Confound (tr.v.): To cause to become confused or perplexed
The headline of the current issue of The Privateer (The Late November Issue - Number 515 - published on November 28) reads like this: "US Dollar Fall = US Debt Default"
Asian Central Banks alone - just the Asian CBs, none of the others in the world - held $US 2.09 TRILLION in "foreign exchange reserves" (mostly US Dollars and debt instruments, of course) as of the latest tally. Over the past year, the total has increased by almost exactly one quarter, or $US 503 Billion. One year ago, on December 3, 2003, the $US index was 89.57 points. Today, on December 3, 2004, it is 80.98 points. That's a fall over one year of 8.59 points or 9.6%.
If the Asian Central Banks have increased their reserves by $US 503 Billion to $US 2.09 TRILLION this year, then a year ago those reserves totalled $US 1.587 TRILLION. 9.6% of $US 1.587 TRILLION is $US 152.5 Billion. That's how much the Dollar's fall over the past year has wiped off the value of every penny of foreign reserves which the Asian Central Banks held a year ago. The continuing fall of the $US has diminished the purchasing power of the Dollars they have bought over the last twelve months too, of course, since the Dollar just keeps falling.
The numbers do not coincide exactly. Not ALL of the Asian Central Banks' reserves are in US Dollars, just the vast majority of them. The point though, doesn't change. Every Central Bank in the world which holds US Dollars - and every Central Bank does, even the European Central Bank which doesn't actually need $US as reserves behind their currency, the Euro - is steadily losing international purchasing power with every day which goes by, and they have been doing so for almost three years now.
When the $US index began its bear market at the end of January 2002, $US 1.00 was worth 135 Japanese Yen. $US 1.00 is now worth 102.5 Japanese Yen. That's a fall of 24.1%. When the $US index began its bear market at the end of January 2002, $US 1.00 = 1.16 Euros. $US 1.00 is now worth 0.747 Euros. That's a fall of 35.7%. These are BIG falls, big enough to have produced double digit interest rates and to have had the IMF knocking down the door demanding "austerity" programs and massively reduced budget deficits or even budget surpluses if they had occurred in the currency of any other nation. But because the nation is the US and the currency is the US Dollar, Treasurer Snow could actually stand up in Europe on the eve of the G-20 Finance Ministers and Central Bankers meeting a short two weeks ago and tell the world that the US still had a "strong Dollar policy".
Nobody argued, nobody was impolite enough to fall on the floor laughing, nobody even made a comment about it.
The grave problem for Mr Snow, and Mr Greenspan, and Mr Bush, is that at least some of the rest of the world is slowly awakening to the fact that the US has a WEAK Dollar policy. The US (government, that is), having had the inestimable advantage for decades of being able to borrow INTERNATIONALLY in terms of its own currency - you have to be a reserve currency nation to do that - has decided to solve its debt problem by defaulting on its debt. To the extent the Dollar falls, that is what is happening.
The amazing thing about all this is certainly not the fact that the US (government) is doing it - throughout the 1970s, everyone in the US was borrowing all they could get their hands on in confident anticipation of paying it back in a devalued currency - the amazing thing is that the US (government) thinks it can devalue its way out of debt without any ill effects to its economy, its financial structure, its international reputation, or its "super power" status in the world. The US (government) is acting on the assumption that internal US interest rates will stay low, that foreign creditors will continue to throw good money after bad, and that the rest of the world will continue to ask "how high?" when the US (government) says "jump!".
Consider this. Over the year 2001, in a desperate effort to stave off "recession", the Fed lowered its official interest rates from 6.50% to 1.75% (0.25% lower than they are now) in not much more than eleven MONTHS. For the first half of 2001, the Dollar continued to rise. Over the second half of 2001, bisected by the tragedy of 9/11, the Dollar stopped rising and basically hovered. 2001 was the last year during which the myth - put forward in the middle of Mr Clinton's second term - that the Treasury was on the way to PAYING OFF the national debt held sway. The budgetary results of Mr Bush's first full year in office put paid to that one. The unprecedented ratcheting down of official US interest interest rates put paid to the Dollar bull, which turned into a Dollar bear at the end of January 2002. Please remember, all this happened very recently, not quite three years ago.
For three years, US budgetary processes (government, corporate, consumer, et al) have descended further and further into chaos. For three years, the US government has been looking toward a US economic "recovery" which has never - IN REALITY - arrived. For three years, the paper markets of the world, almost all of which are ultimately underpinned by the US Dollar, have been ever more engulfed in a maelstrom of "hedging" as derivatives designed to offset risk have expanded to LITERALLY unimaginable proportions. As the structure which is the global financial system has ballooned into a structure of nightmare proportions and enforced complexity, the foundation under the structure has been steadily undermined.
Imagine a tower of Pisa 500 miles high leaning against a gartantuan pile of interlocking girders trying to hold it up while the entire mess sinks slowly in quicksand. You have at least a pale approximation of the picture. Now try to imagine the financial world standing in the shadow of this looming edifice while professing to have not a care in the world. You have a pretty good approximation of present world "markets". They are indeed "confounded". They don't see any way to continue to hold the structure up, yet they cannot see any way to prevent its eventual fall.
The result is to continue to add new girders to the superstructure holding up the tower, any old girders arranged any old way. That's why you have such phenomenon as occurred on December 3, when the $US index fell a whopping 0.99 points while the yields on one year plus Treasury debt paper were plummeting by 13-16 basis points. That is why you have such phenomenon as a global Gold stock selloff in the face of ever increasing $US Gold prices.
Over it all lies a number of astounding assumptions, assumptions which fly directly in the face of ALL of economic history, let alone economic theory. The absence of any savings in the US assumes that present prices will not rise no matter how far the Dollar falls. The present derivative-driven rush into Treasuries to hedge against a falling Dollar assumes that interest rates will not rise no matter how much debt is contracted and how far the US Dollar falls. The deficits being added to at ever increasing speed by the US government assumes that foreigners will never lose their appetite for US debt paper, no matter how low US interest rates remain and how far the US Dollar falls.
Gold hit another bull market spot future closing high - $US 456.00 - on December 3. Everyone is looking for the "inevitable" Dollar rally. Everyone is absolutely SURE that Gold will reflect that rally, when it happens, by turning turtle. After all, Gold's strength is merely a reflection of the Dollar's weakness, isn't it?
Between late 1997 and early 2002, when Gold spent almost the entire period below $US 300, the US was seen as the "model" economy and financial system with inexhaustible markets, an unshakeable currency, and a government which was on the road to paying off the debt they had so assiduously piled up over the previous 200 plus years. Those were the years of the great financial delusions and bubble markets. The delusions in large part remain, the bubble markets do not (even the US real estate market is now hissing as the air escapes). The main difference between then and now, however, is that all the "reasons" given for the US mirage of prosperity in the late 1990s have now been blown away.
It is the slowly growing realisation that this is so which is "confounding" the markets at present as everyone tries to "hedge" against a risk which is not going to go away, which is growing, and which ultimately cannot be hedged against. To genuinely strengthen its currency, not just to see it bounce on the currency markets, the US government would have to stop creating ever larger "supplies" of it. To do that would guarantee an instant, profound, and lengthy economic downturn in the US and throughout the world.
The US did that, for a short while, at the beginning of the 1980s, and Gold did "weaken". Until there are genuine prospects of a repeat, and there are certainly none on the horizon, Gold will not weaken against the US Dollar, no matter when the inevitable "bounce" in the US Dollar comes, how high the bounce is, and how long it is sustained.
As the "floor" (or foundation) under the paper markets crumbles, so does the "roof" over the $US Gold price. That will continue as long as present fiscal, financial, and economic "policies" are pursued. Realise that, and realise that $US Gold is now well into the second leg of its post 2001 bull market, and you have literally nothing to worry about.