On Friday, November 15, the latest Producer Price Index (PPI) number was announced by the US Labor Department. The October PPI came in at 1.1%, up from 0.1% in September and more than FIVE TIMES the expected 0.2%. This is the biggest monthly rise in the PPI since January 2002. But it is not "inflationary", economists were quick to point out, because the increase in prices for cars and trucks which contributed greatly to the PPI jump were "exagerated".
Neither the stock market nor the US Dollar reacted overly adversely to this PPI jump, or the 0.8% drop in industrial production, because "consumer sentiment" was up. The "gauge of consumer sentiment" produced by the University of Michigan rose to a preliminary November figure of 85 from October's 80.6. This figure reverses a five month slide in consumer sentiment.
As everybody up to and including Alan Greenspan (see his testimony to Congress) maintains, the driving force behind the US economy is consumer spending. For consumers to spend, they must be "confident", right? According to the latest figures, they are, so the US economy will be fine, right?. That's the message which the Fed hopes the public will continue to "consume", anyway.
On November 6, the Fed cut its "target" Fed Funds rate by 0.50% to 1.25% and its Discount rate to 0.75%. In REAL terms, both these rates are now NEGATIVE, which means that capital placed at these rates of interest would lose purchasing power in terms of US producer and CONSUMER price rises. Consider something else. So far in 2002, the US Dollar - as measured by the $US index - is down by 10.26% (117.21 to 105.19). For any foreign investor in the US, US interest rates don't come anywhere NEAR making up for this drop in the currency.
"You know that if the Fed cuts rates, it will be admitting to anyone with eyes to see that all the talk about US "recovery" was so much hot air. WHY CUT RATES IF THE US ECONOMY IS IN RECOVERY AND IS GROWING?"
(Gold This Week - November 1)
Of course, as the latest figures on US industrial production show (amongst many other things), the US economy is not "growing". In the words of Alan Greenspan, it has hit a "soft spot". But as long as the consumers remain "confident", the hope that it will grow survives.
In the "old days", the driving force behind a growing economy, and individual financial health, used to consist of three words: EARN - SAVE - INVEST. Now, it consists of three very different words: BORROW - SPEND - CONSUME. These two methods of "getting ahead" are mutually exclusive. Indulging in the second method makes the first impossible.
Now, getting ahead by earning, saving, and investing involves a few prerequisites. It involves a medium of exchange, a money, whose future purchasing power can be confidently expected to at least hold its own and preferably improve. It requires a REAL rate of return on investment, either in the form of an INCREASE (not a decrease) in industrial production or a REAL return on deferred consumption via POSITIVE interest rates. For individuals in most western countries, neither of these very desirable features are available.
So, savings are regarded as a one-way ticket to the poorhouse, ask anyone on a fixed income, and savers are actively discouraged by Central Banks. What is actively, indeed desperately, ENCOURAGED is borrowing and spending.
For this, we have everything from zero interest rate loans, 1,2,3, or even more year "interest free" periods on credit purchases, and sweetheart deals on mortgage refinancing. And, of course, we have US interest rates which do NOT provide a positive rate of return but which DO reduce servicing costs to vanishingly low levels.
In the process, the US and most other western nations have built a debt structure which REQUIRES negative REAL rates of interest so that the servicing costs involved in the borrowing can continue to be paid. With the 0.5% rate cut of November 6, the US has reached the point where further rate cuts are going to be almost impossible, and the Fed signalled as much in the press release which accompanied the cut.
Now, what the Fed is praying for is one more surge in borrowing. They may well get it too, for a very simple reason. Most US "consumers" either already have or very soon will come to the conclusion that this is "IT" for US rates. They are as low as they are going to get. When that happens, there is always a surge in borrowing, the idea being to get in now before rates start going UP. Perversely enough (for Central Banks), what usually happens is that borrowing gets its last and biggest surge when the Central Bank first RAISES rates after a long series of cuts. That confirms that rates are going higher, and the last rush is on to borrow now.
So, with the Fed having shot its bolt, the only thing left is to do what they did between December 2001 and November 2002, try to hold rates FLAT for as long as possible. The only way they can do THAT is if the Dollar does NOT fall and perceived inflation (higher consumer prices) does NOT cut in. In fact, the Fed is worried that if they cannot get "consumers" to sustain their borrowing, "DEFLATION" - lower prices - might cut in.
We have long found this a wonderfully hilarious concern. It is a well known fact that the huge "asset inflation" (stock market boom) of the last half of the 1990s was driven in large part (low rates also had a lot to do with it) by "deflation" (imploding prices) in the hi-tech sector as the price of computers and related hardware/software plummeted almost as fast as the Nasdaq soared. In modern "economic speak", inflation is only a concern if the price of something you want to buy goes up and deflation is only a concern if the price of something you want to sell goes down. In this parlance, a soaring stock or real estate market is not "inflationary", and of course neither was charactarised as being "inflationary". But now, with stock markets having plummeted and real estate looking "toppy" at best, the "wealth effect" has cut in and it is feared that people might curtail their borrowing. That's "deflationary"!
All stops must be pulled out to prevent that from happening. To do that, the prices of things that people own and might want to sell must either recover or sustain their present levels - stock markets must be revived and the real estate market must NOT be allowed to fall. And the prices of things that people want to buy (like consumer goods) must NOT be allowed to rise. Nor must consumers gain an expectation that they might be about to rise.
The Fed must, at all costs, prevent any tinge of "inflationary expectations" from seeping into the consciousness of American consumers. That means a "strong Dollar policy" regardless of the actual weakness of the Dollar. It means interest rates as low as humanly or inhumanly possible. It means a continuing flood of foreign investment to sustain the trade and current account deficits. It means ever larger government deficits to offset any tendency to slow consumption on the part of the private sector. It means that nobody, anywhere, must be allowed to rock the economic/financial boat. It means any measure conceivable to control the prices of "inflationary indicators" - like oil and GOLD. And, in extremis, it means the furnishing of distractions, like continuing "terrorist alerts" and, ultimately, external war.
This policy is doomed to fail. The only question is when. The one certainty is that the longer the present imbalances can be perpetrated, the worse the smash up when they finally can no longer be sustained. And the best signal that they are about to fail is, as it has been ever since Gold and "money" were divorced three decades ago, "a rise (especially a sharp rise) in the U.S. Dollar price of Gold".
Physical Gold is now the safest monetary asset you can own, with nothing else even in contention. By owning it, you are betting that the US government can not do something which cannot be done. You are betting that they cannot base a healthy economy on a process of: BORROW - SPEND - CONSUME. They can't, but they can and very likely will destroy the economy in the process of trying.