History Points to Higher Rates

The Daily Reckoning PRESENTS: Today, Greenspan presides over his final rate-setting meeting – the results of which will not come as a surprise to anyone. While most believe there won’t be a large amount of additional rate hikes in the United States’ future, Puru Saxena sheds a different light on this situation. Read on…


The New Year started with a bang, as the global equity markets charged ahead. Investors worldwide seem to be celebrating the Fed’s announcement, which stated that its policy outlook “was becoming considerably less certain,” that the number of additional rate hikes to control inflation “probably would not be large,” and the future rate decisions “would depend on the incoming data.”

That statement was perceived as a rather soft message, and investors now believe that the interest-rate hikes are about to end. On this expectation, the markets reacted sharply and equities, as well as bonds rallied, the U.S. dollar sunk, and precious metals rebounded after the recent sell-off.

In my opinion, the markets overreacted to this news, as I feel that the Fed funds rate is going to rise significantly in the future. Perhaps the Fed will pause momentarily after the Fed funds rate is pulled up somewhat more, but the overall trend for interest-rates is now up. Looking back at history, it is interesting to note that the Fed funds rate went up from 1955 to 1981. Thereafter, the cost of money (interest-rate) declined for the next 23 years. I believe this cycle reversed when the Fed funds rate bottomed at 1% and think that we are now in the early stages of a major uptrend, which will probably last for years.

Over the past year, the money supply in the United States has grown by 7.3%. In other words, inflation is running above 7% – still significantly higher than the current Fed funds rate of 4.25%! Quite simply, even today, the Fed is literally giving money away. In my view, the Fed has no choice but to continue raising its rate, otherwise the massive ongoing inflation will surface through even higher commodity prices and the public will smell a rat. If the Fed doesn’t continue to hike, the price of gold and oil could go up to the point where people lose faith in the modern-day monetary system – not what the Fed wants!

When commodity prices went crazy in the 1970’s, the Fed increased its interest-rate to almost 20% in 1981. If they hadn’t increased the Fed funds rate dramatically, the American currency would have collapsed as people continued to exchange their dollars for tangibles.

Today, the majority of analysts feel that the Fed will not raise rates any further because if it does, the U.S. stock and property markets will get badly hurt. However, these analysts seem to forget that during the 1970’s, the U.S. economy was in a mess, Britain had to be bailed out by the International Monetary Fund (IMF) and America’s stock market was in shambles. Yet, the Fed continued with its rate-hiking program without caring too much about asset-values! Why? Remember, the Fed can tolerate a recession or a bear-market, but it can’t survive if people realize that the U.S. dollar is basically a junk currency that will only become worthless over time, due to inflation. So, the Fed has to ensure that the U.S. dollar loses its purchasing power rather gradually. If this process speeds up and becomes evident, the Fed must intervene to halt the U.S. dollar’s destruction (temporarily) by raising its interest-rate.

In the current environment, as the energy shortages become more evident, consumer price levels and commodities are going to rise significantly. Therefore, in order to maintain the public’s confidence in the U.S. dollar, the Fed will continue with its monetary tightening.

If my assessment is correct and interest-rates continue to rise, the equity and real estate markets will come under pressure. According to Gavekal Research, the tightening is already taking effect, and the monetary base has not been expanding as rapidly in the United States for a while now.

The global economy also faces some other challenges, which may disappoint equity investors after the first quarter of this year. After a substantial rise, the American housing market is showing signs of an imminent slowdown, which may hurt consumption in the world’s largest economy, as Americans have continued to spend by borrowing against their rising home prices. U.S. consumption accounts for roughly 70% of GDP, and if housing starts to deflate, its economy may come under strain. History has shown that the emerging economies have always suffered badly whenever with the U.S. economy has softened. Therefore, caution is warranted if you have invested in the developing markets.

Recently, China announced that it plans to diversify its foreign exchange reserves and will reduce its exposure to the U.S. dollar. China’s reserves are close to US$800 billion, and any major shift may cause the U.S. dollar to decline resulting in turbulence in the capital markets.

Finally, crude oil prices may really surprise most people over the coming months. My research has convinced me that our world faces an energy crunch due to rising global demand and tight supplies. Several oil provinces in the world are now past their peaks and the global output may decline in the face of rising demand, especially from the emerging economies of India and China. The previous bull-market in energy that took place in the 1970’s caused a severe recession in the United States. Moreover, Britain also had to be rescued by the International Monetary Fund during this period. History has shown that the global economy did not react too well when oil prices really exploded higher. Accordingly, the price of energy is another factor, which investors must watch closely.

I expect some more upside in the equity markets over the coming weeks. However, I am of the opinion that once a top is formed, the global stock markets may embark on a very overdue and lengthy correction. Therefore, investors are advised to book their profits and fresh buying should only be done after a major shakeout.


Puru Saxena
for The Daily Reckoning

Editor’s Note: Puru Saxena is the editor and publisher of Money Matters, an economic and financial publication. An investment adviser based in Hong Kong, he is a regular guest on CNN, BBC World, CNBC, Bloomberg TV & Radio, NDTV, RTHK Radio 3 and writes for several newspapers and financial journals.

The above is a FREE segment from Money Matters. The entire report is available only by subscription – available at www.purusaxena.com

Send in the clowns!

When a great man dies in office, the nation hangs its head in black sorrow and drapes its balconies in black crepe. But when a great man retires, there is no suitable rite of passage. People know that some important milestone has been reached, but they don’t know what to do about it.

Yes, dear reader, the big day has finally come…the last day…the ultimate, final, end-of-the-road day is here. As of tomorrow, the world will be different. There will be no Alan Greenspan at the helm of the world’s financial ship.

There are few precedents. The most powerful men in the world do not usually walk out of office; they are usually carried out…or thrown out. Lincoln was shot in the head by a member of a famous family of actors. So died Roosevelt of natural causes. Wilson lost his mind…though no one seemed to notice much difference. Caesar, of course, was cut down on the Capitol steps. Louis 14th died of old age. The British turned on Churchill and voted him out of office. One great exception to the rule was Emperor Diocletian …who retired in good health and good grace from his post and spent the rest of his life raising cabbages.

It seems a shame that Alan Greenspan should be turned out with no more than shallow newspaper articles and empty-headed hagiographies to mark the day. Here, we offer some suggestions:

Two minutes of silence: At noon today, we should stop all the clocks and ATM machines. People should hush-up and reflect on what Alan Greenspan has done for the nation and its money, and what it would mean if the nation’s great credit bubble were finally popped.

Another minute of silence: Because it may take more than two minutes to figure it out…and begin breathing again.

A very happy hour: What more suitable honor could George W. Bush bestow on Alan Greenspan than to open the nation’s bars and offer free drinks to everyone? Alan Greenspan never took the punch bowl away. George W. Bush kicked his drinking problem years ago, but he still likes to have a good time spending other peoples’ money.

He learned to pass on the punch, but never passed a single Congressional boondoggle without signing on. Alan and George…George and Alan – what a pair! Between the two of them, the nation has wobbled from debt to insolvency…from mere tomfoolery to complete absurdity…from idle conceit to active hallucination. Isn’t that worth hoisting a glass or two, and staggering through an off-key round of Auld Lang Syne, before we all fall under the table?

A boisterous parade: Yes, we can see it…a marching band, making a lot of noise. Clowns – many, many clowns – jugglers…yes…lots of jugglers.

We also need freaks, elephants – a whole circus of extravagant and grotesque forms. The circus acts would be followed by organized groups, but not the Shriners, nor the Free Masons. We suggest a contingent of economists – Alan Greenspan’s own league of mumblers, fumblers, equivocators and prevaricators. And yes, how about the guild of mortgage brokers, or real estate appraisers?

And don’t forget the lenders: Fannie Mae and Freddie Mac ought to have a float – lots of float – enough floats to get them from here to the moon. Surely, they would all turn out for a parade honoring Alan Greenspan! All of Wall Street’s finest – twanging colorful suspenders, and waving fat bonus checks! And let’s not leave out the grifters, flimflam artists, conmen, safecrackers, croupiers, bookies and shysters, for whom Alan Greenspan is practically a living saint.

Who are we leaving out? We cannot forget the members of Congress, re-elected several times thanks to Greenspan’s easy-money policies. We can see them marching by now…waving at the voters, bending over to kiss a baby, or fondle a teenager. And, oh yes, how about a few marching ranks of Chinese businessmen, resplendent in new Rolex watches, all rich as Republican war contractors, thanks to America’s free-spending ways?

And bringing up the rear, finally, the Maestro himself; the beloved chief of the Fed, would be carried along on a throne of papier-mache, an immense chair formed of 100-dollar bills and U.S. Treasury notes. It would balance on the shoulders of a squad of credit-drunk working stiffs – like an Egyptian pharaoh on a golden throne raised up by Nubian slaves. Oh, how the crowds would love it. But only we would see the delicious irony, dear reader, of that papier-mache throne…and those bent-over debt slaves carrying it. We would get the joke and chuckle to ourselves as the parade wound by.

For, the poor lumps still don’t get it. They never understood what was happening then and they still don’t understand now; they’d be thrilled to carry him.

After the parade has passed by and the bars have closed up, when the street sweepers are gathering up the confetti and paper beer cups…perhaps one final tribute could be offered, a genuine testament to Greenspan’s fulsome Reign of Error at the Fed. It could be framed as a bit of advice: Let a lone airplane cross against the sky…towing a banner where anyone can read: GOLD…BUY IT!

More news from the pundits at The Rude Awakening…


Dan Denning, reporting from Melbourne, Australia:

“The ‘peak oil’ debate keeps raging on the message boards and blogs of the Internet…but neither camp presents an idea that would prevent oil prices from soaring much higher than they are currently.”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.


Bill Bonner, back in London with more opinions…

*** The price of gold shot over $560. This is a new stage of the bull market, says John Hathaway of the Tocqueville Fund. People are starting to notice. Ordinary investors are beginning to put small amounts of gold in their portfolios – just in case. The price of gold is no longer creeping up – it’s soaring. Gold is up 25% in the last three months.

But even if the price of gold went to $1,000, all the gold in the world would still represent only 1.4% of global financial assets. When times get tough and people begin to worry, typically they want to hold more gold. In 1934 and 1982, for example, investors worried that the whole financial system might come crashing down. They bid up the price of gold to a point where it was worth more than 20% of global financial assets.

[Ed. Note: There’s a lot of room left in this bull market – which means there is still plenty of time to join the gold rush. Don’t be overwhelmed by all the different ways to invest in the yellow metal – our friends at EverBank have the quickest and easiest solution: their 5-Year MarkeSafe Gold Bullion CD. There has been so much demand for this CD that they have extended their special offer until February 14, 2006.

*** We misquoted MSNBC’s Joe Scarborough in yesterday’s edition – he said that you earned a million dollars a DAY – not a year, as we wrongly put it – going all the way back to the year of Jesus’ birth, you still wouldn’t have enough money to cover the nation’s financial obligation.

One DR reader helps us to further put America’s debt into perspective:

“If you earned $1 million per year for two thousand and twelve years, it would only amount to $2.012 billion – which is less than 20% of the annual budget for NASA.

“Now the truly sad statistic is that if you earned $1 BILLION per year for that same period, you would, as you rightly point out, only accumulate less than a quarter of the gaping hole in the Empire’s troubling balance sheet.”

The word ‘billion’ is thrown around an awful lot – and it is such a big number that it’s hard for most people to wrap their head around. Realizing this, our friend, Bill Murphy from LeMetropolecafe.com posted some helpful statistics on his site:

“The next time you hear a politician use the word ‘billion’ casually, think about whether you want the politician spending your tax money.

“A billion is a difficult number to comprehend, but one advertising agency did a good job of putting that figure into perspective in one of its releases.

“A billion seconds ago it was 1959.

“A billion minutes ago Jesus was alive.

“A billion hours ago our ancestors were living in the Stone Age.

“A billion days ago no one walked on earth.

“A billion dollars ago was only 8 hours and 20 minutes, at the rate our government spends it.”

*** Dan Denning sends us a “Strategic Suggestion” for the Empire of Debt documentary…

He recommends that we model the documentary after the classic movie Easy Rider:

“Who needs Bernanke and Greenspan when you can have Bonner and Wiggin? The movie begins with Bill and Addison stuffing copies of EOD in the saddlebags of their hogs in Mt. Vernon Square in Baltimore.

“Bill will be playing Captain America, or Wyatt, played by Peter Fonda in the original. We’ll outfit him a leather jacket with Confederate flag on the back. His helmet will be painted like the French tricolour. And before leaving Baltimore, he’ll fill the teardrop shaped gas tank (painted like the Stars and Stripes) with $10k in $20 St. Gaudens gold double eagle coins (the secret currency).

“Addison will play Billy, played by Dennis Hopper in the original. He will be in charge of this road trip, and ride a hog painted in red and gold racing flames, like the colors on the cover of Financial Reckoning Day.

“The trip begins in Baltimore, where it all started anyway, but stops first in New York to pick up Eric Fry, before heading down to the gold conference in New Orleans. Along the way, the trio will try not to run afoul of the crypto-fascist ideology creeping into American politics. They will spread a gospel of four Gs, ‘gold, guns, God, and guitars.’

“Eric, drawing on his California roots and channeling Jack Nicholson, will re-deliver his mounted sermon from anywhere the trio stops. It will go something like this, with a nod to the original script by Peter Fonda and Dennis Hopper.

“When asked what the people at Agora and The Daily Reckoning are really like, he’ll say:

“‘Well, they are people, just like us…from within our own solar system. Except that their society is more highly evolved. They don’t have no wars. They got no monetary system. They don’t have any leaders, because each man is a leader. Because of their technology…they’re able to feed, clothe, house and transport themselves…equally and with no effort.’

“This will scare most people. Bill will look on, scribbling notes, knowing that it always happens this way. But Addison will wonder.

“‘Why are they scared of us?’ he’ll ask Eric. ‘Is it what we have to say about gold? Or is it the way I sound on the guitar?’

“‘They’re not scared of you,’ Eric sagely replies, ‘They’re scared of what you represent to them.’

“‘All we represent to them is somebody who needs a haircut,’ Addison says as he scratches his mop of greying hair. Bill says nothing, nervously kicking his loafer in the dirt. Eric fills the awkward silence.

“‘Oh, no. What you represent to them…is freedom. Freedom’s what it’s all about.’

“‘Oh yeah, that’s right. That’s what it’s all about,’ Addison says, visibly perking up and reaching for the Shiraz. Eric studies him and the replies.

“‘But talking about it and being it…that’s two different things. It’s real hard to be free…when you are bought and sold in the marketplace. Don’t tell anybody that they’re not free, because they’ll get busy…killing and maiming to prove to you that they are. They’re going to talk to you and talk to you about individual freedom. But they see a free individual, it’s going to scare them.’

“Bill strums a Johnny Cash tune on the guitar. Addison frowns and speaks.

“‘Well, it don’t make them running scared.’ Eric nods and smiles.

“‘It makes them dangerous,’ he says.

For the rest of the story, you’ll have to either read Empire of Debt, or wait for the movie!

Get your copy of “The Most Feared Book in Washington” here:

Empire of Debt: The Rise of an Epic Financial Crisis