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LAST ACID TEST ON ANALYTIC VIEWS

Two weeks ago, the essay which appeared on this website reviewed several important economic beliefs and policies, which in my analysis, are totally backwards, counter-productive, and even destructive. The path of folly continues unabated. In August of 2003, a series of articles entitled “Ass-Backward Economics” summarized my entire position, published in part I, part II, part III, and part IV. The irreverent banner was indicative of my disdain for economic directives which have been backwards, ever since Greenspan departed from responsible banking policy in 1996. The price of becoming a folk hero for our myopic Fed Chairman has been cancer through inflation and speculation, erosion of our productive capacity for real wealth generation, and lost competitive nature of the US Economy.

Where there is discredit and malfunction, there is also opportunity, which is clearly laid out in my HAT TRICK LETTER reports for private readers. The energy and mining sectors will flourish in coming months and quarters, despite the baseless claims of the entrenched Wall Street community, whose vested interests are blatant. Asia has begun its overdue mad rush for North American mineral and resource properties, a January forecast of mine. The effects on the US Economy will be highly confusing. Expect those effects to include more USDollar decline, higher commodity prices, more working capital for their producers, and more “bad” price inflation inside the US Economy. The USA will see two major changes. First, our access to commodity markets will become more limited as some supply is set aside for Asian usage exclusively. Second, our real economy will be subjected to even more strain from higher production costs. The USA will experience systemic price inflation only when Asian currencies rise in their exchange rates. The ability to pass along higher costs will remain non-existent, much to the surprise of many analysts. Costs will continue to rise faster than prices, much to the frustration of US firms and workers. Some US firms will succeed in raising prices, only to the extent that their Asian rivals permit from their own exchange rate increases. Rather than attempting to raise prices, more and more US firms will continue to struggle. Some will give up and outsource. Some will shut down operations. Domestically, our wages will rise a little, only a little.

The issue of price inflation will continue to confuse even those in the gold community, the center of the bear camp. Certain forces behind inflation witnessed abroad will foster amplified profit margin stress within the US Economy. Understanding price inflation properly has become a challenge to the gold community. Asia controls the process, with tight control of flood gates. The gold crowd eagerly anticipates a release of those flood waters. We will not see it. Instead, we will see slowly rising prices for finished products, which will frustrate many for its slow pace. The effect of reduced Asian bond purchase generally will have a dampening effect on our economy. Outright Asian bond sales would have a powerful corrosive effect on our economy, and a grand influence upon release of our workers. The main question in my analysis is whether domestic prices will rise in staggered quantum jumps, or whether they will rise steadily enough to crater the bond market and result in higher long-term interest rates. The Chinese currency peg might provide the answer to that question.

Let us continue the review of such ridiculous tenets of conventional wisdom. If it were not so tragic, it would be funny. More backward beliefs and policies, (with what was said over a year ago in italics):

Fallacy f) During the monetization process, Federal Reserve open market operations result in the creation of new assets in the form of US Treasury Bonds, Notes, and Bills, thus strengthening the foundation of the banking system. Wave the wand, debt becomes an asset during the grand counterfeit process, and nobody is the wiser… The American public urges, cheers on, and applauds the illicit alchemy perpetrated in the Fed’s basement. Print currency, dry it with hot air in ample supply, bless it as real money, and call it “paper gold.”… The Dept of Treasury is chartered to manage our national gold treasure, fully entrusted to ensure that our currency is adequately collateralized… The fact is that the Fed defies Congress and will not admit how much gold bullion it has dishorded on the commodity markets to fortify the no longer defensible USDollar… When actual federal bills are paid with this alchemic output, and longer maturity govt bonds are purchased by the same output, attention will be very negative on the entire corrupted process. Faith in US paper might be eroding right now. (Aug 2003)

In the past year, the practice of central bank monetization has thoroughly gone amok. An explosion in Bank of Japan purchase of US Treasury bonds took place early this year in 2004. They increased their welfare support magnificent style. However, a noteworthy absence in Asian bond support has been detected since this summer. The US Fed may be going it alone much more than ever. Since the article was scribed over a year ago, strange evidence can be pointed to. The M2 money supply figures strangely zoomed over $400 billion higher this summer. Analysts and pundits alike scrambled to determine the root cause. They lost patience in their hot pursuit after a few hours, only to turn to the next Martha Stewart story. If truth be known, the Federal Reserve and Dept of Treasury, with a 97.33% probability <G>, are engaged in the largest monetization sanitization neutralization effort in modern mankind. They are “making good” a ton of JPMorgan bond derivatives, and an equal weight of Fanny Mae mortgage derivatives. Of course, we hear of Greenspan braggadocio that leveraged derivatives have successfully offloaded and offset risk. This is pure heresy, silly speak, and shallow pep talk in an attempt to soothe frayed nerves and endangered confidence in the monetary and financial system. When it comes to Chairman Greenspan, note his topic and ignore his words. His topic identifies the next crisis area. Be amused by his denial, based in ignorance, incompetence, or outright deception.

As for gold, silence following the G-7 Meeting over the October 2 weekend was very loud indeed. Preceding the meeting of finance ministers, promises had been handed out by bankers in France, Germany, and Italy to address their gold dishording position. They were widely anticipated to announce a new position of unwillingness to sell gold from their national treasuries any longer. One can speculate the decision to say nothing might have been motivated by a belief that gold might fire up past $430 quickly, if the bankers publicly stated any positive messages on the wisdom of holding gold. The gold market heard their silence clearly. My take on the matter is that they privately agreed to permit the USDollar to fall, but more importantly, to permit the Japanese yen to rise slowly. Unlike the G-7 Meeting in Qatar last September, finance ministers do not intend to assist currency traders this time. A slower currency correction is their clear unspoken desire.

The latest maneuvers by China to secure copper supplies (Noranda), oil supplies (Alberta oil sands), and silver supplies (Silver Standard), indicate clear a shift in the winds. Asia is growing increasingly frustrated and vulnerable. They hold too much US$-denominated financial paper, and have begun to diversify. First with less purchase of our bonds, next with outright sale. Higher interest rates await the USA but without the benefit of a stronger economy, in both Treasury and Mortgage bonds. The story of economic strength will be more exaggerated than its reality.

Fallacy g) Rising prices for commodities and imported products serve as evidence that the Fed has succeeded in its mission to reflate the economy, and is “on the job.” Wrong, all inflation is not created equal, we are seeing the horrible side of price inflation’s homecoming on the cost side of production and household expenses… Pricing power is totally nonexistent, especially with Chinese competitors omnipresent… Compounding the matter is the rise in energy costs, almost across the board. The declining USDollar has resulted in higher energy costs, just when a shortage of natural gas is evident… We are instead seeing rising production costs and rising energy costs, without the benefit of improved pricing power anywhere… In no way has increased money supply from an open monetary spigot increased capital equipment demand, improved balance sheets, or alleviated pricing power problems… The level of understanding for all things relating to “inflation” is utterly abysmal. The public has granted the Fed and Greenspasm carte blanche in attacking the misdiagnosed deflation problem. He is prescribing heavy doses of more inflation, while we observe the deflationary aftermath following years of unchecked inflation. (Aug 2003)

Commodity prices have enjoyed a break, but not across the board. Copper never retreated in price. Higher prices of certain items like cement resulted in outright critical shortages, which in Florida halted for a time all large construction projects this summer. Steel and cement were in heavy demand for building Summer Olympic venues in Athens. Pricing power remains rather weak, as China continues to send their industrial output to our shores. China has essentially enforced a tight ceiling on the ability of US firms to raise prices for the past year. Service costs do rise, but under the threat of certain functions being dispatched to Asia via outsourcing. Outside health care, restaurants, car repair, and home maintenance and remodeling, almost all service functions are vulnerable to Asian outsourcing. So wages are also bound by an Asian ceiling. Essentially, Asia is exporting price and wage deflation, even as US production costs rise from a declining USDollar. A high-pressure, low-pressure differential continues to build. Asia continues to act as the “boot heel” on US pricing which extends to the labor market.

Costs for corporations have been exacerbated by health care, which might be the main area where workers are forced to bear a greater burden. The nation has no better comprehension of inflation and deflation than a year ago. We do not distinguish between rising prices in speculation (e.g. housing or bonds) from shortages (e.g. crude oil). It is all inflation. We do not distinguish between falling prices from economic progress (e.g. economies of scale) from liquidation (e.g. distress sales), nor over-production (e.g. Asian import supply). It is all deflation. Comprehension of inflation topics is inadequate, if not abysmal!!! The gold community and bear camp can benefit from expanded understand as well. All money supply increase is NOT price inflationary, not at all. This will remain a steady topic of my analysis and writing.

The energy crunch on pocketbooks has been the big thorn in our side. A year ago, any commodity pit battle cry of “$50 oil” would be laughed at. No more. The prediction by Bill Powers (www.CanadianEnergyViewpoint.com) of $50 oil was expert and prescient; see his article "Get Ready for $50US Oil" from last February. While brokerage analysts continue to proclaim $40 oil as around the corner, $60 is more likely. By this time next year, we will be dealing with $80 oil. Production costs will rise universally within our shores and system, and result in more stress than expected. Chairman Greenspan acknowledges the wet blanket impact to our economic performance from higher oil prices. However, he is dead wrong on three counts. Alternative fuel sources will be a drop in the bucket when compared to oil demand. He believes alternatives will take up considerable slack. Technological advances have accelerated depletion of the finite oil resources. He believes new techniques will deliver more oil. World oil demand is on the sharp rise. He believes world demand will go down, amazingly unaware of its finite nature and peak issues. Greenspan’s lack of knowledge in technology is surpassed by his lack of knowledge in the energy industry. His stated views are each in total contrast with expert energy opinions.

As for business equipment, the flood of new money has resulted in flush corporate balance sheets, which my analysis did not foresee. Corporations are indeed in better shape with their balance sheets than my past position expected. That healthier cash situation has not resulted in any substantial increase in business investment inside the USA. Our corporate executives continue to see greater blue sky opportunity in Asia. Stock share buybacks and expanded dividend grants are far more prevalent than new investment and hiring. It was reported earlier this year that fully two thirds of all foreign direct investment inside China came from US firms. The problems with the US Economy have been viewed as fixable with low interest rates and ample credit supply. We continue to misdiagnose the structural problems inside our economy. A transferred, absent, abandoned manufacturing base is the real problem, aggravated by high labor costs and attached health care costs. Low rates and easy finance terms fail to address the need to improve conditions whereby making things in the USA with domestic workers is a profitable venture. The new money directed at our financial and economic system has found its destination in various locations such as residential real estate, bonds of all types, commodities, and a mountain of additional household debt. The destination has so far not been in new production bases, wherein legitimate wealth generation would take place. More “Big Box” superstores, expanded retail shopping malls, and additional mortgage agency store fronts, these are a part of the sickness, not solution. The result of Greenspan’s policies is totally upside down. Refinanced mortgages and yield carry trade do not qualify as sustaining legitimate sources of spending and wealth, respectively.

Fallacy h) Global trade has been beneficial to the US Economy, opening new markets.  Nothing could be further from the truth, as global trade has become a one-way street, replacing our mfg base and its jobs with extreme debt obligations, an unmitigated disaster that has yet to end… They [emerging nations] are grateful to have our markets so open. However, their markets have not been opened sufficiently to our corporations who reciprocally seek foreign markets in which to sell. What has evolved instead is a one-way street… Our nation willingly invites a weakened set of Asian currencies, watches in glee as our import costs are kept low, and at the point of an “open market gun” coerces the Asians to recycle their surplus back in our debt. In doing so, we have allowed the Asians to gradually accumulate claims on the base capital of a significant portion of our nation… The reality has been that Asians purchase some infotech equipment from American firms, but the production for that equipment has typically come from Asian offshore mfg plants… Political leaders continue to parrot the urgent support of a “Strong Dollar Policy,” despite its awesome and far-reaching destruction to our economy… Now we are trapped with low bond yields, a high currency valuation, and a thoroughly lost competitive position. The US Economy is listing badly… The goal of global trade stood on high ideals. The practical outcomes have been far from it. (Aug 2003)

Global trade continues to be a managed hemorrhage of capital and jobs, a 16-lane highway in one direction, hardly offset by a 2-lane highway in the other direction. Imports into the US Economy grow at a rapid pace, while exports are growing anemically if at all. The lack of success with the North American Free Trade Agreement was so deep, that we have broadened it to the Central American Free Trade Agreement, icing on a rotten cake. Since January 2003, exports have grown at 21.6% versus import growth at 17.1% despite a substantial decline in the USDollar exchange rates. In this 2004 years alone, export growth outpaces import growth at 11.9% versus 8.0% to date. With an absent US manufacturing base, a structural problem stares at experts, who fail to recognize it. This failure to rectify the trade imbalance via currency shift was a principal forecast of mine two years ago. It was met with ridicule.

We continue to pursue lower costs from foreign worker output, with little comprehension of the impact from our employees losing their jobs. The shortfall is made up by increased household debt, the same story. We continue to regard foreign purchase of our US Treasury assets as a countervailing balance against our purchase of their manufacturing output. That is the consensus “OK signal” to Wall Street, a complete fantasy. USTBonds are regarded widely as assets, the key heresy of their fallacy. They are not. Asian product output is exchanged for US financial assets, a win-win tradeoff. Bonds are debts, with obligations and potential for undermined national security and systemically rising interest rates. The Strong Policy Policy has become so embarrassing a mantra, that we no longer hear its banter. Changes are in the winds. Asians are beginning to sense their vulnerability in owning low yield bonds, with a currency risk to boot.

Fallacy i) The US Economy will break free of any Zero Bound trap, as broad demand grows, interest rates rise, and critical sectors weather the return to more “normal” interest rates. How little is understood about the powerful Liquidity Trap signaled by zeros… This patterned cycle of capital flow has been the case for four decades.  Is it that simple this time once again, a typical stroll through the economic cycle? I sincerely do not believe it is, no way, not this time… During the sudden next phase [of preceding post-war cycles], debt loads were reduced, balance sheets were repaired, as pent-up demand for cars, housing, and capital equipment gathered… Intense competition, overproduction, and crazed credit expansion prompted the onset of economic winter, manifested by liquidation on multiple fronts… The presence of Chinese competition only aggravates the lost pricing power.  Their continued presence makes for unrelenting price pressure… If rates rise, derivative damage could be an unwelcome new toxic agent to the market mix, both short-term and long-term…The above arguments outline the reasons why Zero Bound interest rates force the US Economy to engage in a “Battan Death March” where pressures abound to stay the course, even against the will of certain financial experts and leaders eager to see the cycle resume. (Aug 2003)

The trap of low bond yields, and low consumer borrowing rates has shown its extreme sharp powerful teeth. The Fed talks about raising rates to neutral, but cannot. A swoon in the financial markets this spring was so powerful, that some experts concluded – THE US ECONOMY HAS MORPHED INTO A HEDGE FUND. Their call is like a voice from the wilderness. Our economy depends desperately upon low rates. The Fed will increasingly reveal its powerlessness, as it attempts to hike rates, only to meet stiff resistance. The economy will block his efforts. The idea of “neutrality” is a joke. A healthy current phase should be a comedown in household debts, a build in pent-up demand for both cars and housing. We have seen none of the above, only worsening. Demand for houses and cars is in a constant state of exhaustion. With little attention given it, the US credit markets have lost control of its direction. Outsized Asian trade surpluses have recycled into our Treasury markets and Mortgage bond markets to such an extent in the last two years, that American banking leaders have forfeited some measure of control. Asians, either with clear intention or from lack of alternative, are subsidizing low US long-term rates. The housing boom has spilled over into consumer spending. Refinanced mortgages and home equity loans support the consumption craze. Meanwhile, US debt obligations mount to foreign investors.

China continues to apply pressure on the price of finished goods and labor. In the past year, we have seen a greater understanding that some solution is required to the fixed Chinese currency regime, the peg of 8.3 yuan per USDollar. However, our leaders are appearing more and more powerless. They expect a higher China currency, through adjustment, to remedy the import-export imbalance. It will not. They expect higher Asian currency exchange rates to improve pricing power seen inside the US Economy. It will, but at a heavy cost of a new torrent of consumer price inflation, even registered in the disconnected CPI index. Long-term interest rates will respond, and be set higher. We are finally seeing the impact of rising interest rates on the leveraged bond business, but that impact is opaque and not easily observed. The USGovt does a superb job in hiding their midnight basement activity, a massive sanitization effort. The unforeseen new development will be that pricing power WILL NOT RETURN, only higher prices will be seen. Production costs will rise relentlessly, even as finished product final pricing power also rises. The USA is badly caught in a bind. Costs will rise faster than product prices. Worse still, China will enforce pricing power, sure to be granted by them in quantum steps. Pricing power will remain a weapon wielded by China.

Any mere discussion of Zero Bound policy on interest rates is the penultimate embarrassment to any monetary authority. Any central bank which publicly discusses its plight of being ensnared in a Zero Bound situation, is admitting its failure and helpless condition. It is like the NASCAR racing crowd talking about competition among turbo-charged race cars whose engines sputter with air filters clogged, whose gasoline is tainted, whose tires roll on near zero air pressure.

Fallacy j) The US Economy is growing again, with profits returning, led by strong productivity and improved balance sheets. What a fantasy sold by Wall Street, and sold well… We may see some temporary resuscitation in the economy from countless billion$ in sloshing funny money to spur activity. But for how long?... The productivity miracle was successfully sold to the public in the last decade. In the last several months that miracle has been quietly dismissed by true experts, even as official govt statistics are slow to ease out their deceptive adjustments used far too liberally… Investors continue to be fooled. Maybe they do not mind being fooled, as long as their stock portfolios are rising in value. The US Economy proceeds with its ultra-slow-motion liquidation of debt, labor force, and inventory. Investors seem not to make the clear connection between jobless recovery and actual economic recession… This nation does not admit its errors, does not correct its errors, and refuses to allow the natural corrections to occur, because the pain would be far too great, even to the point of causing social upheaval. Meanwhile, our leaders compound errors with greater errors with economic policy that is clearly ass-backwards. (Aug 2003)

The US Economy peaked in Q3 of last year, and has been slowing ever since. Consumer spending, especially for durable goods, has lost all impetus. The great productivity miracle has gradually become identified as having been the result of import from India and China, via outsourcing. We import productivity, which explains the lack of job growth amidst supposed recovery. Higher productivity now goes hand in hand with job cuts, which explains why Greenspan does not utter his usual nonsense on the subject any longer. The benefit to the US workers and households is non-existent. Never in our history have the interests of stock shareholders been in opposition to the interests or workers. Corporations and their executives can prosper, even as they direct attention, capital, and hiring to Asia. In doing so, American workers and their families are the losers.

Evidence of economic growth goes counter to real stories. Challenger Grey & Christmas continue to report massive job cuts. The predominant component to job growth is from the Birth-Death statistical model, with over 80% of new jobs this year coming from this controversial source. Detroit automakers are cutting jobs. They expand in Brazil and China, among other locations. Home appliance makers have abandoned our workers for Mexican alternatives. Except for a handful of wealthy friends, almost every single long-standing friend is experiencing financial duress. All real life indications run counter to what we read in USGovt economic reports. I maintain my position:  ALMOST EVERY SINGLE ECONOMIC STATISTIC IS FALLACIOUS.

We all recognize that the Consumer Price Index is absurdly low and out of touch with our reality. Few make the next logic step of concluding that therefore, the economic growth statistic is exaggerated. If the CPI is 1% too low, then the GDP is roughly 1% too high. Rather than return to fiscal responsibility and to monetary sanity and to credit austerity, we move toward greater federal deficits, greater trade gaps, exploding money supply expansion, and to gargantuan new household debts. The public is subjected to broadening offers of 0% commerce.

CONCLUSION

Views professed a year ago still hold true. The improvement to corporate balance sheets is the main surprise which went against my expectations. To expect the flush of cash will foster job growth is knee-jerk and naïve. Few corporations see growth prospects inside our shores.

The failure of our economic policy lies in two areas. First, we rely too much upon debt, and upon foreigners to supply the necessary credit. Second, we mistakenly believe that what improves the individual company through pursuit of low costs, is good for the national economy. Debt is corrosive, weighs down like a growing load in a backpack, and ultimately halts participation in the marketplace altogether. The ultimate outcome, given the lack of discipline evident in spades, is suffocation or bankruptcy. We are seeing both. Low cost solutions found overseas are killing the US Economy. Our wealth generation comes now almost entirely from low interest rates pushing up values of housing, stocks, and bonds. The Fed Valuation Model calls for stock values to rise, when rates decline. This model is badly flawed. What if rates head toward zero as the economy slows radically and profits evaporate? Should stocks head into orbit higher? Trade gaps are seen by Wall Street as a boon, since those surpluses find their way into our financial markets. The real economy where things are made has been coerced into yielding to the grand inflationary machinery, led by financial engineering.

The folly of the United States in the last decade has gone to new, more insane levels. We went through the Roaring Twenties before the Great Depression. Now we proceed after the Roaring Nineties as we march onward to a nearly endless sequence of crises. The problem lies in the guarantee of future extension of capital supply, credit supply, and confidence in the USDollar. The core is in danger, which inevitably causes financial earthquakes. We mistake legal tender as money. We mistake credit availability as wealth. We mistake inflated assets as wealth generators. We mistake our bonds as assets. We mistake foreign purchase of our debts as a balance of our purchase of foreign supplies and foreign made products. We mistake job outsourcing as a benefit. We fail to recognize financial engineering as inflation and fraud. We perpetuate commerce with cost-free finance deals. We permit economic policy to be overridden by political agendas. We disseminate nonsensical forecasts about a reversal in energy prices to levels noted in days of yore. We lie through our teeth on economic statistics.

Today's Market

Today the Dow Jones Industrials wrapped up at 9,777 (-7.82), S&P at 1096 (-0.94), Nasdaq at 1920.71 (-1.10), TENS yield 3.97%. Currencies closed with  JYen at 93.94 (+.48), Can$ at 81.85 (+0.93). Metals finished with gold at 431.9 (+7.3), silver at 731.6 (+0.0), copper at 128.00 (-3.25). Energy ended with crude oil at 54.54 (-0.65), natural gas at 789.0 (-23.5), unleaded gasoline at 139.75 (-3.76). Prices are at major futures contracts.

Jim Willie CB

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