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Dollar Horror
Over the past few days I have found myself almost feeling sorry for Mr Greenspan. If he was not a wealthy member of the elitist fraternity, and if he hadn't played a large part in creating this mess in the first place, I think I really would. At a time of life when his biggest worry should be the blackspot on the roses or not catching flu from his grandchildren, he finds himself at the wheel of an out-of-control juggernaut, by which I mean, of course, the US economy. He is so far behind the curve with raising interest rates, he doesn't even know where the curve is - it's somewhere over the horizon. The need to raise rates to support the dollar will in time become desperate, but for the time being, at least, it is politically impossible to raise official interest rates significantly, because to do so would result in an economic implosion due to the magnitude of private, corporate and public debt, the size of the deficits, the enormity of the derivative pyramid and the extent of leveraging etc. A major economic slowdown or crisis ahead of the November election would definitely be a turn-off for voters. The assumption that the Fed is politically biased towards getting the Republicans re-elected is a logical one, based on the fact that the Republican Party is primarily the party that represents the interests of big business, that is to say, even more than the Democrats, if that were possible. The choice facing Greenspan and the Fed as we go forward is between rapidly raising interest rates in order to buttress the dollar and the severe economic fallout that would result, and keeping them at a low level, which will mean a steeply declining dollar.
In the real world interest rates are driven by supply and demand, regardless of what the official rates are set at. Therefore, in order to keep markets assuaged, and real-world interest rates under control, liquidity must be maintained at all costs. This means continued expansion of the money supply, and if necessary, intervention in the markets to maintain confidence - as is already happening on a grand scale. This requires lots of money, and ever increasing quantities of it, but in a fiat money system where's the problem? - you just manufacture more and more of the stuff. Actually, there is a problem, because money is just a call on other peoples' time, time they use to make goods and provide services - peoples' time is finite, that means there is a limit to what they can produce. So if the money supply is expanding relentlessly, but the quantity of goods and services remains pretty much the same, it means that more and more money is chasing the same quantity of goods so prices get bid up - inflation.
I visited England a few weeks ago and was astonished at how much prices had risen since my last visit. A phone box call minimum charge had trebled, a coffee and a cake cost nearly 5 pounds. It didn't take me long to discover the reason for the price inflation. House prices in Britain have risen by 250% over the past 7 years. I tried to explain to some gloating relatives that they hadn't really got richer, it was just inflation - after all, you've always got to live somewhere. This so-called "wealth effect" has spread out and driven up prices across the board. I was also interested to learn that the UK monetary authorities are fiddling the inflation statistics to exclude house prices completely. Massaging statistics has been raised to the level of a science in the US, where the CPI figure bears no relation to real world inflation as experienced by the man on the street. They should offer a course on it at MIT - you'd be guaranteed a high-paid job when you came out. By the way, if you are the sort of person who enjoys spending lots of money and getting very little for it Britain is definitely the place to head for, especially London. A holiday in Britain would appeal particularly to the kind of person who likes to hold US dollar denominated assets at this time.
The similarities between economic trends in Britain and the US are in certain respects striking. Both countries have stoked up credit-fuelled economic expansion. Both countries have fostered asset price inflation, especially rising house prices, and both have made the ludicrous assertion that such price inflation can be "an engine of economic growth". Curiously, Britain has in the last few years taking to mocking its European counterparts for their lacklustre economies, which is a bit like a guy who borrows $300,000 against the value of his house to buy a Ferrari going and boasting to his next door neighbour who has a fully paid up Ford. Here are a couple of sentences from the front page of a newspaper, The Daily Express from 9th June, I bought while in Britain, which has a population of about 60 million, compared to about 250 million in the US. "Britons will officially owe a massive one trillion pounds by Friday (11th June). It is more than the combined national debt of Africa, Asia and Latin America. The 1,000,000,000,000 mountain means that every man, woman and child in the country will this weekend owe an average of 17,000 pounds on mortgages, credit cards and personal loans. As experts warned that yet another interest rate rise was likely, politicians said the debt was further evidence that Britain faces a borrowing crisis." US readers should find this particularly interesting, as Britain is further along on its "road to ruin" than the US is, even if the US has dug a far deeper hole beneath itself. Interest rates have been rising for some time, house prices have continued to climb despite these rises, but are now showing signs of fatigue, of topping out. Further rate rises can be expected to trigger a slump in the housing market and a debt crisis, particularly if the US goes into decline.
To return to our core theme of the outlook for the dollar; we have established that the Greenspan Fed will not raise rates significantly before November, in order to avoid collapsing the economy ahead of the November elections, and will also ramp the money supply and intervene in the markets to WHATEVER EXTENT IS PHYSICALLY POSSIBLE, in order to prevent bond/stockmarket meltdowns and a liquidity crisis and thus keep the lid on real interest rates. The problem is, however, that the dollar desperately needs the support afforded by much higher rates, and can be expected to plunge if it doesn't get it. This, for the Greenspan Fed, is the preferable evil, for the fallout resulting from a collapsing dollar and incubating hyperinflation will not manifest itself probably until well into next year - and the voters will not get the chance to express their displeasure about this until 2008.
The purpose of the reasoning presented in this article is to explain to readers why I believe we will see a steeply falling dollar during the balance of this year, and an upward trend in inflation in the US, possibly heading for extreme levels. This set of circumstances is extremely favourable for gold.