No Such Thing as a Safe Currency, Save One

Jon Nadler of Kitco quotes Bloomberg's Ben Levisohn:

“For all the concern over the $1.6 trillion US budget deficit and record debt load, the dollar is as valuable now as 35 years ago. Measured against a basket of currencies from the G-10 nations proportioned against each other, the greenback is up about 3 percent since 1975, according to the Bloomberg Correlation-Weighted Currency Index. That was four years after the Bretton Woods agreement set up in 1944 to link currencies to gold, collapsed.”

At the same time, Nadler bears bad news about the darn euro, quoting The Sydney Morning Herald, which notes that even prostitutes in Greece are threatening strikes because of loss of welfare benefits:

"The stakes are high, not just for Greece but for the entire euro zone, where efforts to forge a common economic identity are threatened. Last week, the panic spread to Portugal and Spain, and the cost of insuring their debt against a default soared to record levels as investors bet that, like Greece, governments in those countries won't be able to rein in bloated budgets."

Nadler points out that the continent's financial problems are linked to Democratic Party-style social welfare programs that have decimated its economic growth. Again quoting the Sydney Morning Herald:

"on a continent where the culture and legitimacy of the mother state are so deeply ingrained - and now in some cases unaffordable - a question remains: can the European Commission say 'no more' to prodigal nations like Greece and, to a lesser extent, Spain and Portugal? And how will the countries themselves confront the political fallout of economic distress?"

Given the failure of Democratic Party-style economics in Europe, it is amazing that anyone reads the European-style New York Times anymore, or that Americans have elected an administration that is committed to instituting Europe's failed tribalist philosophy here in the more civilized, individualist United States.

Also of importance are the implications of the dollar's strength. I just blogged about the effects on employment of a strong dollar and how the US government and the Fed have orchestrated the exit of high wage jobs via monetary policy. No currency is safe because the others will inflate as much as we do. What is amazing about this process of dollar repatriation given risk in Europe, which, quoting Nadler, I predicted a month ago using my coin flip method of investing, is that massive deficits and expansion of the monetary base, have been accompanied by increasing DEMAND for the dollar. When the supply of dollars goes up, cheapening them, demand also goes up? Is this a curious application of Say's Law, that supply creates its own demand?

I think not. There is a chasm between Wall Street's short term thinking and longer term reality. Keynes said that in the long term we're all dead, but Keynes is dead and we won't have to wait that long, hopefully (from a death standpoint).

If, given the high inflation rates of the past 40 years the dollar has held its own against other currencies, there is no such thing as a safe currency, save one. Spell it G-O-L-D. That does not mean that gold is going up next week or next month. But the world is on a welfare addiction habit, and the welfare addiction is destroying the source of the "good faith" of the US government. By raising spending, providing stimulus handouts and increasing the money supply, the US government is telling America's hard working employees: "You are fools. Look at the looters at Goldman Sachs." By taxing incomes, the US government is telling you: "Do not work, live off government." By subsidizing the welfare mothers on Wall Street, the US government is telling any entrepreneur: "Why waste your time? Get a value-destroying job in New York City."

If you trust the current pattern of events, trust the current strength of the dollar. Otherwise, think about alternatives. Stocks are fine, but inflation confuses investment, credit is overextended, lending is on hold and the US economy is a mess, starting with over-investment in real estate. This will result in downward adjustments in consumers' wealth and reductions in access to credit.

How will those problems be cured? Ben Bernanke has already done it. Expand the amount of money. But entrepreneurship has been hammered through decades of high tax rates, regulation and harassment of small business. My local pharmacist says he spends half his day filling out government forms. The same in other businesses. So stocks are not exciting. Too much regulation; too much mismanagement; too much malinvestment that needs to be cleaned up.

That leaves commodities. But in the short run, they will be subject to ongoing attacks from the central banks. But are you willing to trust the federal government and the dollar over the long haul?

Hamlet is Us

When the market is down in January, don't expect a good year. In 2008, I noticed that the market was down in January and I went ahead and invested in gold stocks anyway. I was hammered that fall. Marketwatch quotes S&P's Sam Stovall as saying that this "barometer's track record is dicey, as it often fails to identify the start of new bull markets, such as the market-turnaround years of 1982 and 2003."

At 11:01 The Street noted that gold broke 1100 (I like that kind of symmetry, 11:00, 1101, it goes with my coin flipping method of investing). I'm not convinced that gold will remain firm in the short term just yet, although I've been wrong plenty of times before. Kitco today indicates that the 30 day change in the gold price has been slightly positive.

Jon Nadler of Kitco concludes his report today with this remark:

"If you are in the short-term end of the spectrum of players, excitement will not be lacking, on an hourly basis, even. The bigger picture remains unconvincing on several levels for medium-term speculators."

Also on Kitco, Roger Wiegand has a summary of the derivatives blow up over the past ten years.

Here are some of Wiegand's points:

"USA and other nations’ central bankers pumped currencies and bonds to the moon...TARP money was stolen from taxpayers and funneled through conduit AIG to crooked, failed bankers to reliquify their balance sheets with free money. They are supposed to lend some out for growth but are holding it tight earning free interest from the government; taking no risks...Crooked bankers discovered they are “Too Big To Fail” and are doing it all over again with a tacit “no penalty” understanding. Estimated derivative balances today are $204 Trillion Dollars. No one will stop them until everything collapses in one final crashing swoon."

I have a Hamlet problem. I fear the further fall of gold and rise of dollars in light of the likelihood of dollar demand in case of a global issue such as defaults by Greece or Spain (logically that should not happen but the big investors insist on the safety of the dollar). But I also fear the long term prospects for the dollar given the fragility of the banking system and the likelihood of further inflationary movement.

$980 or $1200 Gold?

Jon Nadler of Kitco argues the bear case:

"On the technical side of things, as was expected, the break below the $1,015 (he means $1,115) price marker elicited a fairly heavy subsequent decline in values. At this time, near-term support has held up at the $1,073-1,075 levels, despite such support being fairly moderate in terms of bargain hunting. Thus, a deeper decline towards the $1,055 and ultimately the $980 level now appears more plausible, even if we can expect a bounce from current levels in upcoming sessions. Overhead resistance appears to be in the $1,095-1,097 area, and the metal needs to rise to above the $1,117 mark to get the bulls excited again."

Also of Kitco, Frank Holmes argues:

We believe that the secular bull market for commodities and natural resources stocks that began in 2000 is far from over. The International Monetary Fund believes that commodity prices will rise further in 2010 as a result of global economic recovery and escalating demand from fast-growing emerging markets.

"The expanding middle class in China, Brazil and the other biggest emerging economies want more of the material goods taken for granted in the developed world. They are laying claim to a bigger share of the world’s commodities, many of which could face future supply constraints.

"History shows that commodity supercycles typically last 20 to 25 years, though not without periods of volatility. If the current cycle follows the historic pattern, we could be just starting the second half of a prolonged upward trend."

"To favor the bear case long term you need to believe in the competence of the Fed and the US Congress. Also, you need to overlook the long term trend of dollar depreciation over the past century. To favor the bull case short term you need to overlook the power of the central banks and Wall Street and the dollar mythology.

Dollar Gains, Gold Falls--Can a Chimera Last Forever?

A couple of weeks ago I blogged that my coin flip test confirmed that the dollar was in a strengthening trend and gold in a weakening trend, and it seems that the coin (it was a 1982 penny) was right. Kitco's Jon Nadler notes (gold closed at $1,080 per ounce today):

"The final session of the final January trading day in New York opened with a $1.50 loss in the yellow metal, which was quoted at $1083.90 per ounce. Gold traded in a band of from $1078 to $1088 overnight, as few additional physical buyers (other than pre-Chinese New Year buyers) emerged to take advantage of yesterday’s further significant dip. Today’s GDP numbers may yet aim gold back towards yesterday’s lows."


Nadler adduces a chart that shows that gold supply exceeds demand this year by the largest amount in three years. He quotes bearish sentiment on gold at Goldessential.com and adds:

"George Soros said yesterday that despite the current headline-making woes that Greece is experiencing, he expects the country to get its act together and not collapse in terms of debt. He referenced a six-month turnaround by Hungary some time ago as an example of how a comeback can be achieved. That said, Mr. Soros also mentioned the fact that Germany is in no mood to pump money into the direction of what it sees as ‘profligate spenders in the southern parts of Europe.”

He also notes that Soros has said that he believes that there is a risk of a gold bubble because of low interest rates. But of course, monetary expansion causes both low interest rates and gold speculation. No great insight there. Nadler mentions $1,030 as a possible low-end targeting. As well, he quotes Bloomberg:

"Commodities headed for the biggest monthly drop in 13 months on concern that demand may wane as governments seek to control economic growth."

In the short run, traders like Soros and, more generally, Wall Street hedge funds, are likely to support the dollar. This will also be true if there is any kind of bad economic news.

But what are we seeing in Washington? Ever increasing deficits and insanity. If someone tells you they're a Democrat, send them to a psychiatrist.

This is hard to take. Short term, the dollar looks buoyant. Long term, there could be a breakdown in the dollar that could happen quickly. Prices of gold and stocks go up with monetary expansion. The world's monetary system is unstable unless everyone inflates along with the US, which has already expanded its potential money supply three-fold. So no currency seems safe, including the dollar.

So far, the international financial system has supported the dollar. But how long can a chimera last?

Kitco's Nadler on Markets and the Fed

Jon Nadler had written an article on Kitco a few days ago suggesting that Ben Bernanke's public statement that he would tighten this year ought to give gold bugs pause. Today Nadler writes:

"Bloomberg reports that: “A prospect of higher interest rates in the U.S., the world’s largest economy, probably will strengthen the dollar further and may take 'some of the wind out of the commodity markets’ sails,' said Royal Bank of Scotland Plc’s commodity analysts, led by Nick Moore. The dollar may rally some 15 percent this quarter, they said.”

Nadler recommends a holding of 10 percent of your portfolio in gold. The breakdown in my brokerage account now is as follows:

Cash 45%
Stocks 22%*
High-yield bonds 6%
Gold (GLD) 15%
Agricultural commodities index (DBA) 6%
Silver (SLV) 6%

*Stocks include Kayne Anderson (a gas pipeline investment trust), GE, the health industry index (IYH), a drinking water stock fund (FTSIPCE9R), and several general stock funds.

My pension account, which is 60% larger than my brokerage account, is almost entirely in cash and a GIF (interest bearing account) that TIAA-CREF offers. In addition, I hold cash in two banks totaling about 30% of my brokerage account. One of the banks, Everbank, offers international CDs such as Euros and Yen, but I have it all in the dollar now.

Nadler argues that unless you think that hyper-inflation is a possibility that gold is not a good hedge against inflation. He argues that the 1970s's gold boom was an anomaly that occurred because of the absence of investment alternatives such as small business stock funds.

However, you will recall that the inflation of the 1970s took the following path. First, the Vietnam War debt precipitated aggressive Fed policy and Nixon added inflation in the early 1970s. By 1970 the inflation rate was about 4%, only slightly higher than it has generally been during the past 25 years. But at that time people perceived the 4% as high. Today they perceive 3.7% inflation as no inflation.

The taste for gold did not accelerate until later in the decade, the late 1970s, when the Johnson/Nixon money had circulated for five to fifteen years. This occurred because of speculation that was in reaction to visible inflation approaching and exceeding 10%.

At the time that the inflation was reaching its peak, the Carter Fed under Paul Volcker adopted the monetarist policy of raising interest rates to limit monetary growth and inflation. This resulted in high interest rates occurring at the same time that inflation was peaking. High unemployment and high inflation coincided, resulting in "stagflation". Today, the monetary policy of the past two decades which was almost as inflationary as under Johnson and Nixon has been counteracted by international central bank intervention. Thus, national central banks hold US bonds. This creates a market situation that is inherently unstable in the long run. We all have faith in the rationality and dependability of governments to manage the world economy wisely because of the numerous historical precedents such as......? In other words, I am not clear as to what makes central bankers more judicious investors in the dollar than Americans were investors in Nasdaq tech funds.

In any case, the Fed has required Americans to rely on the sensibilities and market judgments of global central bankers. In response to excessive lending and apparently uncontrolled and incompetent use of derivatives in the past two decades, the banking system contracted its loan volume last year. The Fed's response was to triple the monetary base. Since 2006 the money supply has been growing at an 8% clip, more than double the recent inflation rate. Some fear a banking collapse leading to deflation, others fear increasing Fed aggressiveness in expanding the money supply. In any case, the Fed needs to balance three factors: unemployment; the prospect of the collapse of incompetently managed money center banks that rely on fresh Fed money; and inflation. Any tightening will threaten the incompetently run banks and may result in higher unemployment. Thus, the Fed will likely have to choose between short term unemployment and the risk of additional inflation in the already unstable system.

In reaction to global concerns about inflation and, as Nadler points out, tightening in China, there may be some Fed tightening in the near term, which is why I am holding dollars. Over time, however, there are obvious risks as to Bernanke's judgment.

Mr. Nadler has forwarded me some interesting comments. I had written to him this e-mail in response to an article about Ben Bernanke's statement that he is going to tighten:

"I have about 25% of my portfolio in gold and commodities at this point, about 30% in stocks and high-yield bonds and 45% in cash at this point and have been following your column for the past couple of months. The quote from Bernanke sounds compelling but I'm curious if you have (or know of anyone who has) compared Fed chairmen statements with actual policy decisions over the ensuing two years, say tracking back to the 1970s? My guess is that there have been frequent statements about tightening and austerity but much less frequent examples of actually following through. So what is the real content of a Fed chairman's statement that he will tighten? My guess is that the statements frequently do not match reality. Any opinion?

Mr. Nadler wrote the following response Q&A style:

Langbert: So what is the real content of a Fed chairman's statement that he will tighten? My guess is that the statements frequently do not match reality. Any opinion?

Nadler: Not in all cases. The most notorious example was Volcker, in 1982. There is a CPM Group report that illustrates just how much people had geared up for massive inflation but an equally massive interest rate hike sterilized any such nefarious outcomes. Surprise. In any case, I can find that text next week for you if you require.

L: If the Fed tightens and the dollar strengthens, do you think that there would be an effect on the stock market and employment, which in turn would make Obama's political position worse than it has been becoming? In that case, the guy who is investing in stocks will get creamed along with commodities.

N: Investments in anything (other than dollars and debt instruments) would probably take a hit. Commodities more than stock, likely. Foreign currencies and emerging market equities, as well.

L: Recall that in the 1930s Mariner Eckles tightened in 1935 or so and that led to the bottoming in the late 1930s that was below the initial bottom. I suspect Bernanke is aware of that history and doesn't aim to repeat it. Also, if he tightens, it might be a repeat of Carter's administration, with a tightening at the end which sealed Carter's coffin.

A: The political 'palatability' might indeed be low, but someone has to explain that you cannot rebuild and get on with it without some short-term pain. The sooner Obama makes it clear that the problem was hatched and aggravated during the Bush years, the more likely he is to succeed in selling rate hike and tax hike programs. The Fed is independent and will thus act when it sees fit, not when Obama gives the 'all-clear' signal.

Q: tightening two years into the Obama administration will lead to a couple of years of even higher unemployment and a rough ride for the Messiah. Or will the Fed respond to political pressure and tighten a bit, rescinding the tightening at the first sign of stock market declines and higher unemployment? It seems to me that the political pressure to follow the inflationary path at this point is still greater than the threat of inflation. Also, the reserves already created are going to be inflationary if the banking system decides that the risk of the problems from last year have passed. If Bernanke continues to pander to them, they will relax.

A: The liquidity will be mopped up with various tools. There is no quid-pro-quo that inflation must result from all of this injecting. What is needed more than anything is more regulation, less lobbying, and far less corporatism. Which, is, what America now has - not capitalism.

You will be all right I trust. Though it will have to be a nimble run...

I am not quite as confident as Mr. Nadler that there will be a nimble Fed and banking response to the massive liquidity that the Fed has handed to the banks or that regulation will help, but hopefully you, dear reader, and I will be nimble in responding to the current monetary risks.