by Gary North
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.
What one 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.
My teacher 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.
That was then. This is now.
THE AMERICAN 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?
If Europe 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.
Empires are noted for military strength at the beginning and fiscal weakness at the end. The military budget grows as a percentage of the total budget.
This will 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 her handbag.
SAME OLD, SAME OLD
In The Asia Times (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.
The problem 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.
By the 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.
These numbers 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.
Is this 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.
Well, as 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.
America's 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.
China, 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.
In contrast to European mercantilists of the 17th century, who sought the expansion of their governments' gold reserves, Asian central have sought dollars.
The currencies 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 of trade.
Despite 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.
But perpetual-motion 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 ‘debt 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."
It has 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.
The American 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.
Certainly, 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.
AN APOCALYPTIC FORECAST
Berthelsen 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.
"So 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 dollars."
Wood tends 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 reserves."
The statistics are really quite remarkable. Berthelsen summarizes the concentration of reserves in the central banks of a handful of countries.
Japan's 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.
"Asian 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."
American 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 Arkansas.
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 break.
Then, turning 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.
Think about 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:
That is 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.
November 17, 2003
Copyright © 2003 LewRockwell.com