With a series of coordinated pronouncements and media events, the Barack Obama
administration has been trying to send a signal to investors. The message
received may not have been the one intended.
Reading between the lines, the administration is indicating that the financial
crisis has become so overwhelming to them that there is no alternative but to
throw infinite amounts of taxpayer money at it until, they hope, it passes. But
what if the very measures meant to hold the dike until the storm passes are
actually undermining whatever protection we have left?
Economists generally agree that, in the long term, hyperinflation
does more damage to an economy than severe recession. However, recession has
always made a far more potent political impact. After all, it may be difficult
to notice the monthly debasement of your paycheck (inflation), but it is
abundantly clear when the check suddenly stops coming (recession). Knowing
this, the administration has chosen the path of inflation.
At present, with the US economy in severe contraction, the forces of recession
far outweigh those of inflation. This gives the administration vital breathing
space to flood the economy with more money without stoking acute inflationary
fears. If these fears were to become realized, interest rates would rise,
pushing up the cost of the government's massive deficits and foiling the Fed's
efforts to keep mortgage rates low. At the moment, the government still can
raise very large amounts of cheap money (to be repaid by future generations)
and take aggressive spending action against recession. However, serious
questions remain about the efficacy of the program.
Much of government's spending will be deployed on wealth-consuming entitlement
programs rather than on wealth-creating infrastructure projects. Therefore, the
economy will become even more imbalanced towards the consumer than it was going
into the recession.
In addition to contravening economic laws, the recent string of massive
government financial bailouts, economic stimuli and widely distributed
guarantees all threaten the long-term credit rating of the US government, the
value of Treasury securities, and ultimately, the value of the US dollar.
Although currently hidden by the forces of recession, latent inflation
eventually will emerge. When it does, the value of the US dollar will be
reduced significantly. It will also put strong upward pressure on US interest
rates. This, in turn, will be reflected in rising mortgage rates. Given the
greatly increased size of Treasury debt, any rise in interest rates will
increase the financing costs of the Treasury. In addition, the vast size of
government borrowings will affect the country's triple-A credit rating. If this
should be cut, the costs of Treasury borrowings will be increased further.
All of this should be of great concern not just to US taxpayers but also to all
holders of US dollars, even overseas. Already, American citizens are investing
heavily in physical gold as a hedge against dollar devaluation. It was not
surprising to learn that China wants to replace the US dollar as the world's
"reserve" currency. On March 24, the Financial Times reported that China, as
the main holder of US dollars, is concerned about the inflationary impact if
the US continues to print more dollars. If the US continues to spend beyond its
means and to borrow on a profligate basis, the call for a new global reserve
currency will be supported increasingly by nations other than China.
It is clear that many governments now share the fears of individual Americans
about the long-term value of the US dollar. Any erosion of its reserve status
would damage the dollar severely, serving to magnify the present threats. The
Obama administration is building a dike higher by taking soil from its base.
When the overwhelming waters of depression break the dam, it will collapse all
the faster because of this lack of foresight.
John Browne is senior market strategist, Euro Pacific Capital.
(Euro Pacific Capital commentary and market news is available at
www.europac.net. It has a free on-line investment newsletter.)
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