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When the value of money
changes, nominal prices become less and less meaningful. Often it is
illuminating to measure prices in real money, which has always meant gold.
When we do this, we see that commodity prices haven't really risen that much.
The rise in nominal prices can be mostly explained as a decline in dollar
currency value. When the dollar falls in value, it takes more and more of
them to buy things.
Here are a few more of
our long-term charts, updated to May 2008.
Base metals have had a
big retreat. Base metals are sensitive to capex in general, and a pullback in
activity in China etc. could mean weakness here. However, there has already
been a 60% decline to the lowest gold levels in twenty years. So, maybe the bad news is already in.
A similar story. For some
reason, this looks like a chart that wants to go higher. The sudden breakout
to new highs, followed by a harsh retreat, says "the game is different
now." But, that is just guessing really.
Meat producers are really
getting crushed between higher grain (feed) prices and crappy selling prices.
Here, we are just about touching all-time lows. I've heard that hog producers
have literally been killing piglets and tossing them in a compost heap. They
have negative value at these prices. Such situations can never last for long,
as long as people want to eat meat.
When cotton is this low,
everyone plants corn or soybeans instead. Touching all-time lows. U.S. cotton
production fell 11% in 2007 compared to 2006, as farmers switched to other
crops. For 2008, the USDA expects U.S. cotton production to fall to 14.5m
bales, from 19.2m bales in 2007, a 25% decline. The U.S. is the world's
second-largest cotton producer, at 20% of world production, behind China at
24%. World cotton production is expected to fall 2.6% in 2008 from 2007, to
119m bales. Demand is estimated at 127m bales. World inventories are expected
to drop 7.8m bales to 54m bales, the lowest in five years. (Isn't that
interesting?)
* * *
Now the Fed and ECB are
mumbling about raising their policy rate targets. Will higher central bank
target rates stop the inflation? I doubt it. Historically, when central bank
target rates are below the official rate of inflation (CPI), currency
weakness tends to result. The CPI is basically a lie at this point. If it was
being maintained as it was before, it would probably be over 5% in the U.S.
Maybe over 6%. In general, central bankers seem to like a policy rate of
about 1.5% over the CPI, so even by their own standards they would have to be
around 6.5% - 7.5% or so to be "neutral" or marginally
"hawkish." This is all delusion in any case, but I think it is
significant that central bankers are easy-peasy even by their own standards.
It shows the line of thinking. Over time, I've come to appreciate that this
"line of thinking" is as important to currency values, in today's
chaotic floating-currency environment, as other, more concrete factors. If a
central banker isn't even trying to be "hawkish," according to his
own conception of "hawkishness" whether valid or not, then why
should anyone expect a currency-positive result? I think this
Taylor-rule-type "1.5% over the (unmodified) CPI" guideline is very
common among the academic economists, so it can be used as a sort of litmus
test for where a central banker imagines himself along the easy/hawkish
spectrum.
I say it is delusion
because rate targeting systems do not reliably affect the value of
currencies. The rate-targeting policy is really a method of (attempted)
economic management. It is not a method of currency value management, and is
essentially unusable in this role. It's like using a garden hose to hammer
nails. In 1973, Arthur Burns went to 10%+, but it didn't help stop the
inflation (currency decline), which worsened into 1974. It did blow up the
economy, however. Indeed, it is this blow-up-the-economy effect of higher
rate targets that often leads to currency weakness in many cases. Just think
what would happen to the dollar if the Fed went to 8% tomorrow. Up or down?
Hard to say, but I would put the probabilities on down. The fact
that Burns was "hawkish" (showing that he was prioritizing currency
quality over unemployment etc.) was not sufficient, but I think it was
essentially necessary. The dollar had a big rise beginning around the start
of 1975, which I think had a lot to do with a trend toward significant tax
cuts by both Republican and Democratic parties, but especially the Democrats.
Within this context, Burns was able to cut his policy rates in 1975, and these
rate cuts probably helped the dollar to rise further, as it took the burden
of high interest rates off the economy.
Remember, higher Fed
interest rate targets never stopped the 1970s inflation. It was only when the
interest rate targeting system was abandoned, in October 1979, in favor of
the Monetarist system, that the inflation was messily and painfully brought
to an end. (The Monetarist system was like using a paint brush to hammer
nails. Totally inappropriate, but if you tried hard enough you might manage
to do it.) Much the same could be said of the various currency breakdowns in
1998. The successful Asian governments never got anywhere with the rate
target hikes recommended by the IMF. Even when target rates were raised to
absurd levels in excess of 30%, the currencies just fell further as the
economy collapsed. It was only when they abandoned such techniques and
adopted an ad-hoc Monetarist/direct base-money approach that currencies
stabilized and actually rose dramatically. You could say something similar of
Japan's deflation in the 1990s. No amount of BOJ rate cuts solved the problem
of the too-high (deflationary) yen. It was only when the rate-targeting
process was abandoned in favor of "quantitative easing" that
progress was made. This makes me think that the present inflationary trend
also will not come to an end until the rate-targeting system is abandoned for
another, more Monetarist-flavored method, or better yet a gold standard.
Since this is politically way off in the distance, probably we have many more
years of worsening inflation until that point.
Obama is pretty much a
sure winner in the election this year. He actually has a tax cut program,
mainly aimed at lower incomes, which I will have to look into further.
However, this is matched with a reversal of the Bush tax cuts, on capgains,
dividends and so forth. On balance, the Obama plan is probably a net economic
and currency negative. In practice, I would not be surprised if his tax cut
plans (raising the minimum taxable income to $50,000 for seniors for example)
run into difficulties given declining government tax revenues in the midst of
recession, and only the phase-out of the Bush tax cuts (i.e. a tax hike) is
implemented.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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