FAITH & FAILED TRINITY
by Jim Willie CB
Editor, Hat Trick Letter
October 3, 2007
Faith and confidence in the USDollar, in management of the US banking system, in the viability of the USEconomic structure, in the image of Wall Street honesty, and in the integrity of USGovt federal finances are all at historic lows. Repair seems close to impossible. The US Congress, the current presidential Administration, the USFederal Reserve, and the US Dept of Treasury together appear to be in the center of a grotesque policy failure morass. On the financial economic aggregate front, bring attention to the �Impossible Trinity� as it is called for a brief dissection exercise in diagnostics. Without a gold standard to enforce discipline and balanced accounting across national finances and trade, the simultaneous balance of three factors is rendered an impossibility. The failure of attempts is hidden by means of pure propaganda in its face, falsified economic statistics as a front, which is a specialty well developed by the US managers.
Economic and financial stewardship requires the simultaneous balance act, well analyzed by economic theory experts. Three challenges exist for the intractable mission, doomed from the start without a gold anchor. A) maintain a stable currency exchange rate for the USDollar on the FOREX market, B) maintain an independent monetary policy for setting interest rates and guiding the USDollar money supply, C) maintain a stable open current capital account comprised of the trade gap and that of financial assets. So the US$ exchange rate, the USTreasury credit market yield, and the total balance of trade cannot be tightly managed at the same time. Something must give. Economists unanimously agree that at most, a nation can succeed in two of the three objectives, but never three. The US maestro custodians manage to fail on all three. Like financial laws of physics, offsetting forces are powerfully at work. However, when all three fronts are marred badly by failure, one must conclude vast perverse chronic ineptitude (if not corruption) is involved. The task is impossible from the start without a gold tether on the buck. Add incompetence and perhaps an initiative to fleece the middle class, and performance can fail miserably, as we see.
The fascist merger of state, the penultimate banking sector out of New York City, and certain corporate groups (see oil industry, military defense) stands as the most glaring threat to free market capitalism in the modern history of the nation. Yet it receives no challenge. The retrenchment from globalization forces, manifested ironically as active participation (corporate outsourcing of operations and jobs), has made public opposition muted. The recoil from the security firestorm, regardless of origin for actual threats, has confused the public perhaps as much as frightened it. As we learned seventy years ago in Central Europe, fear is a powerful tool when used in a controlled fashion. The current custodians seem to brandish aggression and arrogance, while dragged down by dishonesty and ineptitude at the same time. The world notices, and makes votes against the USDollar, which serves as a ballot. The more hidden vote is with the embrace of gold.
MY CONTENTION IS THAT ALL MENTIONED INSTITUTIONS HAVE FAILED, THE CONGRESS, THE ADMINISTRATION, THE USFED, AND THE US DEPT OF TREASURY. A FAILED FINANCIAL STATE HAS OCCURRED. AS PROOF, THE LITMUS TESTS REGISTER FAILURES FOR THE USDOLLAR, FOR BOND PURCHASES, AND FOR THE BALANCE OF TRADE. THE MONETARY CRISIS WILL CONTINUE, ECHOED BY AN ECONOMIC CRISIS EXTENDED FROM STRUCTURAL FRACTURE. THE RELEASE VALVE WILL BE THE RISING GOLD PRICE, REGARDLESS OF THE DEPTHS REACHED BY THE USDOLLAR. WE ARE WITNESSING A FAILURE IN CONFIDENCE FOR THE USDOLLAR, THE MOST CRUCIAL ASPECT OF ANY FIAT CURRENCY. A WIDER WAR IS THE WILD CARD.
By the way, keep in mind the latest nonsensical and utterly false mantras circulating in the markets these days. �The USDollar is declining in an orderly fashion� and �Price inflation is under control� have hit the lighted billboards with such regularity as to cause laughter to the well informed. A 15% decline in the DX dollar index in 24 months is not orderly. A 4% decline since the USFed rate cut two weeks ago in veiled desperation is not orderly. As for price inflation, it is running at 10% on an annual basis, if one bothers to count the price increases on the cross section of items within the broad economy. Remember that every economic mythology requires mantras as glue to hold their chapters together, as a practiced fallacious ideology. Last autumn they were �The subprime mortgage problems will be contained� and �The housing market will stabilize in the spring� and �No spillover from the banking problems to the real economy� all spouted about broadly and prominently. Two years ago it was �Global trade surplus recycle provides a stable reliable source of capital for the United States� when now that USTBond support relies upon a printing press increasingly. All heretical economist foundations urgently require mythology of beliefs, mantras for incantations, all profoundly untrue, to serve as false pillars upon which temporary support is gained.
THE IMPOSSIBLE TRINITY
Manage the USDollar: The USDollar has not maintained a stable value in its exchange rate in the FOREX markets versus the major and secondary currrencys, not at all. Since early 2001, when the DX dollar index hit a 121 high, the US$ has fallen over 35%. The major offset has been the euro currency, which has risen from 84 to 141, an amazing 67% leap upward. The primary defense against the ongoing plummet in the last seven years has been the USFed tightening cycle off the long-held 1.0% rate in 2005, which engineered a US$ bounce. The effect to dampen the gold price in 2005 was fully forecasted here in the Hat Trick Letter. Another serious decline in the USDollar will cause another painful round of cost inflation, the increase in prices of almost everything resident to the USEconomy.
Few technical chart patterns are extremely reliable. My reliable favorites are the simple momentum swing pattern, the flat triangles, and the head & shoulders pattern. The DX dollar chart displayed the most horribly dire bearish, a huge head & shoulders bearish pattern. If full potential is realized on the breakdown, the DX could face a further 50% loss from the critical long-term support level of 80. If that occurs, the entire face of the United States will be transformed into a very ugly place. In 1995, the DX index bounced off the 80 level. In very early 2005, the DX bounced off the 80 level again, rising all the way to 92 by the end of that year. With the end of all prospects for a higher short-term USTreasury yield to attract foreign money into USTreasurys, the stage is set for a spectacular decline in the USDollar. The amusing part of the story is the nonsense about how the decline will be good for the USEconomy. How will uniformly higher prices be good? How will discouragement of foreign investors be good? How will erosion of foreign central bank assets be good? Favorable conditions for US exporters is indeed actual and good, provided one can identify big export industries. Multi-national operations to be translated on favorable translations is actual and good, provided investing abroad is the priority, not at home. A new wave of job outsourcing is possible.
The USDollar is clearly being permitted to fall, first because it must in order to resolve imbalances, but also because many key powerful global institutions are losing faith in it. The Asians are investing less in USTreasurys, and have shown a flat account since summer 2005, over two years. In fact, China is using their vast sovereign investment funds as a weapon to fight against the USGovt, in response to trade sanction legislation marching down the pike. The Arab nations must deal with powerful consequences from pegging their currencys to the USDollar. Price inflation, vastly growing money supply, construction booms gone slightly out of control, these are the consequences. The Arab oil producers will soon deliver a fracture blow to the PetroDollar in the coming months, or else permit forces to rip apart their economies and banking systems. A removal of a tight US$ peg by Persian Gulf oil producers means the end of the vastly important PetroDollar itself, the commercial foundation of the world reserve currency enforcement! The world over, revolt against the USDollar is underway, in bloom, even accelerating. A monetary crisis is underway which fails to receive proper publicity. Regardless of monetary policy or the trade imbalance, the USDollar is heading for a crisis decline.
Manage monetary policy: The US Federal Reserve has a �Sophie�s Choice� to contend with. Do they attempt to rescue the USEconomy, dragging horribly down by the housing market? Or do they attempt to rescue the USDollar, under siege globally, indefensible on numerous fronts? Sadly, the USTreasury Bond has been transformed into a War Bond, since the USGovt current leaders are engaged on an unproductive war, whose only certain outcome is the strain toward national bankruptcy. The USFed cast its vote two weeks ago, to defend the USEconomy and to permit the USDollar exchange rate to fall. Ben let go on the rope on his left hand (right side to viewers). The custodians will in all likelihood attempt to manage the decline in an orderly fashion. However, another official rate cut, or a string of them in a fresh new easing cycle, will remove the favorable bond yield differential, which has supported the USDollar for two years.
The amazing overtone to the rate cut on September 18th, is that the USFed has actually reduced interest rates amidst unchecked money supply growth. That is opposite to normal conditions. The international vote of little confidence, possibly to turn ugly into no confidence, has been the rise in long-term USTBond yields since that fateful day of the rate cut. Another rate cut of 50 basis points in late October could result in a push upward with more force in long-term bond yields, like to the 5.0% level. The housing market would not fare well on fixed mortgage rates in reaction. An argument can be made that long-term bond yields have reversed and are now in an uptrend. The steeper USTreasury Yield Curve is evidence of that reversal. We are in a dangerous transition at a time when confidence in both the USDollar and USTreasury Bond is fast vanishing.
My longstanding accusation is that the USFed has acted as a quasi cabinet ministry, who together with the Dept of Treasury deserve the tagteam title of Dept of Inflation. The USFed chairman deserves the shameful title of Secretary of Inflation. They talk about fighting price inflation, but they manage the growth of money and credit. Actually they mismanage it, since they turn a blind eye to grotesque money growth and credit growth. See the exploding credit derivatives and subprime mortgage bonds, for instance. The US$ money supply is growing at around 14% on an annual basis, which is actually regarded as a positive development. This unbridled growth is not solely a treatment to subprime bonds wrecking havoc in the banking system. The below chart is compliments of the Shadow Government Statistics folks, who do outstanding work to remove gimmicks and lies. The USGovt can hide the official M3 Money Supply statistic, but it can be reconstructed. Notice how the M1 Money Supply series is running negative. That can be interpreted to mean that the real tangible economy is in recession, as money shrinks, in the technical sense. By that is meant the monetary aggregate, the total amount of money sloshing about in the actual economy apart from the financial games, is in decline, thus monetary deflation. In the arenas where people lose jobs, mortgages are foreclosed, businesses fail, and bankruptcies find resolution, money is being destroyed. Tell that to the S&P500 and Dow stock indexes!
Maintain an open capital account: The current account deficit remains a veritable hemorrhage. In 2Q2007 the C/A deficit registered at $190.79 billion. The foreign capital inflow at $150.9 billion was insufficient in the quarter to fund the deficit. Where and how was the gap filled? The printing press! The USFed and Dept of Treasury were forced to authorize money off the electronic printing press to cover the gap! The story received no press coverage. What was covered was the lifting of the USGovt permitted debt limit, from $8.965 trillion to $9.82 trillion. All is well, they can borrow more money now on the national credit card, largely squandered on a war, but handled off the official balance sheet. One can make the argument that a large pocket of key financial institutions engages in grandiose false double book accounting methods. See Wall Street firms and their ACA Capital, a garbage can of under-water credit derivatives, and their hedge books themselves, which are rarely marked to market. ACA is shared in ownership by several WS firms.
In some of my initial public articles written four years ago, a strong economic forecast was made. My claim was that the USDollar would be devalued in a big way, but the trade gap would actually worsen. That came to pass in spades, despite some hate email accusing me of gross incompetence! The trade gap remains in the $57 to $63 billion monthly range, having almost doubled. Anyone who claims that a $6 billion improvement accomplishes much of anything should tell his gambling addicted son that a $6300 per week gambling problem has made progress, now that it is only $5700 per week. Only in the last several months, has the US export trade grown at a faster pace than the US import trade. Since January 2002, exports have grown by 71.5% versus growth at 78.3% for imports. During those 5-1/2 years though, import volume grew by $85.6 billion versus growth of $56.1 billion for exports. Thus the trade gap worsened markedly. More recently, however, exports have grown since January 2007 by 6.15% versus growth at 3.71% for imports, but export volume caught up by only $1 billion. Exports are catching up, but had a much lower starting point.
The nasty curve ball in the last several months has been the decline in foreign central bank willingness to hold USTreasury Bonds. Consecutive monthly declines are being registered. This puts added pressure on the USFed/DeptTrez to print more money and buy more USTBonds, in a process called monetization. The whole world is watching in horror! They are losing confidence in the world reserve currency, the mismanaged USDollar. Its legal tender in the financial markets is the mismanaged USTreasury Bond, whose legitimacy is undermined by the printing press. In private circles any such practice is called counterfeit.
We are witnessing a failure of economic and banking stewardship, management, and performance. The entire world is held hostage. Their banking systems are reinforced by gargantuan sums of US$-based securities. To call them �secure� at all is a bad joke and a misnomer in every sense. The backlash from the subprime bond export, complete with fraud, mispricing, mislabeling, and premeditation, has in no way been fully played out. With the European, British, and Japanese central banks frozen on policy, urged to hold on interest rates at the point of a gun, the gold price will serve as a relief valve. These major central banks are expanding the money supply in magnificent fashion, over 14% together. With the US Federal Reserve certain to cut rates further, and with far less likelihood of foreign major central banks to follow suit, the USDollar is in great jeopardy. With the Arab states which form the Gulf Coop Council contemplating a removal of the US$ peg, a fracture in the PetroDollar defacto standard is near. Implications to the USDollar negatively, and to gold positively, are profound. The Asians and Arabs are hedging against US$-based bond losses by purchasing increasing amounts of gold. The transactions are not being hidden. Gold is heading for $1000 in the coming several months. The USDollar is heading for DX=70 in the coming several months. The euro is heading for 150 in the next several months. The Canadian Dollar is heading for 110 in the next several months. The precious metal mining stocks are poised for a substantial runup in the next several months. The season will work favorably until the spring.
© 2007 Jim Willie, CB
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 24 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.
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