Taylor on Gold & Stocks

Strong Dollar is Hurtling the Global Economy Toward Oblivion

My good friend Marshall Auerback wrote an outstanding analytical piece this week for the Prudent Bear Fund titled, "America's 'Strong Dollar' Policy and Argentina's Default: A Root Cause that Dare Not Speak its Name." I would strongly advise you to visit www.prudentbear.com and from the home page, click on the "International Perspective" to read Marshall's latest gem. Not that you should ignore the other excellent articles at this Prudent Bear website. David Tice has an excellent group of analysts who always write insightful article that are far above the quality of regular pap you get from CNBC and other main stream media.

Following are some of the points I got from Marshall's article:

* Argentina is bankrupt to a large extent because it tied its currency to an overvalued dollar.

* Not only is the dollar overvalued, but the U.S. is continuing to pursue policies to make it even more overvalued for the purpose of sucking in global capital into already bloated American financial markets.

* The strong dollar policy is having the effect of destroying American competitiveness by rendering American manufacturing, mining and Agriculture non competitive. (We have frequently noted how Australian produce can be flown into the California markets more cheaply than produce can be sold locally thanks to the strong dollar and how this is putting the California farmer out of business.)

* The strong dollar policy is not only wrecking havoc on American competitiveness, but as it is also sucking capital into the U.S. and thereby misallocating global capital to already overvalued markets and away from poor destitute countries where investment returns could be much greater than they are bound to be in the U.S. when markets disintegrate here.

* In no small part, this lack of capital is leading to the demise of already impoverished countries which, due to extreme poverty are now becoming a security problem for the United States itself!

* The strong dollar policy started under Treasury Secretary Robert Rubin who showed extreme disregard for the competitive nature of American mining, manufacturing and agriculture. What Mr. Rubin was clearly more concerned with were the prosperity of the financial markets, which he knew very well from his prior life at Goldman Sachs. Marshall quoted Robert Rubin in a September 1966 article. Mexico was still boiling when Rubin faced his second potential political disaster, the fall of the dollar to below 80 yen. For Rubin, this was more familiar territory: he had supervised the currency traders at Goldman, and he knew both the fiscal and political risks. "These kinds of occurrences are not without consequences," Rubin said. A declining dollar tends to drive investors out of American stocks, bonds and Treasury debt, putting pressure on the federal government to raise interest rates. "It would take a while to show up, but I'm certain it would have happened," he said.

* Marshall argues quite effectively that this strong dollar policy is unleashing enormously powerful DEFLATIONARY forces around the globe that are extremely destructive. He notes that the IMF, which has over decades been "throwing good money after bad," has suddenly chosen to clamp down and impose draconian measures on Argentina that the United States policy makers would never agree to, like cutting spending in the midst of a depression! Marshall argues that this is taking place at the worst possible time as it has guaranteed Argentina's default. Marshall argues in favor of a more permissive monetary and fiscal policy for Argentina is what that country needs.

I unequivocally agree with Marshall that THE MOST SIGNIFICANT CULPRIT FOR ARGENTINA'S DEFALUT IS THE STRONG DOLLAR,because that has guaranteed a shrinking national income for Argentina from exports, just as it is guaranteeing the U.S. a shrinking income from exports. I have always been for free international trade, but the trade policies of the Clinton and now Bush Administrations are anything but free. They in effect add a 30% or 40% "tax" disadvantage to Argentine and American producers. In effect it is a policy geared to shifting wealth from mining, manufacturing and agriculture to our bankers. That should not be surprising given the crony capitalist arrangements between the bankers (who control the Federal Reserve) and elected officials. One might think of economic Fascism as a characteristic more of Argentina than America, but if one looks at what is happening in America, one might conclude that we are in the process of helping push Argentina back toward that form of dictatorship via our overvalued dollar.

For a time, the U.S. has been able to get away with its pernicious and evil strong dollar policy because it is the world's lone super power. Without the super power status of the U.S. Argentina cannot divert international capital flows into its capital markets as the U.S. can. But a nation that continues to increase its trade deficit and thus become more and more indebted to the world is a nation living on borrowed time. Unfortunately for America, the time allotted for us continue our practice of international thievery by way of printing more claims against the world's wealth may soon end.

GLOBAL ECONOMIC HEROIN ADDICTION

So where does all of this leave America and our financial markets as we head into 2002? What we see is a picture of enormous economic dislocations which are not allowed to self adjust because the U.S. continues to rig the gold price and push a dollar that is already 30% to 40% overvalued into even more extreme overvaluation. The question is, "How long can this rubber ban be stretched?"

America, which in spite of a major decline in equity values since March 1999, still has a more overvalued stock market than before the 1929 crash. Moreover, America has now taken on far more DEBT than ever in our history in relation to GDP. We are dependent on continuing inflows of capital to keep our economy alive and our basic industry (upon which our national security will ultimately hinge) is being systematically destroyed so that Wall Street can continue to "party on." Nor am I touched by the recent notice that J.P. Morgan employees will take a 40% reduction in their 2002 bonuses. I'm wondering how those dozens of million dollar bonus recipients are gong to cope with life's hardships this year when they have their bonuses trimmed to just $600,000 this year? Poor things!

With America's strong dollar policy inviting nations around the world to sell to us, other countries are increasingly engaged in a 1930's style "beggar thy neighbor" currency devaluation policy. That is not only leading to increasing global hostility, most notably between China and Japan, but it is also contributing to the continuously worsening global economic dislocation in trade and growing global deflation.

As Marshall noted in his article, numerous countries around the globe are being starved for capital that is unnaturally flowing to the U.S. The absence of that capital is retarding economic development in those countries and contributing greatly to the utter despair. But junkies don't care about the social harm they do to others around them. So, to use an old analogy of mine, the U.S. is like a giant heroin addict that needs increasingly greater does of heroin (dollars/debt) to avoid withdrawal symptoms that are become ever more frequent and ever more severe. So far the enormously productive dollar-creating machine known as the Federal Reserve Corporation has come through for the dollar junkies of the world. Thanks to Alan Greenspan who is displaying the actions of one experiencing a panic attack, the U.S. is creating money (and debt) at a pace seldom ever seen before in our history. The latest M-3 numbers show an astounding rise of 14.96% rise over the past 52 weeks! Incredible!

BUT EVENTUALLY THE PATIENT DIES

Heroin and other drug addiction, if unabated, eventually lead to the death of the patient because life support systems of the patient are destroyed by the toxic effects of the drugs. The creation of money out of thin air, which leads to mal investment and greater and greater debt loads is no different. Perhaps a stronger patient, like the U.S. compared to Argentina can last a while longer. But eventually, sufficient doses of dollars will kill the U.S. economy just as surely as increasing does of heroin will eventually end the life of a human being. The reasons running the printing presses with reckless abandon is lethal is due to the following dynamics which I have increasingly discussed in these weekly hotline messages. Because of their importance and because conventional wisdom does not consider them, I will mention them once again.

1) As money is created out of thin air, people spend their ill gotten loot foolishly. The old saying, "easy come, easy go" applies here. The signs of foolish spending or mal investment if you will, becomes more pronounced, the longer the period of prosperity. For the U.S. Ian Gordon traces the "good times" to about 1949, when the current Kondratieff 60+ year cycle began.

2) In a fractional reserve system, money is manufactured with debt. It is a demonstrable fact that the longer into the 60 or 70 year cycle the economy travels, rapidly growing amounts of new debt is required to generate the same level of national income or GDP. So as the long wave cycle matures you have the specter of rapidly rising debt with moderately rising income and eventually declining income, leading eventually to national insolvency.

3) So, as debt rises, increasing amounts of income are siphoned away from the economy to repay lenders principle and interest which in turn has the effect of reducing the demand side of the economy. With demand plunging, revenues, profit margins and profits plunge. And as companies being losing money, they lay off workers and refuse to spend for new capital projects which in turn lowers national income still further. But through all of this, DEBT remains a fact of life. From the banks point of view, it must be paid because they themselves do not own the money they lent. The enormous amount of leverage of course is what leads to the all too frequent threat of a run on banks. The only answer our government has to stopping a run on banks is the creation out of thin air of still more money from the creation of debt. In other words, more heroin to stop the withdrawal pains, which leads to a still higher leveraged banking system.

It is also a fact of life that toward the end of the current Kondratieff cycle, which Ian Gordon confidently states we are now in, balance sheets are extremely bloated with debt which means a) banks will not continue to lend to sick companies and sick individuals. b) And/or, people and corporations stop borrowing as they strive to put their balance sheets in order. With money growth dependent on debt creation, the "pushing on a string" analogy of the Federal Reserves attempt to stimulate monetary growth in the 1930's is appears to be a growing reality with us once again. To a great extent, our government has found a temporary way around this problem through government backed mortgage programs which is just another form of increasing leverage in the system and it has been a major reason why the U.S. economy has not yet plunged over the abyss into depression. But these programs too have their limits.

Thus, I believe the ingredients are in place for an economic decline that could be far worse than that of the 1930's, at least for Americans. Not only has the U.S. led the world into the current disastrous position, but we have also become the greatest debtor nation in history. Unlike the 1930's we are becoming ever more dependent on the policies of other nations. The dollar has been propped up because of the false sense of our currency's worth. So, 42% of U.S. Treasuries are now owned by other nations and in addition, enormous capital flows of foreign savings have moved into private sector investments as well.

GOLD RIGGING UNDERPINS THE OVERVALUED DOLLAR

The over valued dollar - which represents an enormous illusion from economic reality, has been fostered in no small part by the gold market rigging put into effect in earnest by the Clinton/Rubin/Summers team when the Mexican bail out - the first of multiple such bailouts to come - was undertaken. From his academic studies at Harvard, Lawrence Summers was well aware that a bail out of the world would be impossible unless the gold price was rigged.

It is clear from a paper Mr. Summers co-authored while at Harvard on the subject of "Gibson's Paradox" that he understood very well that if monetary bailouts were to take place, they would lead to increasing global problems in the financial markets unless the gold price were "capped." This was true Summer argued because if gold prices rose vis-à-vis the dollar, interest rates would rise, thus serving to offset any "benefits" of a bailout, because it would lead to a declining dollar and rising interest rates.

So, when Mexico became the first of many dollar bailouts by the Clinton Administration, the Clinton folks began rigging the gold price starting first by ensuring gold was available from central banks around the world either by gold loans and most likely also by way of gold swaps. Mountains of evidence for this gold market conspiracy are well documented in the legal papers posted with the U.S. Federal court in Boston, Where plaintiff Reginald Howe has filed a lawsuit against the Federal Reserve, the U.S. Treasury department and several major gold bullion banks.

Had the Clinton Administration allowed the gold price to rise from the mid 1990's onward, the global economy would not be in the disastrous shape it is now in. This is so because if gold had been permitted to rise, the dollar would not have become so overvalued (it may have headed in the opposite direction) and the enormous flows of capital into the U.S. that resulted in equity market insanity would never have taken place. Unfortunately, Greenspan and the Bush Administration are continuing to perpetuate by adopting the same strong dollar policy first put into effect by the Clinton Administration. When the Bush Administration first took over, comments from Treasury Secretary O'Neil about an overvalued dollar indicated the new team might look to restore sanity in the markets. But against much complaint from the Democrats and the popular press, Mr. O'Neil was quickly "educated" to spout a strong dollar story. Unlike Bob Rubin who used the power of his office to boost his crony capitalist buddies at Goldman Sachs, Mr. O'neil failed to help out his industry by ushering in a more realistic dollar policy. Once again the bankers won! The Americans people lost!

But the prospects of a rising gold price did not suit the near term political needs of the Clinton Administration, nor the corporate needs of the bankers who dominated the Clinton Administration. The Clinton Administration in effect "drained the mercury from the thermometer" by rigging the gold price and thus ensured that the illness afflicting the U.S. economy would be disguised. That policy allowed Americans to live under an illusion of prosperity and Clinton himself to avoid removal from office via impeachment.

Out of ignorance, Clinton is credited with a great economy when in fact his policies have ensured its ultimate destruction. But while his policies bought more time before the day of reckoning for America, they also fostered ever more outrageous global economic dislocations. It is unfortunate that Bush adopted Clinton's strong dollar policy such that global economic dislocations are becoming increasingly more pronounced. Not withstanding the propaganda heard every day on CNBC, America is nearing the edge of the abyss. As Marshall Auerback points out, Argentina was an important casualty of the strong dollar policy. But failure to recognize that the strong dollar is a major cause for Argentina's demise, guarantees that this pathology snuffs out economic life in America as well. Clearly, in the view of Ian Gordon and in a growing number of analysts - myself included, America is now inexorably moving toward the time when it too faces a massive deflation induced debt repudiation and another depression. Unfortunately, much of our ability to recover as a self serving nation will have been diminished by a manufacturing infrastructure that has been exported thanks to our strong dollar policy that have served bankers and politicians well.