Todd Stein & Steven McIntyre
Housing prices are booming. The NASDAQ and S&P 500 stock indices are at four-year highs. The Russell 2000 index is at an all-time high. The unemployment rate is not far from near-decade lows. This is the legacy that Alan Greenspan wants to leave.
During the 1980s and 1990s, Greenspan became addicted to the attention he was receiving from the highest levels in the White House and on Wall Street. It was in those years that he began selling out his sound money principles in exchange for a lifestyle of private jets and fancy limousines. When the Internet bubble imploded in 2000-2002, Greenspan's magnificent legacy was in danger. Fortunately for him, he held the keys to a 21st century electronic printing press giving him the ability to create and make available more cheap money than this country knew what to do with. This unprecedented liquidity injection bailed out equity investors, junk bond hedge funds, and major banks and created a massive real estate bubble that still exists today.
After cutting interest rates to record low levels, inflation began to rear its ugly head. Despite the government's best attempts at doctoring the Consumer Price Index, the average American could feel that something was different. Whether it was rising gas prices, higher electricity and grocery bills, or increasing healthcare costs, inflation started to creep into society. These inflation fears have caused Greenspan to raise rates in a bite sized fashion over the last few months. The yield curve has become flatter than a pancake as long-term rates refuse to budge despite the Fed's best attempt at jawboning the long end of the curve up.
We believe that Greenspan's recent testimony to Congress was his final attempt to jawbone long rates higher. The financial press was certain a few months ago that rate hikes would end by summertime, now it is a given that rates will be hiked for the remainder of the year. We continue to predict that something in the economy or financial markets will break in the coming quarters. At that time, the Fed will have no choice but to stop hiking rates and likely begin lowering them again. There is no way Greenspan (or his successor) will take the heat for a recession or a deflationary depression. Stagflation is much more politically acceptable as people tend to remember nominal numbers rather than real numbers. A weakening Dollar and $500/oz. gold price are small prices to pay for the Greenspan legacy to be solidified.
The problem is that putting Humpty Dumpty back together again is no small task. While some additional weakening in the Dollar and $500/oz. gold may be palatable to financial markets, the ability to contain the Dollar's further destruction from those levels will be no easy task. Greenspan has helped create structural spending problems in the U.S. that cannot be fixed overnight. Couple this with gigantic wage gaps between the U.S. and Asia and the recipe for a currency disaster is born. Until the U.S. consumer restrains his penchant for spending every nickel he makes, a widening trade deficit and Dollar weakness loom. In fact, as we rapidly approach seven and eight percent current account deficits, the odds of the Dollar decline becoming disorderly only increase. Once again this points to the benefits of owning gold and silver. Gold seems destined to break $500/oz. in the current environment, but if people begin to see through the problems with the Dollar and the interest rate box the Fed is in, then gold prices may quickly leave 500 bucks an ounce in the rear view mirror.
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Aug 05, 2005