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A monumental event happened yesterday that may mark a turning point in the economy. And no, this has nothing to do with the tragic events of a few years ago. Rather, it has to do with the U.S. government bond auction that took an unprecedented move which could spell big trouble for the world's sole economic powerhouse. Before I explain further, let us philosophize for a moment on what money actually is. Essentially, it is a good, and like all other goods, it obeys the rules of supply and demand. Now, one may ask, why would the demand for money ever go out of vogue? Germany in 1920, was one of the most influential countries, economically, in the world. Yet, not even 10 years later, the German currency had to be replaced with the Deutsche Mark, because there was simply no demand for their previous currency. People use money to store value, and if that value disintegrates over a long enough period of time, people find a different way to store that value. The German government had built up such large debt that the only way to repay that debt was to create the money out of thin air - they simply printed it. Unfortunately, they were seemingly unable to get themselves out of the debt, and this printing of money continued at a furious pace for several years. The short term effects of a large injection of money into a system - is an increase in the value of investments, such as the stock market. Long term effects, however, are across the board inflation. The German government was printing so much money, that at one point, the price of items such as a loaf of bread, was rising 25% - per day!
Essentially, every dollar you had saved for retirement was worth only 50 cents, just 3 days later. One week later, it was worth a quarter, and a month later, a penny. No wonder no one wanted the currency! Until 1973, governments throughout the
world decided how much a currency was worth in comparison to other currencies.
If the country of Zimbabwe wanted to set its value of Z$1 equal to US$1, it
could. And then, whenever it wanted to buy $1 worth of wheat from Brazil, it
would just print that new dollar bill, and bam, its got free wheat. To compete,
every country in the world would simply print money to buy new stuff. Soon the
entire world would experience 25% inflation per day, and worthless currencies.
In 1973, countries started experimenting with allowing the market to determine
the value of the currency. Slowly, but surely, most countries in the world now
'float' their currencies, allowing the value of it change as determined by the
free market system. So how do Over the past few years, as the United States has printed money to help ease its enormous deficits, this increased supply has caused the value of the dollar to drop versus several other currencies, specifically, the Yen and the Euro. Unfortunately, for places like Japan, if the US dollar drops in value, more people from around the world can afford U.S. goods as compared to Japanese goods, and this would seriously hurt the export-led Japanese recovery. So to counteract this, Japan's central bank, along with other central banks in Asia have been buying U.S. government bonds, a supposedly safe, secure way of Foreign Direct Investment into the United States, to keep the value of the dollar up. For the past year or so, this has worked, and the value of the U.S. dollar has stabilized. However, in the long run, the United States has no alternative out of its debt except to print money. It has been estimated that if every American paid 100% income tax, it would take 6 months to square away all the debt we've accrued over the past 25 years. This increase in supply will undoubtedly cause the value of the U.S. Dollar to depreciate significantly. It has been a conundrum for some time, that Asian governments would invest all that money in a currency they know has no choice but to decline. During the average U.S. government bond auction over the past several months, over 30% of the debt was always bought by foreign central banks. The question then became, when will these governments wise up? And what happens, if they decide to sell all the bonds they've accumulated. On Friday, in a standard U.S. government bond auction - virtually none of these central banks showed up. In fact, less than 3% of the bonds sold were sold to central banks. In recent history, the lowest this percentage has ever been, is 18%. Have the Asian banks woken up and decided not to support the U.S. currency anymore, or is this just a freak accident? Undoubtedly, if this continues, the U.S. Dollar may soon plummet. The ramifications of such an event are enormous. Since we import almost everything we have in this country, the price of every good will increase proportionally. Oil, wheat, manufactured items, and virtually everything else you can imagine. We will see this as inflation, and interest rates must therefore rise, hurting every person using an ARM mortgage, and ripping havoc through the housing markets. As a hedge against such an event, I am placing an order to buy into Newmont Mining on Monday. As the largest gold producer in the world, Newmont mining is a nice hedge against a potential drop in the Dollar. Potentially, this event may be a freak accident, and Asian central banks may again step up to the plate, delaying any declines in the Dollar. Alternatively, Asian central banks have decided not to support the Dollar anymore, and we may see a plummeting Dollar within days. A third alternative, is that we don't see many central bank purchases, but speculators keep the dollar afloat for a while. In this case, sooner, rather than later, they will have to face the music - but this may be in the order of months, as opposed to days. Not required reading, but... I have never once read anything that directly linked the hyperinflation of Germany in the 1920's to the holocaust of the 1930's, yet it is inevitably intertwined. Recessions exist for a reason, and that is to get rid of the malinvestment and heavily indebted companies that can not turn profits because of poor products or poor management. This allows more profitable companies to form, and the standard of living for everyone gets raised - 2 steps forward, 1 step back. When hyperinflation exists, not only does your previous money become worthless, but so do previous debts. If you borrowed 10 dollars today, and a year from now that 10 dollars only buys a slice of bread instead of a loaf of bread, your debt burden is very little compared to what it used to be. This allows poorly performing and heavily indebted companies to continue to exist and expand, because they essentially never have to pay off any of the debt that they incur. Because no one had faith in the currency, the Germany government instituted the Deutsche Mark in the late 1920's and by law was only allowed to print a certain amount, so as to limit the supply and develop a stable currency. Once the Deutsche Mark was in place, all those heavily indebted companies with no profits crumbled, causing an economic crisis. The Germans, by trying to ward off the natural recession that needed to take place, simply caused a much worse depression to happen later on. Throughout history, when people are faced with an economic crisis of this severity, they always blame the successful minorities - in this case, the Jews. People blame Hitler for the Holocaust, but the Holocaust would have happened with or without him. Of all the terrible people in the world - Hitler was one of the few that was elected through a democratic process. He merely spoke the words that his constituency already believed in their heads: "The Jews are responsible for the fact that I can't feed my kids." If it wasn't Hitler, it would have been someone else. The true cause of the Holocaust was fiscal and financial mismanagement of the German government, and not allowing a natural recession to take place. Recessions are not a bad thing - they simply set us up for the next 2 steps forward. By keeping interest rates lower than they should be and not allowing a full recession to take hold, Greenspan is putting us in dangerous territory |
