The following is an excerpt from Casey’s Daily Dispatch… an ezine with thought provoking commentary that I thought you might find interesting. ~ Tim McMahon, Editor
Words from the Wise
By David Galland,
I would like to share just a few snippets I think you’ll benefit from, starting with the latest posting from Ambrose Evans-Pritchard, which you can read in full here.
Here’s an excerpt:
Today’s release on manufacturing activity by the Richmond Fed is pretty ghastly, as you would expect given that the effects of fiscal stimulus are now wearing off at accelerating pace – before the happy handover to the private sector is safely consummated – and given that the structural East-West imbalances that lay behind the global crisis are getting worse again.
The expectations index for the US 5th District is crumbling:
This follows yesterday’s horrendous fall in the Texas business activity index from the Dallas Fed, which fell from -4 in June to -21 in July. “Thirty-one percent of firms reported a worsening of activity, up from 22 percent in June,” said the bank.
This follows the fall in the ECRI leading indicator for last week to -10.5, a level that has always been followed by recession in the post-war era. The Economic Cycle Research Institute is careful not to jump the gun, waiting for further confirming data before issuing a formal recession call that would hurt its credibility if proved wrong by events.
Then there’s the following chart from a Wall Street Journal article, titled “Why This Isn’t Like 1938 – At Least Not Yet” by Donald Luskin. Kind of makes you wonder, eh?
The primary theme of Luskin’s article, which you can read in its entirety here, is that the stimulus may have averted a depression, but that “toxic, antibusiness rhetoric and policy errors like the Dodd-Frank bill are hurting the still-fragile recovery.”
The policy errors Luskin refers to include raising taxes and tightening by the Fed – which is exactly what happened in the depths of the depression, triggering the second long leg down shown in the chart above. Here’s a quote…
In 1937 the economy was in a strong recovery from a severe crisis, and there was complacency that the worst was over—much like the exuberance about a “V-shaped’ recovery this April. But after 1937 the economy relapsed into what historians call “the recession within the Depression,” a downturn so severe that in any other context it would qualify as a depression itself.
It was triggered by a set of very specific policy mistakes. The Fed tightened by raising reserve requirements. Consumers were hit with new taxes to pay for the then-new Social Security program. Worried about excessive deficits, Roosevelt cut government spending. At the same time, his administration accelerated antibusiness rhetoric and regulation.
Sound familiar? We’re repeating some of the same mistakes right now, even as fears of a “double dip” recession mount. Antibusiness rhetoric from the Obama administration is at toxic levels, and the pending Dodd-Frank financial reform bill is the harshest regulatory initiative in a generation. Taxes are set to rise, to support new social spending such as health-care reform, and if for no other reason because no one will stop the expiration at the end of this year of the 2003 Bush tax cuts.
Of course, there is one fairly glaring difference between 1937 and 2010 – namely that, as Evans-Pritchard points out in his article, what the administration is trying to pass off as a recovery is anything but “strong.”
Words from the Wise
John Hathaway, the manager of the Tocqueville Gold Fund, is one of the clearest thinkers in the field, a contention supported by his latest essay, The Committee to Save the World, which he has kindly agreed for us to excerpt, though you really should read the entire article, which you can do by downloading a PDF from the site linked to here.
What is the alternative to tax and spend? It is no surprise to us that legions of disoriented politicians have reconvened under the banner of austerity. However, anyone with a sense of history will not take such posturing seriously. Didn’t FDR promise to balance the federal budget in 1932? Clamor for belt tightening is likely to further damage the consumer psyche and strengthen the forces of deflation. The recent embrace of spending freezes by European politicians reflects desperation to gain distance from failed Keynesian and welfare state policies.
However, infatuation with fiscal prudence promises to be short lived once the deflationary consequences of these actions blossom into stark reality.
Economic policy on both sides of the Atlantic is in turmoil. European leaders push for austerity. Not so fast, say their U.S. counterparts who fear the deflationary implications of such a course. Keynesian stimulus packages seem to be losing their effectiveness as the economy sputters.
Former Fed Chairman Greenspan suggests the U.S. may have reached the limits of its borrowing capacity. If so, how will bigger stimulus packages be financed? How can interest rates, already at record lows, be lowered further to spur economic growth? What are the political implications of economic stagnation? According to George Soros, they are nationalism, social unrest and xenophobia.
What all of this adds up to, in our view, is the end game for paper currency. When dollar convertibility ended in 1971, it became nothing more than a social contract, similar in many ways to food stamps or air miles. As fissures in the social consensus widen, the fiscal viability of the governments that issue paper money is threatened and public confidence, essential to the acceptance of paper money, is at grave risk. An accelerated decline in confidence would be the perfect recipe for hyper-inflation.
Such an outcome is by no means guaranteed, but the odds seem greater than at any time since the establishment of the dollar as an international reserve currency. Failing a resolution of these seemingly intractable issues, the bid for gold seems likely to remain strong.
David Galland is the Managing Director of Casey Research