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What's New

2011-11-22 11:09:15

Our borrowed existence - series

Question: What’s new?

Answer: Like I always say…I’m glad to be asked. I believe there are some very serious things that are happening in this country and in the world that are not being talked about by nearly enough people. I feel they must be brought to the forefront…now. I would prefer a person or persons with much more knowledge in these areas than myself to do so, but unless this is done very quickly, it may be too late. Perhaps it’s already too late…but I will do what I can. I am not an economist. I am not a politician. I do not have an agenda…other than using this column to inform as many people as I can of the things I see and have researched, in the hope something can be done. These things will take some time and space to cover properly, thus the reason why my articles on this subject has been and will be a series over the next few months, or until I am “shut down” for whatever reason or reasons. As I will do with each article in this series, I will tell you the information I will present has come from several sources, including but not limited to, Stansberry & Associates, Kiplinger, Weiss Research, the Wall Street Journal, the New York Times, the Congressional Budget Office, the National Inflation Association, the Center on Budget and Policy Priorities, several others…as well as my own analysis...for what it is worth. Last month we talked about local and state governments, and the Federal Government and the severe economic woes they are all facing. This month, we will talk more about this and what is going on in the rest of the world. But first, after a basketful of “chiding” email and calls from last month’s article in this series, let me comment on what happened in May on the price of commodities and the slight strengthening of the US Dollar (USD). Over just a few days, we saw all commodities…from copper to corn…silver to soybeans…and oats to oil…take a nose dive. As with any market, there are always going to be ups and downs. I will maintain however…nothing has changed. The long term trend is up for commodities and down for the USD. No paper-currency regime can last for long. The U.S. paper-dollar standard has been around for more than 40 years now. It's certainly long in the tooth…and becoming quite decrepit. The absurd fiscal policies our Federal Government is running (annual deficits of around 10% of GDP) will eventually lead to a collapse in the U.S. bond market and a return to gold-backed currencies around the world. None of our economy's problems or the risks I've described in this series have been resolved. Nothing fundamental has changed – the problems have only gotten worse. We have had a weaker bond market and stronger gold prices for the last two years. The Federal Reserve has been purchasing roughly 70% of all Treasury issuances. The Fed has "propped" up the bond market by printing massive quantities of new money – what it calls "quantitative easing." This kept a bid under the bond market…but led investors to buy gold (and other hard commodities) to protect themselves from the Fed's printing. Yes, over the past three months, the spread between Treasury bonds and gold has suddenly begun to narrow, because Ben Bernanke stated that the Fed will stop printing money as of the end of June 2011, and the USD strengthened on the news. When the USD strengthens, it takes less of them to buy oil and all of the commodities, thus their prices go down. But don’t count on the printing presses stopping for long. How will we pay our debts? How will we pay the interest on the debt? How will we pay for the increased debt ceiling? If we need money…have none…and there’s none to get…what else can happen but to print more of it, while we still can? On May 18, 2011, the Federal Open Market Committee released its minutes…which included nothing unexpected. The Fed said the first step it will take to tighten monetary policy is to stop reinvesting the principal payments on the mortgage debt it holds. In other words, combined with the end of QE2, the Fed will completely exit the Treasury market. Then, the Fed will raise short-term interest rates. If the Fed shrinks its balance sheet at the same time it raises interest rates, it will have a powerful deflationary effect on the economy. We'll see a massive selloff in commodities and a corresponding strengthening of the dollar…for awhile…but…is our economy strong enough to withstand those effects? Many do not think so. The recent rebound in our economy has resulted solely from money-printing…not policy. The fundamentals aren't there. Once the Fed realizes this, it'll step right back in with another round of quantitative easing (QE3). More “quantitative easing” must lie ahead. Those much smarter than I and myself guess the printing presses will start up again later this year. Even if we’re wrong about the timing, it's inevitable we'll see a lot more money-printing in 2012 – simply because it's an election year. Furthermore, as hard as this might be to swallow…with the current political structure of the U.S. – where roughly 10% of the population pays for the majority of the government – a significant cut in spending is going to be hard to come by, no matter who wins the next presidency. Many remain as convinced as ever that our country is facing a fiscal catastrophe unlike anything we've ever experienced before. I believe this. The amount of price inflation (which is the delayed impact of the monetary inflation we've seen since 2008) will be beyond anyone's biggest forecast. Perhaps you still don’t buy this. That’s okay. By the time I’m through with this series, I will have committed a significant amount of space to it and I will stand by my claim now and then…that the USD is in more peril than ever before of losing its status as the world’s reserve currency…and that when it happens…it will not be good for any of us. Now, as promised at the end of last month’s article, let me provide you with some more information relative to the title of this series, “Our Borrowed Existence,” and some things that are happening throughout the rest of the world. Recently, there was a meeting of several of the most powerful countries in the world, including Russia, France, China, Japan and the United Arab Emirate States. The U.S. was not invited, nor did we know about the meeting. Robert Fisk, a veteran Middle East correspondent based out of Beirut for more than 30 years, reported in the British Independent newspaper, “In the most profound financial change in recent Middle East history, Gulf Arabs are planning…along with Russia, France, China and Japan…to end the dollar dealings for oil, moving instead to a basketful of currencies including the Japanese Yen, Chinese Yuan, the Euro (if it survives), Gold and a new unified currency planned for nations in the Gulf Cooperation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.” In the same story, Fisk interviewed a Chinese banker who said, “These plans will change the face of international financial transactions. America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate.” Sure enough, after Fisk published his story, U.S. officials and central bankers from around the world immediately denied these plans. There is an old central banking adage that asks, “How do you know exactly when a currency is going to be devalued?” The answer, “Right after the head of the central bank goes on television to adamantly deny that any such transaction would occur.” Guess who just went public a few weeks ago to say the U.S. will not devalue its currency? You guessed it, U.S. Treasury Secretary, Tim Geithner. Giving warning for such an event is never in the plan. China holds more U.S. Treasury Bills than does any other does any other country in the world, BUT it’s getting out of them. Take a look at this graph of China’s holdings of U.S. Treasury Bills. Additionally, China holds nearly $1 Trillion of U.S. debt. Many assume large foreign ownership of U.S. debt makes the U.S. vulnerable to foreign governments. I am one of these. There are others who think the vulnerability is the other way around. For example, the U.S. could protect Taiwan with its Navy. Or, instead, the U.S. could send a message that any attack would mean no payments on our debt to the attacking country until it withdraws and makes reparations. To me and others of my opinion, even this scenario does not mean the dollar cannot lose its value and…its status as the world’s reserve currency. Take a look at the Yuan in China. Since mid-2010, it has gained 5.0% versus the dollar, which adds to the 17.4% appreciation that occurred between mid-2005 and mid-2008. Now, add to this a question after looking at the above graph. Why do you suppose China has gotten out of roughly 20% of its U.S. Treasury Bills in the past several months? Do you think this trend will continue? I do. Unless something immediately and drastically changes…it has to. Why? The U.S. is running a very loose monetary policy, and because China links to the dollar, it is experiencing rising inflation. Prices for commodities like oil are rising rapidly in China. China imports lots of commodities for processing into consumer goods. It is feeling that inflationary pain before it hits home in the U.S. Letting the Yuan gain versus the dollar is one way for China to ease the pain from the Fed’s overly loose monetary policy. It’s also a way for China to enhance the purchasing power of its workers and companies. Here is one piece of information you may not believe, but it’s true. HSBC, one of the largest banks in Mexico, no longer allows the deposit of USDs into their banks. The reason it gives is on the heels of money laundering allegations, but maybe it’s because they do not want to be stuck with lots of USDs as the currency continues to decline. You make the call. What do you suppose this all means? It’s not just around the world. Right here at home there are businesses that are accepting other currencies instead of the USD and can do so without doing anything illegal. Check the Coinage Act of 1965. With the current spending and printing of USDs, it looks like we believe we are immune to the laws of economics and finance. Name one country in the history of the world that has been successful in trying to inflate its debts away. My research has shown there to be none. Maybe yours will show differently. Porter Stansberry, of Stansberry and Associates, a primary source for this series, calls one of the biggest problems we all face in solving this problem, the normalcy bias. It refers to our natural reactions when facing a crisis. This normalcy bias causes smart people to underestimate the possibility of a disaster and its effects. In short, people believe that since something has never happened before, it never will. This normalcy bias also makes people unable to deal with disaster, once it has occurred. It is the human nature to have a really hard time preparing for and dealing with something they have never experienced before. There are all kinds of examples throughout history. One of the most recent is Katrina. While it was apparent when the storm hit the mainland that the levies were not going to hold, and it was reported to all what would happen when they failed…tens of thousands of people stayed in their homes, directly in the line of the oncoming waves of water. They thought something like this could not happen in the U.S. Sure, in a third world country things happen like this…but not here in our country. As a result nearly 2,000 residents died. We are seeing it happen again in the midst of this problem. We simply refuse to see the evidence that’s right in front of our face, because it is unlike anything we have ever experienced before. The normalcy bias kicks in and we go about our lives as if nothing is unusual or out of the ordinary…even more so if anything happens to counter a trend, such as the early May fall of commodity prices described earlier. The United States has been the most powerful country in the world for nearly 100 years. The USD has reigned supreme as the world’s reserve currency for more than 50 years. Most of us cannot imagine these things changing…but things are changing…and changing fast. For instance…did you know that right now there are more than 47 million people on food stamps? That’s more than 15% of the entire population and that number is up more than 18% in one year. What about the depression-type, shanty towns that are homes to hundreds in more than a dozen major U.S. cities, like Fresno, Sacramento and Nashville? There are more than 2,000 homeless in the Fresno shanty town alone. They even have a security desk at the entrance because the encampment has gotten so large. Equally as disturbing, depressing and fatalistic in all of this is the spin that politicians put on everything…from the President to Congress to regulatory agencies to many state elected officials. The vast majority of all of these do not tell it like it is. And if some do, since so many don’t, we would never know. Take for instance the unemployment rate. Back in the 1930s, anyone without a job that was not retired was considered to be unemployed. Today, the government calculates the number of unemployed by the number of people receiving unemployment benefits. It totally leaves out the number of people who are no longer eligible for unemployment benefits. There are as many or more of these people than there are those receiving unemployment. This is why our real unemployment is over 18%. Guess when the real job losses began to occur. In the Fall of 2009. With all of the extensions of unemployment, these people who became unemployed back then, no longer are receiving unemployment benefits. Since they are no longer being counted, our unemployment percentage actually falls! This is why we have seen the unemployment rate drop about one per cent since the first of the year, even though it went up 1/10th of a point most recently. There are not more jobs. There are not more people with jobs. But there are a whole lot more people each month not being counted as unemployed because they are no longer receiving unemployment benefits. So, with more falling off the scrolls than are being added, our unemployment percentage actually decreases, yet we are closing in on 20% of all people being unemployed! On April 27th, Ben Bernanke said, in his highly touted, first in a long time press conference, when asked what the Fed was doing to thwart the price of oil said, “The Fed can't create more oil. We don't create the growth rates of emerging-market economies.” No, the Fed can't create more oil or any other form of real wealth. But it does create more dollars, which chase the same amount of oil, causing oil prices to rise. Rising commodity prices aren't the disease. They're the symptom. The disease – inflation – is nothing more or less than the Fed's constant debasement of the dollar. The rest of the world is doing all they can to promote jobs. We claim to be doing so here. A few days before Bernanke’s press conference, our President said, “I think about creating jobs when I get up…throughout the day…and when I go to sleep at night.” Really? Recently the CEO of Intel, Paul Otellini said, “I can tell you definitively that it costs us more than $1 billion more per factory for us to build, equip and operate a semiconductor manufacturing facility in the United States.” Why? He said, “90% of the costs are not from higher labor rates, but higher taxes and regulatory charges that other nations just don’t impose.” Few people realize we have the second highest corporate tax rate in the world. Other world countries are moving in. Japan’s new Prime Minister had just announced a reduction in their corporate tax rate by 15% before the Earthquake and Tsunami. What do you suppose they will reduce it by now to promote business? When do we start listening to the guys and gals running the businesses, providing the jobs, and giving them what they need, instead of professors and people who have never so much as run a lemonade stand? This isn’t hate, folks. Nor is it partisanship…or doom and gloom. This is just telling it like it is. How can anyone purport to know how to lead the biggest business in the world…the U.S. Government…when they have never made decisions and been held accountable to run any profitable business in their lives…much less as big of a business as is the U.S. Government? It has to be just a “guess” on what to do by these people, and the “guess” is most always based upon them getting re-elected. How sad is this? Here’s another example of not telling it like it is. Take a look at the different ways the Federal Government understates the inflation rate. These may seem hard to believe, but again, check me…they’re true. 1. It excludes food and fuel costs from its rate of "core inflation." Each month, the Federal Reserve calms national inflation fears by pointing to the low rate of core inflation, currently at an annual pace of just 2.1%. It reaffirms that the economy is meeting the goal set for it by the Fed of keeping core inflation around or below two percent. Claiming that food and fuel are too unstable to be included in the inflation rate, it excludes precisely those areas in which inflation is felt most deeply. As stated earlier, in the past year, the cost of commodities from corn to soybeans has doubled and the price of gasoline at the pump is more than one third higher than it was one year ago. The average American household budget devotes one-third of its cash to food and energy costs. Leaving these elements out of the inflation rate has no justification. 2. It substitutes less expensive products when prices rise. When prices go up, the economists who generate the Consumer Price Index substitute a less expensive alternative product for the one that has risen in price. For example, if the cost of steak goes up, the CPI does not reflect the increase, but simply replaces steak with hamburger in computing the price index. 3. It excludes "hedonistic" products as price rises. “Hedonistic” products are those that are evaluated on how much pleasure versus how much pain are caused. For instance, when faced with whether or not a consumer would like to have a sports car, many say, “Yes.” But when put side by side with a more functional vehicle for the family in size and gas efficiency, a large percentage do not take the “hedonistic” sports car. The Fed removes all hedonistic products from its inflation calculation. We of course know that is not always the case. Hedonistic products are purchased by many. The Fed adjusts for price rises by “dumbing” down the luxury elements of the products whose price it measures. It might, for example, measure the price of cars without air conditioning as a way of avoiding reporting the increase in the cost of automobiles. Even when the luxury features cannot easily be removed from the product, the CPI economists assume that they are. 4. In averaging the price of different commodities, it uses a geometric – not an arithmetic mean. Since the geometric mean, which compares the square roots of product prices, comes out lower, it understates the rate of inflation. To the layman, an increase in total spending of 50 cents on a base of $2 would represent a 25% increase in price. But that uses the arithmetic mean. The geometric mean compares the square root of (new price/original price) multiplied by the same for the other commodity. Using this method of calculation, the increase in price would only be 22.5%. The CPI switched to geometric comparison in 1994. How can any of us make the decisions we each need to make when there is no source one can go to get the facts…the real facts? But no matter how the federal economists bend and twist the data, most Americans can and will “connect the dots.” They can and will realize that we are in for a massive bout of inflation…that will come as the result of out of control spending…which will demand the printing of more money…which will set up the essence of this entire series…the USD losing its status as the world’s reserve currency…which will cause everything about your life to be different. This inflation will be dramatically different from the last hyper inflation of the late 70s and early 80s. That inflation was caused by too much money chasing too few products. To slow down the economy and tame price increases, the Fed raised interest rates. But the type of inflation that is coming has nothing to do with demand. Rather, it is caused by the upward push of costs like gasoline, taxes, food, health insurance and soon…interest rates. This cost-push increase in prices cannot be tamed by cooling off the economy, which is, in fact, so “cool” already that it is approaching zero growth. I remember when I was young, playing marbles. One of the kids owned a set of marbles. He always brought them to the game. They were “tiger eye” marbles…big and good looking. From time to time we would have a disagreement about a rule or an infraction of a rule. Most of the time we worked things out, but one time, when things got a little heated, he said, “I am taking my marbles and going to find another game.” He did. We didn’t have any other marbles. Our game was over. I wonder what happens when hundreds of thousands of businesses say, “We’ve had enough. We’re taking our ‘marbles’ somewhere else and going to find another ‘game.’” Once again…this is enough for this issue. I will be back next month to provide some history of our monetary system and how this relates to the things that are happening today.