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January 15,2010
by David Galland, Managing Editor,
The Casey Report
An interesting article by Ambrose Evans-Pritchard came my way
the other day. It’s worth a read, if for no other reason than
that he paints an appropriately dark picture of the current
state of the U.S. economy.
You can read it here.
While I very much share Mr. Evans-Pritchard’s view that the
global economy is far from out of the woods, our views diverge
in that he sees devastating deflation speeding our way down the
tunnel. Casey Research readers of any duration know that we see
devastating inflation.
While we could both be right, with deflation first and inflation
later, I’m not so convinced.
For starters, there is already a massive inflation operation
being run by the Fed, evidenced in a historic spike in the
monetary base over the last two years.
And the Obama administration is far from done.
The Democrats’ reinvigorated focus on jobs – the single most
important factor in this November’s elections – will soon
translate into a flurry of new initiatives designed to put
people back to work, most of it funded at taxpayer expense.
To believe in the deflationary case would seem to require
believing that Obama and his minions are ready to forgo any
further political aspirations by collectively putting their feet
up on their desks for the balance of their sole term at the apex
of global power.
Given Obama’s meteoric rise to power – evidence that he
possesses a certain drive and competence in the game of politics
– that seems highly unlikely. And so it seems safe to assume
we’ll soon witness a redoubling of his efforts to keep interest
rates down… to make it easy and cheap for strapped consumers and
businesses to keep borrowing… and to otherwise flood the economy
with money.
In a deflation, the value of the money increases – which is
actually a pretty desirable thing, if you ask me. Inflation, by
contrast, means that pretty much everything you own in the local
currency steadily loses value – forcing investors into a
perpetual game of catch-up. It’s hard for me to calculate how
the government can dramatically increase the money supply and
yet have each of the currency units become increasingly more
valuable over a sustained period of time.
Arguing against that point, Evans-Pritchard makes the case that
the U.S. government is making much the same mistakes that were
made in the first part of the Great Depression, i.e., being
overly tight with the money. And that the velocity of money is
falling.
There are a couple of key differences between now and then,
however. First, the Fed didn’t actually know what the money
supply was back then. They literally had no monitoring tools in
place, mostly because no one thought it was important enough to
track. Second, they didn’t have fiat monetary powers. Today,
neither of those factors apply.
Everyone knows what the money supply of the U.S. is and watches
it keenly. Including our foreign creditors. And so it is not
surprising to see the Fed publicly talking about tightening up a
bit. But it’s just talk at this point.
With the economy continuing to struggle, the only reasonable
assumption that can be made is that the Fed – in cahoots with
the entirely politicized Treasury – will keep shoveling money
onto the economic embers, and continue to do so until economic
activity again flares up.
That will, of course, require increasing the quantity of money
that actually makes it into the economy – but that should be
child’s play for Team Obama – with direct hiring and spending,
continuing to buy mortgages and other loans to suppress interest
rates, forgiving the bad debts of banks, or changing accounting
rules so that banks can postpone reckoning day. And that’s just
for starters, all of it packaged nicely in the name of the
public good.
And once the money starts to flow, there
will
be a pick-up in economic activity, which will beget yet more
money moving around. At first, this money will be a palliative
for the economic worries, but then comes the inflation – a small
trade-off, the politicians will decide, if it buys them enough
of a recovery to make it through the November elections and get
the president the second term you know he so strongly desires.
There is something else that I think the deflationists are
missing, and that has to do with confidence in the currency. If
the U.S.’s many creditors come to agree with our point of view –
that the dollar is being led to the altar as a sacrificial lamb
to political expediency – then they’ll further reduce their
purchases of our Treasuries and start trading their dollars for
stronger currencies and tangible assets, including precious
metals.
At that point, interest rates will have to begin rising to
attract new buyers. As you can see in the chart of long-term
Treasury bond rates, a significant move off recent lows has
already occurred, and rates are looking poised for a breakout to
the upside.
Of course, the higher those rates ratchet, the more it will cost
the U.S. government to carry its massive debt. While rising
rates will continue to drive demand to the short end,
suppressing those rates, in time the sheer quantity of paper
that will have to be rolled over, and the rising tide of
inflation, assures that short-term rates will have to rise too.
At that point, the train begins to leave the track.
As the train wreck approaches, the government is going to have
to find creative new ways to fund its social contract with
impatient voters. Perhaps, for instance, pegging everyday fines
and assessments to the amount of income a person makes. Executed
brashly, such policies might even allow the government to charge
a person of means, say, $290,000 for a speeding violation.
I know what you’re thinking: C’mon, let’s be realistic –
that
could never happen. Think again…
Europe slapping rich with massive traffic fines
By FRANK
JORDANS
The Associated Press
Sunday, January 10, 2010; 11:30 AM
GENEVA -- European countries are increasingly pegging speeding
fines to income as a way to punish wealthy scofflaws who would
otherwise ignore tickets.
Advocates say a $290,000 (euro203,180.83) speeding ticket
slapped on a millionaire Ferrari driver in Switzerland was a
fair and well-deserved example of the trend.
Germany, France, Austria and the Nordic countries also issue
punishments based on a person's wealth. In Germany the maximum
fine can be as much as $16 million compared to only $1 million
in Switzerland. Only Finland regularly hands out similarly hefty
fines to speeding drivers, with the current record believed to
be a euro170,000 (then about $190,000) ticket in 2004.
The Swiss court appeared to set a world record when it levied
the fine in November on a man identified in the Swiss media only
as "Roland S." Judges in the eastern canton of St. Gallen
described him as a "traffic thug" in their verdict, which only
recently came to light.
"As far as we're concerned this is very good," Sabine Jurisch, a
road safety campaigner with the Swiss group Road Cross.
Full story here.
Or maybe the government will force you to convert some or all of
your IRA or 401(k) into Treasuries perhaps packaged up in an
annuity. You’d be given the choice of making the switch or
making a withdrawal and paying all outstanding taxes at that
point. This is something that Doug Casey has warned about for
several years now.
The seeds of that possibility may be headed for the soil: the
following article from
BusinessWeek
reveals that the Treasury is now looking very hard
at the trillions in retirement accounts and trying to figure out
new ways to “help” the owners
of those accounts.
In my view, what’s important in this little dissertation can be
summed up as follows:
1.
The current administration and its congressional allies
have powerful political motives to soak the economic soil with
fresh dollars. The Christmas Eve announcement that the Treasury
is removing the $400 billion cap on losses it will cover for
Freddie and Fannie is a classic example of how far they are
willing to go to keep the money moving.
2.
Unlike the Great Depression, the U.S. is now on a fiat
money system – which is purpose-built for the current scenario.
Open the taps, and if that doesn’t work, open them even wider.
Failing to do so would be political suicide, and Obama and his
team are just not into the idea of serving a single term.
3.
Given the size of foreign holdings of U.S. dollars, the
nation is faced with a “rock and a hard place” situation, where
a sharp loss in confidence on the part of our creditors would
likely lead to a currency crisis that drives the value of the
dollar quickly lower, at the same time that it drives interest
rates higher.
Something will have to give. We think that something will
ultimately be the U.S. dollar, as it’s politically more
acceptable to have a failing dollar than a smoking hole where
the economy used to be.
Before this thing is over, I would not be surprised to see a new
currency regime adopted that introduces exchange controls and a
different category of dollar to be issued for the purpose of
paying back foreign creditors. Such a dual-track currency system
is nothing new but has been used by desperate regimes numerous
times throughout history.
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