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The reliance
upon the U.S. dollar as the world's reserve currency and "safe
haven" asset has created a perverse, but deeply entrenched, mindset among
global investors. In fact, many believe the major financial players have no
alternatives to owning U.S. debt and dollars. They argue that the market for
U.S. dollars and Treasuries is the only financial pool large enough to handle
the massive liquidity that sloshes around the globe on a daily basis. This
idea makes a mass exodus from U.S. debt holdings seem impossible. This
provides a nice explanation why the U.S. Treasury bonds can rally even while
the government openly flirts with default and ratings agencies issue
downgrades. But just because an illogical event occurs habitually does not
mean it is logical or tenable.
The
sophomoric reasoning behind the dollar "exceptionalism"
argument is like assuming a stock can never fall unless a significant portion
of shareholders decide to sell. In reality, a buyers strike is all that is
needed to puncture a market. If the U.S. experienced just one disastrous
Treasury auction, prices could nose-dive and yields could skyrocket across
the board on all U.S. debt.
But the
problem doesn't just lie with the United States. Investors around the world
are finally beginning to understand that central bank's thirst for creating
inflation, in order to keep their banks and governments solvent, will never
be quenched.
This week,
the Swiss government took action to weaken the surging franc by lowering
interest rates and printing currency. The franc was pushed down briefly, but
then snapped back. It's hard to keep a good currency down. Similarly, the
Bank of Japan announced that it won't stand for Yen appreciation much longer
and would likely soon intervene to buy dollars and weaken the Yen.
Meanwhile,
problems at the overly indebted countries just get worse. Italian and Spanish
debt yields are now following the upward spiral of Greek bonds (and hitting
multi year highs). Italian ten-year notes have surged from just above 3% in
late 2010 to well over 6% today. For a country whose debt to GDP ratio is
currently over 120%, a doubling of interest rate expenses spells disaster.
Enter Jean
Claude Trichet who will certainly use his printing
press to buy much of the weakening Italian debt that is now festering on the
balance sheets of the biggest European banks. But the size of the bailouts
needed to deal with Italian and Spanish debts will be several orders of
magnitude greater than those needed for Ireland or Greece. Anticipating a
massive increase in the Euro money supply, investors are flocking to gold to
protect themselves from currency debasement.
Adding fuel
to the gold fire is the recent debt deal reached in Washington. The
disgusting agreement virtually assures that over the next decade the U.S.
will add an additional $8 trillion in public debt, an increase of nearly 80%
in ten years! The back-end-loaded deal will cause the amount of deficit
reduction to be just $21 billion in 2012 and $42 billion in 2013.
But even this
modest debt reduction depends on rosy assumptions from Washington that are
always wrong. For example, the Obama administration predicts GDP growth will
average well over 3% for the coming decade. But the annualized GDP growth in
the first half of 2011 was just 0.9%. That means the actual deficit and debt
figures will be far greater than the projections. Given the immediate
increase in borrowing needs, and the obvious slowing of the tepid
"recovery," there can be little doubt that the next round of
quantitative easing will be launched sooner rather than later.
The
incompetency of U.S. credit rating agencies has long been suspected. But
their actions in the wake of the debt ceiling agreement now confirm them as
liars. After threatening to downgrade U.S. credit if Washington failed to cut
$4 trillion in spending, neither Moody's, Fitch nor
S&P had the courage to carry through, despite the fact that the total
cuts would amount to only half their requirements. But a credit rating
downgrade on Treasuries did come-from China. The Dagong
Global Credit Rating agency cut the credit rating on U.S. sovereign debt to A
from A+, 5 notches below AAA. And since the Chinese are the biggest foreign
buyer of Treasuries, their opinion counts.
This week,
more evidence of U.S. stagflation emerged. The ISM manufacturing and
non-manufacturing reports showed a slowdown in new orders and employment and
the ADP report showed that the U.S. lost 7,000 goods-producing jobs in July.
Other data releases showed that layoffs surged 60% last month to a 16-month
high. Meanwhile, YOY consumer prices are up 3.6% and M2 money supply is up
7.5% YOY and rising at a 14.6% annual rate in the last quarter. As the problem
with stagflation becomes worse, international investors will avoid the U.S.
dollar and U.S. debt at an ever increasing rate.
With soaring
debt-to-GDP ratios in Japan, Western Europe and America, the desirability of owning
precious metals will grow as investors realize the fiat currency system's
days are numbered. Those holding U.S. dollars and U.S. debt will feel the
biggest brunt of the change. But it is always darkest before the dawn. As a
result of the carnage the re-establishment of gold as the world's reserve
currency is, hopefully, only a few years away.
Michael Pento
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