"In the meantime, we will watch to see if the present shaky edifice of financial "business as usual" can continue to stand upright in the face of the news that isn't deemed "fit to print" - the REAL news which daily paints an ever starker picture of a financial world strained to the breaking point by a pile of debt which just keeps on growing."
(Gold This Week - July 16, 2004)"
There is the real world, and then there is the world portrayed by the 9/11 Commission whose report was released this week, and then there is the world portrayed by Mr Alan Greenspan who spent two days this week (July 20-21) testifying to Congress about the state of the US economy. We will leave any decisions as to which report (the 9/11 commission's or Mr Greenspan's) is more at variance with reality to those who enjoy such pastimes. Suffice it to say here that Mr Greenspan must be in the running.
Mr Greenspan, by his own stated admission, holds that no one can now know what money is. He also maintains that it is impossible to perceive an investment "bubble" until it bursts. Mr Greenspan talked about "irrational exuberance" in US stock markets way back in December 1996. He spent the next three plus years, until the stock market bubble burst in early 2000, mangling economic theory out of all recognisable shape in an all out bid to rationalise the exuberance. He has played up the "miracle" of US "productivity" while the US trade deficits have been setting new annual records year on year for the past decade. And that was all long before his Congressional testimony on July 20-21.
On July 20, as reported by the Financial Times, Mr Greenspan told the Congress that: "The economy appears well-prepared if rising inflation pressures demand 'a more dynamic adjustment'." A more dynamic adjustment? - to US interest rates, that is.
The US economy is well prepared for this, is it? As The Privateer has pointed out in several recent issues, when you combine Federal, State and local government borrowing with business and consumer borrowing, the stark picture emerges that the US is borrowing almost exactly one quarter (24.8%) of its annual GDP. For nearly three years now, this borrowing has been done with official US rates at 40 year lows. Is this the picture of an economy "well prepared" to cope with higher interest rates, especially if Mr Greenspan deems it necessary to adjust them (upward) "more dynamically"? The mind boggles.
On July 21, Mr Greenspan's venue moved from the Senate Banking Committee to the House Financial Services Committee. There, among many other things, he told the rapt Congressmen that the US economy was in a self-sustaining expansion that no longer needs the hefty monetary stimulus the Fed put in place with 13 interest-rate cuts dating to 2001. He also stated that US business was not acting the way they did in previous US economic "recoveries" because they were not ramping up either their capital investments or their permanent hiring.
This is truly Barnum and Bailey stuff. If a Congressman's memory stretches back before his or her last long lunch, they would at least have an inkling of the fact that under a regime of Central Bank setting of "official" interest rates, a "recovery" is the phase which is driven by DECLINING rates, not RISING rates. Mr Greenspan's problem is that US business undertook no capital investment nor long-term hiring (they did just the oppposite) while the Fed was cutting rates from 6.5% to 1.0% in 2001-2003. And now, with the prospect of higher (and quite possibly much higher) rates to come, he expects them to start investing and hiring?? Well, why not, anything seems to go these days. Mr Bush still expects to bring "democracy" to Iraq, after all.
Even Wall Street could not quite make themselves swallow Mr Greenspan's line whole. On July 22, Reuters ran a story under the headline: "Fed's economic view too rosy for some analysts". But the really important markets, important to Mr Greenspan and the Fed at any rate, took it all on board without a murmour. The $US index leaped from a post April 2004 low of 87.30 on July 16 to 89.46 (its highest level since June 29) on July 23. And, of course, $US Gold fell a hefty $US 16.30 to $US 390.50, its lowest level since June 17.
We said that Wall Street didn't swallow Mr Greenspan's line whole. There were two jarring developments which did not fit the picture that Mr Greenspan and his fellow "Fedsters" are trying so hard to sell. First, the $US oil price (the "transitory factor" which Mr Greenspan singled out as being responsible for the "uptick" in US price inflation) remained stubbornly well above the $US 40.00 level. In fact, by July 23, spot future oil on the NYMEX was all the way up to $US 41.71, only $US 0.62 below the $US 42.33 2004 high it set on June 1.
The other "jarring development" was on US stock markets. On June 23, the Dow closed BELOW the 10000 point level for the first time in three months. The Nasdaq closed at 1849 - a new 2004 low. And the S&P 500, having broken below the 1100 mark for the first time since May 24 on July 21, lost ground for the sixth week in a row, closing at 1086.
The stock market, as it always does, is looking for a source of future earnings and can't find one despite the Fed's ever more rosy scenarios. The currency markets, on the other hand, have reverted to their pre June 30 expectations. Back then, they were all sure that the imminent Fed rate rise would "strengthen" the US Dollar by offering a better rate of return to investors in same. June 30 came, the Fed duly raised rates, and the Dollar commenced a slide which remained almost unbroken, until this week.
Now, having heard what Mr Greenspan had to say and coming to the conclusion that the Fed might be planning to raise rates a bit faster than they thought they would, the currency markets have decided that this will offer even better rates of return to investors in US Dollars, so of course this time, the Dollar WILL get stronger.
So far (since Mr Greenspan bagan his testimony on July 20), it sure has.
We would ask you now to stop and reflect for a moment on what has happened to other (not the US Dollar) currencies in times of financial "crisis". Think about the Asian Crisis of the late 1990s. Think about the recurrent crises in Latin America over the past 30 years or so. What happens when the Central Bank starts raising interest rates at an accelerated level? That's right, the currency, which was already falling due to the "crisis", begins to fall much faster. That's when the "currency sharks" (ask Mr Soros) really go to town. The reason is simplicity itself. The very fact that the Central Bank is FORCED to raise rates faster than they want to is proof positive that the crisis is not only real but is likely worse, or far worse, than it has been seen to be.
But the US (and the US Dollar) is not in any kind of economic "crisis"! Isn't it? Mr Greenspan is in the very unenviable position (for a Central Banker) of no longer "controlling the punchbowl". The US economy and the US Dollar is at the mercy of the foreigners who hold gigantic amounts of US Dollars and Treasury debt. As we report in the Late July issue of The Privateer (published on July 25), the latest figures for international investment in $US assets (stocks, Treasuries, Agencies, etc.) show that they fell by more than ONE QUARTER (25.8%) in May from their level in April.
This figure would have shaken Mr Greenspan and the Fed to their core. It has, demonstrably, become MANDATORY to do WHATEVER is necessary to maintain the exchange value of the US Dollar. Another fall of international investment in the US like the one in May would be potentially catastrophic. This week, Mr Greenspan has been very successful. Next week, next month, three months from now? That's going to be MUCH harder.
The Dollar has rebounded. Gold (and Silver) have fallen, but oil hasn't. Treasury yields remain flat. US stock markets are teetering on the brink of renewing their post 2000 bear market, with the Dow below the 10000 level. With the possible exception of the immediate aftermath of the 1987 crash, never in Mr Greenspan's long tenure as Fed Chairman has the big "brush" been laid on as lavishly as it was this week. We'll see how long this new coat of whitewash lasts.