April 11, 2001

The Goldenbar Report
An in depth analysis of financial/economic debates

Inflation Paradox
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Paradox here means an economic dogma that is absurdly unreasonable.

The Fed's McTeer says: Focus on Growth not Inflation!
Goldenbar's Bugos replies: Only if he will Focus on Inflation not Growth!!!

The yen dipped overnight against the U.S. dollar to its lowest since October 1998 after comments from Japan's Economics and Fiscal Policy Minister Taro Aso that the idea of allowing the yen to weaken had been discussed with the U.S. - from Reuters March 30th.

There is no manipulation… say it again… there is no manipulation! If we say it enough, maybe it will even work, the actual manipulation that is. Sorry, I couldn't resist. What does it mean that the idea of allowing the Yen to weaken had been discussed? Ok, to put it another way, substitute the word "Yen" with "the Nikkei" above, and it sounds like this:

The Nikkei dipped overnight to its lowest level since October 1998 after comments from Japan's Economics and Fiscal Policy Minister Taro Aso that the idea of allowing the stock market to weaken had been discussed with the U.S. - fictitious wordplay

Bloody well right it's manipulation! And it is nothing new to us. In fact, allowing the Yen to weaken really means "submitted to the political pressure by helping it weaken," which is precisely what happened when the Bank of Japan slashed interest rates back to zero last month. Of course, since the justification is to prop up the economy, there must be no evil. But there is a reason that this pressure exists in the first place, and it has to do with a global monetary order, which has evolved out of chaos.

The New Order
It has grown out of the necessity to create a world of efficient commerce, but its aim is always to stabilize the nearly century old Fiat paper money experiment. Entire privately financed infrastructures have been erected to exploit the inefficiencies one would expect to find in this kind of monetary system. Indeed, stability (currency or otherwise) is the prime directive of many a monetary policy AND it often appears that even the vast array of trading programs tend to (or perhaps should) collectively move the markets toward stability anyhow. But the volatility continues to grow.

Consequently, critics of capitalism accuse free markets of inherent instability, yet it is not capitalism that is the problem. If you think long enough, you might conclude that a multi trillion-dollar derivatives industry exists, for instance, only to hedge the risks that necessarily must rise if the aim is to stabilize the otherwise unsupportable paper markets at higher and higher levels. For it involves risk-taking to move the markets to higher levels in the first place. But why must a Fiat system expand to survive? Because the system, by the book called an inflationist system, is of use to no one if it cannot continue to grow, or inflate, because that is the very reason it exists in the first place.

So inflation is not the Federal Reserve System's number one enemy. It is their agenda to inflate, but to do it gradually so that it can be controlled, and remain unseen. On the contrary, inflation is your number one enemy, gradual or otherwise, and they have been allowed to do it right under our noses for so long now that it has become impossible to tell the difference between a real price and a nominal price. Historians of money note that our perception of purchasing power must rely on its recent past performance (of the unit), if you will. But today there is additional influence on our varied perceptions of purchasing power. The freely floating exchange rate system, which is really a negotiated (as opposed to free market) exchange rate between other allied nations who subsist under this new monetary order, is a constant source of price distortion. How many industries have grown out of the necessity to stabilize and exploit volatile exchange rates? Or perhaps it should be asked this way: how much business does the average multinational company do trading derivatives in order to balance its books these days? Is it all really necessary? Of course it is, if you want to stabilize an enormous international paper money system.

Anyhow, the Chaos happened long ago. Historians rightfully argue its precise origins, but for the sake of simplicity let's just say that the chaos we refer to here succeeded the Nixon dollar gold break, officially in 1973, and was largely monetary. It was not a good time to be a banker because the dollars that were lent quickly became worth less. Essentially, what Nixon had done was to throw away the anchor, and what the banking community had to do, if it was to survive, was to stabilize the mess, which they were able to do with international currency arrangements and by raising their interest rates into the high teens. This forced some deflation into the "inflationist" US economy in 1981, and thus replaced the anchor, symbolically at least, if only temporarily. Hence, the father of today's reborn Federal Reserve, the head of the global monetary order, must therefore have been Paul Volcker, then Chairman of the Federal Reserve Board.

Our central bankers must have gradually learned that when Americans fear that deflation can be bestowed upon them, this symbolic anchor, as effective as Smith's Invisible Hand, worked for enacting policy. For deflation expectations produce demand for hard currency, and thus help buoy the value of the currency that "appears" the hardest. There are certainly several economic laws that will help you determine which currency that is, but the nation with the most widely circulated currency, and the most net debt, ain't gonna be it by default. However, should the foreign exchange rate of the dollar rise, for many of the unrelated reasons that we will touch on this week, investors will find it expedient to conclude a deflationary outcome. Indeed, that is what has been happening. And accordingly, deflation expectations have been on the rise.

Inflation expectations, on the other hand, will typically produce a surplus of currency if confidence in it breaks down, which, if taken to the extreme, can produce the inflation breakdown Mises refers to as the "crack-up boom." Normally, bankers, being creditors, would prefer deflation to inflation for want of protecting the value of that particular currency, which they have lent in large sums and over long periods of time. But today, bankers are stock/equity holders also, and some are even likely to turn up net debtors. So, today, they are after the best of both worlds. And there is a way that they might have both too.

What if they could incite a fear of deflation without having to cause deflation, which incidentally is not just declining prices, but that part of the price decline attributable to a contracting stock of money? When money supply expands, and prices decline, that is not deflation. That is more profit for bankers. There is plenty of cash in the system. The question is first, what is its quality, and second, who owns it?

One of our subscribers emailed us a question this weekend. It was a challenging question, and I think one that is on all of our minds these days:

Dear Mr. Bugos,
While the Treasury yield-curve is getting steeper, the so-called real yields on the inflation indexed securities, and their prices, have not moved much. If inflation expectations were built into the yield curve, one would expect some movement in the indexed bonds. What am I missing? No other than the great investor Sir John Templeton recently urged investors to exit the share markets in favor of long-dated non-callable bonds... a remarkable statement from a very successful investor and someone who has seen both deflation and inflation. I am not one to dismiss his remarks lightly... signed Goldenbar subscriber.

Mr. Templeton isn't the only one. There is a long list of prominent money managers, who fall clearly in the deflation as the most likely successor to the recent excess (in the US) camp. But we believe that they are wrong and that the deflation fallacy is the path of least resistance, for them, at the moment. It is perhaps hard for a conservative investor to expect that excess will breed further excess until there is something to prevent it. Yet that is the nature of things today, and there seems to be nothing to prevent the Fed from cheapening the price of money at its own discretionary whims, until now. As Wall Street buzzes about rumors of another inter meeting rate cut, sending short term yields to new lows, the long bond is beginning to roll over, forcing a steeper yield curve. The event is so near I can smell it. A crashing long bond will change everything. It might even ignite the gold market.

Learn why in this month's issue (to subscribers). For more information about subscribing to The Goldenbar Report, go to www.goldenbar.com

Up for discussion this week:

  • The dollar price of Gold toys with 20 year lows, but analysts are no longer asking the question "which way is it going to go now?" So since most have already decided that its next stop is $180, it might be worthwhile to observe that it has been gaining on everything but the dollar, and bond, since year end.
  • If the inflation of the money stock, gradual or otherwise, is supposed to manifest in rising prices everywhere, why is the CRB down? Why is the US Treasury's inflation indexed bond trading at a discount to current inflation rates and relative to the 30 year long bond? Why are the biggest, best paid, and most influential analysts telling us to fear deflation rather than inflation?
  • The Strong dollar policy increasingly threatens the survival of the global monetary order, over which it currently presides, with sheer arrogance.
  • What will drive currencies in the future? Rate of return or risk aversion? 10 years ago, had you approached someone - anyone - and said that you think the dollar will rise because the Fed will lower interest rates, they would have given you some spare change for the next bus to Oz.


Edmond J. Bugos

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