THE GOLDEN RACE CAR STRUGGLES
by Jim Willie CB
February 9, 2005

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Bear with me in a comparison of gold and a detailed analogy. The gold price moves like the speedometer of a powerful highly turbocharged race car. Imagine a Ferrari GTO (shown below), Porsche Carrera, or Corvette StingRay. Lost confidence in central banker currency management, the USDollar decline, and rising metal prices influence the race car positively. Conversely, numerous deflationary forces influence the race car speed negatively. Several futile destinations for new money (mostly debt) inhibit the grand initiative to generate price inflation. However, authorities have succeeded primarily in generating cost inflation without much pricing power, without much wage growth. China blocks typical reflation initiatives. China blocks the typical �cost push� seen in previous business cycles.

The Federal Reserve governors regard inflation as a rescue device. Congress believes that stimulus can revive a sluggish economy, restore sector profitability, and revive voter purchase power. Bank centers in Wall Street drool over the notion of cheap money, which they quickly put to work in leveraged machinery to produce wealth. Gold bugs in bear camps often employ knee-jerk thinking that equates radical increases to the money supply and debauched currencies as systemically inflationary, and therefore great for gold. Greenspan has undergone a mysterious transformation from adept financial guide, to technology & stock cheer leader, to serial bubble engineer, to investment community icon, to mad chemlab professor, to financial pathology apologist, to inflation hall monitor, to finger pointer at the USGovt culpability (i.e. scapegoat). While the nation urges on the very inflation which historically has destroyed economies, we fight the market forces for retracement of the bubbles themselves.

Unfortunately, all above groups have been treated to an education, but not a shock. The key is to follow the destination of the inflated money supply. Does new capital go to the furnace to heat up the living room (to produce vigorous activity), or onto the roof to weigh things down (to contribute to collapse)? The Fed has inflated the usual suspects, not the real economy. It has in fact severely damaged the real economy. Ultimately, the health and viability of a nation depend on the strength of its real economy, and in the USA the economic landscape is under siege of severe scorching. To date, the great majority of new money has gone toward unproductive purposes. New federal debt and new household debt add to the total debt burden. The USGovt proposed budget calls for cuts in 150 programs, not without a deficit over $400 billion. Consumer debt has grown over 24% since year 2000, sure to cause some slowdown in the face of tyrannical credit card rate impositions. Housing has enjoyed another boom, with over a 42% rise in federal pooled mortgages since 2000. Without yet another home mortgage refinance REFI round (not likely), households might find less money to spend. The flattening Treasury yield curve throws cold water on speculators, whose carry trade gamers may soon look elsewhere for easy money. Central bank intervention may cap our long-term interest rates for now, but the upcoming launch of an Asian credit market could result in sales rather than purchases in coming months or years. Commodity investments are another destination of new money in speculation. The result has been rising material and energy costs, hardly a help to profit margins and wages.

Asian imports are the tidal wave monetary/ economic �boomerang� in the strange global process. The Chinese have whipped up a giant tsunami of their own in finished product export to the USA shores. We in the US Economy extend credit and issue new debt (credit card, vendor finance, home equity) and purchase Asian imports. Money exits the country and goes to Asia, where it is used to build factories. Their factory output shows up as imported products sold in Wal-Mart and several other �BigBox� retailers like Circuit City (electronics) or Staples (office supplies) or Home Depot (home supplies). So our directed current of trade deficit money flow to Asia returns as a flood of cheap imported products. One can conclude that our new money (monetary expansion) is being devoted to numerous destinations which are NOT assisting price inflation. New money is weighing down the roof, sadly, not heating up the living room. That might explain why real economic prices outside services and energy are tame, why wage growth stinks on ice, and why large site layoffs are still hovering near 100 thousand on a monthly basis. Oh yes, it might also explain why gold is struggling mightily. The golden race car is being inhibited.

THE GOLDEN RACE CAR SEEKS HIGHER GEARS

They impede its operation, acceleration, and pathway. Added household debts act like low octane, if not dirty, gasoline which the engine cannot efficiently process into pure speed. Higher across the board material and energy costs act like so many bricks placed on the backseat and trunk, weighing it down. Stalled worker wages act like a shortening of the driver�s leg, whose foot finds difficulty to keep constant pedal pressure. Foreign central bank interventions to block Asian currency exchange rate upward adjustments, as discussed above, act like a slipped transmission, the clutch unable to shift into the next gear. Federal Reserve interventions to forestall higher long-term interest rates and to monetize mortgage agency debt act like forewarned removal of debris from the roadway just over the horizon, sure to lead the driver to greater caution. The upcoming stall in housing prices will act like a powerful stiff headwind which the race car must fight against. Big hedge fund losses remove billions from the speculation, and commodity markets specifically, acting like a clogged air filter to inhibit air supply for gasoline combustion. Economic recession acts like the turbocharge switch turned off, since available money to push demand across the entire system would be absent. Money supply cutbacks as measured by the Fed, not so much from miscalculation as from a general report card on debt birth & default death, new business creation & failure, act like severe weather warnings which might order all cars off the road.

An excellent mainspring of power, the hard slow crash of the USDollar acts like an awesome aircraft carrier launch device positioned at race course intervals. The regular surge enables the race car to ultimately overcome all obstacles. Its speed will reach supersonic levels over time. Jumps in finished imported product prices lift the car off the road, sending it airborne. However, that will interfere with the US Economy in a very big manner, as consumption will be harmed unless wages rise in offset. Big stock declines among non-commodity (mainstream) shares act like a strong tailwind to assist the race car, not without turbulence from account margin calls. But do not be confused. The failed Fed Reflation effects almost all work to obstruct the race car and its frenetic acceleration to higher speeds in upper gears. The 1970 decade saw few if any inhibitions to the race car, as a clear path was reached in a matter of a few years. The Nixon Wage Price Freeze in 1972 inhibited supply, the exact opposite to today's massive demand. The Volcker Fed Reflation initiative had almost non-existent obstacle when put in force.

Now in 2005, the Chinese Factor makes the entire road an uphill course for the race car. They render pricing power as non-existent, take jobs from our economy, and bid higher the prices for raw materials and energy. The Chinese flag is emblematic of policymaker frustration and the assisted secular deflation phenomenon, completely absent thirty years ago during an unrestricted inflationary period.

The Ferrari race car has several obstacles, each of which will be overcome in time, not without a bumpy and jerky ride full of stalls, interruptions, and occasional needed repairs. Each crisis in our world provides loud cheers from the grand stands, if not actual direct consultant assistance. Events like central bank conflict or mortgage finance scandals or financial derivative meltdown herald the crises. Let us not forget. Exchange traded gold funds will transfer that positive emotion from the matting crowds possibly into a real push of the race car. Time will tell if even the ETF will result in disguised dirty gasoline in the tank or hidden blocks of ballast in the trunk.

The most likely scenario for release from obstructions will be trade war, as Asia withdraws their support and no longer wishes to avoid harming the US Economy. The free market has been disrupted and greatly interfered with, in what has amounted to sustained gigantic intercontinental subsidies. Political conflict is the most likely event to remove that subsidy, so as to enable financial weapons to be used against the USA. As imbalances grow, bank leaders might pay lip service to �flexibility,� but the consequent political pressure on the system leads to uncontrollable strain which will soon break, in a default of tacit agreements unwritten in treaties. Where has a treaty forged an agreement for Asia to recycle their savings into US credit markets in the form of our Treasury and Agency bonds? Nowhere! Where has a treaty agreed that the USA would continue to permit the abandonment of our manufacturing base, and exchange debt for income? Nowhere! The great Asian-American contract is a loose one, easily broken, but with a heavy cost to both parties. That is precisely why mutually damaging trade war is most likely to ensue. The saber rattling has already begun. Chinese leaders have warned the USA for its spending abuse and debt build-up, not to mention our tendency to blame others. Corners within the USA have blamed China for taking our jobs and controlling our fate. The release of financial weapons upon the USA will mark a sea change. For years the IMF (International Monetary Fund) has been accused of causing weaker economies to fail via debt default, by imposing harsh restrictions on debt issuance. Next up, Asia will do harm to the USA by imposing harsh restrictions on current and new debt issuance. The pendulum of financial justice swings both ways.

TURBOCHARGE SWITCH

In my analysis, the golden race car will fire all cylinders, burn clean fuel, enjoy an unimpeded roadway, and reach high speeds only when Asia permits it. Translation� gold will explode in price when Asia is willing to force import prices higher to the USA from appreciating Asian currencys, when Asia is willing to take substantial bank reserve losses, and when Asia has accumulated enough gold positions to benefit in offset from its rise. The process will likely not be so well planned. Instead, it is more likely to occur as a result of political breakdown. The magnitude of the capital flows to neutralize the imbalances is politically and economically untenable. The credit requirements grow as the asset price structures grow to higher levels. Federal Reserve Reflation is putting incredible stress on all imbalances. That is the tragic sour fruit of its outcome. When your neighbor makes increasingly greater demands on your time and effort, eventually you stop and say �ENOUGH� then �NO MAS.� In all likelihood, trade war will start the process of halted Asian support for our bonds, and start the process of Asian currency appreciation. The Chinese yuan pegged to the USDollar will at that time end, and the Japanese yen will rise past 100 parity. Free markets will not cause the gold trigger to be pushed. Trade friction and retaliation will cause it. The financial markets will be the tail of the politically driven dog.

Many are the potential triggers for Asian withdrawal. They might get pissed off at our proposed Congressional 27.5% trade tariff. They might get pissed off at the unending expense of the Iraqi War, which we blithely placed as an off-budget item. They might get pissed off at our barking about intellectual property (music, software, books, movies) enforcement against cheating and the denial of royalties. They might get pissed off about requests to fund $175 billion in Social Security costs after privatization, which would reveal the method of window dressing our federal deficits over the years. They might get pissed off at blockage of their planned acquisitions of hard asset properties like industrial metal and energy firms, e.g. Unocal. They might get pissed off at pressure exerted by USGovt officials for China to revalue its currency upward in the face of gargantuan trade gaps. They might get pissed off at US pressure on Iran for nuclear equipment installation, even if for power generation. They might get pissed off at the USA generally for blaming China for our own problems.

As some authors describe, nobody seems to be alarmed at a giant pile of oily rags accumulating in our financial house, even as trade war risk escalates. All above �pissed off� items are like raised hands looking to light match sticks in the same enclosed basement.

© 2005 Jim Willie, CB
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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com