When we think
of gold’s price at $850, we think of 1980. That was a bad year.
There had been reckless expansion of money under the Federal Reserve
Chairmanship of G. William Miller, who everyone in 1980 wanted
to forget, and generally the public has. He is remembered, if
at all, mainly by his appearance at a Washington costume party,
dressed in a Batman suit. Paul Volcker replaced him in August,
1979, and the FED then slammed on the money breaks. The flame-out
of gold and silver took place in January, 1980. Then, down, down,
down for over two decades.
The FED under
Volcker brought monetary inflation under control long enough for
price inflation to recede. It took back-to-back recessions, 1980/1981,
to accomplish this. It also took Ronald Reagan’s reduction in
top marginal income tax rates. We forget about his desperation
hike in Social Security taxes in 1983, when SSA technically went
bankrupt, and the large tax hike in 1986, known as TEFRA.
We have seen
the triumph of the dollar and the collapse of Communism. We have
seen the rise of America as the only superpower. All of this looks
like it’s forever. But nothing is forever. The futures markets
being what they are, forever is about as secure as the NASDAQ
was in early 2000.
I have been
watching the gold wars since about 1963. That is 40 years. It’s
my entire adult life. Old men lament, "What I have seen!"
Well, I don’t think I’ve seen much yet.
generation saw, 1910—1950, was something to be seen. In the
America of 1910, there was no Federal Reserve System, no income
tax, and a full gold coin standard was in operation. There had
been neither World War I nor World War II. The following names
were unknown: Lenin, Hitler, Mao.
Robert Nisbet put it best. In 1913, the year of his birth, the
only contact that the average American had with the Federal government
was the Post Office.
then. This is now.
EMPIRE: EASY COME, EASY GO
We live in
what appears to be era of the American empire. Three events have
made this era visible: the fall of the Soviet Union (August 19—21,
1991), September 11, 2001, and the fall of Iraq (March, 2003).
The question is: How
long will it last?
were still the main competition, the answer would be simple: a
long time. Europe is in decline. Its population statistics reveal
this. Muslims are replacing the original inhabitants. Europe is
no longer where the challenge will come from. Asia is. I think
the Europeans know this.
noted for military strength at the beginning and fiscal weakness
at the end. The military budget grows as a percentage of the total
not be true of the American empire. The expenses of the welfare
system for the aged will swamp the military budget long before
there is a significant military threat to the United States. The
fall of the American empire will be fiscal, as the fall of every
empire is. But foreign occupation costs, military recruitment
costs, and weapons costs will not be the collective cause. The
unfunded liabilities of actuarially unfulfillable political promises
will be. It will not be enemies at the gates who overwhelm the
American empire. It will be the army of politically armed economic
dependents inside the gates. Granny will bring it down. If you
want a mental picture image of the end of American empire, imagine
a man dressed in uniform, holding an automatic rifle, being pelted
mercilessly by an old lady who is beating him over the head with
(July 15, 2003), John Berthelsen begins with a conventional
survey of the Asian economy and America’s role in it. The numbers
are nevertheless astonishing. American investors have become inoculated
to these numbers — a bad sign.
is Asia’s build-up of dollar reserves. Private Asian investors
and central banks have been buying dollar-denominated assets in
order to keep their currencies from rising against the dollar.
The decision-makers don’t want their export markets to fade. But,
in effect, when governments and their central banks follow a policy
of debasing their currencies for the sake of their export markets,
they have adopted a foreign aid program for America. I call it
the Marshall-san Plan. Berthelsen writes:
At a time
when the United States remains tightly focused on its domestic
economic problems and its international military adventures
of the past two years, Asia has been quietly running up an absolutely
staggering surplus of US dollars.
end of 2003, according to JP Morgan Chase economists in Hong
Kong, the combined countries of Asia are expected to hold an
astonishing 70 percent of the world’s currency reserves. In
the past decade, they estimate, Asia has added US$1.2 trillion
to its US dollar reserves as it runs up whopping trade surpluses
with the rest of the world — principally the United States,
whose annual trade deficit is expected to reach US$500 billion.
Credit Lyonnais Securities Asia (CLSA) in Hong Kong put the
Asian reserves even higher, at perhaps $1.5 trillion.
are gargantuan. Updating Senator Everett Dirkson’s comment, "a
trillion here, a trillion there, and pretty soon we’re talking
big money." Think about a $1.5 trillion reserve. This is
about 70% of the U.S. government’s budget for one year.
a danger to the world economy? For many years, America’s strong-dollar
policy served the world and chiefly the United States very well.
Their currencies cheap against the US dollar, Asian manufacturers
profited by making relatively inexpensive exports and selling
them in the United States at a healthy profit. In a kind cat-and-rat-farm
analogy, in which the cats eat the rats, are skinned for their
fur, and then are fed back to new rats, the Americans benefited
by getting cheap goods that kept their consumer-led economy
roaring. The financial communities benefited from the repatriation
of those profits as the funds flowed back in a ceaseless waterfall
into US stock markets, treasury and corporate bonds, money-market
funds and other financial instruments.
Pearl Bailey sang five decades ago, it takes two to tango. It
takes two to contango, too. America’s strong-dollar policy has
been matched step for step by Asia’s weak-currency policies. When
no currency offers unrestricted redeemability in gold coins, it’s
all a matter of comparison.
supposedly strong-dollar policy is simply an extension of the
weak-dollar policy imposed overnight by the Federal Reserve and
other central bankers in 1985: the Plaza Accord. There has been
no significant reduction in the rate of American monetary expansion
since 1985, except for two years, 1994—95. You
can see the statistics for money narrowly defined, 1990—2002,
which reveals Federal Reserve policy better than the broader definition
of money. You can compare FED policy with policies of the other
major nations. Check the figures for China, especially. Don’t
call this a strong-dollar policy. Call it a weak yuan policy.
This is an
Asian-subsidized program of accumulating reserves. The original
"Asian tiger" strategy of export-led growth, which is
widely understood as the cause of the enormous growth of Asia,
1950—90, is being imitated. The problem is, this understanding
was incorrect. That there were large numbers of exports is unquestionable.
But these exports were made possible because of the low-taxation
policies of the governments, which freed up their economies as
never before. Also, the import of entrepreneurship — "made
in the U.S.A." — helped transform non-Communist East
Asia. But government policy-makers misunderstood the cause of
their nations’ economic success. They adopted mercantilism as
their explanatory methodology: export-led balance of payments
surpluses. China has especially been guilty of this faulty economic
analysis, which now dominates central bank policy.
whose share of exports in total gross domestic product (GDP)
averaged 10.8 percent in 1985—89, now is producing exports
at 28.4 percent of GDP. South Korea’s exports were at 23 percent
during the same period and now are at 54 percent of GDP. Hong
Kong, then at 77.8 percent, is now at 153.5 percent of GDP.
These figures are being repeated across virtually every economy
in Asia. These exports continue to flow into the United States
despite a three-year economic downturn that, if rationality
were to prevail, should have slowed consumer purchases. The
US Federal Reserve’s easy-money policy and record cuts in interest
rates, however, have kept consumers buying at a feverish pace,
far too often on credit.
to European mercantilists of the 17th century, who
sought the expansion of their governments’ gold reserves, Asian
central have sought dollars.
of Asia, however, have almost all remained firmly tied to the
dollar, either through currency pegs, reserve boards or, as
in the case of Japan, as governments have bought dollars to
keep their currencies static and thus to preserve their terms
the US attempts to talk the dollar down, Asian governments regard
any negative changes in their trade balances as inimical to
their economies. While supposedly loosening restrictions so
that their consumers can participate in a demand-led consumer
revolution, Asia in fact is more dependent on exports today
than at any time over the past two decades.
Now, as always,
Asian mercantilist policy must face the monetary results described
in the mid-eighteenth century by David Hume: a build-up of foreign
exchange. A free market would raise the exchange rate of the exporting
countries. This would make Asian imports more expensive for Americans,
who would have to pay more dollars to obtain Asian currencies.
Asian the central banks refuse to allow this market-produced development.
They insist on subsidizing exports to Americans. This policy comes
at the expense of domestic consumers in Asia and American manufacturers.
It cannot go on indefinitely. In the immortal words of the late
Herb Stein, the chairman of Nixon’s Council of Economic Advisers,
when something cannot go on, it has a tendency to stop.
machines don’t work. The monumental scale of Asia’s dollar reserves
and the size of America’s deficit are starting to make economists
and strategists nervous. Wayne Godley, an economist at the Levy
Economics Institute in New York, writes: "If the balance
of trade does not improve, there is a danger that over a period
of time the United States will find itself in a u2018debt trap’,
with an accelerating deterioration both in its net foreign-asset
position and in its overall current balance of payments (as
net income paid abroad starts to explode). Such a trap would
call imperatively for corrective action if it is not at some
stage to unravel chaotically."
been widely reported that the US must take in about $1.3 billion
a day — about $55 million an hour — in foreign investment
to finance its overseas debt. If that river of money falters
or dries up, the difference must be made up by an inexorable
fall in the value of the US currency. Indeed, if it had stopped
already, the fall in the US stock markets since equities began
to lose their luster in 2000 would have been catastrophic.
economy is growing ever-more dependent on Asian investments here.
Berthelsen is correct: this is the result of central bank policy,
not free market entrepreneurship.
Asia has been on a buying spree in US securities of all types.
Despite a three-year economic pause in the United States, Asians
bought a record $201 billion worth of long-term US paper in
2002. That includes another record $97 billion in US government
securities. Asian central banks, with their enormous overhangs
of US dollars, are increasingly doing the buying.
also reported on an in-house report by Christopher Wood, an economist
for Credit Lyonnais Securities Asia.
I had not
previously heard of Mr. Wood. I am familiar with Credit Lyonnais,
but not its Asian branch. What impressed me about the report is
that it came from a company that makes money by advising clients.
It does not make its money selling newsletters. This means that
its recommendations are aimed at conventional people with a lot
of money to invest. Therefore, reports generated by such large
retail organizations in the financial world tend to be reserved.
Wood’s report was not reserved.
long as America continues to secure easy funding, there is no
pressure on policymakers in Washington to do anything other
than run super-easy policies to try to keep their own consumer
credit cycle going," says Christopher Wood, global emerging-markets
equities strategist for CLSA Hong Kong. "Like any profligate
debtor, market discipline will only be imposed on America when
foreign investors demand an interest-rate premium for owning
to grow apocalyptic. "The current trend can continue for
a while," he writes in his 110-page first-half 2003 overview
of the world economy, published last month. "But the longer
American excesses are financed, the more inevitable will be
the ultimate collapse of the US paper-dollar standard that has
been in place ever since Richard Nixon broke with Bretton Woods
by ending the dollar’s link with gold in 1971. The result will
be a massive devaluation against gold of Asia’s hoard of dollar-exchange
are really quite remarkable. Berthelsen summarizes the concentration
of reserves in the central banks of a handful of countries.
foreign reserves currently total $496 billion, followed by China
at $310 billion and Taiwan at US$170 billion, according to figures
compiled in April by the Hong Kong Monetary Authority. Hong
Kong, with 7.5 million people, has reserves of $114 billion,
nearly seven times the total money in circulation in the territory.
Other Asian treasuries are similarly bulging with dollars.
To his credit,
Wood calls a spade a spade: mercantilism. This is one reason why
I am impressed with his overall analysis.
central banks could abandon their mercantilist policies. They
could let their currencies rise, which is what would happen
given Asia’s high savings rates if market forces were allowed
to prevail. This would in turn boost Asia’s consumer demand
cycle. This is also what should be happening from a theoretical
standpoint, as satiated American consumers have already borrowed
a lot and need to rebuild their balance sheets."
consumers have no realization about what is happening, nor should
they. They go into Wal-Mart, and they buy imports from China.
It is not their responsibility to assess the impact of their purchases
on the balance of payments, the build-up of Asian central bank
reserves, or anything else that economists love to chatter about.
They buy their items and walk out of the store. Before they start
their cars’ engines, Wal-Mart has re-ordered the items they bought.
Why not? Wal-Mart is being subsidized by Asian central bankers.
This is why the price of real estate goes up, up, up in Northwest
In the old
Saturday Evening Post, there used to be a regular column
modeled after a baseball pitching analogy, "The Long, Slow
Curve . . . and Then the Fast Break." Here comes Wood’s fast
truly apocalyptic, Wood predicts that by the end of the decade
there will no longer be a possibility that the world’s central
banks can control the situation, and there will be a truly massive
devaluation of the US dollar. "The view here is that the
US dollar will have disintegrated by the end of this decade.
By then, the target price of gold bullion is US$3,400 an ounce."
That is roughly 10 times gold’s current level. If that were
to happen, Asia’s holders of dollars would be forced to start
selling them or see their own reserves collapse. If they start
to sell them, the price of America’s paper will fall even faster.
this estimate: gold in the mid-$3,000 range. Those of you who
follow Richard Russell’s newsletter will recognize the figure.
Russell thinks the Dow Jones Industrial Average and the price
of gold will meet at 3,000. Berthelsen summarizes:
truly apocalypse now, or in 2010. Is it possible? The policymakers
in the administration of President George W Bush in Washington
are far more sanguine. They regard economists, often said to
be the only field in which two individuals have shared the Nobel
Prize for saying exactly the opposite things, to be basically
irrelevant, and presumably by extension strategists. The administration,
facing an election in a year and a half, and the Federal Reserve
intend to keep the party going if they can.
On the fringes
of opinion from the fringes of Asia has come a remarkable prognostication.
If it turns out to be correct, then the world of international
commerce is going to hit a brick wall sometime in the next ten
years, a brick wall so thick that it might even affect the price
of real estate in Northwest Arkansas.