An "Accident" Looking For A Time To Happen
There is one economic/financial item in the US about which no-one seems to give even a passing thought. This is the utter incongruity of a nation whose currency is plummetting standing with almost non-existent interest rates. As you know, the Fed Funds rate in the US remains at 1.25%, the Fed having left it alone when they met on May 6. In Europe, the official rate is double that at 2.50%, the ECB having left it alone when they met on May 8. In the nations where currencies are rising even faster against the Dollar than the Euro, the more the currency has appreciated, the higher the official rates. A case in point is Brazil, where the rate (although it has halved over the past six months) still stands above 10%.
There is an increasingly "roaring" $US "carry trade" going on here. Investors around the world are increasingly desperate for "yield". Because there is no "yield" available in the US (even corporate debt rates have plummeted) the $US is being borrowed at present VERY low rates and sold to buy currencies in countries where rates are higher.
On the other hand, and as reported by Doug Nolan this week: "Bloomberg’s year-to-date tally of Total U.S. Domestic Debt sales is running up 24% from last year at $745 billion. ...Year-to-date issuance of $144 billion is running up 18% year-over-year. Americans, whether in government, business, or simply walking along the street are borrowing like maniacs, seemingly oblivious of the certain fact that as the Dollar falls, the pressure on US interest rates to RISE grows inexorably.
Especially since the advent of "floating currencies" in 1973, there is no exception to the rule that at some point in the dive of a currency - sooner in the case of inherently weak currencies and later in the case of inherently stronger ones - official interest rates in the nation so affected must RISE to compensate both foreign and domestic investors from the risk of continuing to hold the falling currency. The US has not been immune from this in the past and it will not be immune in the future.
Yet, at present, ALL sectors of the US economy are borrowing ferociously, much of the borrowing comparatively long term, while totally ignoring the fact that the Dollar is falling like a rock. There is no consideration of the prospect of higher US rates, and no thought given to what that might mean in terms of higher loan servicing costs when, not if, that comes about.
Nor is there any consideration of the fact that this absolutely out of control borrowing binge is, in itself, the main factor in the weakness of the Dollar. Seldom in the sorry economic history of the past century or two has a nation been so set up to be blind sided by events which they have either not foreseen or refuse to think through. As we have said before in this commentary, the situation is almost "surreal".
It is also, of course, tailor made for an upside explosion on the $US Gold price. Over the past month, the $US Gold price has not done much more than "mirror" the fall of the $US. Since the beginning of this year, the $US Gold price has stood pat while the Dollar has fallen about 7% on a trade-weighted basis and much more than that against the currencies of many of its trading partners. Its price in terms of all these currencies, but the $US in particular, is still severely suppressed.
With the end of "hostilities" in Iraq, the only news coming out of that benighted nation is now bad news. It is fast becoming not a question of having "won" the war, but of having to cope with the "peace". With that, of course, attention switches back to domestic matters for most of the world, Americans included. That has indeed happened, but while the rest of the world stands agog (and with rising concern) in front of the Dollar slump, Americans do not seem to have even noticed it.
This is a desperately dangerous situation. Judging by the acceleration of borrowing documented by Mr Nolan (see above), Americans are hell bent on exposing whatever assets they have left to the full brunt of the effects of what has every potential to become a currency crisis. In current circumstances, with the level of borrowing now being indulged in, any increase at all in debt servicing costs would decimate the US economy. Even without an increase in servicing costs for existing debts, any accleration of the present beginnings of foreign private liquidation of US assets would lead to the same result.
The US economy is indeed an "accident waiting for a time to happen". The rest of the world, having been through currency crises of their own over the last decade or so (as recently as 1991 here in Australia, interest rates spiked to 18%), has little trouble in recognising this. The US is caught up in their victory in Iraq, and in the conviction that "it can't happen here". We visit several big US business websites on a daily basis. Most of them do not mention the Dollar at all. Those that do have been pointing out that the Dollar fall is "good" because it makes US goods more competitive overseas.
In ANY currency crisis, wherever it takes place, the ultimate "insurance" has always, throughout history, been the precious metals, specifically Gold. We are approaching the biggest one the world has ever seen, with the world's reserve currency on the precipice and the US in a state where any move to support the Dollar with higher rates would be instant death for the economy. And with this in prospect, US borrowing is STILL increasing in all sectors.
The greatest accomplishment in any precipitous economic downturn, however caused, is to KEEP WHAT YOU HAVE. You can't do that if the servicing costs of your present debts would become untenable with any increase of interest rates. You can't do that if your international purchasing power is being eroded by a fall in the currency which you hold. In the 1970s, those who survived best were those who not only abandoned US investment markets, but abandoned the Dollar itself. They were only lured back into the Dollar when US interest rates spiked to 20% at the beginning of the 1980s. Short of financial armageddon, there is no prospect of a repeat of THAT.
In the 1970s, many investors recognised the problems of a falling currency and actively looked for ways to protect themselves from it. Now, almost no-one in the US is paying any attention to the Dollar. This is a sure recipe for disaster, and approaching tragedy. Don't get caught up in the "accident". It could happen at any time.
Bill Buckler
THE PRIVATEER |
