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By Daniel R. Amerman, CFA
Finally and with the greatest of
reluctance – the US government has begun the defense of the US economy. This
essential and long overdue defense is likely to be extremely painful for US
investors, precisely because it is so long overdue. To return strength to a US
economy mired in growthless depression requires an extraordinary action – the
Federal Reserve and US government are openly going after the value of the US
dollar.
For the minority of the US population
who are aware of and following these developments, the "headline"
attack on the US dollar is the Federal Reserve's imminent likely return to
quantitative easing. The current
discussion is that this will take the form of the Fed creating money out of
thin air to fund US government budget deficits through the direct purchase of
government bonds. No more pretenses, but
openly getting down to the ugly business of outright monetization on a massive
scale. This strategy aims to deliberately
knock the dollar off its pedestal in the short term, and possibly ends the
dollar's status as a global reserve currency in the longer term.
This focus on quantitative easing misses
the immediate danger, however, and the reason for the assault on the
dollar. For the US economy to grow
again, US exports must become less expensive, while US imports must simultaneously
become more expensive. Imports sharply
rising in price means an immediate exogenous price shock that will send consumer
prices rising for everything imported into the US. This immediate domestic consumer price
inflation is the necessary consequence of a nation successfully slashing
the value of its own currency relative to other currencies, as we will cover in
this article. It is this second blade of
a double assault on the value of the dollar that will be first hitting
investors and consumers, even while the focus is on the first blade of quantitative
easing.
(The
word successfully is underlined above because it is an assumption, we
don't yet know how the counterattacks will play out if and when currency
devaluations grow competitive between nations.)
For the overwhelming majority of US
savers and investors, this assault on our currency by our own central bank and
government will be catastrophic. A
glittering exception is, of course, gold which just reached $1,380 an ounce
last week. Even for gold investors,
however, this assault by the US government on its own currency carries hidden
risks that could involve giving up all the real (inflation-adjusted) profits
from possibly the best time to buy gold in our lifetimes.
The Federal Reserve has been openly
assaulting the dollar by threatening outright monetization of US government
deficits. Simply put, the US government
would continue to spend "stimulus" and other dollars without limit, and
the Federal Reserve would directly create the money as needed to purchase the
Treasury bonds. The monetization amounts
vary as the Fed threatens dollar buyers through the use of rumors, with a range
from this week's widely reported $100 billion a month monetization rate, to $2
trillion over the next year, to whatever it takes to get what the Fed wants.
In some ways, not all that much has
changed. We still have an effectively
bankrupt nation which depends on running trade deficits to pay for the day to
day standard of living for its citizens.
The Federal Reserve has been monetizing on a massive scale for two
years, it has just been doing it to manipulate the mortgage and other markets
rather than directly funding the Treasury.
A bankrupt government, that can't pay its current bills, has no chance
whatsoever of paying for legally binding promises to 78 million Boomers
approaching retirement age - except through inflation, as I have been writing
books and articles about for years now.
What has changed is the intent and the
method, however. The Federal Reserve is
openly threatening the US dollar, and this is extraordinarily serious, because
if there is one thing a central bank can do at will, it is to annihilate the
value of its own symbolic currency. Also, as I wrote about extensively this past spring,
the previous monetization was "sterilized", with the Fed creating
barriers to keep the new dollars out of circulation, which sidestepped
immediate inflationary effects, albeit at a price of partially hollowing out
the real economic basis of the US banking system. The current proposal is the real deal,
however, with the Federal Reserve directly creating dollars which the Treasury
puts directly into the money supply.
The Fed's threats have caught the full
attention of the global currency markets, as intended. The US dollar hit a 15 year low against the
yen last week, and a 17 year low against the Chinese yuan. The US dollar has fallen for five weeks
against the euro, and reached parity with the Australian and Canadian
dollars. According to the Dollar Index
used by International Exchange, Inc., the US dollar has fallen by 4.2% against
a global basket of currencies over the last month (source: Bloomberg).
We have to keep in mind that the
goal of the federal government through openly threatening (and almost certainly
carrying through with) monetization is not monetization for its own sake. No,
the immediate goal is to resuscitate the economy. And for the economy to be
resuscitated, that means that the United States must export more goods, while
importing fewer goods. So more jobs are created in producing the products that
are exported as US exports grow more competitive, and separately, jobs are also
created as more products are produced domestically, because imports are no
longer as cheap.
Those are the really key words – imports are no longer as cheap.
Last year I wrote the article "Inflation
Supply Shock Inferno" with an accompanying video (linked below) that used
simple to follow illustrations to explain how this deliberately created price
shock can quickly lead to explosive inflation in the US. Here's a key excerpt, with round number
illustrations (the same principles work with a 10% change and a 20% change):
What happens to prices? Let's look at Wal-Mart, Target and Best Buy.
What all those "big box" stores have in common is that their aisles
are stacked full of goods made in China, Japan and other nations – for which
the United States can't really pay. Goods
that we're only able buy because they're buying our treasury bonds in exchange,
essentially propping up our trade deficit by paying for our budget deficit.
Now, if the dollar drops in half, that means the cost of virtually everything
that we buy in those stores would double overnight.
So, instead of paying $1,000 for an
HDTV – we’re suddenly paying $2,000.
Instead of paying $3 for a plastic
spatula - we're suddenly paying six dollars.
Instead of $70 for a dish set - all of
a sudden it's $140. We have an
immediate, drastic inflationary price shock, with the prices for everything we
bring in from overseas soaring overnight.
Most importantly, let’s not forget
about oil. The US consumes far more oil
that it produces, the situation is getting worse, and 60% of US oil consumption had to be imported by
August 2009. It’s quite ironic,
really. Day after day, the city streets
and interstate highways of the United States fill up with the largest fleet of
massive, gas-guzzling vehicles in the world.
Yet, we produce neither the gasoline to run to them, nor the real goods
and services to pay for that gasoline.
Ironically, it is the other nations of the world, almost all of whom
have smaller fleets per capita, and more fuel efficient vehicles on average,
who subsidize the driving habits of the United States by deferring consumption,
propping up the dollar, and effectively lending the money to the US through
purchasing our government debt and other financial assets.
Let me suggest that this is an
extraordinarily unstable situation. If
there is anything that a long term history of the world shows us, it is that as
comfortable and natural as unstable relationships can seem to be when we are in
the middle of them, equilibrium will be sought by the very fundamentals of
economics and human behavior, and the return to equilibrium may be sudden and
catastrophic.
If we have to actually start paying our
own way, and other countries stop manipulating the value of the United States
dollar, then we can expect a sudden rise in the price of oil. Which in turn raises the cost of
transportation, heat, energy – and almost everything else.
Instant price shock. Think about the mid 1970s, only permanent
this time.
What about food? Even the food we produce domestically heavily
relies upon fertilizers, which rely on petrochemicals. Oil price shock means food price shock.
Let’s consider a common shopping trip,
of the kind that tens of millions of Americans do every day.
Start at the gas station where more
than half the oil is imported –inflationary price shock.
Move on to the Wal-Mart filled with
imported goods that can’t be paid for on a national basis – inflationary price
shock.
Next to the Best Buy big box
electronics store, also filled with imported goods that can’t be paid for on a
national basis – another inflationary price shock.
And finally to the grocery store,
filled with drastically more expensive imported foods that rely on oil for
transport, and domestic foods that rely on petrochemical-based fertilizers –
still another inflationary price shock, for four external supply based
inflationary price shocks in a row, on all four stops.
If you want to use the technical term
for what I've just been describing, they are what is known as “exogenous supply
shocks”.
A series of interrelated exogenous
supply shocks can set off a chain of events that will lead to an economic
forest fire growing out of control. Each
place the fire spreads to - sets off the places next to it. As the fires combine their strength, the
flames grow hotter still, and spread to still more places, until there is an
inferno. This inferno then creates the
most dangerous part of inflation:
inflationary expectations. Supply
shocks can come and go, but once people incorporate inflation into their
behavior, this sets off a chain of events that can go beyond the control of the
government and the central bank. There
was about a 7 year lag between when the inflationary exogenous supply shock of
the oil embargo of 1973-74 hit an already inflationary American economy, and
when inflation peaked in 1980-81.
Inflation creates its own fuel once external supply shocks ignite the
fire.
The complete article and video can
be found at:
http://danielamerman.com/Video/Shock.htm
To many people, the idea that the
solution to an economy in deep trouble is for a nation to attack the value of
its own currency may be difficult to understand, even counterintuitive. If
you're already in bad trouble, why make things worse by attacking your own currency?
The answer can be found in
elementary economics, something which the US government has been doing its best
to ignore for more than 10 years now. If you have a "strong currency",
that means that your currency is high in value relative to other currencies.
Having a stronger currency makes it cheaper for you to buy goods from other
nations, but more expensive for you to sell goods to these nations. Thus domestic jobs are lost and the real
strength of your economy is reduced in two separate ways: your exporters have a powerful price
disadvantage when trying to sell to other nations, and your domestic producers
have trouble competing with the cheaper goods coming in from overseas.
In a normal economy with a
responsible government that is looking after the interests of its own citizens,
the situation of having a "strong" currency is more or less self
correcting. The result of a strong currency is that you export less and import
more, which means that you can no longer pay for your imports. Therefore the
value of your currency corrects by dropping until a level of equilibrium is
reached, and exports more or less balance with imports.
At least that is how it is supposed
to work in a theoretical world where governments don't manipulate the value of
their own currencies. In the real world, governments (of course) do manipulate
the value of their currencies to try to gain competitive advantages for their
own citizens. In the past, this often
led to a counterattack from the nation whose economy was under assault. These are not new concepts, and historically,
nations usually defend their economies when another nation effectively assaults
their economy through currency manipulation.
However, this has been precisely the
situation with the US economy for more than 10 years now, most openly with
China. Rather than counterattacking -
the US government in successive administrations adopted a policy of pre-emptive surrender. Under a naïve academic theory of so-called
globalization, that in fact ignored the real world "elephant in the
room" of massive Chinese currency manipulation, much of the US real economy
was exported to China and other nations.
Of course, the academics generally weren't the decision makers, as this
situation worked to the short-term benefit of many major corporations and
banks, with the side effect of a corresponding hollowing out of the US real
economy.
As covered in my article on the
subject "US Employment May Be Hammered By Euro Plunge", linked below,
the situation was greatly exacerbated by the falling euro this past spring.
http://danielamerman.com/articles/Employ.htm
As explained in that article, the
entirely predictable result of a falling euro – there is no surprise factor
here – is that a severely wounded US economy could not recover so long as the
dollar was strong relative to the rest of the world. US workers in the US economy were in desperate
need of help, but instead US government policies kept the dollar high, which
meant US companies were handcuffed in their ability to export goods, as well as
handcuffed in their ability to fight against artificially cheap imports that
were the result of Chinese and other currency manipulations.
Finally and belatedly, the US
government is taking the only action that it can take to try to revive the US
economy and pull it out of the growthless depression (in real terms) that it
has fallen into. Currency manipulations from other nations can no longer be
tolerated, and that means the US government must competitively knock down the
value of the dollar relative to other currencies.
The increase in prices briefly
illustrated above isn't theory, and it isn't paranoia - it's the objective. To
resuscitate the US production of goods and the real economy, imported goods
must become substantially more expensive in the United States than they are
right now.
What this will lead to is a rapid
redistribution of wealth within the United States.
Many US manufacturers will benefit.
US workers will, while on average likely having a lower standard of living,
still have an ability to adapt. Wages will at least partially rise with
inflation. More American workers will be finding jobs.
But there will be victims, tens of
millions of innocent victims, and they can be identified primarily by
demographics and past behavior. The most
numerous victims will older Americans, Boomers and retirees, who have
responsibly worked their entire lives.
People who don't have all that many working years ahead of them, and who
have accumulated savings both in dollars, and in financial instruments
that are subject to devastation from high rates of inflation.
It is these Americans whose future
lifestyle will be sacrificed in order to try to bring jobs back to America. Again, this is no theory, but what is
happening in real time. The US government and the Federal Reserve are openly
coming after the value of all of our savings. There should be daily headlines running in
every newspaper in the country about the destruction of the savings and
lifestyles of older Americans – but there are not.
It is a deeply unfair world.
However, there is one investment that has been doing remarkably well and has a
good chance of continuing to do remarkably well, and that is that tangible,
fundamentally contra-cyclical investment which is gold (as well as silver and
some related commodities).
That gold should hit a record price
of $1,380 an ounce even as the Federal Reserve openly discusses monetization in
order to bring down the value of the dollar is no surprise. It is merely a
minority of people rationally acting in their own self-interest. And as more
and more of the population awakens to what is happening to the dreams they
built over decades, and desperately try to hang onto at least part of what
they've built, there would seem to be a very good chance that we've just seen
the very beginning of the gold bull market.
The simple solution is to pull all you
can out of paper investments and symbolic currencies, put them in the gold, and
hunker down to survive the still coming crisis.
Unfortunately, however, we live in a
complex and deeply unfair world, that makes mincemeat of emotional reactions
and simple solutions. As illustrated in step-by-step, easy to understand – but
irrefutable – detail in the article "Hidden Gold Taxes: The Secret Weapon Of Bankrupt Governments"
linked below, a simple solution of just buying gold leaves you handing a good
chunk or perhaps most of your starting net worth over to the government by the
time all is said and done. The way the government – under existing laws –
effectively confiscates the wealth of gold investors in a highly inflationary
environment is little understood by most gold investors, but should form the
central point for their investment strategies.
http://danielamerman.com/articles/GoldTaxes1.htm
| Click Here To Learn About A Free Mini Course That Will Teach You How To Turn Inflation Into Wealth. |
Let me suggest an alternative approach,which is to study, learn and reposition. Almost all financial and economic articles
that you see today are really about the upcoming re-distribution of wealth,
whether those words are used in the article or not. To have a chance, you must learn not just how
wealth will redistribute, but how unfair government tax policies (that can be
relied upon to increase in unfairness) will cripple most simple methods of
attempting to survive inflation.
Then, yes – buying gold (and perhaps a
lot of it) can be one key component of a portfolio approach, as discussed in my
Gold Out-Of-The-Box DVD set. Use
multiple components, each doing what they do best, shift the components in a
dynamic strategy over time, and position yourself so that wealth will be
redistributed to you in a manner that reverses the effects of government tax
policy. So that instead of paying real taxes on illusionary income, you're
paying illusory taxes on real income. And the higher the rate of inflation and
the more outrageous the government actions – the more your after-inflation and
after-tax net worth grows.
Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will
redistribute real wealth to you, and the higher the rate of inflation – the
more your after-inflation net worth grows?
Do you know how to achieve these gains on a long-term and tax-advantaged
basis? Do you know how to potentially
triple your after-tax and after-inflation returns through Reversing The
Inflation Tax? So that instead
of paying real taxes on illusionary income, you are paying illusionary taxes on
real increases in net worth? These are
among the many topics covered in the free “Turning Inflation Into
Wealth” Mini-Course. Starting simple,
this course delivers a series of 10-15 minute readings, with each
reading building on the knowledge and information contained in previous
readings. More information on the course
is available at DanielAmerman.com or InflationIntoWealth.com .
Contact Information:
Daniel R. Amerman, CFA
Website: http://danielamerman.com/
E-mail: mail@the-great-retirement-experiment.com
This article contains the ideas and
opinions of the author. It is a conceptual exploration of financial
and general economic principles. As with any financial
discussion of the future, there cannot be any absolute certainty. What
this article does not contain is specific investment, legal, tax or any other
form of professional advice. If specific advice is
needed, it should be sought from an appropriate professional. Any
liability, responsibility or warranty for the results of the application of
principles contained in the article, website, readings, videos, DVDs, books and
related materials, either directly or indirectly, are expressly disclaimed
by the author.
Copyright 2010 by Daniel Amerman