Tuesday, March 07, 2006

Will Rates Continue to Rise? If So, What Happens to Our Indebted Economy?

I've been quite busy lately (not much blogging), but have been able to keep an eye on the markets. The main themes this week seem to be rising treasury yields & stronger dollar.

Stocks: US stocks have slid for three consecutive days now based on higher Treasury yields--the longest losing streak of the year.

Dollar: The Dollar has increased dramatically against the Euro & Yen, as Treasury yields increased, and upon growing speculation that the Fed will increase rates more than the previously expected two more times. The aforementioned Treasury yield improvement, however, will spell more bad news for the mortgage market (increased rates)

Gold: Gold has taken a spill over last couple of days. The positive news for the dollar when combined with falling oil and reduced bullion demand, slammed gold.

So, will rates continue to rise? If so, will this help the dollar and our economy? I believe many of you already know my answer to this, so rather than express my views, please allow me to share the opinions of someone else: J Taylor from HOWESTREET.COM

This is an excellent read!

Will Rates Continue to Rise? If So, What Happens to Our Indebted Economy?

One of the potential threats to our inflationary thesis is that with even the government's illegitimate, understated inflation numbers as seen above, the cost of living in America is on the rise. At the same time, we Americans continue to rely on foreign savings to the tune of about $3 billion per day to fund our extravagant lifestyle. We keep spending more than we earn. But when foreigners begin to factor in the declining purchasing power of the dollar, will they continue to send their savings to the U.S. so that we can continue to consume more than we produce? Which brings me to what I think could be the real threat to continued economic growth and the inflation play.

The one real threat to the establishment is not inflation, because the Fed and the U.S. government can always print more money faster and faster to keep ahead of the rest of us. Those printing the money are always in charge unless the rest of the world wakes up to the fact that the pieces of paper the government and the banking systems calls money is worthless. So the real threat to the establishment and the Anglo-American empire is the potential for the rest of the world to reject the paper they print. That in part is starting to happen with various countries choosing to "diversify" their foreign currency holdings out of the dollar and into the euro and gold, and now perhaps more so the yen as the Japanese economy begins to grow.

The last time the U.S. had a major problem with the dollar's acceptance issue globally was during the double-digit inflation years during the Carter presidency. Paul Volcker provided the solution that saved the American empire, but it was a very painful solution. To get out ahead of the inflation problem of that time, he did not hike interest rates by ¼% every few weeks. He slammed inflation into the ground by slowing down monetary growth to such an extent that "real" interest rates were the highest since the Civil War!

The rise in interest rates that followed Volcker's tight monetary policy coincided with a decline in equity prices and skyrocketing gold price that resulted in a Dow-to-Gold ratio of approximately 1:1 in 1980. Thereafter, America had its deepest recession since the Great Depression.

The discussion about inflation now reminds me very much of the 1970s, when the constraint refrain was, "Oh it isn't too bad. The economy is growing. Profits are good. No need to worry about inflation." And so Arthur Burns and G. William Millar at the Fed kept raising interest rates to make it look like they were fighting inflation, but all the while, monetary policy was behind the inflation curve. By that, I mean a sufficient amount of money was printed to continue an unhealthy artificial growth so as to ensure that a painful recession did not follow. That lax policy was continued until inflation became such a problem that the very survival of the U.S. dollar as the world's reserve currency began to come into question.

I believe we may be seeing a replay of the same kind of lax Fed policy as took place in the 1970s. Only now, America is so much less able to survive a tight monetary policy than it was in the early 1980s, even though as noted above, that period represented the deepest recession since the 1930s. Back then, the U.S. was a net creditor nation. Now, the U.S. is not only a net debtor nation, it is the biggest net debtor nation in history! Back then, the U.S. consumer saved a considerable amount of his income. Now, the U.S. consumer is actually spending more than he is earning! Back then, the U.S. still had an industrial base that was the envy of the world. Now, the U.S. is quickly losing not only its industrial jobs, but with the advent of the Internet, is losing even its service jobs!

Bernanke is the Anti-Kondratieff Winter guy. He was the guy out front, fighting deflation a couple of years ago when it became a real concern to policy makers. But, like the entire establishment, he has signed on to the false doctrines of Keynes and Friedman that wealth can be created from governments spending, increasing debt, and printing money. That patent falsehood has, however, been sold to generations of American economists, who are so blind they cannot see the reality, which is that wealth is generated only by saving not by dissaving. Yet, look and see who is gaining wealth these days. It is the nations that save, like China and India and the Middle Eastern countries that have the oil revenues to even buy and control our port facilities.

The very jobs of the boys and girls you see daily on CNBC depend on keeping their blinders on. But to people who are not sucked into this establishment vortex, like the taxi driver form Iran, or the son of a Latin American minister of energy, or the Armenian landlord I spoke to last week here in Woodside, America is clearly in a decline.

Outside of America, the world is catching on to an unfolding disaster. They see that America and its currency are in decline, so they are starting to sell dollars and buy euros and gold. Our propaganda operation is working overtime to pull the wool over the eyes of us Americans, so that we will be CONNED into believing the dollar is "as good as gold," even though it is constantly worth less. But no matter how hard the ruling elite spin things, as in the case of inflation statistics or reasons for going to war, ultimately, truth will prevail. And ironically, economic truth may present Mr. Bernanke with a "conundrum" that makes Alan Greenspan's long interest rate conundrum look like child's play in comparison.

If the survival of the Anglo-American empire's currency, namely, the U.S. dollar, depends on raising interest at a time when, thanks to our past financial promiscuity, our economy cannot take rising rates, what is Mr. Bernanke to do? Here is a man who said we can eliminate a replay of the Great Depression by printing a sufficient amount of money and then distributing that money by helicopters if need be. Yet, if he carries out that policy when the dollar buys less and less and the world demands higher interest rates to keep funding our gaping deficit, then massive flows of foreign capital out of the U.S. will occur and interest rates will rise to the moon! Or Bernanke will print money at an ever-escalating rate of speed, thus leading toward a possible hyperinflation.

This is a scenario that I think is coming sooner or later to America. How it will play out I don't know, and neither does anyone else. My own thinking is that the defense of the dollar as a means of defending the Anglo-American empire will be of paramount concern. Yet, if Bernanke follows Volcker's policy of slamming on the brakes to defend the currency, then we will get the mother of all Kondratieff winters, as Ian Gordon and his work predicts will occur.


MMAfia said...

On the money regarding recent market activity... yield curve reverting to norm, dollar gaining strength, and gold (along with other precious metals) taking a dip.

IMO, rates will continue to rise... however, the increase in long-term yield may temper the rise somewhat if it continues on it's path.

However, the rise in long-term yields will adversely affect the housing market, as loan affordability will decline with higher mortgage rates.

This is my main concern. Along with the $400+ billion in subprime ARM loans readjusting by 2007. A housing slowdown, spurned by foreclosures has a very high probability of pushing this economy into a recession. Structural reformation does not happen overnight, and 2007 is just 1 year away. This economy still depends too much on the housing boom, from consumer spending to job creation.



desi dude said...

The one real threat to the establishment is not inflation, because the Fed and the U.S. government can always print more money faster and faster to keep ahead of the rest of us

I think there is a typo. Shouldnt it be deflation. I read elsewhere that defaltion is something you get out of by printing currency.

Out at the peak said...

Inflation is an increase in the supply of money at a rate greater than the expansion in the size of the economy. This is practically measured by comparing the GDP deflator to the rate of increase of the money supply, and setting the interest rate through the central bank to maintain a constant quantity of money. --Wikipedia