Previews of Coming Destructions
March 21, 2006
The recent announcement by the Bank of Japan that it will soon
end its zero interest rate policy serves to illustrate the main
reason why I am a longer term bear on the U.S. economy and dollar.
The two principle factors that need to exist in order to cause
hyperinflation have been set in motion and it is scheduled to
arrive in the middle of the next decade. One is our massive debt
and the other is the fiat currency system which will be employed
to print the imbalances away. The reason why I believe hyperinflation
is the more likely outcome, as opposed to a depression, is that
hyperinflation is more palatable from the Government's standpoint.
It only insidiously destroys the public's wealth, where as a
severe economic downturn would be immediately pernicious for
the consumer and not as easily disguised.
The end of the Yen carry trade, where investors could borrow
yen at a nearly zero interest rates and invest that money in
U.S. treasuries, demonstrates how vulnerable our bond market
is to changes in foreign demand for dollars. Just that announcement
sent yields rising across the curve and the 10 year treasury
yield to 4.80% (a 20-month high). The surge in yields was just
a preview of coming destructions. The damage will be done to
our economy and our dollar in absolute terms and on currency
exchange markets, which should send interest rates and inflation
The Bank of Japan has increased its holdings of U.S. treasuries
115% in the last 4 years alone. The dollar is also under pressure
from China who has well promulgated its desire to distance the
Yuan peg to the dollar, perhaps because it has increased U.S.
treasury holdings 225% in the last 4 years. Our trade deficit
now stands at a run rate of $822 billion for 2006. According
to the Federal Reserve Flow of Funds Accounts of the U.S., as
of 12/31/05 foreign holders owned 47% of U.S. treasuries. One
has to wonder how much more of our country we are willing to
sell away and how much longer foreigners will be willing to ignore
their concentrated positions. But these are the good times. The
challenges that this country faces in the next decade are staggering.
As we creep slowly toward 2017, when the social security trust
fund needs to be tapped, the pressures on our dollar and economy
will reach critical mass. In that year the government will no
longer be able to rob from the trust fund, spending social security
surpluses in the current year budget rather than setting them
aside, and the flaws of our unified budget will be revealed.
For example, noted economist John Williams has stated that according
to GAAP, the actual budget deficit for 2005 alone would be 3.5
trillion, which would include the "off-budget" items
e.g. hurricanes and wars as well as the segregation of funds
collected for social security.
And the information above isn't just my own wild assertion. The
following was derived from the Social Security Administration's
Trustees' report: the federal government needs $5.7 trillion
available to invest today in order to fulfill all of its obligations
through 2079. Barring that, the total amount of negative cash
flow through 2079 is $25.8 trillion! Even worse, according to
the Medicare Trustees' report the shortfall in Medicare over
the next 75 years is an additional $29.9 trillion. It is an inescapable
conclusion to reach that the Federal Reserve almost has to resort
to monetizing this debt. Americans do not have the savings in
which to purchase this wave of new debt and we cannot count on
the never-ending willingness of foreign savers to do so, especially
since that appetite may already be starting to wane.
When one analyzes U.S. statistics of M3 money supply in conjunction
with fed fund rates it is clear to see that either the fed is
unwilling or unable to curtail monetary growth rates. It should
also be noted that the Fed is not alone in the game of currency
debasement. That is why I believe the dollar will drop against
hard assets and certain currencies, but not all. It also seems
clear that those who are not prepared to shelter themselves from
inflation will be left far behind those who prepare now.
The Perennial Pom Pom Pundits, as I like to call them, claim
that Foreigners will not abandon the dollar as their fortunes
are inextricably tied to it. This is a specious argument. A good
illustration would be to look at the some of the major inside
holders of Enron stock. Did they balk at selling their shares
when it became clear that the ship was going down just because
it would hurt the share price? Even those who clung longest to
hope sold what they could when the end became clear.
The central banks have historically shown their willingness to
print money with alacrity in order to mask fiscal imbalances.
Faced with the mounting debts in this country and the inability
of our elected officials to face our greatest fiscal challenges
I can only conclude the path of least resistance is the debasement
of our currency. Investors: plan for continued, increasing inflation.
Mar 17, 2006
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