Sunday, June 6, 2010

Return To The Endgame

There wasn't much discussion about gold specifically in this week's Financial Sense Newshour podcast, but there was some discussion of Jim Puplava's deflation-to-hyperinflation scenario in the third segment [.mp3 file] right after the interview with Gerald Celente. Celente made the point that Americans tend to not believe that government officials are incompetent because they're awed or impressed by pomp.

Puplava believes that the U.S. dollar will go down substantially once the U.S. economy hits the shoals and another round of quantitative easing is put in place. That QE2 will tip the U.S. economy into an inflationary spiral.


I can see his point, but I'd like to disagree regarding the fate of the U.S. dollar.

The fact is, a rising U.S. dollar fits in well with the huge load of public debt that the U.S. has to refinance. If the greenback keeps going up over time, then foreign creditors will be more willing to buy U.S. Treasury securities at low rates. If I (a Canadian) buy a six-month U.S. Treasury bill at 0.19%, and the Canadian dollar drops 2% against the greenback over that period, I've made 2.19% over six months: 4.42% annualized. That's a better rate than I could get with a six-month Canadian T-bill. As long as the greenback has a tendency to rise, I'd be willing to do my part to keep U.S. T-bill rates lower than they otherwise would have been.

And people wonder why there hasn't been much bite in the renminbi-revaluation barks. If the PRC has to revalue the renminbi upwards, then the value of their Treasury security holdings will go down in their own currency's terms. That means losses. It also means the PRC government can scale back on their Treasury holdings for business reasons. In order to keep investing, they would have to peg the value loss as a loss leader.

I've written it before, and will likely write it again, but I think D.C. authorities have come to a decision to sacrifice export growth for the sake of the fisc. The larger the trade deficit, the more capital inflows there are. The more capital inflows, the more funds are available for U.S. Treasury purchases. The more funds available, and deployed, the lower U.S. interest rates will be despite the huge increase in funded Treasury debt. Rising demand for borrowed funds (the exploding deficits) meets rising supply (foreign capital.) As an extend-and-pretend strategy, there's a lot to recommend it. Japanese investors can be assuaged by pointing to the rise in the U.S. Dollar Index and saying their currency gains will come eventually.

In addition, thanks to the Eurocrisis, there's an "altruistic" reason for it. Poor Europe needs a lower Euro to gets its export-driven economy moving again. Why not let the Euro fall to give 'em a hand, while saying in the next breath that the currency losses suffered by foreign investors for most of '09 have been more than made up for in '10?

There's only one potential drawback to this plan. Since the renminbi is pegged to the greenback, a rising greenback pulls the renminbi up with it. PRC officials might complain that the greenback is going too high. If not, however, it can be said that a greenback rise amounts to an upvaluation anyway. It's an argument that misses the point, but could assuage those who think that mainland China has had it too good for too long.

Best of all: it allows for U.S. inflation, provided that the rate is less than that of other major currencies. All it takes is for the U.S. to 'lose' the competitive-devaluation race with other nations that want to inflate faster. All that's required is throwing exporters under the bus.

This aspect means that gold and the greenback will rise in tandem over time.

Given the pragmaticality of this option, I think the U.S. dollar will not collapse except by accident.


One final point I'd like to make: gold and the greenback rising together means that a rising gold price does not make the greenback look bad. Given the current crisis, it makes the Euro look bad.

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