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Chips Are Down for Dollar/Gold
21 Oct 2002
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Currency traders are betting a report expected early this week from a task force regarding Japan's banking problems is a sell signal for the yen whether it is hard-line or soft in its implications for reform. A hard-line approach to their bad loan problem is seen prompting a surge in tradable bad news, while anything less is seen as a drag on the yen anyway.

Everybody seems to be bearish on the yen, but they should be bearish on the dollar. On Thursday, New York Fed President William McDonough said:

The only markets that have seemed relatively calm are the foreign exchange markets - Reuters, Oct 17

The first chart at the top is a two-year chart of the US dollar index. This index hasn't been as volatile since 2000. Even in 2000, while the volatility was greater than it has been this year, the US dollar index only finished up slightly less than it is down so far this year.

Of course, the US dollar index is only down 8% in 2002, and by that absolute measure, Mr. McDonough is right, it has been a calm decline.

If, however, the Fed President means the 3-month period (see blow up of past 3 months - second chart from the top) since August, it's important to note a few things. The CRB rallied 10 percent in those three months.

We take it as a signal that the dollar's purchasing power continues to deteriorate, despite its Forex relationships, and the questionable aggregate price data.

So while the dollar may have seemed relatively calm in foreign exchange markets during the period it was quite weak against most commodities (including gold prices), excluding Silver, Lumber, Cotton, and Orange Juice.

This is important in our view, because we view the break through the 108 level on the dollar index (see top chart) to be a primary rollover, but subjected to the following confirmations:

  1. a primary bull market signal in Gold ($340),
  2. a primary bull market signal in either the CRB (255) or Oil ($31), and
  3. the continuation of the down leg in the dollar index (i.e. break through July's low), particularly in the Dollar/Yen relationship, which appears to be about as contrarian a call as there possibly is today.

Weakness in the dollar against the yen would be a sign that the dollar is definitely in trouble, since we agree; the Japanese economy is in dire straights. Yet, I think it's noteworthy that the yen has held up well in light of the barrage of bearish sentiment. In fact, while it's too early to say anything, who's to say the yen isn't building an important bottom here? See chart.

A relentless bear market in stocks and record low yields in the United States I think continue to undermine the fabric of the dollar's liquidity (or investment) premium, the premium we hypothesize that investors put on the dollar in the foreign exchange markets to reflect the normally higher expectations for returns on dollar denominated assets.

We believe that the break down in the US dollar during June/July signals a primary bear market for it, and barring a sharp bear market rally in shares the dollar should continue lower relative to any currency that the US maintains a chronic trade deficit with (where it is dependent on the inflow of foreign savings), as well as relative to gold, and the CRB (or Oil).

In light of the dollar's moderate decline (only 11% from the 18 year high in the dollar index) so far, the criticism that gold should be doing better is unwarranted. Since the dollar's peak (July 2001), gold has rallied 18%. On that basis gold is doing just fine, isn't it?

What's missing is the bull market signal. But even here, critics beware that the bear market signal for the dollar index occurred only in July, if that's indeed what it was.

So Gold is only three months behind in breaking through $340. In our view, the dollar has only one real chance to prevent a primary gold market reversal any time soon, and that's a strong bear market rally on Wall Street that's able to withstand a likely rise in yields, which means that earnings prospects at least have to stop deteriorating.

The bulls have their work cut out for them.

We're still betting on gold. Besides, war is one of the few ways of sustaining inflations and deflecting domestic strife. At least according to Buffett.

Buffett's Forecast
No, not Warren, his father, the honorable Howard Buffett. On the eve of our current international predicament, it could be appropriate to take a trip down memory lane:

"Because of our economic strength, the paper money disease here may take many years to run its course. But we can be approaching the critical stage. When that day arrives, our political rulers will probably find that foreign war and ruthless regimentation is the cunning alternative to domestic strife. That was the way out for the paper-money economy of Hitler and others. Those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money. You must be prepared to meet their opposition intelligently and vigorously. They have had 15 years of unbroken victory. But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money" - Human Freedom Rests on Gold Redeemable Money, reprinted from the Commercial and Financial Chronicle May 6, 1948, by Congressman Howard Buffett

That was about a generation ago. We've already passed that critical stage once when it led to dollar devaluation and war in the seventies, 25 years later. What a forecast. Look how right Bush is making that (underlined) statement again today, another quarter of a century after the last dollar devaluation.

15 years before 1948 was 1933, the year in which the dollar ceased to be redeemable in gold. One could argue that 1933 was the year the imperialist fate of the United States was sealed. I don't mean to sound like a doomsayer, but there is plenty of history and economic evidence that supports the notion that an inflationist system is the tool of the welfare-warfare state. The roots of the final demise of sound money in 1933 go back another 60 years or so, but it was in that year the dollar became 100% paper, which is what Mr. Buffett means when he says, "they have had 15 years of unbroken victory."

Thus, today it would be more correct to say, "They have had nearly 70 years of unbroken victory," though it wouldn't be unbroken since it was interrupted in the seventies. Nonetheless, again we seem to be at the precipice of a war, and if we're correct in our analysis, another major dollar devaluation.

As for economic strength, the fact of the matter is, the strength that Buffett meant was derived from the institutions of private property and sound money. At least the latter disappeared long ago, and some would argue both have.

Inflation Finances Government Growth
We probably would all agree that there has been a creeping socialist wind over the last century threatening to prove free market proponents (and Mises) wrong, that socialism is indeed inevitable. Mises argued it wasn't.

But as a matter of fact, government growth in the developed world continues without abandon, and it has done this in America just as fast as anywhere else by some measures.

The reason I bring it up is because the United States Constitution promised limited government. Now, over the course of the 20th century we've witnessed how a sound system of private property could become engulfed in bureaucracy and enslaved by a growing nation-state. It's easy. All we had to do is ignore Ben Franklin's advice.

So, the question that needs an answer is how does an economy make the transition from a bureaucracy dependent on inflation and war, and mired in high tax rates as well as large national debts, back to a system of sound property rights and limited government?

The only model we have so far is that this kind of progress is born of crisis. I'm just sticking with the facts in saying this. For the creators of the US Constitution, it took revolution. They were in fact terrorists to the British monarch. But we already know the winners write history.

If one were to look at the history of global banking power, arguably, there has been a shift over the past 200 years from Europe to the United States. It would be hard to argue that the Federal Reserve System isn't on top of the world today, much like the Bank of England was in its glory days, for much of the last millenium. What happened in the United States that suddenly, out of nowhere, came this immense banking power?

Capitalism! Not the kind that's apparently practiced all over the world today. It occurred to me that if any single nation adopted its own system of private property and sound money it wouldn't be too long before its banks became a force to reckon with in the global banking establishment. It wouldn't be too difficult to argue that was the way in which America gained its alleged economic strength in the first place.

Still, none of this answers the question, how a country with enormous debt and high taxes can suddenly start over. How does society rid itself of big government once it has obligated its citizens in some way or another by accumulating massive debt, and by hooking the economy on government incentives?

I don't know. Maybe nothing can be done about it. Why would the masters of such a system concede any power anyway? What politician would come into office, initiate a new constitution, and actually reduce taxes, government spending, as well as the debt, the foundation for his own subsistence?

How do we go back to limited government from where we are today? That is what I would like to know. How can we prove Mises right, and Buffett wrong? Is there another way out for this "paper-money economy" besides the historical examples set out by countries like Germany after their central bank exploded in 1923, or by Russia after the epitome of too much government finally gave way 10 years ago, or in China where it took a massacre of its own people to get the nation thinking about freedom?

20th century history is littered with doomsayers calling for the downfall of capitalism, as did even the honorable Howard Buffett in his day by his warning. But is there one among us that can not only warn, but figure out how the socialism could be unwound as inconspicuously as Greenspan is currently deflating the stock bubble?

Or are the doomsayers going to be right, that it will end badly? Well, almost certainly that critical day has arrived again, and foreign war and ruthless regimentation are indeed proving to be cunning alternatives to domestic strife. The Federal Reserve will quickly find itself with a new mandate. International crisis will necessarily follow. And one day, perhaps not too far off, the Fed will necessarily go the way of the Reich bank.

Inflationist doctrine only moves in one direction. Towards a complete annihilation of the value of the currency, and thus, all debts. Deflationists be warned.

A Privately Chartered Non-Profit Organization
Who owns the Federal Reserve System? It's a privately chartered institution technically owned by the Federal Reserve banks.

Is it independent of government? How can it be if it creates policies for the economy along side the Treasury and the Joint Economic Committee, and is answerable to the government, or at least was until 1999?

Regardless of who owns it, and who runs it, and how it is claimed to be run, who is going to foot the bill when it crumbles? Government. You and I. Either through monetary debasement or higher taxes, or both, or worse.

So when we talk about the monopoly over money today, it is not the private sector, regardless of who owns the Fed. It is effectively the government. Any action as a lender of last resort is a government action. When it comes down to deciding on the level of interest rates, it isn't the free market, it's public policy.

The government does in fact use the Federal Reserve System to help it achieve many aims, and the private banks that have a stake in the Fed continue to use it as a petty cash fund when times get rough on their inflation agendas. Both the government and banking system together have created a monetary aristocracy where their monopoly on global money is shared.

And it's naive to think there is no gold market manipulation when almost every "policy" aim of our inflationist regime compliments the strong dollar "policy." What the heck do you think policy is, a recommendation?

Casey's just sore because he didn't say it first. Jab, jab, all in good fun right? Of course, we agree that many reasons carried gold's bear market other than manipulation, and we agree that many factors will drive its bull market besides the effects and realization of any gold market suppression, which is why we discuss so many factors besides manipulation. In fact, that is the last thing we normally point to in order to explain a gold move. But that doesn't mean we don't believe it exists any more than the lack of evidence means it doesn't.

What it boils down to is that either Casey is underestimating the US government or we're overestimating it. I doubt he would argue there is no motive to manipulate gold prices. If he did, who would care? He'd be wrong. Sorry Doug.

The way I see it is that the obvious motives combined with a reconciliation of trading behavior, as well as recent samples of the government's underhanded policy tactics in manipulating interest rates, currencies, and in promoting financial propaganda are enough I think to infer the manipulation... at least it's safe to assume so from an investor's point of view, and particularly when it's not very arguable that an inflationist policy is one where power is ultimately concentrated in relatively few hands anyway.

The people possessing this enormous power would have to be fools not to act on the motives that could give them almost unlimited control over the world's resources while it lasted. But that would be a prospect not consistent with the government's record.

If you want to call all market intervention foolish, then they're fools, yes. However, if you want to assess the government's ability to fool most of the people most of the time, they aren't fools, as far as we can tell.

Let me say it again, if the government hasn't manipulated gold prices, and hasn't figured out yet that it would be in their interest to do so, then we've completely underestimated United States dollar and economic policy. And if we have, and after reading GATA's charges they still haven't figured out why it's in their interests to do so, then they'd be even dumber than Mr. Casey imagines.

C'mon, don't bet on it, don't be a fool, at least not with your own money!

Ed Bugos

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