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The Rant: The Dollar and the Shoe
There were two pivotal events this week which I’d like to address before getting into the details of two additions to our EI portfolio. The first event lays the groundwork for a shift in our investment paradigm and the second. . . well, let’s just say it epitomizes a legacy.
No. 1: Federal Reserve abandons the dollar
The Federal Reserve moved the overnight funds rate effectively to zero in what can only be interpreted as their utter fear of a looming depression. The more significant Fed announcement was that they will be in the market purchasing large quantities of Treasury and Agency debt (agency debt refers to things such as Fannie and Freddie) as well as mortgage backed securities to provide support to the mortgage and housing markets. The Fed is dead set on re-liquefying the banking system and re-inflating the economy at all cost.
The cost will be borne by the US dollar, here’s why.
Current net US public debt stands at approximately $6 trillion (link). The US Treasury needs somewhere between an additional $5 trillion and $8.5 trillion to cover the 23 different plans it has committed to (so far) as part of its massive bailout and re-liquefaction program. That’s a 100% to nearly 150% increase over the current US Federal debt: a not so insubstantial number except by Zimbabwean standards. It is a sum about equal to the total current money supply and, more than half of the total annual US GDP. FYI: The US government already owns or operates 35% of the economy.
The Treasury has only two authorized options to raise that money: tax or borrow.
Taxing is not a viable option now. The US is in the early stages of what will prove to be the worst economic downturn since at least the Great Depression. Consumer debt stands at approximately $14 trillion and household wealth has dropped 11% this year. Although consumer debt did decline this year, most of that decline is the result of foreclosures: people are just walking away from their debt. Home values dropped a total of $2 trillion this year and nearly 15% of all single-family households owe more on their houses than they are worth. US GDP, 70% of which is consumer spending, is also negative and falling. All in all, tax receipts are falling dramatically and any additional taxes will only aggravate the current economic crisis. The US is taxed and debited out.
Given that the government cannot tax its way out of this mess it has no alternative but to issue more debt (borrow). Up until now buyers of government debt have been willing to accept low rates of return because of the perceived security offered by the US dollar. However foreign funding is drying up and buyers are unlikely to settle for these low interest rates once they consider that the Treasury needs up to $8.5 trillion on top of $6 trillion in already existing debt and, the fiscal deficit is likely to be over $1 trillion next year. On top of that, the country (USA) seeking the trillions of dollars in loans has a current trade deficit of about $1 trillion, is in a recession, and is experiencing negative GDP growth. There is no way any sensible investor would lend money to a company in similarly dire financial straits without being compensated for that risk by high interest rates. If the US Treasury were to increase the interest rates sufficiently to attract buyers the US economy would come to a total standstill and likely head into a deflationary depression: not good---buy gold!
That is the crux of the problem the US Treasury was facing. Increase taxes or increase interest rates to attract lenders to cover the up to $8.5 trillion needed to fund our way out of this self imposed calamity. Either of these options would potentially throw the US into a serious depression.
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The solution to this dilemma, the only solution, was to have the Federal Reserve buy the debt. That is what the Fed announced it is wiling to do this week: buy everything no one else is willing to buy. Lucky for them they are in the unique position of being the only agency that can create money out of fresh air. In so doing the Fed creates money to cover the debt and by default sacrifices the value of the US dollar. The debt now stands ready to be monetized and we will see this monetization process through monetary inflation over the next few years. As this debt monetization process proceeds gold will be the beneficiary. Gold is the last “safe haven” after the dollar and the reason we here at Exploration Insights are becoming a tad more aggressive in our purchases of junior explorers -- with the important caveat that we can see a potentially significant gold discovery: buy gold explorers!
What the Federal Reserve, the Treasury and the government are doing amounts to socialization of capitalism for the benefit of those who profited the most after the very same agencies mitigated the inherent risks of capitalism. This last paragraph segues directly into item number two for the week.
No. 2: Bush the Dodger
So this week’s shoe-throwing incident brought it all home to me. Watching Bush dodge that shoe during his victory lap through Iraq, over and over and over, it became apparent that our 42nd president had finally perfected his one great skill: dodging. It has taken Bush eight long years to perfect this move but in retrospect he has successfully dodged responsibility, truth and reality while debasing US prestige, freedom and its currency in what has to be one of the most shortsighted, self-serving and unprepared administrations in US history.
On CNN George W. Bush this week explained away the drastic measures the Federal Reserve and Treasury have taken as follows. "I've abandoned free-market principles to save the free-market system." He says he made the decision "to make sure the economy doesn't collapse. I am sorry we're having to do it, but I feel a sense of obligation to my successor to make sure there is not a, you know, a huge economic crisis. Look, we're in a crisis now. I mean, this is -- we're in a huge recession, but I don't want to make it even worse." Ah, one last fix.
And so the final coup d'état of this administration is the successful re-branding of American capitalism. In the new America the invisible hand of Adam Smith helps the capitalist reap huge gains while the egalitarian hand of Karl Marx steps in to socialize his huge losses. It appears the incoming administration is likewise committed to bailing US all out and sacrificing the dollar: buy gold!
Brent Cook
www.explorationinsights.com
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