at what’s been going on with commodities between January 2000 and July 2003:
* The producer price index of all commodities rose from 128 to 139.
* The price of crude oil climbed from $24 per barrel to $31.
* The price of gold soared from $270 per ounce to $360.
* The price of natural gas rose from $2 per thousand cubic feet (Mcf) to $5.
* And in testimony before Congress this past July, Fed Chairman Alan Greenspan admitted that natural gas prices were likely to stay high, admitting that "distant futures prices suggest that we are not apt to return to earlier periods of relative abundance and low prices anytime soon."
Because of Keynesian economics, deficits are not only tolerated, but in fact encouraged. Money is pumped into the economy through government borrowing and spending and/or an increase in the money supply.
You see, the banking system, including the Federal Reserve, is the source of all dollar-denominated money. The Fed creates the monetary base, while the banks expand the money supply by issuing loans and thereby creating credit money.
The Fed is able to influence the amount of bank lending through its selection and control of the Fed funds rate, the benchmark for all short-term interest rates. However, it does not directly control the amount of credit money created by commercial banks. The creation occurs when the banks lend out the Fed money.
Fiat Money: A Zero-Sum Game
But money can be pumped into the economy two other ways – first by printing more dollars, which is the domain of the U.S. Treasury, then by federal government borrowing. When a government borrows money, it creates a future liability. If the government can meet that liability with taxes, then there is no net change in the amount of money. Taxpayer money is simply used to pay off creditors. It is a zero-sum game.
However, if the government spends more than it can possibly raise through taxes, then it creates a future liability that must either be defaulted on or paid. Governments hate to default on debt because it ruins their ability to raise funds in the credit markets and creates a crisis in the economy. That leaves governments with an easy way out – monetize the debt so that it pays off dear dollars with future cheap dollars.
Before John Maynard Keynes (circa 1930s and ’40s), governments would raise capital through taxation in an effort to create a stimulus for the economy. When taxation was not enough, governments borrowed money. In the old days, most major currencies converted into gold, which kept a lid on the tendency of governments to over-borrow.
Since the major currencies could be easily and immediately exchanged for a fixed amount of gold, the money supply could only grow as fast as the amount of gold backing it. Typically, gold production grew at about 1% to 2% per year, so that was the cap on the amount of new money that could be created.
Since fiat money is not convertible on demand into gold, its value is derived only through the promise behind it – that it will be accepted in payment for goods, services and taxes. When there is too much fiat currency, its value becomes watered down. And while the issuer of the money will not redeem it with gold, the currency can still be converted into gold or any other real asset.
Excessive money creation has been the norm in Latin America for 50 years. In fact, the plague of it continues today. Since gold has not been a factor in world monetary affairs since 1971, the Latin devaluation – or any devaluation in any other part of the world – has occurred against the world’s kingpin currency. Because world trade is conducted in dollars and since the major asset of the world’s central banks is in dollars, governments and their central banks are not as eager to liquidate their dollar position as they would be to sell yen or pesos. Yet as the 1970s revealed, once push came to shove, an exceedingly expansive U.S. government and an overly accommodative Federal Reserve would create an exodus out of dollars.
Fiat Money: Real Assets
The problem for dollar holders who are wary of the greenback’s falling purchasing power is where to go. With the exception of the Swiss franc, few currencies offer a greater long-term purchasing guarantee than the dollar. Therefore, once dollar inflation begins, dollar holders are left with one major headache: what to buy? The answer invariably comes down to one thing – real assets.
As I mentioned, the last thing anyone wants is a dollar meltdown. This gives Washington some fudge room to create an excess of fiat dollars. But just as a cartel encourages its members to maximize their gain by cheating on their quota, dollar inflation encourages governments to cheat on their dollar holdings.
The result is that typically, the devaluation of the dollar is slow at first, and then accelerates as sellers begin to notice others are liquidating their dollar positions and thus begin to escalate their sale of dollars. It becomes a vicious circle that is usually reigned in by rising interest rates.
What we are seeing right now, I believe, are the first stages of the dollar’s demise. Dollar holders have already begun to cheat on the rules of a dollar-centric world. The evidence of this can be seen in the markets – most notably the falling value of the dollar and the rising price of real assets. If this trend follows the pattern set in the 1970s, we will soon reach a point where the conversion of dollars to real assets will accelerate.
Like a giant boulder moving down a steep hill, once this trend gains more momentum, it will be very hard to stop.
for The Daily Reckoning
September 10, 2003
P.S. Certainly the Fed will do its best to slow the dollar’s demise by using the only instrument at its means – higher interest rates. My expectation is that this policy could occur sooner than most think, and thus we have already seen the bottom on rates. If so, then not only are real assets very attractive, but the bond market is also very dangerous.
John Myers – son of the great goldbug C.V. Myers – has been helping readers earn surprisingly lucrative returns in stocks largely unknown to Wall Street’s wunderkinder since his early 20s. Our man on the scene in Calgary, John has his fingers on the pulse of natural resource profits – including oil, gas, energy and gold.
"To the Gentlemen [and Gentlewomen] of the Daily Reckoning and their friends," begins the letter, optimistically…
"Thank you for reassuring your spineless, unworthy reader, who so foolishly doubted you recently. I speak of myself, naturally. You responded to my treacherous, cowardly questioning in fine style and I am now reassured that the world is moving in exactly the way you have been describing it. You are not 180 degrees wrong, but spot on, as straight and true as a Roman road! We have quite a few of these in England, so I know what I speak of.
"After my recent moment of insanity, when I doubted not just my own judgment – but much, much, worse…yours – I can pronounce myself cured."
What pleasure it gives those of us in the healing professions…to make the blind see and the lame walk! That is our conceit, at any rate: that we give readers fresh eyes to see the developing crises…and strong legs to run for the nearest exit before it is blocked by crowds.
So, open your new eyes, oh dearest reader, and see what is happening; for it is the greatest financial story every told.
It is all there – faith, hope, ambition, greed, stupidity…all the human emotions are on display…vile, obscene, grotesque, and occasionally even laudatory.
Every day brings new evidence…new events…and new absurdities:
It is a marvelous economic recovery; at least that is the picture described by nearly every financial medium. But with our sharp new eyes, we see the image is only paper- thin:
"Consumers hike debt," says one headline in the Arizona Republican. "Higher property taxes on the way," says another.
"Record spike in health care costs," adds the Baltimore Sun.
The poor consumer, already deeper in debt than ever, is having a rough time of it. His income is falling…his debts are increasing. And his living costs are going up.
If the economy really were expanding the way we are told – at better than 3% GDP growth per year – it should be creating 200,000 to 300,000 new jobs per month, points out John Crudele in the NY Post. Instead, for 7 months in a row, jobs have been cut…with 93,000 hacked off in August.
What kind of a recovery is this?
It is a fraud…the latest in a whole chain of fraud that stretches back to the Nixon administration…and even before.
GDP growth is calculated by taking nominal growth figures and subtracting inflation. If the economy were flat, for example, and inflation were running at 3% per year, the government would tell us that GDP was shrinking at 3% per year. The secret of the latest ‘growth’ figures lies in the inflation rate, which the government calculates at 0.8% in the last quarter, rather than the 2.4% figure in used in the first quarter. Result: GDP growth came in above 3% rather than the 1.5% it would have otherwise reported.
Of course, were military spending increases and phony ‘hedonic’ enhancements removed, the GDP growth figure would probably be negative.
Inflation begets deflation…deflation begets inflation. The Fed inflates…the Chinese beget new factories and cut prices…the resulting deflation begets subtracted from the government’s GDP tally – resulting in inflated growth numbers!
A friend from Poland wrote to tell us that the Chinese expression for ‘bubble’ is something like ‘shui pao’ – which works for us; we don’t know any better. So, Shui Pao it is…coming to China, now!
"Factory output soars in booming China," says a Reuters headline. The assembly lines are putting out 17% more this year than last. (Where does it all end up? More on that below…)
But oh no! Gold rose $6.60 yesterday. The bull market in gold, which we keep predicting but keep forgetting to buy into, is getting underway without us.
Open your new eyes, dear reader, and look on in awe: we have what appears to be a major, major bull market in gold developing. At first, people hardly notice. The price of gold is reported as a curiosity. ‘Must be central bank buying,’ they tell themselves. Or, ‘I wonder when those nutty gold bugs will finally give up.’ The average person has no idea. He listens to CNBC and is blind to what is actually going on. Gold…the dollar standard…deflation – they are all occult mysteries to him…strange, forbidding, and vaguely menacing.
But as a bull market develops, more and more people see what is happening. Gradually, one by one at first…and then in droves…they discover the rising market and want to get in before it is too late. Already, the Tocqueville Gold Fund reports that assets are up more than 50% in the last 12 months…but only to $293 million. A prediction: the fund will have billions in it before the bull market in gold has run its course.
The rising price of gold means something. Below, Eric wonders what. We don’t know. But when we look upon the phony mess erected on the sands of the Dollar Standard system, it seems to be leaning. Is it us? Or is the proud tower itself actually tilting more and more…? If so, gold will not hold it up, but it will be a good thing to have buried in your yard when the average investor finally opens his eyes…and sees the Dollar Standard fall.
Over to you, Eric:
Eric Fry writing from New York…
– The stock market charged bravely into the month of September, but that doesn’t mean it will charge victoriously out of the month. Perhaps it will limp into October licking its wounds and happy to be alive…But September has been an unseasonably kind month so far.
– After the first six trading days of the month, the September body count is as follows: four winning sessions and two losing sessions for a net gain of 2.2%. Fifteen trading days remain in this, the most treacherous month of the year for the stock market…Stay tuned.
– Yesterday, the Dow slumped 79 points to 9,507 and the Nasdaq fell 15 points to 1,873. Retail stocks tumbled for the fifth straight day as the companies whined about sluggish consumer spending five sessions yesterday. The dollar also crumbled, dropping 1.4% to a three-week low of $1.122 per euro.
– The gold market relished the stock market’s weakness and the dollar’s troubles by rallying $6.60 to $382.80 an ounce – that’s its highest closing price in seven years. $400 an ounce is so close that the gold bulls can almost taste it. Will the bulls soon take hold of the magical $400-mark? Or will that level withdraw from their clutches of like fruit from Tantalus?
– The gold market has been nothing short of spectacular over the last few months. The dazzling metal has jumped $30 since the bond market topped out on June 13th. The metal’s impressive rise has inspired a dramatic rally in gold shares, which has vaulted the XAU Index of gold stocks to a six-year high.
– Again we wonder, "What does the gold market ‘know?’" Does it know that the Fed’s reflation campaign will succeed too well? Or does it know that President Bush will continue spending billions of taxpayer dollars to preserve Iraq as a breeding ground for terrorists and a habitat for anti- American terrorist acts?
– Or maybe the gold market knows only that U.S. financial assets are very expensive, and worries, therefore, that U.S. stocks selling for 35 times earnings, U.S. bonds yielding 4.40%, and a U.S. dollar selling for $1.12 per euro are all too pricey for risk-averse investors to own in large quantities. The gold market offers up itself, therefore, as an eye-pleasing alternative.
– Gold has always provided a kind of insurance, first and foremost. It is not an ‘investment’ per se. But when economic uncertainties mount, buying a bit of gold ‘insurance’ can be a terrific investment. At the moment, insurance is in demand.
– According to the Federal Government, consumers are still spending money at a rapid clip. "Not true," say the nation’s retailers. According to the folks who are in the business of selling baubles to consumers, spending is slowing down.
– Consumers are not spending with abandon like they used to, and they are not eagerly spending money they don’t have on things they don’t need. For several days running, retailers have been whining about sluggish sales, while Wall Street analysts have been busy slashing their earnings estimates on various retailers. Clearly, somebody isn’t buying as much junk as they are supposed to…if we are to have a ‘healthy’ economy.
– One obvious reason why consumer spending may go from bad to worse is that the ‘recovering’ economy is eliminating jobs, rather than adding them. Meanwhile, the mortgage-refi well is running dry. The swift run-up in long-term interest rates has caused an equally swift and sever run-up in mortgage rates…and that has caused a swift and sever fall-off in mortgage activity.
– Washington Mutual Inc., the second-largest U.S. mortgage lender, announced yesterday that new home loan applications collapsed nearly 40 percent from July. "Wamu’s" experience is hardly unique, which is why consumer spending is likely to drop sharply.
– For the moment, credit is supporting consumer spending. But that’s not a long-term driver of sales. Consumer credit grew $6 billion in July, with the lion’s share of the gains coming from auto loans and other non-revolving debt. But that’s a temporarily palliative.
– "Consumer spending is predicted to show robust growth of around 5.0% in the third quarter," says Asha Bangalore of Northern Trust, "following a 3.8% increase in the second quarter. A large part of this growth in consumer spending came from a surge in auto sales in the third quarter."
– "Households are engaged in raising the savings rate to make up for the loss in net worth during the 2000-2002 period. Year-to-date, the personal saving rate has averaged 3.5%, following a 3.7% average in 2002. This represents a noticeable upward trend in household saving following a 2.3% average in 2001. At the same time, the household debt- asset ratio (18% in the 2003:Q1) is the highest on record since Word War II. This ratio was 13.3% in 1999. The sharp increase in household debt implies that debt service burden will be another constraint in household budgets."
– Three continuous years of losses in the stock market have chastened many investors. Today, they save a little more money than they used to and spend a little less. Saving money may be prudent for Mr. and Mrs. Consumer’s household, but it’s quite painful for the nation’s economy.
Bill Bonner, back in Paris…
*** A number of dear readers have written in defense of Richard Nixon. Even 9 years after his death, the Trickster still has his supporters.
While we see RMN’s shifty eyes and fingerprints on every economic event over the last 30 years, others think they see the long face and long arm of LBJ. "Wasn’t it LBJ’s Great Society spending that doomed the gold standard?" they ask. "Isn’t he the real father of current financial problems, rather than Nixon?"
"Blood test!" they demand.
"You must have been a liberal Democrat when you lived in the U.S.," begins one letter, "to blame Nixon for Woodrow Wilson and FDR’s creations of fake money and Marxist taxes.
"As sincerely as I can be knowing that this e-mail will be deleted without being read," it concludes.
*** "I have a question about the Dollar Standard," begins another. "Your articles you often refer to it as ‘Nixon’s Dollar Standard,’ because he is the one who officially put his stamp on the new policy. But I was always taught that his predecessors were mainly responsible. LBJ had practically destroyed the value of the dollar in order to pay for his war and his social programs. Others played their parts in the drama, which led to the dollar being led away from gold. Nixon just nodded to continuing along a 20 or 30-year path.
"For me, it is intellectual curiosity. I am not taking political sides, but I am interested in the history of the creation of the current situation. I may have been raised in a home that was less concerned about facts and more concerned about justifying having voted for Nixon."
*** And another:
"Ah, Mr. Bonner, I love your stuff, but lately your quintessential Democrat-ness is showing – ‘Nixon is the root of ALL evil’….eh? "I do believe Nixon was preceded by two Democrat regimes. At the time Nixon did the dirty you bemoan, there existed offshore Eurodollar (remember those?) balances sufficiently large that had only 1/3 of the holders knocked on the door at the Fed and demanded the gold at the official rate, which foreigners could do at the time, Ft. Knox would have been left with just a couple of flies buzzing around inside, and that doesn’t even contemplate the other worldwide balances of the time, such as the petrodollars. Those balances hardly appeared just after Nixons’ ’68 election. DeGaulle noticed all this and so demanded the gold, leaving Nixon with few options.
"Obviously, giving up the gold at the official rate amounted to an instantaneous admission the emperor had no clothes – and an instant 100% dollar devaluation. Resetting the ‘official’ rate to something that could reasonably back the worldwide dollar balances, while less damaging than the former, would still have been a disastrous devaluation and a de facto repudiation of U.S. Treasury debt. The course taken was not without risk. As early as 1969, people like Harry Browne were writing, and I was reading, books warning that this situation was developing and that when the U.S. was forced to sever, that the dollar would rapidly fall in value to its intrinsic value, the value of the paper it was printed on. As we know, that didn’t happen. Those same writers remained silent on the cause of their failed prediction, so it took much thought to reason out why the buck retained its value. Like many problems that seem so difficult to understand, the difficulty lay in the utter simplicity of the answer, which now seems so obvious, and remains so true today.
"Like Democrats of today, who condemn Bush actions without proposed workable alternatives, you are eager to condemn Nixon’s act, but I have a question: Given the circumstances, what would your ‘solution’ have been?
"And please don’t say you wouldn’t have allowed the circumstances to arise; they were a virtual fait accompli by the time of Nixon’s arrival. It seems silly to me to think Nixon had the intellect to conjure up the ‘Dollar Standard’ system and all that has flowed from it. His was a reactionary act of national survival, undertaken with great trepidation.
"The few who were astute enough to see it coming were clueless about its effects, and Nixon was just a lowlife…uh, make that lowly politician, not an intellectual giant.
"Who knew in advance the world would not only not devalue the buck, but come to look at it the way a junkie looks at heroin? Harry Browne certainly didn’t, I certainly didn’t, did you? Cheers, keep opining and writing about it!"
Your editor responds:
No, Nixon did not appear on the national stage in like Adam in Eden. Many were the scoundrels who preceded him; many would be those who followed.
And no, we have no party affiliation. We voted once – for Jimmy Carter – and were so ashamed and appalled we vowed never to do it again. Demoplicans…republocrats.. we have no favorites, no prejudices…they all deserve ridicule.
We fault Nixon not because he set the stage…nor even because he wrote his own part in it…but only because he went along. An able politician, Nixon put himself forward as a conservative, and then – like Alan Greenspan and G.W. Bush – became one of the most egregious activists in Washington history. It was he who not only presided over the final destruction of the international gold standard, but also imposed wage-price controls in order to try to mask the damage.
Few are the real heroes who make it to public office. The election process tends to screen out anyone with real principles or convictions. Those who land in the cushy seats of power are – like Nixon, Greenspan, and Bush – mostly dissemblers: frauds, charlatans and mountebanks. They get there by offering the voter what he wants – hollow slogans, puerile ideas, a comforting presence…and the prospect of blaming someone else for his problems while slipping his hand in the victim’s pocket. And so, along comes the New Deal, Making the World Safe For Democracy, Preserving the Union, the Great Society, the War on Poverty, the war on drugs, the war on terror…the EEOC, Social Security…and all the rest of it.
In this light, we have today’s news:
"Senators seek tariffs against China in currency dispute," says an AFP headline. The sordid senators are approaching the problem in typical Nixonian fashion – with a remedy that is both dishonorable and ineffective.
But rare is the senator who would stand up and tell voters that the trade imbalance with China is the wages of their own sin. China’s current account with the rest of the world is in balance, he might point out. It is only with the U.S. that it is out of whack…and if they would only open their eyes, they would notice that they buy a lot of stuff from China, and borrow the money to do it with. As a consequence, the U.S. current account is out of balance with almost every other country on the planet, not just China.
The yuan is not too high; the dollar is too high.
The adjustment, he might point out, should be made – and will be made eventually – by lowering the price of the dollar. It will go lower, one way or another. Voters, he could hint, might want to protect themselves. Then, he could go back to his office, clean out his desk; in politics, he’d be beached within a week, with no volunteers to pour water over him.
But what would WE do, the dear reader wants to know. Suppose we had been in office in August of 1971…?
We know what readers are thinking: we will dodge. We will equivocate. We will give a muffle-mouth answer worthy of the Fed chairman. But no, dear reader, we have an answer that is as forthright and direct as you might expect.
Had voters had the grace to elect us to the nation’s highest office in ’68, we know exactly what we would have done: demand a recount!