one of richard russell's better pieces
dowtheoryletters.com
May 7, 2003 -- At yesterday's meeting, the Greenspan Fed elected to stand firm on interest rates. The Fed has kept short rates at a 41-year low. But wait -- there was disagreement at the Fed. Greenspan's stand is that the Iraq war slowed the economy, and now that the war is over the economy should slowly improve.
But stated Anthony Santomero of the Philly Fed, "The economic recovery has been losing momentum since last summer. Not all this can be laid at the feet of the Iraq situation. Other events and imbalances are still at work."
Yesterday the Fed went into more detail than usual. "The upside and downside risks to the attainment of sustainable growth are roughly equal." The possibility of "a substantial fall in inflation" made weakness a bigger worry than an overheated economy because of the small possibility of "an unwelcome fall in inflation." Note that the Fed steered away from using the dreaded word "deflation." They preferred a "fall in inflation."
Why is deflation so feared by the Fed? It's feared because in the debt-logged US, any deflation could bring down the house. The US system is based on debt and the ability to service that debt. In deflation, dollars are worth more and harder to come by. If the US was to lapse into deflation, the mountains of debt that reside in ever crevice and corner of the US economy could give way to mass bankruptcy -- and paralysis at the Fed. Real interest rates could sink below the zero level, making the Fed impotent, and unable to work its "inflation magic."
This reveals the Fed's fear of gold and even a partially gold-back currency. A system based on gold would force discipline on the Fed. It would prevent the Fed from increasing liquidity at will. Such a system would stymie the Fed and put a brake on debt creation. Since rising debt is a cornerstone of US prosperity, you can see why the Fed will fight to the death the inclusion of gold into the system.
The Fed in its anti-deflation policy has a huge problem. The US depends on roughly $1.5 billion in foreign money coming into the US every day. This is the money that off-sets the US's chronic current account deficit, which is running at half a billion dollars a year. Lower rates or a declining dollar make US investments less attractive. How do you keep foreign money coming in? That's going to be a terrific problem.
The essence of the whole situation is this -- the Fed will to anything and everything to stave off deflation. One thing they are doing now is buying bonds as part of their policy of holding long rates down. Rising rates are deflationary. The war is on. I have for years labeled this war --
INFLATE OR DIE!
Never since I first started using this phrase has it been more true, and more urgent.
By the way, an e-mail at the end of this site by Brian Bloom of Australia goes into detail regarding the total dependence on inflation in the US. Please read this e-mail carefully.
With matters so unusual, so extreme, so critical, I'm adopting a new policy. My new policy is to be very careful about "buy" and "sell" advice. Frankly, I don't know whether the US economy is going to inflate or deflate, I don't know if the US can hold off the BEAR for another months or another year or another five or ten years.
As I see it, the US system under the Federal Reserve is a flawed system, and I don't see how it can endure. But there's the unknown matter of TIMING. I believe we're simply dealing with timing now. And neither I nor anyone else knows how the timing of this bear market is going to work.
Therefore, I'm going to talk about the situation as it develops with the admission that I don't know how the situation is going to work out on a timing basis.
I'll be watching commodities for indications of inflation or deflation. I'll be watching the stock market for indications of the secondary trend. I'll be watching the bond markets because the bond markets are huge and they're sophisticated. I'll be watching the gold market, because in the end gold will win over paper. And I'll be watching the currency markets because the strength or weakness of a nation's currency reveals how that nation is doing in the global economy.
The battle of the currencies is now on. Trillions in "hot money" are moving from one currency to the next. The money is looking for safety, it's looking for yield, and it's looking for the strongest nation. Today the yen exploded higher. The yen has been weaker than the euro ever since October 2000. The dollar has been weaker than the euro ever since June of 2001.
Over recent months the euro and the yen have been stronger than gold. But since April 7 gold has been stronger than the dollar. Eventually, I believe gold will be stronger than all paper currencies. Timing again. Timing, timing, timing.
Today I see two spectacular moves. The first is in the yen which as I write this morning is up 114 points. The second move is in the bonds and here the June 30 year T-bond is up 27 ticks and almost at a new high.
What's happening is that there is so much liquidity that huge masses of currencies are racing around looking for "the next big thing." The market's have become a "mad-house" of activity in a world economy that has become increasingly UNSTABLE.
Therefore, I look for one item after another to suddenly surge, then suddenly sink-- hot money racing to and fro looking for the next item of choice. Subscribers, we're in the international "hot money game" now, and the idea, in my opinion, is to avoid losing money. |
