last few paragraphs on next part#3 article
"Broken Cycle: Spinning Gears"
/ jim
The Cato Institute sees two potential outcomes to the US Ponzi scheme experiment, which has obviously gone amok. Dissenters need only turn attention to federal deficits, trade gaps, debt loads, consumption, obesity, and SUV sales. Natural forces demand resolution, the objective of which is to correct the devastating trade imbalance, now running at a $450 billion annual pace. We can export an overpriced currency (euro to hit $1.60 by 2005), sure to trigger a recession in the EU, which would ameliorate to some degree the current account deficit plaguing the United States. Since most US imports come from Asia, a EuroZone recession would accomplish nothing in the closure of the US trade gap. Hence, the second potential outcome is much more likely. Both the US and EU are free to duke it out as non-producing siblings of world commerce. The European Central Bank will eventually hold its ground in defense of their currency, and resist a rising euro with fiat paper defense to fortify sea jetties. By unleashing monetary excess, coerced to duplicate the errors of the Federal Reserve, the EU would undergo longterm damage from engrained inflationary structural damage. The ECB is under tremendous pressure to copy US inflationary largesse. Such is anathema to Europeans, but is likely. Their leaders will attempt to avert short-term damage, only to ensure long-term dislocations. In time, the US will be forced to suffer Asian currency damage alone. And it is certain to be significant. US imported products would rise substantially in price from currency exchange rate effects. The consumption bubble will wind down.
A titanic battle can be seen over the horizon by students of US Treasury Bonds. Foreign supply is to be threatened from a declining USDollar, even as prices rise for materials, energy, and food, not to mention the relentless rise in health care. So credit supply will face possible interruption, while evidence of price increases hits the economy. Pockets of price inflation threaten all imports, even as profit margin erosion is to slow the US Economy. So higher consumer prices on preferred items will interrupt retail spending, while corporate earnings inhibit their ability to expand and hire. Falling longterm rates always accompany a slowing economy. One cannot lose sight of the role of the USDollar as the predominant instrument of change. Ultimately, higher rates will prevail, in defense of a crippled US currency, since foreign creditors must not be discouraged.
The Fed has been situated between a rock and a hard place for several months. Raise rates to defend the USDollar, and kill the US Economy. Wait until the US Economy is strong enough to withstand higher rates, and risk substantial imported inflation from abroad. Such is the essence of the Greenspasm Gambit, whose resolution is far from over. The result will be a painful US recession to rectify imbalances. The reflation policy is backfiring, and our Fed Chairman is beginning to see the horrendous damage from unintended consequences. He has long run out of weapons in his limited arsenal, as policy has become far more toothless than perceived. The FOREX traders might be far more aware, but then again, they are far smarter.
It is my view that the change in FOMC the January 28th statement of words issued might have been the result of bickering, rhetoric, and outright conflict between the Federal Reserve and the European Central Bank. Greenspasm has given every indication that the Fed will blink first. He has served warning to bond speculators who have enjoyed a downhill ride, a free lunch, in their highly prosperous yield carry trade. The Fed will raise rates eventually, when their patience runs out, or when the USDollar Decline becomes disorderly. Traders must now find a way to unwind their staggeringly large positions without inflicting damage to themselves or the bond market, let alone the economy. Financial leverage contraptions have a way of removing the limbs of their users when they go into reverse. We are witnessing the end game to the Greenspasm Gambit. Given the debt levels and imbalances, a positive outcome comes with heavy odds against.
The Gambit has an unwilling participant, Europe. The ECB now must ward off temptations to relent to American monetary blackmail, or else face an abrupt brick wall in export trade, combined with an incoming flood of cheap Chinese imports. The EuroZone economic future structure and well-being lie in the balance. A clear signal has been sent across the Atlantic from the European Central Bank as we approach the February G-7 meeting in Florida. ECB council member Nout Wellink said an interest rate cut would do little to halt euro gains versus the US$. Wellink said “There is no need to take special measures” when finance ministers meet. He went on to say “The forces at work are much stronger and can’t be neutralized by a minor change in rates.” He implicitly refers to large structural problems with interest rates and currency exchange rates. Small interest rate maneuvers may do precious little to change the US$ bear trend. US federal and trade deficits are squarely on the table for discussion. Economics, politics, and war will enter the closed-door debate.
Little did Greenspasm realize in 1996, when he changed policy to allow monetary growth to far exceed the GDP growth levels, that such colossal disruption, dislocation, and devastation would befall the US Economy and our financial markets. Globalization, technology, debts, foreign dependence, and systemic monetary inflation have combined to make a witch’s brew, only to wreak havoc. Financial engineering has aimed a canon squarely at our nation, yet only the gold bugs seem aware. Our financial devices of leveraged futures contracts, options, interest rate swaps, spreads, carry trades, strangles, straddles, collars, hedges, these are being turned against their makers. Let us not forget the Plunge Protection Team intervention and their many tools. This will be the most challenging and exciting period for the US Treasury Bond market in its entire history. We are entering the next stage of a grand liquidity trap, but with foreign bagholders in control of our burgeoning Treasury debt. This new chapter of stagflation (compared to 1970 decade) will prove to be more deadly. Huge offsetting forces are now aligning. I plan to keep a mishedlo device close by for consultation. Like most weather systems, where large low-pressure zones encounter large high-pressure zones, big storms await us.
As UPI Business and Economics Editor Hutchinson concludes,
“that is what comes of getting your economic policy from Charles Ponzi.” |
