Hello Bill Murphy: How are ya doing? I have read your comments on this thread with great interest. I respect your knowledge, candor,honesty and insight. Would it be possible to get your thoughts and analysis of the editorial I have posted. Valid points have been made by the writer and the material appears to be well thought-out and researched. Perhaps some of the readers who have not had the opportunity to read the material might find it interesting and informative IMHO. If no response is forth-coming, I understand fully. Thank you in advance. Good Dayyyyyy Ronald
The Dollar - Commodities &
The Economic Confidence Model
By Martin A. Armstrong
Princeton Economic Institute
c Copyright August 4th, 1998
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There is a prevailing belief that in order to see a rally in commodities; the US dollar must collapse. In reality, there are a lot of people that are still living in the 1970s. Everything they see is purely through the eyes of the dollar and nothing else. Gold bugs blame the dollar's rise for the steady decline in gold prices. Silver enthusiasts keep cheering for the end of the world so they can at last proclaim victory after standing true to what has proven to be the worst investment for nearly the past 20 years. Every move of the dollar is being hailed as a reason to buy or sell commodities, and in recent times, stocks as well.
The misconception of the dollar and its relative position within the world economy is another sore topic among dollar haters. Most of these groups have yet to throw away their bell-bottom pants from the 1970s, as they remain oblivious to the changes around them. The old sales pitch for commodities and foreign investments during the 1970s and early 1980s had always been the US national debt. Stories about how the US was living on credit cards and that soon its currency would collapse were popular bedtime stories prior to Ronald Reagan. I myself grew up on such trading strategies in those days. But the one side effect of time is that things change. Those who understand that fact about life survive. Those who do not, are left standing behind still clinging to fashions that are as old as the washed out color movies of days long since past.
The burdensome tax rates of the 1960s and 1970s in the US sent just about every American company packing in search of greener pastures. With corporate tax rates at 70% and unreasonable unions combined with socialistic Democrats, "Made in America" became a symbol of poor quality and unrealistic wage demands not to mention just sheer unprofitable operations. The socialistic policies of 40 years of Democratic party combined with the Vietnam War helped to balloon the US budget deficit while the unions contributed to causing consumers to seek better quality from foreign manufacturers. All these trends contributed greatly to the rise in the US national debt and the bearish prejudice against the dollar along with American labor.
By 1980, Iran contributed greatly in changing the trend within America. The hostage ordeal that took Jimmy Carter down and ushered in Ronald Reagan changed not merely America, but the world. Iran struck deep into the heart of middle American pride combined with runaway inflation changed the landscape in American politics. Reagan's philosophies reversed American policy and restored the confidence of its own people within the American economy. Reagan's "deal from strength" policy confronted Russia head-on exposing their economic weakness resulting in the collapse of the Berlin Wall and the rise in American prestige. Soon, smart money everywhere recognized the early signs of change and began to respond to those changes brought about by the new Reagan Administration. The dollar rose dramatically against everything in sight between 1980 and 1985 propagating the current myth that a strong dollar was bearish for commodities.
The Reagan tax cuts changed the American economy is such a profound way, that those still living in the past never bothered to view the world in an objective manner. The 50% cut in American corporate tax rates helped to reverse the trend among multinational corporations. While the trend prior to 1980 was anything but America, the post-1980 trend quickly became America only. Virtually every major multinational manufacturer set up shop inside the US. With corporate tax rates at 60-70% throughout Europe and Japan, Reagan suddenly shifted the balance of business to America. Where not one foreign auto manufacturer could be found inside the US before 1980, the post-1980 period witnessed a move to where even Japanese companies like Toyota began actually exporting parts back to Japan from the US. Toyota itself was shocked. Its California plant became the most productive outpacing Japanese plants. This itself sent shock waves that ultimately changed the mindset of multinationals toward American labor. Even the Europeans found it made more sense to be inside the States than in Europe. These trends were aided by the collapse in the union movements. Reagan's dismissal of the air traffic controllers marked the end of the militant unions in the United States and suddenly job creation began to emerge.
In the post-1980 period, the US economy grew at more than twice that of Europe and Japan often when measured on a combined basis as well. The trend in the dollar surged driving even the British pound to $1.03 by 1985. This trend sparked the birth of G5 as the brainchild of James Baker when he was secretary of the Treasury. The US policy was one of a weaker dollar and the changes made by Reagan were so profound, that intervention became an institutionalized weapon in an attempt to keep the dollar from rising as a consequence to economic reform. With the Plaza Accord in September 1985, the G5 boldly announced that they "wanted" a 40% devaluation in the US dollar. This manipulation ultimately led to the 1987 Crash and merely increased general volatility as political objectives clashed with the underlying economic trends.
The changes within the US economy combined with the G5 manipulation sparked great confusion within the financial markets of the world. While the commodities rallied, they ultimately failed to sustain a bid. The old days of looking at the US dollar as some sort of fiat currency were slowly dying. The world was growing and evolving and the idea of Bretton Woods and a gold standard were rapidly fading into the sunset. Reagan himself had called for a commission to investigate the possibility of returning to a gold standard. However, the overwhelming conclusions from around the world were a resounding NO! Politicians had suddenly reaped a benefit when the gold standard collapsed. Domestic policies were free to divert from international policy restraints imposed by the gold standard. It was the European political circles who were perhaps even more against the idea of a gold standard than Americans. Freed at last from gold, European governments were able to fund their socialistic policies without retribution while all the time looking to the dollar for discipline as the new reserve currency of the world. Such political tactics meant that despite the collapse of the gold standard, the US held the lone role of fiscal responsibility within the global economy. Despite the rise of Japan to the second largest economy in the world, the yen remained strictly controlled and barred by policy from a true reserve status. No bond could be issued in yen without permission of MOF even within the Euro-Yen market leaving the dollar as the key foundation by default. Due to this fact alone, the US debt shrunk dramatically relative to its pre-1980 position within the world economy. As the US economy grew, the debt servicing of the US declined remarkably to nearly the lowest level within the OECD nations.
The commodity industry and dollar haters as a whole have totally misread the events of the past twenty years. They have blamed the strong dollar for their woes when in fact it has been the weakness in the dollar during the post-1985 G5 era that has caused the majority of the damage in commodity prices. Japan, for example, is one of the biggest importers of commodities in the world having little natural resources of its own. As the yen has risen in value during the post-1985 period, commodities in terms of yen have fallen steadily creating a widening spread between costs of raw material and the price of finished goods. This trend contributed greatly to the bubble economy in Japan and rising corporate profits. The same has been true in Germany. It has been the weak dollar that has caused commodity deflation around the world - not the strong dollar!
In reality, a commodity rally can ONLY materialize if we see a dollar rally - not a decline. A dollar decline will only perpetuate global deflation within the commodity sector. If commodities rise in direct proportion to the decline in the dollar, then nothing has changed globally. The commodity rally of the 1970s going into the high for 1980 has been far too often misrepresented as a dollar decline. In fact, commodities rose in terms of every currency - not just dollars due to being artificially suppressed by the gold standard for 30 years. Gold, for example, was in a bull market in every currency including Swiss francs as it rose into its 1980 high. The bull market panic in metals going into 1980 was largely due to the belief that with the collapse in Bretton Woods back in 1971, that gold would be the perfect hedge against the coming fiat currency debacle. With the 1980s, those fears have been proven unrealistic as the world economy demonstrated that it could function even more efficiently with electronic forms of money than gold. With payments freed from gold, the globalization of the economy moved into full swing. Corporates grew exponentially helping to raise the standard of living even in many third world nations. Money could be transferred around the world at the speed of light and the overall financial markets grew at an unbelievable rate.
The misconceptions about the dollar and the rose colored memory of Bretton Woods helped create a skewed view of current events without full investigation of the past. Those who wanted to return to the gold standard were in fact trying to suppress commodity prices. When gold was fixed, government debts still grew beyond the actual amount of gold available when valued at $35. The strength of the gold standard had become its weakness. While politicians and the economy required a growth in money supply that would keep pace with population growth, the restraints of Bretton Woods stood in the way of any natural appreciation in the value of gold relative to money supply growth. No politician wanted to take responsibility for a revaluation of gold. The end result could only be disaster.
The first signs of the failure of Bretton Woods came with the two-tier gold standard in 1968. While gold rallied to $42 on the open market, it quickly collapsed falling to below $35 in 1970. The subsequent collapse of Bretton Woods in 1971 was followed by a period of catch-up for commodities. While OPEC helped create the trend, in fact commodities were not responding to the decline in the dollar as much as they were to being artificially held in check by Bretton Woods.
Consequently, while those in the commodities keep praying for the very thing that has been destroying their future - a weak dollar, the truth lies in a different direction. Bull markets do NOT exist if they are taking place in only one currency. A TRUE bull market is distinctive insofar as that it must take place in terms of all currencies. When commodities, stocks, bonds or real estate rise in terms of ALL currencies, you find the greatest bull markets in history. Commodities rose during the 1970s NOT against the dollar, but against every currency symbolizing the restraints imposed by Bretton Woods.
In the end, the commodities will ONLY respond to a dollar rally and not a decline. While the initial stages of a dollar rally have indeed led to foreign selling, investors will only respond to something as an investment when it rises in terms of their own currency. Thus, a dollar rally causes commodity prices to rise when quoted in dollars. Eventually, the majority will begin to respond to a rally in commodities once they see a sustainable trend emerging in their local currency - not just dollars. Right now, a strong dollar is still leading to a further commodity decline. Until the average consumer in Japan believes that the yen will decline for several years to come, he will continue to view a commodity rally as a selling opportunity due to the appreciation in yen terms. Once the view of the yen honestly changes, then and ONLY then will we see inflation appear in Japan as it did in the US following Bretton Woods.
The European experience will likewise unfold in an opposite manner than from that currently being touted. It will NOT be the success of the Euro that suddenly creates a bull market in commodities, but again the opposite. If the Euro is a success, then why hoard gold? After all, a strong Euro will fuel nationalistic pride against the United States - something more satisfying to many than a gold rally. However, if the Euro fails to be a strong currency, then it will be the same fear in Europe that emerged in the US during the 1970s that will compel a commodity rally. A weak Euro will spark a flight by institutions to the dollar and small investors to gold and commodities.
As we can see from our illustration, those who are biased against the dollar constantly tout the same old pitch from the 1970s. The dollar went down against the yen from 483 in 1931 to 79 by 1995. To expect the dollar to continually decline forever is simply unfounded. To ignore the changes within the US economy and debt structure is sheer insanity. The US has less than 20% of global debt while it also has nearly 25% of the world economy and growing. The very same problems of unions, high wages, oppressive socialistic policies that helped to undermine the US economy during the 1960s and 1970s is now affecting the European and Japanese economies. As the US was forced to address these issues, so will both Japan and Europe. What we are witnessing is the slow and gradual collapse in the theories of Karl Marx. We have seen China and Russia collapse thanks to Marxism. We are now watching in slow motion the collapse of Marxism in disguise known as socialism. Marxism says the state should own everything. Socialism allows for private ownership but with tax rates of 70% or more. The emergence of the European Monetary Union is a direct response to this trend. EMU is the attempt at federalizing Europe with an end goal of reducing the unfunded liabilities that have grown out of socialism worldwide. The unions in Europe are only now reaching their zenith in demands, as was the case during the late 1970s in the United States. Demands for retirement at 55 on a fully paid basis at the expense of business and government will only succeed in driving more capital out of Europe as multinationals seek to survive.
While the years ahead are filled with uncertainty, the 1998.55 turning point on our Economic Confidence model has done far more than merely pick the precise day of the high in the stock markets years in advance. It has pointed to the beginning of the decline in socialism in Europe and Japan. The bubble top this time is far more dangerous in European stock markets than it is in the United States. While we may face a 1 year deflationary mode that causes the dollar to surge, bonds to rally and commodities to fall sharply. We may need to see $192 gold, $3 silver and bonds at 156 in the US with a 23% correction in stocks (50% in high tech), 40% in Europe and a China and Russia devaluation before the trend in commodities will be reversed. For now, the next year remains above all, a very interesting life experience. In the long run, the future appears to be very bright indeed once we get past 2002 - the next bottom on the current 8.6-year business cycle. By then, Europe may be forced to see reality, as was the case in the United States. The Japanese government will be forced to relinquish their dictatorial control over their economy and the yen could emerge as a major currency of reserve status along with the dollar. Thus the next period of solid economic growth appears to be on the horizon between 2003 and 2007. Until then, we have a lot of work to do over the next 4.3 years as Marxism and socialism move closer toward a complete and final stage of collapse.
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