As you know, last weekend was a long one in the US with the markets being closed for the Presidents' Day holiday on February 21. As Tuesday, February 22 dawned, a news story went off like a small bomb on US markets. By now, you undoubtedly know all about it. South Korea's Central Bank announced plans to diversify its reserves, which are the world's fourth largest, into a greater variety of currencies. Here was the instant result:
By the end of the week, the Dow (and the S&P 500) had recovered all their February 22 losses, and a little bit more. Both indexes closed at new 2005 highs on February 25. However, Gold, oil, and the CRB index did not give back ANY of their Feb. 22 gains by the end of the week. All three ended the week higher. And the $US index only clawed back a small portion of its Feb. 22 losses, closing on Feb. 25 at 82.65 - only 0.24 points above its Feb. 22 close.
As several sterling Austrian analysts have pointed out on the internet in recent days, there are in fact three areas in which an increase in monetary inflation can go. One of them is the "traditional" area of real goods and services prices. That's what happened in the 1970s. Another is the area of financial (paper) assets. That's what happened in the 1980s and 1990s. And the third is in the form of a trade/current account deficit. That is what has been happening in the US, with short periods of surcease, since the late 1950s
Right now, not only in the US but in many other countries around the world, we have ALL THREE occurring at the same time. Financial assets (stocks, bonds, etc), especially in the US, are still at remarkably high levels given the "fundamentals". The US trade/current account deficit is now $US 600 Billion plus per year. Both of these RESULTS of monetary inflation have been raging for the past decade. But neither rising stock and bond markets nor rising trade deficits is regarded by the vast majority as a symptom of "inflation". Instead, they are regarded as benign symptoms of what is called "economic growth", ignoring the fact that what is growing is the stock of money.
The looming and rapidly growing problem for the US monetary and financial authorities is that the other symptom, the increase in the prices of REAL goods and services, the symptom which IS universally regarded as "inflation", is growing too. Price rises in raw resources are always the foundation on which price rises right across the gamut of producer and consumer goods is built. And price rises in raw resources, especially those raw resources which are globally priced in US Dollars, are taking off.
Please recall what we said about the CRB index, that it is now back above the 300 level for the first time since EARLY 1981. For almost the whole of the first half of 1981, the US Fed Funds rate stood at 20 PERCENT PLUS. All other US (and world) interest rates reflected this extraordinarily high level of OFFICIAL US interest rates.
Now, here we are twenty-four years later in early 2005. The CRB index is back to its levels of early 1981. In GROTESQUE contrast, the present Fed Funds rate is 2.50 PERCENT - that is ONE-EIGHTH of the level that it reached the last time that the CRB index was above the 300 level. Given the pace of US monetary creation now compared with the pace in the early 1980s, present US interest rates, especially OFFICIAL US interest rates, are absurd. And with global interest rates now converging (Japan excepted with its ZERO official rate policy) since official US rates began to rise last June, the same can be said about rate levels right across the world.
For many years now, led by the US, financial markets and global financial and monetary authorities in the English-speaking world have been wallowing in a warm and soothing vat of denial. In the US, the prices of financial assets have soared and trade deficits have ballooned. But instead of seeing all this as a red light warning of official monetary profligacy and incompetence, the phenomenon has been lauded as economic "management" of the highest order. This facade has now been cracking open for five years. US stock markets cratered in 2000. The $US Gold price bottomed in 2001. The US Dollar began its fall in 2002.
To date, the rest of the world has done its best to counter the effects of this US inflation. Asia has bought GIGANTIC quantities of $US denominated assets - accelerating their purchases even as the US Dollar fell. Europe has held their interest rates steady at 2.0% for more than a year - while the Fed raised rates from 1.0% to 2.5% - transforming a 1.0% premium against official US rates to what is now an 0.50% deficit. Without these actions, the maelstrom which is now looming would long since have engulfed the US Dollar and US financial markets.
Late last year, the cracks in the system threatened to break wide open. Warnings of an imminent "Dollar crisis" littered even the mainstream US media. The $US index threatened to break below its post 1971 fiat era bottom. Gold broke above $US 450.
Then came the new year and a recovery. Faced with the fact that the US Dollar remained the world's reserve currency and that any meltdown would leave no nation unscathed, the rest of the world decided to give the new Bush Administration a chance. Mr Bush was inaugurated on January 20. Then he gave his State of the Union speech. Then the Fed met and raised US rates another 0.25%. Then the G-7 met in London. Then Mr Bush presented the first budget of his second term to Congress.
In early February, new Secretary of State Rice made a "goodwill" tour of Europe while Defence Secretary Rumsfeld made an emergency visit to Nice, France to read NATO the riot act. And as the final act, Mr Bush himself went to Europe this past week.
While the world watched and waited throughout all of the above, they watched and waited in vain. At NO point in all these meetings, Summits, State visits, emergency get-togethers, etc., etc. was there ANY indication from ANY of the US potentates that the US intended to change ANY of its policies in any meaningful way. The final confirmation of this came with Mr Bush's European visit this week.
No sooner had Mr Bush touched down in Europe than the South Koreans made the statement about "diversifying" their reserve assets. The latent fear which has been building up has now begun to spill over. The Asians are not (yet) threatening to SELL Dollars, they are "merely" saying that their pace of buying more Dollars is going to slow. And with the recent report that broad money in Europe is now growing faster than is the equivalent measure (M3) in the US, the ECB will not be holding European rates at 2.0% much longer.
If the Bush Administration refuses to budge, the rest of the world will have no choice. They cannot continue to buy $US assets and keep their interest rates at present levels. The South Korean statement is advance warning of the inevitable.
Gold moved back above its 20-week moving average in $US Dollars, Yen, and Euros this week. In $US terms, Gold is now almost back to the level at which it began the year. When (not if) the Asians DO begin to curtail their purchases of $US assets, the upward pressure on both US prices (all prices, including CONSUMER prices) and US interest rates will become unstoppable. The pressure under the Gold price, not only the $US Gold price but the Gold price in terms of ALL paper currencies, is building fast.